Borrowers Beware: Lenders Owe No Duty to Borrowers to Determine Ability to Repay a Loan

In late 2010, the First District Court of Appeals in California ruled against borrowers who sought to allege fraudulent misrepresentation against a lender who intentionally misrepresented their income in a loan application, and ultimately they could not afford to repay the loan. The Court based its ruling in part on a finding that there is no fiduciary relationship between a borrower and a lender, and that a lender is under no duty to determine the borrower’s ability to repay a loan.

In Mercedes Perlas, et al. v. GMAC Mortgage, LLC, et al. (2010) 187 Cal.App.4th 429, Plaintiff’s borrowed $417,000 from GMAC, a commercial mortgage lender, to be repaid at a fixed interest rate of 6.375 percent with monthly payments of $2,601.54. One of the documents given to Plaintiffs at closing was a loan application, which grossly inflated Plaintiff’s total monthly income, and did not accurately reflect the actual income information Plaintiffs provided to GMAC. At closing, Plaintiffs were presented with the preprinted loan application and other documents. Plaintiffs signed the application and other documents without being given the opportunity to read or review them. Plaintiffs also executed documents prepared by GMAC for a home equity line of credit in the amount of $114,000, which Plaintiffs also signed without review. Plaintiffs ultimately could not make the required loan payments, and the underlying security was foreclosed upon.

Plaintiffs sued GMAC and others, asserting a number of claims, including fraudulent misrepresentation based on GMAC’s representation that Plaintiffs “qualified” for the loan. Defendants demurred to Plaintiffs’ claims on the grounds that Plaintiffs’ claims failed to state a cause of action and were uncertain and ambiguous.

The trial court sustained GMAC’s demurrer to Plaintiff’s fraudulent misrepresentation claim without leave to amend the complaint, and Plaintiffs appealed. On appeal, Plaintiffs argued that they could amend their complaint to properly allege fraudulent misrepresentation, and argued that GMAC’s knowingly false determination that Plaintiffs qualified for the loans constituted a determination and representation by GMAC that Plaintiffs could afford the loans.

The Court of Appeals affirmed the trial court’s judgment, finding that Plaintiffs could not amend the complaint to state a cause of action for fraudulent misrepresentation.

To establish a claim for fraudulent misrepresentation, the plaintiff must prove: (1) the defendant represented to the plaintiff that an important fact was true; (2) that representation was false; (3) the defendant knew that the representation was false when the defendant made it, or the defendant made the representation recklessly and without regard for its truth; (4) the defendant intended that the plaintiff rely on the representation; (5) the plaintiff reasonably relied on the representation; (6) the plaintiff was harmed; and (7) the plaintiff’s reliance on the defendant’s representation was a substantial factor in causing that harm to the plaintiff.

In their complaint, Plaintiffs alleged that defendants knew or should have known at the time the loan documents were prepared and given to Plaintiffs, that Plaintiffs could not make the loan payments based on the actual income information Plaintiffs provided to GMAC. Plaintiffs further alleged that GMAC represented to Plaintiffs that they had the ability to make the loan payments, and failed to disclose to Plaintiffs that they could not possibly afford to make the payments.

Plaintiffs proposed to amend their complaint to allege that GMAC represented to them that they qualified for the loans based on their “true income,” which Plaintiffs provided to GMAC when they applied for the loans, that such representation was false because the Plaintiffs’ qualification for the loan was based on an inflated income figure, and that GMAC knew the representation was false.

The Court found that neither the complaint, nor Plaintiffs’ proposed amendments allege that GMAC expressly represented to Plaintiffs that they had the ability to make the loan payments specified in the loan documents. Essentially, the Court found that Plaintiffs could not rely upon GMAC’s determination that they qualified for the loan in order to decide if they could afford the loan payments. The Court found that Plaintiffs’ arguments ignore the nature of the lender-borrower relationship.

Borrowers beware. In California, absent special circumstances, a loan transaction is at arm’s length, and there is no fiduciary relationship between the borrower and lender. A lender owes no duty of care to borrowers in approving their loan. A lender’s efforts to determine the creditworthiness of and ability to repay by the borrower are for the lender’s protection, not the borrower. And a lender is under no duty to determine a borrower’s ability to repay the loan.

This means that in California, a lender’s assessment that a borrower is “creditworthy,” and a lender’s representation to a borrower that he or she “qualifies” for a loan is not treated as an indication or representation to the borrower that the borrower can actually repay the loan. A lender is under no duty to make such a determination. Before securing a loan in California, borrowers would be well advised to make an independent determination that they can actually afford the loan payments.