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Issue  148  Article  247
Published:  11/1/2007

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Court Rules Mortgagee has Fiduciary Duty for Escrows
Chris Burti, Vice President and Legal Counsel

This opinion was issued in a ruling by the District Court of a hearing on the defendant's Motion to Dismiss in the case of  Smith, v. GMAC Mortgage Corporation, Civil Docket No.: 5:06cv125-V, United States District Court for the Western District of North Carolina, Statesville Division, filed on September 5, 2007.

In 2006, the plaintiff filed a complaint in the Superior Court of Catawba County, North Carolina, against the defendant GMAC Mortgage Corporation ("GMAC"). GMAC filed a Notice of Removal from the Superior Court of Catawba County to the United States District Court for the Western District of North Carolina, Statesville Division and shortly thereafter a motion to dismiss the count of the plaintiff’s complaint that alleged a breach of fiduciary duty.

With respect to consideration of a Motion to Dismiss, the Court will accept the facts stated in the complaint as true.  As alleged, the plaintiff purchased a home located in Hickory, North Carolina in 1997. Typically, she obtained a homeowner's policy of insurance as required by the lender as a condition of the loan. In this instance it was issued by Nationwide Insurance. The Deed of Trust expressly provided that the plaintiff would pay to the lender monthly escrow amounts to be applied toward required property taxes and property insurance premiums. The Deed of Trust imposed the duty of paying these escrow items upon the lender. The Deed of Trust provided that: "If Borrower fails to maintain coverage, Lender may, at Lender's option, obtain coverage to protect Lender's rights in the Property . . . ." Insurance obtained by the lender under these circumstances is referred to in the mortgage lending industry and in this action, by the parties, as "force-placed insurance."

In 2000, the mortgage was transferred to GMAC. The plaintiff was informed that GMAC would "receive and process your payments, manage your escrow account for insurance and tax payment (if you pay sums into escrow), and respond to your inquiries." GMAC sent the plaintiff a letter stating, "your homeowners/hazard insurance will not be affected by this transfer. A notification is being sent to your hazard insurance carrier to send future insurance information to GMAC Mortgage." From September 2000 until December 2002, GMAC made payments to Nationwide for the homeowner's insurance premium. Nationwide sent bills for the insurance premiums directly to GMAC, not the plaintiff. Nationwide periodically sent notices to Smith stating that the Policy premiums were billed directly to GMAC. In December 2002, Nationwide informed GMAC that the insurance policy would be cancelled on January 13, 2003 unless the premium was paid. Sometime prior to January 2003, Nationwide also sent a bill to GMAC for a premium payment that was due on or about January 16, 2003. Subsequently, Nationwide sent GMAC a warning notice extending the grace period until February 4, 2003.

GMAC failed to make the premium payment out of escrow or respond to these notices and Nationwide cancelled the policy retroactive to January 13, 2003. Nationwide stated in the letter notifying GMAC of the cancellation that had the premium been paid, the mortgagee would not have been forced to meet new eligibility underwriting guidelines, and the policy would have remained in effect. 

In August 2003, GMAC notified the plaintiff that it obtained a force-placed insurance policy from Balboa Insurance Group, the insurance company that had recently begun to service the escrow account. This resulted in a much higher premium more than three times higher than the previous policy premium. GMAC also charged the plaintiff with interest on the money advanced for the force-placed insurance. The plaintiff contended that GMAC had "no lawful basis" to obtain force-placed insurance given the circumstances of this case because she did not fail to maintain coverage. The plaintiff also alleged that GMAC received a commission or other compensation when implementing the Balboa force-placed insurance. While the issue of whether GMAC did in fact, pay the premium is disputed by GMAC, the Court observed that it had not been presented with a "‘cancelled check’ or equivalently succinct record of electronic payment as evidence that it made the required payment".

