It is widely understood that in California, when it comes to owner-occupied homes, if the seller carries back a loan, taking a deed of trust to secure the purchase price, if the buyer defaults on the loan the seller may not obtain a deficiency judgment. The seller is limited to foreclosing the deed of trust and getting the house back. In a recent situation the buyer obtained their primary loan from a commercial lender (Washington Mutual) and did not want the seller to also have a deed of trust against the property, so the seller recorded the deed of trust later. The seller could not then claim that they did not make a purchase money loan.
In James Enloe v. Casey Lee Kelso, Enloe sold their house to Kelso for $1.9 million. The sellers got a purchase money loan from Washington Mutual for around $1.8 million and change, and the seller was going to carry back a loan for the balance of about 5% of the purchase price. But Washington Mutual did not want a another deed of trust recorded behind its own. The facts are not clear in the opinion, but it may be that Washington Mutual wanted the buyer to have cash in the deal- like a five percent down payment. If the Seller’s deed of trust was to record in escrow, the Washington Mutual loan would not close. So, the crafty buyer and seller came up with a scheme (to defraud the lender?) In which the deed of trust would record after the sale escrow closed.
Prior to close of escrow, the buyer signed a note secured by a deed of trust in favor of the seller for the 5%. The seller gave the buyer a personal check for that amount. Because escrow would not accept a personal check, the check was marked void. Escrow then closed. Again, the court decision does not indicate if the buyer came up with more cash (to the tune of over $90,000) to cover the five percent difference, but the money came from somewhere. On the same day escrow closed, the Seller gave the buyer a check for 5% amount. A few days later the Seller recorded their deed of trust.
Five years later the buyer entered a short sale agreement, which Washington Mutual and the seller agreed to. The seller got $22,000 cash out of the short sale agreement. The seller than sued the buyer for the balance of their loan. The court said no dice.
Code of Civil Procedure section 580b provides there can be no deficiency judgment “under a deed of trust or mortgage given to the vendor to secure payment of the balance of the purchase price of that real property or estate for years therein.”
The subdivision was enacted to discourage lenders from overvaluing the property, and to prevent the “aggravation of a downturn” that would result from an economic depression. (We saw in the most recent depression how houses were overvalued by lenders) In considering this, the courts look to the substance of the transaction, not its form. Here, it was clear that the seller carry-back loan was intended to be part of the purchase money transaction, and not a loan made later. I am surprised that the court does not provide more details about the transaction, because it looks like an attempt to defraud the lender. Why would the lender care if there was another loan subordinate to its own, unless it wanted to ensure that the buyer had equity in the house, and would not be inclined to walk away. I guess those details were not in this lawsuit, because Washington Mutual was not included. However, it is the substance of the transaction, not the form, and the court reached the right conclusion.