The DirtLaw Blog

California's Homestead Exemption - No Need for Continuous Ownership For Debtor to Claim Exemption

In the recent case of Tarlesson v. Broadway Foreclosure Investments, LLC (May 17, 2010), the California Court of Appeal upheld a debtor's homestead exemption despite the fact that she had deeded away the property at one point because it was deeded back to her.

It appears that the creditor attempted to have a judicial foreclosure or otherwise levy debtor's residence.  Debtor claimed a $150k exemption in the home (pursuant to California Code of Civil Procedure 704.740 and Article XX, section 1.5 of the California Constitution) and creditor objected on the grounds that Debtor had not owned the property continuously.

The Court upheld earlier precedent that since the debtor had continuously resided at the property, that was a sufficient equitable interest to claim a homestead exemption.

Additionally, the creditor argued that debtor should have only been entitled to $50k for her exemption, but the debtor gave evidence (a declaration) that she was single, over age 55, and earned less than $15k/yr to qualify her to a larger homestead exemption.

What is interesting about this case is that although the court looked at the "equitable" interest that debtor had in the property, there was no discussion of whether she had unclean hands or engaged in otherwise inequitable conduct in deeding her property back and forth.

Mailbag with Julia - "Why is my lender still trying to collect even after a foreclosure sale?"

When I started this blog, it was an added service for my clients, but I find that I am getting constant phone calls and emails from people who are not my clients.  To be clear, I work with lenders (private money investors, mortgage pools) and do not engage in borrower or debtor work.  99% of these calls and emails I receive are from borrowers who want free legal advice.  I don't work like that, but I do believe in giving time and general knowledge to my community.  I thought the best way to deal with this was to just start posting some of the fact patterns and my responses. 

 

It's not intended to be legal advice, but I hope it is sufficient general education for people who have an interest.  Remember -

 

I am not your attorney, you are not my client and no attorney-client relationship has been formed by this general discussion.

 

Today's question (with details removed) from Reader R.B. -

"I have a 80/20 loan on a foreclose primary residence home in California effective 2009. The first loan did a 1099c which charged off $$$k and can be excluded from as an income per Califnornia Debt forgiveness law and second loan that did NOT do a 1099 and instead tranferred the account to a collection agency with the outstanding balance of $$$k. Since its a primary residence, am i still covered by the anti-deficiency law or Federal Debt Morgage Act 2007 that will exclude me for being responsible for the 83k debt deficiency? Since they are not issuing a 1099, how will this affect my 2009 taxes and what's the best way to take care of this?"

 

Ok, RB - lots of wrong assumptions in this message that I am not sure even where to begin to correct. Obviously I do not have all the facts of your situation either and cannot provide a meaningful analysis.  Also, I do not give tax advice, and you need a tax specialist for that.

 

That said, you should understand that if you have two loans, you have two lenders who could have foreclosed.  If one lender foreclosed, so only one lender was “paid” by the foreclosure sale.   That lender used the power of sale in the Deed of Trust (one of the two loan documents, listen to my DirtLaw Primer Podcast series for more explanation of your loan documents.) If the “sale price” at that foreclosure sale did not satisfy the loan amount, the law is still that the lender is deemed fully paid, and the deficiency is what you may receive a 1099 for. 

 

However, the other lender is not paid and is still owed money.  And, now there is no collateral for that bank to foreclose on. They are what we call a “sold-out second” or “sold-out junior lienholder.” Accordingly, that unpaid lender can sell the Promissory Note to a debt collection company.  The collection agency can continue to pursue the debt on the unpaid loan. 

 

There is no "deficiency" in this circumstance for the 2nd lender.  There must be an actual sale to create the deficiency.  Since the property was only sold once here, only that lender conducting the sale ended up with a deficiency between the value of the collateral and the amount of their loan.  The 2nd lender ("sold-out junior lienholder") had no sale and no deficiency and therefore the borrower has no anti-deficiency defense or protection as to the sold-out second lender.

 

You should contact your local county bar association and ask for the Lawyer Referral Service for a

bankruptcy attorney or other real estate attorney to answer your questions.

