This article outlines the judicial foreclosure process, and presents the rights exercisable by property owners and junior lienholders before and after a judicial foreclosure sale.
Deficient property value and recourse paper
When a trust deed note is in default, the trust deed holder’s collection efforts are very structured, particularly if the trust deed note evidences a recourse debt and the lender chooses to recover against both the property and the borrower.
To initiate collection efforts, a trust deed holder must first exhaust the security by resorting to the real estate described in the trust deed. The security interest in a property is exhausted when the trust deed holder forecloses on the property or when the trust deed holder’s trust deed is wiped out by a senior trust deed holder’s foreclosure. Only when the security is exhausted and the note evidences a recourse debt may the trust deed holder pursue a money judgment for any deficiency in the property’s value to fully satisfy the debt owed. [Calif. Code of Civil Procedure §726]
Foreclosure is a procedure of selling property to satisfy a debt secured by the property. Foreclosure of the property eliminates the right of redemption held by the property owner and any persons holding junior interests in the property.
A trust deed holder can foreclose on a property, which is the security for a note, in one of two ways:
· judicial foreclosure, under mortgage law, also called a sheriff’s sale [CCP §725a]; or
· nonjudicial foreclosure, under the power-of-sale provision in the trust deed, also called a trustee’s sale. [Calif. Civil Code §2924]
Judicial foreclosure is the court-ordered sale by public auction of the secured property. The process can last from eight months to multiple years before it is completed.
When a trust deed holder nonjudicially forecloses by a trustee’s sale, the property is privately sold by public auction. Trustee’s sales can be completed within four months after a buyer defaults. Unlike a judicial foreclosure sale, the completion of a trustee’s sale denies the foreclosing lender the opportunity to obtain a money judgment for any unpaid balance remaining on the note after the foreclosure sale due to an underbid and insufficient value in the secured property. [CCP §580d]
Trustee’s sales are considerably less expensive than judicial foreclosures, both in time and money. A judicial sale requires the filing of a formal lawsuit which includes litigation expenses, appraisals, attorney fees, and a greater amount of time then would be required for a nonjudicial foreclosure.
However, when the value of a secured property drops below the balance owed on a recourse debt, the lender must consider foreclosing by judicial action, whether or not he ultimately chooses to do so.
A judicial foreclosure, or sheriff’s sale, is the only foreclosure method which allows a lender to obtain a money judgment against the borrower for any deficiency in the value of the secured property to fully satisfy a recourse debt. [CCP §580d]
Editor’s note — The source of recovery on a default in a trust deed securing a purchase-money debt is limited to the value of the secured property. Purchase-money debts include:
· carryback notes secured solely by the real estate sold; and
· purchase-assist loans secured by buyer-occupied, one-to- four unit residences.
Anti-deficiency rules eliminate a buyer’s personal liability for any purchase-money debts. [CCP §580b]
Thus, a carryback seller secured solely by the property sold and a purchase-assist lender secured by a buyer-occupied, one-to- four unit residential property have nothing to gain but much to lose by foreclosing judicially.
Suing to foreclose
As with any lawsuit, the first step in a judicial foreclosure is the filing of a complaint in the Superior Court of the county where the property is located.
The foreclosure complaint must name as defendants the original borrower and anyone else holding a recorded interest in the secured property which is junior in time to the foreclosing lender’s title position. The trustee named in the trust deed being foreclosed does not need to be involved in the lawsuit in any way. A trustee under a trust deed has no interest in the property and thus is not needed in the judicial proceedings.
The lender foreclosing judicially must obtain a litigation guarantee of title insurance. The policy is comparable to a trustee’s guarantee ordered out to assist a foreclosure trustee in the notice process.
The litigation guarantee lists all parties with a recorded interest in the property and their addresses of record. The litigation guarantee ensures that all junior lienholders of record are named and served, and their interests are eliminated at the judicial foreclosure sale.
If a junior lienholder is not named as a defendant:
· his lien is not affected by the outcome of the foreclosure proceedings; and
· his lien on the property being foreclosed remains of record. [CCP §726(c)]
Consider an adjacent property owner who holds an easement and water rights in a parcel of real estate which are subject to a prior trust deed lien since the grant of his easement and water rights occurred after the trust deed was recorded.
The trust deed holder judicially forecloses and acquires the property but fails to name and notify the easement holder of the foreclosure action and judicial sale.
The trust deed holder seeks to extinguish the easements and water rights held by the easement holder in a separate judicial foreclosure action on the same trust deed.
The easement holder claims his rights cannot be extinguished now since the senior trust deed holder already completed a foreclosure and became the owner of the property, and thus no longer holds an interest with priority to the easement.
