Foreclosure Law in California (By William Markham, © 2000

Introduction: a Short Summary of California’s Foreclosure Laws

Lenders often require that their loans be secured by real property. When a lender makes such a loan, it requires the borrower to execute and deliver a loan agreement (which states the terms and conditions of the entire transaction), a corresponding promissory note (which obliges the borrower to repay the loan with stated interest and other charges), and a deed of trust that includes a power of sale (by which the borrower pledges one or more parcels of real estate as security for his obligations under the loan agreement and accompanying note). Collectively, these instruments constitute a secured loan agreement.

If the borrower defaults on such a loan, the lender can sell his property to pay the entire debt at once, along with various other charges that the loan agreement authorizes in the event of the borrower’s default. This act of selling the property to pay the borrower’s debt is called a foreclosure. It is the pre-emptive or premature closing of a secured loan transaction by a forced sale of the collateral that secures the loan.

Indeed, California’s one-action rule establishes that a foreclosure is the only means by which a lender can reach its borrower’s real property after its borrower defaults under its secured loan agreement. When a lender forecloses, it must decide whether it wishes to conduct a non-judicial foreclosure (which is speedy and inexpensive) or a judicial foreclosure (which is time-consuming and costly). As explained below, a lender will choose the latter option only if it seeks a deficiency judgment from the borrower or must litigate an unresolved dispute over the validity, amount, or priority of a lien that encumbers the borrower’s property.

The sale proceeds from a foreclosure sale are used first to pay the costs of sale and then to pay off or pay down the borrower’s debt under the loan agreement. If the sale proceeds exceed the debt, the remaining funds, which are called surplus funds, must be disbursed to junior encumbrancers of record in order of priority, and any remaining sum must be disbursed to the borrower. If, however, the sale proceeds are insufficient to pay off the borrower’s debt, the lender might be able to obtain a deficiency judgment, which is a money judgment against the borrower for the remaining part of his debt under the secured loan agreement.

Whether a lender can obtain a deficiency judgment depends on the foreclosure procedure used and the kind of loan foreclosed. To obtain a deficiency judgment, a lender must bring an action for a judicial foreclosure under Code of Civil Procedure § 726, rather than conduct a non-judicial foreclosure (or “trustee sale”) under Civil Code § 2924 et seq.[1]These references are made to California’s Code of Civil Procedure and Civil Code.

Even then, a lender cannot obtain a deficiency judgment against a borrower who defaults on a purchase-money loan.[2]A purchase-money loan is a loan that is (1) used by the borrower to purchase his own dwelling; and (2) secured by this same dwelling; but the loan will be so treated only if the dwelling has no more … Continue readingNor can the seller of real estate obtain a deficiency judgment against his buyer for failing to make required payments under the seller’s installment contract or carry-back note.[3]Under a seller’s installment contract, the buyer acquires title and possession and, in exchange, delivers a trust deed and agrees to pay a stated price by making successive installment … Continue reading

Here is a quick recap of the above points. Borrowers often obtain loans from lenders only by agreeing to pledge real property as collateral for the loans. To do so, they must enter into secured loan agreements that include a loan agreement, a corresponding promissory note, and a trust deed by which the borrower pledges specified real property to the lender. In nearly every instance, the lender records the trust deed as a monetary encumbrance upon the borrower’s title to the property that he has pledged as collateral. If, after receiving the loan, the borrower fails to repay it as agreed, the lender can exercise its power of sale under the trust deed and force the sale of the borrower’s property at either a non-judicial or judicial foreclosure. The selling of the borrower’s real property to satisfy his debt under the secured loan agreement is an act of foreclosure – a premature closing of a secured loan transaction by liquidating the asset that secured the loan.

The mechanics of these foreclosure procedures are explained at length below, as are the key differences between judicial and non-judicial foreclosures. Each has its distinct advantages and disadvantages, which every borrower, lender, and real estate investor should understand.

The above matters constitute the essential precepts and basic building blocks of California’s law on foreclosures. The remainder of this article provides a more complete explanation of this law, as well as practice pointers and digressions on related matters. Since foreclosure law is a rather dry subject, your author has tried to enliven it by providing colorful illustrative examples.[4]The information presented in this article is given only for general informational purposes and does not establish an attorney-client relationship between any reader and the author of this article. … Continue reading

Real Estate Purchase Contracts and Secured Loan Agreements: A Primer

To understand how secured loan agreements are typically used, it is necessary to understand the basics of standard real estate transactions for the sale of real property in California. I explain these matters below. Readers already familiar with them might prefer to pass over or merely glance at this section of the article.

The Parties’ Contract for the Sale of Real Estate

Many buyers wish to purchase improved real estate, where they can live, spend vacation time, or conduct some sort of business or leisure activity. Before making any bid, savvy buyers often obtain a lender’s pre-approval of a secured loan up to a certain amount, so that they can present it with their bid. Such a buyer will then inspect different properties, usually working with a licensed real estate agent who works for a licensed real estate broker, and who acts as the buyer’s agent.

Once the buyer identifies a property that he wishes to purchase, he can instruct his agent to submit a bid to purchase it. By this bid, the buyer will offer to pay a stated price by posting an initial deposit in a designated escrow account, and by subsequently remitting cash and loan funds into this account to pay the remainder of the purchase price. The bid is typically stated in a proposed contract (typically, a marked-up version of a boilerplate contract prepared by the California Association of Realtors, or “CAR”).

If a seller accepts this offer, or if the parties exchange one or more counter-proposals until they reach agreement, they will have entered into a binding contract for the sale and purchase of real property in California. This contract will typically be subject to certain contingencies, which must be either waived or fulfilled on a very short timeline.

To begin performance of this contract, the buyer must first open an escrow account, using a licensed provider for this purpose. Then the buyer will make his initial deposit in accordance with joint escrow instructions given to the escrow administrator by the seller and buyer (who for this purpose usually will mark-up boiler-plate instructions provided by the escrow administrator).

Inspecting the Property’s Title: the First Contingency

The escrow company is usually a licensed provider of title insurance. Directly after the escrow account is opened, if not sooner, the escrow company/title insurer will provide a preliminary title report (charging a fee, whose expense is borne by either or both parties, according to their contract). This report must verify the condition of the property’s title by examining the public records of the recorder’s office and tax assessor’s office in the county where the property is located.

In that manner, the escrow provider/title insurer can confirm that the seller holds title in fee simple to the property and can therefore convey a grant deed to the buyer. It can also ascertain and list all encumbrances of record against the seller’s title, such as secured loans, liens, tax assessments, recorded easements (another’s right to cross over part of the property or use a pathway or road that lies along it), recorded covenants or equitable servitudes (which confer on a neighboring property or specified persons the right to use the property in some limited way), and other lessor estates in the property, such as leases, licenses, and other such arrangements to possess or use part of the property for limited purposes.

The escrow company/title insurer must also offer to insure the condition of the property’s title, guaranteeing that the seller can convey good title, but subject to the monetary and non-monetary encumbrances listed in its preliminary title report, which are called “exceptions.”

The buyer can then accept the condition of the property’s title, but specify that he does so only on the express condition that his purchase price be used to pay in full the monetary encumbrances upon the seller’s title (e.g., loans, liens, tax assessments, etc.). That is a standard term of most transactions for the sale of real estate, but the parties and the buyer’s lender sometimes agree that a lienor of record can continue to encumber the title after its transfer to the buyer, but only if it first agrees to subordinate its lien to the lender’s trust deed.

The condition of the property’s title is usually resolved very quickly. Indeed, many buyers will not bid on a property until they have examined public records or a private provider’s compilation (e.g., a property profile).

Inspecting the Property’s Physical Condition: the Second Contingency

Shortly after the parties agree to their contract, the seller must make various written disclosures about the property’s condition. The buyer will then have a short, stated period of time to inspect the property. To this end, the buyer should always hire a professional property inspector to examine the property’s condition, including the matters disclosed by the seller.

If the buyer is satisfied, he can waive his inspection contingencies. But if not, he can either withdraw from the contract, or demand that the seller cure specified property conditions at its own expense before the sale is concluded. In response to such a demand, the seller can withdraw from the contract, or agree to make some or all of the requested changes at its sole expense, or agree to do so only if the buyer agrees to split the cost in some manner. The buyer can then withdraw, agree, or make a new counter-proposal. If the parties finally reach agreement, or if the buyer never raises any objection to the property’s physical condition, the buyer’s contemplated purchase will have survived the buyer’s inspection contingencies.

Procuring the Loan: the Third Contingency

When a buyer has offered to pay part of the purchase price with loan funds, the purchase agreement will also depend on a loan contingency: by a stated deadline, the buyer must furnish a lender’s formal, written commitment to make the required loan (it is called a commitment letter). If the buyer fails to do so, the seller can withdraw from the transaction and keep the buyer’s initial deposit; or the seller might afford the buyer additional time to obtain a commitment letter or otherwise raise the required funds. If the lender approves of the buyer’s required loan and gives a commitment letter, then the transaction’s contingencies will have been met, subject only to the buyer’s right to conduct a final inspection shortly before the contract is concluded.

Required Escrow Transactions

At this point, the buyer and seller must jointly complete formal escrow instructions and deliver them to the escrow administrator, unless they previously did so. In practice, the escrow administrator has the parties’ real estate agents complete parts of its boiler-plate instructions before the buyer posts the initial deposit, and then they fill in the remaining blanks and append any special, supplemental instructions after the above contingencies have been either waived or fulfilled.

Also, at this point the buyer will invariably purchase title insurance that the escrow administrator previously offered, so that if an undisclosed claimant comes along after the sale and asserts a legal or equitable claim against his title, the title insurer must pay to oppose the claim and/or indemnify the buyer for his loss if the claim is vindicated (e.g., where a claimant alleges and prevails on a claim to hold superior title to the property under the doctrine of adverse possession).

Now all of the pieces of this complicated puzzle are in place, and the escrow administrator can perform the seller’s conveyance of a grant deed to the buyer, proceeding as follows.

By a stated date, the buyer must deliver to the escrow administrator an executed, notarized deed of trust in favor of his lender, as well as his remaining cash contribution by wire transfer. The trust deed will make a general reference to the lender’s loan agreement, state its principal amount, and refer generally to its unspecified charges and fees if the buyer/borrower defaults under the loan agreement.
Upon being apprised that the buyer has performed the above acts, the lender must wire its loan funds to the escrow administrator.
Upon being notified of the buyer’s and the lender’s performance of the above acts, the seller must deliver to the escrow administrator an executed, notarized grant deed, by which it conveys to the buyer all of its title and interest in the property. The grant deed must specify in what capacity the buyer will hold this title (e.g., “The Acme Seller Corp. hereby conveys all of its legal and equitable title and interest in the below-described parcel of improved real estate to Roger P. Borrower, a married person, but as his separate property”).
Now the escrow administrator must give notice to the buyer, the seller, and the buyer’s lender that it has received the above items, and then it must perform the following acts: (1) immediately record the seller’s grant deed and the lender’s trust deed; (2) use the buyer’s proceeds (all cash payments and all loan funds) to pay all costs of sale, commissions, fees, and like charges; then disburse by wire transfer the payments required to pay off all monetary encumbrances of record (unless jointly instructed otherwise); and, lastly, disburse by wire transfer the remaining sum to the seller as its net sale proceeds (unless instructed to remit this payment by check).

By these acts and transactions, the buyer (aka, the borrower) becomes the holder of title to the property, but this title is encumbered by the lender’s trust deed, which in turn names a trustee. If the borrower defaults under the loan agreement, the lender must first meet certain requirements (explained below), and can then instruct the trustee to foreclose the borrower’s loan agreement and sell the property to recoup the borrower’s entire debt under the loan agreement, plus foreclosure fees, late fees, and other such charges. But if the borrower pays off the entire loan, the lender becomes legally obliged to instruct the trustee to reconvey the trust deed to the borrower, whose title to the property will thereupon cease to be encumbered by it.

After a buyer has acquired title to a real property, he can convey one or more trust deeds to subsequent lenders (often called junior lienors), each of which can foreclose under its trust deed. Suppose he obtains two additional secured loans—say, one from Second Place Lenders and the other from Third Place Lenders. To do so, he must convey a trust deed to each one. Suppose that Second Place records its lien shortly before Third Place records its own. The borrower’s property is now encumbered by three trust deeds: the one held by the original lender, which is said to be in first position; the one held by Second Place, which is said to be in second position; and the one held by Third Place, which is said to be in third position.

That is because the priority of a trust deed or any other lien is determined by the date of its recording. insert

The priority of a lien has enormous importance: if the holder of a senior lien forecloses under its lien, its foreclosure extinguishes all junior liens (or “subordinate liens”) by operation of law. insert Their liens thereupon attach only to any surplus fund that the foreclosure might yield. If there is no surplus fund, the junior liens are extinguished, or “wiped out,” and their holders become mere unsecured creditors of the borrower. insert

These points will make much more sense after you have read the entire article. They have critical importance to understanding foreclosure law and lenders’ assessment of credit risks. Also, a lender will invariably charge a higher rate of interest if it agrees to run the risk of having its trust deed wiped out. Many lenders refuse to make a loan secured only by a property already encumbered by a significant lien. Most refuse to make a loan secured by a property already encumbered by two or more senior liens. [5]When discussing these matters, the terms “trust deed” and “lien” are often used interchangeably, since a trust deed is one kind of lien that a creditor can record against a … Continue reading

When recording their respective trust deeds, Second Place and Third Place will each record a special notice against the buyer’s title that entitles each one to receive any notice of default or notice of trustee sale or judgment sale that any lienor might record against the borrower’s title. That way, each one can protect its lien from the foreclosure of a senior lien, since their respective loan agreements with the borrower entitle each one to cure the borrower’s default on a senior lien and thereby render the borrower immediately liable to it for this sum and fees. If, say, Third Place cures a new default by the borrower on his loan from the original lender, it can charge this sum to the borrower, who must pay it along with fees, or else Third Place can foreclose under its trust deed and acquire title to the borrower’s property, but encumbered by its senior liens, which are the original lender’s trust deed and Second Place’s trust deed.

Real estate transactions are as varied and complicated as their different purposes require. The above explanation merely describes the basics of these transactions, so that my readers can understand how a borrower comes to hold a title to improved land that a lender can take from him by foreclosure if he defaults on its loan.

A Commonplace Example

Throughout this article, I will use the following hypothetical example to illustrate various principles and doctrines of California’s foreclosure laws and show how they can be applied in particular cases.

