Mcle Self-study Article: Beware the "security Side Deal" in Multi-debtor Real Estate Secured Obligations: First California Bank v. Mcdonald
| Publication year | 2015 |
| Author | Charles Hansen and Kevin Brodehl |
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Charles Hansen and Kevin Brodehl
Charles Hansen is a partner at Wendel, Rosen, Black & Dean in Oakland whose core practice is devoted to lending, mortgages, trust deeds, escrows, title insurance, real estate developments, guaranties, and secured transaction litigation. Since 1985, he has also taught advanced real estate courses to law and MBA students at the UC Berkeley School of Law (Boalt Hall).
Kevin Brodehl is a partner at Wendel, Rosen, Black & Dean in Oakland specializing in real estate and secured lending litigation, including numerous appeals, as well as business disputes. Kevin is also the chief author and editor of the Money and Dirt blog at http://moneyanddirt.com.
Disclosure: The authors serve as appellate counsel for Appellants McDonald, et al., the co-borrowers in the case at issue. The authors' practice includes representation of both lenders and borrowers in secured lending litigation.
The intricacies of obtaining a deficiency judgment under California mortgage and foreclosure law are, for many lenders and practitioners, difficult enough with a simple loan structure involving a single borrower. Loans involving multiple borrowers create additional risks and challenges, especially with respect to how the lender disposes of security. These issues are now before the California Supreme Court in First California Bank v. McDonald ("McDonald").1
In the Fifth District Court of Appeal's McDonald decision, which was initially published on October 24, 2014, the court held that under the fundamental and profound rules embodied in Code of Civil Procedure section 726 ("Section 726")—variously referred to as the One Form of Action Rule, the One Action Rule, and the Security First Rule—a lender lost its right to pursue a deficiency judgment against a co-borrower when the lender agreed to a private, pre-foreclosure "short sale" of real estate security property without the co-borrower's consent. In so holding, the court confirmed California's broad and longstanding public policies disfavoring deficiency judgments and requiring that secured lenders exhaust their security in a prescribed manner in order to retain any possible claim to a deficiency judgment. As relevant to McDonald, to obtain a deficiency judgment, a lender must include all real property collateral in a single action for judicial foreclosure with a deficiency reserved. Any deviation from that scheme normally requires borrower consent.
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On February 25, 2015 the California Supreme Court granted review of the McDonald decision on a "grant and hold" basis,2 with briefing and review deferred until the Court issues its opinion in the "lead case," Coker v. JP Morgan Chase Bank, N.A. ("Coker"),3 a case involving a different type of anti-deficiency-based challenge to a short sale.
This article describes the Court of Appeal's opinion in McDonald, explores the legal framework that will guide the California Supreme Court's review, and gauges the Court's potential disposition of the case.
The facts and holding of the McDonald decision are summarized below.4
A. The Multi-Debtor Loan Secured by Real Estate 1. The bank made a loan to John P. DeVincenzo and Sally DeVincenzo that was secured by two separate properties.The bank (initially San Luis Trust Bank, which was later placed into receivership and some of its assets sold to First California Bank; here "Bank") loaned $1,509,000 to John P. DeVincenzo ("John") and Sally DeVincenzo ("Sally"), as reflected in a Promissory Note dated March 19, 2009. Two separate properties secured the loan. the Shafter Property and the Wasco Property. Bank recorded a separate deed of trust against each property. Sally owned the Shafter Property as her sole and separate property; both Sally and John owned the Wasco Property.
2. John died, his children were appointed as the personal representatives of his estate, and the loan fell into default.John died on September 19, 2009. John's three children from his prior marriage (before Sally)—Mary Alice McDonald, Katherine Anne Kelly, and John Peter DeVincenzo III (collectively "Appellants")—were appointed the personal representatives of John's estate, which remained a co-debtor on the loan. After the monthly payment due on December 3, 2009 remained unpaid, Bank declared the loan in default and accelerated the debt.
Bank filed a claim in John's probate proceedings on February 25, 2010 to recover the loan balance, and served the probate claim on each of the Appellants, identifying them as the personal representatives of John's estate. Bank's probate claim noted that the loan continued to be secured by both the Shafter Property and the Wasco Property. John's estate took no action on the claim, and Bank elected to treat the claim as rejected.
