California Court Interprets HAMP Requires Lender to Offer Borrower Permanent Loan Modification When Terms of Trial Plan Period Are Performed by Borrower Promissory Estoppel Claims Allowed to Proceed

By Patric J. Kelly
Adleson, Hess & Kelly, a P.C.
Spring 2013

The Home Affordable Mortgage Program (HAMP) was enacted by Congress with the goal in mind of providing relief to borrowers who had defaulted or were likely to default on their mortgage payments by reducing their mortgage payments to sustainable levels without discharging any of the underlying debt. As part of the program, borrowers could enter into a trial period plan (TPP), a form of temporary loan payment reduction. Division 3 of the 4th District of the California Court of Appeal has now decided that when a borrower complies with all aspects of a TPP, the lender MUST offer a permanent loan modification. Failure to do so, at least under the facts of this case, entitled the borrower to plead claims for fraud, negligent misrepresentation, breach of written contract, promissory estoppel and unfair competition. (West v. JPMorgan Chase Bank, N.A. (2013) 214 Cal.App.4th 780).

HAMP directed loan servicers to determine each borrower's eligibility for a modification by following what amounted to a three-step process: First, the borrower had to meet certain threshold requirements, i.e., the loan originated before January 1, 2009; it was secured by the borrower's primary residence; the mortgage payments were more than 31 percent of the borrower's monthly income; and, for a one-unit home, the current unpaid principal balance was no greater than $729,750; second, the servicer calculated a modification using a 'waterfall' method, applying enumerated changes in a specified order until the borrower's monthly mortgage payment ratio dropped as close as possible to 31 percent; third, the servicer applied a Net Present Value (NPV) test to assess whether the modified mortgage's value to the servicer would be greater than the return on the mortgage if unmodified. The NPV test is essentially an accounting calculation to determine whether it is more profitable to modify the loan or allow the loan to go into foreclosure. If the NPV result was negative—that is, the value of the modified mortgage would be lower than the servicer's expected return after foreclosure—the servicer was not obliged to offer a modification. If the NPV was positive, however, the Treasury directives said that the servicer MUST offer the modification.

Once qualified, the borrower went through a three or more month TPP using the waterfall method of establishing the payments. After the trial period, if the borrower complied with all terms of the TPP Agreement—including making all required payments and providing all required documentation—and if the borrower's representations remained true and correct, the servicer had to offer a permanent modification. (Supplemental Directive 09–01, which states that "if the borrower complies with the terms and conditions of the [TPP], the loan modification will become effective on the first day of the month following the trial period....").

Here, the borrower was offered a TPP. The borrower paid all of the payments on time, and, in fact, paid ten of them, the last of which was rejected by Chase because Chase said that the borrower did not meet the financial requirements of the NPV. The borrower objected, stating that Chase had used incorrect financial information, and requested a re-evaluation with the correct information. Chase said it would do so and would send her the NPV input data if she so requested within thirty days. Chase failed to do so.

Chase sold the borrower's property at foreclosure sale on May 26, 2010, even though Chase told the borrower that no foreclosure sale had even been scheduled. As the court said, "Although Chase Bank had told West no foreclosure sale had been scheduled, her home was sold at a trustee's sale conducted on May 26, 2010. 'In violation of its promises and said letter, and HAMP rules (and Supplemental Directives), two (2) days later, CHASE BANK secretly, sold [West]'s home, on May 26, 2010 during the re-evaluation period. CHASE BANK issued letters dated May 20, 2010, received May 24, 2010, rejecting [West]'s 10th payment ..., made pursuant to the continuing forbearance agreement."

The purchaser at the trustee's sale was a third party purchaser who recorded the trustee's deed on June 10, 2010.
Even after the foreclosure sale, Chase continued to send letters to the borrower, telling her that she may qualify for other foreclosure alternatives, such as HAFA, which involve alternatives such as deeds-in-lieu and short sales.

The borrower sued under a number of legal theories.