Imagine for a moment a young, aspiring professional who recently bought a modest “starter” home in the Silicon Valley for, say, $1.8 million. The home is nothing spectacular at all: it is split-level and has two bedrooms, one bathroom, a cramped kitchen, a small garage, and a fenced-in, tiny backyard. But in today’s roaring real estate market, the hero of our example was forced to pay $1.8 million for this unassuming property, which twenty years ago very likely would have sold for, say, $840,000, and twenty years before that for $175,000.

Those familiar with the Silicon Valley or California generally will know that my above example is by no means an exaggeration. I have personally known people who have paid as much or more to get far less.

So there you have it then: Our young purchaser, now embarked on his career, has just agreed to pay $1.8 million for an ordinary, routine home. Like many purchasers in the Bay Area, he was required to must provide a down-payment equal to 20% of the purchase price, or $360,000. To raise this sum, he sold all of his stock, emptied his savings account, forewent vacations for the past two years, and received loans from relatives who live in less expensive places and chortle at his struggle to make ends meet in modern-day California.

Our hero has thus posted a down-payment of $360,000 and taken a loan of $1.44 million for the remainder of the purchase price. He received this loan from Wells Fargo Bank after completing its arduous application process. Did the bank give him the loan because he solemnly vowed “to repay every penny if it’s the last thing I ever do”? No, of course not. Did it give him the loan because of his fantastic good looks? Or because the stars were aligned properly when he applied? No, and no.

Rather, Wells Fargo (or any other sensible lender) must consider the value of the property that prospective borrower wishes to purchase, as well as his credit rating, financial history, present employment, professional qualifications, and likely ability to pay the loan according to its terms.

The hero in our hypothetical example passed the test: he raised a down-payment of $360,000, procured a loan from Wells Fargo for $1.44 million, and used these funds to purchase a real property in California for $1.8 million. Of note, the loan carries a fixed-rate of interest of 6% per year, and its term is thirty years.

This set of facts will serve as the hypothetical example that I will use throughout this article to illustrate its most important points.

Secured Loan Agreements: The Loan Agreement, Note, and Trust Deed

In the above example, the terms and conditions of the loan will be explained, or rather obscured, in a confusing series of documents written in impenetrable legalese that Wells Fargo will present to our hero for signing on a “take-it-or-leave-it-basis.” Of course, he will sign. These documents, taken together, constitute a secured loan agreement between a borrower and Wells Fargo, which is the lender.

This secured loan agreement, like all others, will include a loan agreement, a promissory note, a deed of trust, a disclosure statement that satisfies the “Truth-in-Lending Act,” the lender’s other disclosure statements, and many other documents that the lender must provide to comply with complex federal and state statutes that govern the making of purchase-money loans.

The loan agreement will state that the borrower must pay a stated sum (the principal amount of the loan) at a stated rate of interest over a fixed term, and that the borrower will become responsible for various charges and fees if he defaults on this obligation or any other material term or condition of the loan agreement. A summary of the terms of payment, including all possible charges after a default, will also be recited in the accompanying promissory note.

Under such an agreement, the borrower must typically make monthly payments for the next twenty-five or thirty years: that span of time is called the term of the loan. If the loan agreement and note specify that interest on the loan will be set at a fixed rate (say, 6% per year), the borrower’s monthly payments will be the same amount for the entire term of the loan. But if the loan agreement and note set interest at a variable rate, the borrower’s monthly payments will vary according to fluctuations in the index used to set the variable rate.[6]Variable-rate loans usually call for the lender to adjust the interest rate once each year according to a complicated formula that depends upon the rise or fall of a specified index.

By the loan agreement and its note, the borrower will become legally obliged to pay Wells Fargo according to their stated terms, and they will be secured by the deed of trust, which is the central document in a foreclosure. The deed of trust invariably includes a power of sale, which upon the borrower’s uncured default expressly authorizes the lender to force a sale of the borrower’s property and to use the sale proceeds to repay his remaining debt to the lender at the time of the sale, along with various charges and fees.

Pre-Payments and Usury Laws

To return to our colorful example, our borrower has just acquired title to a $1.8 million home, using a loan of $1.44 million to fund most of the purchase and cash for the remainder. The terms and conditions of this loan are stated in a loan agreement, and a summary of the debt and payment terms are recited in an accompanying promissory note. To secure his obligations under the loan agreement and its note, the borrower has conveyed a trust deed to Wells Fargo, which encumbers his title to the property and authorizes Wells Fargo to sell it if he fails to pay as agreed.

If all goes well, the borrower will dutifully pay off the loan according to the loan agreement’s schedule of payments. Or perhaps the borrower will do so long before the term of the agreement ends: to pull this off, the borrower will likely require unexpected professional success, an inheritance, a winning lottery ticket, or the foresight to liquidate his momentarily valuable stock-options at an opportune time. If this good fortune befalls him, however, he might discover that he must pay a substantial fee if he wishes to pay off the entire loan prematurely.

If a borrower wishes to defray his loan in advance, he must ensure that the loan agreement does not include a pre-payment penalty, which is a special fee that some lenders charge when a borrower becomes prosperous enough to pay off his loan before its term expires. In such an arrangement, it might be said that the borrower is charged extra if he pays late, or extra if he pays early!

Wells Fargo and most institutional lenders do not charge pre-payment penalties, but pre-payment fees are perfectly legal so long as they are properly disclosed in the loan agreement and do not violate California’s usury laws, which recite alternative formulas to specify how much interest a lender can lawfully charge on its loans.

California’s usury laws have many exceptions and special rules for certain kinds of loans and categories of lenders. One type of loan that receives special, indulgent treatment is a loan that is made or arranged by a licensed real estate broker and secured by real property. Various banks and financial institutions also receive very lenient treatment under these laws.

No serious lender will ever violate California’s usury laws: when a lender charges a usurious rate, it forfeits its right to collect any interest on its loan, must treat the borrower’s past payments of interest as payments of principal, and might become civilly liable to the borrower for treble damages on all usurious interest that the borrower paid during the preceding year.

Events of Default

Every secured loan agreement takes care to establish and define events of default. Each event of default is an act or omission that constitutes a material default under the loan agreement. Most concern the borrower’s obligations to the lender. A borrower is said to default under the loan agreement upon the occurrence of any the borrower’s events of default. When this happens, the lender becomes authorized to foreclose the loan agreement and force the sale of the loan collateral (i.e., the real property that the borrower pledged as collateral for the lender’s loan by delivering the trust deed to the lender).

A borrower’s events of default typically include one or more of the following matters:

The borrower’s failure to make payments to the lender in accordance with the loan agreement’s schedule of payments. Typically, a single missed payment constitutes an event of default. It is by far the most common kind of default.
The borrower’s failure to insure, repair, or maintain the loan collateral (the real property pledged by the trust deed) in the manner required by the loan agreement.
The borrower’s conveyance of the loan collateral to another without the lender’s prior written approval.
The buyer’s use of the loan collateral in a manner or for a purpose forbidden by the loan agreement.
The borrower’s use of the loan proceeds for a purpose not authorized by the loan agreement.
The borrower’s insolvency or filing of a bankruptcy petition for liquidation or reorganization in a federal bankruptcy case; or a creditor’s filing of a bankruptcy petition to have the borrower named an involuntary debtor in a federal bankruptcy case, but only if the borrower fails to have the petition denied within a stated period.
A change of ownership or managerial control of the borrower without the lender’s prior, written consent.
The borrower’s breach of some other material covenant set forth in the loan agreement. Such covenants vary greatly from one agreement to the next and depend on the kind of loan made, its intended use, the borrower’s business, the borrower’s credit history, and like matters.

The Lender’s Power of Sale and Foreclosure Sales

If a borrower defaults under a loan agreement secured by a trust deed, the lender can exercise the power of sale expressly granted to it under the trust deed. By this power the lender is authorized, upon the borrower’s default, to force a foreclosure sale of the loan collateral (i.e., the real property that the borrower pledged as collateral for its loan by delivering the trust deed to the lender).

The proceeds from this sale must be used first to pay various administrative costs and then so far as possible to pay the borrower’s entire remaining debt under the loan agreement (including all principal and interest still owed, as well as various late fees, foreclosure fees, and like charges).

If the sale proceeds do not suffice to pay the full amount owed to the lender, the borrower might become personally liable for the deficiency, which is the difference between (1) the buyer’s remaining debt to the lender; and (2) the sum that the lender recouped from the foreclosure sale. Whether the buyer will owe a deficiency depends on the foreclosure method used and the loan agreement that it forecloses.

Broadly speaking, a lender cannot recover any deficiency from the borrower in a non-judicial foreclosure. See Code of Civ. Proc. § 580d. Nor can a lender recover any deficiency from its borrower when it forecloses any of the following kinds of loans: a purchase-money loan; the mere refinancing of purchase-money debt that does not include additional principal; a seller’s installment contract for the sale of real property; or a seller’s carry-back note for the sale of real property. See Code of Civ. Proc. § 580b(1)–(4).

In other words, a lender can recover a deficiency judgment from its borrower only by conducting a judicial foreclosure of a loan that does not fall in any of the four forbidden categories (purchase-money debt, its mere refinancing, a seller’s installment contract for realty, or a seller’s carry-back note for realty).

A Purchase-Money Loan, Defined

Above all, Wells Fargo made the loan to you only on condition that it be secured by your new home, which in turn is a single-family home where you intend to reside permanently. That means that Wells-Fargo’s loan to you qualifies as a purchase-money loan under California law—i.e., a loan used to fund the borrower’s purchase of a dwelling and secured by this same dwelling; provided that dwelling has only four or fewer units, one of which the borrower intends to use as his primary personal residence for the foreseeable future. See Code Civ. Proc. § 580b(a)(3); see also DMC, Inc. v. Downey Sav. & Loan Assn., 99 Cal. App. 4th 190, 194 (2002) (“A purchase-money lien is a deed of trust given to a lender to secure repayment of a loan used to pay all or part of the purchase price of an [owner] occupied dwelling for not more than four families. The facts and circumstances that exist at the time the debt is created determine the character of the obligation as a purchase-money mortgage.”).

In California, a purchase-money loan is treated as a non-recourse loan. If a borrower defaults on a purchase-money loan, the lender’s sole recourse as a matter of law is to force a sale of the property by foreclosure proceedings. See Code Civ. Proc. § 580b(a)(3). When the underlying loan is a purchase-money loan, the lender cannot obtain a “deficiency judgment” from the borrower — i.e., it cannot obtain a personal judgment against the borrower for the difference between the amount owed under the loan and the amount recouped by the forced sale of the borrower’s property. This restriction is set forth at Code of Civil Procedure § 580b(b)(a)(3).

Since January 1, 2013, any refinancing of a purchase-money loan is afforded the same protections, save to the extent that the new refinancing includes a loan of new principal that is not used to pay off the original purchase-money loan. Any ensuing refinancing loan is treated the same way. See Code Civ. Proc. § 580b(a)(4).[7]This provision, enacted in 2013, has had enormous significance: it allows borrowers to obtain new loans secured by their residences without fear of losing the purchase-money protections that they … Continue reading

As noted above, California’s anti-deficiency protections apply not only to purchase-money loans and the refinancing of purchase-money loans, but also to seller-financed sales of real estate (installment contracts and carry-back notes). See Code Civ. Proc. § 580b(a)(1)–(4).

An Obnoxious, All-Too-Commonplace Example

Recall our borrower in the above example. He purchased a hideously expensive, otherwise unremarkable property for $1.8 million, which he paid by using life savings and relatives’ ill-natured loans to post a down-payment of $360,000, and also by taking a loan of $1.44 million for a term of thirty years at a fixed-rate of interest of 6% per year.

Not long afterwards, he fell deeply in love and got married. But before tying the knot, he and his future wife expressly agreed that he would hold his title to the property as his separate property, and that it would not become part of their community estate. Our borrower, being affable and good-natured, did not do so to deprive his future wife of generous treatment, but only to afford the author of this article a more convenient example for teaching the basic principles of foreclosure law in California. (But many who have gotten married have kept their properties separate for perfectly noble and sensible motives.)

A few years later, our good-natured, unsuspecting borrower introduces his boss to his wife. Shortly afterwards, they begin a torrid affair. One day, when the borrower returns to his modest home, he is not greeted at the door with his wife’s usual barrage of derision and complaints. Instead, he discovers that she is gone, and so too are their belongings and furniture. He then reads the letter that she has left behind, in which she announces that she and his boss have decided to live openly as a couple, and that he shouldn’t bother showing up for work, since he will just be an eyesore and embarrassment there and will be ejected from the premises.

Naturally, our borrower decides to take a long road trip to the Hudson Bay, taking with him a crate of whiskey and his dog, Scooter. He intends to spend a little time with Scooter in the northern hinterlands, where he hopes to “sort things out” before returning to start life anew.

But, of course, there is the little matter of the “note” – as in, the promissory note appended to the loan agreement and secured by the lender’s trust deed, which in turn entitles the lender to have the property sold in foreclosure to satisfy the borrower’s debt under the note if he stops making its required payments. That is not all. If the lender forecloses the loan agreement, there will be a black mark against the borrower’s credit, which will await his return from the northern wilds of Canada’s Hudson Bay.

The borrower should therefore try to avert a foreclosure despite having lost his job and had his poor heart broken at the same time. His only hope, he soon learns, is to consider various alternatives to foreclosure before leaving for the Great North. We will help him to do so in the next section of this article.

Foreclosure Alternatives: Forbearances, Modifications, Short Sales, and Deed Surrenders

There are various alternatives to foreclosure that a distressed borrower might wish to consider before defaulting on his loan and losing his property after a foreclosure sale.

Loan Forbearances

One option available to a distressed borrower is called a “loan forbearance.” By it, the lender agrees that the borrower need not repay his loan for a stated duration, say, six months or one year. During this time, the interest payments that he fails to make are added to his principal debt and thus increase the overall amount of the loan. This relief is therefore costly, but it might make sense for a borrower who has experienced a temporary setback and has a well-founded, reasonable expectation of repaying the new amount of the loan on time and in full.

Loan Modifications

A distressed borrower can request a modification of his loan agreement, so that its term is extended, or its interest rate is lowered, or some other term or condition of the loan is modified, so that it becomes more affordable. Loan modifications are the most common type of foreclosure alternative.

