California Commercial Lease Cotenancy Provisions: When they Can Be Unconscionable or an Invalid Penalty

January 22, 2015

Cotenancy provisions are often required by larger retail tenants in shopping centers of all sizes. They require other specified stores in the center to be open and operating, on the assumption that these other stores will draw the desired mix of potential customers. They come in two flavors; opening requirements, meaning that the requirement is fulfilled before the tenant is required to open; and Operating requirements, meaning that the tenant's obligations continunue only so long as the named tenants remain in business. Parties to a commercial lease may need to consult with a Sacramento real estate attorney to clearly define the cotenancy requirements in their lease, so that they do not face any surprises, as one tenant faced in a recent decision when their cotenancy provision was found to be an unenforceable penalty because the tenant had never really considered what its harm would be if the named store did not open.

Sacramento commercial lease attorney.jpgIn Grand Prospect Partners, LP, v Ross Dress for Less Inc., Ross was negotiating with a shopping center owner Porterville, in Tulare County. Ross wanted a cotenancy provision that required a Mervyn's to opening and running before Ross was required to open. If Mervyn's did not open, or ceased operating, Ross would not owe rent, and did not have to open a store. (The terms of the lease are more fully set out below). Two months after the parties signed the lease; Mervyn's filed bankruptcy, and never opened its store in the Portville center. Eventually Ross notified the landlord that it was going to terminate the lease under the cotenancy provision. This lawsuit ensued, with Grand Prospect, the landlord, claiming that the lease was unconscionable, and the cotenancy rent abatement provision was an unenforceable penalty.

Under California law, an unenforceable penalty lacks a proportional relationship between the forfeiture compelled and the damages or harm that might actually flow from the failure to perform a covenant or satisfy a condition. The test requires a comparison of

(1) the value of the money or property forfeited or transferred to the party protected by the condition to

(2) the range of harm or damages anticipated to be caused that party by the failure of the condition. If the forfeiture or transfer bears no reasonable relationship to the range of anticipated harm, the condition will be deemed an unenforceable penalty.

Here, the lease rental payments (plus CAM charges) which were to be abated were $39,000 per month. However, in negotiating for this provision, the evidenced showed that Ross did no study or analysis to see what the impact of Mervyn's traffic would have on the profits of a Ross store sales. Ross was unable to say whether the closure of Mervyn's stores in other centers where Ross was located impacted Ross sales. Thus, the trial court found that Ross anticipated that it would not have any losses due to Mervyn's absence. When the 1) value of money forfeited, $39,000/month, was compared with the damages anticipated by Ross, $0.00, the Court concluded that the rent abatement provision was an unenforceable penalty.
It is surprising to me that a retailer as large as Ross did not have any analysis of the harm closure of other stores in centers which Ross had a presence. This case is a clear lesson, in any rent abatement situation, for a tenant to determine (before signing the lease) what harm it may actually incur if there is to be a rent abatement.

Commencement Date Requirement: Mervyn's was to occupy no less than 76,000 square feet of leasable floor area, on Ross's commencement date.
"Commencement Date Reduced Occupancy Period" was defined as beginning with the failure of one of the required tenants to be open for business on the commencement date of the Lease and continuing until cured. Ross was not required to open its store for business. That section also stated that, "regardless of whether [Ross] opens for business in the Store, no Rent shall be due or payable whatsoever until and unless the Commencement Date Reduced Occupancy Period is cured."

Ross also had an option to terminate the Lease conditioned upon (1) the Commencement Date Reduced Occupancy Period continuing for 12 months and (2) Ross giving 30 days' notice of termination prior to the expiration of the Commencement Date Reduced Occupancy Period.


Reassessment of California Property Where Entities Are Involved - How To Do The Math

January 16, 2015

California real estate sellers and buyers are rightly concerned about reassessment of the property on sale. A parcel held for many years is assessed, and taxed, based on the purchase price long ago. Prop 13 provides that, real property generally is taxed based on its value at the time of acquisition, not its current value. A sale today would trigger reassessment and an increase in property tax. A problem can arise with ownership of entities such as LLCs or corporations Generally, the transfer of an ownership interest in an entity such as an LLC or corporation is not a change in ownership of the real property held by that entity. However, if one person or entity acquires more than 50%, it is deemed a change of ownership; if you are facing this problem, you may want to consult a Sacramento real estate attorney. In a recent decision the County assessor claimed that more than 50% changed hands; however, the court, demonstrating the math to determine ownership, showed that the assessor was dead wrong, and at risk of paying over $200,000 in attorney fees.

Sacramento property assessment lawyer.jpgIn Ocean Avenue LLC v. County of Los Angeles (227 Cal App 4th 344), Ocean LLC owned the Fairmont Miramar Hotel in Santa Monica. Ocean entered a contract to sell it, but that contract was terminated. On the same day of the termination they contracted to sell ownership of the LLC to a group of three entities; a Trust, MSD Portfolio, and Hotel Investor LLC. Staff for the County assessor reviewed the ownership interests and determined that no one had more than 50% ownership. Ignoring staff, the Assessor re-assessed the hotel. The owners paid the tax, then filed suit.

California Code provides that there can be reassessment when there is a change of ownership in real property, "[w]hen any corporation, partnership, limited liability company, Massachusetts business trust or similar trust, other legal entity or any person... obtains through multi-tiering, reorganization, or any transfer direct or indirect ownership of more than 50 percent of the total interest in [the limited liability company's] capital and more than 50 percent of the total interest in [its] profits[.]" (Cal. Code. Regs., tit. 18, § 462.180, subd. (d)(1)(B).) The Assessor claimed that Michael Dell (that may be his name on the computer you are using) controlled more than 50% of the capital invested by the new owners.

1. The County Failed to Do the Math, So the Court Showed Them How -
The Change of Ownership Theory.

The Court pointed out that the Assessor did not do the multiply-through test, so the court did it for the Assessor Dell owns:

A) 99.99 percent of the capital of MSD Portfolio, which owns 42.5 percent of the Hotel. 0.9999 x 42.5 = 42.49575%

B) 93.3333 percent of Blue Fin and Michelangelo, and those two entities, collectively, own 73.065 percent of Hotel Investor, which owns 8.5 percent of the Hotel.
0.933333 x 73.065 = 68.194%

0.68194 x 8.5 = 5.79649%

Total percentage controlled by Michael Dell : 42.49575% + 5.79649% = 48.29224%

No matter what the Assessor says, the numbers do not add up.