Can the senior trust deed holder judicially foreclose again under the same trust deed lien to extinguish the owner’s easements and water rights?
Yes! Having already completed a judicial foreclosure, the trust deed holder can later foreclose by another judicial foreclosure action to extinguish the previously omitted junior easements and water rights. However, the junior easement holder retains the same right of redemption (for one year) he would have had in the first foreclosure action had he been named. [Diamond Benefits Life Insurance Company v. Troll (1998) 66 CA4th 1]
Additionally, when the foreclosing lender intends to seek a deficiency judgment, the original borrower must be named as a defendant, whether or not the borrower still holds an interest in the property. [Hutchison v. Barr (1920) 183 C 182]
At the time the lawsuit is filed, the foreclosing lender records a Notice of Pending Action against the secured property, called a lis pendens.
The lis pendens places a cloud on the title of the secured property, giving notice of the judicial foreclosure action and subjecting later acquired interests by buyers, tenants or lenders to the result of the litigation without their being named or served with a lawsuit.
After recording the lis pendens, the title company issuing the litigation guarantee is asked to date down the policy through the recording date of the lis pendens to discover any intervening recordings which might affect the proceedings, such as federal tax liens.
Until the court enters a judgment ordering the sale of a property, called a foreclosure decree, the borrower has the right to bring the delinquencies in the note and trust deed current during a period of time called the reinstatement period.
The borrower reinstates the loan prior to the foreclosure decree by tendering payment of:
· the loan delinquencies;
· accrued interest; and
· the lender’s foreclosure costs such as litigation expenses. [CC §2924c]
If the borrower reinstates the delinquent debt, which is a right available until the court’s entry of a foreclosure decree, the lender must abandon its foreclosure attempt and dismiss the lawsuit.
Attorney fees due on a reinstatement are limited in amount by statute.
The foreclosure decree
A lender judicially foreclosing on real estate establishes its right to collect the debt and sell the secured property by obtaining a foreclosure decree at a summary judgment proceeding or a trial.
The court’s final judgment, referred to in foreclosure proceedings as a foreclosure decree, orders the sale of the real estate to satisfy the outstanding debt and cover foreclosure sale expenses incurred by the lender. [CCP § 726(a), (b)]
The foreclosure decree also states whether the borrower will be held personally liable for any deficiency in the property’s fair market value which may later exist at the time of the foreclosure sale. [CCP §726(b)]
The recovery of attorney fees must be accounted for in the foreclosure decree. Attorney fees incurred after the foreclosure judgment are not included in the amount required to redeem the property. [Hambrose Reserve, Ltd. v. Faitz (1992) 9 CA4th 129]
Notice of Levy
A judicial foreclosure sale is conducted by a court- appointed receiver or sheriff, called a levying officer.
After the judicial foreclosure sale is ordered by the court, the foreclosing lender is issued a writ of sale by the court clerk which authorizes the receiver or sheriff to record a notice of levy. The writ of sale and the notice of levy describes the property to be sold and states the levy is against the security interest the lender holds in the property under his trust deed lien. [CCP §712.010]
The receiver or sheriff who conducts the sale records the writ of sale and the notice of levy in the county in which the property is located. [CCP §700.015(a)]
The receiver or sheriff also mails to the owner, and serves on any occupant of the property, the writ of sale and the notice of levy. [CCP §700.010]
The notice of judicial sale
Similar to the notice of trustee’s sale used in a nonjudicial foreclosure, the receiver’s or sheriff’s notice of sale must state the necessary details as to the date, time and location of the sale. [CCP §701.540(a)]
When a deficiency judgment is sought by a lender, the notice of judicial sale also states:
· the property is being sold subject to the borrower’s right of redemption; and
· the amount of the secured debt, plus accrued interest and foreclosure costs. [CCP §729.010(b)(1)]
If a money judgment for any deficiency is prohibited, as occurs with a non-recourse debt, the receiver or sheriff must wait at least 120 days after service of the notice of levy before he may notice the judicial sale. [CCP §701.545]
However, if the lender seeks a deficiency judgment, no waiting period applies for noticing the sale. The receiver or sheriff may notice the judicial sale immediately after the decree is issued. [CCP §729.010(b)(2), (3)]
At least 20 days before the sale, the notice of judicial sale is:
· served on the borrower personally or by mail [CCP §701.540(c)];
· mailed to any person who has recorded a request for a notice of judicial sale [CCP §701.550(a)];
· posted in a public place in the city or judicial district where the property is located, and on the property itself; and
· published weekly in a local newspaper of general circulation. [CCP §701.540(g)]
Highest bidder acquires the property
The public sale held by a court-appointed receiver or sheriff is conducted as an auction. The property is sold to the highest bidder. [CCP §701.570]
Payment at the public sale must be made in cash or by certified check at the time of the sale. However, amounts over $5,000 permit a credit transaction. [CCP §701.590(a), (c)]
If the successful bidder fails to pay the amount bid, the receiver may sell the property to the highest bidder at a subsequent sale. The defaulting bidder is liable for interest, costs and legal fees for his failure to pay his bid. [CCP §701.600]
Often, the foreclosing lender is the highest, or only, bidder at a judicial sale. When intending to seek a deficiency judgment, the lender must bid no less than an amount it believes the court will set as the fair market value (FMV) of the property. If he allows the property to be bid in at the sale for less than its FMV, the lender incurs an uncollectible loss for the difference.
