The DirtLaw Blog

California's New Loan Modification Laws and Suspended Lawyers

Our governor signed S.B. 94, and so now everyone is prohibited from taking "advance" fees to assist with a loan modification for a borrower.  This prohibition includes attorneys and causes some change in law firm practices. 

Normally, when a borrower is coming to an attorney with a loan problem, it is likely because the borrower lacks funds to pay the lender.  It also means they may lack funds to pay the law firm.  Accordingly, to minimize collection issues, many law firms would ask for a retainer and place the funds into the client trust account (which is technically the client's money until earned) and refund the balance if there is a surplus when ther matter is concluded.

However, this new law seems to simply revert law firms to the normal model of invoicing the client regularly as the lawyer's time is billed and then having to wait and hope the client will pay it.

While this is causing a lot of concern, especially knowing that many law firms will decide against doing any loan modification work at all, the abuses were so widespread, it seemed a draconian legislative response was called for.

Because Realtors^TM are prohibited by the California Department of Real Estate from collecting advance fees, they were bringing in attorneys to circumvent this rule because attorneys were allowed to collect fees in advance by the State Bar.  However, attorneys are prohibited from fee splitting with unlicensed persons and so this whole model was problematic.

Just this week, the State Bar announced the suspension of yet MORE lawyers caught up in the unethical practices of loan modification mills. 

"The State Bar created a 10-person loan modification task force in March after receiving thousands of calls from homeowners complaining that lawyers have done no work after taking fees purportedly to help avoid foreclosure. The task force had 738 active investigations underway last month."

California Foreclosure Consultants Now Must Register

After July 1, 2009, it became illegal to act as a Foreclosure Consultant in the State of California unless you registered first with the Attorney General. 

In addition to the $850 filing fee and the application and a copy of the contract you will use with your clients, you must be bonded at a minimum of $100,000.00 and register that bond with the California Secretary of State.

What is a "foreclosure consultant" as defined by California Law?
(California Civil Code 2945.1, "Mortgage Foreclosure Consultant Law")

The following definitions apply to this chapter:
 (a) "Foreclosure consultant" means any person who makes any
solicitation, representation, or offer to any owner to perform for
compensation or who, for compensation, performs any service which the
person in any manner represents will in any manner do any of the
following:
 (1) Stop or postpone the foreclosure sale.
 (2) Obtain any forbearance from any beneficiary or mortgagee.
 (3) Assist the owner to exercise the right of reinstatement
provided in Section 2924c.
 (4) Obtain any extension of the period within which the owner may
reinstate his or her obligation.
 (5) Obtain any waiver of an acceleration clause contained in any
promissory note or contract secured by a deed of trust or mortgage on
a residence in foreclosure or contained that deed of trust or
mortgage.
 (6) Assist the owner to obtain a loan or advance of funds.
 (7) Avoid or ameliorate the impairment of the owner's credit
resulting from the recording of a notice of default or the conduct of
a foreclosure sale.
 (8) Save the owner's residence from foreclosure.
 (9) Assist the owner in obtaining from the beneficiary, mortgagee,
trustee under a power of sale, or counsel for the beneficiary,
mortgagee, or trustee, the remaining proceeds from the foreclosure
sale of the owner's residence.

Guaranty, Guarantee, Potato, Potahto…

For many private money investors (or hard money lenders as they are sometimes referred to), a loan to an LLC alone carries too many risks.  Accordingly, a personal guarantee from the managing member or other members of the LLC with collateral will be required.

 

Since the underlying loan obligation to the LLC was secured by a deed of trust against real estate—and the real estate values have plummeted, we are seeing a rise in the number of lawsuits by lenders against guarantors to enforce of the guarantee agreements.

How do California’s anti-deficiency provisions protect guarantors?  They don’t.  Well, not exactly.

In the seminal case of 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.

 

*The court also reiterated that the “one-action rule” (C.C.P. §726) did not apply to  guarantees.   

More New Foreclosure Legislation

As I predicted last year, more legislation is flooding in.  Two days ago on July 30, 2008, The President signed H.R. 3221, the American Housing Rescue and Foreclosure Prevention Act, which as near as I can tell, is also called the Housing and Economic Recovery Act of 2008. 

The most interesting part of the bill for me is the claims that the bill:

"Expands the FHA program so many borrowers in danger of losing their home can refinance into lower-cost government-insured mortgages they can afford to repay. 

·        Protects taxpayers by requiring lenders and homeowners to take responsibility.  This is not a bailout; in order to participate, lenders and mortgage investors must take significant losses by reducing the loan principal.  In exchange for an FHA guarantee on the mortgage, borrowers must share any profit from the resale of a refinanced home with the government.

·        Contains critical protections for taxpayers’ dollars, including higher refinancing fees that establish a new FHA reserve to cover possible losses from defaults on these government-backed mortgages.

·        Only primary residences are eligible: NO speculators, investment properties, second or third homes will be refinanced."

In reading the summary, I learned that the FHA insured loan can be up to 90% of the present value of the home.  I believe I read somewhere that the FHA loan limits are capped at $625,550.