Sacramento real estate assessment attorney.jpg2. The Equitable Conversion Theory.

The Assessor next argued that under the initial contract, which was terminated, the hotel changed ownership under the equitable conversion theory, which provides that in unconditional contract for the sale of land, of which specific performance would be decreed, the purchaser is granted equitable title, and equity considers him the owner. However, there is no equitable conversion when the contracting parties demonstrate an intent to the contrary (here, they terminated it), or the contract terms were never satisfied (here, the buyer never paid). Thus, the Assessor losses again.

It is fair to guess that the buyers knew about reassessment, and carefully structured the transaction so that reassessment would not happen. The County Assessor was not so smart, and assumed they would just pay up and go away. It pays to do the math.


Title Insurance - Only Insures Against Claims Alleging a Defect, Lien or Encumbrance Against Title - The Preliminary Report Is Not A Contract Guarantying The State of Title

January 8, 2015

Title Insurance - Only Insures Against Claims Alleging a Defect, Lien or Encumbrance Against Title - The Preliminary Report Is Not A Contract Guarantying The State of Title

Buyers of real estate in California routinely buy a policy of title insurance. This insurance is triggered when there is a claim or lien against the property which the title company did not initially identify and point out to the buyer in the Preliminary Report. The Preliminary Report is a report prepared by a title company before issuing a title insurance policy, indicating the conditions under which the insurance company will issue title insurance. Buyers often have misunderstandings about the preliminary report and how it should be looked at, and may wish to consult a Sacramento real estate attorney for assistance. Often people incorrectly view the Prelim as a contract guaranteeing that the title is in such a condition. But that is not the case, as was recently made clear in a Federal Court decision following California law in which alota money was at stake.

Sacramento Title insurance attorney.jpgIn Feduniak v. Old Republic National Title Company (2014 WL 6603253), the plaintiffs bought a $13 million dollar home on 17 mile drive in Pebble Beach. They bought title insurance from Old Republic title Company. The title company missed something - namely, an easement in favor of the California Costal Commission. The easement required that at least 86% of the property be maintained as native dune habitat. At the time the property was purchased, it contained a golf course, violating the native dune requirement. Old Republic Title Company missed the easement; it was not listed as an exception to the title policy. The owner filed a claim with Old Republic. The title company wanted to hire an appraiser to determine the diminishment in value of the property due to the easement, but the owners had them negotiate with the Coastal Commission instead, to remove the easement. The negotiations were unsuccessful, other than to tip off the Coastal Commission that the easement was being violated. The Commission went after the owners, and Old Republic defended them. The Commission issued a cease & desist order, requiring them to submit a fix-it plan. They went back & forth on plans, and the commission filed suit for violation of the Cease & Desist order. They eventually agreed on a rehab plan, but the Commission did not dismiss the suit- it went to trial for over $25 million in penalties, exemplary damages, attorney fees and costs. The owners then sued the title company.

Breach of Contract

The owners claimed that the preliminary report and insurance policy were a contract which was breached by the failure to discover the easement. However, under California law, a preliminary title report is not, a representation as to the condition of title to real property, but is a statement of the terms and conditions upon which the issuer is willing to issue its title policy. The policy also provides that claims of loss whether or not based on negligence, and which arises out of the status of the title to the property covered by the policy, are be restricted to this policy. Thus, there is no claim for breach of contract.

Sacramento real estate title attorney.jpgIndemnification for Defense Costs

The owners claimed that the title company should pay their defense costs in the action in which the Commission sued for violation of the cease and desist order. Old republic had rejected this claim as it had no duty to defend this action. Old Republic pointed to paragraph 4(a) of the Policy, which is set out in full below. It provides that the insurer will provide a defense to any claim which alleges a claim, lien, or defect in the title to the property. But the Coastal Commission action sought civil penalties for the owners' failure to rehabilitate the property; they instead continued to water and maintain the golf course. This was not a claim, lien, or defect in the title. This conduct arose after issuance of the policy, and clearly was not covered.

I guess the owners really wanted a golf course on their property, as the matter got convoluted in their efforts to provide off-site mitigation while maintaining the golf course. This route lasted a couple of years, but the Coastal Commission finally got fed up.

The Standard Title Policy language:
4. Defense and Prosecution of Action; Duty of Insured Claimant to Cooperate.
(a) Upon written request by an insured and subject to the options contained in Section 6 of these Conditions and Stipulations, the Company, at its own cost and without unreasonable delay, shall provide for the defense of such insured in litigation in which any third party asserts a claim adverse to the title or interest as insured, but only as to those stated causes of action alleging a defect, lien or encumbrance or other matter insured against by this policy. The Company shall have the right to select counsel of its choice (subject to the right of such insured to object for reasonable cause) to represent the insured as to those stated causes of action and shall not be liable for and will not pay the fees of any other counsel. The Company will not pay any fees, costs or expenses incurred by an insured in the defense of those causes of action which allege matters not insured against by this policy.


Deeds in Lieu of Foreclosure - The Rule for Determining When The Transfer Causes a Merger, Allowing Junior Liens to Survive.

December 23, 2014

A deed in lieu of foreclosure is occasionally used as an alternative to a foreclosure sale. The borrower merely deeds the property back to the lender "in lieu of foreclosure." The lender does not have to go through the time and expense of a foreclosure, and the borrower/owner gets the process over with more quickly. However, there is some risk for the lender in this situation. Title conveyed by a trustee's deed after a foreclosure sale relates back in time to the date on which the deed of trust was executed. The trustee's deed therefore passes the title held by the trustor (the borrower; remember the 'trustor' is 'poor') as of that earlier time, rather than the title that the trustor held on the date of the foreclosure sale. Liens that attached after the deed of trust was recorded are 'sold out' or eliminated. However, a deed in lieu of foreclosure (as opposed to a foreclosure deed) passes title to the transferee subject to all existing liens. Whether concerned about deeds in lieu or lien priority in general, it is best to consult with a Sacramento real estate lawyer. Hopefully, you can avoid the problem recently faced by a lender when the trial judge didn't follow the law regarding merger. They had to get the court of appeals to set things right.

