SLG Client Alert: New CA Appellate Case Imposes Duty of Care in Handling of Loan Modification Applications

August 29, 2014
To All SLG Client and Affiliates
From: Spencer Scheer
Subject: New CA Appellate Case Imposes Duty of Care in Handling of Loan Modification Applications.

The case of Alvarez v. BAC Home Loans Servicing, L.P., 2014 Cal. App. LEXIS 712 (Cal. App. 1st Dist. Aug. 7, 2014) was just published. It will have significant impact on servicers/lenders. Larger servicers and lenders in particular should  note this ruling carefully.

Recent legislation and case decisions in CA have generally accepted that a lender/servicer has no obligation or duty to provide a borrower with a loan modification. Conversely, Courts will uphold borrower claims based on the failure of a lender/servicer to properly follow either Dodd Frank or HOBR provisions requiring  review and evaluation of loan modification applications on covered loans.

The Alverez case is the first known case where a CA appellate court has found that once a lender accepts an application for a loan modification, it has a duty imposed by law to complete that application process with reasonable care. The impact of the case will be to allow borrowers and the courts to examine in greater detail how a loan modification application is processed to ensure timeliness and good faith and to examine questionable practices by lender/servicers. It also should also be noted that while the Court did not impose a duty on the lender to provide a loan modification, the ability of a borrower to show that the review process was mismanaged or managed in bad faith, can now give rise to a separate action for breach of the duty of the Lender/servicer’s to complete the process with care . The Court’s logic  in allowing damage claims for breach of the duty is that the lender/servicer has deprived the borrower of the right to either obtain a loan modification that he or she qualified for, or to allow the borrower to seek relief from foreclosure elsewhere.

The following language of the Court in the Alverez case is noteworthy.  You should read it, as it raises a very skeptical view of the lender borrower relationship and current servicing practices and finds that the law will act forcefully to protect borrowers:

“With respect to whether defendants’ conduct was blameworthy—the fifth Biakanja factor—it is highly relevant that the borrowers “ability to protect his own interests in the loan modification process [is] practically nil” and the bank holds “all the cards.” (Jolley, supra, 213 Cal.App.4th at p. 900.) As explained in the amicus curiae brief filed by Housing and Economic Rights Advocates et al.: “Traditional mortgage lending involved a bank evaluating a borrower and her security, and issuing a loan with terms reflecting the perceived risk that the borrower would default. The same bank would then (i) retain the loan, making its profit on the interest the borrower paid; and (ii) service the loan, meaning that it would be in contact with the borrower directly, collecting the borrower’s payments and negotiating any changes in loan terms. See Eamonn K. Moran, Wall Street Meets Main Street: Understanding the Financial Crisis (2009) 13 N.C. Banking Inst. 5, 32 (‘ “Traditionally, banks managed loan ‘from cradle to grave’ as they made mortgage loans and retained the risk of default, called credit risk, and profited as they were paid back.” ’) [citation omitted]. [¶] [*16] These tasks have been dispersed among different actors in the modern mortgage servicing context, however, changing the relationships between the borrower, the loan originator, the ultimate holder of the loan, and the servicer of the loan. [¶] First, borrowers are captive, with no choice of servicer, little information, and virtually no bargaining power. Servicing rights are bought and sold without input or approval by the borrower. Borrowers cannot pick their servicers or fire them for poor performance. The power to hire and fire is an important constraint on opportunism and shoddy work in most business relationships. But in the absence of this constraint, servicers may actually have positive incentives to misinform and under-inform borrowers. Providing limited and low-quality information not only allows servicers to save money on customer service, but increases the chances they will be able to collect late fees and other penalties from confused borrowers..

,,The borrower’s lack of bargaining power coupled with conflicts of interest that exist in the modern loan servicing industry provide a moral imperative that those with the controlling hand be required to exercise reasonable care in [*17] their dealings with borrowers seeking a loan modification. Moreover, the allegation in the complaint that defendants engaged in “dual tracking,” which has now been prohibited (see Civ. Code, §§ 2923.6, 2924.18) increases the blame that may properly be assigned to the conduct alleged in the complaint. (Jolley, supra, 213 Cal.App.4th at p. 901.)”

The message in this case is clear, especially to larger servicers with more defined and extensive obligations under Dodd Frank and HOBR: You must play by the procedural rules in processing a loan modification application and you must review the loan modification application timely and in good faith, or the borrower can sue for breaching such duty. It is different than a borrower suing because you did not give them a loan modification application, but it can be just as painful, all the same. Other CA appellate courts may take a different view, but right now, Alverez gives the borrowers an important right when contesting the loan modification review process.

Please contact me if you want to discuss.

Spencer Scheer