Even If Done With Good Intentions, Damaging Property Can Lead to Post-Foreclosure Liability For Borrowers

A recent appellate court decision has expanded the potential recovery a lender may pursue against a defaulting borrower.  In Fait v. New Faze Development Inc., the Third District Court of Appeal significantly expanded an exception to California's anti-deficiency rules in cases of bad faith waste.

Fait involved a purchase money loan where the borrowers purchased property planning to replace the existing building with a new mixed-use development.  After evicting the tenants and demolishing the building, the borrowers defaulted on the loan.  The lenders foreclosed non-judicially under their deed of trust, and then sued the borrowers for waste relying upon the 1975 case of Cornelison v. Kornbluth that gave lenders the ability to sue for damages for waste after a non-judicial foreclosure if the waste was committed in bad faith.  The trial court found in favor of the defendants, holding that because the demolition was motivated by a good faith belief that the property could be developed, the waste (demolition of the building) was not done in bad faith.

The appellate court reversed, holding that an action for bad faith waste did not require that the plaintiff lender prove “recklessness and intent to despoil at the time of demolition."  Instead, according to the ruling in Fait, regardless of the borrower’s motives or intentions, any act that damages the lender's security and is not committed “solely or primarily as a result of the economic pressures of a market depression" qualifies as bad faith waste for purposes of the anti-deficiency statutes.

The court's expanded definition of bad faith waste is so broad that potentially any intentional or negligent act that reduces the value of real property security is potentially a basis for a bad faith waste claim by a lender.  Consequently, lenders may have a post-foreclosure avenue for recovery against borrowers who damage or destroy improvements without obtaining their lenders’ consent before doing so.

Please click here to view our previous advisory on how disgruntled borrowers are more likely to sue lenders for fraud as a result of a recent California Supreme Court decision.