Articles Posted in real estate loan

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In California, generally when a real estate buyer defaults on the loan and loses the property to foreclosure, the lender may not pursue a deficiency judgment against the borrower where the foreclosure sale proceeds are not enough to cover the amount of the debt. Lenders may go after loan guarantors for a deficiency judgment, but only if they are true guarantors. Where the borrower and the guarantor are the same, however, the guaranty is considered an unenforceable sham. I like reading about sham guaranty cases, because the courts actually call them a sham, a word not used often enough in judicial opinions. Sacramento real estate attorneys see the argument applied when either the guarantors are trying to squirm out of liability, or where the bank set up the transaction to avoid the antideficiency laws. In a recent decision out of Napa County, it does not appear that the borrowers intended to set-up the lender for a sham, but were able to make the sham argument that they were the sole owners of the borrower LLC, which was merely a shell and they were its alter ego. The court said no, there was adequate separation between the guarantors and the borrower.

attorney sacramento sham loan guaranty.jpgIN CADC/RAD Venture 2011-1 LLC v Richard Bradley et al. Bradley and Yates were owners of No Boundaries LLC, which owed property in Seattle. They were selling that building and wanted to exchange it for 7 acres in Napa. Bradley entered a contract to buy the Napa land, and No Boundaries submitted a loan application. The loan was approved, with Bradley and Yates being required to sign loan guaranties. At the last minute the buyers decided to change the borrower to the newly created Nohea LLC. The bank was willing to allow the change in borrowers because the defendant guarantors had enough money to justify the loan. The $2.1 million loan closed, and Bradley and Yates signed commercial guaranty agreements in which they waived their rights under the California antideficiency laws. Nohea LLC did not provide the bank with any financial information. Of course, the loan went into default, the bank foreclosed, and brought this lawsuit against Bradley and Yates, the guarantors. Bradley and Yates claimed that the guaranties were unenforceable shams.

A threshold issue in sham guaranty cases is whether the guarantor of a loan is also obligated as a borrower. An example is where a partnership was the borrower, and the partners are guarantors. Under partnership law, general partners are already liable for the debts of the partnership, so the guaranty added nothing. Likewise where a corporation is organized solely to take out a loan, and is not capitalized. Thus the corporation was a mere instrumentality used by the defendants, who were in fact the buyers.

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Guarantors of California commercial real estate loans are regularly required to sign waivers of defenses. Guarantors would otherwise have the usual defenses that borrowers have, such as anti-deficiency protection (see at bottom re: the Gradsky Waiver). Civil Code section 2856 specifies what specific defenses may be waived; the waiver often includes language which provides for waiver of all defenses listed in Civil Code section 2856. However, Sacramento real estate attorneys occasionally see situations where the lender engaged in such bad behavior that the waivers come into question. This situation arose in a decision last year from Southern California.

sacramento loan guaranty waiver attorney.jpgIn California Bank & Trust v. DelPonti, Five Corners LLC obtained a loan to develop a 70-unit townhome project. DelPonti was one of the guarantors. After 18 months of work, the bank stopped paying approved payment applications, bringing the project to a halt. The bank entered an agreement with Five Corners in which the bank promised to pay the subcontractors if they discounted their bills, mitigating the guarantors’ damages. Nonetheless, the bank foreclosed on the project. The bank sued Five Corners and the Guarantors for the deficiency. The trial court ruled for the guarantors, finding that the bank was guilty of willful misconduct, and a) the bank breached the loan agreement by refusing to honor the four approved payment applications, and b) the bank led the Guarantors to believe that they would be released from the guaranty if they performed according to the later agreement. The Court of Appeals also ruled for the Guarantors, finding that the waivers they signed did not include equitable defenses for their bad conduct.

The bank argued that the Guarantors waived all their defenses under the guaranty agreement. The Court said, no, not all of them. Section 2856 provides lists of the specific defenses (set out below) to enforcement of the guaranty. However, a guarantor cannot be held liable where a contract is unlawful or contravenes public policy. Here, the Bank was arguing that, before default, the Guarantors waived the bank’s own misconduct. But that was not expressly waived in the Guaranty, nor provided for in the Civil Code. The Court did not interpret Civil Code section 2856 to permit a lender to enforce predefault waivers beyond those specified, where to do so would result in the lender’s unjust enrichment, and allow the lender to profit from its own fraudulent conduct. Thus, these Guarantors waiver was limited to those statutory defenses expressly provided for in the in the agreement. “A waiver of statutory defenses is not deemed to waive all defenses, especially equitable defenses, such as unclean hands, where to enforce the guaranty would allow a lender to profit by its own fraudulent conduct. The doctrine of unclean hands bars a plaintiff from relief when the plaintiff has engaged in misconduct relating directly to the transaction concerning which suit is brought.”

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There are numerous anti-deficiency laws concerning California real estate. An Important one, especially with commercial real estate, is CCP section 726(a). It is broadly described as the “one form of action” rule. This broad rule has two components – a) the “one action rule”, a prohibition of multiple lawsuits to collect a debt secured by real estate; and b) the “security first rule,” which requires the creditor to proceed first against all the real property security (exhausting the security) first through judicial foreclosure before enforcing the underlying debt. 726 provides for a lender to file a judicial foreclosure lawsuit which will allow them to recover a deficiency judgment against the borrower. This statute is subject to many Judge-made requirements and sub-rules, and a careful lender or borrower will want to consult a Sacramento real estate attorney. In a decision from Southern California, the lender got a big surprise when they discovered that because of its mistake, it could not obtain a deficiency judgment.

