The Demise Of Short Sale Deficiencies On Residential Loans in California: A Post-Mortem Examination

Daniel Armstrong, Associate, & Gene Wu, Partner, Anglin Flewelling Rasmussen Campbell & Trytten LLP

For decades, lenders have grappled with, and sometimes stumbled over, the anti-deficiency rules found in the California Code of Civil Procedure (“CCP”) sections 580a through 580e.  CCP §580d precludes a lender from collecting a deficiency after a non-judicial foreclosure.[1]  CCP §580b prohibits a deficiency judgment on a “purchase money loan.”  Effective January 1, 2013 that prohibition also covers the refinance of a purchase money loan unless the lender has advanced new principal in the refinance transaction.

There are many familiar exceptions to these sweeping rules including the “fraud exception” found in the California Financial Code. For example, under certain circumstances §7460 allows a lender to recover actual damages for fraud and limited exemplary damages.  Less familiar, however, are recent expansions of the anti-deficiency statutes for short sales.  Even when a borrower and a lender agree to sell an underwater property to a third party, and the parties agree the lender may recover the deficiency, CCP §580e now supersedes the parties’ agreement.

In September of 2010, the California Legislature added §580e which, at the time, prohibited any deficiency judgment for a short sale involving a first deed of trust.[2] Less than a year later, in July of 2011, the Legislature expanded this prohibition to include short sales of dwellings regarding any deed of trust.[3] This present version of §580e makes clear that its provisions cannot be waived by any agreement, including the short sale agreement. Unlike other legislation purportedly designed to ameliorate the effects of the real estate market collapse (such as the Perata Mortgage Relief Act and portions of the California Homeowner Bill of Rights) §580e does not expire on its own terms and will, unless repealed, become a permanent fixture of California short sale law.

With the recent increase of short sales in California—from a few thousand in 2008 to approximately 110,000 in 2010[4]—many were completed before the effective dates of the amendments to §580e. Some of these short sale agreements provided that borrowers would remain obligated to repay any deficiency following the sale. These clauses conflicted with the later enacted §580e. The question remained whether these contractual obligations were enforceable if the short sales were completed before the effective dates of the amendments.

On July 17, 2013, the Court of Appeal of California answered this question in Bank of America, N.A. v. Roberts, 2013 Cal. App. LEXIS 563 (Cal. App. 5th Dist.) The Roberts court held the amendment to §580e did not apply retroactively.[5] Bank of America was thus entitled to enforce the deficiency clause in its short sale agreement because the sale was conducted before the effective date of the applicable amendment to §580e.

Six days later, on July 23, 2013, the Court of Appeal filed its opinion in Coker v. JP Morgan Chase Bank, N.A., 2013 Cal. App. LEXIS 573 (Cal. App. 4th Dist.) Although this court was likewise presented with the question of whether §580e applied retroactively, it did not reach the issue. Instead Coker focused on §580b—the provision that prohibits a deficiency judgment following foreclosure on a purchase money loan. Coker recognized that a short sale is not a foreclosure, but held that §580b applies to a purchase money loan regardless of the mode of sale. Thus §580b prohibited a deficiency judgment following the short sale even though the borrower agreed in the short sale agreement to remain responsible for any deficiency. The court found it unnecessary to determine whether §580e applied retroactively because §580b prohibited a deficiency judgment.

It may appear that the holding in Coker swallows the rule of Roberts. After all, the finding that §580e is not retroactive seems ineffectual if §580b will nonetheless prohibit a deficiency judgment following a short sale. But the distinction lies in the nature of the loan at issue—i.e. whether it is a purchase money loan. The Roberts court addressed a short sale on a home equity loan (non-purchase money loan); therefore §580b was not applicable and since the short sale was conducted before the amendment to §580e the deficiency clause was enforceable. The Coker court, on the other hand, addressed a short sale on a purchase money loan, which warranted the anti-deficiency protection of §580b.

In summary, sections 580b & 580e, as interpreted through Coker and Roberts, provide broad anti-deficiency protection, even for borrowers who executed short sale agreements that preserved deficiency liability. Nonetheless, there is an exception. Short sale agreements that assigned deficiency liability for non-purchase money loans remain enforceable in two narrow circumstances: 1) the loan is secured by a first deed of trust and the sale was completed before September 30, 2010; or 2) the loan is secured by a second deed of trust and the sale was completed before July 15, 2011.  

Following the recent amendments to sections 580b & 580e and the holding of Coker, the future of short sale deficiency judgments on residential loans in California looks grim for lenders. But the holding of Coker leads to an interesting tension perhaps not considered by the court. Although newly amended §580b(c) prohibits a deficiency judgment on any loan originated after January 1, 2013 that refinances a purchase money loan, there is an exception to the extent the lender advances new principal (termed a “new advance”.) If §580b is indeed applicable “regardless of the mode of sale” (to short sales) as stated by the court in Coker, does the exception in §580b(c) for any “new advance” conflict with the broader prohibition on deficiency judgments following short sales in §580e? If so, Coker may breathe new life into a narrow class of short sale deficiency judgments going forward, unintentionally reviving a specter of the deficiency liability it helped send to the grave.

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The Demise Of Short Sale Deficiencies On Residential Loans in California: A Post-Mortem Examination was published in the Summer 2013 issue of the California Mortgage Bankers Association’s “California Mortgage Finance News.” Click here for a copy.

Congratulations to lead author Daniel Armstrong and co-author Gene Wu.

D_Armstrong_MiniGene_Wu_Mini


[1] A deficiency exists if the total debt exceeds the fair market value at the time of sale.

[2] Stats. 2010, ch. 701 (Sen. Bill No. 931) § 1, p. 4069

[3] Stats. 2011, ch. 82 (Sen. Bill No. 458) § 1, p. 1954; the statute is limited to short sale of a “dwelling of not more than four units” and applies only when the short sale is conducted “in accordance with the written consent” of the lender. Notably, the anti-deficiency protections of §580e are not available if the borrower is a corporation, limited liability company, limited partnership or political subdivision of the state; the protections are also not available to the extent the borrower commits fraud with respect to the sale or waste with regard to the real property.

[4] Sen. Judiciary Com., Report on Sen. Bill No. 458 (2011-2012 Reg. Sess.) as amended April 4, 2011, p. 2

[5] The Court of Appeal also determined that the “one-form-of-action rule” in CCP §726 was not applicable to a short sale.