A borrower’s request for a loan modification must be approved by the lender or its assignee. That can pose complications when the original lender no longer holds the loan, but instead sold it to, say, a group of investors, who in turn bundled the loan with many others and sold income streams generated by this large bundle of loans. But loan servicers have worked out efficient methods for requesting and obtaining approval from these kinds of investors.

Generally speaking, lenders approve of proposed loan modifications only when they are likely to provide overall higher returns than would a foreclosure proceeding against the distressed borrower’s property. That outcome will typically arise only if the borrower has a reliable source of income and sufficiently low debts so that he can likely honor the modified agreement.

California’s public policy therefore encourages lenders to consider and grant loan modifications for borrowers who are likely to perform the modified agreements successfully. To this end, why California’s HOBR forbids a lender to initiate, schedule, or conduct non-judicial foreclosure proceedings against its borrower’s property while it considers the borrower’s first-time application for a modification of a “first lien” loan, or while the borrower remains eligible to request reconsideration of such an application after it has been initially denied. During these intervals, a lender (or its servicer or trustee) is forbidden to serve and record a notice of default (which initiates a non-judicial foreclosure), or serve and record a notice of trustee sale (which sets the date for a non-judicial foreclosure sale), or conduct a non-judicial foreclosure sale. See Civ. Code § 2923.6(c) (stating these points at length and in detail); see also Willis v. JPMorgan Chase Bank, N.A., 250 F. Supp. 3d 628, 631 (E.D. Cal. 2017) (“[Civil Code] Section 2923.6 prohibits ‘dual tracking,’ in which a lender proceeds with the foreclosure process while reviewing a loan modification application.”).

Short Sales

In some instances, a borrower might elicit his lender’s agreement to let him sell the property at a stated price to an arm’s-length purchaser, even though the stated price will not suffice to repay the loan in full. In this event, the borrower will request that the lender forgive the difference, which is called a “deficiency.” The lender, however, will respond by demanding that the borrower agree to pay the entire deficiency over time and with interest. Haggling might ensue, and the borrower and the lender might reach a compromise agreement.

If so, the borrower’s ensuing sale of the property to an arm’s-length purchaser is called a short sale, which in its simplest form proceeds as follows. Using an escrow account, the borrower sells his property to the purchaser in exchange for a stated purchase price. After the costs of sale are deducted from this price, the net sale proceeds are paid to the lender. Typically, this price fails to pay the borrower’s entire debt under the loan agreement: to address this deficiency, either the borrower pays part of it to the lender, or the lender forgives the entire deficiency.

By such a short sale, the borrower walks away from liability for the full deficiency and averts a non-judicial foreclosure; the seller procures a speedy payment of a substantial part of its loan without bearing the costs and burdens of a foreclosure (and perhaps receives a supplemental payment from the borrower); and the purchaser acquires title to the property free and clear of the borrower’s grant deed and the lender’s trust deed.

Short sales can become much more complicated when there are senior or junior lienors. Also, a short sale might constitute a taxable event for the borrower, who has received the benefit of a forgiven debt (the part of the lender’s loan that the lender forgives). A borrower who contemplates a short sale should confer with his accountant about its tax consequences.

Lastly, owing to California’s anti-deficiency statutes, a purchase-money borrower usually has no incentive to pay any money or make any substantial concession to his lender in exchange for its approval of a short-sale: even if the lender were to foreclose the borrower’s purchase-money loan and seize the property that secures it (the borrower’s dwelling), and even if this foreclosure would result in a very large deficiency, a lender could not obtain a judgment for any part of it: no deficiency judgment can be entered to recompense a lender (or its assignee) for the difference between the amount of its purchase-money loan and the amount that the lender recoups by a foreclosure sale of the property that secures its purchase-money loan. See Cal., Code Civ. Proc. § 580b(3). This point is explained at length below.

Surrendering the Deed in Lieu of Foreclosure

Another alternative is that the borrower can agree to convey his title to the property (his grant deed) rather than oblige the lender to conduct foreclosure proceedings. This is called a surrender of the deed in lieu of foreclosure. Typically, the borrower will wish to negotiate some advantage in exchange for this concession, such as a negotiated move-out date that might not be available from the eventual purchaser of the property at a foreclosure sale, who can use a simple action for unlawful detainer to gain possession of the property from its foreclosed borrower.

Under Civil Code §§ 2923.5 and 2923.55, a lender and its servicer must explain these matters to a distressed borrower against whom they contemplate conducting a non-judicial foreclosure. These are called foreclosure alternatives. Each carries peculiar benefits and drawbacks. All of them will cause serious harm to the borrower’s credit rating, but usually not as much as harm as will a foreclosure.

In our above example, none of these options appear tenable or bearable for our unhappy borrower. Having lost his job, and unable to afford his monstrous debt of $1.3 million to Wells Fargo, and lacking the composure or patience to consider tenable options, he knows only that he will inevitably default on the note, since he is headed north to frolic with his dog while drinking whiskey from a crate. But he does not wish to suffer the credit stigma or pay the many fees and extra costs of the inevitable foreclosure. He therefore tells his lender that it needn’t bother with the formalities and technical requirements of a foreclosure, and that he prefers instead simply to turn over his title to the property rather than lose it by a foreclosure proceeding. Some lenders sometimes accept the surrender, while others typically refuse, or impose unreasonable conditions on their willingness to do so, but the matter can often be negotiated.

As with all other debts, the one thing our unfortunate borrower must not do is simply ignore the debt, hoping that it will miraculously disappear. Unlike his ex-wife, his debts will not disappear, but rather will increase and involve him in further and further complications unless he attends to them.

Comparison of Different Foreclosure Alternatives

Sometimes property values lose substantial value over time. This can happen in a particular region that suffers from local problems that afflict the local housing market. As we have recently seen, it can also happen across the entire country at the same time: The national drop in prices that occurred across all markets from 2007 to 2011 showed that property values across the country had been over-valued and did not properly reflect the fundamentals of the properties in question (i.e., the ratios between property prices and rental values were excessively high, as were the ratios between property prices in given locations and the average incomes of the people in these locations.).

If there has been a local or national collapse of property values, as has recently occurred, many borrowers might find themselves burdened with loans that exceed the dwindling value of their properties.

Some might decide that the struggle is not worth the effort. They will wish to renounce ownership and the accompanying burden of paying the loan. Others might not have a meaningful choice, if they have taken a variable-rate loan that has become unaffordable or if they have suffered a loss of income (many borrowers have lost income, have seen their interest rate “re-set” at an unaffordable price, and have seen the value of their properties fall well below the amount owed on their unaffordable loan).

These circumstances are discouraging and have imposed anxiety and suffering on countless households during the past few years. The hapless anti-hero of my foreclosure story is not the only one to face the loss of his home under the foreclosure laws.

Here are a few comments in passing about different options that a distressed borrower might wish to consider when keeping current on the loan is no longer possible or not worth the effort.

A purchase-money borrower in particular should have no qualms about considering these different options. The bargain between a lender and a purchase-money borrower in California is that, if the borrower defaults, the lender’s sole recourse will be to foreclose on the property. The lender understood this point when agreeing to make the loan. It is an essential condition of the transaction, imposed by the laws of California.

The first option to consider is obtaining a loan modification or a refinancing of the loan on more favorable terms. A modification alters the terms of the existing loan. A refinancing loan is an entirely new loan on different terms. A borrower should not lightly re-finance a purchase-money loan, since the new loan will not be a purchase-money loan to the extent that its amount exceeds the amount of the original purchase-money loan, and to this extent the borrower will become exposed to personal liability for any “deficiency” owed under the refinanced loan.

Another option, mentioned in passing above, is to surrender the deed in lieu of foreclosure (i.e., turn over title to the lender, sparing the necessity of foreclosure proceedings). This requires a negotiation with the lender, or perhaps simultaneous negotiations with more than one lender. The success and terms of the endeavor critically depend on whether the loan or loans are purchase-money loans. Lenders often try to require the borrower to sign a promissory note in exchange for agreeing to accept the surrender. A purchase-money borrower has little incentive to give such a note. The details of these negotiations can be tricky.

Another option is to “walk away,” or simply allow the foreclosure process to run its course. (“Walk away” is a curious term for this approach, since the distressed borrower typically chooses to “walk away” from the obligation by staying put at the property while paying nothing until being forced to leave).

Still another option is to attempt to negotiate a short-sale. A short-sale is the sale of the property for less than is owed on the loan, done with the lender’s approval, so that the lender removes its lien against the property upon the sale and releases the borrower from further liability. Section 580e of the California Code of Civil Procedure, which is a new provision, clarifies that after a short-sale no deficiency will lie against the borrower so long as the entire sale proceeds are delivered to the lender or its assignee. Short-sales require the lender to agree in advance to the arrangement. If the borrower has more than one lender or other encumbrancers, he usually must negotiate an arrangement that satisfies all of his lenders and encumbrancers.

When considering these different alternatives, there is another key consideration: Does the borrower wish to qualify for another home loan in the foreseeable future? These days most borrowers cannot obtain a home loan unless the loan is underwritten by Freddie Mac or Fannie Mae, which are two government-sponsored entities that re-purchase and guarantee most of the home loans made in today’s mortgage markets. These two entities take a very dim view of borrowers who simply allow a foreclosure to happen. Their policies on the matter are as follows: If a borrower allows a foreclosure to occur, he will not be eligible for a loan underwritten by Freddie Mac or Fannie Mae for the next five years. If however there are extenuating circumstances (e.g., catastrophic illness), Freddie Mac or Fannie Mae may agree to underwrite a new home loan three years after the foreclosure. For deeds in lieu of foreclosure, the time periods are somewhat shorter: Four years for an ordinary surrender, and two years when there are extenuating circumstances. For short sales, however, the time period is always two years. (These time periods are subject to change, so you should check the latest credit guidelines posted by Freddie Mac or Fannie Mae.)

This in turn means the following. For all practical purposes, a distressed borrower who “walks away” cannot qualify for a new home loan for at least three years and possibly not for five years, and if he surrenders his deed he cannot qualify for at least two years and possibly for as long as four years. But if he negotiates a short sale, he can qualify two years after the unhappy event. (Obviously, whether a borrower can qualify for a new home loan will also depend upon his overall credit situation when he applies for a new loan.)

Before deciding which alternative to pursue, it is always necessary to consider the possibility of a deficiency judgment. “Walking away,” or allowing a foreclosure to occur, might be a poor option if the loan is not a purchase-money loan. Where the loan is not a purchase-money loan, the lender can seek a deficiency judgment against the borrower for the difference between the foreclosure proceeds and the final arrears owed under the loan. To obtain such a judgment, the lender must prosecute a judicial foreclosure (see above)

To avoid a deficiency judgment, the borrower of a full-recourse loan must either (1) await confirmation that the lender will choose to conduct a trustee sale and thereby waive its right to a deficiency; or (2) try to negotiate a loan modification, a loan refinancing, a surrender of the deed, or a short sale.

Short-sales, however, have their own disadvantages. The seller of a property owes certain obligations to the buyer. These obligations are imposed by the disclosure statutes, other statutes, and the contract of sale. In contrast, a defaulted borrower does not owe these obligations to his foreclosing lender.

A borrower who contemplates negotiating a short-sale should work with an experienced real estate broker or real estate attorney to make certain that the matter is properly conducted.

Tax Consequences of Forgiven Debt

A borrower might find himself relieved of part of his debt obligation to a lender because of a modification, re-financing, short-sale, deed surrender or foreclosure (public or private). This borrower might owe certain tax liabilities that are imposed against the forgiven debt, since the forgiven debt can be treated as taxable income. Any such borrower should confer with his accountant or attorney about the tax consequences arising from the forgiveness of his debt.

Each of these different options deserves a separate article of its own, as does the topic of the mass-scale securitization of home loans. I have merely referred to certain important points in passing.

Our Hypothetical Buyer Defaults, Then Runs Out of Options

In our hypothetical example, our borrower has lost his job and not made a payment to his lender in over three months. Before then, however, he timely paid the loan for five years. During this time, he paid $518,011.65 in principal and interest, thereby reduced the loan’s principal balance from $1.44 million to $1,339,982.74, and thus acquired additional equity in the property.

But now he is out of work, dejected, and listless. It hasn’t helped matters that his lender properly rejected his applications for a loan forbearance or loan modification while meticulously fulfilling its obligations under California’s HOBR. The lender also advised him that he could surrender his grant deed and forgo a foreclosure, but only if he also gave an unsecured promissory note of $17,000 in exchange for this privilege. The borrower, after conferring with an attorney, rightly rejected this last option: he will lose his home by a deed surrender or a foreclosure, but if the lender forecloses he stands to lose only his property, but not owe any damages. That is because his loan is indisputably a purchase-money debt, for which the lender cannot obtain a deficiency judgment.

Things thus look grim in Mudville: our borrower has run out of foreclosure alternatives. Nor is he in any humor to run around to try to line up a “hard money” loan, which even if feasible, would likely serve only to forestall his default while saddling him with further debt at a high rate of interest. Disillusioned by his former wife’s treachery and his former boss’s gleeful cruelty, he lacks the patience or composure right now to attempt any such effort. He has only one remaining ambition in life—to travel with Scooter to the Great North, where he hopes to gain a fresh perspective on things.

Our borrower is thus resigned to enduring the lender’s foreclosure proceedings, and it shall be my role to explain below what they are and how they work.

Foreclosure Proceedings and the One-Action Rule

When a borrower defaults under a loan agreement secured by real property in California, his lender can initiate foreclosure proceedings in order to force a sale of the borrower’s property and thereby recoup part or all of his remaining debt under the loan agreement. Under California’s one-action rule, foreclosure is the only authorized procedure by which a lender can reach a real property that its borrower has pledged as collateral for its loan. insert cite.

Before initiating a foreclosure, a lender must decide whether to pursue a non-judicial foreclosure (also called a trustee sale) or a judicial foreclosure, which are the two permitted forms of foreclosure authorized in California. In a landmark decision, the California Supreme Court explained the differences between them.

California has an elaborate and interrelated set of foreclosure and antideficiency statutes relating to the enforcement of obligations secured by interests in real property. Most of these statutes were enacted as the result of the Great Depression and the corresponding legislative abhorrence of the all too common foreclosures and forfeitures which occurred during that era for reasons beyond the control of the debtors.

Pursuant to this statutory scheme, there is only one form of action for the recovery of any debt or the enforcement of any right secured by a mortgage or deed of trust. That action is foreclosure, which may be either judicial or nonjudicial. In a judicial foreclosure, if the property is sold for less than the amount of the outstanding indebtedness, the creditor may seek a deficiency judgment, or the difference between the amount of the indebtedness and the fair market value of the property, as determined by a court, at the time of the sale. However, the debtor has a statutory right of redemption, or an opportunity to regain ownership of the property by paying the foreclosure sale price, for a period of time after foreclosure.

