California Supreme Court Holds Lenders Owe No Duty of Care in Loan Modification Negotiations
After years of division in California as to whether banks or loan servicers owe their borrowers a duty of care when considering requests for loan modifications, the California Supreme Court finally settled the issue on March 7, 2022 in Sheen v. Wells Fargo Bank, No. S258019 (Cal. Mar. 7, 2022) (“Sheen v. Wells Fargo”). As set forth in the facts of that case, a borrower took out a second and third mortgage with a Wells Fargo and, subsequently missed scheduled payments on both loans. Wells Fargo initiated foreclosure proceedings and scheduled a foreclosure sale of the property by a trustee in February of 2010. One month prior to the sale, the borrower’s representative contacted Wells Fargo and applied for a loan modification, in hopes of avoiding the foreclosure.
The foreclosure sale was canceled, but the modification was not extended. Instead, in March of 2010, Wells Fargo sent the borrower letters informing him that the loan had been “charged off” and the full amount of both loans were due—the loans did not specifically mention foreclosure. According to the borrower’s allegations in the case, the letters led him to believe that the loans had been modified to be unsecured loans, which he believed would prevent any foreclosure proceedings, because he had not received written determination on the modification.
After sending the letter to the borrower, Wells Fargo sold the plaintiff’s debt to a third-party creditor and the new creditor foreclosed on the borrower’s home four years later. As a result of this foreclosure, the borrower sued Wells Fargo claiming that the bank had breached its "duty of care to process, review and respond carefully and completely to the loan modification applications [the borrower] submitted,” which forced him to “forgo alternatives to foreclosure.” The borrower sought monetary damages relating to the foreclosure, including “the value of the home, the hotel and storage costs plaintiff incurred when he vacated the property, and the damage to his credit rating.”
Wells Fargo objected to the borrower's claim as invalid, arguing that the borrower's allegations were insufficient to support the borrower's claim, and the lower court agreed. The Court of Appeals affirmed the lower court's decision but noted that there remained an issue as to whether or not a lending bank owed a borrower a duty relating to general negligence principals and the extent of losses that can be assessed if such a duty is owed and breached—an issue that has divided California courts for years.
The California Supreme Court issued a ruling providing no such duty exists.
At the outset of its analysis, the Court clarifies that even if the borrower was permitted to bring a claim in tort, according to the tort principal called the “economic loss rule,”[1] a lender should not be liable in tort for a borrower’s “purely economic losses.”
The Court further disposes of the tort claim by holding that imposing tort obligations on the lending bank when the parties had contractual obligations to one another via the loan documents would permit the use of tort law to “work around” the intact contractual rights and obligations belonging to each party. As such, the Court determined that the only proper remedy for the sought borrower’s relief was through the provisions of the contract between the parties.
In assessing this avenue of relief, the Court found that the plaintiff had no basis for their claim under the parties’ contractual rights and obligations, as there was no agreement between the parties that “should [the borrower] default and attempt to renegotiate his loan by submitting a modification application, Wells Fargo would "process, review and respond carefully and completely to the . . . applications [the borrower] submitted."
Finally, the Court posed that it was the role of the legislature, not the court, to impose regulatory rights and obligations with regard to loan modification negotiations and to “prescribe whether a lender must act ‘reasonably’ and (in some detail, if it chooses) what constitutes "reasonable" behavior within this sphere.”
[1] See Sheen v. Wells Fargo, page 13–16 (explaining the economic loss rule to mean: “there is no recovery in tort for negligently inflicted ‘purely economic losses,’ meaning financial harm unaccompanied by physical or property damage[]”).