Daily Development for Thursday, September 30, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

MORTGAGES; “ONE ACTION” RULE; MIXED COLLATERAL: California’s new “mixed collateral” statute permits a lender to foreclose on personal property through a UCC foreclosure even a real estate mortgage secures the same debt, and lender can still foreclose on the real estate notwithstanding the “one form of action rule.” But lender cannot seek a deficiency in the personal property foreclosure without running afoul of the rule.

Kearns v. Transamerica Home Loan, 2004 Banks. LEXIS 1389 (9th Cir. BAP 9/2/04)

Consumer borrowers gave lender a lien on their car and their home to secure a $34,000 debt. They executed separate financing instruments for each form of security. Later, borrowers declared bankruptcy, which discharged their personal liability on the debt, but the liens passed through the bankruptcy unaffected. Apparently the borrowers attempted to make further payments on the debt, but eventually defaulted and the lender decided to foreclose.

Lender first conducted an Article 9 repossession and “commercially reasonable” sale of the car. Thereafter, the borrowers attempted to sell their home, and the lender interposed a demand in the escrow for payment of $17,400 as a condition to its release of the real estate deed of trust. (Apparently this amount took into account any homestead protection or else borrowers had not declared this property to be their homestead.)

Borrowers protested that the lender, by selling the car, had triggered their rights under the California “one form of action rule,” CCP 726, which has been construed to provide that if a lender seeks to collect a debt secured by a real estate mortgage through an action other than a mortgage foreclosure, the borrower may either block the first collection effort or else permit it to proceed and then treat the mortgage in the real estate as terminated. Therefore, the borrowers asserted, the deed of trust on the real estate was no longer of any effect and the lender, by seeking to prevent their sale of the property by making a demand in the escrow, slandered their title.
The matter wound up in bankruptcy court, and the bankruptcy court gave summary judgment to the lender. On borrowers’ appeal to the 9th Cir. BAP, held: Affirmed.

The appeals court acknowledged that this appeared to be a matter of first impression following the enactment of California’s new “mixed collateral” statute. It doesn’t say what the law was prior to the statute, but does note that CCP 726 at one time covered both real property and personal property liens, but it was amended to apply only to real property liens when California adopted the UCC. The new “mixed collateral” statute (Cal Com. Code Sec. 9604) is part of the recent revision of Article Nine, but California’s version of the statute is non uniform. Here is the relevant language:

(a) If an obligation secured by a security interest in personal property or fixtures is also secured by an interest in real property or an estate therein:

(1) the secured party may do any of the following:

(A) Proceed, in any sequence, (i) in accordance with the secured party’s rights and remedies in respect of real property as to the real property security, and (ii) in accordance with this chapter as to the personal property or fixtures.

(B) Proceed in any sequence, as to both, some or all of the real property and some or all of the personal property or fixtures in accordance with the secured party’s rights and remedies in respect of the real property, by including the portion of the personal property or fixtures selected by the secured part in the judicial or nonjudicial foreclosure of hte real property in accordance with the procedures applicable to real property . . . .”

This seems clear enough, and Section (A) appears to authorize the procedure used by the lender. But of course the statute doesn’t indicate whether the lender must proceed with foreclosures under Section (A) in any set order. Further, the court noted that in general, Section 726 does not bar lenders with additional security for the same debt from choosing the order in which it proceeds against the security. It concluded that the UCC language should be read that lender can use whatever foreclosure device it chooses to execute on the personal property, and in whatever order it chooses as well.

The borrower pointed that another part of the UCC contained a sort of “safe harbor” exempting proceedings under that part from Section 726 requirements, and that such “safe harbor” did not appear in connection with the mixed collateral language. Borrower argued that this meant that Section 726 did apply and that the lender was required to foreclose first on the real property.

The court felt that the absence of the “safe harbor” was not dispositive here, but it acknowledged that in some circumstances the requirement that the lender proceed first against the real estate had the additional impact in California that lender would be driven into the provisions of the various California anti-deficiency statutes. Normally, California’s anti-deficiency provisions would not prevent a lender from foreclosing on additional security for the same debt, but it would bar deficiencies. The borrower argued that if the lender were proceeded to foreclose first under a UCC foreclosure device that permitted deficiencies, the anti-deficiency scheme would be frustrated.

The court noted that the whole issue was moot in this particular case, since the borrowers enjoyed protection for a personal judgment for any deficiency as a consequence of the prior bankruptcy. But it noted that borrowers’ anti-deficiency argument was relevant to its interpretation of the statute, and therefore noted that the proper interpretation of the mixed collateral statute was that the lender could foreclose pursuant to the UCC, but Section 726 would be triggered if the lender proceeded to seek a judgment for a deficiency following its non judicial foreclosure. Lender didn’t do that here, so it was not prevented from foreclosing against the real estate after proceeding against the car.

Comment 1: The case seems straightforward enough, but unfortunately nothing is that straightforward when we’re talking about California’s extremely complex real estate security provisions - made all the more complex by frequent and convoluted judicial interpretations. Since this is a decision of first impression on what likely is an important issue, and since California likely is the dominant real estate economy in the nation, the editor concluded that the case was worth reporting to a national audience.

Comment 2: The editor isn’t necessarily criticizing the California courts that have wrestled with the proper application of the anti-deficiency and one form of action statutes. These are obviously statutes intended to be “anti-market” and to protect debtors from agreeing to security realization practices that are deemed to be too harsh. The fact that the consequences may be inconvenient for lenders would appear to be an intended outcome. Further, it’s not surprising that we have a jillion hair-splitting decisions, since lenders are paying smart lawyers to come up with ways around the restrictions. From time to time, lenders have been successful in going into the legislature and getting changes in the statutory scheme to avoid the spirit of the California system. For example, in a protracted battle some years ago, lenders obtained legislation that , in the editor’s view, basically gutted the overall intent of the California scheme as it applies to letters of credit. At least part of the battle is set forth in the DD for 7/2/96. The editor takes no position as to whether what the lenders did was bad or good or necessary or unnecessary. He merely points out that many inconsistencies in the California scheme result from lenders ramming their tanks against the citadel.

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