Other assumptions – do not assume that the California tax rules and the Federal tax rules on mortage debt forgiveness relief are the same.  They are not and the California FTB explains this here:

http://www.ftb.ca.gov/aboutFTB/newsroom/Mortgage_Debt_Relief_Law.shtml

The DirtLaw Blog Primer Podcast Series

Dear Clients, Readers and now Listeners - Happy New Year! I am pleased to introduce The DirtLaw Blog's Primer Podcast Series.  It is intended to provide the basics to help the listener better understand mortgage lending topics. 

PLAY EPISODE 01 (Length ~4Min)

I include the script below as well for those who prefer to peruse the contents.  

EPISODE 1 – UNDERSTANDING YOUR LOAN DOCUMENTS

Hello and Welcome to Episode 01 of the Dirtlaw Blog’s Primer Series.

Today’s subject is “UNDERSTANDING YOUR LOAN DOCUMENTS” and I am your host, Julia Wei, real estate attorney in Palo Alto, California and editor of The DirtLaw Blog.

For any Californian either buying a home or investing in a trust deed, it is critical to understand the two major components of your loan documents.

The primary document is the Promissory Note.  This is the “debt” instrument.  It is essentially an IOU wherein the borrower agrees to repay the lender the money he or she borrowed to purchase the property.   Occasionally it is also called “Loan Agreement” or just “Agreement” when part of a Home Equity Line of Credit.

A promissory note by itself is merely a contract.  It is memorializing promises between two parties to perform something.  If you are the borrower and you fail to honor the contract, it is a breach of the contract.   If the bank or lender only has a promissory note with the borrower, it is an unsecured loan and in order to enforce the debt instrument, the bank or lender would have to sue the borrower for breach of contract.

That can be a messy and time-consuming process for the bank, which is why banks also have the borrower execute a Deed of Trust. Other states have “mortgages” but technically, California is a Deed of Trust state so I will be using the term Deed of Trust more frequently.

The Deed of Trust is a document that is usually publicly recorded and secures the performance of the obligation under the Promissory Note.  It is the “security instrument.”

The Promissory Note is a 2-party agreement, it involves only the lender and the borrower.  However, the Deed of Trust is a 3-party agreement.  The borrower is the “trustor”, the lender is the “beneficiary” and those two parties have designated a “Trustee”.

The Deed of Trust contains the power of sale and is the basis for what is known as the non-judicial foreclosure sale. 

The Deed of Trust is really a transfer of title from the borrower/Trustor to the Trustee for the benefit of the lender/Beneficiary.  “If I, the borrower do not pay my obligations under the Promissory Note, I have given title to the Trustee such that the lender/beneficiary can notify the Trustee that they may sell my house (which is also the collateral) to satisfy the debt.”

When the obligations under the Promissory Note have been satisfied, then the Deed of Trust can be reconveyed, with a Deed of Reconveyance which rescinds the power of sale from that Deed of Trust and the borrower owns the property free and clear of that Deed of Trust.

The Promissory Note and the Deed of Trust are just two documents, and hardly seems to account for that big stack of papers that borrowers must sign at the title company’s office to close escrow.

That is because both state and federal law require multiple disclosures that must be provided as well to the borrower.  These disclosures will be the topic for Episode 2 of the Dirtlaw Blog’s Primer Series – “Reading Your Loan Disclosures”

Thank you for listening and this concludes the podcast.

A look back at 2009 - California's Foreclosure Laws

It's no surprise that in the current economic climate that California's government officials have made more law to tackle the foreclosure volume.  In late 2008, we saw the passing of emergency legislation, S.B. 1137, which amended California Civil Code 2923 et seq. to include an additional contact requirement to offer loan modifications to borrowers.  With S.B. 1137, lenders or their loan servicers had to attempt contact with the borrower on multiple occasions before recording the Notice of Default.

That piece of legislation essentially increased the time non-judicial foreclosure timeframe from four months to five months.

In 2009, California's Foreclosure Prevention Act almost doubled the time for foreclosure by imposing an additional 90 day moratorium on foreclosures.  The theory is that after the Notice of Default is filed, the normal 90 day reinstatement period will double to 180 days to give the borrower and lender time to work out a loan modification. 

The Act only applies to first loans, so Home Equity Lines of Credit (HELOC) and other junior liens are exempt.

The downside I see from this moratorium is that potential for "shadow inventory" created by all the loans in default where the borrower has no intention of continuing on the loan due to the loss of equity in the property.  It will take much longer now for those properties to be re-enter the market, which could prolong the price uncertainty for these homes.  Only time will tell.

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.)