In late 2004, the plaintiff obtained a second policy from Nationwide which had a premium less than the force-placed insurance, but still about 60% higher than the premium under the original policy. According to Plaintiff, the increased amount of the force-placed insurance resulted in Smith experiencing difficulty paying the necessary amount due and consequently, she fell behind in her mortgage payments. GMAC instituted foreclosure proceedings and after considering the facts as represented by Nationwide, the Clerk of the Court denied GMAC's petition to foreclose on the property.

As a result of GMAC's alleged misconduct and alleged improper mortgage servicing practices, the plaintiff's credit score has been damaged and she has incurred fees, costs, and expenses related to her home mortgage and homeowner's insurance. GMAC also allegedly failed to pay county taxes on Smith's home in a timely manner.

The plaintiff maintained that in establishing the escrow account and obligating the consumer (to make payments into it, GMAC "obligated itself to certain duties of care and fiduciary duties in administering the account on the consumer's behalf” and that “GMAC had a duty to forward in timely fashion funds paid by Smith into escrow for homeowner's insurance and property taxes.” The plaintiff also challenged the practice of outsourcing these duties in order to save costs and claimed that GMAC engaged in the outsourcing without instituting proper oversight.

The Court notes that the Deed of Trust provided that "the Security Investment shall be governed by federal law and the law of the jurisdiction in which the Property is located." Thus the Court concluded that North Carolina law governed the issues in the case.  The Court’s analysis of the North Carolina law as applied to the plaintiff’s claim of fiduciary duty is clear and concise and would not benefit from paraphrasing. The court observes that the existence of a fiduciary relationship between mortgagor and mortgagee is a question that neither the Supreme Court of North Carolina nor the Fourth Circuit has directly addressed.

"‘For a breach of fiduciary duty  to exist, there must first be a fiduciary relationship between the parties.’ Dalton v. Camp, 353 N.C. 647, 651, 548 S.E.2d 704, 707 (2001). Although North Carolina courts have been reluctant to define conclusively the term ‘fiduciary relationship,’ the North Carolina Supreme Court broadly defines such a relationship as one ‘where there has been a special confidence reposed in one who in equity and good conscience is bound to act in good faith and with due regard to the interests of the one reposing confidence.’ Volumetrics Med. Imaging, Inc. v. ATL Ultrasound, Inc., 243 F.Supp.2d 386, 404 (M.D.N.C. 2002) (quoting Abbitt v. Gregory, 201 N.C. 577, 598, 160 S.E. 896, 906 (1931)). Such confidential relationships ‘are not limited to a purely legal setting but may be found to exist in situations which are moral, social, domestic, or merely personal.’ Rhone-Poulenc Argo S.A. v. Monsato Co., 73 F.Supp.2d 540, 545 (M.D.N.C. 1999) (quoting Curl v. Key, 311 N.C. 259, 264, 316 S.E.2d 272, 275 (1984)). In general, North Carolina recognizes two types of fiduciary relationships: ‘(1) those that arise from “legal relations such as attorney and client, broker and client, principal and agent, trustee and cestui que trust,” and (2) those that exist “as a fact, in which there is confidence reposed on one side, and the resulting superiority and influence on the other.”’ Rhone-Poulenc, 73 F.Supp.2d at 546 (quoting Abbitt, 201 N.C. at 598; See White v. Consolidated Planning, Inc., 166 N.C.App. 283, 293, 603 S.E.2d 147, 155 (2004).”

“Specifically, North Carolina courts have described the following relationships as examples of a fiduciary relationship that arises as a matter of law: attorney-client, business partners / joint venturers, trustor-trustee, principal-agent, and mortgagor-mortgagee in transactions affecting mortgaged property. See Corneilus v. Helms, 120 N.C.App. 172, 175, 461 S.E.2d 338, 340 (1995) (lawyer-client relationship is a fiduciary relationship as a matter of law); HAJMM Co. v. House of Raeford Farms, Inc., 328 N.C. 578, 588, 403 S.E.2d 483, 489 (1991) (business partners are each others' fiduciaries as a matter of law); Rhone-Poulenc, 73 F.Supp.2d at 545 (fiduciary relationship exists as a matter of law between joint venturers under North Carolina law); Carroll v. Roundtree, 36 N.C.App. 156, 158, 243 S.E.2d 821 (1978) (remarking in dictum that trustor-trustee, principal-agent, and mortgagor-mortgagee are ‘known and definite’ fiduciary relationships) (internal citations omitted).”

