Deficiencies & Purchase Money Loans after the Collapse of the Housing Market
In the early to mid 2000’s it seemed everyone purchased a home. As a result of the housing bubble, a topic outside the scope of this article, many found themselves owing significantly more on their home than it was worth. Almost everyone who purchased a home in the mid 2000’s discovered they were underwater. Inevitably, consumers began defaulting and a large portion of home buyers lost their homes.
There are four scenarios home buyers find themselves in when they default on their underwater mortgage; judicial foreclosure, non-judicial foreclosure, short-sale, or deed in lieu of foreclosure. A deed in lieu of foreclosure is when a lender accepts the deed to the home in exchange for the debt owed by the consumer. This is almost never done because as I said before almost every home purchased in the mid 2000’s is underwater. We will speak specifically about judicial foreclosure, non-judicial foreclosure and short-sale.
As an aside, you may be wondering why a lender doesn’t just sue on the promissory note for the amount owed on the loan. First, California Code of Civil Procedure §726(a) states that “[t]here can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property…” This is commonly referred to as the “One Action Rule.” That means that the lender can only go down one road to recover when a home owner defaults. Also, “the creditor will be forced to exhaust the security before he may obtain a money judgment against the debtor for any deficiency…” (Security Pacific National Bank v. Wozab, (Cal. 1990) 51 Cal.3d 991, 997; see also Walker v. Community Bank, (1974) 10 Cal.3d 729; Roseleaf Corp. v. Chierighino, (1963) 59 Cal.2d 35). This is commonly referred to as the “Security First Rule” which brings us back to judicial foreclosure, non-judicial foreclosure and short-sale.
So let talk about non-judicial foreclosures. This process makes up the majority of remedies exercised by lenders because it’s quick and cheap. In a non-judicial foreclosure the property is sold by power of sale written in a deed of trust – also known as a trustee’s sale. California Code of Civil Procedure §580d states, “No judgment shall be rendered for any deficiency upon a note secured by a deed of trust or mortgage upon real property…in which the real property…has been sold by the mortgagee or trust under power of sale contained in the mortgage or deed of trust.” The main point here is that the type of loan or property does not matter…the lender who forecloses is barred from recovering a deficiency.
What about a second or junior lien-holder that did not initiate the non-judicial foreclosure? Remember, California Code of Civil Procedure §580d only applies to the lien-holder who initiates the non-judicial foreclosure; any other lien-holder will be able to sue on its promissory note unless the loan was for “purchase money” for an owner-occupied residential one-to four unit dwelling one of which the borrower intends to occupy.
It’s important to remember that when one lien-holder forecloses then all the lien holders are foreclosed and usually the junior lien holder is left without the home as security. California Code of Civil Procedure §580b states: (a) No deficiency judgment shall lie in any event for the following: (1) after a sale of real property or an estate for years therein for failure of the purchaser to complete his or her contract of sale. (2) Under a deed of trust or mortgage given to the vendor to secure payment of the balance of the purchase price of that real property or estate for years therein. (3) Under a deed of trust or mortgage on a dwelling for not more than four families given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that real property or estate for years therein. (Note: California Code of Civil Procedure §580b (3) defines purchase money).
The Court has said that if a senior lien holder forecloses then a junior lien holder of a purchase money loan cannot collect. (Brown v. Jensen, (1953) 41 Cal.2d 193). California Code of Civil Procedure §580b “deprives the holder of a purchase money note and deed of trust … of any remedy…” (Schumacher v. Gaines, (1971) 18 Cal.App.3d 994; Freedland v. Greco, (1955) 45 Cal.2d 462). “The legislature intended that a properly conducted foreclosure sale should constitute a final adjudication of the rights of the borrower and the lender.” (Smith v. Allen, (1968) 68 Cal.2d 93). This rule also applies to previous lenders who allow their liens to be assumed in order to effectuate sale. (Costanzo v. Ganguly, (1993) 12 Cal.App.4th 1085).
The courts have also outlined the purposes of California Code of Civil Procedure §580b. They have explained that the ‘[p]urposes of this section are to discourage land sales that are unsound because land is overvalued and, in even of depression in land values, to prevent aggravation of downturn that would result where defaulting purchasers lose land are burdened with personal liability.” (Bargioni v. Hill, (1963) 59 Cal.2d 121; Laforgia v. Kolsky, (1987) 196 Cal.App.3d 1103).
The moral of the story here is if a lien holder engages in non-judicial foreclosure then: 1) the lien holder who initiated the foreclosure cannot recover a deficiency no matter what type of loan, and 2) all other lien holders whose loan is for purchase money for an owner-occupied residential one to four unit dwelling one of which the borrower intends to occupy are barred from recovering a deficiency.
