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CA Court of Appeals Finally Finds Servicers Cannot Negligently Handle Your Loan Mod Application

There has been significant progress in the case law involving mortgage loan servicer negligence in the handling of loan modification applications.  Recently, in Alvarez v. BAC Home Loans Servicing, the California Court of Appeal (First Appellate District, Division Three) held — for the first time– that a mortgage loan servicer owes a duty of care to borrowers in reviewing their loan modification application.  Although another appellate decision in Jolley v. Chase Home Finance had issued a similar ruling, Jolleyinvolved a construction loan and didn’t specifically discuss whether the holding would apply to a residential mortgage loan.

Prior to this case, there had been divergence in opinion at the trial court level– many finding that a duty of care could be found if a servicer was neligent in reviewing a loan mod application, and others finding that servicers could never be negligent in such circumstances because the servicer was acting in its “conventional role as a lender.”  By relying on the1991 case Nymark v. Heart Fed Savings & Loan Association, many trial courts concluded that reviewing a borrower’s loan modification application could be considered part of its role as a conventional role as a lender and therefore could not be negligent in its conduct related to the handling of the loan modification.

In Alvarez, the California Court of Appeal correctly held that the Nymark rule could not be read that broadly and effectively sheild servicers from neglience in every circumstance.  Instead, the court noted, “[e]ven when the lender is acting as a conventional lender, the no-duty rule is only a general rule. …Nymark does not support the sweeping conclusion that a lender never owes a duty of care to a borrower. Rather, the Nymark court explained that the question of whether a lender owes such a duty requires “the balancing of the ‘Biakanja factors.’ ” The court explained that the Nymark rule simply said that if a bank was acting in its conventional role as a lender, then several factors should be considered in determining whether a duty of care exists.   These factors, called the “Biakanja factors,” named afterBiakanja v. Irving., a case in which a court set forth the various considerations necessary to determine whether a duty of care exists, are: “(1) the extent to which the transaction was intended to affect the plaintiff, (2) the foreseeability of harm to the 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.” In analyzing these factors, the Alvarez court concluded that the plaintiffs had sufficiently demonstrated that their mortgage loan servicer owed a duty of care and could be held liable for acting negligently. Notably, the court cited to the Homeowners’ Bill of Rights related to their analysis of the 6th factor as a compelling basis to find a duty of care exists.

In its ruling, the court also observed an extremely important distinction– one that few courts had ever considered before– between mortgage loan lenders (often times called originators) and mortgage loan servicers.  Mortgage loan servicers do not lend money, they simply service the loan, according to other regulations and laws, in order to collect payments for the investors of the loan.  Thus, they don’t act like “conventional lenders”  in what were usually transparent arm-length transactions where conventional lenders protected their own banking interests.  The Alvarez court acknowledged that the difference between current mortgage loan servicers and the conventional lender involved in the Nymark case weighed into its analysis: “The[ir] 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.” Importantly, the court concluded that “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 their dealings with borrowersseeking a loan modification.”In essnce, the court acknowledged that servicers generally hold all of the cards during the loan modification evaluation, and this imbalance of power changes the nature of bargaining power and level of transparency between a borrower and a servicer.

This holding is important because it is the first time a CA appellate court has found that a servicer owes borrowers a duty of care during the loan modification processes.  The impact of this holding will permit homeowners who have suffered harm as a result of a servicer’s carelessness in processing a loan modification application to file a lawsuit and hold them accountable. The opinion can be found here –Alvarez.

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