i. What is a deficiency?
A deficiency is “the difference between the amount of the indebtedness and the fair market value of the property…” Garretson v. Post (2007) 156 Cal. App. 4th 1508, 1516. Lets say the mortgage against a property was $500,000. Lets say the fair market value of the property was $300,000. The deficiency would then be $200,000.
California law has long been concerned about deficiencies. For over a century, California has had a dramatic boom-bust cycle, in which real estate prices first go way up and then crash dramatically downward. This cycle threatens property owners with ruin, if they buy property at the peak of the boom, lose the property in foreclosure during the bust and are slammed with personal liability for the deficiency.
To protect property owners, during the Great Depression of the 1930s, California enacted the Anti-Deficiency Laws. Collectively, these laws make it difficult for a lender to collect a deficiency judgment, for real property secured debts. The purpose of these laws is “(1) to prevent a multiplicity of actions, (2) to prevent an overvaluation of the security, (3) to prevent the aggravation of an economic recession which would result if creditors 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.” Torrey Pines Bank v. Hoffman (1991) 231 Cal.App.3d 308, 318 (internal citations omitted).
ii. The California Anti-Deficiency Laws
1. CCP 580b: No deficiency for purchase money loans on owner-occupied residences
a. The scope of CCP 580b protection
The first of the Anti-Deficiency Laws is Code of Civil Procedure Section 580b. It prohibits deficiency judgments after the foreclosure of a purchase money mortgage or deed of trust. It applies only to residential properties, of one to four units, occupied in whole on in part by the borrower. “Under 580b, a vendor taking back a purchase money trust deed may look only to the security for recovery of the debt; no deficiency judgment will lie following a sale under the trust deed. The vendor thus assumes the risk that the value of the security may become inadequate” Lawler v. Jacobs (2000) 83 Cal. App. 4th 723, 732.
When you sign loan documents, there are often pages of “fine print.” If you read the fine print, you will find that lenders often seek to have the borrower waive the protection of laws enacted to guard borrowers. If a lender tries this with CCP 580b, however, the waiver is not enforceable. The protections of CCP 580b cannot be waived, either at the time that the loan is made or later. DeBerard Properties, Ltd. v. Lim (1999) 20 Cal. 4th 659.
What happens if a purchase money mortgage or deed of trust is in junior position, and the senior mortgage forecloses first, and wipes out the junior? As long as the junior mortgage or deed of trust was a purchase money lien, at the time that the loan was made, Section 580b prevents the lender from suing on the note, even though the security is now worthless. Brown v. Jensen (1953) 41 Cal. 2d 193, 197; Raub v. Lee (1960) 181 Cal.App.2d 529.
Section 580b prohibits a lender from suing the borrower, after a foreclosure, for the deficiency. It does not prevent a lender from taking additional actions under the loan documents. If, in addition to the real property mortgage or deed of trust, the lender has a security interest against personal property, the lender may pursue the personal property collateral. Christopherson v. Allen (1961) 12 Cal. Rptr.
b. What is a purchase money loan for CCP 580b purposes?
Under Section 580b, the critical question is whether a given loan is or is not a purchase money loan. This is determined at the time that the loan is created. If a loan is purchase money, it does not cease to be so because new notes are exchanged on substantially similar terms, DMC, Inc. v. Downey Savings & Loan Association (2002) 99 Cal. App. 4th 190, or because the property is transferred to a new owner, who either formally assumes the loan or simply takes the property subject to the loan. Frangipani v. Boecker (1998) 64 Cal. App. 4th 860.
To qualify as a purchase money loan, it is not necessary that every dime of the loan go to the purchase price. A loan is still a purchase money loan, under CCP 580b, even if some of the loan money goes to termite work, roof repairs and closing costs, as long as all of the expenses were necessary to complete the closing. Shephard v. Robinson (1981) 128 Cal. App. 3fd 615. Separate loans, however, made for improvements to the property, not necessary to complete the purchase, do not get purchase money protection. Allstate Savings & Loan Association v Murphy (1979) 98 Cal. App. 3rd 761 (Loan made to build swimming pool not a purchase money loan under 580b.)
c. Exceptions to CCP 580b
i. The lender can sue for fraud
The lender can sue the borrower for fraud in persuading the lender to make the loan in the first instance. Birman v. Loeb (1998) 64 Cal. App. 4th 502.
