Wednesday, April 23, 2014

FYI: Cal App Ct Allows Claim for Impairment of Collateral/Security Following Non-Judicial Foreclosure Sale of Property

Tuesday, July 3, 2012

The California Court of Appeal, Third District, recently held that the holder of a loan was not barred from asserting a claim for "bad faith waste" following a non-judicial foreclosure sale, where the developer had demolished a building on the property and failed to produce evidence that the demolition was caused "solely or primarily [by] economic pressures of a market depression." 
A copy of the opinion is available at: 
A real estate developer ("Developer") purchased real estate with a seller-financed loan, intending to tear down the existing building and to redevelop the property into a mixed-use commercial development.  The loan was secured by a deed of trust against the property and was eventually transferred to the plaintiffs ("Plaintiff Holders").  Starting the development project, Developer tore down the building.  However, prior to beginning any new construction, Developer defaulted on the loan.
Plaintiff Holders initiated non-judicial foreclosure proceedings pursuant to the deed of trust, and purchased the property at the foreclosure sale for a small fraction of the amount owed on the loan.  A few months later, alleging in part that Defendants committed waste and impaired Plaintiff Holders' security by demolishing the building, Plaintiff Holders sued Developer as well as the project and construction directors (collectively, "Defendants") for "bad faith" waste and intentional and negligent impairment of the security.

Moving for summary judgment, Defendants argued that their conduct did not constitute "bad faith" waste, as they intended to add value to the property and, as such, lacked any improper intent.  They also argued that a claim for intentional impairment was derivative of the waste cause of action, and thus could not survive without evidence of "bad faith."  Defendants also asserted that the non-borrower project and construction directors were Developer's innocent agents and were therefore not liable for Developer's torts. 
In response, Plaintiff Holders argued that the claim of bad faith waste merely required that Defendants acted intentionally in demolishing the building, and that there was a triable issue as to whether Defendants knew of the security interest and owed a duty to exercise reasonable care not to eliminate that interest.
Relying on the California Supreme Court's opinion in Cornelison v. Kornbluth, 15 Cal. 3d 590 (1975), the trial court ruled in part that absent recklessness and intent to despoil at the time of the demolition, the bad faith waste cause of action could not be maintained.  The trial court also agreed that the Developer's non-borrower agents should not be held liable if Developer itself was protected from liability. 
The trial court granted summary judgment in favor of Defendants.  Plaintiff Holders appealed.  The Court of Appeal reversed and remanded, ruling that under a proper reading of Cornelison, Plaintiff Holders were not barred from asserting a claim for bad faith waste.
The Appellate Court began its analysis with a detailed review of the Cornelison opinion, which explained that waste is conduct on the part of the person in possession of secured property that substantially impairs the security interest in the property, even if the person is not personally liable on the promissory note.  The Court also observed that Cornelison specifically defined "bad faith" waste as any waste that is not committed solely or primarily as a result of economic pressures of market depression. 
Noting that the Cornelison decision hinged largely on the California Supreme Court's analysis of state anti-deficiency statutes, and the public policy to preclude the imposition of personal liability on defaulting borrowers where land values are caused by a decline in the economy, the Court of Appeal stressed that a proper interpretation of Cornelison mandated a result different from that reached by the trial court. 
In so doing, the Appellate Court noted Cornelison's distinction between conduct that impairs the value of the property because of an economic downturn, and conduct that impairs the value of property that is not solely or primarily . . a result of the economic pressures of a market depression." Cornelison v. Kornbluth, supra, 15 Cal. 3d at 604.  Under Cornelison, the Court noted, damages for waste resulting from economic pressures would be the functional equivalent of a deficiency judgment, and would thus be prohibited under the anti-deficiency statutes.  On the other hand, damages for waste resulting from other causes would not be the functional equivalent of a deficiency judgment, and therefore would not be precluded under the anti-deficiency statutes.
Observing that Cornelison specifically listed "reckless, intentional, and at times even malicious despoil[ing] of property" as examples of conduct not resulting from economic pressures, the Court of Appeal interpreted Cornelison as also allowing claims for "bad faith" waste "whenever the owner's impairment of the value of the security is not caused by economic pressures of a market depression, whether the owner acts recklessly, intentionally, maliciously, or with some other mental state."

Accordingly, the Appellate Court ruled that even though the building demolition was the result of good intentions to redevelop and add value to the property, the dispositive question for the trier of fact was whether the demolition was caused by the economic pressures of a market depression or by something else.

The Court also ruled that Defendants may be held liable for intentional impairment of the security, because they had failed to show that "intent to harm" was a required element of the cause of action. 

Similarly, reasoning that third-parties could be held liable for negligent impairment of security, the Court ruled that the negligent impairment claim could go forward against the non-borrower defendants partly in light of their participation in the demolition of the building.

Eric Tsai
McGinnis Wutscher Beiramee LLP
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