In a nonjudicial foreclosure, also known as a “trustee’s sale,” the trustee exercises the power of sale given by the deed of trust. Nonjudicial foreclosure is less expensive and more quickly concluded than judicial foreclosure, since there is no oversight by a court, neither appraisal nor judicial determination of fair value is required, and the debtor has no postsale right of redemption. However, the creditor may not seek a deficiency judgment. Thus, the antideficiency statutes in part serve to prevent creditors in private sales from buying in at deflated prices and realizing double recoveries by holding debtors for large deficiencies.

All. Mortg. Co. v. Rothwell, 10 Cal. 4th 1226, 1236 (1995) (internal citations and quotations omitted).

Below, I offer what I hope is a full and complete explanation of these matters.

Non-Judicial Foreclosures

The foreclosure process can take place in one of two ways. Either the lender will invoke its power of sale under its trust deed and instruct its trustee to initiate a non-judicial foreclosure; or it can bring a lawsuit for a judicial foreclosure.

The first of these options, a non-judicial foreclosure, proceeds as follows.[8]See generally Kachlon v. Markowitz, 168 Cal. App. 4th 316, 334–35 (2008) (“Under a deed of trust containing a power of sale… the borrower, or ‘trustor,’ conveys nominal … Continue reading

Pre-Foreclosure Notices and Disclosures/Foreclosure Alternatives. Broadly speaking, the lender and its servicer must make a good-faith effort to avert foreclosure by advising a borrower in arrears of various matters and foreclosure alternatives, or by making a diligent effort to do so if the borrower cannot be found. These matters are set forth in great detail at Cal. Civ. Code §§ 2923.5, 2923.55. Strict compliance is required.
If, in response to the above disclosures, a distressed borrower wishes to pursue a “foreclosure alternative,” the lender’s servicer must establish a “single point of contact,” evaluate the borrower’s application for relief in good faith, and desist from initiating a foreclosure sale until the borrower definitively fails to qualify for alternative relief. See Cal. Civ. Code §§ 2923.6–2923.7.
The Notice of Default. If the borrower has not cured his arrears or been approved for a loan modification or another foreclosure alternative, the lender can instruct a foreclosure trustee to initiate a non-judicial foreclosure by recording and serving a notice of the borrower’s default in a form entitled “Notice of Default.” This must be prepared, served, and recorded in strict compliance with the elaborate, technical provisions of Civil Code §§ 2924, 2924.17, and 2924b.
Notice of Sale. Unless the borrower has reinstated or redeemed the loan, or made some alternative arrangement that the lender accepts, the lender can instruct the foreclosure trustee to serve and record a Notice of Trustee Sale ninety days after the notice of default was recorded and at least twenty days before the trustee sale announced in the notice. This notice must strictly comply with the requirements of in accordance with Civil Code §§ 2924 and 2924b.
The Borrower’s Statutory Right of Reinstatement. The borrower can terminate foreclosure proceedings and reinstate the loan agreement by curing the arrears stated in the notice of default no later than five days before the foreclosure sale. By so doing, the borrower is said to reinstate the loan agreement, and the lender, its servicer, and/or the trustee must file a notice of rescission of the notice of default. See Cal. Civ. Code § 2924c.
The Borrower’s Statutory Right of Redemption. The borrower can avert foreclosure by timely exercising his statutory right of redemption—i.e., paying off the entire debt owed under the loan agreement before there is a foreclosure sale. See Cal. Civ. Code § 2903.
The Trustee Sale. The trustee or its authorized representative must conduct the sale in the county where the property is located and in the manner prescribed by Civil Code §§ 2924g–2924h. These statutes set forth very specific, elaborate procedures that must be strictly observed.
Post-Sale Bidding Rights: Eligible Tenant Buyers and Other Eligible Bidders. After the noticed foreclosure sale is conducted, “eligible tenant buyers” or other kinds of “eligible bidders” are entitled to make post-sale bids on the property. The sale must be awarded to “eligible tenant buyers” who timely submit a matching bid or any other kind of “eligible bidder” who timely makes the highest overbid. If no such bids are made, the sale will be awarded to the highest bidder at the foreclosure sale. These matters are set forth in Cal. Civ. Code § 2924m, which was enacted in 2025, and which establishes a right of first refusal for “eligible tenant buyers” and overbid rights for other kinds of “eligible bidders.”
The Trustee’s Deed. Once the sale is complete, the trustee will convey a trustee’s deed to the successful bidder. This deed will convey to the successful bidder legal title to the foreclosed property, free and clear of the foreclosed borrower’s grant deed, the deed of trust or other encumbrance under which the foreclosure was conducted, and all junior encumbrances that until then encumbered the foreclosed borrower’s title to the property. The trustee’s deed will remain encumbered by any senior encumbrance of the buyer’s title (i.e., any encumbrance recorded before the trust deed was recorded).

Below is a further, more detailed explanation of these matters.

Pre-Foreclosure Compliance: the California Homeowner’s Bill of Rights

In 2013, the California Legislature enacted a law entitled the California Homeowner’s Bill of Rights (the “HOBR”). In 2019, it modified this law. The HOBR is codified in various parts of the California Civil Code, most notably at §§ 2923.5, 2923.6, 2923.7, 2924, 2924.9, 2924.10, 2924.11, and 2924.12.

Although well-intentioned, the HOBR seems excessively complicated and appears to impose onerous regulatory burdens on lenders, their servicers, and foreclosure trustees. That circumstance likely has not helped to lower the price of real estate in California. Nor is this law a model of brevity and clarity. But its aims are certainly worthy.

Broadly speaking, the HOBR aims to protect distressed purchase-money borrowers from avoidable foreclosures. Before a lender or its servicer can instruct a foreclosure trustee to initiate a non-judicial foreclosure of a purchase-money loan, it must contact the borrower in person or by phone, or make a diligent effort to do so, “in order to assess the borrower’s financial situation and explore options for the borrower to avoid foreclosure.” See Cal. Civ. Code §§ 2923.5, 2923.55.

During this initial contact, the lender or its servicer must notify its borrower of his right to request a subsequent meeting within the next fourteen days and to name another person whom the lender or its servicer can contact to discuss the borrower’s possible options. The lender or its servicer must also provide a toll-free telephone number that the borrower can use to find a counseling agency certified by the federal Department of Housing and Urban Development. See Cal. Civ. Code §§ 2923.5, 2923.55. If the lender or its servicer cannot seem to reach the borrower, it must meet the HOBR’s exacting due-diligence requirements and provide a corresponding declaration. See Cal. Civ. Code §§ 2923.5, 2923.55; see generally Argueta v. J.P. Morgan Chase, 787 F. Supp. 2d 1099, 1107 (E.D. Cal. 2011) (offers a complete explanation of these matters).[9]See id. (“‘A mortgagee, beneficiary, or authorized agent [must] contact the borrower in person or by telephone in order to assess the borrower’s financial situation and explore … Continue reading

If a lender or its servicer fails to comply with the foregoing requirements, the proper remedy is a postponement of a foreclosure sale until the omission is cured. See Mabry v. Super. Ct., 185 Cal.App.4th 208, 223 (2010) (“If section 2923.5 is not complied with, then there is no valid notice of default, and without a valid notice of default, a foreclosure sale cannot proceed. The available, existing remedy is … to postpone the sale until there has been compliance with section 2923.5.”); see also Cal. Civ. Code § 2923.55 (imposes the same and related requirements upon the lender’s servicer).

The HOBR imposes additional statutory obligations if the borrower requests “a foreclosure prevention alternative.” See Cal. Civ. Code §§ 2923.4, 2923.7. These obligations are complicated, highly technical, and particular, and the lender must strictly comply with them. See generally Morris v. JPMorgan Chase Bank, N.A., 78 Cal. App. 5th 279, 295–97 (2022) (explains in precise detail how a borrower’s request for a foreclosure alternative must be processed by the lender and its servicer.).

Here is how the Court in Morris summarized these statutory obligations:

At the heart of the [Homeowners’ Bill of Rights] are mandated procedures designed to promote good faith negotiation of some form of foreclosure alternative (§ 2923.4.), typically modification of the borrower’s loan terms. Two provisions are most pertinent here.

First, ‘[w]hen a borrower requests a foreclosure prevention alternative, the mortgage servicer shall promptly establish a single point of contact’ (§ 2923.7, subd. (a)), a channel of communication referenced here in shorthand as a SPOC. The SPOC must remain assigned to the borrower’s account until her application for a foreclosure prevention alternative is resolved or her loan is brought current (§ 2923.7, subd. (c)), and is responsible for ensuring that the borrower is considered for foreclosure alternatives offered by the servicer (§ 2923.7, subd. (b)(4)), informing the borrower of the process for applying for a modification and of relevant deadlines (§ 2923.7, subd. (b)(1)), and coordinating receipt of all of the borrower’s application documents and of any missing elements of it (§ 2923.7, subd. (b)(2)). The SPOC must have access to current information and personnel necessary to inform the borrower of the status of her application (§ 2923.7, subd. (b)(3)), and those personnel must include individuals empowered to stop the foreclosure process (§ 2923.7, subd. (b)(5)). Failure to comply with the SPOC requirement is among the nine listed HBOR violations for which statutory remedies are available under sections 2924.12 and 2924.19.

Second, the HBOR prohibits what is sometimes known as ‘dual tracking,’ a practice that, described broadly, occurs when a lender or servicer pursues foreclosure while simultaneously going through the motions of reviewing a borrower’s application for foreclosure mitigation, without a good faith intent to entertain the application. While the SPOC requirement applies just to the ‘mortgage servicer’ (§ 2923.7), the ‘dual tracking’ prohibition applies to any ‘mortgage servicer, mortgagee, trustee, beneficiary, or authorized agent’ (§ 2923.6, subd. (c)). In essence, it forbids the initiation and pursuit of a trustee’s sale until a completed and still pending application of loan modification is fully resolved. (§ 2923.6, subds. (c)–(h).) Where loan modification is denied, the bar on dual tracking prohibits the recording of a notice of default, the recording of a notice of sale, or the conduct of a sale, until the lender or servicer sends the borrower a written denial letter, giving reasons for the denial and advising the borrower she has 30 days to appeal. (§ 2923.6, subds. (c), (d), (f).) Along with failure to comply with the SPOC requirement, prohibited ‘dual tracking’ is among the HBOR violations for which statutory remedies are available under sections 2924.12 and 2924.19.

There are some notable limitations built into the HBOR’s foreclosure prevention scheme. From the standpoint of substantive rights and obligations, the HBOR does not confer upon borrowers any right to receive a loan modification or other loss mitigation option. (§ 2923.4.) And servicers have no obligation to review a successive loan modification application from a borrower who has already ‘been evaluated or afforded a fair opportunity to be evaluated consistent with the requirements of this section, unless there has been a material change in the borrower’s financial circumstances since the date of the borrower’s previous application and that change is documented by the borrower and submitted to the mortgage servicer.’ (§ 2923.6, subd. (g).)

From the standpoint of remedies, consistent with a settled precept of nonjudicial foreclosure law prior to the HBOR’s enactment, the HBOR’s remedial scheme states that no violation of its provisions shall ‘affect the validity of a sale in favor of a bona fide purchaser.’ (§§ 2924.12, subd. (e), 2924.19, subd. (e).) It also limits liability—for injunctive relief prior to foreclosure, and for damages following foreclosure—to ‘material violation’ of listed provisions. (§§ 2924.12, subds. (a) & (b), 2924.19, subds. (a) & (b).) And it further limits post-foreclosure liability to claims for ‘actual economic damages pursuant to section 3281’ resulting from violations that were ‘not corrected and remedied prior to the recordation of the trustee’s deed upon sale.’ (§§ 2924.12, subd. (b), 2924.19, subd. (b).”)

See Morris v. JPMorgan Chase Bank, N.A., 78 Cal. App. 5th 279, 295–97 (2022).

Of critical importance, a foreclosure trustee cannot serve or record a notice of the borrower’s default until the lender has definitively rejected the borrower’s application for a foreclosure alternative, including any appeal by the borrower from an adverse decision. See Civ. Code § 2923.18 (provides specific dates).

If, however, a borrower does not apply for a foreclosure alternative, the trustee can serve and record the notice of default thirty days after the date when the lender or its servicer first contacted the borrower as required by Civ. Code §§ 2923.5 and 2923.55; or thirty days after the date when the lender or its servicer exhausted its statutory obligation to try to contact a borrower who could not be found. See Civ. Code §§ 2923.5, 2923.55.

The Notice of Default

After a lender or its servicer has complied with the above requirements, it will typically compile a packet and transmit it to its trustee, so that the trustee can initiate and conduct a non-judicial foreclosure. The trustee must review the packet to satisfy itself that it has cause to proceed.

The packet (or electronic folder) should include copies of the following documents: (1) the loan agreement and its accompanying promissory note; (2) the trust deed that secures the borrower’s obligations under the loan agreement and note; (3) the assignment, if any, by which the lender or its servicer came to hold the foregoing instruments; (5) a brief explanation or calculation of the borrower’s arrears under the loan agreement and note, including recurring costs and other allowed charges; (6) a declaration of compliance with pre-foreclosure procedures set forth at Civ. Code §§ 2923.5 and 2923.55, along with competent, admissible evidence that supports the declaration (or a summary of that evidence); and (7) instructions to initiate a non-judicial foreclosure to recover the borrower’s arrears, specified recurring costs, and other specified charges. The trustee must review this packet and satisfy itself that it has proper cause to proceed.

Assuming the above papers are in order, the trustee will initiate a non-judicial foreclosure sale by serving and recording a notice of default, which must be made in strict compliance with the very technical, abstrusely worded provisions of Civ. Code § 2924.

The notice of default must be sent by mail to the lender, its servicer, the borrower, all junior encumbrancers of record, various tax authorities, and all persons who have recorded a request for special notice. It must include all manner of disclosures, identify the specific grounds of the borrower’s default, and set forth the sum that the borrower must pay to exercise his statutory right of reinstatement. See Civ. Code §§ 2924; 2924c.