ii. The lender can sue for waste
If the borrower, in bad faith, deliberately damages the collateral of the lender, then the lender can sue for “waste”, i.e. for damaging the lender’s collateral. Evans v. California Trailer Court, Inc. (1994) 28 Cal. App. 4th 540.
iii. The lender can sue in non-standard transactions
In the landmark case, Spangler v. Memel (1972) 7 Cal. 3rd 603, the California Supreme Court created a major exception to the protections of 580b. In that case, a residence had been sold for $90,000, with the buyer paying $26,100 and the seller taking back a $63,900 deed of trust. The parties agreed that the buyer was going to tear down the house, and build an office building on the site. In order to finance the office building, the buyer took out a construction loan of $450,000. The original seller agreed to subordinate its purchase money loan to the construction loan.
The buyer defaulted to the construction lender, who foreclosed, which wiped out the purchase money junior loan. Since there was no question that the junior loan was purchase money, under Brown v. Jensen (1953) 41 Cal. 2d 193, 197, the original seller ordinarily would not have been able to sue on her sold-out note.
The Supreme Court, however, held that 580b only applied to the “standard transaction” where the seller “sells the property to a purchaser who is going to continue the same or similar use of the property.” In the standard transaction, the Court reasoned, it is fair to put the risk of loss until the seller, since the seller knows how much the property is worth. When, however, the buyer plans to radically alter his or her use of the property, it is not fair to put the risk of loss until the seller. The Court thus held that the seller, in this case, could sue under sold-out junior note.
Using similar logic, the Court of Appeal in Nickerman v. Ryan (1979) 93 Cal. App. 3rd 564, held that 580b did not apply to a transaction in which a note and deed were given to an ex-wife to equalize a division of former community property.
2. CCP 580d: No deficiency after a non-judicial foreclosures
The simplest and most far-reaching aspect of the Anti –Deficiency Laws is CCP 580d. It provides that, if a lender forecloses upon a mortgage or a deed of trust, via a non-judicial foreclosure, it cannot recover a deficiency judgment. The rule could hardly be simpler; if a lender wants a deficiency judgment, it must foreclose judicially.
There are some very limited exceptions to this rule. As with CCP 580b, the lender may sue the borrower for fraud in persuading the lender to make the loan in the first instance. Further, the lender may sue the borrower for “waste” for damaging the collateral. Romo v. Stewart Title of California (1995) 35 Cal. App. 4th 1609. In both cases, however, the lender cannot sue, if it makes a full-credit bid at the non-judicial foreclosure sale. If it makes a full-credit bid, the lender is considered fully paid, so it cannot sue under any other theories. Kolodge v. Boyd (2001) 88 Cal. App. 4th 349.
3. CCP 726: The One Form of Action Rule
a. Secured creditor must pursue collateral first
One of the least understood, but most important, of the California Anti-Deficiency Laws is CCP 726(a), the “One Form of Action Rule.” It provides that, “A secured creditor can bring only one lawsuit to enforce its security interest and collect its debt.” Security Pacific National Bank v. Wozab (1990) 51 Cal. 3rd 991, 997. Under this rule, the creditor is supposed to pursue its collateral first; it is permitted to seek a personal judgment against the borrower, only after exhausting its collateral.
If the lender ignores this rule, and brings a personal lawsuit against the borrower, or takes any other action to collect upon the debt, without having first foreclosed on the real property security, this gives the borrower two options.
First, the borrower can raise CCP 726(a) as an affirmative defense against the lawsuit, which will delay the lawsuit and force the creditor “to exhaust the security before he [or she] may obtain a money judgment against the debtor for any deficiency.” Roseleaf Corp. v. Chierighino (1963) 59 Cal. 2d 35, 38-39.
Second, the borrower may permit the lawsuit against him or her to proceed to judgment, but, in that case, the creditor will be held to have made “an election of remedies, electing the single remedy of a personal action, and thereby waiv[ing] his [or her] right to foreclose on the security or to sell the security under a power of sale.” Roseleaf Corp. v. Chierighino, ibid. In short, if the borrower goes forward with a personal lawsuit, it loses it mortgage or deed of trust; it no longer has a lien against the property.
