February 19, 2010 Limiting Mortgage Lender Liability: No Reason for Open Season Against Banks for Negligence

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1 February 19, 2010 Limiting Mortgage Lender Liability: No Reason for Open Season Against Banks for Negligence by Allison Schoenthal, Partner HOGAN & HARTSON LLP While the Federal and New York legislators are enacting new laws to further protect homeowners from foreclosures and predatory lending, 1 lending institutions have been left exposed to a surge in lawsuits by mortgage loan borrowers and contested foreclosure actions. 2 In particular, claims against lenders for negligence negligently processing loan applications, negligently approving mortgage loans, or negligent underwriting are appearing with increased frequency. This article discusses the conditions under which state and federal courts in New York have been consistently rejecting such claims. To sustain a claim for negligence under New York law, a plaintiff must show that: (1) the defendant owed the plaintiff a cognizable duty of care; (2) the defendant breached that duty; and (3) the plaintiff suffered damages as a proximate result of that breach. 3 The absence of any one of these elements requires dismissal of the claim. 1 See, for example, Governor s Program Bill No. 46, which was passed by the New York legislature on November 16, The legislation, among other things, places additional burdens on lenders prior to and during foreclosure actions in an effort to protect New York State homeowners, tenants and neighborhoods in the wake of the ongoing foreclosure crisis. 2 The number of foreclosure filings hit a record high in the third quarter of (October 15, 2009). Foreclosure filings in New York exploded during the past two years, resulting in the creation of new foreclosure parts within the New York Courts to address only foreclosure actions, as well as new rules specific to foreclosure cases. See e.g. Press Release, Chief Judge Kaye Announces Residential Foreclosure Program, (June 18, 2008). 3 Stagl v. Delta Airlines, Inc., 52 F.3d 463, 467 (2d Cir. 1995) (citing Solomon v. City of New York, 66 N.Y.2d 1026, 1027, 489 N.E.2d 1294, 499 N.Y.S.2d 392 (1985)). 1

2 LENDERS OWE NO DUTY TO BORROWERS The threshold issue in any negligence action is whether the defendant owed a legally recognized duty to the plaintiff. 4 Courts are reluctant to impose a duty on lenders beyond the duty to make disclosures as required by federal or state legislation. Specifically, both state and federal courts in New York have routinely held that the lending bank owes no duty of care to a borrower or prospective borrower, whether that borrower is a consumer or a commercial entity. By way of example: In Ceballos v. Wells Fargo Bank, N.A., et al., Index No /2008 (New York Supreme Court, Queens County), the borrower sued lender Wells Fargo, among others, alleging that plaintiff s income was inflated on the loan application and that fraudulent representations were made to the lender by the mortgage broker regarding the property and plaintiff s ability to qualify for a loan. Plaintiff alleged that Wells Fargo was negligent in its underwriting of the home mortgage loan and failed to use due diligence to verify plaintiff s income. Wells Fargo moved to dismiss the complaint arguing that it owed no duty to the borrower. The court agreed, dismissing the negligence claim, affirming that, Concerning the allegations of negligent underwriting, a mortgagee owes no duty to ascertain the accuracy of information provided to it by the mortgagor. In George B. Eronini v. Wells Fargo Home Mortgage, Index No /2009 (New York Supreme Court, Richmond County), the borrower claimed that Wells Fargo unlawfully increased his mortgage loan payments and advised tenants that a foreclosure action would be commenced. Eronini sued Wells Fargo for negligence and breach of contract. In its motion to dismiss, Wells Fargo argued that a lender (Wells Fargo) owes no duty in negligence to a borrower (Eronini). The court dismissed the negligence claim holding that, The plaintiff has failed to state a cognizable cause of action, rather, that any duty was owed by the defendant merely because of its role as [mortgagee]. In Yolanda Mejias v. Premium Capital Funding, LLC d/b/a Topdot Mortgage and Wells Fargo Bank, N.A., 23 Misc.3d 1115(A), 885 N.Y.S.2d 712 (N.Y. Sup. 2009), the plaintiff alleged that the lender should have known 4 See e.g. Gilson v. Metro. Opera, 5 N.Y.3d 574, 576, 841 N.E.2d 747, 807 N.Y.S.2d 588 (2005) ( [i]n any negligence action, the threshold issue before the court is whether the defendant owed a legally recognized duty to the plaintiff.); Lauer v. City of New York, 95 N.Y.2d 95, 100, 711 N.Y.S.2d 112, 115 (2000) (Duty is an essential element of any negligence case, without which there can be no liability as a matter of law, however careless the conduct or foreseeable the harm. ). Borrowers claims will also fail where insufficient evidence is offered of a breach of a duty, or fail to identify any damages suffered as a proximate result of a breach. 2

