Thursday, August 28, 2014

FYI: Cal App Ct Holds Mortgage Loan Investor May Have "Aider and Abettor" Liability For Lender Misconduct, Servicer Has Duty Not to Mishandle Loan Mod Apps

The California Court of Appeal, First District, recently held that a mortgage loan investor may be liable for the fraudulent omission by the originating lender under an aider and abettor theory.  Additionally, the Appellate Court held that a servicer which undertakes review of a loan modification has a duty not to mishandle the application or make material misrepresentation about the status of the loan modification. 

A copy of the opinion is available at: http://www.courts.ca.gov/opinions/documents/A138443.PDF

In October 2005 and January 2006, the borrowers (“Borrowers”) refinanced their homes by obtaining loans with negative amortization and prepayment penalties.  The loans were subsequently sold, and the Borrowers sued the mortgage loan investor’s successor (“Investor”) for fraud and violations of the Unfair Competition Law (“UCL”) (Bus. & Prof. Code, § 17200 et seq.), alleging that they were induced to obtain loans by misrepresentations and concealment of material facts.  The Borrowers also alleged that the loan servicer (“Servicer”) failed to exercise reasonable care in processing their applications for loan modifications.

On appeal, the First District began by analyzing whether the loan documents concealed the terms of the Borrowers’ loans.  The Borrowers’ complaint alleged that the loans were designed to cause negative amortization, and the monthly payment amounts listed in the loan documents for the first two to five years were based entirely upon a low “teaser” interest rate which existed for only a single month, and which was substantially lower than the actual interest rate that would be charged.  The Borrowers alleged that payments following the contractual payment schedule in the loan documents inevitably caused negative amortization, allegedly resulting in significant loss of equity and supposedly making it much more difficult to refinance the loan when coupled with the prepayment penalty.

Relying on Boschma v. Home Loan Center, Inc. (2011) 198 Cal.App.4th 230, the Appellate Court held that reliance can be proved in a fraudulent omission case by establishing that the originating lender “had the omitted information been disclosed [the plaintiff] would have been aware of it and behaved differently.”  Because the Borrowers alleged facts to show that they would have acted different had they been aware of the material loan terms, the First District concluded that the Borrowers sufficiently alleged a cause of action for fraud. 

Next, the First District turned to whether the Investor could be held liable for alleged conduct by the originating lender.  The Court answered in the affirmative.  The Complaint alleged that the Investor was directly liable for the fraud as an aider and abettor because it dictated use of the supposedly deceptive loan documents by the loan originator, and it allegedly directly engaged in deceptive marketing of the option ARM loans at issue. 

More specifically, Borrowers alleged that the originating lender would originate mortgage loans according to the terms set in place by the Investor.  The Investor allegedly engaged in deceptive marketing of its pay option ARM by aggressively promoting the teaser rate, including television commercials emphasizing that the payment rate could be as low as 1%.  The Investor also supposedly instructed its own loan officers to sell refinance loans by holding themselves out as experienced mortgage lending professionals specializing in helping people improve their financial situation. 

As you may recall, “California has adopted the common law rule that liability may be imposed on one who aids and abets the commission of an intentional tort if the person knows the other’s conduct constitutes a breach of a duty and gives substantial assistance or encouragement to the other to so act.”  See, e.g., Peel v. BrooksAmerica Mortg. Corp. 788 F.Supp.2d 1149, 1161 (C.D. Cal. 2011).  The First District found that the Borrowers sufficiently alleged liability for fraud based on a theory of aiding and abetting because the Investor actively participated in the creating, designing and formulating of the loan documents and/or dictated the terms of the option ARMS loans sold to the Borrowers.

The Investor unsuccessfully attempted to argue, for the first time on appeal, that it could not be liable for the fraud committed by its predecessor because it did not assume the predecessor’s liabilities when it merged with its predecessor.  However, the general rule of successor nonliability does not apply if the transaction amounts to a consolidation or merger of the two corporations.  See, e.g., Fisher v. Allis-Chalmers Corp. Product Liability Trust (2002) 95 Cal. App.4th 1182, 1188.  Because the Borrowers alleged that the Investor merged with its predecessor, the allegations are sufficient to defeat a challenge on the pleadings as to Investor’s successor liability. 

