As discussed in Part 1 of this series, the vast majority of California commercial mortgage loan foreclosures are conducted non-judicially. Accordingly, this Legal Update will not address judicial foreclosures. Part 2 will give a brief overview of postponements of trustee’s sales, bidding at a trustee’s sale, bid chilling, and the effect of shelter in place or stay at home orders on trustee’s sales.
Prior to completion of sale, the foreclosure may be postponed (other than by operation of law, e.g., as a result of the automatic stay, pursuant to the agreement or court order) at the trustee's discretion or upon the lender's instructions. If sale is postponed for a period of or periods totaling more than 365 days, a new notice of sale must published. Notice of and the reason for postponement must be given at the time and place sale is scheduled. If a postponement is due to a legal action or injunction, the sale may not be held sooner than 7 days after the dismissal of the action or termination or expiration of the injunction. That 7 day period does not apply in the case of a postponement due to a bankruptcy following expiration of or relief from the automatic stay. Postponing the sale will also revive the borrower’s right of reinstatement if a new notice of sale is recorded. If the sale is postponed for less than 5 business days, the postponement will extend the period during which the property may be redeemed.
The Trustee’s Sale
A non-judicial foreclosure sale may be held by the trustee by public auction at a public location in the county in which the real property is located and at a time specified in the notice of sale. Any person may bid at the foreclosure sale. The foreclosing lender may credit bid up to the amount of the secured debt. The trustee may require any other bidder to show evidence of the bidder's ability to deposit the full amount of the final bid in cash, cashier's check drawn on a state or national bank, check drawn by a credit union or savings and loan association authorized to do business in California or cash equivalent that has been designated in the notice of sale as a condition to bidding. Any person (other than the foreclosing lender) who is a successful bidder at a foreclosure sale, including any junior lienholder, must pay the amount bid in cash or by cashier's check at the conclusion of the foreclosure sale. Competitive bidding is not common in commercial mortgage loan foreclosures largely as a result of this cash or cash equivalent requirement and the fact that third parties may generally not conduct adequate property due diligence prior to the sale.
The Credit Bid
A foreclosing lender must be careful in formulating the amount of the credit bid. The amount of any credit bid will reduce the amount of any deficiency and, thus, the amount of any potential recovery against, e.g., a guarantor. In particular, care should be taken to assure that the foreclosing lender does not make a full credit bid or an overbid1 without a complete understanding of the consequences of and a valid reason for doing so. A full credit bid (1) will prevent the lender from seeking any deficiency judgment from a guarantor or possibly seeking damages against the borrower (e.g., for fraud or waste) or a third party (e.g., for waste or other damage to the property, fraud or negligence), (2) may expose the lender to liability to the debtor for rents previously collected by the lender and not applied to reduce the secured debt prior to the foreclosure, and (3) may bar the lender from receiving hazard insurance proceeds after the foreclosure for a casualty that occurred before foreclosure. An overbid by the foreclosing lender may subject the lender to liability to any junior lienholder and the borrower for amounts bid in excess of a full credit bid.
Formulation of the amount of the credit bid can be a complex process that may need to take into account a wide range of factors, including the following: (1) the value of the property (taking into account the condition of the property and any environmental issues and factoring in any appropriate reserves or impounds the lender may hold), (2) any fraud, waste or other potentially compensable factors, whether caused by the borrower or a third party affecting the value of the property, (3) any rents previously collected and held by a receiver, (4) any damage to the property in respect of which there may be insurance proceeds, (5) the amount of any senior loans, (6) any delinquent tax liens, (7) any junior lienholders and the possibility that portions of the foreclosing lender's loan may be legally or equitably subordinated to the junior lienholder, and (8) any enforceability issues relating to amounts that constitute a portion of the secured obligation. In addition to considering such factors in formulating the amount of the credit bid, some lenders have an institutional policy of reducing the amount of the credit bid by a predetermined loss reserve amount.
An underbid (i.e., a bid in an amount less than the secured debt) a should not ordinarily void the foreclosure sale. The price bid at a non-collusive foreclosure sale conducted in accordance with state law requirements conclusively establishes "reasonably equivalent value," and, therefore, the sale is not subject to challenge as a fraudulent transfer. However, if there is even a slight irregularity or unfairness in the sale process and the sale price is grossly inadequate, that may be grounds for the sale to be set aside. An unrealistic underbid may also result in adverse tax consequences to the foreclosing lender.
It is illegal for the foreclosing lender or any other person (1) to accept or to offer to accept any consideration of any type not to bid, or (2) to fix or to restrain bidding in any manner. The restraint prohibition is sufficiently broad as to be construed to preclude a lender’s disclosure of its proposed bid to a third party. Whether a foreclosing lender’s agreement prior to the foreclosure to sell the property to a third party after the foreclosure may also constitute a restraint of bidding and, thus, bid chilling has been questioned.
Potential Effect of Shelter in Place Orders on Non-Judicial Foreclosures
Under Executive Order N-33-20 (the “SIP Order”), all individuals living in the State of California have been ordered to stay at home or in their residence, except for those working in critical federal infrastructure sectors or in essential services. Certain financial services are listed as essential services, but it is not clear that trustee’s sales or procedures relating to trustee’s sales are among them. Nonetheless, some institutional foreclosure trustees are refraining from conducting trustee’s sales for two reasons. First, the SIP Order may, by its terms, prohibit trustee’s sales. Second, even if the SIP Order doesn’t prohibit trustee’s sales, the SIP Order effectively precludes trustee’s sales from being public auctions in public places, and if a trustee’s sale is not a public auction, the sale may be subject to invalidation. Similar local orders may have the same effect. Under these circumstances, if a notice of sale has been recorded, the lender will need to postpone the trustee’s sale until the applicable orders cease to be in effect; if the requisite time since recordation of the notice of default has passed and a lender is entitled to record a notice of sale, the lender may wish to defer doing so to avoid having to postpone the sale during the pendency of the SIP Order. Whether title insurers will insure title conveyed by a lender that has foreclosed during the effectiveness of the SIP Order or a similar local order is unclear.
1 A full credit bid is a credit bid in the total amount of the secured obligation, plus attorneys' fees and costs and expenses of foreclosure, and an overbid is a bid in excess of the total amount of the secured obligation, plus attorneys' fees and costs and expenses of foreclosure.