Deficiency Judgments / Debt Collections

Notice: The materials available at this web site are for informational purposes only and not for the purpose of providing legal or tax advice. You should contact an attorney or CPA to obtain advice with respect to any particular issue or problem. See Legal Notice section for additional disclosures. 

For a better understanding of the tax implications, debt forgivingness and possible lender pursuit of their loss, please reference all three sections:

 

Tax Implications     Judgments / Collections     Credit

 

Introduction:

The ability for a lender to pursue a deficiency judgment or collect on a defaulted loan are two separate issues and depend on the type of loan (purchase money or refinance money), how the loan is foreclosed (judicial or non-judicial), and the position of loan (first, second, third, etc). 

 

There are many intricacies that may require a paid professional analysis of your loan documentation such as if you loan has a "power of sale clause", if the second was recorded with your original deed or written as a personal loan and many other individual circumstances to determine if you would be subject to a judgment / collection effort.

 

It can also be a very simple, self analysis of the law, such as a single purchase money loan on a primary residence to see that clearly the lender has no recourse.

 

Remember during a loan modification or short sale the details of the any deficiency or later collection efforts will be negotiated with the lender and placed in the approval letter.  Also recently the federal government released plans for more widespread use of short sales and indicated in the release that the short sale would ‘release the lender’s claim’. 

From: How The Home Affordable Short Sale/DIL Program Works

“Treasury will also share the cost of paying junior lien holders to release their claims”

It remains to be seen how this will play out but clearly this administration would not allow finically distressed individuals to place themselves in more jeopardy by participating in a plan to help save the tax payers money.  We’ll see though very soon.

 

 

This section will provide an overview of the basics to help you decide on the best course of action.  As the legal notice states, this information is not to be construed as legal advice or suggesting a specific course of action.  Use this information to educate yourself about the different facets and ramifications of your options.

Mortgage Basics

In most cases property in California purchased with a ‘mortgage’ have both:

  1. A Deed of Trust
  2. A Promissory Note

Deed of Trust = A three-party instrument (borrower, trustee, and beneficiary) securing a specific financial interest in the title to real property which is held by the trustee and holds it as security for a loan. 

 

Promissory Note = A contract where one party (the maker or issuer) makes an unconditional promise in writing to pay a sum of money to the other (the payee), under specific terms.

 

Purchase Money = As defined under California Civil Procedure Section 580b ‘no deficiency judgments shall lie in any event’ under ‘purchase money’ residential loans.

 

Per CCP 580 A-D there are two types of Real Estate Debt in California:

Non-Recourse or ‘purchase money’ = lender cannot pursue deficiency

Recourse or ‘refinance money’ = lender can pursue deficiency

 

Deficiency Judgment Facts

In California lenders are not allowed to pursue a judgment against a homeowner without first ‘looking to the security for recovery of the debt’.  If there is equity in the property they can complete a non-judicial foreclosure to recover their interest.  The only time a lender would attempt a judicial foreclosure is when the property has no equity but the owner has significant assets and lender thinks court will rule in their favor.  Judicial foreclosures rarely are completed in less than a year.

 

The law then indicates if a lender chooses to proceed with a non-judicial foreclosure, because of the ‘one action rule’ then they are not allowed to later pursue a deficiency.  That is if a foreclosure is completed by non-judicial means, a second action to recover a deficiency judgment is not permitted.

 

Read the Fine Print! (but don’t worry)

Lenders often use ‘fine print’ language to 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.

 

Sold-Out Junior Lender

It has been shown that when there is only one loan on property the lender can foreclose by judicial or non-judicial means and pursue deficiency based on the particular circumstances.

 

When there are two or more loans on a property that is sold at trustee sale the ‘junior loans’ get ‘sold-out’, or they lose the security interest of the property to the senior, foreclosing lien holder.

 

When that occurs the security interest of the loan(s) is taken away and Section 580b prohibits a lender from suing the borrower for the deficiency, but, it does not prevent a lender from taking additional actions under the signed promissory note.

 

Deficiency / Collections

A deficiency is the difference between the fair market value of the property and the amount received, providing the amount received is less than the amount owed.

 

Deficiencies and the lender’s ability to pursue collections stem from the seller defaulting on the promissory note and triggered by the foreclosure.  Once the foreclosure process is complete, if the loan is not ‘purchase money’, then the ‘sold-out junior’ lenders may be able to collect on the promissory note by suing the borrower or selling off their interest to a collection agency.