While the bill obviously has good intentions, I find myself wondering how the logistics of such a "rescue" would work.

Hypothetically, Homeowner John & Jane Smith bought a house in Nov. 2006 in San Jose, California with a purchase price of $750,000.00.  They did a 5/15/80, so they made a downpayment of $37,500.

Their two loans were $600k and $112,500, with the smaller of the two loans being a fixed and the larger loan having a low teaser rate that adjusted and a 2 year pre-payment penalty.

Now the house in August of 2008 is worth about $600,000.00, and the loans exceed the value of the house by $112k.  How does the HOPE rescue work?

First, the Smiths have to be owner-occupants to qualify. Next, their lender has to agree to modify the loan. Well, there are 2 lenders, so this can be a logistical nightmare.  The senior lender has $600k, and they are out at 100% LTV (loan-to-value). 

The FHA loan that the Smiths would want to re-finance will go to 90% LTV, which means the FHA loan is capped at $540k.  The senior lender has to take a $60k discount and waive its prepayment penalty, the junior lender has to agree to take a 100% discount. 

How feasible is this rescue package?  I have seen many short sales fall through because the junior lender will not take a discount.  Occasionally, the senior will also refuse to waive the pre-payment penalty. 

How successful will this new loan be for the homeowner?  At $540k, with perhaps a 7% loan, 30 year fixed, fully amortized, the monthly payments would still be $3,600.

How motivated will the homeowner be to do this, when they know that they must share the future appreciation with the lender who discounted their loan?

If the homeowner walked away and took the one-time hit, they could be renting a house for $2500/mo. in San Jose.  Which choice do you think the Smiths will make?

California's Anti-Deficiency Laws - a brief refresher

What is the anti-deficiency statute?  It is California Code of Civil Procedure Section 580(b).

The code states in relevant part:

"No deficiency judgment shall lie in any event after a sale of real property or an estate for years therein for failure of the purchaser to complete his or her contract of sale, or under a deed of trust or mortgage given to the vendor to secure payment of the balance of the purchase price of that real property or estate for years therein, or under a deed of trust or mortgage on a dwelling for
not more than four families given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that dwelling occupied, entirely or in part, by the purchaser."

In plain English - the statute addresses 2 types of loans:

1) purchase money loans and

2) seller carryback loans.

Under the statute, seller carryback loans are not entitled to seek a deficiency judgment against the borrower.  However, there is an exception under California's stare decisis (case law) that does permit the seller to recover against the borrower under certain circumstances.

As for the purchase money loans - no deficiency if it is owner-occupied, residential one to four.  What does that exclude? vacation homes, home-equity lines of credit (HELOC), investment properties where the borrower does not reside there, apartment buildings more than 4 units.

These loans are commonly referred to as "non-recourse" loans because lenders on these types of loan know their only recourse is the security (collateral).

DISCLAIMER: THIS IS NOT INTENDED TO BE A PRIMER ON HOW TO AVOID YOUR DEBTS AND LOAN LIABILITY.  CONSULT WITH A BANKRUPTCY SPECIALIST AND TAX ADVISER.  Please do not email or call me for tax advice.  I am not an accountant or tax professional. 

What We Learned about Subprime Lending in 2007

Back in March of 2007, I noted on here at The DirtLaw blog that a domino effect was occurring, with local Californian company Central Pacific Mortgage getting little press.

Well, when Countrywide began imploding, it seems that national papers began to pay attention.

Things We Learned in 2007:

-  the bad underwriting practices of 2005 are coming back to haunt the industry.  Time to revert to tighter underwriting policies.

- when lenders are under water, likely scenarios include

1. the short sale,
2. the deed-in-lieu
3. the judicial foreclosure plus deficience judgment and
4. debtors surrendering collateral in bankruptcy
5. debtors walking away from the property and not bothering to file bankruptcy

All in all, we've had a busy year at the firm, and I expect to see an increase in the number of judicial foreclosure lawsuits and deficiency judgment activity as well as more loan modifications.

Let's see if my other predictions come to pass about legislation trying to:

a) craft stricter penalties for "predatory lending" (only now vaguely defined by the California Finance Code)

b) modify the anti-deficiency statutes to include re-finance and HELOC loans as well as purchase money loans (possibly with a sunset provision)

c) abridge or abolish the availability of the stated-income loan (think this is already happening, so score 1 for the DirtLaw Blog.)

Judicial Foreclosures in California Part I - Code of Civil Procedure Section 580(a)

The Dreaded Deficiency Judgment

Most people are familiar with the non-judicial foreclosure.  This is a private Trustee's Sale that follows the statutory guidelines of California Civil Code Section 2924 et seq.  California is a trust deed state instead of a "mortgage" state so we generally do not use terms like "mortgagor", "mortgagee" etc. and instead the parties are the Trustor (borrower), the Beneficiary (lender) and the Trustee.

When the borrower seeks out a loan, the borrower executes a promissory note and deed of trust.  The deed of trust contains the power of sale.  The borrower give the Trustee the power to sell the borrower's house (the collateral) if the borrower fails to make loan payments to the beneficiaries (bank/lender).

