The U.S. District Court for the District of Massachusetts recently ruled that borrowers may proceed with a lawsuit to prevent foreclosure of a residential mortgage loan where the borrowers claimed they were induced by the bank to default on the loan as a first step in negotiating a modification of the loan. The July 22 ruling involved joint borrowers who were not in default under their home mortgage loan, but stopped making payments when the bank allegedly told them it would consider them for a loan modification if they first defaulted and then submitted certain requested financial information. According to the decision, the borrowers promptly submitted the financial information requested by the bank. However, rather than determine the borrowers’ eligibility for a modification, the bank moved to foreclose on the property once the borrowers were in default. The court held that, in telling the borrowers that stopping their payments and submitting the requested financial information were the steps necessary to enter into negotiations for a loan modification, the bank should have known that the borrowers might take those steps. The borrowers did not claim that the bank promised to modify their loan, only that the bank promised to consider them for a loan modification if they took certain steps, including defaulting on their payments. The borrowers also did not claim that the bank promised not to foreclose, but the court found that such a promise would be implicit in a promise to negotiate a loan modification if the borrowers voluntarily stopped making payments.
Nutter Notes: The court ruled that if the borrowers can prove that they reasonably relied on the bank’s promise to negotiate a loan modification if they defaulted, then the borrowers would be entitled to the value of their expenditures in reliance on that promise and a return of the loan to non-default status. The court in this case broke new ground under Massachusetts common law because the borrowers did not claim that the parties had actually agreed on the terms of a loan modification, only that the bank had promised to enter into negotiations over those terms. While the court did not hold that the bank must grant a loan modification to the borrowers, it did hold that the bank could not take advantage of the borrowers’ default by foreclosing if the bank had induced the borrowers to default with a promise to consider them for a loan modification and then failed to follow through on that promise. The bank, which is a federal savings bank, also tried to argue that a claim under Massachusetts common law to enforce a promise under a theory of promissory estoppel theory is preempted by the Home Owners’ Loan Act (“HOLA”). The court found that a state-law claim of promissory estoppel is presumptively preempted under OTS rules implementing HOLA, but that the presumption of preemption is rebutted because the doctrine of promissory estoppel is not designed to regulate lending and does not have a disproportionate or substantial effect on lending under OTS preemption criteria.