Lenders Beware -- California decision may ignite next wave of lender liability litigation

by Sheppard Mullin Richter & Hampton LLP

In a recent decision from the California Court of Appeals entitled Jolley v. Chase Home Finance, LLC, the Court severely curtailed lenders’ ability to dispose of lender liability claims on summary judgment, thereby adopting a marked departure from existing law. In so doing, the Court admonished lenders that the “world [has been] dramatically rocked in the past few years by lending practices colored by short-sighted self-interest.”

In the wake of Jolley, lenders need to be extremely careful about how they communicate with defaulted borrowers and how they exercise their remedies. Otherwise, lenders will be far more likely to face juries on lender liability claims, as well as an increase in frequency with which such claims are asserted against them.

Jolley should be a familiar story: (1) Jolley obtained a construction loan, (2) he then defaulted, (3) he then requested a loan modification, (4) Chase decided not to modify the loan and instead pursued foreclosure, and (5) on the eve of foreclosure, Jolley filed a lawsuit alleging that Chase was guilty of, among other things, fraud, breach of contract and negligence. Chase filed a successful motion for summary judgment at the trial court level.

The Court of Appeals reversed, holding that Chase’s statements to Jolley that the requested modification was “highly probable”, “likely” and “look[ed] good” were not just opinion and could be fraudulent. The Court further held that such statements could be sufficient to bind Chase to enter into a modification. These holdings precluded the grant of summary judgment for Chase on the borrower’s fraud and breach of contract claims.

The Court of Appeals then reversed an entire body of case law that favored Chase on Jolley’s negligence claim. The Court held that the determination of whether a lender can be liable for negligence is a question of fact. As a consequence, lenders may no longer be able to dispose of a disgruntled borrower’s negligence claims at the summary judgment level.

Even more troublesome was the fact that the Court relied on legislation primarily directed to consumer loans, some of which will not go into effect until 2018, as a potential basis for a finding of negligence in the commercial loan context. That legislation will, among other things, require lenders to provide defaulted borrowers with a “single point of contact” for all matters related to the loan, and prevents lenders under certain circumstances from “dual-tracking” (i.e., simultaneously pursuing foreclosure while negotiating a modification).

Jolley is cause for much concern in the lending community. Chase has already filed a request for rehearing, and may appeal the decision to the California Supreme Court if the request is denied.

Thus, while the final chapter in this litigation has yet to be written, we encourage lenders to consider adopting the following practices to mitigate its impact:

  • First, although pre-dispute jury trial waivers are ineffective in California, lenders and borrowers can enter into “judicial reference” agreements at any time that may require a borrower to litigate in front of a retired judge or attorney rather than a jury.
  • Second, if a potential modification is to be discussed, the lender should insist that the borrower first execute a pre-negotiation agreement, in which the borrower acknowledges, among other things, that there is no modification unless and until all necessary approvals have been obtained and all loan modification documents have been duly executed.
  • Finally, once a borrower defaults, lenders need to be extremely careful about their communications with the borrower. Phone calls and meetings should be summarized in confirmatory letters or e-mails, and all contemplated written communications from the lender should be vetted by counsel before delivery to the borrower.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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