The non-judicial foreclosure is the quickest way for the bank to take the collateral once the borrowers have stopped paying.  For years, the Bay Area experienced soaring house prices and lenders did not need to worry about any deficiency on their loan if the lender had to take a property back at sale.

These days, the house prices are less rosy and lenders are facing a market where the value of the home is LESS than the loan.  That is the dreaded deficiency.

If the borrowers are still working age, or have other assets, lenders may choose to pursue a judicial foreclosure and seek a deficiency judgment.  What does that mean? It means that the bank will file the Complaint in Superior Court and the sale will not be a private remedy.  Instead, the foreclosure would be conducted by a sheriff--a public sale.  After the sale, the difference in the "fair market value" and debt amount will be the deficiency judgment against the borrowers.

Example - Borrower owes $500k.  The house is worth $400k (as determined by the court appointed independent appraiser "referee") at the time of the sheriff's sale.  The actual sale price may be higher or lower than $400k and Court may issue a deficiency judgment for $100k.

This means the bank has taken the house, sold it, evicted the borrower and the borrower has a judgment against them for $100k.  The bank can then enforce that judgment in a number of ways, such as wage garnishment or if the judgment debtors owns other property, levy against it.

Borrowers may have thought they were safe to walk away from their homes that were in foreclosure because they thought that California's anti-deficiency laws protected them.  What is the anti-deficiency statute?  That is California Code of Civil Procedure Section 580(b) and this applies to purchase money loans and purchase money loans on residential 1-4 units owner-occupied.

Guest Blogging

Occasionally, I am asked to write articles of interest for other Real Estate blogs here in Silicon Valley.  Additionally, reporters occasionally phone me for my thoughts on what is happening with sub-prime lending. 

My recent article for the SiliconValleyBroker on (you guessed it) Short Sale purchasing. 

My quotes to the Palo Alto Weekly (she unfortunately confused the term Short Sale with Short Sell during our phone call).

People Just Can't Get Enough of Short Sales

I've had three calls this week about short sales and the burning question has been, "Can the lender come after the borrower for the difference?"

If the loan (Deed of Trust) is a purchase money loan secured by a house that is the borrower's principal residence, the answer is generally, "No."  California's anti-deficiency laws (California Code of Civil Procedure Section 580(b)-(d) protect homeowners by preventing lenders from doing any more than taking back the property.  These anti-deficiency laws were enacted in Dustbowl era to give homeowners a fresh start, without a deficiency judgment hanging over their heads.

However, the code section is fairly specific.  The loan had to be for the purchase of the property.  The borrower has to occupy it as his or her principal residence. 

Vacation home? No luck.

Investment home? No luck.

In both those circumstances, the lender can choose to file a judicial foreclosure (I am doing more of these this year than in years previous) against the borrower.

Here is the more tricky part - refinance loans or home equity lines of credit.  Technically those are not purchase money loans so in theory, a lender could go after the borrower for the difference.  However, I suspect that in response to the present fears about the volatile sub-prime lending market, legislators will be amending California's anti-deficiency statutes to include refinance loans.  That's my prediction for 2008-2009.  You read it here first at the Dirtlaw Blog TM!

Selling When in Foreclosure and the Dreaded Short Sale

With the recent economic trend, many of the two-year adjustable rate mortgages (or as they are colorfully referred to in the press, "exploding ARMs") have converted.  As a result, many homeowners find themselves in the position that they can no longer afford their monthly mortgage payment.

If these borrowers get too far behind with their lender, a Notice of Default is recorded against their home.  Some borrowers attempt to refinance or sell their property.

As a result, we are seeing an increase in the number of short sales.  What is a short sale? That is when the property value is less than the debt against the property. 

We typically see this when there are multiple loans against the property, for example:

1) Purchase Money Loan from Bank - Deed of Trust

2) Private Money 2nd Deed of Trust from Junior Lienholder or

Home Equity Line of Credit (HELOC) lien.

Many Realtors (TM) who recall the early 90's remember that the short sale is a difficult sale to navigate.  Much of the possibility of closing escrow depends on how many junior liens are against the property.

Often times, it is the junior lienholder who has recorded the Notice of Default and is conducting the Trustee's Sale.  The junior has usually discovered that the borrower is not keeping property taxes and insurance current, or has neglected to pay the senior.  Accordingly, the junior lender will advance the funds to bring the loan current and conduct their own foreclosure sale.

The sums advanced accrue interest as well, as allowed by the terms of the Promissory Note and Deed of Trust. 

In the Short Sale situation, it is the junior lienholder who is faced with receiving a short payoff.  Accordingly, they will rarely agree to a short sale if they feel they could either 1) get more at the Trustee's Sale or 2) take it back at Trustee's sale, fix it up and re-sell for more.

How can one increase the odds of a short sale closing?  Make sure the purchaser/offeror gets the escrow going, and circulate an executed copy of the purchase contract subject to lender approval.  Have the escrow officer get the payoff figures ASAP so that the junior can see the estimated closing statement.