3 that Plaintiff could not afford to make mortgage payments on the subject property. Plaintiff asserted a claim for negligence alleging that the lender had a duty to Plaintiff to exercise due care and diligence when requiring Plaintiff to make mortgage payments and that it failed to exercise due care because it knew or should have known that Plaintiff could not afford the mortgage. In its motion seeking dismissal of the Complaint, Wells Fargo argued that it owed no duty to Plaintiff and that Plaintiff had not set forth any special relationship between the parties from which a duty could be found. The Court granted Wells Fargo s motion, finding no basis for attributing to [the lender] any duty of care towards plaintiff. In Dellmero Lobban v. Lincoln Management Restoration Group, et al., Index No. 4135/2009 (New York Supreme Court, Suffolk County), the borrower claimed that his signature was forged on a contract directing that insurance proceeds be paid by the lender, Wells Fargo, to the contractor rather than to Plaintiff. The borrower sued Wells Fargo alleging that it acted negligently by releasing insurance funds based on the forged document. The Court granted Wells Fargo s motion to dismiss, holding that, a mortgagee owes no duty to the plaintiff, mortgagor. The cases above, 5 as well as those in the accompanying notes, should undoubtedly be relied upon when moving to dismiss a borrower s negligence claim in New York. 6 5 The Ceballos, Eronini, Mejias and Lobban actions were successfully defended by the author s firm Hogan & Hartson, LLP. 6 For state law cases finding that no duty exists, see: Tenenbaum v. Gibbs, 27 A.D.3d 722, 813 N.Y.S.2d 155 (2006) (dismissing negligence claim holding, as a mortgagee bank, [defendant] did not owe any duty of care to ascertain the validity of the documentation provided to it by mortgagor); Beckford v. Northeastern Mrtg. Inv. Corp., 262 A.D.2d 436, 437 (1999) (lender did not owe... a duty of care to ascertain the accuracy of the information provided to it by borrower); Cendant Mortgage Corp. v. Packes, 37 A.D.3d 515, 516, 831 N.Y.S.2d 200, 201 (2d Dep t 2007) (mortgagee not liable to mortgagor for negligent misrepresentation based on inaccurate appraisal, absent a special duty of care outside of contractual duty); Harris v. Adejumo, 36 A.D.3d 855, 856, 830 N.Y.S.2d 561, 562 (2d Dep t 2007) (no duty of care owed by lender to prospective borrower); CFSC Capital Corp. XXVII v. W.J. Bachman Mech. Sheet Metal Co., Inc., 247 A.D.2d 502, , 669 N.Y.S.2d 329, 332 (2d Dep t 1998) (dismissing negligence claim and holding that mortgagors failed to demonstrate the existence of any duty on the part of [the mortgagee]... nor ha[d] they demonstrated the breach of any such duty ); Marine Midland Bank, N.A. v. Cafferty, 174 A.D.2d 932, 571 N.Y.S.2d 628 (3d Dep't 1991) (mortgagee had no duty to monitor construction project and thus cannot be held liable to the mortgagor for negligence in the administration of the loan). For federal court cases, see: In re Lois/USA, Inc., 264 B.R. 69, 121 (Bankr. S.D.N.Y. 2001) (dismissing negligence claim because no special relationship existed between lender and prospective borrower); Middle East Bank, New York Branch v. Harmony Sportswear, Inc., No. 93 Civ. 228 (JFK), 1994 WL 74057, at *6 (S.D.N.Y. Mar. 10, 1994) (dismissing negligence claim because borrower did not identify legal duty independent of the contract); Sinclair Broad. Group, Inc. v. Bank of Montreal, No. 94 Civ (LMM), 1995 WL 70577, at *7 (S.D.N.Y. Feb. 21, 1995) (dismissing negligence claim, where plaintiff alleged negligence arising from defendant s oral promise that a 3