 

Whether the bank can pursue a deficiency judgment after a foreclosure depends in part on whether the promissory note makes the seller personally liable for the debt.  If a short sale is completed is it important to have language in the final agreement that both releases the lien and satisfies the debt.  There will be circumstances where the lender will not agree to both the release and satisfaction language then the borrower must weight their options and choose the best course based on a cost / benefit analysis.  See the short sale section for a more detailed discussion regarding this.

 

California Association of Realtors Deficiency Chart – Updated January 25, 2008

 

Foreclosure Procedure in California

Seal of CACalifornia is known as a title theory state where the property title remains in trust until payment in full occurs for the underlying loan. The document that secures the title is usually called a deed of trust or mortgage.

 

The primary method of foreclosure in California is the non-judicial foreclosure. This type of foreclosure does not involve court action. When the deed of trust is initially signed, it will usually contain a provision called a power of sale clause, which upon default allows a trustee to sell the property in order to satisfy the underlying defaulted loan.

 

The trustee acts as a representative of the lender to effectuate the sale, which typically occurs in the form of an auction. Unlike many states where trustees are appointed by lenders, title companies primarily serve as trustees managing foreclosure sales in California.

 

In February 2009 California Governor, Arnold Schwarzenegger signed into law a 90-day moratorium on home foreclosures SB2X-7 and AB2X-7.  The bill covers owner-occupied homes where the first loan was recorded between Jan. 1, 2003 and Jan. 1, 2008.  The bill exempts lenders who have a loan modification program in place meeting the standards set forth in the bill but provides oversight and accountability by requiring regular reports to the legislature on loan modifications and foreclosure reductions, and coordination with appropriate state regulators.

 

Law Alert!

2009 California law amends loan foreclosure procedures

 

On February 20, 2009, California enacted the California Foreclosure Prevention Act (SBX2 7), adding 90 days to the 3-month period currently required in Civil Code §2924 between the notice of default and the notice of sale for a non-judicial foreclosure. The Act is applicable to loans recorded between January 1, 2003, and January 1, 2008, that are first liens on owner-occupied principal residences. Depending on the date of implementing regulations, the Act will take effect in early June 2009. Consumer advocates argue that wide loopholes will prevent the legislation from significantly slowing foreclosures. State regulators must grant an exemption from the extended foreclosure period if the lender has put a mortgage modification program in place that meets a satisfactory combination of specified features, including deferral of a portion of the principal, a reduced interest rate for at least 5 years, or an extended amortization period. To be exempt, the modification program must additionally include an adjustment in monthly mortgage payments so that these do not exceed 38 percent of the borrower's gross income-a ratio more favorable to the lender than the 31 percent ratio of the federal Homeowner Affordability and Stability Plan. Significantly, SBX2 7 does not require the lender to actually grant the loan modification to in order to be exempt from the additional 90-day period, but only to put a complying program in place.

 

On July 8, 2008, California signed into law SB 1137 as urgency legislation, effective immediately. The new law (1) establishes detailed procedures as part of the foreclosure process requiring lenders to contact homeowners in default on their mortgages to assess the homeowner's financial situation and explore options for avoiding foreclosure; (2) requires a purchaser to maintain under the building codes vacant residential property purchased at a foreclosure sale and authorizes local governmental entities to impose civil fines and penalties for violations of up to $1000 per day; and (3) gives a tenant or subtenant, in possession of a rental housing unit at the time the property is sold in foreclosure, 60 days instead of 30 days to vacate the unit.

Source: ceb.com

 

 

Check out a comprehensive legal description of the Foreclosure Process.

The laws that govern California foreclosures are found in California Civil Code, Section 2924.

To view these statutes visit: http://www.leginfo.ca.gov

 

Attorney Q and A:

 

Gibson Law, PC

Can a sold-out junior lender sue the borrower on its note?


Question:  If a senior lien forecloses on a property, this wipes out the mortgage or deed of trust of all junior lien-holders. Can those sold-out junior lien-holders now sue the borrower under their note?

 

Answer: 

 

1.  The primary exception to this rule relates to purchase-money loans, otherwise, the general answer is “yes”.  A sold-out junior mortgage holder can sue under the note after its lien is wiped out by the foreclosure by the senior. National Enterprises, Inc. v. Woods (2001) 94 Cal. App. 4th 1217.

 

2.  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.

 

Bryan Whipple, Attorney at Law
Re: Deficiency judgment california investment property

 

Question: Can a foreclosing lender get a deficiency judgment on an investment property after foreclosure? If so, what if the foreclosure never concluded but we decide to sell short (short sale)?

