If one begins with the basic tenet that financial institutions ‘run the show’ in the area of monetary matters, then the entirety of the procedural structures for the enforcement of obligations secured by real property make sense. With the exception of legislation passed in California in the 1930’s in the midst of the Great Depression, there have been no protections favorable to borrowers using real property as security for their obligations put into place since that time. One should also remember that during this same time period significant changes were made in The Bankruptcy Statute of 1898 through the Chandler Act that went into effect in June of 1938, with a series of changes through 2019.
California has been a “Trust Deed” state since the enactment of the first ‘codes’ in 1872, that were carried here from New York in the form of the “Field Code”. The specific borrower protection provisions (with the date of the original enactment) in the area of real property security transactions (other than truth in lending and related State and Federal requirements that are outside the scope of this article) are as follows:
- CC §2953 (1937 and subsequently amended in 1939, 1941) – a BORROWER cannot waive his/her/its rights under CC §§2924, 2924b, 2924c or CCP§§ 580a or 726 and such waiver is “void and of no effect” – a statement of Public Policy.
- [CC §§2924, 2924b and 2924c relate to nonjudicial foreclosure sales under the Power of Sale in a deed of trust that are outside the scope of this presentation]
- CCP §580a (and subsequently amended in 1933, 1968, 1982, 1988) permits a deficiency following a nonjudicial foreclosure of real property security, but is totally contradicted by CCP §580d (1940 and subsequently amended in 1989) which prohibits a deficiency on a sale under power of sale irrespective of the type of underlying loan. NOTE: CCP §580b statutorily prohibits a deficiency judgment (via judicial action) on a purchase money obligation.
- CCP §726 (1933 and subsequently amended in 1937, 1963, 1967, 1968, 1970, 1982, 1983, 1987, 1989 and 1992) sets out the procedural framework for a judicial action for the recovery of a debt secured by a mortgage or deed of trust.
- NOTE: Under CC §2856 (1996) A GUARANTOR OR SURETY CAN WAIVE, among other rights or defenses, any rights that are “based upon, directly or indirectly, the application of Section 590a, 580b, 580d or 726 of the Code of Civil Procedure to the principal’s note or other obligation.
The Judicial Foreclosure “Action”
A judicial foreclosure action which will permit a lender to obtain a deficiency judgment arises in a limited context and is spelled out in CCP §726. The obligation sued upon cannot be a ‘purchase money’ obligation because no deficiency will lie (CCP §580b) and the judicial action on the obligation cannot be for a deficiency following foreclosure under power of sale (CCP §580d).
The first step in the judicial foreclosure process is to purchase a “Litigation Guarantee” from a title company which will set forth the names and addresses of all parties having an interest that may be subject to foreclosure who will need to be named in the action. NOTE that the statute of limitations on a promissory note is six (6) years (UCC 3118(a)); most practitioners erroneously believe that it is four (4) years based upon a breach of contract. Next, the action is commenced by the filing of a complaint and the naming of all parties specified by the title company who have an ‘interest’ in the real property. Venue is typically where the real property is located. The plaintiff at a default prove-up or at trial will have to prove up the amount of the debt. The prayer of the complaint will seek ‘foreclosure’ by a court appointed officer (receiver or commissioner) for that purpose. The court appointed officer then will proceed to conduct a sale pursuant to a decree in the Judgment and a subsequent ‘writ of sale’ issued by the court authorizing the sale.
The conduct of the sale is governed by CCP §716.020 and §712.010 et seq. and is enforced like a writ of execution. The court appointed officer then should follow the procedures of CCP §701.540 et seq. (note that the normal 120 day waiting period of CCP §701.545 is expressly obviated by CCP §729.010(b)(2)).
If the Plaintiff will be seeking a deficiency judgment, the property will be subject to a right of redemption only by the judgment debtor or its successor in interest (CCP §§729.010; .020). There is a three month period of redemption after the date of sale if the property is sold for more than the debt and a twelve month period if the sale of the property fails to satisfy the secured indebtedness. CCP §729.030. The procedure for redemption through the judicial process is found at CCP §§729.060 – .080.
The procedure for the obtaining of a deficiency judgment is governed by CCP §726(b). Within three months of the date of the foreclosure sale an application for a deficiency judgment must be filed with the Court for the purpose of conducting a fair value hearing [NOT A FAIR MARKET VALUE HEARING] “at which the court shall take evidence and at which hearing either party may present evidence as to the fair value of the real property or estate for years therein sold as of the date of sale … .” This is where the case law has shifted back to the borrowers when Courts have a chance to weigh in on the issue of valuation and create any “wiggle room” to benefit borrowers. The appraiser is to ignore the fact that the property will carry a one-year right of redemption. The rationale in Rainer Mortgage v. Silverwood, 163 Cal. App. 3d 359 at 366 (1985) was that the lender took that risk, not the borrower. In addition, Courts have held that the appraiser is to look at normal market conditions, and not temporary adverse market conditions. Cornelison v. Kornbluth, 15 Cal. 3d 590 at 600 (1975) a unanimous California Supreme Court held:
“as a consequence during the great depression with its dearth of money and declining property values, a mortgagee was able to purchase the subject real property a the foreclosure sale at a depressed price far below its normal fair market value and thereafter to obtain a double recovery by holding the debtor for a large deficiency. (Citations). In order to counteract this situation, California in 1933 enacted fair market value limitations applicable to both judicial foreclosure sales (§726) and private foreclosure sales (§580a) which limited the mortgagee’s deficiency judgment after exhaustion of the security to the difference between the fair value of the property at the time of the sale (irrespective of the amount actually realized at the sale) and the outstanding debt for which the property was security. Therefore, if, due to the depressed economic conditions, the property serving as security was sold for less than the fair value as determined under §726 or §580a, the mortgagee could not recover the amount of that difference in his action for a deficiency judgment.
Accord: Rainer Mortgage, supra, at 363.
Why Would a Lender Proceed With a Judicial Foreclosure?
- The borrower is solvent, the obligation is non-purchase money, and enough potential deficiency is present to justify litigation
- A judicial foreclosure action is often combined with a nonjudicial foreclosure when the lender wants to get a receiver appointed under CCP §564(b)(2). The nonjudicial foreclosure will later moot out the judicial foreclosure action, but the receiver is in place collecting rents, etc.
- There is a solvent guarantor and the guarantee does not have sufficient waivers for the lender to proceed to collection after a nonjudicial foreclosure sale
- A negotiation can take place between lender and borrower for an agreed upon deficiency under a side settlement agreement
Why Wouldn’t a Lender Proceed With a Judicial Foreclosure?
- The transaction does not qualify for a deficiency judgment
- The lender wants to get the property back in 120 days
- The lender wants to avoid litigation
- NOTE: A lender doing nothing does not eliminate the ‘sold-out junior’ situation. A senior lienholder can foreclose, and the junior lender with a non-purchase money loan can simply sue on the then created ‘unsecured obligation’ with a six year statute of limitations from the date of breach (UCC 3118(a). It is anticipated that many thousands of these loans (HELOCS) will be bundled and sold for pennies on the dollars to collection agencies which will create havoc for borrowers for many years to come.
The area of judicial foreclosure is complex. However, understanding the motivations and the realities of the present economic climate will enable parties to navigate the process with success.
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