California has laws that regulate whether a lender would have recourse against a borrower if they were not paid in full. The most well known of these concern foreclosure. Code of Civil Procedure (CCP) Sec 580b bars recourse on purchase money loans for personal residence and CCP 580d bars recourse after a Trustee Sale foreclosure. On July 15, 2011, California passed SB458 which became CCP 580e and which bars recourse after a short sale of a 1-4 unit dwelling. But the question has come up whether there can still be any recourse despite these laws. The answer is yes although actual use may be rare.
In 2010, the California Association of Realtors (CAR) created a new Disclosure addressing Homeowner Liability after Foreclosure which actually included references to short sale as well. In that Disclosure, CAR noted that these California laws might not preclude deficiency liability on loans insured or guaranteed by VA or FHA. CAR's analysis was apparently based upon two Federal cases: Herlong-Sierra Homes, Inc. v US (1966); and US v Rossi (1965). However, in both of these cases foreclosure occurred in Federal Court, not California, and therefore California's protections did not apply.
The recent communication being circulated cites another Federal case: Carter v Derwinski (1993) which addressed whether a State prohibition against recourse (such as SB458) could bar the VA from suing for deficiency after a State foreclosure action. The Court said that the VA did have this right based upon the fact that in a VA loan, the VA separately guarantees the lender from loss on the loan. Therefore, if there is a loss, VA has recourse against the borrower on the guarantee, not on the loan itself. Significantly, the Court was very divided in its decision. Similarly, In 1998, another Federal Court relying on the Carter case, ruled that Farmer's Home Administration (FmHA) had deficiency recourse following an Arizona trustee Sale (US v Rezzonico).
Although my research to date has not discovered an FHA case with a similar holding, the rationale in both cases above would lead to a similar conclusion for FHA insured loans.
In Summary, if the loan is guaranteed or insured by the Federal Government, the Federal agency may pursue deficiency recourse regardless of a State's laws barring recourse after a Trustee Sale.
Whether that same result would occur after a short sale is not at all clear and does not appear to have been decided by any cases as yet.
Unlike a foreclosure in which the creditor is enforcing a right established in the loan documents when the loan was made, a short sale is more in the nature of a loan modification in that it includes an Agreement by which the parties - including the creditor and borrower - change the terms for payment. As such, arguably for any deficiency to survive the short sale, there would have to be agreement by the creditor and borrower for that result. As you recall, before CA passed SB458, short sale agreements often contained written provisions whereby the lender "reserved the right to pursue the deficiency".
The best practice for Realtors is to use the CAR Homeowner Liability After Foreclosure Disclosure.
In my experience over the past four years and counselling over 4,000 upside-down debtors, I have not seen any instances of any of the Federal agencies suing any foreclosed or short-sole borrowers for a deficiency. However, given the above-decisions, that does not mean that such an action could not occur.
Because this is only a Federal Government right, the same result would not apply to private lenders or, arguably, private insurers such as PMI. Similarly, we would not expect any recourse right to exist for FNMA or Freddie Mac loans since those are not Government agencies.
As with any such situation where the law is evolving, it is important that borrowers understand that they may not always be able to avoid the consequences of defaulting on their loan obligations. However, under most circumstances, a short sale will provide a much more likely means of avoiding recourse than will a foreclosure.
If you or someone you know has been contacted by a creditor demanding payment after a short sale or after foreclosure, be sure to get legal help right away. Our BPE Law $200 flat fee Consultation Program can offer knowledge of what to expect and form strategies to respond and hopefuly eliminate any liability. Of course, our Consultations are best if obtained before a short sale or foreclosure occurs. To schedule a Consultation, please contact our office at (916) 966-2260.
The information presented in this Article is not to be taken as legal advice. Every person's situation is different. If you are upside-down on your loan, especially if you're facing a lender lawsuit, get competent legal advice in your State immediately so that you can determine your best options.