Also, the notice of default must be accompanied by the lender’s or servicer’s declaration of its compliance with Civ. Code § 2923.5 and § 2923.55 (contacting the borrower to discuss foreclosure alternatives; due-diligence requirements when the borrower cannot be reached). This declaration must be premised upon “competent and reliable evidence” that the declarant’s representative reviewed before executing the declaration. See Civ. Code § 2924.17.

The trustee can serve and record the notice of default no sooner than thirty days after (1) the lender or its servicer made the required first contact with the borrower; or (2) the lender or its servicer completed a diligent effort to contact the borrower in the manner prescribed by Civ. Code § 2923.5 and § 2923.55. But if the borrower requested a foreclosure alternative, the trustee can serve and record the notice of default only after the lender or its servicer definitively completes all applicable procedures set forth in Civ. Code § 2924.7.

The Notice of Trustee Sale

If, after ninety days, the defaulted borrower does not pay the reinstatement demand (or cure any other material default listed in the notice of default), the trustee will schedule a trustee’s sale of the borrower’s property and prepare a corresponding notice of trustee sale, which must disclose various matters in accordance with Civ. Code § 2924, including the date, time, and location of the trustee’s sale of the borrower’s property.

The trustee can publish, post, and mail this notice no sooner than ninety days after the recording of the notice of default and must do so at least twenty days before the sale. The trustee must also record this notice at least fourteen days before the sale. See Civ. Code § 2924.

If there is no junior lien for federal taxes, the sale can be conducted twenty days after the notice is served; but if a federal tax lien was recorded after the trust deed was recorded, the date of the sale must be set at least twenty-five days after the notice is served, or else the federal tax lien survives the foreclosure sale and will encumber the winning bidder’s title. See 26 U.S.C.A. § 7425(b)(1),(c)(1).

The Borrower’s Right of Reinstatement

As indicated above, the notice of default must notify the borrower of the sum that he must pay to cure his default and reinstate the loan agreement; typically, this notice will specify a sum certain, plus recurring charges and authorized foreclosure fees and costs. See Civ. Code § 2924c.

To avert foreclosure, the borrower can pay this sum as of right no later than five days before the foreclosure auction of the borrower’s property. Civ. Code § 2924c. To ascertain its exact amount, the borrower can request, and the lender or its servicer must promptly provide a reinstatement demand. This demand typically indicates that it will remain valid only for a stated duration, after which the borrower must obtain a new payoff demand that reflects subsequent charges. If the borrower timely pays the reinstatement demand, the lender or its servicer must record a rescission of the notice of default, and the loan agreement will be deemed reinstated by operation of law. See id.

The Borrower’s Right of Redemption (Non-Judicial Foreclosure)

The borrower can avert foreclosure by timely exercising his statutory right of redemption—i.e., paying off the entire debt owed under the loan agreement before there is a foreclosure sale. See Civ. Code § 2903. To do so, he must pay the full amount owed under the loan agreement, including special fees and charges. In exchange, the trustee must reconvey the trust deed that the borrower previously pledged to secure the loan. In a non-judicial foreclosure, the borrower can exercise this right only until the foreclosure sale occurs, but not afterwards. See Civ. Code § 2903.

The Trustee’s Sale

The lender’s trustee is charged with conducting the foreclosure auction in accordance with various statutory requirements. Among other things, the auction must be publicly advertised and held open to the public. See Civ. Code § 2924f–h. Unless an eligible tenant buyer makes the winning bid at this sale, it will not be final, but rather is subject to the right-of-first refusal afforded to eligible tenant buyers and the overbid rights afforded to other eligible bidders under Civ. Code § 2924m.

Mandatory Valuations for Dwellings That Secure Purchase-Money Loans

Since January 1, 2025, the lender must furnish a competent valuation of any dwelling that will be sold to pay a borrower’s debt for a purchase-money loan. The trustee cannot accept any bid that is less than 67% of the valuation figure. See Civil Code § 2924f(f).

Post-Sale Rights of “Eligible Tenant Buyers” and Other “Eligible Bidders”

If an “eligible tenant buyer,” or all “eligible tenant buyers” acting together, submit the last, highest bid at the foreclosure auction, they must be deemed the winning bidders. Otherwise, the trustee must tentatively accept the last, highest bid made at the foreclosure auction, but subject to certain post-auction bidding rights given to “eligible tenant buyers” and other kinds of “eligible bidders” under California Civil Code § 2924m, which became operative only in 2025. These bidding rights are as follows:

Eligible tenant buyers, acting collectively, can purchase the trustee’s deed to the foreclosed property by matching the last, highest bid at the foreclosure auction. To do so, they must either tender their matching offer within fifteen days of the foreclosure auction or submit a notice of intent to bid and tender their matching offer within forty-five days of the foreclosure auction. If the eligible tenant buyers timely submit such a bid and tender its amount, the trustee must accept it and convey his trustee’s deed to them. See Civ. Code § 2924m(c).
Other kinds of “eligible bidders” can also bid, proceeding as follows. Any of them can submit a notice of intent to bid within fifteen days of the foreclosure auction. If any such bidder does so, it can tender a bid that exceeds the last, highest bid at the foreclosure auction within forty-five days of the foreclosure auction. See id.
If the eligible tenant buyers do not make a matching bid, the trustee must accept the highest bid that he might timely receive from another eligible bidder and convey the trustee’s deed to this bidder. By definition, bids by eligible bidders other than eligible tenant buyers must exceed the last, highest bid made at the foreclosure auction. If two or more eligible bidders timely make such bids, the trustee must accept the highest one. If no such bid is made, the trustee must accept the last, highest bid made at the foreclosure auction and convey the trustee’s deed to this bidder. See id.
California Civil Code § 2924m thus re-structures how trustee’s sales proceed in non-judicial foreclosures. Briefly stated, the auction typically elicits a last, highest bid that is not made by an “eligible bidder.” Thereafter, the eligible tenant buyers have an option to purchase the foreclosed property by matching the last, highest bid. To do so, they must either tender it or give notice of their intent to do so within fifteen days of the foreclosure auction; if they give the notice rather than tender their bid, they must tender it no later than forty-five days after the auction. If this tender is timely made, the eligible tenant buyers will be deemed the winning bidder. If the eligible tenant buyers make no such bid, any other kind of eligible bidder can offer a bid that exceeds the last, highest bid at the foreclosure, in which case the winning bidder will be the eligible bidder that makes the highest bid in the required manner. If no such bid is made, then the winning bidder will be the bidder at the foreclosure auction that made the last, highest bid. The foreclosure trustee must thereupon convey a trustee’s deed to the winning bidder. Only then is the foreclosure sale and conveyance of the trustee’s deed final. See In re Spikes, 662 B.R. 704, 709–710 (Bankr. E.D. Cal. 2024).
The foreclosed borrowers and their closely-affiliated insiders (parents, children, trusts, companies that they own, etc.) cannot qualify as “eligible tenant buyers” or “eligible bidders” under Civil Code § 2924m. See Civ. Code § 2924m(a).

The Trustee’s Deed

The foreclosure trustee typically has a duty to convey a trustee’s deed to the winning bidder. It conveys a deed of ownership to the foreclosed property that is free and clear of (1) the foreclosed borrower’s title to the property; (2) the trust deed or other encumbrance under which the foreclosure was conducted; and (3) any encumbrance of the foreclosed borrower’s title that was recorded after the trust deed or other encumbrance under which the foreclosure was conducted. See Bailey v. Citibank, N.A., 66 Cal. App. 5th 335, 356 (2021)(“The trustee’s deed therefore passes the title held by the trustor at the time of execution, free of liens or encumbrances attaching after the deed of trust was recorded.”). The trustee’s deed is encumbered, however, by any monetary encumbrance of the foreclosed borrower’s title that was recorded before the trust deed or other encumbrance under which the foreclosure was conducted. See Brown v. Copp, 105 Cal. App. 2d 1, 6 (1951) (“A trustee’s deed conveys the absolute legal title to the purchaser, as against all claims subordinate to the deed of trust, but subject to all prior rights, interests, and titles.”); Romo v. Stewart Title of California, 35 Cal. App. 4th 1609, 1614 (1995) (“[W]hen the junior lienholder makes a full credit bid and acquires the property at the trustee’s sale, the debt secured by the junior lien is satisfied and the lien is extinguished. However, the junior lienholder, like any other successful purchaser, takes the property subject to the senior lien.”).

No Deficiency Judgment Allowed after a Non-Judicial Foreclosure

If a lender conducts a non-judicial foreclosure, it exhausts all of its remedies against the borrower by recouping what it can from the sale. The lender cannot obtain a judgment for any shortfall or deficiency, which is called a deficiency judgment. See Dreyfuss v. Union Bank of California, 24 Cal. 4th 400, 407 (2000) (“A ‘deficiency judgment’ is a personal judgment against a debtor for a recovery of the secured debt measured by the difference between the debt and the net proceeds received from the foreclosure sale.”). A non-judicial foreclosure affords a speedy, efficient remedy for the lender (although many lenders object that the numerous changes to this procedure since 2010 have made it anything but speedy and efficient), but in exchange the lender foregoes its ability to recoup any deficiency from the borrower. See Code Civ. Proc. § 580d(a). But a lender can pursue guarantors and sureties for the deficiency. See Code Civ. Proc. § 580d(a).

Judicial Foreclosures

A judicial foreclosure is a regular lawsuit filed in a California Superior Court in accordance with Code of Civil Procedure § 726. It is the only legal claim by which a lender can recover the unpaid part of a loan from real property that the borrower previously pledged as security under a deed of trust or mortgage. See Code. Civ. Proc. § 726(a) (“There can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property or an estate for years therein, which action shall be in accordance with the provisions of this chapter.”).

A Deficiency Judgment Can Be Obtained in a Judicial Foreclosure

When prosecuting this claim, the lender must look first to the property to recoup its loan (principal, interest, late charges, and allowed fees). If, however, the forced sale of the property at a foreclosure auction fails to make the lender whole, the lender can obtain a personal judgment against the borrower for any shortfall: any such judgment is called a deficiency judgment. See Bank of Am., N.A. v. Roberts, 217 Cal. App. 4th 1386, 1396 (2013) (In a judicial foreclosure, “the creditor must first exhaust the security before seeking any monetary judgment for the deficiency.”).

Deficiency Judgments Are Not Given on Purchase-Money Debt or Seller-Financed Sales

There are two kinds of loans, however, for which a lender cannot obtain a deficiency judgment even if it brings an action for a judicial foreclosure: purchase-money loans and seller carry-backs. Also, a lender that conducts a non-judicial foreclosure cannot obtain a deficiency judgment against its borrower.

That is, a lender cannot obtain a deficiency judgment for a purchase-money loan—i.e., a loan taken by a borrower to purchase a dwelling and secured by this same dwelling, provided that (1) the borrower purchased the dwelling to use as his primary residence; and (2) dwelling has no more than four units (three of which the borrower can rent to others). When a borrower defaults on such a loan, the lender’s only recourse is to sell the dwelling at a foreclosure sale and recoup what it can, but it cannot obtain a deficiency judgment against the borrower for any shortfall. See Cal Code Civ. Proc. § 580d(a)(3).

Nor can a seller obtain a deficiency judgment on a contract for the sale of realty by installment payments or in exchange for a promissory note secured by the property itself. If his buyer defaults, the seller can recover the property by foreclosure, or sell it by foreclosure and collect the net proceeds, but he cannot otherwise recover any shortfall from the buyer. See Cal Code Civ. Proc. § 580b(a)(1–2).

In addition, a lender cannot obtain a deficiency judgment if it elects to conduct a non-judicial foreclosure. Rather, a lender that chooses to have its own trustee conduct a trustee sale can recoup from the borrower only what that sale yields. See Cal Code Civ. Proc. § 580d(a). But the lender can obtain a deficiency judgment against “a guarantor, pledgor, or other surety.” See Cal Code Civ. Proc. § 580d(b).

Failure to Heed the One-Action Rule: the Lender’s Forfeiture of Its Collateral

If a lender brings a legal claim other than a judicial foreclosure to recover an unpaid loan from its the borrower, it forfeits its right to recover the debt from any real property that the borrower pledged as collateral for the loan. See Sec. Pac. Nat’l Bank v. Wozab, 51 Cal. 3d 991, 997 (1990) (explaining these points).

Judicial Foreclosure: Practice and Procedures

“An action for foreclosure under a deed of trust is a proceeding in equity in which the court has broad powers to grant appropriate relief as needed to protect the parties’ rights.” Majestic Asset Mgmt. LLC v. The Colony at California Oaks Homeowners Assn., 107 Cal. App. 5th 413, 423 (2024), review denied (Mar. 12, 2025) (citing, inter alia, Cummins v. Bank of America, 17 Cal.2d 846, 849 (1941)).

This action, which is commonly called a judicial foreclosure, is governed by Code of Civil Procedure § 726. It entails two distinct stages of litigation, which by law must be spaced apart from one another by at least three months.

The First Stage of a Judicial Foreclosure. During the first stage, the Court typically determines the following issues: (1) whether the borrower defaulted on the loan agreement; (2) whether the lender can accelerate the buyer’s entire debt under the loan agreement; (3) whether the buyer’s debt under the loan agreement is secured by a deed of trust that confers a power on sale on the lender; and (4) whether the lender is entitled to a foreclosure decree, an order of sale, and a deficiency judgment against the borrower.

If necessary, the Court must also decide disputes over the validity, amount, or priority of recorded encumbrances upon the property, as well as other, related issues.

If the Court orders a foreclosure sale, it will either conduct the sale itself or instruct a court-appointed receiver or referee to do so in accordance with its instructions. After the sale is conducted, the foreclosure proceeds will be impounded or held in trust in an interest-bearing account until further order of the Court.

The Second Stage of a Judicial Foreclosure. During the second stage, which takes place at least three months after the foreclosure sale, the Court must perform some or all of the following judicial tasks:

Establish the fair-market value of the property at the time of its sale.
Ascertain the fees and costs for the Court’s services (e.g., the receiver’s fees and costs).
Ascertain the borrower’s final debt to the lender under the secured loan agreement, including all outstanding principal and interest, late charges, and foreclosure costs.
Ascertain the borrower’s final debt to each junior encumbrancer of record.
Rule on the lender’s motion for attorney’s fees and costs.
Determine whether there will be a deficiency and, if so, fix its amount.
Determine whether there will be a surplus fund, and, if so, fix its amount and declare how it must be disbursed; but if not, decree that the junior encumbrancers’ respective liens were extinguished by operation of law upon the foreclosure sale [or upon the disbursement of any surplus fund yielded by the foreclosure sale.
Fix the price of the borrower’s statutory redemption.
Recite the above findings in a final accounting and order its final reconciliation by having the impounded sale proceeds disbursed to pay in the following amounts in the following order of priority: (1) the Court’s fees and costs; (2) the amount that the borrower owes to the lender, including its attorney’s fees and costs; and, if available, (3) the amounts due to each junior encumbrancer in order of priority; and, if available, (4) any remainder to the foreclosed borrower; but if there is a deficiency, the Court must declare its amount and render the borrower liable to the lender for this sum.
Supply the above figures as appropriate in the Court’s judgment rendered during the first stage of proceedings, or state the Court’s findings, rulings, and awards in a final judgment rendered after the second stage of the case. The final judgment should attach and incorporate by reference the Court’s final accounting.

