Friday, February 15, 2013

FYI: Cal App Ct Reverses Ruling In Favor of Lender on Construction Loan, Citing California Homeowner Bill of Rights

The California Court of Appeal, First District, recently ruled in part that triable issues of material fact existed as to whether: (1) a successor bank assumed a failed bank's liability for claims related to a construction loan under a "purchase and assumption" agreement; (2) the failed bank and the successor bank owed borrower a duty of care partly in light of policy considerations set forth in the recent "California Homeowner Bill of Rights" and other legislation governing loan servicing; and (3) the borrower stated claims for "fraudulent" or "unfair" practices under California's unfair competition law.


The Court also ruled that the lower court improperly took judicial notice of the purchase and assumption agreement, where the content and legal effect of the agreement itself were in dispute.


A copy of the opinion is available at:


Plaintiff-borrower ("Borrower") obtained a construction loan from a bank ("Failed Bank") that eventually became insolvent and went into receivership under the Federal Deposit Insurance Corporation ("FDIC").  Over the course of construction, Borrower allegedly sought but was unable to obtain reimbursement of pre-paid construction costs or disbursements of up-front funds pursuant to the loan agreement.  Such alleged funding problems supposedly caused Borrower to incur delays in construction and substantial additional expenses.    Borrower eventually obtained a loan modification from Failed Bank that increased the principal amount of the loan by over $2 million and which supposedly provided that Failed Bank would supply any additional funds Borrower needed to complete the construction project.


Almost two years following the loan modification, Failed Bank was placed into receivership.  As its receiver, the FDIC executed a so-called "purchase and assumption" agreement (the "P&A") with another financial institution ("Assuming Bank") allowing Assuming Bank to acquire certain of Failed Bank's assets, including all loans and loan commitments.  The P&A also provided in part that Assuming Bank would "assume no liabilities associated with borrower claims arising out of [Failed Bank's] lending activities," and also that "Assuming Bank specifically assumes all mortgage servicing rights and obligations of Failed Bank." 


Several months after Assuming Bank's acquisition of Failed Bank's assets, Borrower, who had not yet completed construction, defaulted on his loan.   Nevertheless, Borrower tried to secure a loan modification from Assuming Bank in order to complete construction.  Borrower also sought enforcement of a so-called "rollover" provision whereby the loan would convert to an amortizing loan.  Assuming Bank allegedly declined to honor the rollover provision because Borrower defaulted and construction had not been completed.  Accordingly, Assuming Bank demanded payment in full and initiated foreclosure proceedings against Borrower's property. 


Shortly thereafter, however, an employee of Assuming Bank allegedly kept Borrower's hopes for a loan modification alive by supposedly repeatedly assuring Borrower that Assuming Bank would not pursue the foreclosure as long as there was still the potential for a loan modification.  Despite these alleged assurances from the employee, Assuming Bank went ahead with the planned foreclosure.


Two days before the scheduled foreclosure sale of the collateral, Borrower, asserting in part that Assuming Bank had "stepped into the shoes" of Failed Bank, filed a lawsuit against Assuming Bank and others, alleging various causes of action, including fraud, breach of contract, negligence, violation of California's unfair competition law.  Borrower also sought declaratory relief, accounting, and contract reformation.


Assuming Bank moved in part for summary judgment, claiming that it was not liable for Failed Bank's conduct prior to failure and that, moreover, the P&A specifically provided that Assuming Bank had acquired only the assets of Failed Bank and not its liabilities.  Along with its motion, Assuming Bank requested that the lower court take judicial notice of the P&A it submitted to the court.


In response, Borrower argued that Assuming Bank failed to provide the complete P&A agreement.  Borrower included a declaration from an expert stating that the actual full-length P&A was never made public, and that the complete P&A contained additional provisions related to Assuming Bank's assumption of Failed Bank's liabilities that could affect the outcome of this case.  In addition, Borrower unsuccessfully sought the full-length P&A from the FDIC, which was allegedly willing to produce it provided all parties to the litigation signed a confidentiality agreement.  Assuming Bank allegedly did not agree to do so.


Following Borrower's unsuccessful attempts at procuring a copy of the full-length version of the P&A and at keeping discovery open, the lower court, taking judicial notice of the P&A documentation Assuming Bank submitted, granted summary judgment in favor of Assuming Bank.  The lower court reasoned in part that Assuming Bank never assumed liability for claims related to Failed Bank's lending activities.  The lower court also concluded that, because the assurances from Assuming Bank's employee were mere "opinions," rather than statements of fact, Assuming Bank never agreed to a modification of Borrower's loan.  The lower court also ruled in part that according to the typical lender-borrower relationship, Assuming Bank owed Borrower no duty of care that would support a negligence claim.  


The Court of Appeal affirmed in part and reversed in part, ruling that there were triable issues of material fact as to the causes of action for misrepresentation, breach of contract/promissory estoppel, negligence, unfair or fraudulent business practices, and reformation.  However, the Appellate Court affirmed the lower court's rulings as to Borrower's requests for declaratory relief and an accounting.


