The California Court of Appeal, Second District, recently reversed a judgment which subordinated a senior lienholder to a mechanic’s lien where the senior lienholder completed its foreclosure after it had accepted a deed-in-lieu of foreclosure from the former owner. The mechanic’s lienholder argued that the doctrine of merger subordinated the senior lienholder when it accepted the mechanic’s lien. However, the Court held that “[u]nder well-established California law, the senior beneficiary’s lien and title ordinarily do not merge when a deed in lieu of foreclosure is given if there are junior lienholders of record.”
A copy of this opinion is available at: http://www.courts.ca.gov/opinions/documents/B248491.PDF
As you may recall, “[t]itle conveyed by a trustee’s deed [i.e., in a foreclosure sale] relates back in time to the date on which the deed of trust was executed. The trustee’s deed therefore passes the title held by the trustor as of that earlier time plus any after-acquired title, rather than the title that the trustor held on the date of the foreclosure sale. Liens that attached to the property after execution of the foreclosed deed of trust are therefore eliminated or ‘sold out,’ and the purchaser at the trustee sale takes title to the property free of those junior liens.” 1 Bernhardt, Cal. Mortgages, Deeds of Trust, and Foreclosure Litigation (Cont.Ed.Bar 4th ed. 2014) §2.99, pp. 2-111 to 2-112 (internal citations omitted.)
In contrast, “[a] conveyance by a trustor through a deed in lieu of foreclosure (as opposed to a foreclosure deed) passes title to the transferee subject to all existing liens … If the grantee is the beneficiary under [a] senior deed of trust, under traditional merger concepts, its lien would normally merge into its title and be destroyed, but this would have the effect of making its title subject to the (former) junior deed of trust, which is clearly not the result that  parties intend.” Id. at §7.17, p. 7-23.
In 2008, Borrower purchased property with the proceeds of a purchase money loan from Lender. The loan was secured by a first-position deed of trust. Later in 2008, Borrower hired Contractor to make improvements to the property.
In 2009, Contractor recorded a mechanic’s lien against the property and filed suit for breach of contract and quiet title. Later, in September 2009, Lender recorded a notice of default and election to sell under its deed of trust, stating that Borrower was in default on the loan.
In November 2009, Borrower transferred the property to Lender by grant deed in lieu of foreclosure (the “deed-in-lieu”). The deed-in-lieu expressly provided that “[t]he Indebtedness shall remain in full force and effect after the date hereof. The interest of Grantee in the Property upon effectuation of the transfers, assignments or conveyances as provided in this Grant Deed shall not merge with the interest of Lender pursuant to the Loan Documents, but shall be and remain at all times separate and distinct, and the Loan Documents shall be and remain at all times valid and continuous liens on the Property.”
In December 2009, the trustee recorded a notice of trustee’s sale. In January 2010, Lender recorded a trustee’s deed upon sale, stating that Lender (i.e., the owner of the Property under the deed in lieu of foreclosure) was the foreclosing beneficiary under the deed of trust and purchased the Property at the foreclosure sale.
At trial, Contractor argued that Lender’s interest in the property merged with Borrower’s interest in the property when it accepted the deed-in-lieu. According to Contractor, due to the merger, Contractor’s lien on the property became senior to Lender’s lien on property. The trial court agreed, and held that “the mechanics lien has priority and was not extinguished by the sale of the property to [Lender].”
The California Appellate Court reversed the trial court’s judgment.
The Appellate Court noted that “[u]nder well-established California law, the senior beneficiary’s lien and title ordinarily do not merge when a deed in lieu of foreclosure is given if there are junior lienholders of record.” The Court relied upon the California Supreme Court’s decision in Davis v. Randall: “‘Merger is always a question of intent when the question is as to whether a mortgage lien is merged in the fee, upon both being united in the same person. Equity will keep the legal title and the mortgagee’s interest separate, although held by the same person, whenever necessary for the full protection of the person’s just rights. If there is an intervening mortgage the acquirement of the title will not operate as a merger.” Davis v. Randall (1897) 117 Cal. 12 (internal citations omitted).
The Appellate Court held that there was no evidence that Lender intended to subordinate its lien to Contractor’s lien. Accordingly, the Appellate Court reversed the trial court’s ruling, and held that “the foreclosure after acceptance of the deed was therefore valid and eliminated all junior liens, including plaintiff’s mechanic’s lien.”
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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