We have been getting many calls lately from California homeowners (and even some commercial business owners) asking us if their lender can hold them liable for their second mortgage in California. And if so, can they sue them on the note without first seeking the foreclosure route. This article will attempt to provide some illumination to these issues and will relate to owner occupied single-family residences in California who have second mortgages that are in default or at risk of going into default. At issue is the One Action / Security First Rule of California Code of Civil Procedure Section 726(a).
This article is general legal information only and not intended to serve as legal advice or a substitute for legal advice. As law is constantly changing and evolving, the information may not be 100% complete, accurate or up-to-date. For specific questions about your legal liability in regard to junior loans, please contact a skilled and experienced real estate or foreclosure defense lawyer.
Steve Vondran is a California Real Estate Lawyer who is licensed to practice law in California and Arizona. He also holds a real estate broker’s license in California and Arizona and has a background in mortgage brokering and commercial real estate. HE can be reached at firstname.lastname@example.org or (877) 276-5084.
The common second mortgage default scenario:
You own a home and have a first and second mortgage, both secured by a deed of trust on your primary residence. The first mortgage is 500k and the second mortgage is 100k. You are paying the first mortgage but are delinquent on the second mortgage. The second mortgagee is threatening to sue you on the note or otherwise hold you liable for your default on the second mortgage. You are concerned and don’t know whether or not they can sue you or not or whether you should try to workout a deal with them.
The general rule regarding a lenders rights when you are in default of your promissory note, and assuming the deed of trust has a “power of sale clause,” is the ONE ACTION RULE:
A secured lender has the option of “electing its remedies” when a deed of trust and note and not being paid as agreed. They can either pursue judicial foreclosure (which means they file a lawsuit against you seeking a court order to sell your real property, and to seek a deficiency judgment if the loan is not subject to California’s anti-deficiency laws under section 580 of the Civil Code) or, they can seek to pursue a non-judicial foreclosure sale (which allows them to sell your property after sending you a notice of default, deed of trust, and complying with other provisions of California Civil Code Section 2924 et seq – the California Foreclosure Laws.
What this means then is a secured lender must either seek to go to court to foreclose on your judicially, or then can seek to perform a non-judicial foreclosure sale. The COMPLETION of either one constitutes an “action.”
Now, in most cases, a junior lien holder (i.e. a second mortgagee) is not going to foreclose on you either judicially or non-judicially. Why is that? Because in order for them to get paid, they first mortgage holder (the senior lien holder) would have to get paid first following the trustee sale (in the case of a non-judicial foreclosure sale) or following the Court ordered sale of the property in a judicial foreclosure. In these times when property values are declining faster than temperatures at the north pole, second mortgage holders are not often left holding a lot of “security” for the loans they gave to borrowers. This raises a problem. Many of the junior lien holders have no security and no interest in foreclosing. What these junior note holders might want to do is to waive the security and “sue you on the note.” The question is, whether they have the legal right to do this in California?
Enter the California “One Action Rule.” What does the one action rule state? Well, lets start by getting the statutory law on the table – California Code of Civil Procedure Section 726, the (“Security First”) One Action Rule
(a) There can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property or an estate for years therein, which action shall be in accordance with the provisions of this chapter. In the action the court may, by its judgment, direct the sale of the encumbered real property or estate for years therein (or so much of the real property or estate for years as may be necessary), and the application of the proceeds of the sale to the payment of the costs of court, the expenses of levy and sale, and the amount due plaintiff, including, where the mortgage provides for the payment of attorney's fees, the sum for attorney's fees as the court shall find reasonable, not exceeding the amount named in the mortgage.
