A loan by a bank that was well intended when made experiences payment defaults. Our story often begins here! The borrower (Sheen) understandably requests the loan be modified, a classic strategy in any workout situation. And now the homework assignment: is the lender (Wells Fargo) negligent if it fails to process, review and respond carefully and completely to the loan modification request the borrower submits? This was the situation and the question in the Supreme Court Case Sheen v. Wells Fargo Bank, National Association et al., 12 Cal. 5th 905 (March 22, 2022).
The Lender Has No Duty of Care to the Borrower to Process, Review and Respond Carefully and Completely to Borrower’s Loan Modification Application
The California Supreme Court earlier in 2022 responded to this question by holding that a lender has no separate duty to a borrower to review or act on a loan modification request. The relationship between the borrower and lender, said the court, is based on the contract between them, and if the terms of the loan documents or agreement of the parties do not provide that the lender will act on a loan modification request, the law imposes no separate tort obligation on a lender to do so.
The Sheen case arose out of a real estate loan and foreclosure situation, but the holding was not limited to this type of loan. The decision by the California Supreme Court resolved inconsistent rulings by lower courts on this issue.
A major factor given by the court was its view that the longstanding economic loss rule in California should guide the parties here; that is, when an aggrieved party suffers economic damages arising out of a contract, contract principles and not tort remedies should be applied. Accordingly, Sheen’s claim of negligence – a tort claim – based on the lender’s failure to process, review and respond carefully and completely to the loan modification request would not be allowed. This is helpful to lenders as it eliminates several potentially expensive remedies otherwise available to borrowers who prevail on tort claims.
Lender Beware: the Borrower May Still Make Tort Claims Such as Negligent Misrepresentation
While the Sheen case clears up the question about a lender’s general duty of care to a borrower, it also provides a cautionary note that should be heeded by lending officers. The court observed that in some situations the lender could make statements or representations to the borrower that lead the borrower to expect no foreclosure will occur (in actuality, the defaulted loan in Sheen was eventually foreclosed upon), but such claims of negligent misrepresentation were not part of the case appeal. The court also discussed the possibility that an aggrieved borrower could assert promissory estoppel claims to obtain relief against lender malfeasance when the lender has led the borrower to change its position or fail to protect itself in reliance on the lender’s statements that it will or will not do certain things. Again, the court noted that such claims were not part of the Sheen appeal. (The court was offering hypothetical approaches in response to the borrower’s assertion that it had no other remedies available, but was not saying the facts of Sheen necessarily supported these theories.)
Where does this leave lenders and borrowers? The grounds for stating successful negligence claims against lenders have been clarified and narrowed but lending officers must still be very cautious not to inadvertently or otherwise mislead borrowers about loan requirements. If the lender misleads a borrower or says it will (or will not) take some action if a borrower does certain things, the lender may still be held liable under tort claims if it does not follow through!
This blog is written as of June, 2022. Recommendations and legal requirements are changing rapidly, so please continue to review our legal updates or review postings on relevant government websites.
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