FYI: Cal App Ct Holds No Deficiency Judgments Allowed on Purchase Money Loans, Even If Foreclosure Not Completed

The California Court of Appeal, Fourth District, recently held that California's anti-deficiency protections apply to a short-sale as to a purchase money loan secured by owner-occupied residential property, regardless of whether a foreclosure was initiated or completed.  The Court also held that the anti-deficiency protections at issue could not be waived.

 

A copy of the opinion is available at:  http://www.courts.ca.gov/opinions/documents/D061720.PDF

 

Following the borrower's default on a residential purchase-money owner-occupied mortgage loan, the lender initiated foreclosure.  Prior to the completion of the foreclosure, the borrower found a third-party interested in purchasing the subject property, but at a price less than the balance due on the subject loan. 

 

The lender agreed to the short-sale of the property on several conditions, including that the borrower remain liable for any deficiency resulting from the sale.  The sale resulted in a deficiency in the amount of $116,686.89.  When the lender attempted to collect on the deficiency, and the borrower filed her declaratory judgment action in response.

 

The trial court sustained the lender's demurrer and entered judgment dismissing the borrower's action with prejudice.  The borrower appealed.

 

As you may recall, in California, a creditor may not seek a deficiency judgment following the trustee's sale in a non-judicial foreclosure. See Cal. Code of Civil Procedure § 580b ("section 580b"); Roseleaf Corp. v. Chierighino (1963) 59 Cal.2d 35, 43-44. This prohibition exists even if the loan was not a purchase money loan. See Cal. Code of Civil Procedure § 580d.

 

A creditor may seek a deficiency judgment in a California judicial foreclosure in certain circumstances.  See, e.g., Arabia v. BAC Home Loans Servicing, L.P. (2012) 208 Cal.App.4th 462.  However, a creditor may not recover a deficiency judgment after judicially foreclosing on a purchase money loan. See §§ 580b, subd. (a)(3); 726, subd. (b).

 

Thus, section 580b prohibits a deficiency judgment following a foreclosure on a purchase money loan secured by owner-occupied residential property.  See Budget Realty, Inc. v. Hunter (1984) 157 Cal.App.3d 511, 513.  Section 580d further extends this anti-deficiency protection to include any loan secured by a deed of trust recorded against residential real property after a nonjudicial foreclosure. See National Enterprises, Inc. v. Woods(2001) 94 Cal.App.4th 1217, 1226.

 

On appeal, the borrower advanced multiple arguments as to the trial court's error, but the Court determined that it was only necessary to address one: whether or not Section 580b prohibits the collection of a deficiency under a purchase money loan following an approved short-sale of the subject property.

 

The lender argued that: (1) section 580b only applies after a completed foreclosure; (2) section 580b does not apply where the Borrower waives the "security first rule" of section 726 of the California Code of Civil Procedure ("Section 726"); and (3) the borrower waived any rights to protection under 580b by agreeing to the conditions of the short-sale.

 

The Court rejected each of the lender's arguments in reaching its conclusion in favor of the Borrower.

 

First, the Court interpreted section 580b to include any sale of properties given as security for purchase money loans.  The Court read the language of section 580b "No deficiency judgment shall lie in any event … after a sale of real property" to mean that the legislature intended for Section 580b to apply to all sales.  The Court noted that the focus of section 580b is not on the type of sale, but rather, on the type of loan: purchase money loans.  Thus, the Court determined that the statute does not require a foreclosure sale of the property for its protections to apply. 

 

Second, the Court rejected the lender's argument that the borrower waived the "security first" rule by determining that it was merely a variant of its prior argument that a foreclosure was necessary for Section 580b to apply, which it previously rejected. 

 

As you may recall, the "security first rule" requires that a secured creditor first proceed against the security before enforcing the underlying debt.  The lender argued, and the Court distinguished and rejected, a prior California case in which a debtor was deemed to have waived any protections under 580b by failing to raise the "security first" rule under Section 726 during the creditor's action for specific performance and judicial foreclosure.  See Scalese v. Wong, 84 Cal.App.4th 863 (2d Dist. 2000). 

