California Lenders Must Be Diligent Not to Get Burned Twice: a Reminder of the Consequences of the Full Credit Bid Rule in Light of the California Wildfires

• Jurisdiction: California,United States
• Author: Kathryn A. Moorer and T. Robert Finlay
• Publication year: 2019
• Citation: Vol. 37 No. 1

California Lenders Must Be Diligent Not to Get Burned Twice: A Reminder of the Consequences of the Full Credit Bid Rule in Light of the California Wildfires

Kathryn A. Moorer and T. Robert Finlay

Kathryn A. Moorer is a senior associate at Wright, Finlay & Zak. She focuses on real estate litigation, including lender and servicer liability defense, wrongful foreclosure defense, California's Homeowner's Bill of Rights compliance disputes, fair debt collection practices/credit reporting defense, title disputes, habitability and landlord-tenant disputes, bankruptcy adversary actions and appeals in both state and federal court. In addition, Ms. Moorer has extensive experience responding to consumer complaints filed with the California Department of Business Oversight and Consumer Financial Protection Bureau.

T. Robert Finlay is a founding partner of Wright, Finlay & Zak. He has focused his legal career on consumer finance and mortgage-related litigation, compliance, and regulatory matters. Mr. Finlay is at the forefront of the mortgage banking industry, handling all aspects of the ever-changing default servicing and mortgage banking litigation area, including compliance issues for servicers, lenders, investors, title companies, and foreclosure trustees.

Recently, multiple wildfires swept across the State of California leaving a wake of destruction in their path. The fires destroyed a multitude of residential properties and the entire Northern California city of Paradise. While foreclosure moratoriums will temporarily stop all foreclosure activity, they will eventually be lifted, giving lenders the option to foreclose on affected properties that serve as security for defaulted loans. Before going to sale on a fire damaged property, lenders should understand the risks created by their foreclosure bids, including, but not limited to, the potential loss of the lender's right to insurance proceeds.

Rather than show up with cash at its own sale, a foreclosing lender can make a "credit bid" up to the full amount of the borrower's indebtedness, "since it would be useless to require [the lender] to tender cash which would only be immediately returned to [it]."¹ While the foreclosing lender has the option of bidding up to the full amount of the debt (i.e., a "full credit bid"), doing so can limit the lender's right to recover additional amounts due to any impairment of the security. Indeed, a successful full credit bid establishes the value of the real property and prevents the lender from claiming that the property is worth less than the amount of the bid.² This concept, created through case law, has become known as the "Full Credit Bid Rule."

Pursuant to this rigid rule, a full credit bid extinguishes the debt entirely and precludes the lender from recovering any additional amounts to satisfy the debt. If the lender makes a successful full credit bid, it "cannot pursue any other remedy based upon the recovery of any part of the secured debt, or recover from any other security, regardless of the actual value of the property on the date of the sale."³ Accordingly, the lender is prohibited from recovering fire or other insurance proceeds payable for pre-sale damage to the property, pre-sale rent proceeds, or even damages for the borrower's waste.⁴ The Full Credit Bid Rule also bars the foreclosing lender from recovering a condemnation award,⁵ as well as any amounts that may have been payable from a guarantor of the debt prior to the foreclosure sale.⁶ The rule also prohibits a lender from recovering title insurance proceeds. This is because the lender's only interest in the property (i.e. the repayment of the debt) has been satisfied and extinguished by the full credit bid; the presumption is that any further payment would necessarily result in a double recovery or windfall to the lender.⁷

[Page 23]

Due to the foregoing, a lender making a credit bid at a foreclosure sale must be aware of its potential rights to rents, additional or supplemental security, insurance proceeds, and/ or any damages caused by the borrower's waste. As stated by the California Supreme Court, "[t]he lender, perhaps more than a third party purchaser with fewer resources with which to gain insight into the property's value, generally bears the burden and risk of making an informed bid."⁸ California courts have consistently held that the purchaser at a foreclosure sale has the duty to assess the value of property correctly.⁹

The Full Credit Bid Rule may impose harsh consequences for a lender who makes a successful full credit bid on real property with a substantially lower fair market value. It is well established that a lender who purchases an encumbered property at a foreclosure sale by making a full credit bid is not entitled to insurance proceeds payable for pre-foreclosure damage.¹⁰ For example, in Altus Bank v. State Farm Fire & Cas. Co.,¹¹ the court relied on the Full Credit Bid Rule to prohibit the lender from recovering any insurance proceeds resulting from a pre-sale fire that completely destroyed the residence on the property. Despite the fact that the lender made a claim...