Fraud and Negligent Misrepresentation Claims
The borrower sued under state law. As part of the fraud and negligent misrepresentation claim, the borrower said that Chase defrauded her by falsely representing that Chase would re-evaluate her case and send her the NPV data. Chase also told her that there was no foreclosure sale scheduled, just two days before the scheduled foreclosure sale. The court held that she could rely on these representations, and that her reliance on these false representations caused her damage, that is, the loss of her home to foreclosure. And, this was all at a time when she was making her payments. The Lender argued that the alleged misrepresentations could not have been the cause of the foreclosure because the Borrower owed the money notwithstanding the alleged misrepresentations and she could not have paid the arrears or the entire loan (tender) to stop the foreclosure even if the misrepresentation had not been made. The Borrower alleged that the Lender "lull[ed]" her into "a false sense of security, so she would not hire an attorney to protect her rights," and then pursued the foreclosure sale despite telling her, on May 24, 2010, that the foreclosure sale had not been scheduled. The court of appeal found that there was sufficient causation because under the facts alleged, the Borrower was likely to have prevailed had she taken legal action prior to the trustee's sale.

Thus, the court said that she stated a claim for fraud.

Breach of Contract Claims
She also stated a claim for breach of contract. The court concludes that the TPP constitutes a written contract. Even though Chase's TPP stated only that Chase would reevaluate the application for assistance if payments were made and the borrower's other representations remained true and correct, the court held that Chase's obligations under HAMP were to offer a permanent loan modification. The obligations became part of Chase's contract, regardless of what the TPP agreement said. Thus, Chase breached its obligations under the contract, i.e., the TPP, by failing to offer the borrower a permanent modification.

Claim to Set Aside Foreclosure Sale; Usual Procedural Requirements Upheld by the Court
The borrower sued to set aside the trustee's sale, as well. However, the court followed well-settled law, and refused to set aside the sale based upon the facts set forth above. Instead, the court held that a tender was required, because only procedural irregularities were alleged in the sale. It was noted that the trustee's deed recited compliance with applicable statutory requirements. Usual arguments were made that the trustee was not properly substituted, that proper notice of the sale was not given and other similar arguments. These arguments were all rejected.

Quiet Title Claim Rejected
The borrower sought to have title quieted in her name. However, Chase, the defendant in the case, no longer owned the property. As a result, this claim was dismissed.

Promissory Estoppel Claims Allowed to Proceed
Many plaintiffs are pursuing defendant lenders and trustees for damages under a claim of promissory estoppel. The elements of promissory estoppel are (1) a promise, (2) the promisor should reasonably expect the promise to induce action or forbearance on the part of the promisee or a third person, (3) the promise induces action or forbearance by the promisee or a third person (detrimental reliance), and (4) injustice can be avoided only by enforcement of the promise.

Here, although not artfully pleaded in the complaint, the court found it reasonable that the borrower was making the following claims regarding the promises made by Chase: (1) in the TPP, Chase promised the borrower that it had offered her a trial loan modification under the HAMP guidelines and, during the trial modification period, Chase would not pursue foreclosure; (2) a letter to the borrower promised her that Chase would reevaluate the denial of a permanent loan modification if she timely submitted evidence the NPV input values used by Chase were inaccurate; (3) on May 24, 2010, a Chase representative promised the borrower she could resubmit her updated financial data for reevaluation for HAMP modification; and (4) on the same day, the Chase representative promised West there was no foreclosure sale date or sale scheduled. The promises, the court found, were "definite enough" for the court to determine "the scope of the duty" imposed by them. In other words, Chase made promises it did not keep to the borrower's detriment. At least at the pleading stage, this was enough to move forward in the lawsuit.

Unfair Competition Claim Allowed to Proceed
The borrower claimed unfair competition. In analyzing what Chase had done, the court had no problem in concluding that the actions of Chase were sufficient to support a claim of both unfair and fraudulent business practices.

It should be noted that since this case was an appeal from the Lender's demurrer which was sustained without leave to amend (i.e., the case was thrown out at the pleading stage without a trial), the appellate court generally must view the allegations in the borrower's complaint as being true. As such, the facts may be found to be different when the case ultimately goes to trial.