Sacramento merger attorney.jpgIn Decon Group, Inc. v. Prudential Mortgage Capital Company LLC, the owner of a commercial property had a mortgage with Prudential. They hired Decon to renovate the property, but did not pay the bills, so Decon recorded a mechanic's lien for $437,000, and filed suit to foreclose the lien. The owner was in default on the loan, so the lender took back a deed in lieu of foreclosure from the owner. The lender then conducted a trustee's sale, and took title to the property. In the action to foreclose the mechanic's lien, the judge ruled that, on taking back the deed of lieu, the two interests, as beneficiary under the deed of trust and as grantee under the deed in lieu merged, destroying the senior lien. Thus, the junior mechanic's lien was not eliminated by the foreclosure. The court ordered that the property be sold at auction. The lender appealed.

The court of appeal reversed the lower court, finding that no merger had occurred. It first noted that, under ordinary circumstances, where the holder of a mortgage acquires the estate of the mortgagor (debtor), the mortgage interest is merged in the fee and the mortgage is extinguished.... But this rule is never applied where there is an intervening lien on the property, and where there is no evidence of an express intention to extinguish the first mortgage and hold subject only to the second.

The Supreme Court articulated the rule as follows: " 'Merger is always a question of intent when the question is as to whether a mortgage lien is merged in the fee, upon both being united in the same person. Equity will keep the legal title and the mortgagee's interest separate. If there is an intervening mortgage the acquirement of the title will not operate as a merger.

Sacramento deed in lieu attorney.jpgThus, where it benefits the holder of the first to eliminate all junior liens, the court assumes that the intent was that there not be a merger on the transfer by deed in lieu. The senior lien remains in place. In this case, even more clearly, was the language in the deed of lieu that expressly stated that there was no merger:

"[t]he Indebtedness shall remain in full force and effect after the date hereof. The interest of Grantee in the Property upon effectuation of the transfers, assignments or conveyances as provided in this Grant Deed shall not merge with the interest of Lender pursuant to the Loan Documents, but shall be and remain at all times separate and distinct, and the Loan Documents shall be and remain at all times valid and continuous liens on the Property."

Here the intent was clear to everyone except the trial judge. Unfortunately for the lender, they would have had to post an appeal bond for much more that the $437,000 mechanic's lien to prevent the sale from occurring pending the decision.


A California Easement for Ingress Means Just That - to Enter and Leave Your Property

December 16, 2014

The proper use of an easement is often the subject of disputes in California. An easement is a restricted right to a definable use or activity on someone's property, and it must be less than the full right of ownership. Real estate attorneys are often consulted when someone interferes with use of an easement; if legal action is pursued, the judge must interpret the language of the grant of easement to determine what the original parties intended. In a recent decision, a developer had an easement over other property for ingress and egress. Being a bonehead, he did much more that use it to access the property, and then lost the development to Bank in foreclosure. The Bank, which then inherited the dispute, had to make a ridiculous argument to the court to avoid a judgment that misuse of the easement subjected it to damages.

sacramento easement scope attorney.jpgIn Schmidt v. Bank of America, N.A., Parks owned two adjacent properties in La Mesa, California. She conveyed the western parcel to Schmidt, reserving to herself an easement for ingress and egress for public road purposes along the eastern 40 feet. She later sold the adjoining property (the dominant tenement), along with the easement over the eastern property. Time goes by, and eventually the owner of the eastern parcel began construction of a condominium project. In doing so, he built features on, under, and around the easement area. It was graded for use as a private roadway, a locked gate was added. He installed sewer pipes, and storm drains under the easement area. The developer went belly up, and defendant Bank of America foreclosed. The Bank ended up owned the condominium property, including the features on and under the easement. The eastern owner, Schmidt, sued for trespass, nuisance, and other relief.

In the lawsuit the Bank argued that the scope of the easement covered the structures and improvements affecting the easement. The Schmidts countered that the grant was for only a right of ingress and egress that allowed the Bank to use only the surface of the easement. The phrase "for public road purposes" did not create a public right of way.

The court first focused on the deed language to determine the extent of the easement granted, interpreting it like any other contract. The language:

"RESERVING to the grantor, her successors, assigns and/or heirs, the right of ingress and egress for public road purposes, and incidental purposes, over the Easterly 40 feet of the following described land..."

sacramento easement use attorney.jpgThe court found that the grant was limited to the right of ingress and egress, and that the phrase "for public road purposes," was a limitation on the right of ingress and egress, not an expansion. For 'public road purposes' means to allow one to reach a public road. The language did not create a public easement, but a private easement that vested use rights only in the neighboring property.

The Bank argued that "for incidental purposes" meant that the easement should be interpreted broadly and include any use incidental to a public road. But the court said no; incidental purposes are those incidental to the main purposes of the easement - ingress and egress.

Next, having interpreted the easement language, the court looked at the uses complained of in this case. Whether a particular use of an easement by either the servient or dominant owner unreasonably interferes with the rights of the other owner is a question of fact. The court needed to determine if the facts indicate that the a actual use of the easement was withing the terms of the grant of easement. The Bank claimed that the uses were compatible with a public roadway easement. The Supreme Court has established that "[t]he establishment of a public highway practically divests the owner of a fee to the land upon which it is laid out...." If a public right, Schmidt did not have any rights in the property. However, the court has already concluded that the easement was for private right of ingress and egress, a much more restrictive grant of easement. This granted the Bank unobstructed passage, but no other use.


Altered Deeds In California - Sometimes They Are Void, But When They Are Not Somebody Loses

December 9, 2014

Altered or forged deeds are subject to some specific rules in California. In some cases, where it is altered by a party to the deed, they may be declared void, and of no effect. If it is altered by a third party, it is not entirely void - it is still valid as between the original parties. In a recent decision, The person who should have been an owner of property did not consult a Sacramento real estate attorney, and misunderstood what a deed actually said. When it was improperly altered before recording, the result did not change the effect of the conveyance - she had no interest in the property.

