Friday, April 25, 2014

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

Monday, July 29, 2013

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:

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.

Eric Tsai
McGinnis Wutscher Beiramee LLP
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