“North Carolina has identified those relationships which, as a matter of law, do not satisfy the criteria necessary for a fiduciary relationship…‘In less clearly defined situations, the question whether a fiduciary relationship exists is more open and depends ultimately on the circumstances. Courts have historically declined to offer a rigid definition of a fiduciary relationship in order to allow imposition of fiduciary duties where justified.” HAJMM, 328 N.C. at 588; Hinton v. West, 207 N.C. 708, 178 S.E. 356, 360 (1935) (‘Courts of equity have carefully refrained from defining the particular instances of fiduciary relations in such a manner that other and perhaps new cases might be excluded.’) (quoting Pomeroy's Equity Jurisprudence (3d Ed.), vol. 2, §956). Consequently, the determination of when a fiduciary relationship exists is dependent upon a variety of factors. Id.”

“The Rhone-Poulenc court identified several factors used to determine when a fiduciary duty exists including: ‘the degree of kinship between the parties, the disparity in age, health, mental condition and education and business experience between the parties; and the extent to which the ‘servient’ party entrusted the handling of its business affairs to the ‘dominant’ party and placed trust and confidence in it.’ Rhone-Poulenc, 73 F.Supp.2d at 546.”

“Ultimately, the question of the existence or non-existence of a fiduciary relationship is ‘determined by the specific facts and circumstances of the case’ and is ‘a question of fact for the jury.’ Powell v. Omli, 110 N.C.App, 336, 347, 429 S.E.2d 774, 779 (1993) (emphasis in original)”

It is well established, in the Court’s observation, that in North Carolina the parties to a contract are not fiduciaries to each other and they do not owe any duty beyond those imposed in the contract.  GMAC argued that the plaintiff failed to allege "anything more than a typical debtor-creditor contractual relationship." In support of its motion, the defendant cited Wells v. N. Carolina Nat'l Bank, Dalton v. Camp, and Stern v. Great Western Bank, arguing that they prohibit the Court from finding in favor of the plaintiff on this issue. The Court not only found each of these cases distinguishable, but pointed out that they reflected the very existence of the possibility of a fiduciary relationship between a lender and a borrower. “While Defendant references several non-binding cases addressing fiduciary duty and the mortgagor-mortgagee relationship, none of Defendant's cited material provides convincing support as to why Plaintiffs' claim is not cognizable under North Carolina law.”

North Carolina courts have recognized that fiduciary obligations may arise between a mortgagor and a mortgagee under certain circumstances. The Court suggests that perhaps the obligations should exist. The opinion cites several opinions beginning with Hinton v. West, 207 N.C. 708, 178 S.E. 356, 360 (1935) and continuing with Carroll v. Rountree, 36 N.C.App. at 158, McNeil v. McNeil, 25 S.E.2d 615, 617, 223 N.C. 178, 181 (1943), and Cross v. Beckwith, 16 N.C.App  361, 363, 192 S.E.2d 64, 66 (1972).

 In discussing this issue under Hinton the Court observed that the North Carolina Supreme Court noted that a treatise on fraud identified the relationship between mortgagor and mortgagee as one of eight enumerated "relations of confidence," which give rise to a presumption of fraud because of the "undue advantage which the situation itself gives to one over the other." Hinton, 178 S.E.2d at 360. The state court cited the treatise's characterization of the mortgagor - mortgagee relationship with approval:

   “‘Upon principle, this should be so. It is due to good faith and common honesty that such a presumption should arise in every case where confidence is reposed, and the property and interests of one person are committed to another. To every such person his trust should be a sacred charge - not to be regarded with a covetous eye.’ Id at 361.”