What to Do?
The West case raises many questions even for private lenders regarding situations where the private lender, loan servicer, or trustee enters into modifications or forbearances with a borrower in default.

Many of the loan servicer's and lender's problems in the West case were of their own making. This case should not be interpreted as meaning that a lender or trustee should not enter into a trial modification or forbearance agreements. However, the West decision instructs loan servicers, trustees, and lenders that applicable laws and regulations apply to the lender, loan servicer or trustee as implied in the deed of trust or modification agreement, even though not expressly set out. Even laws that do not apply to a particular licensee may be applicable if such laws are incorporated into the lender's deed of trust. All current deeds of trust should be carefully reviewed to make sure no such inapplicable law references are in the deed of trust. For example, just because one may be using a Fannie Mae form does not mean that one should subject oneself to Fannie Mae rules and regulations.

In addition, this case does not conclude that just because a lender enters into a trial or temporary forbearance or loan modification it must always offer a permanent modification. Such agreements are still subject to California law relating to the existence of and interpretation of contracts (i.e., offer, acceptance, consideration and conditions to a permanent modification becoming enforceable).1

The Lender in the West case admitted that the TTP was an enforceable contract but that the contract permitted the Lender to reconsider the borrower's qualifications for a permanent loan modification even if the borrower fully performed the TPP. The court of appeal (incorporating terms from HAMP regulations) held that the TTP, if performed, included a promise that the borrower would be given a permanent modification. Even for lenders not subject to HAMP, care should be taken in drafting temporary modification plans and forbearance agreements not to promise, or imply, that the borrower will receive anything more than time unless the lender intends for performance of the temporary modification or forbearance agreement to lead to some permanent modification or arrangement with the borrower. Where the lender only intends a modification or forbearance to be temporary, the modifications or forbearance agreement should clearly state that the modifications are temporary. Because of cases such as West and because of the passage of the Homeowner Bill of Rights in California (SB 900/AB 279), many loan servicers and lenders are revising their forbearance agreements, temporary modification agreements, extension agreements and permanent modification agreements. It is prudent for lenders and servicers to have their agreements reviewed by competent counsel to make sure they are in compliance with rapidly changing law.

It is clear that this court was not going to let the borrower be abused by allowing the servicer to make promises and representations that were not kept. Do not let yourself fall into this same category. If promises are made, keep them. Follow up on any oral conversations with written confirmation of what was said, particularly if there are discussions of postponing foreclosure sales based upon required actions of the borrower. Clarity is very important here. Clearly, written forbearance agreements should be employed whenever there are discussions of altering the loan agreement or the foreclosure proceedings. In fact, we recommend that pre-forbearance letters go out to borrowers before even entering into discussions with the borrowers so that there are no misapprehensions.

And, understand that both federal and state laws may be incorporated into any contract you make, for example, here the obligation under HAMP to provide a permanent loan modification if the TPP is complied with by the borrower. As with other recent loan modification and foreclosure cases, the court of appeal found that the provisions of the HAMP program become part of the contract (i.e., the deed of trust or TPP) even though those provisions (or regulations) are not expressly part of the deed of trust or in the TPP.

Even if you are not subject to certain federal laws and regulations, if one uses language that intimates that such laws and regulations apply, one may have just incorporated the laws and regulations into one's agreements. Many other laws can impact what is set forth in a written contract, even though the written contract may be at variance with the law. The law generally wins.

The bottom line: review your practices and procedures within your shop to make sure that misunderstandings cannot happen, especially when verbal representations are being made. Put things in writing. Obtain signatures. And, make sure you keep your promises!

For any questions on this or other real-estate or creditor bankruptcy related matters, contact me at:

Patric J. Kelly
577 Salmar Avenue
Second Floor
Campbell, California 95008

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1 Nungaray v. Litton Loan Servicing, LP (2011) 200 Cal.App.4th 1499.