The Lender also raised a statute of limitations defense, arguing that actions for damages based on fraud must generally be filed within three years after actual or constructive discovery of the fraud.  Cal. Code Civ. P. § 338(d).  However, the First District was not willing to hold as a matter of law that the Borrowers would have discovered the purported fraud earlier through reasonable diligence (e.g., in October 2005 and January 2006 when the loans were originated).  Because the complaint alleged that the fraud was discovered in December of 2008, and because the original complaint was filed in August of 2011, the Appellate Court held that this claim was not barred by the statute of limitation.  Therefore, the First District concluded that the Borrowers sufficiently pled a cause of action for fraud against the Investor.

The First District then turned to whether the Borrowers alleged a cause of action under the UCL.  Having concluded that the Complaint alleged a cause of action for fraud, the same allegations were sufficient to state a cause of action under the UCL based on the defendants’ fraudulent conduct. 

Finally, the First District examined the Borrowers’ cause of action for negligence in the servicing of their loans.  The Borrowers alleged that the Servicer breached a duty of reasonable care owed to Borrowers by: (1) failing to review their loan modifications in a timely manner, (2) foreclosing on their properties while they were under consideration for a HAMP modification, and (3) mishandling their applications by relying on incorrect information. 

Specifically, one of the Borrowers alleged that an employee of the Servicer told him that his loan modification application was rejected because his monthly gross income was inadequate.  However, his paystubs showed his monthly gross income was more than twice the amount incorrectly described by the employee.  Additionally, the Servicer allegedly made other miscalculations to the Borrowers’ income and falsely advised that no documents had been submitted for review when in fact documents were sent and received.

The First District reached its conclusion by analyzing the balancing factors recognized in Nymark v. Heart Fed. Savings & Loan Assn. (1991) 231 Cal.App.3d 1089, 1095-96.  As you may recall, Nymark is commonly cited for the proposition that as a general rule, a financial institution owes no duty of care to a borrower when the institution’s involvement in the loan transaction does not exceed the scope of its conventional role as a mere lender of money.  However, the First District held that Nymark does not support the sweeping conclusion that a lender or servicer never owes a duty of care to a borrower. 

Rather, the Appellate Court opined, Nymark requires the balancing of five factors: (1) the extent which the transaction was intended to affect the plaintiff, (2) the foreseeability of harm to plaintiff, (3) the degree of certainty that the plaintiff suffered injury, (4) the closeness of the connection between the defendant’s conduct and the injury suffered, (5) the moral blame attached to the defendant’s conduct, and (6) the policy of preventing future harm.  Nymark, 231 Cal.App.3d at 1098. 

In applying the balancing factors, the First District followed the court in Lueras v. BAC Home Loans Servicing, LP (2013) 221 Cal.App.4th 49, and held that while a lender or servicer does not have a duty to offer or approve a loan modification, “a lender does owe a duty to a borrower to not make material misrepresentations about the status of an application for a loan modification or about the date, time, or status of a foreclosure sale.”  Luceras, 221 Cal.App.4th at 68.

Furthermore, according to the Appellate Court, the mishandling of the documents deprived the Borrowers of obtaining the requested relief.  The Court noted that the injury to Borrowers is present under the allegations at issue in that the Borrowers lost the opportunity to obtain a loan modification, and there allegedly was a close connection between the Servicer’s conduct, and under the allegations at issue there was actual supposedly suffered because to the extent Borrowers otherwise qualified and would have been granted a loan modification. 

Thus, the Court held that, under the allegations at issue, Servicer’s conduct in mishandling the application papers would have directly precluded Borrowers’ loan modification application from being timely processed.  Moreover, the Court held there is public policy of preventing future harm to home loan borrowers as shown by the recent actions taken by both the state and federal government to help homeowners caught in the foreclosure crisis.

Notably, the First District did not attach moral blame to the Servicer’s alleged conduct because the facts are not clear at this stage of the proceeding.  However, in light of the other factors weighing in favor of finding a duty of care, the Court noted that the uncertainty regarding this factor was insufficient to tip the balance away from finding a duty of care.  Therefore, because Servicer allegedly agreed to consider modification of the Borrowers’ loans, the Court held that the Borrowers had alleged sufficient facts to demonstrate that the Servicer would have breached a duty of care by allegedly mishandling the Borrowers’ loan modification applications.

Accordingly, the First District reversed the judgment of dismissal as to Borrowers’ fraud, UCL and negligence causes of action.  The matter was remanded to the trial court for further proceedings.



Eric Tsai
McGinnis Wutscher Beiramee LLP
 
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