The California Court of Appeal, Fourth District, recently ruled that a GSE forbearance agreement provided incident to a HAMP loan modification application imposed a duty on a loan servicer to act in good faith to evaluate the borrower for a loan modification or other foreclosure alternatives, and therefore that the borrower should be granted leave to amend his complaint to allege causes of action for negligence, fraud/misrepresentation, breach of contract, and unfair business practices in violation of the California Business and Professions Code.
In so ruling, the Court concluded in part that, although there was no requirement in the forbearance agreement to offer or approve a loan modification, the good faith duty required the servicer to evaluate options to foreclosure, and that the servicer improperly foreclosed after informing the borrower that no foreclosure would occur while he was being considered for a loan modification or other non-foreclosure options.
A copy of the opinion is available at: http://www.courts.ca.gov/opinions/documents/G046799.PDF.
Plaintiff borrower ("Borrower") obtained a home mortgage refinancing loan that was secured by a trust deed against Borrower's property. About two years after the refinancing, Borrower requested a loan modification under the Home Affordable Modification Program ("HAMP"). Instead of a loan modification, defendant loan servicer ("Servicer") and Borrower entered into a forbearance agreement whereby Borrower would make reduced mortgage payments for a period of up to six months. The forbearance agreement, part of a broader program instituted by a federal government-sponsored enterprise ("GSE"), expressly stated that Servicer would suspend any scheduled foreclosure sale as long as Borrower continued to meet his payment obligation under the forbearance agreement.
The forbearance agreement further provided among other things that at the end of the forbearance period, Borrower would have to either resume regularly scheduled loan payments or reinstate his loan in full, that Servicer would offer to modify the loan or, if no foreclosure alternative could be identified, Servicer could foreclose in accordance with the original loan agreement.
As guidance to loan servicers, the GSE issued an announcement (the "Announcement") stating in part that loan servicers (1) "should offer" the forbearance program if borrowers have a willingness and ability to make the reduced monthly payments, (2) "should work" with borrowers during the six-month period of forbearance to identify the feasibility of, and implement, a more permanent foreclosure prevention alternative, (3) "should evaluate and identify" a permanent solution during the first three months of the forbearance period, and (4) "should implement" the alternative by the end of the sixth month.
Borrower made the requisite payments under the forbearance agreement, but Servicer allegedly did not work with Borrower to evaluate him for a more permanent solution. Meanwhile, however, Borrower submitted the information and documentation needed to apply for a HAMP loan modification. Nevertheless, while waiting for Servicer's determination, he received a notice of default and, several months later, received a notice of trustee's sale.
Servicer eventually orally offered Borrower a HAMP loan modification, which he allegedly accepted, but also sent Borrower inconsistent communications stating that he was not eligible for HAMP but was being considered for other foreclosure alternatives, that his home would not be sold during the review period, and that he was being considered for a HAMP modification. After being informed that the communications had been sent in error, Borrower followed up with Servicer, GSE, and the California Attorney General's Office, to find out whether a foreclosure sale would occur and whether he was eligible for a loan modification. The foreclosure sale nevertheless took place about three months after the date of the notice of trustee's sale.
Borrower filed suit, alleging negligence, breach of contract, fraud/misrepresentation, violation of California Code section 2923.5 for improper foreclosure procedures, and violation of California's unfair competition law ("UCL"). The complaint also sought to quiet title. Servicer and GSE demurred. The lower court sustained the demurrer without leave to amend and dismissed with prejudice. Borrower appealed.
The Court of Appeal affirmed in part and reversed in part.
In reviewing Borrower's negligence claim that Servicer breached a duty of care in mishandling his application for a loan modification, refusing to offer him a loan modification, and foreclosing his property, the Appellate Court noted that lenders generally do not owe a duty of care to borrowers. However, the Court examined six factors that may affect a court's determination as to whether a lender owes such a duty to a borrower. Those factors are: (1) the extent to which the transaction was intended to affect the plaintiff; (2) the foreseeability of harm to the plaintiff; (3) the degree of certainty that the plaintiff suffered injury; (4) the closeness of the connection between the defendant's conduct and the injury suffered; (5) the moral blame attached to the defendant's conduct; and (6) the policy of preventing future harm. See Biakanja v. Irving, 49 Cal.2d 647 (1958); Nymark v. Heart Fed. Sav. & Loan Assn., 231 Cal.App.3d 1089, 1098 (1991).