Judicial sale completed
A certificate of sale is issued to the successful bidder on the completion of a judicial sale.
Although the bidder purchased the property at the public auction, he will not become the owner of the property nor will he be able to take possession of it by removing the owner until the applicable redemption period expires. [CCP §729.090]
The certificate of sale reflects the owner’s continuing right to redeem the property and avoid losing it to the highest bidder. [CCP §729.020]
Redemption follows foreclosure
On a judicial foreclosure, a trust deed which secures a seller carryback note as a lien solely on the property sold, or a lender’s purchase-assist loan as a lien on a buyer-occupied, one-to-four unit residence, the property owner:
· is not liable for any deficiency in the property value to fully satisfy the debt [CCP §580b]; and
· has three months after the judicial sale to redeem the property by paying off the entire debt and costs. [CCP §729.030]
However, if the owner is liable on a recourse debt for a deficiency in the property’s value, the owner has up to one year after the judicial sale to redeem the property. [CCP §729.030]
The property can only be redeemed by the owner or the owner’s successor-in-interest since all junior lienholders are wiped out by the judicial foreclosure sale, ending their period for redemption.
Successors-in-interest to the owner are lienholders or buyers who acquire the owner’s interest in the property by deed prior to the judicial foreclosure sale. [CCP §729.020; 15 Calif. Law Revision Commission Reports 2001]
For example, a junior lienholder holds a trustee’s foreclosure sale and bids in the property and receives a trustees deed prior to completion of the senior lienholder’s judicial foreclosure sale. Since the junior lienholder owns the property at the time of the judicial foreclosure sale, he is considered the owner’s successor-in-interest.
As the successor-in-interest to the owner, the junior lienholder is entitled to redeem the property after the senior lienholder’s later judicial foreclosure sale, subject to the redemption period rights which are available only to the owner. [CCP §729.020]
The successful bidder who purchases the property at the judicial foreclosure sale is not considered the owner’s successor-in- interest, but is the creditor’s successor until the end of the redemption period. [CCP §729.020]
The redemption price for property sold in a judicial foreclosure action is the total of:
· the purchase price of the property bid at the judicial foreclosure sale;
· taxes, assessments, insurance premiums, upkeep, repair or improvements to the property paid by the successful bidder at the sale; and
· interest on the above amounts at the legal rate on money judgments (10%) from the time of the payments through the date the redemption amount is tendered in full. [CCP §729.060]
On redemption, the owner or his successor is entitled to:
· an offset for any net rents collected by the lender under an assignment of rents provision in the trust deed; and
· an offset for the rental value of the premises for any period of time the successful bidder occupied the property following the sale. [CCP §§729.060; 729.090]
If the property is not redeemed by the owner or his successor-in- interest within the owner’s redemption period, the receiver issues the bidder a sheriff’s deed to the property, and the sale is final. [CCP §729.080]
Obtaining a deficiency judgment
The remaining balance owed on a note may be greater than the fair market value (FMV) of the secured real estate at the time of the judicial foreclosure sale. The difference between the lesser amount of the market value (fair price) of the lender’s security interest foreclosed by the sale and the greater amount of the balance due on the note is a deficiency.
If a money judgment for the deficiency in the property value to fully satisfy the debt is not barred by anti-deficiency statutes, the lender will be awarded a money judgment at a hearing following the foreclosure sale which sets the amount of the deficiency — the difference between the FMV of the property on the date of the sale and the amount of the debt — called a fair value hearing. [CCP §§580a; 580b]
A fair value hearing, noticed within three months after the foreclosure sale, will set the dollar amount awarded as a deficiency judgment. [CCP §§580a; 726(b)]
The amount awarded as a deficiency judgment is based on the entire amount of the debt under the note and trust deed on the date of the judicial foreclosure sale, and the greater of:
· the FMV of the property on the date of the foreclosure sale, minus any amounts owed on liens senior to the trust deed being foreclosed, called the fair price of the lender’s security interest; or
· the amount bid for the property at the judicial foreclosure sale. [CCP §580a]
The lender will be awarded a money judgment for the portion of the debt not covered by the fair price of the lender’s secured position on the title of the property or the price bid at the sale, which ever amount is higher.
