Consider the typical situation when a person wishes to purchase a home. The purchaser typically puts a certain amount of money down, say 10% of the purchase price, and finances the remaining 90% through a loan from a bank or other mortgage lender. The purchaser then signs a promissory note in favor of the lender and executes a trust deed or mortgage on the property to secure the lender. The trust deed on a mortgage provides the lender with security in the event the purchaser fails to make required payments on the loan. Typically, the loan would be paid off over a 30-year or 15-year fixed period, or when the property is sold and transferred to a new purchaser.
However, in some instances, the purchaser is unable to continue making monthly mortgage payments, and he defaults on the loan. In that instance, the lender will “foreclose,” and seek to recover the remaining balance on the loan. There are two ways for the lender to proceed. One way is for the lender to bring a judicial foreclosure action, which is a legal proceeding in court. The other, more common method of foreclosure in California, is for the lender to institute a non-judicial foreclosure, also known as a “private sale.”
Since a judicial foreclosure proceeding is an action in court, it may take a year or more to resolve, and will be subject to the all of the defenses a borrower may have in a breach of contract action, including the statutes of limitation applicable to such actions. In the case of a judicial foreclosure action, the four-year statute of limitations for breach of a written contract would apply. Since this type of foreclosure requires full court proceedings, the lender would typically need to hire an attorney to prosecute the action.
A non-judicial foreclosure action, on the other hand, is not an action filed in court and, therefore, is not subject to a statute of limitations defense. Moreover, a non-judicial foreclosure may result in a foreclosure sale, with proceeds paid to the lender, in a much shorter period of time than would be the case in a judicial foreclosure action. That period of time may be as short as 110 days from the time the lender provides the purchaser with notice of default. Nonjudicial foreclosure proceedings are also less expensive than judicial foreclosure proceedings, since the lender may not require the assistance of an attorney.
Since non-judicial foreclosure proceedings are quicker and less expensive than judicial foreclosure proceedings, the question arises, why would a lender proceed judicially? The answer is that, in some cases, a lender may be able to obtain not only the amount for which the property is sold, but also the difference between the sale price and the full amount the lender is owed (i.e., the “deficiency”), in the event the sale proceeds are less than what the lender is owed. In that instance, the lender will be made whole through a judicial foreclosure proceeding. In contrast, in a non-judicial “private sale,” the lender may not recover any deficiency.
California Anti-Deficiency Statutes
However, a judicial foreclosure proceeding is not available in many, if not most instances in California. Consider the typical scenario mentioned above: a purchaser obtains a loan in order to purchase a home in which he intends to live. In that situation, the “anti-deficiency” statutes apply. The anti-deficiency statutes provide that a lender may not obtain a deficiency judgment under a deed of trust or mortgage given to the lender to secure repayment of a loan that was in fact used to pay all or part of the purchase price of the dwelling, if the dwelling is occupied entirely or in part by the purchaser. In the case of such a “purchase money loan,” no deficiency may be collected by the lender.
One Form of Action Rule
Also relevant in the typical scenario referred to above is California’s “one-form-of-action rule.” This rule provides that foreclosure is the only form of action that may be pursued by a lender to recover any debt or enforce any right secured by a trust deed or mortgage. Under the one-form-of-action rule, if the purchaser/borrower defaults on the loan secured by a deed of trust or mortgage given to the bank or other mortgage lender, the lender must look to recover what the lender is owed first — and perhaps only — from the security, that is, the property subject to the trust deed or mortgage. Moreover, in the “purchase money loan” scenario described above, the lender will not be able to seek or obtain a “deficiency” and, therefore, must proceed by way of non-judicial foreclosure, rather than a judicial foreclosure action.
In the event the property is sold in a non-judicial foreclosure proceeding, the lender will be paid first out of the proceeds of sale. If the lender is paid in full, any remaining funds will be paid to the purchaser/borrower if there are no other lenders with security interests in the property, or to any such secured lenders subordinate to the bank or other mortgage lender which provided the original loan enabling the purchaser/borrower to purchase the subject property. Of course, typically the proceeds of sale will not be sufficient to pay the original lender, so there will be nothing left after partial payment of the loan is made to the original lender out of the proceeds of sale.
It is not uncommon for a producer/borrower to obtain a home equity line of credit (HELOC) or other form of second loan, giving the second lender a trust deed or mortgage on the same property. In that instance, the second lender, or “junior lienor,” will have security in the property for repayment of the loan, but that security will be subordinate to the original lender who holds a first trust deed or mortgage on the property.
In that situation, in what position does the second trust deed holder find himself if the original purchaser/borrower defaults on the loan he obtained from the original lender? In a typical situation, the original lender will institute a non-judicial foreclosure proceeding. If there are insufficient funds from the sale of the property to fully pay off the first trust deed holder, there will be nothing left to pay off the second trust deed holder. In that event, the second trust deed holder, also referred to as a “sold-out junior lienor,” will not benefit from a foreclosure proceeding, either judicial or non-judicial, because his security for the property will have been wiped out. Since he no longer has a security interest in the property, he is not constrained by the one-form-of-action rule, and may seek a personal judgment against the borrower.
One final note: the one-form-of-action rule in the anti-deficiency statutes does not apply to in the event the lender has obtained a guarantee of the loan from a third-party. In that event, if the purchaser/borrower has defaulted on the loan, the lender may file a legal action against the guarantor on the guarantee, and may collect the full amount of the unpaid loan from the guarantor.
For further information, contact our team of trusted attorneys at Gehres Law Group.