In January, the Supreme Court of California affirmed the Court of Appeal’s application of Code of Civil Procedure section 580b and held that the statute’s antideficiency protection applies to short sales just as it does to foreclosure sales.
In Coker v. JPMorgan Chase Bank, N.A., the lienholder had begun the foreclosure process when the borrower asked the lienholder to release its security interest so that the borrower could sell her property to a third party. The lienholder provisionally approved the sale in 2010 and agreed to release its security interest, subject to several conditions, including:
(1) borrower must net zero from the sale;
(2) total proceeds were to be received by the lienholder;
(3) lienholder reserved the right to rescind the sale if any variances occurred in the transaction; and
(4) borrower was still responsible for all deficiency balances remaining on the loan because the amount paid was for the release of the security interest only.
The borrower accepted the terms and sold the property soon thereafter.
After the sale, the lienholder sought to collect the remaining balance, and the borrower brought a declaratory action, claiming that section 580b prohibited the lienholder from collecting the deficiency. The trial court sustained the lienholder’s demurrer without leave to amend, but the Court of Appeal reversed, holding that the agreement to pay the deficiency balance was an unenforceable waiver of the statute’s protections. The lienholder appealed. The Supreme Court of California granted review and affirmed the judgment of the Court of Appeal.
The Court analyzed the Legislature’s intent in reformatting the statute in 2012 to determine if that decision shed light on the application of the statute at the time of the short sale in 2010. The Court noted that the Legislature had amended the statute twice prior to 2010, but had never repudiated the Court’s basic approach in applying the statute to limit a lender’s recovery on a standard purchase money loan to the value of the security. Reasoning that its focus in determining the reach of section 580b was on substance rather than the form of the loan transaction, the Court reiterated the two-part test “to determine the applicability of section 580b: ‘Does the sale vary from a standard purchase money transaction, and if so, does applying section 580b’s antideficiency protection comport with the Legislature’s intent?'”
The present case was resolved under the first step of this inquiry. The Court rejected the argument that the security interest could be destroyed by agreeing to the short sale, but rather held that the short sale is the same as a foreclosure sale, in that it allows the lienholder to realize and exhaust its security. The Court went on to analyze whether applying section 580b to short sales would comport with the Legislature’s intent. The Court rejected arguments that this application would have no effect on future loan decisions and would not provide additional deterrence to lender overvaluation of real property, citing its prior rulings which established that section 580b’s key purpose is to “stabilize the state’s economy,” a public purpose that cannot be contravened by private agreement.
Additionally, the Court rejected the argument that the Legislature’s enactment of section 580e’s antideficiency protections for borrowers who conduct a short sale should be the sole source of such borrowers’ protection. The Court ruled that the statutory interpretation applying the protections of section 580b remained in effect at the time of sale because section 580e was enacted after the sale, but noted that section 580b was not altered by the enactment of section 580e. However, the Court declined to resolve any conflict between section 580b and section 580e.
Finally, the Court briefly considered the relationship between section 580b and section 726’s requirement that a lender follow particular procedures to collect a defaulting borrower’s assets. The Court found that no conflict existed and ruled that a borrower may waive her rights under section 726 by agreeing to a short sale but still remain entitled to the protections provided by section 580b.