Re: Enforcing Deed of Trust Guarantees
On November 9, 1995, the Fourth Appellate District (San Diego) issued a decision that when enforcing a personal guarantee after foreclosing on a deed of trust which secured the underlying debt, the guarantor is entitled to a judicial hearing to determine the fair market value of the property as of the date of foreclosure, regardless of the amount bid at the foreclosure sale, and any judgment against the guarantor cannot exceed the difference between the total amount of the debt and the greater of the foreclosure sale price or the fair market value of the property determined by the court. Bank of Southern California v. Dombrow. There are several useful rulings in the case, including judicial approval of a Gradsky waiver the language of which is specifically quoted in the decision, but once again the court has found a way to avoid awarding a deficiency judgment after the lender foreclosed on the real property security.
The bank loaned $585,000.00 secured by a first deed of trust and a year later made an additional loan of $150,000.00, initially secured by a first deed of trust on another property, which subsequently was reconveyed and substituted by a deed of trust on the original property in fourth position. The lender thus had two loans, one in first position and one in fourth position, both personally guaranteed by Mr. and Mrs. Dombrow.
The borrower went bankrupt, the lender sued Mr. and Mrs. Dombrow on their personal guarantees, and the lender obtained relief from the bankruptcy stay and foreclosed its first deed of trust with a full credit bid of that note only. This left the lender’s lawsuit to enforce the guarantee of the second note which had been in fourth position for $186,533.61.
The holder of a senior lien who is also the holder of a junior lien, who forecloses on its senior lien, cannot claim the rights of a sold out junior lien holder including the right to sue for a deficiency. The court reasoned that the right of a sold out junior to sue for a deficiency is intended to protect the junior lien holder against the actions of the senior lien holder. Where the sold out junior is in fact the same person as the senior lien holder, it needs no such protection since the elimination of its lien is the result of its own action and not the action of others. While the Court did not say so, it was not going to create a loophole in the California anti-deficiency protections allowing lenders to obtain deficiency judgments by the obvious and simple subterfuge of dividing their loans between senior and junior liens, foreclosing on the senior lien and suing for a deficiency as a sold out junior.
The lender’s Gradsky waiver was upheld. Under the 1968 case of Union Bank v. Gradsky, it was held that although guarantors are not directly protected by California’s anti- deficiency rules, since a guarantor who pays a lender pursuant to the guarantee is entitled to recover the amount paid from the borrower whose debt was guaranteed, and is entitled to enforce all security interests the lender held for the debt, if the lender eliminates those security interests and the guarantor’s ability to recover what it owes the lender from the security, whether by giving up the security interest or foreclosing on the security, the guarantor is exonerated. The Gradsky court specifically stated that this right to be exonerated can be waived. The court held that the Gradsky waiver language quoted in the decision constitutes a valid Gradsky waiver.
The court makes no mention of the recent case of Cathay Bank v. Lee in which the Court of Appeal for Orange County held that a similar Gradsky waiver did not give the guarantor adequate notice of his right to be exonerated if the lender foreclosed or otherwise prevented its security interest from being available for enforcement by the guarantor. This decision will be useful to lenders who have old-style Gradsky waivers in their personal guarantee forms, and may even provoke Supreme Court review in order to reconcile this conflict between the decisions of the two courts of appeal. We do not recommend the language quoted in the Bank of Southern California case, and recommend that lenders’ personal guarantee forms include a more specific and overt description of the Gradsky rights being waived, as required by Cathay Bank v. Lee. Nonetheless, this decision should help some lenders avoid summary judgment in enforcing their guarantees.
A guarantor is entitled to a hearing to determine the fair market value of the foreclosed property as of the date of foreclosure, and its liability is limited to the total amount of the debts owed by the borrower to the lender minus the greater of the foreclosure sale price or the fair market value of the property as of the date of foreclosure. Civil Code _580a provides a procedure for determining the amount of a deficiency judgment against a borrower and provides that the deficiency judgment cannot exceed the same amount described in the preceding sentence. The court characterizes 580a as “a forgotten statute” since the 1939 enactment of section 580d which eliminates deficiency judgments after the exercise of the private power of sale under a deed of trust. The Court also notes that no previous court has held section 580a applicable to guarantors.
The court found that section 580a has been applied to suits for deficiency judgments by a sold out junior lien holders and found no reason to distinguish between a suit for a deficiency judgment by sold out junior lien holder against the original debtor and a similar suit against a guarantor. The Court next found that the Gradsky waiver and other waivers included in the personal guarantee did not identify the guarantor’s rights under 580a nor its right to have its liability limited to the excess of the borrower’s debt over the fair market value of the property. While not directly holding on the issue, in a footnote the Court expressed serious doubt whether public policy would sanction such a waiver of the limitation on the amount of a deficiency.
At the deficiency judgment trial, the lender’s expert testified the property was worth $700,000.00 and the borrower’s expert testified the property was worth $1,200,000.00. The Court found that the property was worth $1,200,000.00, which exceeded the amount of the lenders two notes, and both notes were held satisfied by the lender’s acquisition of the property at the foreclosure sale. In the end, the lender got the property, and the guarantor paid nothing and was awarded attorneys’ fees at the trial level and on appeal. Added to its own attorneys’ fees, the lender may have paid out as much or more than the debt owed under the junior loan it was attempting to collect.
California courts continue to avoid enforcing personal guarantees after the lender has foreclosed on the real property security. If the lender is not willing to accept the security in full satisfaction of its loans, then the lender should consider suing the guarantor directly first, and letting the guarantor have the security to enforce its right to reimbursement from the debtor. If the guarantor’s assets are insufficient to easily satisfy the debt, then the lender should review with its attorneys very carefully whether it can prove a case that the fair market value of the property is enough less than the total debt that it is worth suing the guarantor for the deficiency and risking an award of attorneys’ fees if the lender’s lawsuit is unsuccessful. In particular, the lender’s valuation of the property at the time the loan was made should be reviewed carefully since it will be obtained in discovery and may support the guarantor’s position that the property is worth as much or more than the debt.
If a situation arises where you are considering non- judicial foreclosure and you think you may also need to collect on a personal guarantee because the security is not sufficient, please call me to discuss how best to recover all that you are owed.