Governor Brown Signs Bill Protecting California Homeowners from Claims by Junior Mortgage Holders Following Consent to and Completion of a Short Sale

July 22, 2011

Dear Insolvency Law Committee Constituency List members:

The following is an EBulletin prepared by Insolvency Law Committee member Robert G. Harris: 

Governor Brown signs bill protecting California homeowners from claims by junior mortgage holders following consent to and completion of a short sale

On July 11, 2011, Governor Brown signed SB 458 into law.  Click [HERE] to read the text of the bill.  SB 458 amends section 580e of the California Code of Civil Procedure (enacted in 2010) to apply certain limitations on first mortgage holders who accept short sales to junior mortgage holders.  In order to mitigate the impact of the ongoing foreclosure crisis and to encourage the approval of short sales as an alternative to foreclosure, the bill was passed with an urgency provision and became effective on July 15, 2011, when it was filed with the Secretary of State.

Code of Civil Procedure section 580e, as amended, prohibits a deficiency judgment on a note secured solely by a deed of trust or mortgage for a dwelling of not more than 4 units should the trustor or mortgagor sell for less than the remaining debt with the written consent of the holder of the deed of trust or mortgage if title has been voluntarily transferred to a buyer by grant deed or by other document that has been recorded and the proceeds of the sale are tendered as agreed.

SB 458 clarifies an ambiguity in the original wording of Code of Civil Procedure section 580(e).  With respect to a multiple collateral loan made for business purposes, a short sale conducted pursuant to section 580(e) might arguably have been interpreted to extinguish the entirety of a debt obligation secured by a 1-4 unit dwelling and other residential, commercial, or vacant land property, or other personal property related to or used in connection with the property.  Such an interpretation would have left commercial lenders with multiple collateral no choice but to foreclose and reject any short sale in order to protect their security and ability collect the loan balance.  In order to resolve the issue, SB 458 replaced the words "fully discharge" in section 580(e) with language treating the deficiency as though the 1-4 unit dwelling had been sold through foreclosure under a power of sale under Code of Civil Procedure section 580d. 

Other important provisions of SB 458 are as follows:

●  A holder of a note shall not require the trustor, mortgagor, or maker of the note to pay any additional compensation, aside from the proceeds of the sale, in exchange for the written consent to the sale.

●   Exceptions to the new law include a lender asserting damages for a borrower's fraud or waste, a borrower that is a corporation, LLC, limited partnership, or political subdivision of the state, and liens secured by a public bond, as well as by public utility liens;

●   Any purported waiver of the provisions of section 580e is void and against public policy.

AUTHOR COMMENTARY

Second mortgages are generally, unless the mortgage was used to purchase a home, recourse as to the borrower.  As a result, a second mortgage holder can usually sue the homeowner for the balance of debt owing following a foreclosure by senior lien holder or a short sale in which liability is not explicitly released.  Typically, the threat of suit has been used to extract a cash payment from the homeowner as consideration for consent to a short sale.

Now that requiring payment to a mortgage holder to accept a short sale is illegal, there is a valid concern that, unless the first and second mortgage holders are the same entity, there may be little incentive for the second mortgage holder to accept a short sale. If a lender thinks a borrower may recover financially and wants to preserve its right to go after him or her, it may refuse to consent to a short sale and seek a judgment for the loan balance, sell the debt, or assign it to a collection agency.   It is worth noting that the new law does not prohibit a mortgage holder from negotiating for a contribution from someone other than the borrower, such as another lender, an agent, a relative, or some other third party.

These materials were prepared by Robert G. Harris of Binder & Malter, LLP in Santa Clara, California.

Thank you for your continued support of the Committee.

Best regards,

Insolvency Law Committee
The Insolvency Law Committee of the Business Law Section of the California State Bar provides a forum for interested bankruptcy practitioners to act for the benefit of all lawyers in the areas of legislation, education and promoting efficiency of practice. For more information about the Business Law Standing Committees, please see the standing committees web page.