 The Court recognized the truism that the “ purchase of a personal residence is often the largest and most significant transaction that a given individual undertakes.” Since in the vast majority of cases, the buyer borrows a large portion of the purchase price securing the promissory note with a Deed of Trust that usually requires escrows for ad valorem taxes and homeowners' insurance, the mortgagor places trust and confidence in the mortgagee's assumption of this responsibility and justifies a finding that the allegations survive a Motion to Dismiss. “This almost universal practice reflects the significant bargaining power of mortgagees over that of mortgagors. The level of confidence that a mortgagor (servient party) instills in the mortgagee is significant under these circumstances. When there is a cognizable level of confidence between two parties, both are "bound to act in good faith and with due regard to the interests of the one reposing confidence." Abbitt, 201 N.C. at 598 (fiduciary relationship found between plaintiff and defendant with respect to the plaintiff's sale of his stock to the defendant).”

The Court determined that a reasonable jury could find that the circumstances surrounding the mortgager-mortgagee relationship between parties created a fiduciary duty through the obligations of trust, confidence and good faith and that in failing to make timely escrow account payments to Nationwide, GMAC “arguably breached these extra-contractual obligations which may exist between mortgager and mortgagee.” … “Ultimately it is the duty of the jury, not the Court, to make findings as to whether or not an extra-contractual fiduciary duty exists under these facts.”

It is not very difficult to follow the logic of this decision. One can also readily envision that the facts as alleged provide a compelling tale from which a jury verdict in favor of the plaintiff would occasion little surprise. While the Court did not address the issue of the policy premium in the analysis, its extensive delineation in the statement of facts suggest that it may have been troubled by the potential benefit to GMAC in force-placed coverage. If there is a financial gain at stake the fiduciary issues become more significant than where mere negligence is all that is at play.

The ramifications of this decision remain to be seen. It is not an appellate opinion of the sort that will receive wide coverage and possibly result in changes in operations in lender’s back rooms. Nor does it provide any helpful or cautionary tale with regard to title examination. It is most likely best considered a bellewether. A bellewether serves to create or shape future trends or to portend future developments. The term refers to the leader of a flock from the ancient Anglo-Saxon practice of tying a bell on the neck of a wether (usually a castrated ram) so that the flock of sheep following the leader may be more easily found.

And what trend might be suggested that this decision presages? The trend seems to be that the special knowledge of lenders and other experts in the highly complex residential mortgage industry and the relative lack of knowledge of typical homeowners will impose greater responsibility on these experts than has traditionally been the case. The elements that the court considered as suggesting that a fiduciary relationship between lender and borrower would be permitted to be argued to a jury can be said to exist in the instance of a lender steering business to its affiliated title insurance agency.

It may be observed that borrowers are likely to assume that if the lender is satisfied with the state of the title to their property it is fine and implicitly they are fine as well. It is common for a lender to be provided coverage in a policy that the owner in the transaction is not afforded. One can readily envision a situation where a serious title defect arises that is covered in the loan policy and excluded from coverage in the owner’s policy.

If that coverage exceeds industry norms in the case of an affiliated business relationship, the fact that the lender will receive its loan fees for closing, the profit from issuing the policy as well as being repaid the loan while the borrow is left with the debt and potentially no property, will militate strongly against the contractual nature of the relationship and heavily toward a fiduciary one. One may argue that requesting the borrower to use the affiliated agency before the loan is approved is coercive at least to the degree that most loan applicants are disinclined to “make waves”. If this argument is persuasive, it can make it even more likely “that a reasonable jury could find that the circumstances surrounding the mortgager-mortgagee relationship between parties created a fiduciary duty through the obligations of trust, confidence and good faith”. The same sort of issues may be even more likely to arise in the context of a title agency owned in part by a real estate brokerage. That industry markets itself as reposing in itself special trust and confidence and yet their fees are dependent on the deal closing. If there is any question regarding proper underwriting of the policy, the potential is great that impermissible self-interest might be found to have influenced a “breach of fiduciary duty”. Extreme care in underwriting and extensive record keeping will have to be maintained by companies with an affiliated agency in order to refute such allegations when they arise.


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