Suppose a debtor defaults on a mortgage while owing $110,000 on the loan. The sale of the property nets only $90,000, excluding costs and fees, leaving you with a deficiency of $20,000. A deficiency judgment is your way of collecting this $20,000. You must sue the debtor. And if you win, the money can be taken from the debtor’s personal assets – through wage garnishment or seizure of bank account assets, for example.
Unfortunately for lenders, California law strongly favors borrowers in this situation. Unlike many other states, it strictly limits the ability of a lender to collect a deficiency judgment. The following are some examples of the limits on a mortgage lender’s freedom of action in this situation.
Judicial vs. Non-judicial Foreclosures
Two options exist for foreclosure under California law: non-judicial foreclosures and judicial foreclosures:
Most residential foreclosures are non-judicial in nature (the same cannot be said of foreclosures on commercial properties). Non-judicial foreclosures are carried out by the lender, not the court, and are subject to California’s anti-deficiency statute. This means that, as a lender, you are stuck with any deficiency – you have no recourse to the borrower’s personal assets.
Some residential foreclosures and most commercial property foreclosures are carried out by the court. Although deficiency judgments are allowed in principle, several exceptions exist, including:
Deficiency judgments are not allowed for purchase money loans.
Deficiency judgments are not allowed for seller-financed (“seller carry-back”) loans
Deficiency judgments are not allowed for refinanced purchase money loans executed on or after January 1, 2013, except under certain circumstances.
If a deficiency judgment is allowed, the amount of the deficiency will be the lesser of:
The amount owed on the mortgage minus the fair value of the property as determined by the court; or
The amount owed on the mortgage minus the proceeds of the judicial sale.
For this reason, the lender is not guaranteed to receive the full amount of the outstanding balance – the fair value of the property may exceed the proceeds of the judicial sale (which is a very common occurrence).
The One Action Rule
Under California’s “one action rule,” a lender can only pursue one action to recover a mortgage or a debt. He can:
Conduct a judicial foreclosure;
Conduct a non-judicial foreclosure; or
Sue directly on the promissory note.
The lender, however, is subject to a significant disadvantage: he cannot sue on the promissory note as an alternative to foreclosure. If the debt is secured, he must pursue the security first.
At CKB Vienna LLP, we advise you on the best way to collect on any deficiency that may be owed to you and we can help you collect this deficiency. We can also help you structure transactions in a manner that will help you avoid this situation in the first place.