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From Banking and Finance Law Daily, June 17, 2014

Borrowers’ state law claims against bank, based on loan officer’s statements, rejected

By Thomas G. Wolfe, J.D.

Although mortgage borrowers alleged that statements by a bank’s loan officer supported their claims against the bank under North Carolina law for breach of a fiduciary duty and negligent misrepresentation, the Supreme Court of North Carolina disagreed. The court determined that, under the facts of the case, the borrowers’ home loan refinancing with the bank was “an arm’s length transaction” that did not give rise to a claim for breach of fiduciary duty; similarly, the borrowers failed to demonstrate “justified reliance” on the loan officer’s alleged misstatements about lien priority in support of their negligent misrepresentation claim (Dallaire v. Bank of America, N.A., June 12, Newby, Justice).

Consequently, the North Carolina high court ruled that the state’s Court of Appeals had erred in overturning the state trial court’s order granting summary judgment in favor of the bank on both claims.

Background. In 2005, the borrowers, a married couple, filed for bankruptcy due to their various business debts. At the time of the bankruptcy, the borrowers’ home was encumbered by three liens: (i) Bank of America, N.A. held a “first priority” deed of trust on a mortgage note in the amount of $138,900; (ii) Bank of America held a “second priority” home-equity-line deed of trust in the amount of $25,000; and (iii) Branch Banking & Trust (BB&T) held a “third priority” lien securing a business loan in the amount of approximately $241,450.

In 2006, the bankruptcy court discharged the borrowers’ personal liability on all three liens, but the three liens remained valid against their home. In 2007, in response to an advertisement in the mail from Bank of America offering home mortgage refinancing services, the borrowers submitted a loan application to the bank. While the loan application asked whether the borrowers had declared bankruptcy within the past 10 years, the borrowers apparently checked the box marked “No.” At the same time, however, one of the borrowers maintained that he separately disclosed the bankruptcy to a loan officer with Bank of America. According to that borrower, the loan officer repeatedly assured him that “the bankruptcy and BB&T mortgage would not be a problem” and that “the new [Bank of America] loan would be secured by a first lien mortgage” against the borrowers’ home.

A real estate title agency advised Bank of America that the loan was cleared to close, apparently based on the mistaken belief that the BB&T lien on the borrowers’ home had been completely extinguished in the bankruptcy proceeding. Eventually, the borrowers obtained home loan refinancing from Bank of America in the amount of $166,000 in exchange for a deed of trust on the home. Under the terms of their mortgage refinancing, the borrowers were required to “promptly discharge” any liens that Bank of America determined to have priority over the home loan, “provided that Bank of America, in its discretion, notified the [borrowers] of any such lien.” The bank did not notify the borrowers of the BB&T lien, which had not been paid off and which attained “first priority” status on the house.

In 2010, approximately three years after the refinancing transaction, a friend of the borrowers expressed interest in purchasing the borrowers’ home. After the borrowers’ bankruptcy attorney conducted a title search, the borrowers discovered that the BB&T lien was senior to the Bank of America lien.

Borrowers’ complaint. The borrowers filed an action in state court against Bank of America and the company engaged by the bank to prepare the title report—HomeFocus Services, LLC (later known as LandSafe Services, LLC). In contending that the “junior status of Bank of America’s lien substantially decreased the marketability and value of their home and exposed them to increased personal liability,” the borrowers asserted claims under North Carolina law for negligent title search, negligent misrepresentation, breach of contract, and breach of fiduciary duty.

Procedural context. When the state trial court granted the defendants’ motion for summary judgment on all of the claims, the borrowers appealed to the North Carolina Court of Appeals. The North Carolina Court of Appeals determined that some of the borrowers’ claims lacked merit. Still, the intermediate appellate court reversed the summary judgments in favor of the bank on the borrowers’ claims for breach of fiduciary duty and negligent misrepresentation; the court determined that further factual development was necessary to address whether a fiduciary relationship between the bank and the borrowers had been created, and, if so, whether the bank “negligently misrepresented the priority the loan would receive.” The bank appealed that ruling to the Supreme Court of North Carolina.

Claim for breach of fiduciary duty. In addressing the borrowers’ claim against Bank of America for breach of fiduciary duty, the North Carolina Supreme Court observed that, ordinarily, “borrower-lender transactions…are considered arm’s length and do not typically give rise to fiduciary duties…Rather, borrowers and lenders are generally bound only by the terms of their contract and the Uniform Commercial Code.”

While underscoring these general principles, the court recognized that “it is possible, at least theoretically, for a particular bank-customer transaction to give rise to a fiduciary relation given the proper circumstances.” However, the court ultimately determined that these special circumstances were not present in the case before it because: (i) the bank loan officer’s mere assertion that the borrowers “could obtain a first priority lien mortgage loan” was not sufficient “to take the parties’ relationship out of the borrower-lender context” or otherwise transform it from an “arm’s length” relationship to a fiduciary relationship.

As a result, the court decided that the state trial court had not erred in granting summary judgment to the bank on the borrowers’ breach-of-fiduciary-duty claim.

Claim for negligent misrepresentation. Next, the North Carolina high court addressed the borrowers’ contention that Bank of America’s loan officer repeatedly assured them that their new home loan would be secured by a first lien mortgage, and that the borrowers reasonably relied on the bank’s “negligently prepared information, resulting in substantial harm to their net worth.”

Outlining the principles of a claim for negligent misrepresentation under North Carolina law, the court stated that negligent misrepresentation occurs “when a party justifiably relies to his detriment on information prepared without reasonable care by one who owed the relying party a duty of care.” At the same time, the court noted that “a party cannot establish justified reliance on an alleged misrepresentation if the party fails to make reasonable inquiry regarding the alleged statement.”

With these principles in mind, the court determined that, even if it were to assume that Bank of America owed a duty to the borrowers beyond the terms of the loan agreement, the borrowers did not produce any evidence “suggesting they made reasonable inquiry regarding the loan officer’s alleged misstatements of lien priority.” The court pointed out that the borrowers themselves acknowledged that “determining the effects of a previous bankruptcy on a home’s liens is complicated. Yet, there is no indication the couple made pertinent inquiries or sought outside advice about the liens in 2007 as, for example, they did in 2010 when preparing to sell their home.”

The court found that since the borrowers failed to produce evidence showing that they made a reasonable inquiry, or were prevented from doing so, they failed to demonstrate the justified reliance necessary to support their negligent misrepresentation claim. Accordingly, the North Carolina Supreme Court determined that the state trial court did not err in granting summary judgment to Bank of America on the claim.

The case is No. 51PA13.

Attorneys: John F. Scarbrough and James E. Scarbrough (Ferguson, Scarbrough, Hayes, Hawkins & DeMay, P.A.) for Jacques and Fernande Dallaire. Robert A. Muckenfuss (McGuireWoods, LLP) for Bank of America, N.A. J.L. Pottenger, Jr. for amicus curiae Jerome N. Frank Legal Services Organization Mortgage Foreclosure Clinic. Edwin M. Speas, Jr., Andrew H. Erteschik, and Lynn C. Percival IV (Poyner Spruill LLP) for amicus curiae North Carolina Bankers Association. Laura E. Collins for amicus curiae University of North Carolina School of Law Consumer Financial Transactions Clinic.

Companies: Bank of America, N.A.; Branch Banking & Trust; HomeFocus Services, LLC; LandSafe Services, LLC

MainStory: TopStory BankingOperations Loans Mortgages NorthCarolinaNews

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