Borrowers and lenders will continue to struggle with the economic consequences and challenges presented by the COVID-19 pandemic for some time. Some commercial mortgage loans may be subject to enforcement moratoria. Some loans may have payment deferrals granted or be restructured pursuant to the Interagency Statement on Loan Modifications, the CARES Act or other government mandates, and some will otherwise be restructured. At the same time, commercial mortgage lenders and their borrowers are reviewing their portfolios and evaluating potential alternatives and outcomes. If a deferral, forbearance or restructuring is ineffective or infeasible, alternatives may include a deed-in-lieu of foreclosure, discounted note payoff, short sale, loan sale or receiver’s sale. Commercial mortgage lenders may also consider loan enforcement if those alternatives prove to be ineffective or infeasible.
California law relating to real property secured transactions is complex and may seem unusual if not surprising or frustrating to lenders, especially out of state lenders. In a series of Legal Updates, we will give a brief overview of California law relating to enforcement of commercial mortgage loans, including foreclosure alternatives, the non-judicial foreclosure sale, the one action rule and anti-deficiency protections and appointment of a receiver and receiver’s sales. Loans other than single asset, bilateral loans governed by California law present special issues that will not be addressed in this series of Legal Updates, although the fundamental principles discussed will also be applicable to such other loans.
This Legal Update gives a brief overview of California real property foreclosure alternatives.
There are two types of real property foreclosures in California: (1) judicial foreclosure and (2) non-judicial foreclosure (sometimes referred to as foreclosure by trustee’s sale or public sale). Except in the case of double tracking (as discussed below), non-judicial foreclosure is by far the more common form of foreclosure.
A judicial foreclosure action is commenced by filing a complaint.2 The minimum time from commencement of the action to the foreclosure sale may be 9 to 12 months, or even longer depending on the court’s docket, time requirements under local court rules, delays resulting from calendaring limitations for motions and delays in service of writs, etc. by the sheriff. The borrower may reinstate the loan up to the time the court enters a decree of foreclosure by paying the delinquent amounts and the lender’s costs and expenses. The borrower may redeem the property up to the time the court orders the sale by paying the entire amount of the secured indebtedness and the lender’s costs and expenses. After the sale, there is generally a statutory right of redemption for a period of one year if a deficiency judgment is not waived by the lender.3 During the redemption period, the borrower has a right to possession and use of the property, subject to the purchaser's right to receive rents and profits.4 A deficiency judgment is permitted unless prohibited by the anti-deficiency protections or the loan documents. The amount of the deficiency is limited to the excess of the secured debt plus costs of sale over the greater of the amount of the sale price at the foreclosure sale or the fair value of the property as determined by the court at a fair value hearing, which must be conducted not more than three months after the foreclosure sale. The lender may also seek to recover the deficiency from a guarantor. The lender’s lien on any part of the real property collateral that is not included in the foreclosure action will be deemed waived.
The principal advantages of or reasons to choose a judicial foreclosure are:
- A deficiency judgment against the borrower is available if the loan is not non-recourse and not otherwise prohibited by the anti-deficiency statutes.
- If the security instrument does not include a power of sale, the lender may foreclose only judicially.
- If there are material disagreements with the borrower or there are title or priority disputes, they may be adjudicated through judicial foreclosure, which has the effect of quieting title.
The principal disadvantages of or reasons not to choose judicial foreclosure are:
- The borrower generally has a statutory right of redemption following the sale and right to possession and use of the property during the one year redemption period.
- Judicial foreclosure, even if uncontested, typically takes much longer than non-judicial foreclosure.
- Because of the potential of a deficiency judgment, judicial foreclosure may engender a borrower’s opposition and counterclaims.
- Costs of a judicial foreclosure typically exceed those of a non-judicial foreclosure, especially if the foreclosure is contested.
- Judicial foreclosure may be barred by the statute of limitations.
- All real property collateral must be included in the action or the security interest in that collateral will be deemed waived.
- A deficiency judgment may not be available if prohibited under the anti-deficiency protections (because the loan is a purchase money loan where the lender is the vendor of the property to the borrower or the property is a 1-4 family owner occupied dwelling) or as limited by the loan documents.
