Smith v. Home Loan Funding – An Excessive Remedy Against Mortgage Broker

The decision in Smith v. Home Loan Funding, Inc. (Feb. 25, 2011) 2011 DJDAR 2968 may have satisfied a “feel good” impulse at the Court of Appeal.  However, it seems that Justice Gilbert jumped the rails when he affirmed the award of damages.  Even more, he awarded attorney’s fees when there was no contract between the parties providing for such recovery.  The result is intellectually disappointing.

The case involved a loan that was placed by Home Loan Funding (HLF).  According to the opinion, “Anthony Baden worked for HLF as a loan officer.  He had no real estate or mortgage broker license.  In March 2006, Tonya Smith contacted Baden in response to an advertisement she received from HLF.  She sought a $40,000 home equity line of credit.  Her home had existing first and second mortgages.”

Here comes the fact that gave rise to a finding of liability.  “[Anthony] told [Tonya] he could ‘shop the loan.’  When asked whether Baden ever told her that he was a mortgage broker Smith replied, “I believe so, yes.”  Smith testified that she trusted Baden completely, and believed he would provide her with the best loan.”

In fact, “Baden provided Smith with a $700,000 first trust deed.  The loan had a term of 30 years with a variable interest rate. The loan contained a 3.85 margin over the indexed interest rate.”

In addition, “Smith did not want a prepayment penalty on the new loan. Baden represented to her that the new loan would have none.  Baden reassured Smith and her husband throughout escrow that there would be no prepayment penalty and sent an email to assure them.”  But when it came time to close, “a prepayment penalty was reinserted into the transaction by means of a rider.”

The loan was favorable to the broker.  “Smith’s expert, Luis Araya, testified that the commission available to HLF for the sale of the loan on the secondary market was greatly enhanced by the inclusion of both a prepayment penalty and a heavily marked-up margin.  Araya also testified that a 3.85 margin is ‘astronomical.’”

Now we start to wonder about the bona fides of the transaction, and whether they support the award of damages.  “Araya testified that Smith cannot refinance her loan in today’s market. She cannot provide sufficient documentation of her income.  There are no longer loans available without documentation of income.”

Duh.  Those days are gone.  But this statement suggests that the borrower (Tonya) obtained what is sometimes referred to as a “liar loan,” with no evidence of income or ability to repay the loan.  Meaning we can expect this loan to tilt into foreclosure.

The court noted that “a mortgage broker has a fiduciary duty toward the borrower.”  HLF argued that since it placed the loan in-house, it acted as the lender, not as a mortgage broker.  The court rejected this argument: “But that HLF ultimately persuaded Smith to accept one of its loans, hardly negates that HLF undertook to act as Smith’s broker.  Instead, it is evidence of HLF’s and Baden’s self-dealing at the expense of Smith.”

Mercat St. Josep in Barcelona

Now the thorny issue of damages.  On appeal, “HLF contends the trial court erred in awarding damages for the full life of the 30-year loan.  It claims there is no evidence Smith would hold the loan or the property for 30 years . . . In Stratton v. Tejani (1982) 139 Cal.App.3d 204 . . . The court stated that residential real property typically is held for only seven to ten years.”

That’s an accurate statement regarding property ownership.  Even more, what if the house goes to foreclosure (perhaps likely, given that the loan was made without proof of income)?  It seems that if the court were to award damages on a 30-year basis, it would provide a windfall to the customer.

But that argument went nowhere on appeal.  Stated Justice Gilbert, “We think Stratton is not applicable here. That the mortgage has a term of 30 years is sufficient to support the trial court’s calculation . . . The evidence is that Smith does not qualify to refinance.  She is more likely than anyone to be saddled with a 30-year mortgage.”

To rub salt in the wound, the court of appeal affirmed an award of attorney’s fees to the borrower based on a clause in “the note secured by the deed of trust.’”

Common sense tells me that the promissory note is separate from the claim against the mortgage broker, which claim was based on breach of fiduciary duties.  Remember when the court said, “You shopped the loan, you’re a mortgage broker.”  On appeal “HLF points out that under section 1717 a prevailing party cannot recover fees for actions based on tort including breach of fiduciary duty and misrepresentation.”

But when it came to attorney’s fees, the court lumped it all together, even though no claim was stated under the promissory note or the deed of trust.

Here comes the train wreck.  “Here, not only did HLF have a fiduciary obligation, but Baden made an express oral promise to Smith that he would shop the best loan for her.  [T]he trial court treated the oral brokerage agreement and the loan documents as a single agreement. This was justified because they were all part of the same transaction.  The award of attorney fees was proper.”

That seems like piling on.  The defendant was held liable as a fiduciary because of shopped the loan.  Then the court mashed all of the documents together and said, “Hey, we found an attorney’s fees clause in one of the contracts.”  That is not a logical outcome.  But, because the California Supreme Court almost never takes up business cases for review, the decision will be binding.

Smith v. Home Loan Funding, Inc. (Feb. 25, 2011) 2011 DJDAR 2968