The Demise of Deficiency Judgments in Residential Loans

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Among the many changes in the financial services industry, two important events occurred this year that effectively signaled the extinction of deficiency judgments in loans secured by residential property.

First, on July 11, 2013, Governor Jerry Brown signed Senate Bill 426 into law.  Senate Bill 426 expanded the anti-deficiency statutes to provide that "no deficiency judgment shall be owed or collected" in the context of a loan secured by residential property.  The new language replaces the old language, "no deficiency judgment shall lie," to clarify that the anti-deficiency protections afforded by existing statutes, sections 580b and 580d of the Code of Civil Procedure ("CCP"), are intended to prohibit not only deficiency judgments but also collection actions by lenders after a foreclosure.

Second, on July 23, 2013, in the case Coker v. JP Morgan Chase Bank, the California Court of Appeal, Fourth Appellate District, confirmed that the anti-deficiency protections afforded to borrowers under existing statutes also apply to a short sale, even if the new CCP section 580e did not apply retroactively.  The new CCP section 580e, which became effective as of January 1, 2011, provides that no deficiency judgment shall be owed or collected in connection with a short sale consented to by a lender.  However, courts have consistently held that CCP section 580e does not apply retroactively.  The Coker decision effectively invalidates any agreement entered into by borrowers obligating them to repay a deficiency amount in connection with a short sale (without the benefit of the new CCP section 580e) where the protections of CCP section 580b otherwise apply to the loan transaction.

The plaintiff, Coker, obtained a mortgage loan to purchase a residence.  The loan was secured by a deed of trust recorded against the property.  After the collapse of the real estate market, Coker was no longer able to make payments on her loan.  Consequently, JP Morgan Chase Bank, the lender that succeeded to Coker's original lender, initiated a non-judicial foreclosure process.  In an effort to avoid foreclosure, Coker entered into a short sale transaction with the bank.  The bank provided its consent to the sale but only on the condition that Coker would remain liable for a deficiency in the amount equal to the difference between the balance owed on her loan and the purchase price obtained through the short sale.  Coker executed documents agreeing that the bank was releasing her under the deed of trust but that she would remain liable for the amount of the deficiency.  Coker's short sale closed and the bank recorded a full reconveyance of Coker's deed of trust.  Subsequently, a collections agency on behalf of the bank sent a letter to Coker demanding that she pay $116,687, the deficiency amount.

The Coker case is one of first impression because although CCP section 580e was in effect by the time the court heard the case, no other California court had previously ruled whether the existing statutes (without the benefit of the new section 580e) would protect a borrower for a deficiency after an approved short sale.  The court relied on the black letter language of the existing statutes and the legislative history of sections 580b and 580e for its decision.  Specifically, the loan made to Coker was a purchase money loan, and even without the benefit of new CCP section 580e, the deficiency protections applied because the existing statute's language does not limit such protections to a foreclosure sale, but rather such protections apply to any sale.

The Coker case is distinguished from another recent case decided on July 17, 2013, Bank of America v. Roberts, where the court held that a lender may recover against a borrower who defaulted on a loan executed in connection with a short sale approval, the amount of which was based on the deficiency amount owed by the borrower under a junior loan (a home equity line of credit) after taking into account the amounts recovered from the short sale.  The loan in Coker was a purchase money loan whereas the loan made in Roberts was a home equity line of credit, which is not subject to the protections afforded under CCP section 580b because it is not a purchase money loan.  Since the new CCP section 580e does not apply retroactively, the Roberts court enforced the deficiency amount owed to the junior lender based on the fact that the loan was not a purchase money loan and as such was not subject to the protections of CCP section 580b.  It is important to note that there is now a narrow class of lenders that may pursue borrowers for a deficiency obligation and only if the loan in question is not a purchase money loan: (a) a senior lender that forecloses judicially, (b) a junior lender that is a "sold out" lienholder following a senior lender's foreclosure (but not if the senior lender and the junior lender are the same party), or (c) following a short sale entered into prior to the effectiveness of the new CCP section 580e or without a lender's consent.

In summary, the prior passage of CCP section 580e, the recent passage of Senate Bill 426, and the conforming decision by the Fourth Appellate District are significant because it is now clear that California's anti-deficiency statutes not only protect borrowers in nearly all circumstances when dealing with a residential loan (from judgments or collection action) but also trump any separate agreement the lender may have with a borrower for the payment of any deficiency either following a foreclosure or a short sale where such lender consented to the short sale.  This leaves open the question of what will happen with the borrowers who already made payments to lenders for such deficiency obligations in the context of purchase money loan.  Some new cases will likely come out of this.