Senate Bill 931 – First Trust Deed Lender Prohibited from Deficiency against Short Sale Borrower
Senate Bill 931 (effective January 1, 2011) provides that a seller’s first trust deed lender cannot obtain a deficiency judgment against a seller after a short sale. Providing written consent to a short sale obligates the first trust deed lender to accept the sale proceeds as full payment and discharge of the remaining amount owed on the loan. This law applies to first trust deeds secured by one-to-four residential units, but does not limit the lender from seeking damages for fraud or waste by the borrower.
While the induction of Senate Bill 931 was highly advantageous to borrowers in that first trust deed lenders as a matter of law can no longer seek to recover a deficiency judgment against a short sale borrower, the law did not limit a borrower’s liability to other “junior" lenders secured by the real property. See Article under Services: Guide to Foreclosure for a detailed discussion of “sold out" junior lender’s right to deficiency judgments. Thus, borrowers could still face liability from a “sold out" junior for a breach of the promissory note.
Senate Bill 458 (July 15, 2011): Law against Short Sale Deficiency Expanded to Include “Junior" Lenders
Senate Bill 458, a California Association of Realtors sponsored bill, signed into law on July 15, 2011, expands the protection afforded to short sellers in Senate Bill 931 by prohibiting a deficiency after a short sale for one-to-four residential units, regardless of whether the lender is a senior or junior lender. Thus, a “sold out" junior lender that previously had recourse against a defaulting short sale borrower through seeking a deficiency now can no longer recover a deficiency against a short sale borrower.
Although a lender cannot require a borrower to pay any additional compensation in exchange for short sale approval, the new law does not prohibit a borrower form voluntarily offering a monetary contribution to a lender in hopes that the lender will agree to a short sale. Allowing short sale borrowers to voluntarily offer money to a sold out junior lender as a catalyst for the lender to accept the short sale is extremely important because there is no incentive for “sold out" juniors to consent to a short sale (as opposed to just letting the property go into foreclosure) as they are essentially waiving their right to a deficiency under SB 458 (see Short Sale for discussion on short sale issues, such as mutual consent by all parties). A lender is also permitted under the new law to negotiate for contribution from someone other than the borrower, such as other lenders, agents, relatives, etc…
As with Senate Bill 931, exceptions to Senate Bill 458 include a lender seeking damages for a borrower’s fraud or waste; a borrower that is a corporation, LLC, limited partnership, or political subdivision of the state; a lien secured by a bond as specified; a public utility lien; and additional rules apply is a note is cross-collateralized by more than one property.
Case Example – Betsy Borrower
Betsy Borrower buys her dream home located in Big Sur on the West Coast of Northern California in 2005 for $750,000. Betty puts $100,000 down and takes out a purchase money mortgage with Bank of America for $650,000 to cover the rest of the purchase of the home.
In 2007, Betty’s home has appreciated to $850,000. Betty wants to add some fixtures, such as an outdoor shower, spa, and downstairs equipment room, so Betty takes out a Home Equity Line of Credit (HELOC) with Chase for $100,000.
In 2009, Betty can no longer keep up with either of her loans and the house has dropped in value to $500,000. After 3 months of non-payment, Bank of America sends Betty a Notice of Default to start foreclosure proceedings.
In the meantime, Betty finds a suitable buyer to purchase the property for $500,000.
Bank of America agreed to the short sale upon Betty’s request because it is cheaper, faster, and there is no right to a deficiency by the Bank of America regardless of whether a foreclosure (purchase money loan that was never refinanced – i.e. no deficiency) or short sale (SB 931 and/or SB 458) is followed.
Chase was initially reluctant to agree to the short sale because Chase could pursue Betty for the $100,000 deficiency in a foreclosure scenario (“sold out" junior recourse lender). However, Chase also knows that collecting $100,000 from Betty is going to be difficult and highly risky because Betty can always file for Chapter 7 Bankruptcy and discharge the entire $100,000 as unsecured debt.
Betty offered Chase $5,000 to accept the short sale – Chase accepted.
In a foreclosure scenario, Bank of America would foreclose using Non-Judicial foreclosure. Chase would be a “sold out" junior and would have the right to sue Betty for $100,000 deficiency.
In a short sale scenario (before the inception of Senate Bill 458), Chase would still be a “sold out" junior and would have the right to pursue Betty for $100,000 deficiency.
Now, since the inception of Senate Bill 458, Chase as a matter of law can no longer secure a deficiency against Betty for $100,000 for breach of the promissory note.