Read on to find out why a lender who acquires a property by foreclosure assumes all responsibilities the prior owner owed to existing residential tenants.

Facts: A tenant entered into a lease agreement and took possession of a residential unit that the owner created by the illegal conversion of a garage. The owner defaulted, and the lender foreclosed and took title to the property at the trustee’s sale, operating it as REO inventory held by the lender. The lender served a 90-day notice to vacate on the tenant in the main house but did not serve a notice to vacate on the tenant of the converted garage. Prior to the expiration of the lease term, the tenant of the converted garage was denied access to the property by another tenant occupying the main house.

Claim: The tenant sought money losses from the REO lender, claiming the lender failed to prevent the interference of the tenant’s right to occupy the converted garage for the remainder of the lease term since the lease agreement giving the tenant occupancy was entered into prior to the foreclosure sale and remained valid after foreclosure under the Protecting Tenants Against Foreclosure Act (PTFA).

Counter claim: The lender claimed it were not liable for interference of the tenant’s possession of the property since the lender fulfilled its duty by posting a 90-day notice to vacate on the main building of the property containing the converted garage.

Holding: A California court of appeals held the lender, as the owner-by-foreclosure, was liable for the existing residential tenant’s money losses due to the lender’s failure to protect the tenant from third party interference with their use of the property since the lease agreement entered into by the tenant prior to the foreclosure sale remained enforceable. [Nativi v. Deutsche Bank National Trust Company (January 23, 2014) _CA4th_]

Protecting Tenants Against Foreclosure Act (PTFA)

The Protecting Tenants Against Foreclosure Act (PTFA) was enacted in 2009 amid the Great Recession and resulting spate of property foreclosures.

PTFA’s general aim is to protect residential tenants blamelessly caught between their defaulting landlord and a mortgage lender. More specifically, PTFA’s objective is to prevent tenants from being abruptly displaced after the rented property is foreclosed. Low-income tenants with no recourse during the market mania were the primary target demographic inspiring PTFA. However, PTFA is equally applicable to all residential tenants, as foreclosing mortgage lenders are slowly beginning to discover.

So what exactly does PTFA do?

On acquiring a property at a foreclosure sale, the successful high bidder, whether the mortgage lender or a third-party, is to serve existing tenants with a 90-day notice to quit due to foreclosure if they intend to force the tenants to vacate. [See first tuesday Form 573]

In addition to the 90-day notice to vacate requirements, PTFA places the owner-by-foreclosure in the position of the landlord under the rental or lease agreements entered into by the prior owner. With the original landlord out of the picture, it is the owner-by-foreclosure who needs to manage and maintain the rental property for the occupancy of the preexisting tenants.

Further, PTFA protects tenants from being evicted prematurely by preserving their existing lease agreements as enforceable. A tenant is entitled to live out the remainder of the lease term if:

  • the owner-by-foreclosure is not going to occupy the property as their primary residence;
  • the existing tenant holds a bona fide lease agreement; and
  • the lease agreement was entered into before title was transferred to the new owner. [Public Law 111-22 §701, §702, §703]

Under California state law, a lease agreement entered into after a trust deed is recorded is subordinate to the trust deed and is extinguished by a foreclosure sale. [Bank of America v. Hirsch Merc. Co. (1944) 64 CA4th 175]

PTFA’s conditions, which preempt state law, create a landlord-tenant relationship between the owner-by-foreclosure and the existing tenant.

Thus, the owner-by-foreclosure of a residential property must:

  • confirm the existence of all bona fide residential tenants who hold a valid lease on the property;
  • determine the terms of the lease agreement the tenant entered into with the previous owner; and
  • verify whether their lease agreement is protected by state or federal law.

Though the owner-by-foreclosure is required to honor an existing residential lease agreement through the end of its term, they are not obligated to renew the lease agreement when the lease term ends.

Lender as landlord, an uncomfortable fit

Lenders are not in the business of managing property, though they may. It’s not in their collective DNA or part of their business objective of merely handling money. Thus, much like a cabdriver stepping into the role of a trial attorney, the position of landlord does not come organically to mortgage lenders. Real estate agents need to be diligent to ensure lenders comply with PTFA regulations and meet their duties as landlords. Included in these duties is the obligation to protect a tenant from interference by another tenant.