Sacramento altered deed attorney.jpgIn Lin v. Coronado, Lin pooled her $150,000 with $100k provided by River LLC and Elevation LLC to buy a residential property at a trustee's sale. The property was bought by the LLCs for $250,000. The original deed from the trustee was to "Cal-Western Reconveyance Corporation (herein called trustee) does hereby grant and convey, but without covenant or warranty, express or implied to RIVER FOREST FINANCIAL LLC 75%, ELEVATION INVESTMENTS 25% HELEN LIN." However, the deed that was recorded states "Cal-Western Reconveyance Corporation (herein called trustee) does hereby grant and convey, but without covenant or warranty, express or implied to RIVER FOREST FINANCIAL LLC 75%, ELEVATION INVESTMENTS 25%." Lin was not named in the recorded deed. River LLC and Elevation sold the property to Coronado, the defendant in this appeal.

Lin filed suit against River & Elevation for fraud, and also against Coronado, the buyer, to quiet title. Regarding the quiet title, she claimed that the deed was altered after it was executed, it was void, and thus did not convey title. The buyer claimed that Lin never had an interest in the title in the first place, so they were a bona fide purchaser for value, and the claim failed. The Court agreed with the buyer.

Altered Deeds

When a deed is altered or changed by someone other than the grantor before it is delivered or recorded, and the alteration is without the grantor's knowledge or consent, the deed is void and no title vests in the grantee or subsequent purchasers, even bona fide purchasers for value; and if the deed is altered after delivery by the grantee before recordation, the deed is void and conveys no title to the grantee.

sacramento forged deed attorney.jpgHowever, the court found that in this case"...the only alterations which will affect the validity of an instrument are those which are material; that is, alterations which change the legal effect of the instrument." The test for determining the materiality of an alteration is "not whether the liability of either of the parties is increased or decreased or reduced as a result but whether the instrument has the same legal effect after the alteration as it had before."

Here, in the original declaration of trustee's sale, Lin had no percentage interest in the property. Recording a deed without her name on it had no legal effect. Thus, the alteration - removing Lin's name from the deed - was not sufficiently material to render the deed void. Lin had no claim against the title to the property. Lin also tried to have the court reform the deed to reflect her interest. But the court could not do that because it was not shown to be void. Civil Code section 3399 allows reformation "so far as it can be done without prejudice to rights acquired by third persons in good faith and for value." Here, Coronado was a good faith purchaser, and reformation would prejudice her rights.


A Full Credit Bid on California Property Prevents a Lender From Recovering Insurance Proceeds; the Simple Solution

December 2, 2014

When a foreclosure sale occurs, the lender often bids at the sale the entire amount due on the loan. If no one bids higher, they obtain the property. But are they entitled to then collect insurance for pre-foreclosure damage? Sometimes insurers obtain their own insurance policy, which covers them for all damage to the property. However, commercial lenders often are insured through their borrower's policy, which only covers the value of the debt. There is an important difference if the lender forecloses, and parities in this situation may need to consult with a real estate attorney. In a recent case, the lender discovered that making a full credit bid at the foreclosure sale was a mistake, and lost its chance to collect on the policy.

sacramento credit bid attorney.jpg In Najah v. Scottsdale Insurance Company, the plaintiff sold a commercial property taking back a note for $2.5 million secured by a 2nd deed of trust. The first loan was for $2 million. There was a structure on the property, and the terms of the Notes required that the buyer not remove or destroy the building, and to repair any damage that occurred. The Note required the buyer to provide an all risk insurance policy insuring the seller, which the buyer obtained.
The Buyer went into default and the first lender pursued foreclosure. The seller, holder of the second, bought the interest of the first lender for the balance due on the first loan, $1.75 million. The Seller was also assigned the first deed of trust. The seller then foreclosed on its 2nd deed of trust. At the foreclosure sale, the Seller made a full credit bid - that is, it bid the full amount due on the 2nd Note.

The Seller took possession of the property, and discovered that the prior owner had trashed the building. They had taken out the HVAC equipment, water heater, commercial laundry, kitchen appliances, etc. Also there was damage throughout. The Seller, now again the owner, made a claim against the insurance policy that had been required by the promissory note. The insurer denied the claim, and suit ensued.

The Insurance Policy and the "Standard Mortgage Clause"

The policy included a provision stating that even if the insurer denied a claim for "covered loss of or damage to buildings or structures" due to "[the buyer's] acts" or because the Buyer "failed to comply with the terms of this Coverage Part," the "mortgageholders" would "still have the right to receive loss payment," so long as certain conditions were met. This is called the 'standard mortgage clause.' It operates as an independent contract of insurance between the insurer and the lender/mortgagee, the same as a separate policy would provide. However, the amount payable to the mortgagee under the policy is limited to the amount necessary to satisfy the debt, even if it is less than would be required to repair the physical damage to the property, and once the debt is satisfied, "[the lienholder] ha[s] no further claim on any insurance proceeds."

full credit bid attorney.jpg

The Full Credit Bid Rule

When the lender obtains a property at a foreclosure sale by making a full credit bid--bidding an amount equal to the unpaid debt, including interest, costs, fees, and other expenses of foreclosure--"it is precluded for purposes of collecting its debt from later claiming that the property was actually worth less than the bid. This is called the full credit bid rule. Because a full credit bid extinguishes the mortgage debt, the lender is not entitled to insurance proceeds for preforeclosure damage to the property.
Here, the lender argued that this rule did not apply in this case, because they held two deeds of trust securing two separate debts. Thus, they should have the same remedy as a third party who owned a senior, unforeclosed deed of trust. However, the buyer in a foreclosure on a junior deed of trust takes the property subject to the more senior deeds of trust. Thus, a full credit bid is presumed to establish the value of the total indebtedness - what was bid (the junior) and what the property is still subject to (the senior). In other words, the total of their bid plus the outstanding lien. Thus, a full credit bid "conclusively established the value of the property as being equal to the [total] indebtedness secured by the property." Because the insurance covered only the amount of the debt, they were not entitled to any insurance proceeds for preforeclosure damage.

