July 25, 2013
Dear constituency list members of the Insolvency Law Committee, the following is a legislative update that may be of interest to insolvency professionals:
SUMMARY
On July 11, 2013 Governor Brown signed into law SB 426 which expands the anti-deficiency language in Code of Civil Procedure (“C.C.P.”) sections 580b and 580d by expressly prohibiting not only: (i) a deficiency judgment against the borrower in connection with either a “purchase money” deed of trust covered under C.C.P. §580b or following a non-judicial foreclosure of a deed of trust covered under C.C.P. §580d, but now also (ii) any liability for any deficiency in the foregoing situations. However, SB 426 expressly recognizes the right of a lender to collect any such deficiency from any additional collateral held or from any third-party guarantor.
As discussed herein, the new statute could be viewed as “clarifying” rather than “amending” existing California law so that when it becomes effective, it will apply to deficiency obligations then existing and held by any lender or its assignee.
A. New Legislation (C.C.P. §§580b and 580d)
Prior to the enactment of SB 426, C.C.P. § 580b prohibited a deficiency judgment in connection with the following: (1) any sale of real property for failure of the purchaser to complete the contract of sale;(2) under a deed of trust given to the vendor to secure repayment of the purchase price of the encumbered property; (3) under a deed of trust on residential property given to a lender to secure repayment of a loan (“purchase money loan”) used in whole or in part to pay for the purchase price of a residence to be occupied, in whole or in part, by the purchaser; or (4) a loan used to refinance a purchase money loan except to the extent that the lender advanced new principal to the borrower which was not used to repay existing principal or interest or loan fees and costs.
Similarly, prior to the enactment of SB 426, C.C.P. §580d prohibited a deficiency judgment on a note secured by a deed of trust on real property in any case in which the property had been sold under a power of sale (i.e. a non-judicial foreclosure).
SB 426 clearly provides that not only is a deficiency judgment prohibited, but that no deficiency shall be collected or even owed in such situations. However, such protections apply only to the borrower and to its non-encumbered assets. The statute expressly provides that although a deficiency may not be collected from the borrower, the new provisions do not affect the liability: (i) of any guarantor, pledgor or any other surety might have with respect to the deficiency; or (ii) that might be satisfied in whole, or in part, from other collateral pledged to secure the obligation that is the subject of the deficiency.
B. C.C.P. §580e
Although SB 426 does not expressly address C.C.P. §580e, any deficiency subject to C.C.P. §580e will be similarly affected.
C.C.P. §580e (a)(1) provides that no deficiency may be collected and no deficiency judgment may be requested for a loan secured solely by a residence in any case where the lender agrees to a short sale and receives any agreed portion of the sale proceeds. However, C.C.P. §580e(a)(2) simply prohibits a deficiency judgment, and does not prohibit collection of any deficiency in those situations where the lender has other collateral securing its loan in addition to the residence.
Although SB 426 does not address C.C.P. §580e(a)(2), its prohibition of the collection of any deficiency will apply to a short sale covered under §580e(a)(2) because C.C.P. §580e(a)(2) expressly provides that the “rights, remedies, and obligations of any holder, beneficiary, trustor, mortgagor, obligor, obligee or guarantor of the note … shall be treated and determined as if the dwelling had been sold through foreclosure under a power of sale contained in deed of trust … in the manner contemplated by Section 580d”.
In other words, the lender’s right to collect a deficiency under C.C.P. §580e(a)(2) will be treated (i.e. prohibited) just as if the lender had conducted a foreclosure under C.C.P. §580d.
C. Extent of Application of SB 426
If a statute is merely declaratory of or clarifies existing law, it will be applicable to all existing covered transactions that exist as of the date that the statute goes into effect. From the present case law, it could be concluded that under existing case law a lender would be precluded not only from obtaining a deficiency judgment under C.C.P. §§580b and 580d, but also would be prohibited from collecting any deficiency owed under the subject obligation.
