Friday, April 25, 2014

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

Friday, August 2, 2013

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:

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. 

Eric Tsai
McGinnis Wutscher Beiramee LLP
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