In a judicial foreclosure the lender goes to court, gets an order to foreclose and then seeks to be awarded a judgment for the deficiency. However, the deficiency judgment is limited to the lesser of: 1) the amount of the debt that exceeds the fair value of the property at the time of the foreclosure sale; or 2) the amount of the debt that exceeds the sale price of the property at the foreclosure sale. (California Code of Civil Procedure §726(b)). There are virtually no advantages for a lender to engage in judicial foreclosures because they are complicated, expensive, slow and have a redemption period for the borrower. Additionally, the rules regarding purchase money under California Code of Civil Procedure §580b apply in judicial foreclosures. That means purchase money deficiencies for an owner-occupied residential one to four unit dwelling one of which the borrower intends to occupy cannot be recovered.
California Code of Civil Procedure §580e states: “(a)(1) No deficiency shall be owed or collected, and no deficiency judgment shall be requested or rendered for any deficiency upon a note secured solely by a deed of trust or mortgage for a dwelling of not more than four units, in any case in which the trustor or mortgagor sells the dwelling for a sale price less than the remaining amount of the indebtedness outstanding at the time of sale, in accordance with the written consent of the holder of the deed of trust or mortgage, provided that both of the following have occurred: (A) Title has been voluntarily transferred to a buyer by grant deed or by document of conveyance that has been recorded in the county where all or part of the real property is located. (B) The proceeds of the sale have been tendered to the mortgagee, beneficiary, or the agent of the mortgagee or beneficiary, in accordance with the parties’ agreement.”
Now in English. California Code of Civil Procedure §580e prohibits a lender who holds a deed of trust on real property from either claiming a deficiency or seeking a deficiency judgment from a borrower/seller after having agreed to a short sale. Here, the type of loan is irrelevant and it doesn’t matter whether the property is occupied by its owner or a tenant. Position of title is also irrelevant; it applies to both senior and junior lien holders. The only real limitation here is that California Code of Civil Procedure §580e does not protect LLCs, Corporations, Partnerships or Political Subdivisions of California.
Violation of Federal and California Debt Collection Law
So what happens when a creditor or debt collector attempts to collect on a home loan deficiency in violation of California Code of Civil Procedure §§580b, 580d or 580e? Let’s start with California Code of Civil Procedure §§580b, 580d. It’s important to notice that these two sections prohibit judgments not collection. Notice also that the law does not say that the debt is not still owed; it simply states that a judgment is not allowed. Only California Code of Civil Procedure §580e prohibits collection and states that the debt is no longer owed.
The good news is the courts have weighed in here. The Federal Fair Debt Collections Practices Act (FDCPA) states, “[a] debt collector may not use any false, deceptive or misleading representation or means in connection with the collection of any debt. Without limiting the general application of the foregoing, the following conduct is a violation of this section: (2) the false representation of – (A) the character, amount or legal status of any debt…” (15 U.S.C. §1692e and Cal. Civ. Code §1788.17 applying this law to original creditors). The Court has said, “[i]t is plausible that the least sophisticated debtor could be misled by a letter stating that her debt is ‘due and owing’ when that debt is subject to California’s anti-deficiency law, and the letter does not advise the debtor as to the significance of section 580b.” (Herrera v. LCS Fin. Servs. Corp., (N.D. Cal. Dec. 22, 2009) 2009 U.S. Dist. LEXIS 122775).
Often, original creditors and debt collectors try to collect on deficiencies as a result of non-judicial foreclosure stating that the debt is “due and owing.” Clearly this is misleading and deceptive. I am of the opinion that any collection efforts are illegal based on case law interpreting California Code of Civil Procedure §§580b as outlined above. The court has said that “[t]he legislature intended that a properly conducted foreclosure sale should constitute a final adjudication of the rights of the borrower and the lender.” (Smith v. Allen, (1968) 68 Cal.2d 93). To me the court is saying the debt is no longer owed. As such any collection efforts necessarily violate both the FDCPA and Cal. Civ. Code §1788 et seq. (The Rosenthal Act).
Easier still are collection attempts after a short sale. California Code of Civil Procedure §580e states outright that the deficiency is no longer owed and cannot be collected. Any attempt to collect would certainly be a violation of both the FDCPA and Cal. Civ. Code §1788 et seq. (The Rosenthal Act).
This is very complicated law. If a creditor or debt collector is attempting to collect a deficiency and you think it’s a violation of law you should contact counsel. Fitzgerald Campbell, A Professional Law Corporation is experienced in all aspects of debt and illegal collection and we can protect you as well as assert any rights you may have.
Hope this helps!
William Campbell, Esq.
Posted in: Debt Collections