The lender and the borrower present evidence at the fair-value hearing to establish the property’s fair market value. The court may appoint an appraiser, called a probate referee, to advise the court on the value of the property. Thus, evidence consists of the opinions of appraisers (and the owner) about the FMV of the property on the date of the sale. [CCP §§580a; 726(b)]
The formula for a deficiency
Consider a lender who judicially forecloses on the security interest it holds in real estate under a first trust deed lien securing a recourse debt. The property is encumbered by unpaid property taxes, a lien which has priority to the lender’s trust deed, but is not paid by the lender.
At the foreclosure sale, the lender acquires the real estate, subject to the property tax liens, on a credit bid at a price less than the amount owed on the debt, called an underbid. The bid is for a dollar amount which is less than the dollar amount of the fair price of the lender’s security interest in the property.
At the deficiency hearing, the lender is awarded a money judgment calculated as equal to the sums of all amounts remaining unpaid on the note and trust deed, minus the fair market value (FMV) of the property on the date of the foreclosure sale rather than the amount of the underbid, plus the unpaid property taxes.
Within one year after the foreclosure sale, the owner redeems the property for the amount of the underbid entered by the lender, plus interest on that amount from the date of the foreclosure sale.
The redemption amount is less than the fair price the court set for the lender’s security interest since the lender’s underbid was less than the fair price of the lender’s security interest in the property. As a result, the difference between the amount of the underbid and the greater fair price of the lender’s security interest becomes an unrecoverable loss for the lender, since the owner redeemed the property and paid the money judgment.
However, the property is still encumbered by the unpaid property taxes.
The owner claims the unpaid property taxes were improperly added to the deficiency judgment and he will incorrectly have to pay them twice:
· once when the unpaid taxes were added into the amount of the deficiency awarded to the lender; and
· again as a lien which remains on the property the owner redeemed.
Here, the amount set as the deficiency is correct, although the mathematical approach was not. The first trust deed lender’s secured position on title to the property was subject to property taxes. Thus, the dollar amount of unpaid taxes (and any other liens with priority) must first be deducted from the property’s FMV to set the fair price of the lender’s interest in the property. Only after establishing the fair price of the lender’s secured position can the amount of the fair price be deducted from the debt and costs owed to determine the deficiency which becomes the amount of the money judgment. [Luther Burbank Savings and Loan Association v. Community Construction, Inc. (1998) 64 CA4th 652]
The correct formula for calculating the deficiency (a negative amount) is to enter the FMV of the property and subtract both the unpaid tax liens (and any other prior liens) and the remaining debt owed the foreclosing lender. Any negative result is the amount of the deficiency awarded to the lender.
The fair price
Again, a deficiency judgment is awarded to a lender based on the unencumbered cash value of the property, a value which is set consistent with current market conditions on the date of the foreclosure sale, called fair market value (FMV). [CCP §726]
Clouds on title, such as a junior lien or a lis pendens, which are wiped out at a foreclosure sale do not affect the property’s FMV. [Nelson v. Orosco (1981) 117 CA3d 73]
Editor’s note — However, a federal tax lien with a 120-day right of redemption may reduce the price a buyer would pay for the lender’s position in the title since the price paid is the amount the Internal Revenue Service (IRS) would pay the buyer to acquire the property.
Additionally, the price paid for the property or the lender’s credit bid at the foreclosure sale is not considered when setting the property’s FMV. [Rainer Mortgage v. Silverwood, Ltd. (1985) 163 CA3d 359]
The FMV of property is set without concern for any negative impact the foreclosure sale may have on the property’s value, or the price a prudent buyer would pay at the foreclosure sale for the lender’s position on the title. [San Paolo U.S. Holding Company, Inc. v. 816 South Figueroa Company (1998) 62 CA4th 1010]
Once the FMV of the property is determined, the amount of the deficiency is the mathematical result of subtracting all prior lien amounts and the amount of the debt being foreclosed from the property’s FMV.
If the amount remaining is negative, the lender is awarded a deficiency judgment for that negative amount, the portion of the debt not covered by the fair price of the lender’s secured position in the property. Thus, any underbid below the fair price for the lender’s position in the property, whether made by a third-party bidder or the secured lender itself, results in a loss for the lender. The amount of the difference between the fair price of the lender’s position and the underbid is not recoverable in either the deficiency judgment or on redemption by the owner.