NOTE: A petition for review was granted by the Supreme Court; this case may not be cited.

Sacramento security first attorney.jpgIn First California Bank v. McDonald, the bank made a $1.5 million dollar loan to a husband and wife. The loan was secured by a deed of trust on property in Wasco. As additional security, the wife signed a deed of trust on her separate property located in Shafter. Eventually, Sally wanted to sell the Shafter property. The Bank agreed to the sale with the understanding that the bank would get the proceeds, and the couple would not be released of liability. The husband did not sign the release agreement.

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Under California foreclosure law, a trustee’s sale eliminates all interests in the property that are recorded after the deed of trust was recorded. For that reason, holders of interests want to get notice that the property is being foreclosed. Generally, the foreclosing trustee is only required to provide notice of the recording of the notice of default to the parties identified in statutes or specified in the deed of trust. Other persons with lesser interests that are junior to the deed of trust are not automatically entitled to notice. Civil Code section 2924b(a) provides a process for anyone to record a request for notice, which then obligates the trustee to send them a copy of the Notice Of Default. Civil Code 2924b (b), set out in full below, describes who otherwise must be provided notice. The trick is whether you are included in the specified categories. In a recent decision, an easement holder was disappointed to learn that he was not, and the easement was lost. They should have recorded a request for a copy of the notice of default.

Saccramento notice of default attorney.jpgIn George Perez as Trustee v. 222 Sutter St. Partners, there was a foreclosure and the subsequent quiet title action was about whether the foreclosure of 425 Bush Street in San Francisco extinguished easement rights. The easement holder had not received notice from the trustee of the foreclosure.

The easement holders argued that an easement holder is included in section 2924b, subdivision (c)(2)(A), as “[a] successor in interest, as of the recording date of the notice of default, of the estate or interest or any portion thereof of the trustor or mortgagor of the deed of trust or mortgage being foreclosed. It continued that it was a successor to the mortgagor of the deed of trust, who was the owner. But this is impossibility. An easement is an interest, but the mortgagor/owner cannot own an easement across one’s own property. Thus, the easement holder cannot be a successor to that interest.

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When California lenders and buyers seek title insurance, they want to be sure that the title to the property that they are receiving, or the security for their loan, is what they expect it to be. In the case of the lender, they want to be sure that they are in first place, so that if they need to foreclose, the property will be unburdened by any senior lien or liability, and they can get their money out of it. A preliminary title report, the precursor to the policy, is an offer to sell an insurance policy, but not like any other kind of offer to make a contract. If I offer to sell you my “used Buick, which has 20,000 miles on it, for $12,000,” and you accept, when you discover that it really has 97,000 miles on it, you have a claim against me for breach of contract and fraud. But Sacramento & Yolo commercial real estate attorneys are often faced with explaining to clients that the preliminary report cannot be relied on in the same way. That was the answer some mortgage investors got from the court, when the preliminary report stated that the title company would get a full release of a notice of abatement action before issuing a policy.

Sacramento title insurance policy attorney.jpgIn Stockton Mortgage Inc. v Tope, the plaintiff Lender loan $315,000 to Tope to buy and rehab a Stockton property. The lender obtained title insurance from Alliance Title Company, underwritten by First American. The preliminary report had the standard language stating”

“[T]his Company … is prepared to issue, or cause to be issued, as of the date hereof, a Policy or Policies of Title Insurance … insuring against loss which may be sustained by reason of any defect, lien or encumbrance not shown or referred to as an Exception herein or not excluded from coverage pursuant to the printed Schedules, Conditions and Stipulations of said Policy forms.”

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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.

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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.

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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;

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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.

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I have written before about courts calling to account lenders who reneg on loan modifications after the borrower made numerous trial plan payments. Courts have ruled against lenders based on promissory estoppel, offer and acceptance creating a contract, for lack of a signed, written modification; and lack of a modification signed by the lender. Usually, when the property is about to be, or already has been, sold at a trustee’s sale, the borrower consults a Sacramento real estate attorney about such a situation. In a recent decision the lender was disappointed when the court found that the plaintiff properly alleged numerous claims against it.

Sacramento real estate loan attorney 2.jpgIn James Rufini v. CitiMortgage, Inc., the Sonoma homeowner sought a loan modification. In June 2009 CitiMortgage approved the loan modification, and told him he would receive a permanent modification in October after timely making three trial payments. He continued making the trial payments through December, in January the lender told him that his permanent loan modification agreement would be ready in three days. Three months later, since he had not received the written agreement, he rented out the house (and lived with his son) to offset expenses while waiting for the modification. The modification was then denied because the home was not “owner-occupied.” The lender then refused to accept his mortgage payments at the modified level. A notice of trustee’s sale was recorded, and the borrower got a 30-day postponement, while the lender was requesting additional information, like income information. Meanwhile, CitiMortgage transferred the loan to PennyMac. CitiMortgage kept discussing the modification, and the property was foreclosed. The borrower claimed that the lender’s contact said he had known all along the loan had been transferred to PennyMac.

BREACH OF CONTRACT