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Recent California Appellate Cases that Affect Real Estate Lenders

Recent Supreme Court and Court of Appeal Decisions on Real Estate Secured Loans

• Coker: purchase money home mortgagor cannot waive protection from deficiency judgment to facilitate short sale

• McDonald: lender gets harsh sanction for technical violation of “one form of action” rule

• Petersen: group of borrowers can bring “mass action” against their lender

• Yvanova: borrower has standing to challenge foreclosing lender’s chain of title to her mortgage in wrongful foreclosure action

• Sham guaranty cases

Carol Coker v. JPMorgan Chase Bank NA et al, 62 Cal.4th 667 (2016)

• The California Supreme Court held that Code of Civil Procedure §580b, which bars deficiency judgments on purchase money loans secured by 1-4 unit dwellings, made a home borrower's agreement to remain liable on a note after a short sale unenforceable

• Lender argued §580b did not apply because there was no foreclosure sale, but Court said the purpose is to limit lender’s recovery to value of security, no matter how it is exhausted

• The opinion also extensively reviewed the jurisprudence of §580b. The Court paid particular attention to the narrow exception to §580 for certain “non standard” purchase money loans—it’s still valid, and still narrow. Examples ;(1) I sell you a lot and take a note for purchase price but agree to subordinate to a construction loan you get later from another lender; (2) I buy the lot but give you trust deeds against other properties for the price

• It was not so clear why the Court granted the lender’s petition for review. SB 931, enacted in 2010, bars deficiency judgments after a short sale of an owner (natural person) occupied 1-4 unit residential property. This is new Code of Civil Procedure §580e.

First California Bank v. McDonald (2014 5th Dist.) 231 Cal.App.4th 550, review granted then dismissed

• Code of Civil Procedure §726—the “One Form of Action Rule "Protects borrowers who pledge real property as security for a debt

• Requires the lender to liquidate and apply the value of the lender’s real estate collateral to reduce the borrower’s debt before the lender seeks a judgment against the borrower personally

• Operates as both a defense and a sanction: borrower can raise § 726 as a defense if the lender brings an action against the borrower on the note without also seeking foreclosure; if the borrower does not raise this defense, lender who obtains judgment on the note waives its rights to its real property collateral.

• Collection activity short of an actual lawsuit can trigger the rule-- for example, a real property-secured lender’s offset of its borrower’s deposit account is considered a violation of Section 726. Bank of America v. Daily (1984), 152 Cal.App.3d 772

• Even protects co-borrower who has no interest in the real property collateral

First California Bank v. McDonald

Loan secured by two parcels• First California makes a loan

loans to Mr. and Mrs. McDonald, a married couple

• Two pieces of real estate collateral—one is community property, other is Mrs. McDonald’s separate property

Default and short sale• Husband dies; his kids, not his

widow, appointed executor of estate

• Loan goes into default• Wife asks bank to agree to short

sale of her separate property collateral

• Bank agrees, all of the short sale proceeds are applied to the debt

• Unpaid loan balance is about $1.5 million

McDonald• Bank brings an action against husband’s estate to foreclose the community collateral

and for a deficiency judgment• Husband’s kids argued that short sale of widow’s separate property collateral without

their consent violated §726 and the appropriate sanction is complete loss of the right to collect the remaining loan balance loan balance

• The Court of Appeal agreed; petition for rehearing denied• Where ‘s the “action?” Lender’s conduct short of filing a lawsuit can implicate the

“security first” aspect of §726• On 2/25/15, Supreme Court accepted the case for review on a “grant and hold” basis

—no briefing until the Court decided Coker; on 3/9/16, the Court dismissed the review, remanded to trial court to consider whether estate consented to the short sale

• On remand, Bank may pursue its right to foreclose on the Wasco Property and might be able to obtain a deficiency judgment if it can prove appellants consented to the release of the Shafter Property and the application of the proceeds from that sale.

McDonald

• What, if anything did the estate lose? All of the short sale proceeds went to reduce the debt. Only conceivable economic loss would be if short sale proceeds were less than fair value of the widow’s separate property

• The concurring opinion of Acting Presiding Justice (and long time state legislator) Poochigian says the result is way too harsh, and invited the Supreme Court to review and set some standards for the proper sanction for a §726 violation; argued that that the fair result would be a remand to the trial court to make sure the short sale was at market price—”The range of available remedies should be broadened so that considerations of prejudice and bad faith can mitigate the harshness of the one-size-fits-all rule affirmed today”

• Petition for review argued Court should set guidelines for how to remedy a §726 violation

• Current standard is murky

Where does McDonald leave the punishment for violating §726?

