(Wednesday, November 16, 2011 – Marin County, CA)
CALIFORNIA LEGISLATURES CONTINUE TO CURTAIL LIABILITY
OF DISTRESSED SELLERS IN SHORT SALE PROCEEDINGS —
DO THEIR EFFORTS HELP YOU?
There is a wide range of confusion swirling about with the recent enactment of several key pieces of legislation surrounding a seller’s resulting liability after they have completed a “short sale” of their property due to financial distress.
In the 1930s California Civil Code of Procedure (CCP) 580b was passed as a way to prevent distressed borrowers from being sued by their lender after the lender had foreclosed on the property. California has a “one action” rule, which essentially means that if the primary lender seeks to foreclose, then they can only seek the amount they get in foreclosure and the seller is “protected” by 580b so that the lender cannot sue the seller for any difference between the loan amount and the foreclosure sale amount. Or, if the primary lender agrees to a short sale, then they can only recover that which they received in the short sale, and cannot sue the seller after a short sale.
As originally drafted, CCP protected a seller of a distressed (underwater) property by precluding the lender from foreclosing on a property and then suing the homeowner in court for the remaining amount owed over what the lending institution was able to secure at auction. This is known as a “deficiency”. However, this only applied to “purchase money” loans (loans taken out to actually buy the property), so if you had ever re-financed your home (and most people did) then that new loan was not a “purchase-money” loan and thus the lender could sue you in court for the money. And it only applied to foreclosures, not to “short” sales, which is an agreement by the bank to allow you to sell the house for less than the seller’s loan amount (as opposed to a bank selling it at auction). Foreclosure is a costly process and banks are not in the home ownership/sales business. Likewise, the amount recovered at auction is often substantially less that what a bank can get in a negotiation on a short sale. **Note: Under this version of the law secondary lenders (home equity lines of credit (HELOC), second mortgages), known as junior mortgages could still sue you in court for breach of contract for failing to pay back the money secured by the house on their loan. CCP 580b offered no protection against these deficiencies or the ensuing lawsuits.
In August of 2010 (effective June 2011), SB 1178 was passed to amend the protection under CCP 580b to include non-purchase money loans, so in effect if you refinanced for a better rate, you were still protected from any deficiency if your home value later became underwater. **Note: SB 1178 did not protect you from a “cash-out” refinance, nor does it protect you from a refinance to improve your home. It only protects you to the extent that you refinanced the original debt (purchase price) of the home loan. However, once again, SB 1178 did not apply to short sales, but only to foreclosures. Also, you were still subject to a lawsuit by junior mortgages.
On September 20, 2010 (effective January 1, 2011), SB 931 was passed and codified as CCP 580e. With this improvement in the law, lenders could no longer sue you for deficiencies in short sales either, as they once could under previous versions of the law. So a distressed seller was protected in the event his home was foreclosed on or if he performed a short sale on his house. Either way, the bank could not sue him for a deficiency. However, junior mortgages could still sue you on their mortgages, as SB 931 did not apply to them.
On July 15, 2011, SB 458 was signed into law. SB 458 amended CCP 480e to prevent junior (also called secondary) mortgages from being able to sue you for breach of contract for any deficiencies due to a short sale. Up until this point, junior mortgages were able to sue you in court for breach of contract, so this closed one of the last remaining loopholes.
**Note: Because of these new laws, junior mortgages are increasingly losing their incentive to agree to a short sale (which is necessary to complete the transaction.) Also note that nothing in the law, as it exists today, precludes a junior mortgage from suing a seller in court for breach of contract if you go into foreclosure as opposed to a short sale. However, if a junior mortgage realizes that you are financially distressed and that a foreclosure may result in a lower home price, the property going in a state of disrepair, a substantially longer timetable for completion and more costs involved in the process, then they may be more willing to negotiate. Therefore, it is likely that the junior mortgage will come to the table willing to negotiate to avoid these problems.
It is also important to remember that the entity being protected by these laws is the borrower/seller. If someone else has acted as a guarantor on your loan, the lending institutions can likely still sue him or her.
Keep in mind:
• This is only for dwellings with four units or less.
• Residential and investment properties qualify.
• Mortgage insurers are also precluded from suing you on a deficiency.
• These laws only protect residential property, not commercial property.
• The lenders are prohibited from asking for a contribution for the borrower/seller. However, the law does not preclude the lender (senior or junior) from soliciing additional funds from, your relatives, friends, or work colleagues, or from the real estate agent’s commission. Also a junior mortgage can ask for a higher cut of the proceeds from the sale that would normally go to the primary mortgage. Finally, nothing in the law prohibits the seller/borrower from “volunteering” to pay extra money in order to facilitate a short sale.
• You cannot commit legal “waste” of the property. Legal “waste” is intentionally damaging the property or allowing it to fall into a state of disrepair due to neglect. This will not preclude you from protection of these statutes, but will permit the bank/lender to sue you for the damages you have caused (which can offset the money you save with the anti-deficiency statutes)
• If you committed fraud in obtaining your loan, you can be sued for that fraud under CCP 726(f). It will not preclude you from the protection of the anti-deficiency statutes.
• The courts have yet to determine if the new enacted CCP 580e will be retroactive, although a strong argument can be made for it.
If you have additional questions, please contact the law offices of Garteiser Honea at (415) 785-3762 or find us at www.sftrialattorneys.com.
