The phrase “bad faith” has been defined as, “intention to deceive; treachery or dishonesty” (http://dictionary.reference.com/browse/bad+faith?s=t). When most attorneys hear the phrase “bad faith,” they think of tort claims against insurance companies (“bad faith litigation”) or unscrupulous individuals who “act in bad faith.”
Yet in the context of whether a foreclosing lender is permitted to pursue a borrower for “waste,” a recent California decision held that “bad faith” waste had nothing to do with the borrower’s state of mind – i.e., whether malicious or innocent – but instead was based on whether the waste was “solely or primarily” a result of the economic pressure of a market depression. (Donna Fait, et al. v. New Faze Development, Inc. et al. (2012) 207 Cal.App.4th 284.)
Post-Foreclosure Recovery for “Bad Faith” Waste. In California, the question of whether a foreclosing lender could pursue claims for “bad faith” waste was first raised in a 1975 California Supreme Court decision. There, the court addressed the question of whether California’s anti-deficiency statutes affected a lender’s ability to pursue a tort claim against a borrower for “waste” after a non-judicial foreclosure. The court said “no,” unless the borrower committed “bad faith” waste. (Cornelison v. Kornbluth (1975) 15 Cal.3d 590.)
As an example of “waste,” the Cornelison court noted that a borrower might forego general maintenance and repair of a building in order to “keep up his payments on the mortgage debt.” (Id. at 603.) In contrast, the court noted other borrowers may be “reckless, and at times even malicious despoilers of property.” (Id. at 604.) It is these latter circumstances in which the court adopted the phrase “bad faith” waste. (Id.)
New Case: Possible Recovery For Any “Waste.” In the recently-decided Donna Fait, the borrowers were neither reckless nor malicious. In 2005, they purchased certain real property for a mixed-use development. They evicted the tenants of the building located on the property and then demolished the building. At that point, the real estate market collapsed and the borrowers defaulted on their loans without completing development of the property.
The lender pursued a non-judicial foreclosure and ultimately took title to the property. Thereafter, the lender sued the borrowers and several individuals associated with the borrowers alleging “bad-faith” waste and intentional and negligent impairment of security (i.e., for demolishing the building and failing to pay real property taxes).
The trial court granted the borrowers’ summary judgment, holding that the borrowers demolished the building based upon a good-faith belief that the property could be developed and had made substantial efforts to get the development project underway. The trial court held that there was an, “absence of recklessness and intent to despoil” at the time of the demolition.
The Court of Appeal reversed. The court held that the question of “bad faith” waste did not turn on the “absence of recklessness and intent to despoil at the time of demolition.” Instead, the court held that any waste that is not committed “solely or primarily” as a result of the economic pressures of a market depression qualifies as “bad-faith” waste. (Donna Fait, supra, at 294.)
Thus, the question of possible tort liability for “bad faith” waste did not depend upon the borrowers’ subjective beliefs, or even their admitted good faith belief that the property could be developed. Instead, the question of “bad faith” waste requires a determination that the conduct was not “solely or primarily as a result of the economic pressures of a market depression.” (Id. at 299.)
Possible Recovery Against Non-Borrowers for Impairment of Security. The court also reversed summary judgments granted to third parties (i.e., non-borrowers) on claims of intentional and negligent impairment of security. This portion of the holding raises the interesting question of whether third parties should obtain advance approval from secured lenders prior to conducting any significant demolition or repair work on real property burdened by a deed of trust.
In sum, while California courts continue to require a finding of “bad faith” waste in order to allow a lender to pursue post-non-judicial foreclosure remedies against a borrower for “waste,” that phrase does not equate to waste caused by “bad faith” conduct of the borrower (or third parties). Instead, the focus is directed to whether the waste was caused by factors other than the economic pressures of a market depression.