First, case law is clear that C.C.P. §§580b and 580d do not prevent a secured creditor from collecting the deficiency from additional collateral. Freedland v. Greco (1995) 45 Cal.2d 462, 466; Hatch v. Security-First Nat. Bank (1942) 19 Cal.2d 254, 260-61; Mortgage Guarantee Co. v. Sampsell (1942) 51 Cal.App.2d 180, 183-86; see also Paradise Land and Cattle Co. v. McWilliams Enterprises, Inc., 959 F.2d 1463 (9th Cir. 1992) (permitting a secured creditor to collect against a third party guarantor or surety).
Second, a number of California decisions have expressly acknowledged that the purpose of C.C.P. §§580b and 580d was to prevent a borrower from being obligated to repay the unpaid balance of a loan (i.e. the deficiency) following any foreclosure on the real property collateral. The oft-repeated explanation is stated in Cadlerock Joint Venture L.P. v. Lobel (2012) 206 Cal. App.4th 1531:
The anti-deficiency statutes are to be construed liberally to effectuate the legislative purposes underlying them, including the policies ‘ “… (2) to prevent an overvaluation of the security, (3) to prevent the aggravation of an economic recession which would result if [debtors] lost their property and were also burdened with personal liability, and (4) to prevent the creditor from making an unreasonably low bid at the foreclosure sale, acquire the asset below its value, and also recover a personal judgment against the debtor.” ’ ” (emphasis added)(internal citations omitted)
Similarly there is other oft-repeated language from the California Supreme Court in Alliance Mortgage Co. v. Rothwell (1995) 10 Cal.4th 1226:
Thus, the anti-deficiency statutes in part “serve to prevent creditors in private sales from buying in at deflated prices and realizing double recoveries by holding debtors for large deficiencies.” (Commonwealth Mortgage Assurance Co. v. Superior Court (1989) 211 Cal.App.3d 508, 514 (emphasis added)
Further, it has regularly been held in cases such as Walters v. Marler (1978) 83 Cal.App.3d 1147 that C.C.P. §580b has the additional public policy of putting the risk of loss from a shortfall in the value of the collateral on the lender. Therefore, it would be illogical to permit recovery of the deficiency from the borrower:
Section 580b of the Code of Civil Procedure prohibits a foreclosing mortgagee from proceeding personally against a mortgagor to recover a deficiency after the security is exhausted, and places the full risk of inadequate security on the purchase money lender. (internal citations omitted)
Case law is clear that the anti-deficiency laws under C.C.P. §§580b and 580d are to be interpreted broadly to accomplish the purposes of the statutes. Thus, the conclusion could be drawn that the chief purpose of C.C.P. §580d and one of the chief purposes of C.C.P. §580b is to prevent the borrower from being liable for any deficiency. As a result, it is likely that SB 426 could be held to be declaratory of existing law. A credible argument therefore could be made that immediately upon SB 426 becoming effective, it will apply to all outstanding deficiency obligations, regardless whether the deficiency was created before or after the enactment of SB 426. This conclusion remains to be confirmed by the case law interpreting this new statute.
D. Applicability to Assignees of Deficiency Obligations
Finally, it is currently not uncommon for certain lenders which hold notes or loans subject to C.C.P. §§580b and 580d to sell such notes/loans following the foreclosure on the underlying residences to debt collection agencies at a discount. Usually this is done without representation or warranty as to collectability of such assets.. It is also not uncommon for the assignees to press the borrowers for payment on the deficiency.
However, California case law makes it clear that if a loan is subject to C.C.P. §§580b or 580d, the prohibition against deficiency judgments will apply to any third-party assignee of the note/loan. Costanzo v. Ganguly (1993) 12 Cal.App.4th 1085. It would be prudent for lenders and their assignees to take account of this prohibition in their actions.
These materials were prepared by Peter S. Muñoz (pmunoz@reedsmith.com) of Reed Smith LLP, in San Francisco, California. Editorial contributions were provided by ILC member Monique Jewett-Brewster of Bryan Cave LLP, in San Francisco, California.
Thank you for your continued support of the Committee.
Best regards,
Insolvency Law Committee