Imagine the following situation: A lender holds a mortgage on real property, and a second lender takes a second mortgage. The debtor defaults, and the first mortgage holder conducts a foreclosure sale. The foreclosure sale doesn’t yield enough proceeds to pay both mortgage holders, so the second mortgage holder seeks a deficiency judgement against the debtor. What are the second mortgage holder’s rights?
There is no simple answer to this one as no less than three parts if the California Civil Procedure Code may have to be consulted:
These three Code sections work together in ways that are not at all obvious.
Section 726 states (in plain English) that a mortgage holder must choose between two options: sue the debtor for the debt, or conduct a foreclosure sale of the property. What it cannot do is hold a foreclosure sale, collect the proceeds, and then sue the debtor for any deficiency. In other words, if the mortgage holder conducts a foreclosure sale that does not generate enough proceeds to pay the debt, he has to write-off the deficiency.
The ambiguity lies in the question of whether a second mortgage holder has to write-off the debt owed to him as well. This would seem unfair, especially if the second mortgage holder did not initiate the foreclosure sale. Section 726 alone does not clearly answer this question.
The Deficiency Judgment Rule
Section 580b is composed of cryptically worded “legalese.” At first reading, it appears to say even more clearly that a second mortgage holder cannot collect on a debt owed by the mortgage debtor after the first mortgage holder has held a foreclosure sale. Although this section does limit the options of the second mortgage holder, it is not as bad as it sounds. There is always the purchase money security rule.
The Purchase Money Security Rule
Section 580d allows a second mortgage holder to sue the debtor for the value of the mortgage even after the first mortgage holder has foreclosed as long as the debt that the second mortgage secured was not original purchase money for the property.
What It All Adds up To
The foregoing provisions of the California Code of Civil Procedure, read together and in light of court decisions interpreting these provisions, appear to add up to the following rule:
After a first mortgage holder completes a foreclosure sale, a second mortgage holder cannot sue the buyer to satisfy any deficiency if the second mortgage secured original purchase money for the property, even if the second mortgage holder was not involved in the foreclosure sale. However, the second mortgage holder can sue the buyer to satisfy a second mortgage that did not secure original purchase money.
At CKB Vienna, There Is No Such Thing as a Detail
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