 

The Court distinguished the present case from Scalese on several grounds including that the present short-sale was never under any judicial process and that, in fact, no sale of the secured property ever took place in Scalese for which a deficiency could arise.  Accordingly, the Court determined that the Trustee's reliance upon Scalese was in error, and that the Borrower was not required to assert the "security first rule" instead of agreeing to the short-sale. 

 

Finally, the Court briefly addressed the lender's argument that the borrower waived any rights to protection under 580b by agreeing to the conditions of the short-sale.  The lender asserted that by agreeing to be liable as to the deficiency as a condition to the short-sale, the borrower waived any protections afforded by Section 580b.  However, the Court determined that any attempted waiver of the protections of Section 580b were void as a matter of public policy.

 

Accordingly, the Appellate Court reversed the lower court's dismissal of the Borrower's declaratory judgment action, and remanded the matter for further proceedings consistent with its opinion. 

 

 

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

Admitted to practice law in Illinois

 

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FYI: Ill App Ct Rules Mortgagee Must Sue Payor Bank For Conversion When Co-Payee Forges Mortgagee's Indorsement on Hazard Ins Proceeds Check

The Illinois Appellate Court for the First District recently ruled that a mortgagee's only recourse for forged checks for hazard insurance proceeds was to sue the payor bank under the Uniform Commercial Code for conversion for cashing the insurer's checks over the mortgagee's forged indorsements.

 

In so ruling, the Court noted that:  (1) because the checks had been cashed by the joint co-payee on the checks, the checks had not been lost, destroyed, or stolen, precluding recourse against the insurer as the drawer of the funds; and (2) the insurer's obligation on the underlying insurance policy was suspended, and the suspension continued, because the checks had not been properly "paid" under Section 3-602(a) of the UCC. 

 

A copy of the opinion is available at:  http://www.illinoiscourts.gov/Opinions/AppellateCourt/2013/1stDistrict/1122387.pdf.

 

Plaintiff bank ("Bank") extended a mortgage loan to the owners ("Owners") of an apartment building.  Defendant insurance company ("Insurer") issued a hazard insurance policy for the property, identifying Owners as the named insureds under the policy, and Bank as the mortgagee.  After a fire damaged the building, Owners entered into an agreement with a contractor to repair the apartment building pursuant to which Owners assigned their rights to receive payment under the insurance policy.  Insurer issued checks totaling over $250,000, naming Bank, the contractor, and Owners as co-payees, and mailed the checks to the contractor per the Owners' instructions.   

 

Several months later, Insurer learned that the contractor's agent had forged Bank's indorsement on the checks and that the payor bank had paid the funds to the contractor. 

 

Bank later demanded payment from Insurer, asserting that it was entitled to the insurance proceeds pursuant to its mortgage agreement with Owners.  Insurer declined to pay the claim, as it asserted it had already done so.  Bank then filed a declaratory judgment action, alleging it was entitled, as the mortgagee, to the insurance proceeds pursuant to the insurance policy.  As an affirmative defense, Insurer argued that it should not be held liable for the tortious and fraudulent act of a third party.  The parties filed cross-motions for summary judgment.  The lower court granted Insurer's motion, but denied Bank's motion.  Bank appealed.

 

The Appellate Court affirmed, concluding that Bank's sole remedy was to sue the payor bank for conversion under the Uniform Commercial Code ("UCC") for cashing the insurance checks over Bank's  forged indorsement.

 

As you may recall, the UCC provides that where the drawer (here, Insurer) writes an uncertified check, the underlying obligation is suspended until the check is paid or until the check is dishonored, and that, once the check is paid, the obligation is discharged to the extent of the amount of the check.  See 810 ILCS 5/3-310(b)(1). The UCC further provides that a check is considered "paid" to the extent payment is made by or on behalf of a person obliged to pay the check and to a person entitled to enforce the check.  See 810 ILCS 5/3-602(a). 

 

Moreover, where a check is made payable jointly to two or more persons, the check may only be enforced by all of them, and a joint payee, acting alone, is not entitled to enforce the check.  See 810 ILCS 5/3-110(d). 