The Solution

The lender could have avoided this problem by underbidding their security interest at the foreclosure sale. Underbidding has risk, in that a third person may bid higher and obtain the property, but this can be avoided through the instructions to the trustee, or attending the sale to observe the bid and raise to a full credit bid if necessary. By underbidding, the lender would then have a deficiency balance, which could be recovered by a claim on the insurance policy.


The Security First Rule - how a lender with multiple California properties as security for its loan must protect itself when releasing one of the properties from the deed of trust, and still get a deficiency judgment.

November 18, 2014

The security first rule is one of the numerous anti-deficiency protects provided to borrowers under California law. "Security first" means that a creditor must first exhaust all real property security through judicial process in the "one form of action" authorized by Code of Civil Procedure section 726--that is, a judicial foreclosure. The rule is violated if the lender attempts to obtain a personal judgment against the debtor before first exhausting all the real property in a judicial foreclosure lawsuit. This can be a serious penalty in the case of commercial properties, and lenders and borrowers should consult with a real estate attorney to be sure of their options. If the creditor violates the security first rule, it loses its chance to get a deficiency judgment, which holds the borrower personally liable for the balance of the debt above the value of the property.

If the borrower raises the security first rule as an affirmative defense, there are four ways the case may proceed:
1. The lender may amend the judicial foreclosure to include the omitted security;
2. The lender may prove that the borrower waived their protections under section 726;
3. The lender may prove that an exception to the antideficiency protections apply;
4. If none of the above, the lender may proceed with judicial foreclosure without obtaining a deficiency judgment, but if that is the case, it would be quicker and cheaper to just conduct a trustee's sale.
In a recent decision, the lender needed to prove #2 applied- that a borrower waived the protection. They did not, at great cost.

security first rule sacramento attorney.jpgIn First California Bank v. MacDonald, Sally and John borrowed over 1 million dollars secured by property in Wasco, Ca. As additional security, they also signed a deed of trust against a parcel in Safter which was owned by Sally as her sole and separate property. Sally sold the Shafter property by agreement with the Lender in which it agreed to the sale, the lender would receive all the net proceeds of the sale, and the Borrowers would not be released of liability. Apparently, John did not sign the agreement. John died, the note went into default, and bank filed a lawsuit for judicial foreclosure of the Wasco property. The trial Court issued a decree ordering sale of the Wasco parcel, finding that a deficiency judgment could be entered against John's estate (Sally had filed bankruptcy and discharged her personal liability).

The Court of Appeals said no. The first sentence of section 726 states that 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..." A component of the one form of action requirement is the security first rule, which requires the lender to proceed first against all the real property security first in a judicial foreclosure before further enforcing the underlying debt.

Code of Civil Procedure section 726(b)) provides that the decree for the foreclosure of a deed of trust "shall declare the amount of the indebtedness or right so secured and, unless judgment for any deficiency ... is waived by the judgment creditor ..., shall determine the personal liability of any defendant for the payment of the debt secured by the mortgage or deed of trust and shall name the defendants against whom a deficiency judgment may be ordered following the proceedings prescribed in this section."

Sacramento one form of action attorney.jpgHere, the lender had not shown that John had agreed to Sally's sale of the Shafter property. As it was her sole and separate property, they probably dealt only with her. While common sense may indicate that John was aware of his wife's plan to sell the property, and should have spoken up if he objected, but that was for the Lender to prove to the court, but they did not do so. All they needed was John's signature on such an arrangement, in which he made a knowing waiver of his rights.


Aiding and abetting breach of fiduciary duty - the two ways the aider may become liable.

November 13, 2014

Parties such as corporate directors, partners and managers of LLC's owe each other a fiduciary duty, which is a duty of loyalty and a duty of care. These are legal duties to act solely in another party's interests, and not profit from their relationship with their principals unless they have the principals' express informed consent. Violating this duty can result in liability. But, even if you do not owe someone a fiduciary duty, you can be found liable for aiding and abetting someone else in breaching such a duty, something to be aware of in any any transaction.. Under California Law, liability may be imposed on one who aids and abets the commission of an intentional tort if the person-

(a) knows the other's conduct constitutes a breach of duty and gives substantial assistance or encouragement to the other to so act, or

(b) gives substantial assistance to the other in accomplishing a tortious result and the person's own conduct, separately considered, constitutes a breach of duty to the third person.

Aiding-abetting focuses on whether a defendant knowingly gave 'substantial assistance' to someone who performed wrongful conduct, not on whether the defendant agreed to join the wrongful conduct. An aider and abettor does not 'adopt as his or her own' the tort of the primary violator. Rather, the act of aiding and abetting is distinct from the primary violation; liability attaches because the aider and abettor behaves in a manner that enables the primary violator to commit the underlying tort. In a recent California decision, just such an aider and abettor was found liable, which may result in millions in damages.

fiduciary duty sacramento attorney.jpgIn American Master Lease LL v. Idanta Partners Ltd. AML was an LLC formed to own real estate. (Hold on, the facts take some explaining) Roberts, the founder, designed it for people who did not want to individually manage their real estate investments. They could convey the property to AMC, and receive in return membership interests in the LLC. All members of the LLC would be "tenants in common," in that they all owned interests in the same LLC, but no interest in the real estate. Roberts and his family were the majority owners of the LLC, and Roberts was the Manager. Several others also joined. Defendant Idanta Partners was a venture capital firm, 80% owned by the Bass family of Texas.

Roberts, the manager, and other members entered into a management agreement with AML. Roberts remained the managing member, but under the agreement the other members became the Operating Group. AML needed a new financing partner, and the Operating Group proposed Idanta. Roberts objected, and presented an amendment to the Operating Agreement which prohibited that no deals could be done without majority approval. Roberts wanted to make all the decisions. Roberts told the others that he controlled the company. The Operating Group said screw you, and formed a new company, FPI which would partner with Idanta. The Operating Group gave the new company a license to use AML's business method. Roberts objected several times that the license agreement was not authorized. He claimed that the Operating Group was in breach of the operating agreement, which contains a non-compete, and any income from the new venture belonged to AML. The lawsuit began alleging a cause of action for aiding and abetting breach of fiduciary duty.

