California Appellate Court Rules that Lender Cannot Condition a Short Sale on the Borrower Owing a Deficiency

August 28, 2013
To All SLG Clients and Affiliates:
From: Spencer Scheer

California Appellate Court Rules that Lender Cannot Condition a Short Sale on the Borrower Owing a Deficiency. Expansion of Short Sale Deficiency Protection:
Lender Clients frequently call me, distressed that a borrower is engaged in a strategic default and is seeking to affect a short sale.  They often want to know if they can require a borrower to agree to a deficiency i.e. to remain liable after the short sale,  for all or a portion of the balance owing.  There was uncertainty re cases that arose before the implementation of the most recent short sale deficiency statute (CCP § 580e, most recently amended July 15, 2011).  As to agreements that occurred before the enactment of CCP § 580e, it was unclear if a lender could enforce rights to a deficiency if agreed to by the borrower. The answer is becoming clearer, and the news is not that good for lenders.

In the case recent case of  Coker v. JP Morgan Chase Bank, N.A., 218 Cal. App. 4th 1 (Cal. App. 4th Dist. 2013) the lender conditioned an agreement to allow a short sale, on the borrower agreeing to remain liable for any deficiency. The Court used C.C.P. §580b (Anti Deficiency Statute) to hold that any purchase-money loan is subject to anti-deficiency protection and that the protection did not require that there be a foreclosure sale to invoke the protection on covered loans. The Court found that short sales are also protected. Borrowers cannot waive the protection.

The effect of this case is more restrictive on lenders. Cal Code Civ Proc § 580e, prohibits collection of a deficiency on a loan secured by a 1-4 unit dwelling, upon an agreed short sale under specified conditions, and the protections cannot be waived. Courts have held that the short sale protections under Cal Code Civ Proc § 580e are not to be applied retroactively (See e.g. Bank of America, N.A. v. Roberts, 217 Cal. App. 4th 1386, 1395, (Cal. App. 5th Dist. 2013),   Coker v. JP Morgan Chase Bank, N.A, supra). The holding in Coker v JP Morgan Chase Bank  found a way around this by finding that C.C.P. §580b (Anti Deficiency Statute) provides another basis to prohibit such deficiency claims on a short sale, even though the short sale deficiency statute cannot be applied retroactively. This may allow borrowers to retroactively challenge either prior enforcement and collection on such agreements, as well as prospective attempts to enforce such agreements. However, to further confuse things: It still can be argued that a deficiency agreement on a  non-purchase-money loan (prior to the enactment of Cal Code Civ Proc § 580e, on covered loans) can be enforced.

Lenders need to carefully consider any attempt to collect a deficiency after a short sale, on covered loans.