This rule can be quite harsh to creditors, in practice. In Security Pacific National Bank v. Wozab (1990) 51 Cal. 3rd 991, the bank was owed approximately one million dollars, which was secured by real property. The bank made the mistake of grabbing approximately $3,000 out of the borrower’s checking account, using the power of set off. The Supreme Court held that, by setting off the $3,000, the bank lost its lien against the real property. The one million dollar debt was still owing, but it was no longer secured by the real property.
A similar result occurred in In re Prestige Limited Partnership – Concord (9th Cir. 2000) 234 F. 3rd 1108. In that case, a lender had a lien against the borrower’s real property. It lost that lien, however, by attaching and levying upon unpledged assets of the general partner of the limited partnership, which was it, the general partner of the borrower. As these cases show, it is very risky for a secured creditor to do anything to collect upon a real property secured debt, without first seeking to foreclose upon the real property.
b. Exception: Secured creditor need not pursue “environmentally impaired” collateral, CCP 726.5
The One Form of Action rule forces the secured lender to look primarily to its real property collateral to be paid its debt. Real property collateral, however, can be a liability, not an asset, if it is contaminated by toxic waste. Under the federal Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. Section 9601 et. seq. (“CERCLA”), any one who owns land, which is contaminated by toxic waste, is potentially liable for the potentially astronomical costs of cleaning up the land. Secured lenders thus need to be very wary about foreclosing upon contaminated properties.
CCP Section 726.5 permits lenders sometimes to escape the rigors of the One Form of Action if the real property collateral is “environmentally impaired.” “Environmentally impaired” means that the costs to clean up the property are 25% or more of the fair market value of all security for the loan and the lender did not have actual knowledge of the problem at the time that the loan was made. CCP 726.5(e)(3).
If the property is “environmentally impaired”, the lender is permitted to waive its lien against the impaired property. It can then obtain a personal judgment against the debtor, and/or pursue other collateral. Before the lender may do this, however, it must obtain a court order, valuing the property and determining that it is “environmentally impaired.” Further, the lender has none of these special rights, if the environmental problem was not, to some degree, caused by or contributed to by the lender or some party affiliated with it. CCP 726.5(d).
There are several statutes associated with this law. First, Civil Code Section 2929.5 gives the lender the right to inspect the property, under certain circumstances, to see if there are environmental problems. Second, CCP Section 564(c) permits the lender to have a receiver appointed to investigate environmental issues on the land. Finally, CCP Section 736 permits a secured lender to sue a borrower for breach of contract, under certain circumstances, if it breaches any environmental provision in the loan documents. (Well-drafted loan documents now contain contractual promises that the borrower will not permit any environmental contamination to occur on the land
iii. When are guarantors liable for deficiencies?
A peculiarity of California Anti-Deficiency Law is that guarantors of secured debts are often in a worse legal position than are the primary debtors. As discussed in other sections, most of the protections of the California Anti-Deficiency Laws cannot be waived. Thus, lenders cannot get around the Anti-Deficiency Laws, by putting waivers of their protections into the fine print; such waivers generally are not enforceable.
That is true, however, primarily for primary borrowers. In many areas, it is not true for guarantors. Guarantors are able to waive the protections of the Anti-Deficiency Laws. Civil Code Section 2856(a). Thus, if the lender’s guarantee is drafted properly – meaning that it waives every right given to the guarantor or the borrower under each of the Anti-Deficiency Laws, and all other laws benefiting guarantors -- the guarantor can often be in a far weaker position than the primary borrower.
The position of guarantors is so bad, under the law, that there is a fair amount of case law on the often-litigated question of whether a person is a “true guarantor” or simply the primary borrower in another form. Torrey Pines v. Hoffman (1991) 231 Cal. App. 3rd 308, involved the situation where the borrower was a revocable living trust, and the guarantor was the person who the trustee and beneficiary under that trust. Unable to pursue the borrower, due to the Anti-Deficiency Laws, the lender pursued the guarantor. The Court of Appeal, however, found that the trustee-beneficiary of a revocable living trust is already liable for the debts of that trust. Since this person was already liable to the lender, the guarantee added nothing and had no meaning. Thus, the purported guarantor was just the borrower in disguise, and the Anti-Deficiency Laws thus protected him.
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