Lenders don't owe borrowers a general duty of care, top state court rules

Clarifying a hotly-contested negligence theory that borrowers have used to sue lenders, the state Supreme Court agreed with lawyers from Kutak Rock LLP and Munger, Tolles & Olson LLP that the economic loss doctrine bars recovery.

The justices held that lenders do not owe a duty of care to borrowers in the handling of the loan and cannot be liable for the borrower's economic losses. The outcome of the class action is expected to have a significant impact on the real estate banking industry. Sheen v. Wells Fargo Bank N.A., S258019 (Ca. S. Ct., op. filed March 7, 2022).

One lower court observed that the "issue of whether a tort duty exists for mortgage modification has divided California courts for years."

Benjamin J. Horwich, the MTO partner who argued for the lender at the high court, said, "Courts have been befuddled by this confusion." The Supreme Court's unanimous opinion by then-Chief Justice Tani G. Cantil-Sakauye went further, he added. "This case will be cited frequently because it goes beyond the context presented to resolve questions about California negligence law."

Lenders and loan servicers do not owe borrowers a general duty of care to protect a borrower's economic interests, including when processing, reviewing or responding to a mortgage modification application, the court held. It affirmed a state appellate panel and a trial court, both of which had upheld Wells Fargo's demurrers.

(Left to right) Steven M. Dailey and Jeffrey S. Gerardo / Photo Credit: Thomas Kurtz

The lead plaintiff, Kwang Sheen, contended that after he'd missed payments and sought to refinance his home loan, he'd been misled by ambiguous Wells Fargo letters into believing his mortgage loan modification application had been approved when it had not. When his home was foreclosed upon, he sued the bank for negligence.

Steven M. Dailey and Jeff S. Gerardo of Kutak Rock LLP handled the successful demurrer at the trial stage; Dailey argued successfully before the 2nd District Court of Appeal. When Sheen took the case further, Dailey and Gerardo enlisted Munger, Tolles' Horwich and Miller-Ziegler to defend their lower court wins before the Supreme Court.

"This then became a collaboration between us and Kutak," Horwich said. "Rachel and I are experienced appellate lawyers, but we needed the nuanced understanding of banking law that Jeff and Steve supplied, and we brought our knowledge of the architecture of tort law to bear."

Rachel Miller-Ziegler

The winning argument: Under the economic loss doctrine for contracts, there is no recovery in tort for financial harm unaccompanied by physical or property damage. As long as the lender does not step beyond its customary role, it does not owe a duty of care to the borrower and is allowed to determine how best to recoup the money it is owed.

Said Miller-Ziegler, "Everyone knows the economic loss rule, but the court took a rigorous look beyond it to engage in more legal areas that had not been previously examined."

- John Roemer