(b) The decree for the foreclosure of a mortgage or deed of trust secured by real property or estate for years therein shall declare the amount of the indebtedness or right so secured and, unless judgment for any deficiency there may be between the sale price and the amount due with costs is waived by the judgment creditor or a deficiency judgment is prohibited by Section 580b, shall determine
the personal liability of any defendant for the payment of the debt secured by the mortgage or deed of trust and shall name the defendants against whom a deficiency judgment may be ordered following the proceedings prescribed in this section. In the event of waiver, or if the prohibition of Section 580b is applicable, the decree shall so declare and there shall be no judgment for a deficiency. In the event that a deficiency is not waived or prohibited and it is decreed that any defendant is personally liable for the debt, then upon application of the plaintiff filed at any time within three months of the date of the foreclosure sale and after a hearing thereon at which the court shall take evidence and at which hearing either party may present evidence as to the fair value of the real property or estate for years therein sold as of the date of sale, the court shall render a money judgment against the defendant or defendants for the amount by which the amount of the indebtedness with interest and costs of levy and sale and of action exceeds the fair value of the real property or estate for years therein sold as of the date of sale. In no event shall the amount of the judgment, exclusive of interest from the date of sale and of costs exceed the difference between the amount for which the real property or estate for years therein was sold and the entire amount of the indebtedness secured by the mortgage or deed of trust. Notice of the hearing shall be served upon all defendants who have appeared in the action and against whom a deficiency judgment is sought, or upon their attorneys of record, at least 15 days before the date set for the hearing. Upon application of any party made at least 10 days before the date set for the hearing the court shall, and upon its own motion the court at any time may, appoint one of the probate referees provided for by law to appraise the real property or estate for years therein sold as of the time of sale. The probate referee shall file the appraisal with the clerk and the appraisal is admissible in evidence. The probate referee shall take and subscribe an oath to be attached to the appraisal that the referee has truly, honestly and impartially appraised the real property or estate for years therein to the best of the referee's knowledge and ability. Any probate referee so appointed may be called and examined as a witness by any party or by the court itself. The court shall fix the compensation, in an amount as determined by the court to be reasonable, but the fees shall not exceed similar fees for similar services in the community where the services are rendered, which may be taxed and allowed in like manner as other costs.
(c) No person holding a conveyance from or under the mortgagor of real property or estate for years therein, or having a lien thereon, which conveyance or lien does not appear of record in the proper office at the time of the commencement of the action need be made a party to the action, and the judgment therein rendered, and the proceedings therein had, are as conclusive against the person holding the unrecorded conveyance or lien as if the person had been a party to the action. Notwithstanding Section 701.630, the sale of the encumbered real property or estate for years therein does not affect the interest of a person who holds a conveyance from or under the mortgagor of the real property or estate for years therein mortgaged, or has a lien thereon, if the conveyance or lien appears of record in the proper office at the time of the commencement of the action and the person holding the recorded conveyance or lien is not made a party to the action.
(d) If the real property or estate for years therein mortgaged consists of a single parcel, or two or more parcels, situated in two or more counties, the court may, in its judgment, direct the whole thereof to be sold in one of the counties, and upon these proceedings, and with like effect, as if the whole of the property were situated in that county.
(e) If a deficiency judgment is waived or prohibited, the real property or estate for years therein shall be sold as provided in Section 716.020. If a deficiency judgment is not waived or prohibited, the real property or estate for years therein shall be sold subject to the right of redemption as provided in Sections 729.010 to 729.090, inclusive.
(f) Notwithstanding this section or any other provision of law to the contrary, any person authorized by this state to make or arrange loans secured by real property or any successor in interest thereto, that originates, acquires, or purchases, in whole or in part, any loan secured directly or collaterally, in whole or in part, by a mortgage or deed of trust on real property or an estate for years
therein, may bring an action for recovery of damages, including exemplary damages not to exceed 50 percent of the actual damages, against a borrower where the action is based on fraud under Section 1572 of the Civil Code and the fraudulent conduct by the borrower induced the original lender to make that loan.
(g) Subdivision (f) does not apply to loans secured by single-family, owner-occupied residential real property, when the property is actually occupied by the borrower as represented to the lender in order to obtain the loan and the loan is for an amount of one hundred fifty thousand dollars ($150,000) or less, as adjusted annually, commencing on January 1, 1987, to the Consumer Price Index as published by the United States Department of Labor.
(h) Any action maintained pursuant to subdivision (f) for damages shall not constitute a money judgment for deficiency, or a deficiency judgment within the meaning of Section 580a, 580b, or 580d of the Code of Civil Procedure.
