Full question:
If a lender/bank makes a non-judicial foreclosure on my real property, and at the sale gets no bidders and buys in the property itself for the balance on the loan, can it then also sue me personally on a personal guaranty I signed when I made the loan? Or has it made an election to accept the property instead of the balance due on the loan?
- Category: Real Property
- Subcategory: Foreclosure
- Date:
- State: California
Answer:
When a property is sold at auction for an amount less than the amount owed under the promisory note, typically in many states a lender will pursue a deficiency judgment or enforce any personal guarantees.
When it comes to enforcing loans secured by California real estate, California is a “single action” state. Civil Procedure Code Section 726(a) provides in part that “[t]here can be but one form of action for the recovery of any debt or the enforcement of any right secured by a mortgage upon real property.” This “one-action” rule applies whenever a lender with a loan secured by real property collateral exercises its remedies to recover a debt or to protect its security. The purpose of the one-action rule is to protect a defaulting mortgagor from being harassed by a lot of different actions filed against it by the mortgagee.
California’s “one-action” statute prohibits the secured lender from pursuing any other judicial cause of action, such as suing the borrower directly, without foreclosing on the real property collateral. As a result, if a lender takes real estate collateral as security for a loan, then lender must foreclose on its real estate security first. Further, a lender can only bring one “action” against the borrower, and must use it as the primary source of repayment when collecting the loan.
A corollary to the one-action rule, the “security-first” rule (also codified in Civil Procedure Code Section 726(a)) provides that a creditor must first proceed against the security for the debt prior to trying to enforce, by judicial action or otherwise, the underlying debt. Perhaps the most notorious instance of a creditor running afoul of this prohibition is Security Pacific National Bank v. Wozab, where the creditor set off approximately $3,000 in the debtor’s accounts held by the creditor in partial satisfaction of a $1,000,000 debt without first foreclosing on the real property securing the debt. The California Supreme Court held that the creditor’s exercise of its equitable right of setoff, while it was not an “action,” violated the requirement that a creditor rely on its security before attempting to enforce the debt. As a result, the creditor in that case lost its security.
Even though California’s “one-action” rule applies to foreclosures, lenders can start both a judicial process and a nonjudicial power of sale process (also known as a “trustee’s sale”). Simply beginning a nonjudicial foreclosure is not deemed to constitute an “action” in California. Neither the commencement of a judicial foreclosure action, nor the filing of a notice of default which commences the nonjudicial foreclosure process, is considered an irrevocable election of remedies under the one-action rule. A lender is deemed to have elected its remedy, and had its one action, only when a judgment has been entered if a judicial foreclosure action is completed. A lender that completes a nonjudicial foreclosure sale is also deemed to have elected its remedies and may not seek a deficiency judgment against the borrower. So, a lender will not be deemed to have made an election between these two foreclosure methods until one of them has been completed.
For these reasons, when enforcing the lien of a deed of trust in California, prudent lenders often begin both an action for judicial foreclosure and nonjudicial foreclosure proceedings. Starting both offers the lender a more streamlined and reliable method of seeking the appointment of a receiver as part of the judicial foreclosure proceeding (as distinguished from seeking a receiver as an adjunct to an action for specific performance of the lender’s assignment of rents clause in its deed of trust). It also enables the lender to maintain the threat of a possible deficiency judgment against the borrower (assuming, of course, that the loan is of a type where a deficiency judgment is allowed, and has not been made fully non-recourse by contract).
California's anti-deficiency laws do not offer much protection for guarantors.
In a landmark decision, Union Bank v. Gradsky, the court first enumerated the Gradsky doctrine and found that while the legislature did not intend for anti-deficiency statutes (California Code of Civil Procedure Sections 580(b) and 580(d)) to protect guarantors, that the doctrine of estoppel prevented lenders from going after the guarantor once the lender had already foreclosed on the collateral.
The reasoning was that once a guarantor pays the debt of another, the guarantor assumes the rights of the lender/creditor and should be entitled to pursue the borrower to recover the losses. Accordingly, if the lender has already foreclosed on the collateral, they have prevented the guarantor from going after the collateral and harmed the guarantor by altering the position of the parties from the time of the bargained for guarantee.
