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CASE UPDATE: Deficiency Judgment Not Allowed Because Bank Failed To Include All Properties Securing Loan In Judicial Foreclosure Sale.

In First California Bank v. McDonald, (2014) 2014 WL 6675937, the court held that a bank/ secured lender could not maintain an action for a deficiency judgment because in the underlying judicial foreclosure action the bank only included one of two properties securing the loan.

The bank made the subject loan to a husband and wife secured by two properties, the “Wasco” property, which was community property, and the “Shafter” property, which was the wife’s sole and separate property. After the husband died, the loan went into default.  The bank and the wife agreed to a private sale of the parcel that was her separate property (Shafter), and then the bank filed a lawsuit to foreclose on the remaining parcel and obtain a deficiency judgment.  The trial court granted a decree of judicial foreclosure stating that the bank was entitled to obtain a deficiency judgment against the representatives of the husband’s estate, but the court of appeal reversed. 

The issue involved the “one form of action” rule, which the appellate court described as follows:

Generally, a creditor to a loan secured by real property has two potential sources of repayment if the loan is not repaid and goes into default—proceeds from the sale of the real property collateral and a personal judgment against a debtor (or what is known as a deficiency judgment). For policy reasons, resort to real property collateral for repayment of secured loans is favored, and deficiency judgments are not, and creditors must follow certain statutory mandates in order to ultimately obtain a deficiency judgment.

There are two basic statutory requirements under Code of Civil Procedure section 726 for creditors seeking deficiency judgments: (1) “security first,” which means that a creditor must first exhaust all real property security to qualify for a deficiency judgment; and (2) such exhaustion of the real property collateral must be through a single judicial foreclosure lawsuit. These requirements in section 726 are referred to as the “one form of action” rule….If any of the real property collateral is exhausted through any other means, such as a private sale without the consent of the debtors, a deficiency judgment is barred….

In this case, the court held that the bank failed to strictly comply with section 726, and therefore waived its right to a deficiency judgment against the husband’s estate, because the husband’s estate never consented to the separate, private sale of one of the two properties securing the loan.

Note that in two important ways, the section 726 rules protect debtors from unreasonably high deficiency judgments resulting from low bids at a judicial foreclosure sales.  First, section 726 creates a fair value limitation by requiring that the amount of the deficiency to be calculated by subtracting the fair value of the property from the amount of the remaining indebtedness.  (However, the debtor has the burden to apply to the court after the sale for a fair value determination.)  The second protection is a debtor’s right to post-sale redemption.  This is a statutory right the debtor can assert against the purchaser at a foreclosure sale, and it allows the debtor to “redeem” the property (i.e., buy it back), based on the foreclosure sale price, not on the amount of the debt.  So to avoid this, creditors/lenders are permitted to cut off the debtor’s right of redemption provided the creditors/lenders waive their right to a deficiency judgment.

Finally, note that a creditor has no right to a deficiency judgment when the property securing a loan is sold at a “private” or “nonjudicial” foreclosure sale.

©2014 Miles Dolinger. This article is not intended to and does not constitute legal advice or a solicitation for the formation of an attorney-client relationship

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Miles J. Dolinger
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