• The current state of the law is the Security Pacific National Bank v Wozab (1990) 51 Cal.3d 991, 1002 Supreme Court opinion, which waffles a bit. Wozab held that a lender who offset a borrower's deposit account did not forfeit its right to collect the unpaid loan balance, but went on to add that if the bank's conduct had been really bad (like refusal to restore offset funds on borrower's demand), the worse punishment of loss of debt might have been appropriate

• The McDonald outcome—loss of the right to collect the balance of the debt-- doesn’t seem to square with Wozab because there was not any finding that the lender’s conduct was really bad and, in fact, is wasn’t

• Lessons from McDonald Be really careful when you have multiple real estate collateral and more than one borrower; do not agree to any short sale of one piece of property unless and until you have received the express consent of any co-borrower, even if that co-borrower has no interest in the short sale property

Petersen v. Bank of America (2014 4th Dist.) 232 Cal.App.4th 238, review denied

• 900-ish Countrywide borrowers can join together as plaintiffs to make claims against B of A, as successor to Countywide, for this alleged pattern of bad behavior by Countrywide– inflated home appraisals thru a controlled appraisal subsidiary– misrepresentation to borrowers that they could "afford" the loan Countrywide

offered them– misrepresentation of loan terms, like fixed interest loans that become variable

rate and negative amortizations loans• Borrowers joined together as parties under CCP §387, which allows parties to join

if they allege claims from the same transaction or series of transaction the litigation of which will present at least one common claim of fact and law

• Did not file their case as a class action• Lengthy dissent says the holding in inconsistent with federal decisions under nearly

identical joinder rule; majority distinguishes those cases because they involved claims against many different lenders

Petersen “mass action”• Practical motivation: joinder avoids the disadvantages of a

class action lawsuit—e.g., Iead plaintiff needs to prove several things to get class certified in a sort of mini-trial before the case can get going, settlement procedures are cumbersome, under recent federal law (Class Action Fairness Act) the case can get removed to federal court which is perceived to be a less favorable forum for plaintiffs

• “Mass" action under the joinder of parties rule avoids requirements/disadvantages of class action, but still gets the efficiencies of a single lawsuit/lawyer, and the leverage of having to defend claims which, though maybe small on individual bases, add up to a whole lot of potential liability

Yvanova v. New Century Mortgage Corporation (2016) 62 Cal.4th 919

• In 2013, California Courts of Appeal reached different conclusions whether a defaulting borrower could bring an action against a foreclosing mortgagee/beneficiary other than the original lender, based on the claim that the foreclosing party did not have a valid assignment of the borrower’s loan. The cases arose in the context of loans that had been “securitized” by transfer into a trust owned by many investors– Jenkins v. JPMorgan Chase Bank, N.A. (2013) 216 Cal.App.4th 497

(4th District 5/17/13) held that the borrower, who was not a party to the assignment contract, lacked standing to bring an action

– Glaski v. Bank of America (2013) 218 Cal.App.4th 1079 (5th District 7/31/13) held otherwise.

Yvanova• In Yvanova, the Supreme Court sided with Glaski, and disapproved Jenkins and

other opinions “to the extent they hold borrowers lack standing to challenge an assignment of the deed of trust … a plaintiff in Yvanova’s position is not asserting the interest of parties to the assignment. She is asserting her own interest in limiting foreclosure on her property to those with legal authority to order a foreclosure sale”

• Narrow holding and did not address these related questions:– Whether a borrower may file a lawsuit to preempt a threatened foreclosure

(that was the context of the Jenkins litigation) – Whether Yvanova alleged sufficient facts that the assignment was void (she

alleged the assignment of her loan was transferred to the trust well after a stated “closing date” and that before the purported assignment, her loan was transferred to a bankruptcy trustee)

– Whether the transfer in Glaski was actually void– The substantive elements of a wrongful foreclosure action