Accordingly, most savvy transactional lawyers who draft guarantees will include contractual Gradsky waivers as enumerated by Civil Code Section 2856 which states:
§ 2856. Waiver of suretyship rights and defenses; contract language; effectiveness; applicability; validity of waivers executed prior to January 1, 1997
(a) Any guarantor or other surety, including a guarantor of a note or other obligation secured by real property or an estate for years, may waive any or all of the following:
(1) The guarantor or other surety's rights of subrogation, reimbursement, indemnification, and contribution and any other rights and defenses that are or may become available to the guarantor or other surety by reason of Sections 2787 to 2855, inclusive.
(2) Any rights or defenses the guarantor or other surety may have in respect of his or her obligations as a guarantor or other surety by reason of any election of remedies by the creditor.
(3) Any rights or defenses the guarantor or other surety may have because the principal's note or other obligation is secured by real property or an estate for years. These rights or defenses include, but are not limited to, any rights or defenses that are based upon, directly or indirectly, the application of Section 580a, 580b, 580d, or 726 of the Code of Civil Procedure to the principal's note or other obligation.
(b) A contractual provision that expresses an intent to waive any or all of the rights and defenses described in subdivision (a) shall be effective to waive these rights and defenses without regard to the inclusion of any particular language or phrases in the contract to waive any rights and defenses or any references to statutory provisions or judicial decisions.
(c) Without limiting any rights of the creditor or any guarantor or other surety to use any other language to express an intent to waive any or all of the rights and defenses described in paragraphs (2) and (3) of subdivision (a), the following provisions in a contract shall effectively waive all rights and defenses described in paragraphs (2) and (3) of subdivision (a):
The guarantor waives all rights and defenses that the guarantor may have because the debtor's debt is secured by real property. This means, among other things:
(1) The creditor may collect from the guarantor without first foreclosing on any real or personal property collateral pledged by the debtor.
(2) If the creditor forecloses on any real property collateral pledged by the debtor:
(A) The amount of the debt may be reduced only by the price for which that collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price.
(B) The creditor may collect from the guarantor even if the creditor, by foreclosing on the real property collateral, has destroyed any right the guarantor may have to collect from the debtor.
This is an unconditional and irrevocable waiver of any rights and defenses the guarantor may have because the debtor's debt is secured by real property. These rights and defenses include, but are not limited to, any rights or defenses based upon Section 580a, 580b, 580d, or 726 of the Code of Civil Procedure.
(d) Without limiting any rights of the creditor or any guarantor or other surety to use any other language to express an intent to waive all rights and defenses of the surety by reason of any election of remedies by the creditor, the following provision shall be effective to waive all rights and defenses the guarantor or other surety may have in respect of his or her obligations as a surety by reason of an election of remedies by the creditor:
The guarantor waives all rights and defenses arising out of an election of remedies by the creditor, even though that election of remedies, such as a nonjudicial foreclosure with respect to security for a guaranteed obligation, has destroyed the guarantor's rights of subrogation and reimbursement against the principal by the operation of Section 580d of the Code of Civil Procedure or otherwise.
(e) Subdivisions (b), (c), and (d) shall not apply to a guaranty or other type of suretyship obligation made in respect of a loan secured by a deed of trust or mortgage on a dwelling for not more than four families when the dwelling is occupied, entirely or in part, by the borrower and that loan was in fact used to pay all or part of the purchase price of that dwelling.
(f) The validity of a waiver executed before January 1, 1997, shall be determined by the application of the law that existed on the date that the waiver was executed.
A lender has a few choices when they are faced with going after collateral with declining value and a loan guarantee. The lender can 1) conduct a non-judicial foreclosure and walk away from the guarantee; or 2) conduct a judicial foreclosure and sweep in the guarantee claims and name both the borrower and the guarantor; or 3) go after the guarantor for the entire amount owed.
Additionally, if the guarantee contains all the necessary waivers, the lender can both non-judicially foreclose on the collateral and go after the guarantor for the deficiency owed.
This content is for informational purposes only and is not legal advice. Legal statutes mentioned reflect the law at the time the content was written and may no longer be current. Always verify the latest version of the law before relying on it.