Noting that other state and federal courts have concluded that a lender might owe a duty of care to a borrower under certain circumstances, the California Appellate Court ultimately concluded that a loan modification is the renegotiation of a loan and that the six factors listed did not support the imposition of a common law duty to offer or approve a loan modification.
According to the Court, a lender's obligation to offer, consider, or approve a loan modification and to explore foreclosure alternatives were created by the loan documents, controlling law, and any directives and announcements from governmental or quasi-governmental entities, such as the GSE here. As the Court explained, if Borrower's inability to repay his loan created the need for a loan modification, the harm suffered from denial of the loan modification would not be closely connected to the lender's conduct.
The Court further concluded that Borrower failed to state a negligence claim because he had failed to allege that Servicer did anything improper that made him unable to make the original monthly payments. Notably, Borrower did not allege that Servicer caused his initial default by negligently servicing the loan, but rather alleged that Servicer owed him duties to "follow through on their own agreements," which, the Court pointed out, were contract-based allegations. Nevertheless, noting that there was a "reasonable possibility" that Borrower could amend his complaint to state a cause of action for negligent misrepresentation, the Court of Appeal reversed and remanded to allow Borrower the opportunity to amend his complaint to state such negligent misrepresentation claim.
Turning to the breach of contract claim, the Appellate Court first rejected Borrower's argument that Servicer had an ongoing obligation to suspend the foreclosure because the deferral period had not ended. The Court then went on to examine whether Servicer had an obligation under the forbearance agreement in light of the Announcement's guidelines. Concluding that the duty to act in good faith in working with a borrower was imposed "expressly" in the forbearance agreement through the Announcement, the Court focused on the term "should" used repeatedly in the Announcement.
In so doing, the Court rejected Servicer's assertion that "should" was entirely permissive and imposed no obligations on loan servicers. The Court stated, "[t]he sense of moral obligation, strong recommendation, preference, or propriety imparted by the word 'should' equates with good faith; that is, although [Servicer] had no contractual duty to offer [Borrower] a loan modification or an alternative to foreclosure, it had a contractual duty to work with him to identify the feasibility of . . . [foreclosure alternatives] and to do so in good faith."
The Appellate Court thus ruled in part that Borrower should be granted leave to amend to state a claim for breach of contract in light of its interpretation of the forbearance agreement and the Announcement, noting that although the forbearance agreement did not impose an obligation on Servicer to offer Borrower a loan modification or an alternative to foreclosure, Servicer's discretion to work with Borrower should be exercised in good faith.
As to the alleged violation of California Code Section 2923.5's requirement to contact Borrower to assess his financial situation prior to filing a notice of default, the Court noted that the only remedy under that section is a one-time postponement of the sale. Because Borrower never sought postponement of the sale, the Court reasoned that Borrower could not state a cause of action under Section 2923.5 and accordingly affirmed the lower court's dismissal of that claim.
Next, the Appellate Court turned to Servicer's assertion that Borrower lacked standing to assert a UCL claim under California's Business and Professions Code Section 17204. The Court observed that the allegation that Borrower's home was sold at the foreclosure sale satisfied the economic injury requirement for standing but that Borrower's complaint did not satisfy the "causation" element. See Kwikset Corp. v. Superior Court, 51 Cal.4th 310, 322 (2011)(holding that standing requires a plaintiff to show both injury in fact and that such injury was caused by the defendant's unfair business practice).
With regard to the sufficiency of Borrower's UCL allegations, the Court again reasoned that, although the forbearance agreement did not require Servicer to offer Borrower a loan modification, the agreement did impose a duty to act in good faith to evaluate and try to identify a permanent foreclosure alternative. Thus, the Court concluded that Borrower should be granted leave to amend as to the causation element and Servicer's misrepresentations that it would not proceed with the foreclosure sale.
With respect to the fraud/misrepresentation claim, the Appellate Court allowed Borrower to amend to show detrimental reliance on Servicer's misrepresentations as to the suspension of the foreclosure sale, noting that he already had the obligation to make loan payments and that assembling the materials needed for a loan modification constituted merely nominal damages.
Finally, the Court rejected Borrower's assertion that tender of the full payment of the loan was not necessary in order to maintain a quiet title action, thus affirming the lower court's ruling on that cause of action. With respect to the other causes of action, however, the Court of Appeal reversed and remanded with instructions to grant leave to amend.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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