State high court sides with lenders in loan modification process

In a landmark decision sure to have a significant impact on the real estate banking industry, the California Supreme Court declared that lenders/loan servicers do not owe borrowers a duty of care in the loan modification process. In Sheen v. Wells Fargo Bank, N.A., 2022 DJDAR 2345 (March 7, 2022), the court unequivocally put to bed an issue that has divided California's appellate courts and trial courts alike. In holding that there is no duty of care in handling modifications, the court effectively extinguished a borrower's claim against lender or loan servicer for negligence claims in processing a loan modification.

In the underlying case, plaintiff Sheen obtained a second and third mortgage loan from Wells Fargo, the lender and loan servicer. After Sheen missed payments, Wells Fargo commenced foreclosure proceedings and scheduled a trustee's sale. Prior to the sale date, Sheen applied for a loan modification but Wells Fargo did not directly respond to that request. Based on several letters Wells Fargo later sent to him advising him that the loans had been charged off and the balances accelerated, Sheen alleged that he believed his loans had been modified to become unsecured and could not be foreclosed on. In 2014, Sheen's property was foreclosed on and sold at a trustee's sale.

Sheen subsequently sued Wells Fargo and others alleging causes of action for, inter alia, negligence and sought monetary damages for "the loss of his house ... , the hotel and storage costs plaintiff incurred when he had to vacate the property, and the damage to his credit rating." Wells Fargo demurred to Sheen's negligence claim and argued Wells Fargo owed no duty to Sheen. The trial court agreed with Wells Fargo's position.

The 2nd District of the Court of Appeal affirmed the trial court's judgment, relying in large part on the economic loss doctrine, which bars a party from recovering in tort for purely "economic losses" that arise from contract-based issues. Sheen v. Wells Fargo, 38 Cal. App. 5th 346, 353-58 (2019). The 2nd District's ruling was in direct contrast to the opinion in Alvarez v. BAC Home Loans Servicing, L.P., 228 Cal. App. 4th 941 (2014). Recognizing the split in appellate authority on this issue, the 2nd District invited the Supreme Court to resolve the divide.

The California Supreme Court analyzed the economic loss doctrine and narrowed in on the unavailability of a tort remedy for parties in contractual privity. Under the economic loss doctrine, a party to a contract is barred from recovering in tort a monetary loss separate from injury to a person or property, such as those sought by Sheen. In other words, "there is no recovery in tort for negligently inflicted 'purely economic losses,' meaning financial harm unaccompanied by physical or property damage" absent a breach of a duty arising independent of the contract between the parties or from intentional conduct intended to harm.

The court held that Sheen's negligence claim directly arose out of the mortgage loan documents and improperly attempted to assert a duty on Wells Fargo that was contrary to Wells Fargo's contractually agreed upon right to foreclose in the event of nonpayment by Sheen. The court also found that the oft-cited principle in Nymark v. Heart Fed. Savings & Loan Assn., 231 Cal. App. 3d 1089 (1991), that a lender does not owe a duty of care to a borrower as long as it does not exceed the conventional role as a lender of money, complemented its analysis of the economic loss doctrine and provided another basis to decline finding the duty urged by Sheen since a "lender's involvement in the loan modification process ... is part and parcel of its assessment regarding how best to recoup the money it is owed."

Finally, the court rejected Sheen's argument that the factors in Biakanja v. Irving, 49 Cal. 2d 647 (1958), compelled the trial court to find a duty of care and found that Biakanja was inapplicable to the facts at hand given that its factors are "employed to ascertain whether a court should recognize a duty, but are useful and appropriate for that purpose only in situations involving parties that are not in privity with one another."

While the plaintiff's bar will undoubtedly continue to bring lawsuits against lenders and servicers in connection with loan modification reviews under statutorily prescribed rights, such as those in the Homeowner's Bill of Rights, or other reliance-based claims, such as fraud or promissory estoppel, the California Supreme Court's decision is being lauded by the lending industry because it limits potential monetary exposure for clerical issues or underwriting claims when the parties renegotiate the loan terms. 