A non-judicial foreclosure is commenced by the trustee5 under the deed of trust recording a notice of default and election to sell (an “NOD”) and mailing required copies of the recorded NOD to entitled persons.6 After 3 months, the trustee may record a notice of sale (a “notice of sale”), post the notice at the security property and publish the notice in a local paper of general circulation. The notice of sale will set the sale date, which may not be less than 20 days after the recordation of the notice of sale. However, the sale is typically not scheduled until at least 30 days after recordation of the notice of sale in order to be assured that notice of the sale has been timely given to taxing authorities. Accordingly, the minimum time from commencement of the foreclosure to the foreclosure sale is typically about 4 months. The borrower and subordinate lienholders may reinstate the loan up to the date that is 5 business days before the date of the foreclosure sale by paying the delinquent amounts and the lender’s costs and expenses. The borrower may redeem the property up to the time of the trustee’s sale by paying the entire amount of the secured indebtedness and the lender’s costs and expenses. The borrower has no redemption right after the sale. No deficiency judgment against the borrower is available after the trustee’s sale, but the lender may seek to recover the deficiency from a guarantor, except as limited by the guaranty. All real property collateral need not be included in the foreclosure.
The principal advantages of a non-judicial foreclosure are:
- It takes approximately 4 months to complete.
- The cost will generally be lower than that of a judicial foreclosure,7and the procedures, which are handled by the foreclosure trustee, are straightforward and standard.
- Because no deficiency judgment against the borrower is available after the non-judicial foreclosure and there is no required court action by the foreclosing lender, the likelihood of opposition to the foreclosure may be reduced.
- The borrower has no redemption right following the foreclosure.
- The statute of limitations does not bar non-judicial foreclosure.
- All real property collateral need not be included in the foreclosure, and the lender should be able to conduct serial sales (subject to any contrary policy the trustee may have).
The principal disadvantage of a non-judicial foreclosure is that no deficiency judgment is available against the borrower.
Even though the foreclosing trustee handles the foreclosure process, counsel should monitor and review the NOD, the TSG and the notice of sale. Counsel should also assist the foreclosing lender in formulating its credit bid, which will be discussed in a subsequent Legal Update.
Double Tracking Foreclosures
Although it is not common for a lender to pursue judicial foreclosure alone, it is common for a lender to pursue judicial and non-judicial concurrently in order to obtain appointment of a receiver to collect rents from, to complete construction or address environmental issues at, to secure, manage and operate and to sell the security property. After the receiver is appointed, the lender will typically pursue only the non-judicial foreclosure.
If the lender holds mixed real property and personal property collateral, the lender may foreclose on the real property collateral in accordance with the real estate law and on the personal property collateral in accordance with the Uniform Commercial Code. Real estate lenders commonly choose to have the foreclosure trustee hold a unified foreclosure sale of the real and personal property security. If there is significant personal property collateral, the lender may wish to proceed against the personal property separately, in which case, the order and manner of exercising rights and remedies is important, especially if the lender is proceeding judicially, and the lender should consult with counsel on the foreclosure strategy.
1 On April 6, 2020, the California judicial council issued amendments to the California Rules of Court that have the effect of generally staying any action for judicial foreclosure until 90 days after the governor declares the state of emergency related to the COVID-19 pandemic lifted or until the amendments are further amended or repealed by the Judicial Council.
2 This Legal Update will not address other filings, motions, papers and procedures handled or issued by counsel or the court (e.g., notice of lis pendens, judgment of foreclosure, order of sale, writ of sale, writ of execution, notice of levy, notice of sale, certificate of sale, deed of sale, notice of right of redemption, notice of motion and motion for deficiency judgment).
3 There is no statutory right of redemption if the deficiency judgment is waived by lender or if the security property is a leasehold with unexpired term of less than two years. There is a three month statutory right of redemption if deficiency judgment is available but not awarded.
4 The post-foreclosure redemption price is calculated as (a) the sum of the purchase price at sale, the amount of assessments and taxes and reasonable amounts for fire insurance, maintenance, upkeep and repair and improvement of property paid by the purchaser, the amount of protective advances paid by the purchaser on prior obligations, interest on all of the above, and the amount of any junior liens of the purchaser on property minus (b) rents and profits paid to purchase or value of use and occupation of the property to the purchaser.
5 For foreclosure purposes, the trustee is typically the foreclosure department of a title company or a foreclosure company that the lender substitutes in place of the original trustee.
6 Before recordation of the NOD, the trustee will obtain a trustee’s sale guaranty (a “TSG”) from a title company, which includes assurances as to information applicable to notices required for the foreclosure, and may obtain date downs of the TSG prior to the notice of sale and foreclosure.
7 Because trustee's fees are generally calculated as a predetermined, statutorily limited percentage of the loan balance, this may not be true in the case of a large loan.