Facts: An owner of property encumbered by a mortgage contracts for renovations. The contractor is not paid and records a mechanic’s lien on the property. The homeowner defaults on the mortgage and the mortgage holder records a notice of default (NOD). In a pre-foreclosure workout, the homeowner conveys the property to the mortgage holder by a deed-in-lieu foreclosure in exchange for cancellation of the mortgage debt.

The mortgage holder discovers the junior mechanic’s lien and records a notice of default (NOD) under their trust deed. The mortgage holder acquires ownership of the property at the trustee’s sale. The holder of the mechanic’s lien now seeks to foreclose on its lien and clear title of the mortgage holder’s interests in the property.

Claim: The contractor claims the mortgage holder’s right to foreclose under their trust deed was eliminated and the trustee’s sale is void since the security interest under the trust and title merged, eliminating the trust deed when the mortgage holder became the property owner under the deed-in-lieu of foreclosure.

Counter claim: The mortgage holder claims their ability to foreclose was not eliminated when it accepted the deed-in-lieu of foreclosure and the trustee’s sale was valid and wiped out the contractor’s mechanic’s lien.

Holding: A California court of appeals held the mechanic’s lien was eliminated by the trustee’s foreclosure sale, leaving the contractor with no interest in the property to foreclose since the trust deed holder was not barred by a merger from foreclosing under their trust deed after becoming the owner under the deed-in-lieu of foreclosure. [Decon Group Inc v. Prudential Mortgage Capital Company, LLC (June 30, 2014)_CA4th_]

Editor’s note — As a long established rule, California courts hold that when a trust deed holder accepts a deed-in-lieu of foreclosure from an owner in default, the trust deed and title do not merge to eliminate the trust deed when there is a junior lien on title. Thus, the trust deed holder retains the right to foreclose and eliminate any junior liens encumbering the property, even though they became the owner of the property before foreclosing. [See first tuesday Form 406]