Locke Lord QuickStudy: California Court of Appeal Rejects Tort Duty in Reviewing Borrower for a Loan Modification, Highlighting Split Among Intermediate Appellate Courts

Locke Lord LLP
August 8, 2019

On August 5, 2019, the California Court of Appeal for the Second District held that a lender owes no “tort duty of care during a loan ‎modification negotiation.‎”  Sheen v. Wells Fargo Bank, N.A., ___ Cal.Rptr.3d ___, 2019 WL 3543079, *4 (Ct. App. August 5, 2019).  In so ruling, the Court of Appeal highlighted the current split in the appellate courts on this issue and rejected the contrary line of cases finding such a duty exists. 

The court’s decision was largely based on a recent California Supreme Court decision, not arising in the mortgage context, which addressed the scope of tort duty owed by a utility toward businesses that lost money as the result of a methane gas leak.  Southern California Gas Leak Cases, 7 Cal.5th 391 (2019). In the Gas Leak case, the Supreme Court carefully analyzed the economic loss rule, determining that “a financial transaction gone awry” falls within the domain of contract law or the law of fraud, as opposed to negligence.  Following the lead of the Gas Leak case, the Sheen court determined that a failed loan modification is “a financial transaction gone awry and nothing more.”  Sheen, 2019 WL 3543079, *5. 

The Sheen court went on to analyze case law from around the country, and noted that at least 23 states have refused to impose tort duties on lenders with respect to loan modifications.  Id.  The court also analyzed the Restatement of Torts, noting that under the Restatement, “there can be no liability in tort for economic loss caused by negligence in the performance or negotiation of a contract between its parties.”  Id. *6 (emphasis in original).  Finally, the Sheen court pointed out that “it is strange to impose a negligence duty on lenders to carefully review loan modification applications when there is no such tort duty to approve applications as a result of that review.”  Id. at *7, quoting Carbajal v. Wells Fargo Bank, N.A., CV 14-‎‎7851, 2015 WL 2454054, *6, (C.D. Cal. Apr. 10, 2015) ‎affd. 697 Fed.Appx. 555‎ (9th Cir. 2017) (emphasis in original). 

The decision in Sheen will strengthen the argument that a borrower cannot state a claim for the negligent review of a loan modification application, though the current split in authority remains. The Sheen decision appears to invite the California Supreme Court not only to resolve the present dispute among the intermediate appellate courts, but also provides a roadmap for the high court to decline to extend a tort duty based on its own recent decision in the Gas Leak case. 

And while the Sheen case will be useful in arguing that tort claims based on a loan modification review should be dismissed, borrowers are still free to assert breach of contract or statutory claims if applicable.Thus, even if the California Supreme Court adopts the reasoning in Sheen and finds that no duty of care exists in a loan modification review, claims involving loan modification reviews will likely continue under other theories.