The Full Credit Bid at a Foreclosure Sale: Don’t Make One Without the Advice of Knowledgeable Counsel

by Buchalter
Contact

Buchalter Nemer Lender Alert, July 2014

While the Great Recession appears to be slowly receding, rising oil costs and other price increases threaten to choke off what had appeared to be an economic recovery. Accordingly, foreclosures may become more frequent in the future. Therefore, this is an excellent time to review a lender’s strategy for bidding at its foreclosure sale.

It is assumed that the lender has already done the appropriate due diligence to make an informed decision as to whether it is willing to become an owner of the encumbered real property. Obviously, this due diligence would include, but not be limited to, a determination of the environmental condition of the property.

Since the entry of a credit bid at a foreclosure sale reduces, if not eliminates, many of the lender’s rights, extreme caution should be taken to see that the lender does not needlessly reduce its rights. Assuming that the lender is the beneficiary of a valid and enforceable Deed of Trust which is a first priority lien on the subject real property, the opening bid at the foreclosure sale is frequently recommended to be between 20% and 30% of the lender’s equity in the property. See, Restatement of the Law Third, Property (Mortgages), § 8.3 Adequacy of Foreclosure Sale Price: Bernhardt and Hansen, California Mortgages, Deeds of Trust and Foreclosure Litigation § 2.87 (Calif. Cont. Ed. Bar, Fourth Ed.) and Hansen: “The Full Credit Bid ‘Rule’ and Occam’s Razor,” 30 Cal. Real Prop. J. 32 (No. 4, 2012). If the lender is not the beneficiary of a valid and enforceable first priority lien on the property, then a credit bid of materially less than 20% of the equity in the property may be appropriate.

The determination of the lender’s equity in the property is not always the easiest task to accomplish. Frequently, appraisals tend to over value the property because they are typically “looking backwards” at transactions which closed, but fail to take into consideration the current trend in prices. Therefore, consideration should be given to obtaining one or more broker’s price opinions as being more reflective of the market today for the property.

There are two principal exceptions to the 20/30% credit bid rule. First, if there are junior Internal Revenue Service tax liens where the IRS has a right after the foreclosure sale to redeem property from the successful bidder consideration should be given to increasing the bid to a level which is commensurate with the whole of the equity in the property.

The second situation where the 20/30% rule should be disregarded is where there is competitive bidding and it is in the foreclosing lender’s interest to increase the bid to approximate the fair market value of the property. Of course, appropriate consideration should be given to the anticipated expense and cost in marketing the property. Therefore, it may be appropriate for the foreclosing lender to allow itself to be outbid once the price passes the estimated market value of the property because of the anticipated expense and delay in disposing of the property.

The principal disadvantage of a full credit bid by lender at its foreclosure sale is that it may have a eliminated its right to recover from guarantors, foreclosure on additional security, retain rents collected by a receiver, collect insurance proceeds, collect damages claims, etc. There is a substantial body of case law dealing with these issues, and the outcomes are not always what might be expected and many of the decisions have some conflicts between them. However, the problems created by a full credit bid can be avoided if the foreclosing lender, as its initial bid, only credit bids 20/30% of the apparent equity in the property (assuming that it has a valid and enforceable first priority lien on the property).

One of the more comprehensive discussions of the full credit bid by the California Supreme Court is found in Alliance Mortgage Co. v. Rothwell (1995) 10 Cal.4th 1226, where the Court held as follows:

“At a nonjudicial foreclosure sale, if the lender chooses to bid, it does so in the capacity of a purchaser. [Citation.] The only distinction between the lender and any other bidder is that the lender is not required to pay cash, but is entitled to make a credit bid up to the amount of the outstanding indebtedness. [Citation.] The purpose of this entitlement is to avoid the inefficiency of requiring the lender to tender cash which would only be immediately returned to it. [Citation.] A ‘full credit bid’ is a bid ‘in an amount equal to the unpaid principal and interest of the mortgage debt, together with the costs, fees and other expenses of the foreclosure.’ [Citation.] If the full credit bid is successful, i.e., results in the acquisition of the property, the lender pays the full outstanding balance of the debt and costs of foreclosure to itself and takes title to the security property, releasing the borrower from further obligations under the defaulted note. [Citation.]” (Alliance Mortgage Co. v. Rothwell (1995) 10 Cal.4th 1226, 1238.)1

Under the “ ‘full credit bid rule,’ when a lender makes such a bid, it is precluded for purposes of collecting its debt from later claiming that the property was actually worth less than the bid. [Citations.] Thus, the lender is not entitled to insurance proceeds payable for prepurchase damage to the property, prepurchase net rent proceeds, or damages for waste, because the lender’s only interest in the property, the repayment of its debt, has been satisfied, and any further payment would result in a double recovery. [Citation.]” (Alliance Mortgage Co. v. Rothwell, supra, 10 Cal.4th at pp. 1238-1239.

In conclusion, the credit bid is a very useful “tool in the foreclosing lender’s toolbox.” However, it is a “tool” which needs to be knowingly used, otherwise there can be potential adverse consequences.

1 The lender “is not required to open the bidding with a full credit bid, but may bid whatever amount [it] thinks the property worth. [Citation.]” (Commonwealth Mortgage Assurance Co. v. Superior Court (1989) 211 Cal.App.3d 508, 520.)