The Borrower’s Right of Reinstatement (“Equity of Redemption”). As of right, the borrower in a judicial foreclosure can tender the arrears that he then owes under the loan agreement, including attorney’s fees, foreclosure costs, and costs of suit that the lender can claim at that stage of the case. If the borrower does so, the lender must reinstate the loan agreement and move to dismiss the case. insert cite.

The Lender’s Pre-Foreclosure Notices. Before bringing the action, the plaintiff, which is typically the lender or its servicer (hereafter, the “lender”), does not need to comply with the exacting pre-foreclosure requirements that govern non-judicial foreclosures. The stated rationale is that judicial foreclosures are closely supervised by the courts and therefore do not require the same meticulous regulations that govern non-judicial foreclosures. See Arabia v. BAC Home Loans Servicing, L.P., 208 Cal. App. 4th 462, 469–70 (2012) (“[T]he differences between nonjudicial and judicial foreclosures make clear that the Legislature decided that a nonjudicial foreclosure requires a more comprehensive statutory scheme than a judicial foreclosure because the latter involves significant judicial involvement.”).

Even so, before filing suit for a judicial foreclosure, a lender should give formal notice to the borrower of his default under the loan agreement and the lender’s election to claim and recover the full sum due under the loan agreement (i.e., the lender’s election to invoke the loan agreement’s acceleration clause). See Guracar v. Student Loan Sols., LLC, 111 Cal. App. 5th 330, 351 (2025) (“[A]n acceleration clause requires some affirmative act manifesting the election to exercise it.”).

The Plaintiff’s Complaint and Notice of Lis Pendens. To initiate the action, the lender must file a complaint in the California Superior Court for the county where the borrower’s property is located. The lender must also record a related notice of pendency of action (lis pendens) in that county, then file a conformed copy in the action.

In its complaint, the lender must name the following parties as defendants: the borrower and all encumbrancers of record—i.e., all lenders and lienors that filed trust deeds, mortgages, judgment liens, other liens, or tax assessments against the borrower’s title. If the borrower conveyed his title to the property to another, the lender must also name the grantee.

In its complaint, the lender must also allege or describe the following matters:

The real property at issue (i.e., its street address; assessor’s parcel number; and exact legal description).
The names of the plaintiff (the lender) and the defendants—i.e., the borrower, as well as all encumbrancers of record, with a clarification of which encumbrancers have claims senior to the lender’s trust deed, and which ones have junior encumbrances.[10]A senior encumbrancer is one that recorded its lien before the lender recorded its trust deed, while a junior encumbrancer is one that did so afterwards..
The secured loan agreement placed in issue (i.e., the loan agreement, its appended promissory note, and its trust deed, all of which should be appended as exhibits to the complaint).
General allegations that explain the case and the relief that the lender seeks.[11]Here is one way to plead the matter: “Plaintiff, a secured lender, brings the present action for a judicial foreclosure under § 726 of the Code of Civil Procedure to enforce its rights under a … Continue reading

Also in its complaint, the lender should allege the following matters in a section of its complaint entitled “General Allegations”:

The lender holds a secured loan agreement, a related promissory note, and a trust deed, all of which the buyer duly executed and delivered to the lender in exchange for its loan under the loan agreement (the “Loan”). The lender’s trust deed was timely and properly recorded in due and good form when the lender disbursed its Loan for the borrower’s benefit, and it specifically includes a power of sale that entitles the lender, upon the borrower’s default, to foreclose the loan agreement and force a sale of the real property that the borrower pledged as collateral for the lender’s Loan.
The original amount of the Loan was [$ insert.] The outstanding amount of this Loan at present is [$insert], plus specified late charges, foreclosure fees, attorney’s fees, foreclosure costs, and costs of suit.
On [insert date], the borrower defaulted under the loan agreement by failing to make a required payment, nor has the borrower since cured this default. On the contrary, the borrower failed to make further required payments on [insert dates.] The present amount of the borrower’s arrears under the loan agreement is [$insert], plus specified late charges, foreclosure fees, attorney’s fees, foreclosure costs, and costs of suit.

In the complaint’s prayer for relief, the lender should specifically request the following relief (omitting items that are clearly inapplicable to the case at hand):

“WHEREFORE, the Court should find that (1) the borrower is in default under the loan agreement; (2) the lender is entitled to accelerate the borrower’s remaining debt under the loan agreement; (3) the lender is also entitled to exercise its power of sale under the trust deed; (4) the lender shall be entitled to a personal judgment against the borrower for any deficiency in the foreclosure proceeds; (5) if there is any surplus fund, it shall be disbursed according to law; and (6) the borrower shall have a statutory right of redemption under Code of Civil Procedure §§ 729.010 et seq. until one year [or three months if there is no deficiency] after the date of the foreclosure sale. On the basis of these findings, the Court should decree and order that the borrower’s property be sold at a foreclosure auction, and that the sale proceeds shall be impounded until further order of the Court. insert

AND WHEREFORE, not less than three months after the foreclosure sale, the Court shall set one or more hearings at which it will ascertain and fix the following amounts:

The probable fair-market value of the foreclosed property when it was sold.
The Court’s own fees and costs in this case.
The borrower’s final debt to the lender under the loan agreement and to each junior lienor under their respective liens.
An award of attorney’s fee and costs to the prevailing party.
The amount that the foreclosed borrower must pay to the winning bidder at the foreclosure auction to exercise his statutory right of redemption; as well as the date on which this right shall expire if it has not been exercised before then.”

Responsive Pleadings. Any other party in the case can file a responsive pleading, such as a demurrer, motion to strike, or answer, as well as any cross-claim that concerns the matters placed in issue by the lender’s complaint.

How the Court Adjudicates These Issues. In a judicial foreclosure, the Court closely supervises all proceedings to ensure that they are conducted equitably and according to law. See Code Civ. Proc. § 726. insert.

The parties can employ discovery procedures, bring or oppose motions, present stipulations, and request evidentiary hearings to decide disputed issues of material fact. Acting on its own, or during a case-management conference, the Court might set one or more evidentiary hearings and briefing schedules, using these procedures to adjudicate all disputed facts and issues.

In most judicial foreclosures, the Court will look to the parties to perform nearly all of the above work, including the preparation of proposed orders, decrees, findings, property valuations, accountings, an interim judgment, a final judgment, post-judgment awards and orders, and ancillary documents required to perform the foregoing tasks.

The parties may try to reach agreement on some or all of these points. If they disagree on some or all of these matters, they can submit competing proposals to the Court along with explanatory briefs and proofs, so that the Court can rule on each disputed point.

The entire litigation can be long, very costly, and grueling. Nor, of course, will it be the Court’s only matter. But if a lender wishes to obtain a deficiency judgment, such a lawsuit is the only way to obtain it. Remember, a lender can never obtain a deficiency judgment on a purchase money-loan, a seller’s installment contract, or a seller’s carry-back note.

The Borrower’s Rights of Equitable and Statutory Redemption in a Judicial Foreclosure

Before the Court issues a foreclosure decree, the borrower can reinstate the loan agreement by exercising his equity of redemption, which entitles him to cure his arrears, including certain costs of suit. If the borrower does so, the lender must move to dismiss the action, and the Court shall then make corresponding findings and dismiss the action. By operation of law, the loan agreement will be deemed reinstated and treated as though no default had ever occurred. See Code Civ. Proc. § 726;

After a judicial foreclosure, the foreclosed borrower can exercise his statutory right of redemption, which is the right to purchase the property from the foreclosure purchaser. This right is governed by Code of Civil Procedure sections 729.010 et seq. The foreclosed borrower can exercise this right at any time within three months of the foreclosure auction, if the foreclosure proceeds paid off the borrower’s debt under the loan agreement (i.e., principal, interest, proper late charges, court costs, and sale costs). He can do so at any time within one year of the foreclosure sale, if its proceeds merely paid down his debt under the loan agreement and resulted in a deficiency judgment. See Code of Civ. Proc. § 729.030.

To redeem the property, the foreclosed borrower or his successor-in-interest must give notice and deposit the redemption price, which is intended to be equal to the foreclosure purchaser’s investment in the property; plus statutory interest; but less post-sale income or profits generated by the property, as well as the imputed value of the purchaser’s post-sale use of the property. See Code of Civ. Proc. § 729.060.

The redemption price is therefore equal to the sum of the following items: (1) the purchase price at foreclosure; (2) any amount that the foreclosure purchaser paid to protect the property from senior encumbrances; (3) the full amount of any junior encumbrance recorded by the foreclosure purchaser before the foreclosure sale; (4) post-sale taxes and assessments paid by the foreclosure purchaser; (5) reasonable post-sale costs paid by the foreclosure purchaser for the property’s insurance, maintenance, upkeep, and repairs; and (6) interest at 10% per year on the foregoing items; less (1) post-sale rents and profits that the foreclosure purchaser received from the property; and (2) the imputed value of the foreclosure purchaser’s own post-sale occupancy of the property. See Code of Civ. Proc. § 729.060.

Comparing Non-Judicial and Judicial Foreclosures: Pros and Cons

A non-judicial foreclosure, or trustee’s sale, is much more expeditious than a judicial foreclosure: It will happen approximately four to seven months after the lender first gives notice of the default (depending on the loan in question and the diligence of the foreclosure trustee).

In contrast, a judicial foreclosure takes as long as any other lawsuit on the regular civil calendar – that is, approximately eighteen months or longer. It will entail costly attorney’s fees, procedural complications, and the risk of cross-claims from a desperate or aggrieved borrower.

A non-judicial foreclosure is usually much better for the lender, since it is typically quicker and far less expensive to organize and conduct. A lender should accept the expense and delay of a judicial foreclosure only when it expects a large deficiency and can likely enforce a corresponding deficiency judgment against the borrower or his guarantor.

Also, a lender might prefer a judicial foreclosure if there is any significant dispute over the validity, amount, or priority of any recorded encumbrance that affects the lender’s rights under its trust deed.

As noted above, a lender cannot obtain a deficiency judgment if the underlying debt arises from a “purchase-money loan,” and therefore it just about never makes any sense for a lender to pursue a judicial foreclosure in order to recoup a borrower’s default on such a loan.

The matter can be summarized as follows. A lender cannot get a deficiency judgment if it forecloses by a non-judicial foreclosure (per Code of Civil Procedure § 580d), nor can it do so if the underlying loan was a purchase-money loan or a property seller’s carry-back note or installment contract secured by the property sold (per Code of Civil Procedure § 580b). Therefore, a lender will choose to sell the property at a non-judicial foreclosure if (1) the sales proceeds will likely pay the entire loan; or (2) the loan falls within the purview of Code of Civil Procedure § 580b. Lastly, a lender can always pursue a borrower for fraud in inducing it to make the loan or for bad-faith waste of the property.

It is often the case that the lender will forgo a judicial foreclosure and use a trustee’s sale even if (1) the sale will likely or certainly fail to yield funds sufficient to pay the full debt; and (2) the lender is entitled to a deficiency judgment for the remainder against the borrower. That happens when the lender prefers the convenience and expedience of a trustee’s sale, or has reason to doubt that it could enforce its deficiency judgment after going to substantial expense to procure it. This last point usually depends on the likely amount of the deficiency and the borrower’s ability to pay it.

There is an additional advantage to conducting a non-judicial foreclosure rather than a judicial one: the finality of the sale. A non-judicial foreclosure becomes definitive once the foreclosure trustee conveys the trustee’s deed to the winning bidder. That must happen no later than forty-five days after the foreclosure auction, as explained above.

In contrast, the winning bidder at a judicial foreclosure might be required to sell the property to the defaulting borrower under the redemption statutes, which entitle the defaulting borrower to redeem his property by paying the foreclosure purchase price to the winning bidder, along with redemption fees and related surcharges. For this reason, a property in judicial foreclosure is typically sold at a special discount, which compensates the purchaser for the risk of being forced to sell the property at a specified price to the defaulting borrower under the redemption statutes.

Each kind of foreclosure therefore has advantages and disadvantages, and the benefits of a judicial foreclosure are not available to lenders that seek to recoup debts that fall within the purview of Code of Civil Procedure § 580b.

Lastly, a judicial foreclosure is the proper approach when there are several encumbrancers, and a dispute has arisen between the lender and any of them that might bear upon the disbursement of sale proceeds. In a judicial foreclosure, the Court can rule on the validity, amount, and priority of any disputed encumbrance of record.

Our Example Revisited

To return to our lovely example, in which you find yourself driving north to forget your wife’s abandonment and the simultaneous loss of your job under humiliating circumstances, we can now easily apply the above rules. Wells Fargo, having made a purchase-money loan to you, has no interest in convening a judicial foreclosure: It cannot recover any deficiency because the loan was a purchase-money transaction (you used the loan to buy the home). Moreover, the value of your home is so high that Wells Fargo will have its entire loan paid off from the sales proceeds. Moreover, there is no controversy between competing lenders, and therefore no need for any sort of judicial determination of priorities. Wells Fargo will therefore foreclose upon your home by use of a trustee sale, which will take place 125 days after you first receive a formal notice of your default from Wells Fargo, unless you can either cure your default or convince Wells Fargo to accept an alternative, such as a loan forbearance or modification, a short sale, 0r permitting you to surrender your grant deed in lieu of taking it by foreclosure.

But suppose you encumbered the property not only with the Wells Fargo loan, but also with a second loan from Second Place Loans, Inc., which made a loan to you of $200,000 and secured it by a deed of trust, which was second in priority, after Wells Fargo’s deed of trust. In this case, Wells Fargo is said to hold the first deed of trust, and Second Place Loans, Inc. is said to hold the second deed of trust.