Footnote to Yvanova case• The Court was careful to say it was not expressing any opinion whether a borrower

has standing to challenge the foreclosing lender’s chain of title in a preemptive, pre-foreclosure lawsuit. A couple of cases from the Fourth District--Gomes v. Countrywide Home Loans, Inc. (2011) 192 Cal.App.4th 1149 and Jenkins v. JPMorgan Chase Bank, N.A. (2013) 216 Cal.App.4th 497—said “no” to that question because: – Civil Code §2924 is a comprehensive statutory scheme for non-judicial foreclosure– “… such a preemptive action seeks to create ‘the additional requirement’ that the

foreclosing entity must ‘demonstrate in court that it is authorized to initiate a foreclosure’ before the foreclosure can proceed.” Jenkins at pg. 512, citing Gomes at pg. 1156

• Changes to §2924, effective 1/1/13 (so it did not govern the Yvanova dispute), resolves this issue for foreclosures of first lien home mortgages—it added the “additional requirement” Gomes found lacking. New section §2923.55(b)(1)(B)(iii) requires the mortgagee, trustee, or loan servicer to inform the borrower, before filing a notice of default, of the borrower’s right to request copies of any assignments of the deed of trust “required to demonstrate the right of the mortgage servicer to foreclose.” But that said, this new rule will expire on 1/1/18 unless specifically extended by a later enactment. Section 2923.55(i)

Very recent cases address questions Yvanova left open

Elements of wrongful foreclosure cause of action • Sciaratta v. US Bank National Association said the elements are: (1) an unlawful or

fraudulent sale; (2) prejudice to the borrower; and (3) tender of payment or excuse for no tender. Sciaratta alleged that her lender, Chase, had assigned her loan twice, and that the second assignee had completed the foreclosure. Since her lender had no right to assign her loan twice, she alleged that the second assignment—and any enforcement action taken by the second assignee--was void. The trial court granted the defendant’s demurrer on the ground that Sciaratta had failed to adequately allege prejudice. The Court of Appeal reversed—it held that the allegation of foreclosure without legal authority—without more—was a sufficient allegation of harm:

“Accordingly, we conclude that a homeowner who has been foreclosed on by one with no right to do so—by those facts alone—sustains prejudice or harm sufficient to constitute a cause of action for wrongful foreclosure. When a non-debtholder forecloses, a homeowner is harmed by losing her home to an entity with no legal right to take it. Therefore under those circumstances, the void assignment is the proximate cause of actual injury and all that is required to be alleged to satisfy the element of prejudice or harm in a wrongful foreclosure cause of action.” (Pgs. 2-3).

Cases that answer open questions from Yvanova

• The Court also addressed the requirement of tender of payment, albeit indirectly. Sciaratta’s action included claims for quiet title and cancellation of the trustee’s deed. The trial court sustained the defendant’s demurrer to those related claims on the ground that Sciaratta had not tendered payment. The Court reversed that decision as well, citing Glaski v. Bank of America (2013) 218 Cal.App.4th 1079, 1100 for the rule that tender is not necessary where the plaintiff alleges a void transfer. So, although the issue was not directly before the Court, it appears to say (as did Glaski) tender is not a necessary allegation of a cause of that action that a foreclosure was wrongful because the foreclosing beneficiary had no legal right to do so.

• Preemptive challenge to foreclosure• Saterbak v. JPMorgan Chase Bank, N.A. involved a borrower’s action to enjoin foreclosure of her

home. She challenged the beneficiary’s authority to foreclose because, she alleged (a) her loan was transferred to a trust after the stated closing date for transfers of loans into the trust and (b) the signature on the assignment was forged or “robosigned.” The trial court sustained the defendant’s demurrer without leave to amend. The Court of Appeal affirmed, on the ground that Saterbak had no standing to allege her claims because she was not a party to the agreement to transfer her loan. The Court characterized her claim as an allegation the transfer was merely voidable, at the election of the parties to the transfer, rather than void, and noted that Yvanova conferred standing only upon allegations of a void transfer:

Cases that answer open questions from Yvanova

• “Moreover, Yvanova recognizes borrower standing only where the defect in the assignment renders the assignment void, rather than voidable. (Yvanova, supra, 62 Cal.4th at pp. 942-943.)” [Opinion, pg. 8] The Court relied on a New York appellate opinion for its conclusion that Saterbek’s allegations, if true, would merely make the transfer voidable.