Wow, that is a mouthful. What does it all mean? Well there are many cases in California that attempt to ascertain what this section really means. Without going into great detail, here are a few general observations that appear to be well accepted in regard to California’s one action rule (aka single action rule):
(1) Secured Lender’s have the right to choose or elect how they want to foreclose on you. They can go the judicial foreclosure route (i.e. file a lawsuit and potentially seek a deficiency judgment) or they can seek to go the non-judicial foreclosure route. The non-judicial foreclosure route is NOT technically considered to be an “action” because such is done privately and does not involve use of the Courts (except the small little often unmentioned fact that foreclosure trustee sales are normally carried out of the courthouse steps). The “action” part of the ONE ACTION RULE seems to refer to resorting to a judicial foreclosure and the court process. That being said, a secured lender may elect to “double track” or “dual track” by filing both a non-judicial foreclosure action AND seeking to pursue a non-judicial foreclosure at the same time. Why would they do this? Well following a completed non-judicial foreclosure sale there is no way to seek a deficiency judgment in most cases and by filing the judicial foreclosure lawsuit, the lender may be able to keep you sweating with the threat of a deficiency judgment (assuming your loan is not protected purchase money under 580). But again, once one action is completed, that should be the end of the road for the lender under the ONE ACTION RULE.
Keep in mind, a “secured creditor” can be any creditor of any type of loan or judgment that has a security interest on your real property. This includes for example the case where one party got a divorce judgment for 100k against the other forcing them into bankruptcy when the creditor tried to enforce the note without first foreclosing. See DiSalvo v. DiSalvo (in re DiSalvo) (BAP 9th Cir. 1998) 221 B.R. 769. In that case, the Court held that the 726(a) rule applied and since the creditor forced the debtor into bankruptcy court without first filing for foreclosure, that sanctions were appropriate against the creditor (at first the judge wiped out the debt completely, which I believe was reversed on appeal). At any rate, sanctions for the 726 violation was appropriate even though the case did not involve a bank dealing with a defaulting borrower under a promissory note and deed of trust.
Now TWO QUICK POINTS: you may be wondering what the rationale is for having the SINGLE ACTION rule in California. The stated rationale you will often hear is to protect the debtor against multiple actions that affect the debt. It is not clear how allowing dual tracking serves that purpose but sa la vie.
Next, you may be asking, what would a lender prefer to do to enforce their debt? File a non-judicial foreclosure sale or seek a judicial (court) foreclosure? Here are some quick pros and cons about each to keep in mind:
NON-JUDICAL FORECLOSURE v. JUDICAL (COURT / LAWSUIT) FORECLOSURE - PROS AND CONS
· Non Judicial Foreclosure is probably the preferred route for most lenders. It is quicker and cheaper and does not involve attorney fees to the extent litigation does. Judical foreclosure involves filing a lawsuit, service of process, discovery, potential for lender counterclaims (such as TILA recoupment claims – discussed in other blogs).
· In a private trustee sale, there is no judicial oversight, and the lenders would prefer this sort of freedom. In one particular regard being that of the “produce the note theory.” This is where a lender would be asked to show it holds an original copy of the promissory note to prove it has the right to enforce the debt. If the lender files a suit in a court of law, this is something they may be required to show to prove their STANDING to file the lawsuit and to prove they are the REAL PARTY IN INTEREST TO BRING THE LAWSUIT. Given the nature of MERS loans, securitized loans, and the secondary loan market, they don’t want to be bothered with these “technicalities” as they seem to believe it is. In a private sale, anyone could essentially foreclose on you, at least in my opinion. There is no judicial oversight of any of these types of issues.
· There is no right of redemption following a private trustee sale as there is in a judicial foreclosure sale. What this normally translates to is more money for the lender at the foreclosure auction. Why? If you were bidding on property at a judicially ordered sale, and if you knew the defaulting borrower would have one full year to redeem the property and get it back, you probably would pay less, and the bids would come in less to take into account this potential contingency.
· In a Court of law, there are statutes of limitations that don’t apply to the same extent in a non-judicial foreclosure setting. The statute of limitations in a California written breach of contract case is 4 years. Another reason why non-judicial foreclosure sales are often preferred, sometimes out of necessity.