If you default on the Wells Fargo debt, and Wells Fargo forecloses, the foreclosure will have the effect of extinguishing Second Place’s deed of trust. The foreclosure of a senior lien always has the effect of extinguishing all junior liens. In this event, Second Place will no longer be your secured creditor, but will find that it is merely an unsecured creditor for its entire loan in the exact same manner as, say, Visa is your unsecured creditor for credit-card charges that you have made, but not yet paid. Second Place will therefore not allow Wells Fargo to foreclose. It will cure your arrears to Wells Fargo rather than suffer the loss of its security, and it add this cost to your obligation to Second Place. If you fail promptly to pay this cost, Second Place will foreclose its loan to you and take your property by a foreclosure sale conducted under its second deed of trust. If property values are sufficiently high, it will use a trustee sale to conduct its foreclosure, since it is the quickest way to have the property sold and your debt paid.

But suppose the value of the property falls significantly after you take the loan from Second Place. In this instance, Second Place might decide that it is better to conduct a judicial foreclosure, recoup what it can from the foreclosure sale, and procure a deficiency judgment for the remainder, including its attorney’s fees and costs of suit. Unlike Wells Fargo, Second Place did not make a purchase-money loan to you, and it is therefore entitled to a deficiency judgment if there is a shortfall after the foreclosure sale. (A new loan cannot be a purchase-money loan, but a loan taken to pay off a purchase-money loan is treated as a purchase-money loan, except to the extent that it exceeds the amount of the purchase-money loan.)

Remember, if the lender uses a trustee sale, it can recover only the sale proceeds, but nothing else. In a judicial foreclosure, however, the lender can obtain a deficiency judgment against the borrower for any outstanding amount still owed after the sale of the property, but this option is not available for purchase-money loans or seller-financed property sales (i.e., a seller’s installment contracts and carry-back notes).

Generally speaking, a lender might prefer a judicial foreclosure despite the long delay and high expense when (1) its claim qualifies for a deficiency judgment; (2) a trustee sale will likely result in a large deficiency; and (3) the borrower likely has the means to pay a substantial part of this deficiency.

Let us again consider that accursed home that you unwisely purchased in the Silicon Valley when you still loved your ex-wife and loyally reported to your ex-boss every day. You will recall that you paid $1.8 million for it by making a down-payment of $360,000 and using a Wells Fargo loan of $1.44 million. Suppose that the foreclosure happens five years later – after you have paid down the loan to, say, $1.3 million (typically, you pay mostly interest during the early years of loan repayment, then begin to retire principal more and more quickly as your repayment continues). Suppose that the fair-market value of the home has since risen to, say, $2.1 million.

You have also taken the second loan for $200,000 from Second Place. You therefore hold $600,000 of equity in the Property – that is, the $2.1 million value of the property, less the Wells Fargo encumbrance (now reduced to $1.3 million), less the Second Place encumbrance of $200,000.

If you default on the Wells Fargo note, but not on the Second Place note, Second Place will cure the Wells Fargo arrears and charge you for it (lest Wells Fargo forecloses, thereby extinguishing Second Place’s second deed of trust). If you fail to pay Second Place for the cost of curing the Wells Fargo arrears, it can foreclose on the second deed. If it decides to do so, it will use a trustee sale, since the property has enough value to support its lien. A purchaser will pay at least $210,000 to buy a property worth $2.1 million that is encumbered by a senior lien of $1.3 million. Indeed, a sensible purchaser will be willing to pay up to $450,000–500,000 to buy the $2.1 million property with a $1.3 million senior encumbrance. In this instance, suppose the property sells at a trustee sale for $250,000. is used first to pay the trustee’s fees and minor costs of the sale, $200,000 goes to Second Place, and the remainder is, say, $45,000. That remaining sum is called the surplus fund. It must be disbursed to junior lienholders in order of priority, with the remainder to the foreclosed borrower. In our example, there are no such junior lienholders, and therefore the entire surplus would be remitted to the borrower).

The lucky purchaser at this sale will have paid $250,000 to pay off Second Place and acquire a property worth $2.1 million that is encumbered only by a first encumbrance of $1.3 million, and whose equity is therefore $800,000. That purchaser thus paid $250,000 to acquire real equity of $800,000. Not bad for a day’s effort.

After making this purchase and buying some very good French wine to celebrate the occasion with his ravishing, but faithless mistress, our lucky purchaser will use an action for unlawful detainer to evict our hapless borrower from his former home, or expedite his move by paying him a small sum to leave rather than suffer the additional indignity of having a sheriff’s deputy arrest him for trespassing at the end of the unlawful detainer proceedings.

Then the new purchaser can refurbish the property for, say, $30,000, list it for sale, sell it for $2.1 million, and easily make a net profit of, say, $420,000((($420,000 = (1) the resale price of $2,1 million; less (2) $250,000 to buy the property at Second Place’s foreclosure sale, $30,000 for refurbishing, $1.3 million to pay off Wells Fargo’s loan, and, say, $120,000 for costs of sale).

Diligent, savvy investors in highly valued markets can make a fortune in this manner, provided that they have the capital to fund the venture, and provided that property values do not collapse while they are holding many.

But suppose that real estate prices tumbled after Second Place made its loan. In that event, it might instead conduct a judicial foreclosure, even though it will take a long time to complete, and even though the sales price will be a little lower to account for the defaulting borrower’s right of statutory redemption. After the judicial foreclosure, Second Place will receive a judgment against the borrower personally for the outstanding balance, which will be the difference between its loan of $200,000 and the sum it received from the foreclosure sale, plus a substantial award for attorney’s fees and other costs of suit.

Say that real estate prices have fallen dramatically: The country has been dragged into a catastrophic depression, and your home is no longer worth $1.8 million, but rather is worth only $800,000. In this instance, Second Place will conduct the judicial foreclosure, since no one will pay $200,000 (plus the surcharge for curing the Wells Fargo debt) to acquire an $800,000 property that is encumbered by a $1.3 million purchase-money loan. After the judicial foreclosure, Second Place will have a deficiency judgment against you for the outstanding amount owed on your obligation.

If you never took a second loan, but merely owe $1.3 million to Wells Fargo at the time of foreclosure, Wells Fargo will perform the foreclosure by a trustee sale, even if the value of the property has fallen far below the amount of the debt, since there can be no deficiency judgment on a purchase-money loan. The rationale for this should by now be clear: if there is a general collapse of the economy, a simple homeowner, who borrowed only to purchase his home, should not be forever undone by a deficiency judgment for the balance of his loan; his loss should be limited only to the loss of his home, unless he has taken additional loans against it after acquiring title.

What It All Means?

If you find yourself hopelessly confused by all of this, do not despair. The laws on foreclosures in California are abstrusely worded and perhaps a little confusing at the outset. It is easiest to understand them if you grasp their underlying principles, which are as follows:

Foreclosures (both judicial and non-judicial) permit a lender to recover its loan after its borrower has failed to pay it as agreed. That in turn encourages lenders to make loans that are secured by their borrowers’ real properties.
When a borrower defaults on such a loan, the lender can foreclose the loan agreement and recover the unpaid balance of the loan and default charges from a forced sale of the borrower’s real property. Indeed, California’s one-action rule requires the lender to use foreclosure proceedings to recover a debt secured by real property. If a lender fails to do so, it forfeits its collateral and can only seek a money judgment against the borrower.
There are two methods of foreclosure: (1) a civil action for a judicial foreclosure conducted by the local California Superior Court (i.e., the Superior Court located in the county where the at-issue property lies); or (2) a non-judicial foreclosure conducted by a private trustee.
Judicial foreclosures are closely supervised at every stage by the presiding court and conducted in accordance with Code of Civil Procedure §§ 725a–726. Non-judicial foreclosures must be conducted in strict compliance with Civil Code §§ 2923.3–2924p, which are a series of highly technical, involved, and poorly drafted statutes adopted at different times to serve different and sometimes contradictory purposes. But the courts have done a pretty good job of deciphering them, so look to their decisions for guidance and clarification.
A judicial foreclosure is very expensive and takes a long time to conduct (typically, one year to eighteen months, or longer). A non-judicial foreclosure is much quicker and less expensive to conduct, even if recent statutes have made them more time-consuming, complicated, and costly than they used to be.
A lender can obtain a deficiency judgment only by prosecuting an action for judicial foreclosure. This remedy is not available when the lender forecloses by a non-judicial foreclosure. Usually, a lender should incur the great cost and endure the long delay of a judicial foreclosure only in order to obtain a deficiency judgment on a loan eligible for this relief, and only when the expected deficiency will be substantial and the borrower likely has the means to pay it. On rare occasions, a lender might use a judicial foreclosure to have the Court rule on the amount, validity, and priority of a contested lien before disbursing the sale proceeds.
Deficiency judgments are not available for purchase-money loans, a seller’s installment contract, or a seller’s carry-back note. These anti-deficiency laws protect (1) borrowers who use purchase-money loans to buy their own dwellings; and (2) buyers of seller-financed real estate. For such loans, a lender can recover only the property that serves as collateral, but not a personal money judgment against its customer. A lender should therefore use a non-judicial foreclosure for loans of this kind.
If the lender forecloses by court proceedings under Code of Civil Procedure § 726, the foreclosed borrower will have a statutory right of redemption—i.e., the right to buy the property from its foreclosure purchaser. In consequence, bidders at judicial foreclosures usually discount their bids to take into account the risk of a statutory redemption, which the foreclosed borrower can make at any time within one year of the foreclosure sale if there is a deficiency judgment against him, or within three months of the sale when there is no deficiency against him.
If the lender forecloses by a non-judicial foreclosure, the borrower’s right of redemption will expire upon the sale of the property.
A junior lien is extinguished by the foreclosure of a senior lien, but no foreclosure may take place without written notice in the statutory manner to the borrower and all junior lienholders, who therefore have occasion to cure the default of the senior lien before it is foreclosed.
A distressed borrower can slightly mitigate the harm to his credit report and avoid certain foreclosure fees by surrendering his title in lieu of losing it in a foreclosure proceeding. A surrender of the deed at least suggests that the borrower sought to act responsibly when confronted with his inability to pay the loan, but many lenders make the process complicated and use it to (1) force the borrower to continue to make payments on the doomed loan while the request is administered; and (2) determine whether the borrower of a non-purchase-money loan has sufficient means to pay a deficiency.
A defaulting borrower should think twice before deciding to squat in his property until his lender forecloses. This is often a fool’s bargain: the borrower gains a short period of free rent, but the ensuing foreclosure is then listed on his record, harming his credit and good name for many years. Yet again, a surrender of the deed also entails significant harm to the borrower’s credit, but there is no public record of a foreclosure.
To avert foreclosure, a distressed borrower might also apply for a loan forbearance or loan modification, or try to negotiate the terms and conditions of a short sale.
If the distressed debt is a purchase-money loan or a seller-financed sale of real property, the borrower should usually decline to pay any additional payment in exchange for surrendering his deed or permission to make a short-sale.
Sometimes deliberate squatting is a distressed borrower’s last best option. Each case turns on its own facts.

Bankruptcy Relief

Bankruptcy proceedings can offer specific, limited relief to a distressed borrower who cannot manage his home loan or loans. (By the term “home loan,” I refer to any loan that is secured by a deed of trust or mortgage recorded against the primary residence of the borrower.) To consider the intersection of bankruptcy law and foreclosure law, it is necessary to consider the following points:

Bankruptcy Proceedings

“Bankruptcy” refers to the various proceedings conducted in the United States Bankruptcy Courts, which sit in the various federal judicial districts located across the United States. These courts conduct their proceedings in accordance with “bankruptcy law” – i.e., the United States Bankruptcy Code, the Federal Rules of Bankruptcy Procedure, applicable federal case law, various local bankruptcy rules, and in some instances applicable state case law.

The Automatic Bankruptcy Stay

A borrower who seeks relief in bankruptcy is called a “debtor.” As soon as a debtor files a petition for bankruptcy relief, all creditor actions against the debtor are automatically stayed by operation of law and in accordance with Section 362 of the United States Bankruptcy Code. This means that any foreclosure proceeding is automatically stayed if the borrower files a petition for relief in his local United States Bankruptcy Court.

No Modification of Home Loans in Bankruptcy Court

Of critical importance, the bankruptcy courts cannot modify a deed of trust or mortgage that secures a home loan: The underlying debt can be discharged, but if the lender can salvage part or all of its loan by foreclosing on the property, it will typically be given relief from the bankruptcy stay in order to conduct a foreclosure sale, and even if it does not obtain this relief, it will be treated as a secured creditor who can conduct the sale under the auspices of the bankruptcy court.

Limited Relief Under Chapter 13

If a borrower is in arrears on a home loan, and if he is otherwise eligible for relief, he can file a petition for relief under Chapter 13 of the United States Bankruptcy Code, asking the local bankruptcy court to approve of a proposed “reorganization” of his debt. His plan must provide that he will make all future monthly payments owed on his home loan or home loans, and his plan must also propose to cure any arrears on the loan or loans by making specified payments over time. By filing for this relief, the borrower can stop foreclosure proceedings, but only if (1) he can make all new monthly payments in full, (2) is otherwise eligible for relief under Chapter 13 relief, and (3) proposes to pay the outstanding arrears over time. This is a complicated matter, as relief under Chapter 13 has many eligibility requirements and is governed by various specific procedural and substantive requirements.

Lien-Stripping: Avoiding Worthless Junior Liens

A debtor in bankruptcy can rid himself of junior deeds of trust. It is a procedure called “lien-stripping,” and it works as follows. If a debtor in a Chapter 11 or Chapter 13 proceeding owes a home loan secured by a deed of trust in junior position, he can have the deed of trust voided upon showing that it is worthless: To do so, he must bring a “Lamb motion” in order to establish that the current fair-market value of the home is insufficient to support any part of the deed of trust – in which case the bankruptcy court will declare the deed worthless and voided. The debtor can then treat the underlying loan as an unsecured, non-priority debt in his plan of reorganization. “Lien-stripping” is not available in Chapter 7 proceedings. The necessary prerequisite to “lien-stripping” is a clear showing that the junior deed of trust is wholly unsecured and therefore worthless. If granted, the lien-stripping takes effect only upon the debtor’s discharge, which in turn is given only after the confirmation and subsequent performance of his plan of reorganization.