Sacramento real estate management attorney.jpgHere, the court found liability under test (b) above. Idanta gave substantial assistance to the other in accomplishing a tortious result and Idanta's own conduct, separately considered, constitutes a breach of duty to the third person. AML proved that Idanta had actual knowledge of the fiduciary duties that the Operating Group owed to AML as managers of AML. Idanta made a conscious decision to aid the Operating Group in performing a wrongful act; here, it was improperly acquiring rights to the AML business methods, and hiring the Operating Group to execute those methods.

Mixed Collateral Security - What the Lender Must Do to Be Sure It Avoids The California Antideficiency Rules

November 4, 2014

When the same debt is secured by liens on both real property and personal property, the lender has options as to how they are allowed to enforce their security interest. They can enforce against the real property under real property law, against personal property under the Commercial Code, or both. There are specifics under both areas of law which must be observed, or the lender may lose their security, and a party in this situation may want to consult with a business and real estate attorney. Otherwise, they may run into the problem faced by a lender recently when they failed to adequately describe the personal property in the deed of trust. The Court of Appeals found that the deed of trust did not successfully describe personal property as additional security, and thus any further recourse for the lender would be contrary to the purpose of the antideficiency laws.

mixed collateral attorney sm.jpgIn Thoryk v. San Diego Gas and Electric Company, the owner of an avocado ranch in San Diego County wanted to subdivide it into two-acre homesites. The owner borrowed $1 and ½ million from Highland for this purpose. There was a wildfire which did extensive damage to the property, and the project stopped. Highland foreclosed and obtained title to the property. The owner believed that San Diego Gas and Electric was at fault and sued for damages. Highland joined the suit, claiming that its deed of trust was secured by more than just the property, and extended to any of the owner's recovery of damages caused to the property; i.e. it was also secured by personal property. Highland argued that it was entitled to a judicially imposed lien under the terms of its deed of trust and related note.
The owner argued that he was protected by the antideficiency laws, which prohibits collecting money from the owner after a trustee's sale. However, where there are liens established upon both personal and real property in the subject transaction, a foreclosing lienholder using the power of sale may continue to pursue remedies against the former property owner/borrower. The creditor is not seeking a personal judgment for the unpaid balance of a loan, but instead seeks to enforce additional security secondarily liable for the principal loan.

The Court noted that where additional collateral was created for an obligation, a debtor-creditor relationship may survive a nonjudicial foreclosure, if the proceeds of the sale were insufficient to pay the debt, by showing that the language of the trust deed and note created additional collateral, beyond the real property security that it took under power of sale. It looked at the terms of the deed of trust. There, "real property" was defined to also include all fixtures, easements, water rights, plans or engineering reports, permits, entitlements, "and all money held on deposit for any of the foregoing or otherwise related to the Real Property; and all other rights, royalties, and profits relating to the real property, including without limitation all minerals...."

deed of trust attorney.jpgAlso provided was that it "shall constitute a Security Agreement to the extent any of the Property constitutes fixtures or other personal property, and Lender shall have all of the rights of a secured party...
with regard to the personal property, such as fixtures, the lender is given all the rights of a secured party, "including without limitation the right to recover any deficiency in the manner and to the full extent provided by California law."

Here, there was no express provision in the deed of trust that assigned any tort claims for injury to the real property as "additional security" for the mortgage debt. Without more specific language, the court refused to find that the deed of trust language included in the "personal property" defined by the trust deed as money "related to the Real Property. Thus, the lender was restricted to the real property alone. A better description in the deed of trust was required.


Collecting A Judgment against a Bankrupt LLC - When You Can Hold The Members Liable.

October 16, 2014

Individuals create LLCs, same with corporations, for ownership and investment purposes primarily to enjoy limited liability. If you invest $10 in an LLC and someone gets a huge judgment against the LLC, the most you could lose is your investment -the $10. The judgment creditor would not be able to come after you personally to collect the balance of their judgment. However, not all LLCs or corporations have assets from which a judgment may be collected. Sacramento area business and real estate attorneys are occasionally asked by clients withe judgments what can be done to go after the members, managers, directors or shareholders. As one group of LLC members recently discovered, if the LLC's distributions to them leaves the LLC penniless and essentially dissolved, the creditor may collect from the members.

Yolo LLC attorney.jpgIn CB RICHARD ELLIS, INC. v. TERRA NOSTRA CONSULTANTS, the real estate broker was seeking their commission on sale of 38 acres in Murrieta for $11.8 million. While the broker had the property listed, the buyer made an offer. Before closing, either the listing ended or the LLC which owned the property fired the broker, it was not clear. The sale closed. A few days after the cash went from escrow to the seller LLC's bank account, it all left the account and was distributed to the members. The broker arbitrated its dispute with the LLC (because there was an arbitration provision in the listing agreement) and obtained a judgment against the LLC. But, of course, the LLC had no money.

The broker than filed suit against the members. Its argument was in the Corporations code, which provides for liability in the event the entity has been dissolved. Applicable was the old Section 17350 (which was replaced by the equivalent section 17707.07) provides:

(a) (1) Causes of action against a dissolved limited liability company, whether arising before or after the dissolution of the limited liability company, may be enforced against any of the following:

(A) Against the dissolved limited liability company, to the extent of its undistributed assets, including, without limitation, any insurance assets held by the limited liability company that may be available to satisfy claims.

(B) If any of the assets of the dissolved limited liability company have been distributed to members, against members of the dissolved limited liability company to the extent of the limited liability company assets distributed to them upon dissolution of the limited liability company.

sacramento broker commission attorney.jpgIt was subsection (B) that the broker was looking at -over $11 million was distributed to the members. But, argued the members, this code section only applies when the corporation had been dissolved. Another section of the corporations code (old 17355, now replaced by 17707.1 ), states that an LLC shall be dissolved when it provides so in the operating agreement, when the members vote to dissolve, or a court issues a decree of judicial dissolution. None of these formal steps had occurred!