 

Finally, where a payor bank pays a person not entitled to enforce a check, such as a joint payee who forged the signature of a co-payee, the co-payee may sue the payor bank for conversion, or sue the drawer for enforcement of a lost, destroyed, or stolen instrument, but not on the underlying contract.   See 810 ILCS 5/3-420; 810 ILCS 5/3-309; 810 ILCS Ann. 5/3-310 Comment  4 (providing two potential remedies:  sue drawer of funds under Section 3-309 for enforcement of a lost, destroyed, or stolen instrument; or sue the payor bank under Section 3-420 for conversion).

 

Noting there was no dispute in this case that the contractor was not entitled to enforce the checks because of the forged indorsements, the Appellate Court concluded that Bank could not sue Insurer on the insurance policy itself but could sue the payor bank for conversion.  In so ruling, the Court agreed with Insurer that Bank could not sue it as the drawer under Section 3-309 for the enforcement of a "lost, destroyed, or stolen instrument" because the checks had been cashed by the contractor rather than lost or stolen.    

 

Accordingly, pointing out that Bank had not cited any other UCC provisions that allow a payee to sue a drawer of a check, the Court determined that Bank's only remedy was to sue the payor bank for conversion under Section 3-420, thus rejecting Bank's assertion that it should be allowed to sue Insurer on the underlying contract.  As the Court explained, the Illinois Appellate Court decisions on which Bank relied predated the passage of Section 3-310 under which Insurer's obligation on the underlying insurance contract was suspended, and, because the checks were not properly "paid" under Section 3-602(a), "the suspension of the underlying obligation continues . . . ."

 

The Appellate Court thus affirmed the lower court's grant of summary judgment in favor of Insurer.

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

Admitted to practice law in Illinois

 

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FYI: Cal App Ct Rejects Borrower's Anti-Deficiency, "One Form of Action," TARP, and Unclean Hands Defenses to Collection Following Short Sale

The California Court of Appeal for the Fifth District recently held that California's amendments to its short sale anti-deficiency statute does not apply retroactively, and thus the lender was not precluded from seeking a deficiency judgment where the borrower and lender agreed to a short sale as to a second lien loan, with the parties agreeing that the borrower will repay the remaining balance due, before the statute was amended.

 

The Court also affirmed the lower court's ruling that California's "one form of action" rule did not apply to the lender's action seeking a deficiency judgment, because the parties agreed to a short sale, thereby waiving any rights under said rule, lender exhausted the security before seeking a deficiency judgment, and multiple actions were not initiated against Borrower.

 

Additionally, the Court rejected the borrower's argument that the federal Troubled Asset Relief Program ("TARP") applied to the lender's deficiency judgment action because the borrower did not raise this issue at trial, holding that the borrower failed to cite to authority supporting her position, and that there is no private cause of action available under this statute.

 

The Court also held the doctrine of unclean hands did not preclude the lender from recovering a deficiency judgment.  Because the short sale agreement was not a coercive transaction, there was nothing inequitable or prejudicial to Borrower regarding the terms of the short sale.

 

A copy of the opinion is available at: http://www.courts.ca.gov/opinions/documents/F064109.PDF.

 

Borrower obtained a home equity line of credit from Lender, which provided a credit limit to Borrower in the principal amount of $250,000 ("Home Equity Loan"), secured by a second deed of trust on certain real property.  After the first lien holder initiated non-judicial foreclosure proceedings on the property, Borrower sought to avoid foreclosure by requesting that Lender agree to a short sale, which would satisfy the first lien and $27,000 of Lender's lien.  In exchange, Borrower would agree to continue to repay Lender under the Home Equity Loan.

 

After Borrower defaulted on her obligation under the Home Equity Loan, Lender initiated an action for deficiency judgment.  The trial court awarded summary judgment to Lender, holding that Lender met its initial burden in establishing breach of contract. 

 

Borrower appealed, arguing that California Code of Civil Procedure sections 508e (anti-deficiency statute relating to short sales) and 726 (the one form of action rule) precluded Lender from seeking a deficiency judgment.  Additionally, Borrower argued that the doctrine of unclean hands prevents Lender from recovering a deficiency judgment, and that Lender was required to modify the Home Equity Loan under TARP.  Lastly, Borrower asserted that a genuine issue of material fact existed, and therefore summary judgment was not proper.