Now back to the ONE ACTION RULE in California. What the above amounts to is that the lender must chose what it wants to do and how to foreclose on their security instrument (the mortgage or deed of trust), but regardless of which route a secured lender chooses, under Section 726, they must FIRST SEEK TO GET THEIR MONEY OUT OF THE SECURITY THEY HOLD ON YOUR PROPERTY BEFORE THEY CAN EVER SEEK TO WAIVE THE SECURITY AND JUST GO AND SUE YOU ON THE NOTE (SUE FOR BREACH OF CONTRACT AND TRY TO GET A JUDGMENT AGAINST YOU).
That means, a second mortgage holder holding a secured junior lien cannot just try to take you to court and sue on the note. They must wait for the first mortgage holder to foreclose on you and take what they can get. Or, they must initiate the foreclosure, see what proceeds are derived, see that the senior lien-holder gets paid all that they are owed and then take whatever peanuts are left after that as their proceeds. In this declining real estate market where so many people are “upside-down” this often is not a very attempting proposition for second mortgage holders / loan servicers such as Wachovia, Wells Fargo, Chase, WAMU, Bank of America, Countrywide, Deutsche, SPS, OCWEN, U.S. Bank, Citimortgage, etc. If one of these lenders who are secured, partially secured etc., try to sue you without first foreclosing then you will want to either make sure you raise the 726 defense, or else seek sanctions against them for failing to comply with the California One-Action Rule. If you don’t raise the defense, you waive it and shoot yourself in the foot. Again, the creditor must proceed against the security initially to be in compliance with the law.
But note that there appear to be at least a few circumstances where a junior lien holder can legally get around the 726 one action rule and sue directly on the obligation, namely where their security has become “LEGALLY WORTHLESS” (but be sure to contrast that with “ECONOMICALLY WORTHLESS” which is not subject to a 726 workaround).
SITUATIONS WHERE A JUNIOR LIEN (SECOND MORTGAGE) MAY BECOME LEGALLY WORTHLESS ENTITLING THE HOLDER OF THE LOAN TO SUE YOU DIRECTLY WITHOUT FORECLOSING:
(1) When the real property doesn’t exist - See Dyer Law & Collection Co. v. Abbott, 52 CA 545, (1921).
(2) Where the security is destroyed: See Cohen v. Marshall, 197 Cal, 117 (1925) wherein the Court stated: “There can be but one action for the recovery of any debt, or the enforcement of any right secured by mortgage upon real or personal property, which action must be in accordance with the provisions of this chapter.” It is the settled law, however, that in case of a failure or destruction of the security, without the fault of the mortgagee, the mortgagee will not be restricted to a procedure which manifestly must prove to be vain and idle.”
(3) When the real property is not owned by the borrower – See Otto v. Long, 127 C 471 (1900). The Court set forth some rationale for the one action rule: “1. To confine the mortgagee to one action; 2. To make the security the primary fund from which satisfaction is to be made; and 3. To give plaintiff a judgment for the deficiency, if any, remaining after exhausting the security.”
(4) Where a senior lien holder forecloses (“sold out junior”) and the junior is left POSITIVELY holding nothing but a bag of foreclosure dust, then for all practical purposes their lien/security is deemed legally worthless and they are entitled to sue on the note to try to collect something off their debt. See Roseleaf Corporation v. Willy F. Chierghino, 59 Cal.2d 35, (1963) wherein the Court held: “the one form of action rule of section 726 does not apply to a sold out junior lienor…….there is no reason to compel a junior lienor to go through foreclosure when there is nothing left to sell…….their security has been rendered valueless by a senior sale.” A senior foreclosure sale conveys the property to the purchaser free of all junior liens and the junior can then sue on the note and seek a deficiency subject to 580 anti-deficiency protections (which may be reduced in an action on the note) and any other “non-recourse” provision that may have been provided for. NOTE: in these circumstances, the borrower may be subject to both the foreclosure of the first mortgage and a suit for breach of the note on the second (i.e. multiple actions that 726(a) was seeking to avoid).
