Cotenant Owner vs. Junior Creditor — Battle for Sale Proceeds from Senior Creditor Foreclosure

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After a foreclosure sale by a senior creditor, California’s Civil Code section 2924k governs how the sale proceeds are applied in the following order of priority:

  • first, to pay the costs of the sale such as trustee’s fees
  • then to pay the debt secured by the deed of trust that is the subject of the sale
  • then to pay junior liens in order of their priority
  • and last, to the trustor (generally the debtor and property owner)

But section 2924k does not specifically address the rights of a cotenant owner of the foreclosed property.

A recent case published by California’s Fifth Appellate District — Zieve, Brodnax & Steele, LLP v. Dhindsa — provides guidance.

Facts: senior creditor forecloses; surplus proceeds available for distribution

At the time of the foreclosure sale by the senior creditor, the property was owned as joint tenants by an Uncle (75%) and his Nephew (25%).

The senior creditor’s lien covered all interests in the property.  That loan was taken out by the Uncle and the Nephew’s father when they purchased the property.

After a series of intra-family transfers, the Uncle ended up with a 75% interest while the Nephew had 25%.

After those transfers, Uncle obtained a $225,000 home equity line of credit, and secured the indebtedness by executing a second deed of trust against the property.

In prior litigation between Uncle and Nephew, a trial court ruled that the senior creditor’s first deed of trust lien covered “the whole of the fee simple title to the property,” while the junior creditor’s second deed of trust covered only “Uncle’s undivided 75 percent interest in the Property.”

The senior creditor foreclosed and a trustee’s sale was completed.  After the payment of sale costs and the debt secured by the first deed of trust, surplus proceeds of over $150,000 remained available to potential claimants.  The Nephew and the junior creditor both submitted claims.  The trustee deposited the money with the superior court pursuant to Civil Code section 2924j.

Trial court: junior creditor gets all of the surplus proceeds

The trial court ruled that the entire surplus should be paid to the junior creditor, and rejected Nephew’s claim.

Nephew appealed.

Court of Appeal: reversed; cotenant owner keeps proportionate share of proceeds

The Court of Appeal reversed the trial court’s judgment.

The opinion described a cotenant’s rights in real property and the impact of foreclosure, as developed by both statute and decades of case law:

  • cotenants own undivided interests in real property by one joint title (in other words, title is not fractionalized as with tenancies in common)
  • each cotenant can sell or encumber his or her own interest in the property without the knowledge, approval, or consent of the other cotenants
  • but if a cotenant attempts to sell or encumber any larger interest in the property, the other cotenants are not bound, regardless of the good faith of the purchaser/encumbrancer
  • when a deed of trust is a lien on the interest of only one cotenant, the beneficiary (lender) can foreclose the lien against that interest; the foreclosure sale purchaser becomes a tenant in common with the other cotenants
  • when a senior lienholder forecloses, the junior lienholder “is entitled to share in any surplus sale proceeds that represent the proportionate interest of the cotenant whose interest was the subject of the junior lien.”

While section 2924k does not expressly address the rights of cotenants, the statute did not abrogate the legal principles above.

The court concluded that Nephew was entitled to 25% of the surplus sale proceeds because the junior creditor’s second deed of trust did not encumber his interest in the property.  The junior creditor was entitled to 75% of the proceeds, consistent with the scope of the junior lien.

Lesson

As stated in the court’s opinion, after a foreclosure sale by a senior creditor, a junior creditor can recover from the surplus sale proceeds “only to the extent the junior lien actually encumbered the property sold in foreclosure.”  Cotenants whose property rights are unaffected by the junior lien are entitled to their proportional share of the sale proceeds.

[View source.]

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.

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