3. Pursuant to a private agreement between only Bank and Sally, Sally sold one security property and Bank reconveyed the deed of trust on that property—all without Appellants' consent.Between the time that Bank filed its probate claim in February 2010 and filed its superior court complaint in November 2010, Bank and Sally agreed to allow Sally to sell the Shafter Property in a private "short sale." That sale was not a foreclosure sale, of course. Bank and Sally made their agreement on the condition that Bank would receive the net proceeds of the sale and neither of the debtors (Sally or the estate) would be released from personal liability for the debt. When the parties entered into this private agreement, Appellants (not Sally) were the personal representatives of the estate. Thus, Sally had no authority to bind the estate. Pursuant to the agreement between Bank and Sally, Sally sold the Shafter Property. The record contains no evidence establishing the "net proceeds" of the sale, whether Bank actually received the proceeds, and if so, what commissions and fees were deducted from the gross sales amount before the net proceeds were purportedly applied to the debt.
Appellants received no notice of the sale, and there was no evidence that they consented to the sale. There were no judicially supervised proceedings to ensure that the Shafter Property was sold in a public and open manner subject to fair value protections under Code of Civil Procedure sections 726(b) and 580a, or subject to a right of post-sale redemption pursuant to Code of Civil Procedure sections 726 and 729.010 through 729.090.
B. Bank's Lawsuit for Judicial Foreclosure and Deficiency Judgment 1. Bank filed its complaint for judicial foreclosure of the remaining security property and for a deficiency judgment against Sally and Appellants.[Page 52]
Bank filed its complaint on November 8, 2010, seeking judicial foreclosure of the remaining Wasco Property and a deficiency judgment against Sally and Appellants. The complaint referenced the Wasco Property, but was silent as to the Shafter Property that had already been sold privately. The fact that there had been a second item of real property security was, in effect, airbrushed out of the picture entirely.
2. The trial court granted Bank's motion for summary adjudication and entered a decree of foreclosure for the remaining security property, with Appellants liable for any deficiency.Bank moved for summary adjudication of its judicial foreclosure claim. In their opposition to the motion, Appellants relied on their affirmative defense under Section 726: specifically, that Bank's unilateral release and reconveyance of the Shafter deed of trust after Sally's private sale, without Appellants' consent, rendered it impossible for Bank to satisfy the necessary prerequisites to obtaining a deficiency judgment. Appellants also relied on Pacific Valley Bank v. Schwenke5 as the leading statement of applicable law under similar facts. Appellants argued that, based on their affirmative defense, John's estate could not be held liable for any deficiency judgment.
While Bank's motion remained pending, Sally filed for Chapter 7 bankruptcy protection. The Bankruptcy Court allowed Bank to continue with its foreclosure action, but prohibited Bank from seeking a deficiency judgment against Sally.
The trial court granted Bank's motion, and entered a decree of judicial foreclosure. The trial court acknowledged that Bank and Sally privately sold the Shafter Property in a private transaction without Appellants' knowledge or consent, but held that Appellants' consent was unnecessary as they did not own the property and Bank had agreed to apply all of the sale proceeds to the loan. The trial court further ruled that after the judicial foreclosure sale of the remaining real property security (the Wasco Property), the Bank would be entitled to request a deficiency judgment against Appellants as a matter of law. Appellants then appealed.
C. The Court of Appeal's OpinionThe Court of Appeal described the "central issue" presented by its decision as:
Was Bank's right to collect a deficiency judgment against appellants dependent upon Bank obtaining their consent to the arrangement in which Bank released its deed of trust to the Shafter Property? Stated in terms of the summary adjudication statute, was appellants' consent a material fact that must be undisputed for Bank to prevail on its claim for a deficiency judgment? We answer 'yes' to these questions.6
The Court of Appeal summarized its holding as follows:
There are two basic statutory requirements under Code of Civil Procedure section 726 for creditors seeking deficiency judgments: (1) "security first," which means that a creditor must first exhaust all real property security to qualify for a deficiency judgment; and (2) such exhaustion of the real property collateral must be through a single judicial foreclosure lawsuit. These requirements...
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