New California Case Illustrates Peril of Full Credit Bid

by Snell & Wilmer
Contact

In a new California case, a lender that made a full credit bid at a foreclosure sale lost its right as mortgagee under a lender’s insurance policy for damage to the property that occurred prior to foreclosure. This was so even though the lender held multiple deeds of trust, and foreclosed on only one of them. The case provides valuable guidance in devising a foreclosure bidding strategy.

In Najah v. Scottsdale Ins. Co., ___ Cal.Rptr.3d ___, 2014 WL 4827882 (Cal.App. 2 Dist., Sep. 30, 2014), plaintiff (lender) sued defendant (insurer) for failing to pay a claim for property damage that occurred prior to plaintiff’s foreclosure on the property. The trial court entered judgment in favor of the defendant insurer. The Court of Appeal affirmed.

In 2006, plaintiff sold a commercial property, taking back a promissory note secured by a second deed of trust. The note provided that buyer would not perform any demolition, construction, or remodeling until the note was paid in full, and it required the buyer to obtain lender’s insurance, which the buyer did. In January 2008, the buyer defaulted. After the senior lender initiated foreclosure under the first deed of trust, plaintiff purchased the senior lender’s promissory note and took assignment of the first deed of trust. Shortly after the default, but before acquiring the first deed of trust, plaintiff visited the property and discovered severe damage to the building. Plaintiff submitted a claim for the property damage to the defendant insurer, which eventually denied the claim. In November 2008, plaintiff foreclosed on the property under the second deed of trust. Plaintiff took the property on a credit bid including the full amount of principal, interest, fees, and costs due under its promissory note.

The Court of Appeal held that the lender’s right to recover insurance benefits as mortgagee under the lender’s insurance was barred by the “full credit bid rule.”[1] The court explained that the full credit bid rule prevents a lender who obtains property upon a full credit bid from pursuing any other remedies, including collection of insurance proceeds payable for pre-foreclosure damage to the property. The lender’s only interest in the property is the repayment of its debt, and when it takes the property on a full credit bid its debt is repaid in full.

The rule serves two purposes. First, the rule prevents the lender from “double recovery” – a dubious justification given that all the lender recovers in a foreclosure is the value of the collateral irrespective of the amount bid. The lender derives no additional value by over-bidding. To the contrary, an excessive bid merely compromises the lender’s deficiency rights. If anything, the rule gives the insurer a windfall because the insurer has collected the premiums and avoided paying an otherwise legitimate claim based solely on the fortuitous circumstance of the lender’s full credit bid.

Second, the rule “serves to protect the integrity of the foreclosure auction” by preventing lenders from “impeding bids from third parties willing to pay some amount between the value the lender places on the property and the amount of its full credit bid.” The court reasoned that the purpose of the foreclosure process is to enable the property to be sold for its fair market value in a competitive bidding process. This goal is frustrated when a lender discourages competitive third-party bids by making a full credit bid for more than the property’s fair market value. In the court’s view, when a lender intends to make a claim that the property was impaired due to waste covered by an insured claim, it should not be allowed to discourage third-party bids on the strength of its full credit bid while preserving insurance claims.

The court perceived an inconsistency between a lender’s full credit bid and the lender’s insurance claim for property damage because it regarded the lender’s claim for property damage as recognition that the property was worth less than it bid.

The simpler explanation for denying the plaintiff any recovery in this case was that the mortgagee coverage under the insurance policy was limited to the amount necessary to satisfy the debt. Once the debt was satisfied upon the plaintiff’s full credit bid, the plaintiff had no further claim under the policy. But that explanation only resolved the issue as to the lender’s rights under the second deed of trust. The court also concluded that, even as the holder of the first deed of trust, the lender had no claim against the lender’s insurance. To reach that conclusion the court relied upon the policy justifications for the full credit bid rule discussed above.

The lesson from this case is that a lender foreclosing on impaired property should plan its bidding strategy carefully. The lender must closely evaluate its insurance coverage, including all limitations and exclusions. The lender must also carefully assess whether it will assume the borrower’s insurance rights, and whether those rights have been compromised. And the lender must assess the full extent of impairment to the property, the cost to restore it, and the diminution in its value. These steps should be done with the involvement and advice of legal counsel, considering that the lender’s evaluation may be subject to discovery in the event of litigation. To preserve claims against insurers or others responsible for waste or other property damage, the lender should discount its bid by the amount of the claim, or base it upon an appraisal of the property’s “as-is” value taking the impairment into account.

[1] The court did not address whether the lender had a right to pursue the insurance claim in the capacity of a successor to the borrower’s rights. Deeds of trust commonly encompass not only the real property, but the borrower’s associated personal property including contract rights. In this case the trial court found that the property damage was caused almost entirely by the borrower. Therefore, the borrower had no claim against the insurance policy.

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.

© Snell & Wilmer | Attorney Advertising

Written by:

Snell & Wilmer
Contact
more
less

Snell & Wilmer 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.
Custom Email Digest
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.