The Court of appeal said get lost. The purpose of section 17350 was designed to prevent unjust enrichment of LLC members, when the members have received assets which the LLC needs to pay creditors. Here, there was a de facto dissolution, and the broker could make the claim against the creditors. Otherwise, an LLC could be free to distribute all its assets, and then the next day vote to dissolve, with the members escaping free and clear.


Judicial Reference Better than Arbitration In California - But the reason the court can refuse to order reference

September 30, 2014

Judicial reference, unlike arbitration, works within the court system. A lawsuit is filed, and the judge appoints a referee to assist in the case, or decide it on their own. Parties can agree, in their contracts, that disputes are to be determined by a general judicial reference. This means the entire dispute is to be resolved by a referee. An advantage of judicial reference over other forms of dispute resolution (read 'binding arbitration') is that a referee's decision is treated like a judge's decision for purposes of appeal. On the other hand, an arbitrator's decision cannot be appealed for errors of fact or law, as I have railed about several times in this blog. But as some parties found out in a 2011 decision, a judicial reference provision is not a guaranty that the dispute will be decided by a referee, and parties interested in reference should consult with a Sacramento business and real estate attorney as to what is possible. In this case the California Supreme Court concluded that a judge could decline to appoint a referee if there is a possibility of conflicting rulings on a common issue of law or fact.

Sacramento judicial reference attorney.jpgIn Tarrant Bell Property, LLC v. The Superior Court, 120 residents of a mobile home park in Alameda County sued the park owners complaining that they had not maintained the common areas of the park and subjected residents to substandard living conditions. Of those residents, 100 residents' leases had a provision that provided that disputes were to be resolved, first, by arbitration, or should the arbitration provision be found to be unenforceable, by general judicial reference. Key here is that the remaining 20 residents, 17% of the total, had leases that did not require arbitration and reference.

The plaintiffs asked the judge to order arbitration or reference, the park owners opposed either. The trail court judge refused to order arbitration or reference. The opinion does not describe why the court denied arbitration, but focuses instead on denial of reference.

The concern was that, with two groups of plaintiffs one having the lease provision and the other not, there was a possibility of inconsistent judgments:

Woodland  judicial reference attorney.jpg"Ordering two groups of real parties in interest to try their cases in separate but parallel proceedings would not reduce the burdens on this court or the parties, result in any cost savings, streamline the proceedings, or achieve efficiencies of any kind. The parties would be required to conduct the same discovery, litigate, and ultimately try the same issues in separate but parallel forums. A general reference would thus result in a duplication of effort, increased costs, and potentially, delays in resolution. Moreover, it would not reduce any burden on this Court, which would almost certainly have to hear, and decide, all of the same issues."

The Court of Appeal did not overturn the decision, and neither did the Supreme Court. The Supreme Court started with the judicial reference statutes, Code of Civil Procedure Sections 638 +. Section 638 provides that the court may appoint a referee if the parties agreement states that the dispute shall be heard by a referee. "May" is permissive, meaning that the court has discretion, even if the parties agreement states "shall," which does not allow for discretion.

Thus, the court will not follow the intent of the parties, (at least 83% of them), in refusing to enforce a provision for judicial reference that they had in their leases. The facts here, where there were 120 different lease contracts, are not common for most contracting parties. But a common scenario where the problem would arise is a real estate purchase contract. Often, when there are real estate sales disputes, the brokers are included as defendants. But, the brokers are not parties to the purchase contract. Thus, a judicial reference provision would apply only to the dispute between the buyer and seller, but not between the plaintiff and broker.


California Homeowner's Insurance & Neighbor Lawsuits - How to determine if an encroachment was an "accident" that will be covered

September 23, 2014

Homeowners Insurance is not limited to fires, fallen trees, and general mayhem. When a homeowner is sued by a neighbor, the homeowner should routinely 'tender' the claim to the carrier (present the lawsuit to the insurance company, asking the insurer to provide your defense in the lawsuit). The question then becomes whether or not the lawsuit will be covered under the terms of the policy. Standard insurance policies cover an "occurrence", which is usually defined as an accident. If you are sued over a neighbor issue, you should consult a Sacramento real estate attorney regarding whether there may be insurance coverage. Over the years the California courts have set out guidelines for determining what could be considered an "accident" for these purposes. One homeowner, after an earthquake, rebuilt their residence encroaching onto their neighbor's property "by accident." The neighbor sued, and the homeowner tendered the suit to their insurance carrier. The homeowner was disappointed when the court found that, even though they had a good faith but mistaken belief that they were legally entitled to build where they did, it did not qualify under the policy and the insurer did not have to cover the defense. The bottom line - mistakenly believing that you have a right to do something, and then doing it, does not result in an accident.

sacramento homeowners insurance attorney.jpgIn Fire Insurance Exchange v. the Superior Court, the property was in Big Bear. When the owner tendered the claim to their insurer, the insurer denied the claim, so the homeowner sued the insurer. The insurer argued that the owners intentionally built their house over the property line, so it was not an accident. The owners countered that they were mistaken, believing that they owned the property where they built, so the construction was an accident.

The court first looked at the language of the insurance policy: it covered -

"those damages which an insured becomes legally obligated to pay because of ... property damages ... resulting from an occurrence to which this coverage applies." An "occurrence" is defined in turn as "an accident including exposure to conditions which results during the policy period in ... property damage."

"Accident" is given a commonsense interpretation that it is an unintentional, unexpected, chance occurrence. An accident does not occur when somebody does a deliberate act (like building a house) unless something independent and unforeseen happens which causes the damage. For example, a driver may intentionally speed. If he negligently hits another car, the speeding was still intentional, but hitting the other car, the act which cause the harm, was not intended, and was thus an accident.

sacramento encroachment attorney.jpgWhen the owner deliberately intended to perform every step that led to the damage, the fact that he did not intend to cause harm does not transform it into an accident. The court reviewed several decisions where an insured committed an act based on the mistaken belief that they had a legal right to do so. For example, a party was accused of sexual assault. The insured thought there was consent, but their mistaken belief did not make it an accident.

The general principal California is that the term "accident" refers to the nature of the conduct itself rather than to its consequences. Here, the homeowner intended to build the house where they built it. That they had a mistaken belief that it was on their land did not transform it into an accident - there conduct was intentional, and there was no independent, unforeseen happening that caused the harm.


