Homeowners who are “upside-down" on their loans and want to avoid foreclosure recently received a tremendous benefit from California Governor Jerry Brown. On July 15, 2011, Senate Bill 458 was signed into law extending the anti-deficiency protections of Senate Bill 931.

Senate Bill 458 prohibits any deficiency judgment to be requested or rendered for senior or junior liens after a Short Sale of one-to-four residential units. The previous Senate Bill 931 allowed a homeowner to sell their home at a value less than the existing mortgage, requiring the senior lienholder to accept the sale as a full payment of the existing obligation. The difficulty with Senate Bill 931 was that if the junior lienholders did not forgive the debt, the secondary loan on the property turned into personal debt after the Short Sale was completed. Many junior lienholders sold the lien to debt collectors who proceeded to seek the deficiency from the seller after the Short Sale was completed. This practice is now illegal.

Pursuant to Senate Bill 458, all the lenders that agree to a Short Sale must accept the agreed upon Short Sale payment as full payment of the outstanding balance of all loans. It is important to note that SB 458 does not apply to: (1) Properties that are residential rentals, commercials, vacant, and retail; and (2) Trustors that are corporations, limited liability companies, limited partnerships, or political subdivisions of the state. The lenders are permitted to seek damages if there is fraud, or if there are other properties intertwined with the loan. In addition, this does not change the process of a Short Sale. The homeowner must still apply and obtain approval from all the lenders. Depending on the homeowner, applying for a Short Sale may have drawbacks. For instance, the seller must disclose their entire financial status honestly and accurately, risking the chance that the lenders may deny the request for a Short Sale and proceed with the foreclosure. Moreover, this law does not prevent the lenders from negotiating with the borrowers’ agents and family.

With regards to credit score, unless the bank has specifically agreed not to report delinquent payments or the shortage of the sale, the homeowner’s credit score will reflect delinquencies and collections. Real estate agents should not give legal advice to clients facing foreclosure, nor assure sellers involved in the Short Sale process that their credit rating will not suffer adverse effects. Sellers of Short Sales must also seek tax advice before entering into a Short Sale contract. There could be tax ramifications due to debt forgiveness. It is unclear how new laws will affect the lenders’ business practice, and what impact it will have on an already declining market. Under new law, lenders are entitled to negotiate sale price with agents, other lenders, and borrowers’ relatives. In addition, financial obstacles affecting title must be disclosed to buyers involved in Short Sale process. (See Kring & Chung’s November 2010 Newsletter discussing notices under Holmes v. Summers)

Sellers, buyers, and agents should seek legal advice prior to proceeding with a Short Sale. In order to protect both parties in a purchase agreement, addendums should be drafted extending time frames to accept and/or decline a Short Sale pending lender approval, time to obtain legal evaluation, and time to speak with a qualified CPA.