Alert August 06, 2013

California State Appellate Court Rules Anti-Deficiency Statute Applicable to Short Sales

The California Court of Appeals reversed a lower court’s ruling and held that California’s anti- deficiency statute precluded a lender from seeking a deficiency judgment against a borrower following a short sale. After plaintiff, a borrower, defaulted on her mortgage loan, she negotiated with a third party to sell her home for a price less than the outstanding balance on the mortgage loan. Defendant, a mortgage lender, agreed to the short sale with certain conditions; specifically that plaintiff was still liable for any deficiency balance remaining on the loan after application of the proceeds from the sale. After the property was sold, defendant began collection activities on the remaining balance of the mortgage loan. As a result, plaintiff filed suit seeking a  declaratory judgment that the requested deficiency violated California’s anti-deficiency statute. The lower court ruled, among other things, that California’s anti-deficiency statute only applied after a property was sold by judicial or non-judicial foreclosure. Plaintiff appealed.

The California Court of Appeals ruled that the plain language of the anti-deficiency statute was not limited to foreclosure sales—or property sold after a judicial or non-judicial foreclosure. The Court also cited legislative intent to broadly construe the statute to accomplish its twin aims—(1) discouraging the overvaluation of real property; and (2) protecting borrowers during times of economic decline—and even cited one item of legislative history expressly stating that the statute applied to short sales. Defendant countered that plaintiff was required to invoke the “security first rule,” which requires a lender to foreclose on secured property before attempting to collect the accelerated underlying debt, and insist on foreclosure in order to avoid a deficiency judgment. In rejecting defendant’s argument, the Court ruled the “security first rule” applies only to judicial foreclosures, and has no place in this case involving a short sale proposed by plaintiff after defendant commenced a non-judicial foreclosure proceeding. Citing Lawler v. Jacobs, 83 Cal.App.4th 723, 736-737 (2000) and Palm v. Schilling, 199 Cal.App.3d 63, 76 (1988), the Court also rejected defendant’s argument that plaintiff waived her claims under California’s anti-deficiency noting that it is well-established that such claims cannot be waived.