 

Answer: A foreclosing lender can obtain a deficiency judgment after a judicial (court) foreclosure, unless the lender was the seller. If the lender elects a trustee sale under the power of sale provision in a deed of trust, it cannot get a deficiency judgment.

 

In a short sale to the lender, it depends upon what you negotiate. Conceptually, I believe the agreement to accept a price that is "short" of what's owed should preclude any further claims by one party against the other - it's kind of a settlement - but we do hear of short sale contracts that are not final closures and do allow the lender to seek various remedies against the short-selling owner/borrower.

 

I would just say ask for a deal that closes out the lender-borrower relationship fully and finally, and read anything you sign beforehand.

 

 

Definitions & Resources:

 

One Action Rule = If a foreclosure is completed by non-judicial means, a second action to recover a deficiency judgment is not permitted.

http://definitions.uslegal.com/o/one-action-rule/

The one action rule is a rule of law that forces a lender to bring only one court action or proceeding against a borrower in a foreclosure. For example, in California, Code of Civil Procedure § 726 has been construed to mean that in the event of default, a secured creditor must, in a single action, first exhaust all its security as a condition of obtaining a monetary deficiency judgment against the debtor personally. If the secured creditor does not resort to all its security before obtaining a money judgment on the underlying debt, the secured creditor may be deemed to have made an "election of remedies" and to have waived the balance of its security.

CCP 726.  (a) There 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 or an estate for years therein, which action shall be in accordance with the provisions of this chapter.

 

Promissory Note = Is simply a "promise to pay." It contains a maker (the payor) and a lender (the payee). An unsecured promissory note is not attached to anything; the loan is made based on the maker's ability to repay. A secured promissory note may also be made based on the maker's ability to repay, but it is secured by a thing of value such as a car or a house.

If your home is used for security and you default on the promissory note, you could lose your home. Most promissory notes attached to property are secured by either a trust deed, also known as a deed of trust, a mortgage or a land contract, and those instruments are recorded in the public records. Promissory notes are often unrecorded.

 

Deed of Trust = A three-party instrument securing a loan or other obligation.  The three parties are borrower, trustee, and beneficiary, as opposed to a mortgage with which there are only two parties (borrower and lender).

 

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.

 

Judgment = The final determination of the rights of the parties in an action or proceeding.

 

Mortgage = From the Old French "dead pledge," meaning the pledge ends (dies) either when the obligation is fulfilled or the property is taken through foreclosure. 

Civil Code Sec. 2920 provides this definition: "A mortgage is a contract by which specific property, including an estate for years in real property, is hypothecated for the performance of an act, without the necessity of a change of possession."

 

Chattel Mortgage = Are referred to as secured transactions, used mainly for movable personal property and governed in most states by Article 9 of the Uniform Commercial Code.

 

Mortgagor or Trustor - Individual or company who borrows money to purchase a piece of real property.

 

California Fair Debt Collection Practices Statutes - Summary

http://www.dca.ca.gov/publications/legal_guides/dc_2.pdf

This Legal Guide covers the federal and California fair debt collection practices statutes. The

Federal statute is called the Fair Debt Collection Practices Act. The California statute is called the

Rosenthal Fair Debt Collection Practices Act.

 

Two Part Article on ‘Note Enforceability’ written for lenders

http://www.mortgagelawnetwork.com/california-foreclosure-primer-the-basics-of-note-enforceability-part-1-of-2/

http://www.mortgagelawnetwork.com/california-foreclosure-primer-the-basics-of-note-enforceability-part-2-of-2/

 

California Non-Recourse vs. Recourse Loan   CA Civil Code 580 A-D

http://www.sandiegohousingsolutions.com/CACivilProcedure577to582.pdf

 

Non-Recourse or ‘Purchase - Money’

If a property goes to foreclosure in California, unless you refinance, the debt is non-recourse, meaning the lender cannot pursue you (unless they can prove fraud). CA Civil Code 580-B. excerpt: ”Where both a chattel mortgage and a deed of trust or mortgage have been given to secure payment of the balance of the combined purchase price of both real and personal property, no deficiency judgment shall lie at any time under any one thereof if no deficiency judgment would lie under the deed of trust or mortgage on the real property or estate for years therein”.

 

Recourse or ‘Refi - Money’

Recourse debt is when the lender is not just limited to taking the property back and the borrower may be personally liable on the debt.  Examples of recourse debt is when a borrower refinances existing mortgages, takes out home improvement loans, equity lines of credit and any debt for purchase of property that is not an owner-occupied one-to-four unit property. 

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