The Ninth Circuit Weighs In: NRS 116 is Facially Unconstitutional

The tide may finally be turning in Nevada.  Since the Nevada Supreme Court dealt a devastating blow to the whole of the financial services industry in September 2014 by holding that an HOA could foreclose on its super-priority lien and thereby extinguish a first deed of trust, first lien holders have been battling to protect first lien interests from extinguishment following HOA foreclosure sales.  While most of the decisions on Nevada HOA super-priority lien foreclosures come from Nevada state and federal courts, the Ninth Circuit weighed in on August 12, holding that NRS 116 is facially unconstitutional.

In Bourne Valley Court Trust v. Wells Fargo Bank, N.A., Bourne Valley purchased the subject property at an HOA foreclosure sale and subsequently filed suit seeking to quiet title on the grounds that, under NRS 116, the HOA foreclosure sale extinguished the first deed of trust. The district court granted Bourne Valley’s motion for summary judgment, holding that pursuant to SFR Investments Pool 1, LLC v. U.S. Bank, N.A., the deed of trust had been extinguished because foreclosure of a super-priority lien under NRS 116.3116(2) extinguishes all junior interests, including a first deed of trust on a property.  Bourne Valley Court Trust v. Wells Fargo Bank, N.A.

The Ninth Circuit vacated the district court’s judgment on the grounds that NRS 116 violated the first lien holder’s due process rights on its face because NRS 116 impermissibly shifts the burden to mortgage lenders to affirmatively request notice of an HOA’s foreclosure proceedings.  Bourne Valley argued that the provisions set forth in NRS 107.090, which sets forth the notice requirements for default under a deed of trust, cured NRS 116’s alleged deficiency—that it required lenders to “opt-in” to receive notice of HOA foreclosure sales.  The Court rejected this argument, finding that it would render the express “opt-in” notice provisions of Chapter 116—found in several different statutory sections—entirely superfluous.

The Court also found that there was sufficient state action to maintain a constitutional due process challenge.  Bourne Valley argued that a facial challenge to NRS 116 could not be maintained because there was no state action.  The Court rejected this argument, holding that the Nevada Legislature’s enactment of NRS 116 was sufficient state action.  While it is true that the actual foreclosure sale is a private action, the Court found this was irrelevant to the facial challenge because, absent the enactment of NRS 116, the foreclosure sale would not have extinguished the deed of trust.  Judge Wallace dissented, noting that he would find that the foreclosure sale did not constitute state action, and that the notice provisions of NRS 107.090 were incorporated into the NRS 116 HOA foreclosure scheme.

Importantly, the Ninth Circuit made a point to reject Bourne Valley’s reliance on Flagg Brothers, Inc. v. Brooks and Charmicor, Inc. v. Deaner, both of which dealt with preexisting contractual relationships between a creditor and debtor and are often cited by investor purchasers from HOA foreclosure sales, to argue that no state action existed.  The Court distinguished those cases, explaining that the authority to extinguish a debtor’s security interest arose from the underlying contractual relationships in both Flagg Brothers and Charmicor, whereas the HOA’s authority to extinguish a deed of trust here was purely statutory.  Since the Bourne Valley decision was released, a host of district court judges have begun staying cases involving a facial challenge to NRS 116 until the mandate for the decision is issued.

On the same day the Bourne Valley decision was issued, the Nevada Supreme Court scheduled oral argument in Saticoy Bay LLC Series 350 Durango 104 v. Wells Fargo Home Mortgage, a case that presents a facial challenge to NRS 116.  Oral argument is scheduled for September 8, 2016.