Buchalter Nemer Lender Alert, July 2014

While the Great Recession appears to be slowly receding, rising oil costs and other price increases threaten to choke off what had appeared to be an economic recovery. Accordingly, foreclosures may become more frequent in the future. Therefore, this is an excellent time to review a lender’s strategy for bidding at its foreclosure sale.

It is assumed that the lender has already done the appropriate due diligence to make an informed decision as to whether it is willing to become an owner of the encumbered real property. Obviously, this due diligence would include, but not be limited to, a determination of the environmental condition of the property.

Since the entry of a credit bid at a foreclosure sale reduces, if not eliminates, many of the lender’s rights, extreme caution should be taken to see that the lender does not needlessly reduce its rights. Assuming that the lender is the beneficiary of a valid and enforceable Deed of Trust which is a first priority lien on the subject real property, the opening bid at the foreclosure sale is frequently recommended to be between 20% and 30% of the lender’s equity in the property. See, Restatement of the Law Third, Property (Mortgages), § 8.3 Adequacy of Foreclosure Sale Price: Bernhardt and Hansen, California Mortgages, Deeds of Trust and Foreclosure Litigation § 2.87 (Calif. Cont. Ed. Bar, Fourth Ed.) and Hansen: “The Full Credit Bid ‘Rule’ and Occam’s Razor,” 30 Cal. Real Prop. J. 32 (No. 4, 2012). If the lender is not the beneficiary of a valid and enforceable first priority lien on the property, then a credit bid of materially less than 20% of the equity in the property may be appropriate.

The determination of the lender’s equity in the property is not always the easiest task to accomplish. Frequently, appraisals tend to over value the property because they are typically “looking backwards” at transactions which closed, but fail to take into consideration the current trend in prices. Therefore, consideration should be given to obtaining one or more broker’s price opinions as being more reflective of the market today for the property.

There are two principal exceptions to the 20/30% credit bid rule. First, if there are junior Internal Revenue Service tax liens where the IRS has a right after the foreclosure sale to redeem property from the successful bidder consideration should be given to increasing the bid to a level which is commensurate with the whole of the equity in the property.

The second situation where the 20/30% rule should be disregarded is where there is competitive bidding and it is in the foreclosing lender’s interest to increase the bid to approximate the fair market value of the property. Of course, appropriate consideration should be given to the anticipated expense and cost in marketing the property. Therefore, it may be appropriate for the foreclosing lender to allow itself to be outbid once the price passes the estimated market value of the property because of the anticipated expense and delay in disposing of the property.

The principal disadvantage of a full credit bid by lender at its foreclosure sale is that it may have a eliminated its right to recover from guarantors, foreclosure on additional security, retain rents collected by a receiver, collect insurance proceeds, collect damages claims, etc. There is a substantial body of case law dealing with these issues, and the outcomes are not always what might be expected and many of the decisions have some conflicts between them. However, the problems created by a full credit bid can be avoided if the foreclosing lender, as its initial bid, only credit bids 20/30% of the apparent equity in the property (assuming that it has a valid and enforceable first priority lien on the property).

One of the more comprehensive discussions of the full credit bid by the California Supreme Court is found in Alliance Mortgage Co. v. Rothwell (1995) 10 Cal.4th 1226, where the Court held as follows:

“At a nonjudicial foreclosure sale, if the lender chooses to bid, it does so in the capacity of a purchaser. [Citation.] The only distinction between the lender and any other bidder is that the lender is not required to pay cash, but is entitled to make a credit bid up to the amount of the outstanding indebtedness. [Citation.] The purpose of this entitlement is to avoid the inefficiency of requiring the lender to tender cash which would only be immediately returned to it. [Citation.] A ‘full credit bid’ is a bid ‘in an amount equal to the unpaid principal and interest of the mortgage debt, together with the costs, fees and other expenses of the foreclosure.’ [Citation.] If the full credit bid is successful, i.e., results in the acquisition of the property, the lender pays the full outstanding balance of the debt and costs of foreclosure to itself and takes title to the security property, releasing the borrower from further obligations under the defaulted note. [Citation.]” (Alliance Mortgage Co. v. Rothwell (1995) 10 Cal.4th 1226, 1238.)1

Under the “ ‘full credit bid rule,’ when a lender makes such a bid, it is precluded for purposes of collecting its debt from later claiming that the property was actually worth less than the bid. [Citations.] Thus, the lender is not entitled to insurance proceeds payable for prepurchase damage to the property, prepurchase net rent proceeds, or damages for waste, because the lender’s only interest in the property, the repayment of its debt, has been satisfied, and any further payment would result in a double recovery. [Citation.]” (Alliance Mortgage Co. v. Rothwell, supra, 10 Cal.4th at pp. 1238-1239.

In conclusion, the credit bid is a very useful “tool in the foreclosing lender’s toolbox.” However, it is a “tool” which needs to be knowingly used, otherwise there can be potential adverse consequences.

1 The lender “is not required to open the bidding with a full credit bid, but may bid whatever amount [it] thinks the property worth. [Citation.]” (Commonwealth Mortgage Assurance Co. v. Superior Court (1989) 211 Cal.App.3d 508, 520.)

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Buchalter | Attorney Advertising

Written by:

Buchalter
Contact
more
less

Buchalter on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!