4 THE LENDER-BORROWER RELATIONSHIP IS CONTRACTUAL Dismissal of borrower negligence claims against lenders is appropriate because the lender-borrower relationship is contractual in nature. For a breach of contract to be considered negligence, a legal duty independent of the contract must have been violated. 7 Settled New York precedent expressly limits the scope of a creditor s legal duty to a debtor under the note and mortgage. In the lender-borrower context, courts recognize that it is merely an arms-length contractual relationship. 8 Accordingly, courts dismiss negligence claims where no special relationship is alleged that could conceivably give rise to an independent duty in negligence. 9 NO SPECIAL CIRCUMSTANCES For special circumstances giving rise to a duty of care, a borrower must show a closer degree of trust than an ordinary business relationship. 10 Typically there is no such relationship between a borrower and a lending bank. In one case, however, the court expanded the duties owed by a lender, ignoring the line of New York precedent holding that no duty exists in a lending context. provision in the loan agreement would not be enforced, holding, Courts have consistently rejected the notion that a lender owes a duty of care to a prospective borrower ). 7 Beckford v. Empire Mut. Ins. Group, 135 A.D.2d 228, 233, 525 N.Y.S.2d 260, 263 (2d Dep t 1998); Luxonomy Cars, Inc. v. Citibank, N.A., 65 A.D.2d 549, 550, 408 N.Y.S.2d 951, 954 (2d Dep t 1978) (holding that a tort may accompany a breach of contract... only where the contract creates a relation out of which springs a duty, independent of the contract obligation, and that independent duty is also violated. ) (emphasis added). 8 See e.g., In re W.T. Grant Co., 699 F.2d 599, 609 (2d Cir. 1983) (a creditor has no fiduciary obligation to its debtor); Cuomo v. Mahopac Nat l Bank, 5 A.D.3d 621, 622, 774 N.Y.S.2d 779, 780 (2d Dep t 2004) (arms-length contractual relationship between borrowers and bank did not give rise to a fiduciary relationship); River Glen Assoc., Ltd. v. Merrill Lynch Credit Corp., 295 A.D.2d 274, 275, 743 N.Y.S.2d 870, 871 (1st Dep t 2002) ( [T]his Court has repeatedly held [that] an arm s length borrower-lender relationship is not of a confidential or fiduciary nature and therefore does not support a cause of action for negligent misrepresentation. ). 9 Pehzman, 2007 WL (negligence claim was not permitted where, inter alia, plaintiff failed to allege adequately the existence of a special relationship between the parties); Heller Financial, Inc. v. Apple Tree Realty Associates, 238 AD2d 198, 656 NYS2d 247 (1st Dep't 1997), leave to appeal dismissed, 90 NY2d 889, 661 NYS2d 833, 684 NE2d 283 (1997) (affirming dismissal of negligence claim because there is no evidence of a relationship of special confidence and trust between lender and borrower). 10 Fleet Bank v. Pine Knoll Corp., 290 A.D.2d 792, 736 N.Y.S.2d 737 (3 Dept. 2002) (finding question of fact as to whether special relationship exists). 4

5 In Mathurin v. Lost & Found Recovery, LLC, 19 Misc.3d 756, N.Y.S.2d 699 (Sup. Ct. 2008), the court denied the lender s motion to dismiss a negligence claim. The plaintiff alleged that she was involved in a mortgage rescue scam whereby the property was transferred by deed to a straw buyer who took out a mortgage from the bank. The buyer made no payments on the mortgage resulting in foreclosure. Plaintiff commenced an action to recover damages against the lender alleging, inter alia, that the lender failed to take measures to verify that [the buyer] would be able to remain current on the subject loan, failed to conduct a reasonable background investigation on [the buyer], and as such, failed to discover multiple mortgage loans involving [the buyer] as a straw buyer. The court held: Considering the present difficulties faced in the subprime mortgage market, a lender underwriting a mortgage has a duty to investigate and ascertain the economic status of the purchaser/mortgagor and whether the purchaser/mortgagor may be committing a fraud against the seller in the underlying transaction. 20 Misc.3d at This case appears to be an anomaly; it is a rare circumstance that a lender is found to owe a fiduciary duty to a borrower. The decision, however, along with a recent decision in IndyMac Bank F.S.B. v. Yano-Horoski, 2009 NY Slip Op 52333(U) (Nov. 19, 2009), in which the court cancelled the borrowers mortgage debt as a sanction for the bank s allegedly poor treatment of the borrowers during loan modification discussions, suggests that the courts may now be swayed by sympathy for borrowers in a turbulent market, rather than governing precedent. It is therefore critical for lenders counsel to understand the relevant case law as well as the applicable laws and court rules -- and the potential pitfalls. Despite the numerous new obligations imposed on banks by the recent flurry of borrower-friendly legislation, there has been no attempt by the legislature to alter the established relationship between a lender and borrower to impose a fiduciarylike obligation. Until that happens, claims of negligence against a mortgage lender will likely be dismissed by New York courts. ALLISON SCHOENTHAL, PARTNER HOGAN & HARTSON LLP 875 Third Avenue, New York, NY direct tel fax ajschoenthal@hhlaw.com 11 It should also be noted that the duty is expanded by Maturin to the seller of the property, not to the borrower. 5

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