Recent “sham guaranty” litigation• In California, a real estate secured lender who forecloses by non-judicial foreclosure

waives any right to collect a deficiency judgment (the loan balance less the foreclosure sale proceeds) from its borrower. Code of Civil Procedure §580d. That limitation does not protect persons who guaranteed the loan. Union Bank v. Gradsky (1968) 265 Cal. App.2d 40.

• But the California appellate courts have crafted a fact-specific exception to that general rule where: (1) the guarantor is already liable for the borrower’s debt; or (2) the guarantor and borrower share a “substantial identity”. A common example of the first situation is a general partner who guarantees a partnership obligation. A common example of the second situation is a sole shareholder of a small corporation who guarantees the corporation’s debt where the corporation is a “sham” entity. These exceptions are commonly called the “sham guaranty doctrine.” Put another way, in order to collect a deficiency judgment against a guarantor, the guarantor “must be a true guarantor and not merely the principal debtor under a different name.” Cadle Company II v. Harvey (2000) .83 Cal. App.4th 927, 932.

River Bank opinion

• Guarantors regularly cite River Bank America v. Diller (1995) 38 Cal.App.4th 1400 to support “sham guaranty” arguments. River Bank did not conclude that a guaranty was a sham, but did hold that the argument presented triable issues of fact which prevented summary judgment for the lender. According to the opinion, those issues included the broad ranging and subjective inquiry whether the lender’s structuring of the guaranteed loan “subverted the purpose of the antideficiency laws.” Pg. 1423

• River Bank holding was a reaction to very unusual facts which showed lender over-reaching--the lender insisted that the guarantors set up a new entity to be the borrower, backed out of a previously agreed upon joint venture agreement with the borrower, and the record included evidence that the lender’s counsel “insisted that in order to render ‘enforceable’ the ‘guaranty … a new ‘borrower’ should be brought into existence”

• Makes what should be resolved on summary judgment a time consuming and expensive process

Pro-lender decisions• CADC/RAD Venture 2011-1 LLC v. Bradley (2015 1st Dist.), 235

Cal.App.4th 775, review denied--no substantial evidence to support jury finding of sham guaranty

• Guarantor says he initially wanted the loan but lender asked for a borrowing entity--“… no indication that Charter Oak forced defendants to borrow through a shell entity or dictated the form that shell entity should take,” pg. 790; record showed that guarantors wanted a corporate borrower for tax reasons (1031 exchange)

• Guarantor says lender looked only to his financial strength “But we do not believe such circumstantial evidence should be accorded weight in all cases, especially where, as here, a defendant chooses to borrow through a corporation for tax purposes,” pg. 791

Pro-lender decisions

• California Bank & Trust v. Lawlor (2013 4th Dist.) 222 Cal.App.4th 625 affirmed trial court grant of summary judgment for lender where guarantor claimed guaranty was a sham, no triable issue of fact

• Guarantors alleged entity borrowers were formed to hold title to real property security for loan, security was only asset of one, principal asset of the other, guarantors were only owners of entities, lender required financial information from guarantors

• “These conclusory statements, however, fail to establish there was no legal separation between those entities and Defendants. Defendants presented no evidence to show these entities were not properly formed or failed to observe the necessary formalities that usually protect their owners from corporate liabilities. Individual may structure their business dealings to limit their personal liability, but they must accept the risks that accompany the benefits of incorporation,” pg. 639

Adverse trial court decision now on appeal

• LSREF2 Clover Property 4 LLC v. Festival Retail Fund 1 357 No. Beverly Drive, Los Angeles Superior Ct. Case No. SC117145, Court of Appeal Case No. B270420

• “I BELIEVE THAT THE EVIDENCE SUPPORTS A FINDING THAT IT WOULD BE INEQUITABLE TO IGNORE THE UNITY OF INTREST BETWEEN THESE TWO ENTITIES.” Trial judge thought these factors Supported that conclusion:– Lender drafted the loan documents– Loan documents required use of a special purpose entity– Lender had to approve of the structure of the borrower– Guaranty read “Guarantor as a primary party and not merely as a surety

unconditionally and irrevocably guarantees the following guaranteed obligations”– Borrower’s general partner (FRF 1 357) has no assets, negative net worth, no bank

account, “not engaged in the daily routine of business”, same directors, mailing address, as Festival Fund (the guarantor), no employees

Bad fact: Lender agreed that the borrower’s general partner will not be liable for loan repayment