First addressing the lower court's taking judicial notice of the P&A and noting that the full-length P&A was available had the parties signed a confidentiality agreement, the Appellate Court ruled that it was error to use judicial notice as a vehicle for determining the content and legal effect of the P&A.  In so ruling, the Court noted that Assuming Bank's request for judicial notice specifically related to the P&A provision according to which Assuming Bank acquired "certain assets of [Failed Bank], including all loan and loan commitments of [Failed Bank]" but that the lower court used the P&A more broadly to prove that Assuming Bank did not in fact assume liability for Failed Bank's alleged improper acts or omissions with respect to Borrower's loan.   See Cal. Code Civ. Proc. § 437c, subd. (b)((1)(use of judicial notice on a motion for summary judgment); Cal. Evidence Code §§450-460 (referring to permissive judicial notice of court records and official acts). 


Turning specifically to the lower court's rulings on Borrower's various causes of action, the Appellate Court noted among other things that triable issues of fact existed as to whether: (1) the P&A submitted by Assuming Bank represented the full extent of its liabilities; (2) representations by Assuming Bank's employee regarding a possible loan modification were actionable; (3)  Assuming Bank had an obligation to continue disbursing funds; (4) Assuming Bank owed a duty of care to Borrower to support a negligence cause of action; and (5) Assuming Bank was liable for alleged "fraudulent" or "unfair" conduct in violation of California's unfair completion law, Cal. Bus. & Prof. Code § 17200 et seq.


In its analysis of Borrower's negligence claim and in particular on the issue whether Assuming Bank owed Borrower any duty of care, the Appellate Court primarily focused on the practice of "dual tracking" a loan in danger of default and on the lender-borrower relationship created by a construction loan. See Connor v. Great Western Sav. & Loan Assoc., 69 Cal.2d 850, 856-58 (1968)(as an "active participant  in a home construction enterprise," lender owed duty of ordinary car to homebuyers); Biakanja v. Irving, 49 Cal.2d 647,  650 (1958)(identifying six non-exhaustive factors for determining whether lender owed duty to borrower:  (1) extent to which transaction was intended to affect plaintiff; (2) foreseeability of harm to the plaintiff; (3) degree of certainty that plaintiff suffered injury; (4) connection between defendants' conduct and injury suffered; (5) moral blame attached to defendant's conduct; and (6) risk of future harm).


In so doing, the Court rejected Assuming Bank's assertion that it owed Borrower no duty of care in this case, referencing evidence of an ongoing dispute between the parties as to their respective rights and obligations.  See Newson v. Countrywide Home Loans, Inc. (N.D.Cal. Nov. 30, 2010, 2010 No. C 09-5288) 2010 U.S. Dist. Lexis 126383, at 15; Ottolini v. Bank of America (N.D. Cal. Aug. 19, 2011 No. C-11-0477) 2011 U.S. Dist. Lexis 92900 at 16). 


Moreover, citing state and federal government efforts to encourage loan modifications, the Court referred to the recently enacted "California Homeowner Bill of Rights" legislation aimed at requiring lenders and loan servicers to deal "reasonably" with borrowers in default by eventually prohibiting the practice of dual-tracking.   While noting that the legislative provisions did not apply to this case, the Court concluded that the policy considerations set forth in the legislation bore on the determination as to whether Assuming Bank owed Borrower a duty of care and that summary adjudication of the negligence cause of action was thus reversible error.  See, e.g., Ansanelli v. JP Morgan Chase Bank, N.A. (N.D. Cal. Mar. 28, 2011 No. C. 10-03892) 2011 U.S. Dist. Lexis 32350, p. *21 (finding that duty of care had been properly pleaded in negligence action after bank reneged on promise to modify loan and reported loan as past due even though borrowers had made all payments under their trial modification plan); Robinson v. Bank of America, (N.D. Cal. May 29, 2012 No. 12-CV-00494-RMW) 2012 U.S. Dist. Lexis 74212, p. *21.


With respect to Borrower's claim that Assuming Bank violated California's unfair competition law due to its employee's statements as to the possibility of a loan modification, the Court held that triable issues existed as to what constituted "fraudulent" or "unfair" practices in light of the recent legislative changes, among other things.  


The Court also reasoned that, given Borrower's allegations of fraud or mutual mistake as to the issue of reimbursement of pre-paid construction costs and their impact on the terms of the original loan agreement, triable issues of fact similarly existed so as to render summary adjudication of the reformation cause of action improper. 


Finally, the Appellate Court affirmed the lower court's rulings denying declaratory relief and an accounting, concluding that: (1) because Borrower had a fully matured cause of action for money damages, declaratory relief was not proper; and (2) there was no fiduciary or other "special relationship" that would give rise to an accounting remedy, nor were the accounts so complicated that an ordinary legal action demanding damages would be impracticable. 




Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
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Chicago, Illinois 60602
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