Secured Lenders Can Obtain Relief From the Automatic Stay

A home-loan lender can obtain relief from the automatic bankruptcy stay in order to conduct foreclosure proceedings upon a showing that (1) the debtor has no equity in the property, and (2) the administration of the property is not necessary to the debtor’s proposed reorganization. This relief is afforded by Section 362 (d) (2) of the United States Bankruptcy Code. Since Chapter 7 cases by definition do not entail a reorganization, a lender can routinely obtain relief in Chapter 7 proceedings upon a sufficient showing that the debtor lacks any equity in the property – a point that can often be deduced from the debtor’s own bankruptcy schedules. If however the lender cannot make this showing, it will be treated as a secured creditor in the bankruptcy, and as such the lender can sell the asset and obtain its relief under the auspices of the bankruptcy court. In Chapter 13 cases, the lender’s relief from the bankruptcy stay will turn on the issue of equity and on the additional issue of whether the borrower proposes a plan under which he keeps current on all future payments and pays down the arrears over time. The plan must otherwise meet the requirements of Chapter 13. If the lender cannot obtain relief from the stay in a Chapter 13 proceeding, it will be treated as a secured creditor, and it can either sell the asset in bankruptcy or receive full monthly payments and eventual payment of the arrears in accordance with the debtor’s plan.

A home-loan lender can also obtain relief from the bankruptcy stay “for cause” upon making a proper showing under Section 362 (d) (1) of the United States Bankruptcy Code. One such ground is if the borrower has failed to maintain adequate property insurance on his home. Another ground is that the property lacks a sufficient “equity cushion” – i.e., sufficient equity to provide full security for the loan. If however the loan has become completely unsecured, an otherwise eligible borrower can remove the deed of trust in a Chapter 11 or 13 proceeding by means of “lien-stripping” (see above).

A home-loan lender can also obtain relief from the bankruptcy stay if the debtor has initiated successive bankruptcy filings in effort to delay foreclosure proceedings, but otherwise without proper bankruptcy objectives that he reasonably can accomplish by his proceedings. This relief is afforded by Section 326 (d) (4) of the United States Bankruptcy Code.

Bankruptcy Reform Unlikely

One proposal that was earlier floated in Congress was the offer of loan modifications in bankruptcy for distressed homeowners who cannot manage their mortgage payments. Such legislation, whose enactment appears highly unlikely, would have authorized the bankruptcy courts to (1) modify loans secured by primary-residence properties; and (2) do so even when the loan has been securitized and has many different owners. At present this relief is not available: The current bankruptcy laws do not permit a bankruptcy court to modify an obligation secured by the borrower’s primary residence: The debt itself can be reorganized or discharged, but only to the extent that it is not secured by the home residence, so that bankruptcy law cannot protect a homeowner from foreclosure, save as described above (limited relief under Chapter 13 and lien-stripping).

Consult an Attorney for Bankruptcies

Bankruptcies are complicated, highly technical matters that must take into account the debtor’s entire financial condition. Be certain to consult a bankruptcy attorney if you are contemplating bankruptcy relief.

APPENDIX I: The Foreclosure Crisis of 2007-11 (commentary provided from 2008 to 2011)

Government-Sponsored Loan Modifications/Private Loan Negotiations

The Obama Administration has put into place programs under which distressed borrowers can qualify for loan modifications and refinancing of their existing loans. A loan can be modified by one or more of the following means: (1) a lowering of the interest rate; (2) a reduction in the amount of loan principal; and/or (3) an extension of the term of loan, possibly with periods of forbearance on collecting the loan. There is abundant information at other websites about the particulars of these government programs. The official government website for these programs is located at this link.

Moreover, the California Legislature now requires lenders to attempt to negotiate a loan modification before foreclosing on broad categories of loans secured by primary residences. There has also been a mandatory extension of the statutory waiting period before a non-judicial foreclosure can proceed against certain broad categories of such loans.

In addition, an enterprising borrower might be able to persuade his lender to agree to a modification all on his own and even in the absence of any public subsidy or public coercion. The task has been trickier than anticipated because (1) lenders have been averse to acknowledging write-downs on the value of their assets, which include their loans to distressed borrowers who cannot pay a dime; and (2) many or most of these loans have been “securitized” and sold to countless, nameless investors across the world, so that the servicer of the loan is unable or unwilling to make an agreement that might be objectionable to one or more classes of investors who have a stake in the loan. The Obama Administration has attempted to address this matter, but so far with very uneven, middling success.

“Securitization” of home mortgages, which in theory was supposed to make home loans more readily available to a larger number while spreading the risk of default, has in practice proven a ruinous double-edged sword that favors only those who earn quick commissions at source or upon re-sale: Many of these loans were (1) made to wishful, credulous borrowers who could not afford them; and then (2) placed in “pools” of loans, against which fancy investment banks sold bonds to wishful, credulous investors who since then have lost their principal!

This writer favors three clear remedies: Force the original lender to bear part of the risk of the loan rather than act as a glorified loan broker; force banks to maintain more capital reserves during “boom periods”, but less during “bust periods”; and return to a clear segregation of deposit banks and trader/investment banks, so that deposit banks can serve as the necessary financial conduits for our society and enjoy public insurance, while investment banks can enjoy as much risk as they can convince others to allow them to take, but if their risks prove foolish, they will have to fend for themselves without any public assistance at all.

These are simple remedies, and they will work. The same “wizards” who involved us all in this mess are now the ones who say that things are too “complicated” for such measures. The only thing that is too complicated are the dizzying explanations that the financial wizards offer for irresponsible, casino-style manipulations that do not further the proper aims of high finance — the raising of capital funds, the protection and productive investment of capital funds, the prudent lending of capital to those who wish to put it to productive use, and the use of financial and insurance contracts to allow businesses and investors to protect themselves against risk. But I digress.

IndyMac Loans

If you are the borrower of a loan made by the failed IndyMac bank, which is now under the control of the Federal Deposit Insurance Corporation (“FDIC”), you are likely eligible for a modification of the terms of your loan agreement. This program, which became known to the public on August 21, 2008, might in turn become a model program that the federal government might use to help other struggling borrowers or that it will at least use when administering loans made by other banks that fail before the present financial crisis runs its course.

Federal Housing Legislation

In July, 2008, the federal government enacted significant housing legislation. This legislation has been modified by the Obama Administration programs. Among other things, this legislation does the following:

Provides federal loan guarantees for troubled loans: A willing lender can now obtain federal loan guarantees of its troubled purchase-money loans. The lender must agree to (1) write down the principal owed on the loan to 87% of current market value, and (2) charge permitted interest at a fixed rate. This is a complicated program that will be administered by the Federal Housing Authority. It makes the federal government a prospective guarantor of a large part of the purchase-money loans made in recent years.

Provides explicit support to Freddie Mac and Fannie Mae. In the end the federal government has made good on its implicit promise to guarantee the obligations of these two government-sponsored entities, which re-purchase or guarantee certain kinds of purchase-money loans. At present, these two firms hold or have guaranteed more than $5 trillion of mortgage debt. The U.S. government has long given an implicit guarantee of this debt. The guarantee has become explicit, subject to various qualifications and mechanisms. This means that U.S. taxpayers have agreed to foot the bill for their possible losses. The repercussions might prove enormous. Federal intervention was surely necessary, and if it succeeds it will have saved the financial system from a ruinous collapse of confidence and funding. This is a very complicated matter that I have not even begun to explain in this brief note.

Provides housing funds to local government agencies. These agencies will use these funds to purchase foreclosed and distressed properties on specified terms and conditions.

This legislation was breathtaking in its scope, but not in its subsequent application, at least so far. Until now it has not received as much attention as its scope and significance would suggest it requires. If this legislation succeeds in its aims, it will help to alleviate the current crisis and restore long-term confidence in the housing and mortgage markets. It means however that the federal government has assumed enormous risks and obligations.

Treasury Authority

The Department of Treasury has obtained authority from Congress to expend as much as $700 billion to protect the financial system from systemic collapse. Under this program, the Treasury Department has authority to provide certain kinds of assistance to distressed homeowners who are confronted with foreclosure. The incoming Obama Administration has announced that it will direct the Treasury Department to avail itself of this authority to provide this relief in certain kinds of cases.

Conclusion

I certainly hope that none of my readers ever undergo the indignity of a faithless wife, a conniving boss, or a foreclosure of overpriced real estate that was an insufferable burden all along. If you are a secured lender, I hope you never lose your loan for having failed to follow the foreclosure rules. Lastly, I hope that this short article has provided a useful overview of California’s bewildering foreclosure laws, but of course you must not deem this as legal advice, as this is merely an article that I have published for general circulation, not specific advice intended for a client.

References[+]

References
↑1	These references are made to California’s Code of Civil Procedure and Civil Code.
↑2	A purchase-money loan is a loan that is (1) used by the borrower to purchase his own dwelling; and (2) secured by this same dwelling; but the loan will be so treated only if the dwelling has no more than four units, at least one of which the borrower intends to use as his primary residence for the foreseeable future when taking the loan. See Code Civ. Proc. § 580b(a)(3). Also, a loan that refinances a purchase-money loan is treated as a purchase-money loan, save to the extent that its principal exceeds the principal of the purchase-money loan. See Code Civ. Proc. § 580b(a)(4).
↑3	Under a seller’s installment contract, the buyer acquires title and possession and, in exchange, delivers a trust deed and agrees to pay a stated price by making successive installment payments. If an installment buyer thereafter misses a payment, the seller can take the property by foreclosure. Under a seller’s carry-back note, the buyer acquires title and possession and, in exchange, delivers a trust deed, a down-payment, and a note under which he must pay the remaining part of the price directly to the seller. If a promissory buyer misses a payment, the seller can take the property by foreclosure.
↑4	The information presented in this article is given only for general informational purposes and does not establish an attorney-client relationship between any reader and the author of this article. Nor should any reader rely on the information presented in this article without first engaging Mr. Markham or another qualified attorney to advise and represent him.
↑5	When discussing these matters, the terms “trust deed” and “lien” are often used interchangeably, since a trust deed is one kind of lien that a creditor can record against a debtor’s title to real property.
↑6	Variable-rate loans usually call for the lender to adjust the interest rate once each year according to a complicated formula that depends upon the rise or fall of a specified index.
↑7	This provision, enacted in 2013, has had enormous significance: it allows borrowers to obtain new loans secured by their residences without fear of losing the purchase-money protections that they enjoyed before the refinancing. Before this law was enacted, a borrower lost his purchase-money protection any time he took a loan to refinance his original purchase-money loan. This sensible revision ends the old, arbitrary distinction. It applies to all refinancing loans made since January 1, 2013.
↑8	See generally Kachlon v. Markowitz, 168 Cal. App. 4th 316, 334–35 (2008) (“Under a deed of trust containing a power of sale… the borrower, or ‘trustor,’ conveys nominal title to property to an intermediary, the ‘trustee,’ who holds that title as security for repayment of the loan to the lender, or ‘beneficiary.’ The trustee’s duties are twofold: (1) to ‘reconvey’ the deed of trust to the trustor upon satisfaction of the debt owed to the beneficiary, resulting in a release of the lien created by the deed of trust, or (2) to initiate nonjudicial foreclosure on the property upon the trustor’s default, resulting in a sale of the property…. When the trustor defaults on the debt secured by the deed of trust, the beneficiary may declare a default and make a demand on the trustee to commence foreclosure. The Civil Code contains a comprehensive statutory scheme regulating nonjudicial foreclosure. Generally speaking, the statutory, nonjudicial foreclosure procedure begins with the recording of a notice of default by the trustee. After the expiration of not less than three months, the trustee must publish, post, and mail a notice of sale at least 20 days before the sale, and must also record the notice of sale at least 14 days before the sale. The sale and any postponement are governed by [Civil Code] section 2924g.”).
↑9	See id. (“‘A mortgagee, beneficiary, or authorized agent [must] contact the borrower in person or by telephone in order to assess the borrower’s financial situation and explore options for the borrower to avoid foreclosure.’ Cal. Civ. Code § 2923.5(a)(2). Failure to comply with this subsection is excused if the borrower could not be reached despite ‘due diligence,’ as defined in the statute. Id. § 2923.5(g). A mortgagee or beneficiary has satisfied the due diligence requirement if it was not able to contact the borrower after (1) mailing a letter containing certain information; (2) then calling the borrower ‘by telephone at least three times at different hours and on different days’; (3) mailing a certified letter, with return receipt requested, if the borrower does not call back within two weeks; (4) providing a telephone number to a live representative during business hours; and (5) posting a link on the homepage of its Internet Web site with certain information. Id. A notice of default may be filed only thirty days after the initial contact with the borrower or satisfying the due diligence requirements. Id. § 2923.5(a)(1). A notice of default must be accompanied by a declaration stating that the buyer has been contacted or could not be reached despite due diligence. Id. § 2923.5(b).”).
↑10	A senior encumbrancer is one that recorded its lien before the lender recorded its trust deed, while a junior encumbrancer is one that did so afterwards.
↑11	Here is one way to plead the matter: “Plaintiff, a secured lender, brings the present action for a judicial foreclosure under § 726 of the Code of Civil Procedure to enforce its rights under a loan agreement and related trust deed. Plaintiff thereby seeks the following remedies and relief against a defaulted borrower, whose debt under the loan agreement is not protected by Civil Code § 580b and is secured by the above-pled the real property: namely, a judicial foreclosure of the loan agreement, whose deed of trust confers of power of sale on the Plaintiff; a corresponding foreclosure decree and entry of final judgment in Plaintiff’s favor; a finding and ruling in this decree and final judgment that the borrower shall be liable to the lender for any deficiency in the foreclosure proceeds; and a public foreclosure auction conducted by the Court or a court-appointed receiver in accordance with this Court’s specific instructions. Not less than three months after the foreclosure sale, Plaintiff shall apply to the Court for following related relief: a valuation of the at-issue property on the date when it was sold; a judicial accounting of the parties’ respective interests in the property, the borrower’s debt to the Plaintiff under the secured loan agreement and to each junior encumbrancer under their respective liens; an award of reasonable attorney’s fees and costs of suit to the prevailing party; a determination of the amount, if any, of the borrower’s personal liability to the lender for any deficiency in the foreclosure proceeds; if there is a surplus fund, an order that indicates how it must be disbursed; a determination of the amount that the foreclosed borrower must pay to the winning bidder at the foreclosure sale in order to exercise his statutory right of redemption; corresponding post-judgment entries of the Court’s findings on the above matters in its final judgment; and such other relief and redress as the Court deems to be necessary or appropriate in this action in order to afford full relief and resolve all issues raised in it.”

“Foreclosure Law in California and Related Matters” (By William Markham, © 2000–2026)