On March 7, 2022, the California Supreme Court finally settled the issue on whether financial institutions or loan servicers owe their borrowers a duty of care when considering a loan modification request. In Sheen v. Wells Fargo, No. 8258019 (Cal, Mar 7, 2022), the California Supreme Court ruled that financial institutions do not owe a duty of care for loan modifications. The ruling should settle years of division among California appellate courts on the issue and relieve lenders from a duty to review and process loan modifications.
In Sheen, the borrower took a second and third mortgage with the lender and eventually defaulted on the loans. In response, the lender initiated foreclosure proceedings. However, a month prior to the scheduled foreclosure, the borrower applied for a loan modification. The lender canceled the scheduled foreclosure and sent a letter informing the borrower that both loans were charged off and were fully due. The borrower claimed that due to failure to receive a written notification of the loan modification decision, he was protected from foreclosure proceedings. The debt was eventually sold to a third-party creditor who foreclosed on the property. Subsequently, the borrower filed a lawsuit against the lender claiming that there was a breach of duty of care to review the borrower for a loan modification. The lender opposed the allegations. The lower court and the appellate court agreed with the lender and ruled in its favor. Borrower appealed the decision to the California Supreme Court which took the case to determine the issue of whether financial institutions have a duty of care to review the borrower’s request for loan modification. The Court, in a unanimous decision, ruled that there was no such duty.
The California Supreme Court considered statutory law and common law and determined that there was no such obligation under either one. The court considered the “Economic Loss Rule.” The Court ruled that even if the borrower had standing to bring a tort cause of action, the lender cannot be held liable for purely economic losses. The Court reasoned that the parties had a contractual relationship, and the use of tort law would grant a work around the contractual obligations of the parties involved. The Court further indicated that there was no contractual obligation imposed on the lender to review the borrower’s request for a loan modification.
The Court also explicitly noted that it was the role of the legislature to impose loan modification obligation and rejected the borrower’s policy argument that the bargaining power in loan modification are lopsided in favor of the lender. The Court acknowledged that this was the case and reasoned that it was the Legislature’s role to remedy the competing costs and benefits. This decision is great news for lenders with a footprint in the California market as the California court decision relieves lenders from the affirmative duty of care to review loan modification requests. This decision is consistent with most rulings in other jurisdictions in the United States. Please be advised that this decision does not change or modify the statutory requirements under the California Homeowners Bill of Rights.
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