Consider a tenant of a mobilehome park who enters into a lease agreement with the landlord. During their occupancy, the tenant’s quiet use and enjoyment of the property is compromised by a neighbor’s disruptive behavior. Disturbances from the neighbor include verbal abuse and racial epithets directed at the tenant. The neighbor also physically interferes with the tenant’s use of roadways within the mobilehome park. The tenant submits multiple complaints to the landlord, who takes no direct action and instructs the tenant to file a complaint with the local police. After contacting the police, the neighbor’s abusive behavior does not end. The tenant and the neighbor later engage in an altercation, and the tenant is injured.

Is the landlord liable for not protecting the tenant’s quiet use and enjoyment of their leased property?

Yes! Quiet use and enjoyment of the property is implied in the lease agreement. Thus, a landlord is duty-bound to prevent interference by a neighboring tenant. This requires the landlord to take corrective action upon notice by the injured tenant. [Andrews v. Mobile Aire Estates (2005) 125 CA4th 578]

Even if the disruptive third-party is not a neighboring tenant under a lease agreement with the landlord, any action by the landlord acquiescing to the interference makes them liable for failing to protect the tenant from injury.

Thus, a mortgage lender assuming the role of landlord needs to ensure an existing tenant retains access to the property free from interference with their leasehold interest. This duty also requires the lender to inform third-parties of the tenant’s property rights to avoid interference, as illustrated in the court holding of Nativi.

Federal v. state law

Historically, California law has required the owner-by-foreclosure to provide an existing tenant with a 30-day notice to vacate. In 2008, this was increased to a 60-day notice.

However, notice requirements were increased once again in 2009. In an effort to synchronize state with federal law, California updated its regulations to reflect the provisions of the PTFA, replacing the 60-day notice requirement with the expanded 90-day notice to vacate. This is expected to sunset on December 31, 2019. Until then, California effectively entitles tenants to the same protections afforded by federal law via the PTFA.  [Calif. Code of Civil Procedure §1161(b)]

Nonetheless, the previous discrepancy stirs up important questions about how state and federal law is applied. Which law takes precedence?

The statute or regulation which provides more protection rules. Central to this logic is the legislative intent of bills like the PTFA, which is meant to increase protective regulations for tenants.

Thus, the PTFA supersedes less protective state laws, but also permits the application of state statutes that provide additional protection, ensuring the initial goal of the law is fulfilled.

Related article: Residential tenants, foreclosure and possession

Unlawful garage unit

What about the illegally converted garage in Nativi? Does this shield the owner-by-foreclosure from liability when the rented space was created illegally?

The impact of an unlawfully converted garage unit on the enforcement of a tenant’s rights hinges on the intent of the protective statute or regulation at issue.

Consider a tenant who enters into a lease agreement with a landlord for a detached guesthouse. The guesthouse was not constructed with a building permit, lacks a certificate of occupancy and is not registered under the local Rent Stabilization Ordinance (RSO). The landlord later imposes multiple rental fee increases higher than the reasonable rental value of the guesthouse.

The tenant sues the landlord for excessive rent increases, claiming the landlord violated the RSO which protects tenants by limiting rental fee increases. The landlord claims the tenant is not entitled to compensation since the lease agreement was unlawful and, thus, the guesthouse was not protected by the RSO.

Is the tenant still protected by the RSO and entitled to compensation when the guesthouse was unlawfully rented to them?

Yes! The statute’s protections include the tenant’s unlawful rental unit to ensure the legislative intent of the ordinance is enforced. Excluding an unlawful rental unit from the scope of the law’s protections allows a landlord to effectively circumvent law and evade the duties owed to their tenants. This, of course, runs contrary to the spirit of the law. [Carter v. Cohen (2010) 188 CA4th 1038]

So, how does the illegally converted garage play into this factual matrix? Essentially, it doesn’t.

An unlawful rental unit has no effect on the application of protective statutes since PTFA’s purpose to protect a susceptible class of people—residential tenants—takes priority, and ensures the law was not enacted in vain.

Stay on top of the real estate law

These tricky factual matters are a reminder for agents and landlords to remain proactive in their transactions.

As an agent, you are best served understanding the protections afforded your clients seeking to rent. Tenants displaced by foreclosure are also in need of trusted agents to help them relocate when their 90-day notice has ended or the lease term is up. Build goodwill by offering advice on what you know—distinguish yourself—as part of your real estate services. These efforts will serve you well in the future when the tenant later decides to become an owner.

Related article: first tuesday’s Buy Versus Rent Comparison Analysis

Similarly, agents representing buyers of foreclosed property especially benefit from keeping tabs on property management rules like PTFA. Make sure you use due diligence and confirm the existence of all residential tenants on the property. Your client will become a de facto landlord after their purchase—even on an illegally converted garage on which a valid lease agreement exists.