(5) Where the mortgage (security) not properly perfected: “A simple action on a note has been permitted where the mortgage was void for the reason that it lacked the signature of the mortgagor's wife (Powell v. Patison, 100 Cal. 236. See Giandeini v. Ramirez, 11 Cal.App.2d 469 (1936).
These are but a few examples where the junior lender may get around the security-first rule. Again, if you are dealing with a second mortgage holder who merely BELIEVES that the real estate market has declined to the point where the security is ECONOMICALLY WORTHLESS, (ex. market dropped) this should not allow them to waive the security and try to sue you for breach of contract. See Barbieri v. Ramelli, 84 C 154, (1890) and Giandeini v. Ramirez, 11 CA2d 469, (1936). Be on the lookout for this and raise the 726(a) “security first defense” and seek monetary sanctions. In these cases, the law in California is to force the second mortgage holder to foreclose on the property judicially and let the market place decide if they are right. See Security-First National Bank v. Chapman, 31 CA2d 182 (1939). If after the first is paid, there are insufficient funds, then the junior creditor should seek the deficiency judgment within three months, if available.
Another thing to look out for, if a Creditor takes security for an obligation, and the security is worthless at the time the creditor takes the mortgage or deed of trust to secure the obligation, the one action rule should still apply, and the creditor should be forced to foreclose on the security first. This happened in the case of In re DiSalvo, 221 B.R. 769, 9th Cir. 1998). In this case the Court stated: “there was evidence in this case that the security was without value at the time the trust deed was executed…….a creditor does not have the right to accept worthless security and then waive it, thereby converting the obligation into a personal one……where, as in this case, the mortgage on its face purports to be a security for a debt, a foreclosure and sale is the proper mode for determining whether the security is in fact valueless.” (Citing the Security-First Case above).
The same rationale holds that foreclosure should be pursued rather than an action on the note for attachment if your second mortgage is even PARTIALLY SECURED. Again, it is up to the marketplace to make the determination as to value, not a lender.
So, in most cases, your second mortgage will probably be either under-secured (partially secured) or not secured at all. But the lender should follow the one action rule and choose a foreclosure path (either judicial or non-judicial) and seek to foreclose on the “security first” and recover a deficiency judgment only if not barred by the section 580 California anti-deficiency judgment statute (which basically protects purchase money – also the subject of another blog). Again, these are fact-intensive inquiries and if you have a question about potential liability in regard to your second, or first mortgage, contact a foreclosure or real estate lawyer. In the words of Forrest Gump, “that’s all I got to say about that.”
KEYWORDS: CALIFORNIA ONE ACTION RULE / CALIFORNIA SECURITY-FRIST RULE / CALIFORNIA FORECLOSURE DEFENSE LAWYER / CALIFORNIA FORECLOSURE DEFENSE ATTORNEY / CALIFORNIA CHAPTER 7 BANKRUPTCY / DEFICIENCY JUDGMENT LIABILITY / CAN SECOND MORTGAGEE SUE ON THE NOTE? / JUNIOR LIEN HOLDER FORECLOSURE OPTIONS / NEWPORT BEACH FORECLOSURE LAWYER / NON-JUDICICAL FORECLOSURE SALE V. JUDICIAL FORECLOSURE SALE.
NOTICE: The foregoing information is general legal information only and shall not be relied upon as legal advice, or a substitution for legal advice. If you have specific legal questions about your foreclosure case you should seek out the advice of a real estate attorney. In addition, the information posted above may not be 100% complete, accurate or up-to-date. Law is always changing. The Law Offices of Steve Vondran is licensed to practice law in the state of Arizona and California and only seeks to solicit and serve Clients in these two states. Steve Vondran, Esq. is a licensed attorney and real estate broker in California and Arizona. He can be reached by email at email@example.com or toll free (877) 276-5084. This is an advertisement and communication pursuant to State Bar Rules. Please do not send us private or confidential information through any of our above-listed websites. Sending us an email does not create an attorney-client relationship (only signing a legal retainer will do this). Copyright 2010 – Vondran law - All Rights Reserved