The One Step a California Judgment Creditor Must Take In Addition to Recording An Abstract of Judgment to Collect Surplus Funds from a Foreclosure Sale.

September 10, 2014

A creditor who is awarded a money judgment in California must still collect the money that they are owed. The two most common steps they take are to garnish wages (if possible) and to record an 'abstract of judgment' in any county where the debtor owns real estate. The abstract then creates a lien against the property. If the owner seeks to sell, or refinance, the judgment must be paid off to clear title. The judgment creditor could also foreclose the judgment lien, if there is sufficient equity in the property.

However, what if a senior lien forecloses? In a decision out of Costa Mesa, the judgment creditor was disappointed to learn that recording the abstract was not enough. As explained below, the foreclosing trustee was not required to search the record for abstracts. The creditor is required to also record a request for notice under Civil Code section 2924b(a). However, that does not work if a notice of default had been already recorded - in that case the creditor must monitor the foreclosure, and make a demand on the trustee immediately after the sale, before surplus funds have been distributed. Unsure creditors should consult with a Yolo and Sacramento real estate attorney.

Yolo real estate attorney 3.jpg In Banc of America Leasing & Capital, LLC v. 3 Arch Trustee Services, the creditor obtained a judgment against the real property owner. It recorded an abstract of judgment. Unfortunately for the creditor, the notice of default and notice of sale had already been recorded. The sale occurred, and, the borrower having equity in the property, there was a surplus of almost $115,000 left after paying the senior lien. The trustee paid this money to former owner, who also had the judgment against him. He made out ok.

The creditor sued the trustee, claiming that they had notice of the creditor's interest due to the abstract, and the judgment should have been paid. The court said no. A trustee owes no duty to provide notices to any person unless the trust deed or the statute specifically provides for such notice. Civil Code section 2924b governs notices of default in nonjudicial foreclosure proceedings. The trustee must mail a default notice as follows:

First, section 2924b, subdivision (b) requires a trustee to give notice to:

(1) the trustor or mortgagor at his or her last known address if different than the address specified in the deed of trust, and

(2) to those persons who had recorded a statutory request for notice.

sacramento foreclosure surplus funds.jpg Second, section 2924b, subdivision (c), requires a trustee to give notice to other categories of parties, including 'the successor in interest, as of the recording date of the notice of default, of the interest being foreclosed.' Section 2924b, subdivision (c)(1) requires this additional notice, however, only if the party acquired the interest 'by an instrument sufficient to impart constructive notice of the ... interest in the land ... and provided the instrument is recorded in the office of the county recorder so as to impart that constructive notice prior to the recording date of the notice of default and provided the instrument as so recorded sets forth a mailing address which the county recorder shall use, as instructed within the instrument, for the return of the instrument after recording.

This creditor did not record prior to recording of the notice of default. It was out of luck. Anyone who is interested in a specific property or creditor may record a request for notice of the notice of default and notice of sale. BUT, this must be recorded after the recording of the deed of trust or mortgage and prior to the recording of the notice of default.


What NOT to Do When Buying Property and Concerned about a Prescriptive Easement

August 28, 2014

Figure this - you are in the process of buying a commercial real property and you see service vehicles (such as FedEx, UPS, and other companies) from the neighboring business crossing over the property to access their business, and some of the other property employees parking in the soon-to-be your parking spaces. What do you do? Ask the owner of the neighboring property about it? That is what the disappointed buyer in today's post. Your Sacramento real estate lawyer might advise you to get representations from your Seller, as a condition to your contract. Also, some title insurance policies will cover prescriptive rights, but our buyer just brought it up with his future neighbor eight months before escrow closed. He told him that he did not want their vehicles crossing the property line. The neighbor replied 'no problem. We'll take care of it.' But they did not take care of it -in fact, the neighbor already believed that he had a prescriptive easement. The sale closed escrow, the trespass continued, and the buyer sued the trespassing neighbor.

sacramento real estate attorneys.jpgIn Steven Hoffman v. 162 North Wolfe LLC, The buyer, who was a commercial real estate broker, sued the Sunnyvale neighbor, claiming that the neighbor defrauded them by falsely advising that they had no claims or interest with respect to the property. (Here's the google street view of the two properties) The Hoffmans alleged two fraud claims--concealment/suppression of facts, and intentional misrepresentation. After the conversation discussed above, the buyer did not bring the matter up with his seller, nor did he again discuss it with the neighbor. He claims that he thought it was taken care of.

concealment/suppression of facts- No legal relationship

The court first noted the necessary elements of a concealment/suppression claim consist of "'(1) misrepresentation (false representation, concealment, or nondisclosure); (2) knowledge of falsity (scienter); (3) intent to defraud (i.e., to induce reliance); (4) justifiable reliance; and (5) resulting damage. The defendant argued that it had no relationship with the buyer, thus did not have any duty to disclose their prescriptive rights. The court agreed, stating that the person charged with concealment or nondisclosure of facts must be under a legal duty to disclose them. Such a duty to disclose can arise from the relationship between doctor and patient, employer and prospective employee, seller and buyer, or parties entering into any kind of contractual agreement. But none of those situations existed here- they had no relationship, and thus no legal duty to disclose a claim to prescriptive rights. The plaintiff argued that, when a party does make a representation, he has an obligation to speak honestly and not make misleading statements. However, in this case, the neighbor was NOT asked if they claimed an interest in the neighboring property, and the statement that "we'll take care of it" cannot be reasonably construed as speaking about their claimed interest in the property.

Concealment/suppression of facts- No Justifiable Reliance

The plaintiff must also show that they actually relied on the misrepresentation or concealment, and that such reliance was reasonable. But after the conversation with the defendant, the plaintiff here continued to see, continuing for eight months, vehicles from the other property crossing the property the plaintiff was buying.

Intention Misrepresentation
The plaintiff claimed that the statement "We'll take care of it", was an intentional misrepresentation." But the court concluded that this was "too vague to be enforced." And, even if it was considered a misrepresentation, again there was no justifiable reliance.