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Calif. Supreme Court Allows Creditor Holding Senior and Junior Liens to Seek Deficiency on Sold-Out Second Lien

The Supreme Court of California recently held that the anti-deficiency statute in California Code of Civil Procedure § 580d did not bar a creditor holding two deeds of trust on the same property from recovering a deficiency judgment on the junior lien extinguished by a non-judicial foreclosure sale on the senior lien.

A copy of the opinion in Black Sky Capital, LLC v. Cobb is available at:  Link to Opinion.

The bank extended two loans to the borrowers that were secured by deeds of trust on a commercial property.  The bank sold both loans to an investor that subsequently foreclosed on the first deed of trust and acquired the property at a public auction.

The investor sued the borrowers to recover the amount still owed on the second deed of trust extinguished by the trustee’s sale.  Both parties moved for summary judgment.

The trial court granted summary judgment in favor of the borrowers, holding that Code of Civil Procedure § 580d barred a deficiency judgment on the junior lien.  The appellate court reversed the trial court’s judgment.

The Supreme Court granted review.

As you may recall, “California has an elaborate and interrelated set of foreclosure and antideficiency statutes relating to the enforcement of obligations secured by interests in real property.”  Alliance Mortgage Co. v. Rothwell, (1995) 10 Cal. 4th 1226, 1236.

Secured creditors must abide by the one form of action rule, and that action is foreclosure which may be either judicial or non-judicial.  Code of Civil Proc. 726(a).

In a judicial foreclosure, a secured creditor may seek a deficiency judgment to recover the difference between the amount of the debt and the fair market value of the property if the property is sold for less than the amount of the outstanding debt.  However, the debtor has a statutory right to redemption.  Alliance Mortgage, 10 Cal. 4th at 1236.

In a non-judicial foreclosure, also known as a trustee’s sale, the creditor exercises the power of sale under the deed of trust, and the debtor has no statutory right of redemption.  But under section 580d, “the creditor may not seek a deficiency judgment” after a non-judicial foreclosure.  Id.

Specifically, Section 580d(a) provides that “no deficiency shall be owed or collected, and no deficiency judgment shall be rendered for a deficiency on a note secured by a deed of trust or mortgage on real property or an estate for years therein executed in any case in which the real property or estate for years therein has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.”

The question before the Supreme Court was whether California Code of Civil Procedure § 580d barred a deficiency judgment on a junior lien held by a senior lienholder that sold the property comprising the security for both liens.

The Supreme Court began its analysis by observing that before the enactment of section 580d, a debtor had a statutory right to redemption under a judicial foreclosure but not under a trustee’s sale.  This right to redeem, as the Supreme Court explained, was similar to the prescription of a deficiency judgment, which had the effect of making the security satisfy a realistic share of the debt.

The Supreme Court next analyzed the leading case of Simon v. Superior Court, (1992) 4 Cal. App. 4th 63, which held that section 580d precludes a deficiency judgment for a junior lienholder who was also the foreclosing senior lienholder.

In Simon, the junior and senior loans were issued just four days apart, and the deeds of trust securing the loans were recorded on the same date.  Simon treated the two loans as one to prevent creditors from circumventing the provisions of section 580d.  It was in that context that Simon said courts will not penalize creditors from extending multiple loans secured by trust deeds on the same property.

Here, the Supreme Court found no evidence to suggest that the two notes in this case were executed in separate transactions to evade section 580d.

The Supreme Court observed that the loans at issue here were executed in separate transactions more than two years apart.  There was no evidence of any irregularity at the foreclosure sale to suggest that the investor sought an excessive recovery by obtaining a deficiency judgment on the junior lien.

Because no sale occurred under the junior deed of trust, the Supreme Court held that section 580d did not bar a deficiency judgment on the junior loan.

However, the Supreme Court cautioned that, where there is evidence of gamesmanship by the holder of the senior and junior liens on the same property, two liens may still be treated as a single lien within the meaning of section 580d.

Accordingly, the Supreme Court affirmed the judgment of the appellate court.

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Eric Tsai practices in Maurice Wutscher’s Commercial Litigation and Consumer Credit Litigation groups, and in its Regulatory Compliance group. He concentrates his practice primarily on the defense of consumer and commercial financial services companies, including mortgage lenders and servicers, mortgage loan investors, third party debt collectors, and other financial services providers. He also counsels clients on regulatory compliance, licensing, and other consumer protection matters. Eric earned his undergraduate degree from the University of California, Irvine. Prior to attending law school, he worked as a loan officer for national direct lenders. He earned his Juris Doctor from California Western School of Law and thereafter obtained a Master of Laws (LLM) in Taxation from the University of San Diego School of Law. Eric publishes extensively on various issues affecting consumer lending and litigation, including both federal and California-specific developments. He is licensed to practice law in California, Nevada, and Oregon, and is admitted in all United States District Courts in the State of California, the United States District Court for the District of Oregon, the United States District Court for the District of Nevada, the U.S. Tax Court, and the Ninth Circuit Court of Appeals. He is also a licensed real estate broker in the State of California.

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