 

The Court first addressed Borrower's argument that section 508e bars Lender's action.  The original version of section 580e provided that no deficiency judgment may be rendered against a homeowner "under a note secured by a first deed of trust" if the holder of the first deed of trust consented in writing to a short sale and received the proceeds thereof.  In that event, the short sale proceeds received by the holder of the first deed of trust would result in a discharge of the remaining indebtedness.  Stats. 2010, ch. 701, § 1, West's Cal. Sess. Laws, vol. 3, p. 3967.  After the execution of the short sale agreement here, section 580e was amended to expand the anti-deficiency protection in the event of a short sale to any deed of trust, including junior lienholders, if the holder of said deed of trust consented to the short sale and received the proceeds of the sale as agreed.

 

The Court held that the California legislature did not intend for the amendment to section 508e to apply retroactively.  As you may recall, there is a strong presumption against retroactive application of legislation.  See McClung v. Employment Development Dept., 34 Cal. 4th 467, 475 (2004).  This presumption applies unless there is express language of retroactive application.

 

The Court found that the California Legislature enacted the amendment with prospective application in mind, and did not intend any retrospective application.  The Legislature stated it was seeking "to encourage the approval of short sales as an alternative to foreclosure."  Based upon the intent of the Legislature and taking into consideration that the parties agreed to the short sale under the laws that existed at that time, the Court held it would be unfair to retroactively apply the amendment to section 508e.

 

Next, the Court analyzed the application of section 726.  As you may recall, section 726 is both a "security-first" and "one-action" rule:  it compels the secured creditor, in a single action, to exhaust its security judicially before it may obtain a monetary "deficiency" judgment against the debtor.  If a creditor brings an action on the debt before foreclosing the security, the borrower may raise section 726 as an affirmative defense, which requires the creditor to foreclose the security before seeking a deficiency judgment. 

 

The Court also examined four instances in which section 726 does not apply.  Notably, a debtor can waive the protection of section 726 by failing to insist that the creditor first proceed against the security, or by consenting to an arrangement in which the beneficiary of the trust deed relinquishes the security without retiring the note.

 

The Court reasoned that because Borrower and Lender entered into a short sale agreement whereby Lender agreed to release its lien in exchange for Borrower's promise to continue to repay the obligation, Borrower waived its right to assert section 726.  Because Borrower and Lender agreed to a short sale, preventing a foreclosure, Borrower could not complain that Lender did not proceed through a foreclosure action.  Moreover, the security was exhausted through the short sale, and Borrower was not subject to multiple actions, as a short sale is not an "action" that is subject to section 726. 

 

Next, the Court examined Borrower's claim that under TARP, Lender was required to modify her loan.  However, the Court noted that the Borrower improperly failed to raise this issue with the trial court. 

 

Moreover, even if Borrower had raised this issue below, the Court held that Borrower failed to provide adequate citation to authority supporting her claim that TARP provided a defense to Lender's action.  Lastly, because TARP was established as part of the Emergency Economic Stabilization Act, which has been consistently construed to create no private rights or private causes of action on the part of borrowers, the Court rejected Borrower's arguments. 

 

The Court also rejected Borrower's claim that the doctrine of unclean hands precluded Lender's action.  As you may recall, "the [unclean hands] doctrine demands that a plaintiff act fairly in the matter for which he seeks a remedy. He must come into court with clean hands … or he will be denied relief, regardless of the merits of his claim." Kendall-Jackson Winery, Ltd. v. Superior Court, 76 Cal. App. 4th 970, 978 (1999). 

 

The Court held that Borrower failed to present any evidence that the short sale agreement constituted a coercive or unconscionable transaction.  The Court also held there was nothing inequitable or prejudicial to Borrower in terms of the short sale agreement -- Lender consented to the short sale as Borrower requested, subject to the understanding that Borrower would remain responsible for repaying the Home Equity Loan.

 

Lastly, the Court rejected Borrower's argument that summary judgment was improper due to a triable issue of fact.  Borrower argued that Lender's statement indicated that the first deed of trust had been foreclosed, which was an evident error that neither party relied on, as both parties understood the real property was sold via a short sale.

 

Accordingly, the Court affirmed the lower court's grant of summary judgment in Lender's favor.

 

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

Admitted to practice law in Illinois

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

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