Daily Development for Friday, September 15, 2000

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
randolphp@umkc.edu

MORTGAGES; FORECLOSURE; DEFICIENCIES; ANTI DEFICIENCY STATUTES: California court refuses to apply Spangler exception to subordinated commercial purchase money loan where "earmarks" senior loan balance at time of foreclosure is not significantly greater than the purchase money loan and the buyer/borrower and seller were of approximately equal levels of sophistication and understanding with respect to development potential of property. Lawler v. Jacobs, 2000 WL 1279200 (Cal.App. 1 Dist.)

This case is noteworthy because it represents an attempt by the lower California appeals courts to make sense of the recent California Supreme Court decision in DeBerard v. Lim, 85 Cal.Rptr.2d 292 (1999), reported in the DIRT DD for 12/1/99. In DeBerard, a purchase money lender, in order to facilitate a workout by its borrower, agreed to subordinate to deeds of trust securing modifications made in bank loans to the borrower if borrower would waive antideficiency protection on the purchase money note. The court found that the purchase money antideficiency law, CCC Section 580b, does operate in the case of a postsale modification of the purchase money loan.

Of more relevance to the instant case, the DeBerard court also concluded that Spangler v Memel, 102 Cal.Rptr. 807 (Cal. 1972) did not apply to facts the facts before it. Spangler is a well known California case that permitted a purchase money lender to avoid the purchase money andidefiency law (even when there was no express borrower waiver) where the seller had subordinated its purchase money loan to a senior lender in order to facilitate construction financing on the property. Spangler had been extended in a series of subsequent Court of Appeals cases to a number of other types of "nontraditional" lending scenarios where arguably the purchase money creditor had a better argument that circumstances justified its being able to collect a deficiency. The DeBerard court, however, limited the application of Spangler to the types of loan settings existing in that case where the parties anticipate at time of loan a substantial increase in the value of the security as a consequence of the anticipated expenditures of the senior loan proceeds and where the borrower is more sophisticated than the seller and better able to assess the risks of whether that new value will be realized.

In Lawler an owner of a choice 128 acre property in Woodside, in the "high end" portion of the absurdly high end Silicon Valley. The owner had himself planned to subdivide, but ultimately determined to sell the property for $9 million to the purchasers, taking back a $3 million purchase money mortgage. Seller agreed to subordinate to a deed of trust securing a loan of up to $8.2 million, including $4.5 million to cover part of the cash paid to seller at closing and the balance for costs of sale and infrastructure improvements to qualify the property for subdivision. Everyone was aware that the local community likely would raise substantial obstacles to development of the parcel, which it ultimately did. Because of these difficulties and other factors the development failed and no money was ever disbursed for infrastructure. The bank loan went into default and the bank bid in its claim for $6 million, covering interest accrual and other miscellaneous small disbursements to the borrowers in addition to the original $4.5 million used to finance the original down payment. No monies had ever been advanced for construction.

The court of appeals looked to the relative value of the property at time of sale and the amount of planned construction financing. It concluded that this was not a case in which the parties anticipated a huge increase in value caused by the construction project in order to cover the purchase money obligation. In fact, the court argued, the original purchase price was consistent with appraisals, and later, at foreclosure, the undeveloped property sold for approximately the amount of cash that the seller originally received, suggesting substantial intrinsic value in the raw land itself. The court further noted that the owner of the property himself had fiddled with plans for subdividing the property prior to selling it to the developers. Hence, it was difficult to conclude that there was a substantial imbalance in the sophistication of the parties respecting the development potential of the property.

Consequently, this case provided no exception to the ordinary application of Section 580b. The court further held, not surprisingly after DerBerard, that there was no reason to uphold the waiver of antideficiency protection in the face of the policy laid out by the legislature in adopting the statute.

Comment 1: In DeBerard, the California Supreme Court expressed considerable discomfort with the Spangler precedent and commented that it was upholding Spangler on its facts because the legislature, by letting it stand for so many years, had implicitly approved the case. On the strength of that, we should expect the lower California courts to begin the process of whittling away Spangler into nothingness, and this decision certainly participates in that enterprise.

Comment 2: Were Spangler still really an authority to contend with, the editor would conclude that the Court of Appeals in this case did not do justice to Spangler's reasoning. For instance, the court emphasized the fact that little money had been advanced for construction and from that concluded that there had been little increased risk imposed on the subordinated lender as a consequence of the construction plan. But shouldn't the question of validity of the anti-deficiency claim be answered as of the date that the purchase money debt is incurred, and not on the date that it is wiped away? At the time the debt was incurred, the purchase money deed of trust stood to be subordinated to $8.2 million in additional financing, an amount that, added to the purchase money mortgage, created an indebtedness almost 30% greater than the sale price - certainly enough to justify the conclusion that there was a significant risk undertaken by the seller that the developers would mess up the improvements and the seller's purchase money deed of trust would be wiped out.

Further, the court noted that the seller was not unsophisticated in that he himself planned to subdivide his land and in fact later undertook to subdivide other land that he did not sell in this transaction. But should the question be whether the seller is in fact unsophisticated or whether the seller has entrusted the enterprise to the sophistication of others? Isn't is a fool's job to attempt to evaluate through court testimony a decade later which of the two sides was more sophisticated than the other?

But Spangler may have made no sense to begin with, so perhaps it is unnecessary to criticize the clumsy cutting of the executioner.

Comment 3: The real question is whether purchase money antideficiency protection really makes any sense in commercial real estate finance, especially in California. Given modern bankruptcy laws, don't debtors have enough protection already? Why preserve a 75 year old statutory policy that no one ever really understood in order to protect speculators from the consequences of their own hubris? But, as the DeBerard court said, that's a question for the legislators. In the meantime, the virtually impenetrable mysteries of California anti-deficiency lore provide full employment for armies of real estate litigators, so the situation ain't all that bad.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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