This case continues a twisted journey through the complexities of California's anti-deficiency and "one action" provisions. The basic facts are easy to state, and the original conclusions hard to argue with based upon the then existing provisions of California law. But then things get crazy.
Borrower executed a deed of trust. Later, as part of a settlement agreement on a default, Borrower's principles arranged for Western, a bank other than the mortgagee, to issue $375,000 "standby" letters of credit as additional collateral for a loan. When the borrower later defaulted again, mortgagee foreclosed privately on the property and entered into an agreement with borrowers whereby borrowers would not contest the mortgagee's calling in the letters of credit to an amount not in excess of the deficiency. In fact, the deficiency exceeded the balance on the letters of the credit, and the mortgagee made a call on Western to pay on the letters.
Simultaneously, borrowers notified Western that they had no liability to Western to reimburse Western's payment of the letters of credit, since the California law barred any deficiency following a private foreclosure sale, and if Western were able to seek reimbursement from borrowers, this would amount to borrowers paying a deficiency. (The editor guesses that Borrower's waiver of the right to object to lender's making a call on the letters of credit probably related to uncertainty about whether such a call would be a violation of the "one action" rule.)
Seeing itself between a "rock and a hard place," Western refused to honor the letters of credit, and this action for declaratory relief ensued. The trial court ordered Western to pay on the letters of credit but the California Court of Appeals, in 1993, reversed, holding that to permit the mortgagee to call on the letters of credit after it had foreclosed would be to expose the borrower to liability on a deficiency in violation of the California anti-deficiency statute, CCC 580d.
While an appeal to the California Supreme Court was pending, the California legislature amended the California anti-deficiency laws to provide what the court describes here as the "independence " doctrine. The statute provides (with minor exceptions not relevant here) that a lender may call on a standby letter of credit given as additional collateral without regard to the restrictions of the anti-deficiency laws or the one form of action laws. Borrower's waivers of anti-deficiency defenses in connection with such letters of credit will be upheld. The California Supreme Court vacated the earlier Court of Appeals decision and remanded for reconsideration following the enactment.
Held: The statute is not retroactive, and has no application to these facts. The court "sticks by its guns" as to the basic issue, notwithstanding new arguments raised by amicus briefs. Western had the power to refuse to pay on the letters of credit, since it would have been barred from recovering against the borrowers under 580d. The court deals with UCC language that seems to require the standby letter of credit to be paid by holding that the mortgagee implicitly agreed, when it took the letter of credit, that it would not call on it after a non-judicial foreclosure, and that in making such a call under those circumstances the mortgagee was involved in a "fraud" constituting a defect under California's version of UCC 5-114.
The court says that the result would be different if the mortgagee had called on the letters of credit before foreclosing or if the lender had foreclosed judicially. In either of these latter cases, Western would have had to pay on the letter of credit, because it could not establish that it would be subject to an improper deficiency judgment.
Further, the court acknowledges that in this case there were critical special facts that might make a difference, and remands to the trial court for a determination of those facts. These special facts deal with the fact that the letters of credit were issued after the original mortgage loan, as part of a settlement arrangement involving a default by borrowers. At that time, the borrowers waived their right to protection under the anti-deficiency laws. The court indicates that ordinarily a borrower may not waive its rights to anti-deficiency protection at the time of the borrowing, but reserves the question of whether there can be such a waiver for separate consideration after the original borrowing, and whether that is what happened here.
The court has a few choice words to say about the judgment of the California legislature in adopting statutes that purport to change the sacred anti-deficiency protection that California borrowers (especially purchase money home borrowers) have enjoyed over the years, but in any event holds that the legislation does not operate retroactively, so have no impact here. It states that the legislation would purport to change existing law and therefore alter pre-existing contractual relationships, which it concludes the legislation cannot do. (This conclusion is not beyond dispute - remedial aspects of contracts frequently can be changed - and undoubtedly the bank's lawyers will make this argument on appeal.)
There is a dissent with a very interesting alternative position. Under the suggested approach in the dissent, Western would have to pay on the letters of credit and would have the right to recover reimbursement from the borrowers. This would preserve the "independence" principle. Thereafter, however, borrowers would have the power to force the mortgagee to disgorge the gains it had inequitably obtained by violating its implied promise not to collect on the letter of credit in such a way as to violate the anti-deficiency protection.
Comment: California specialists may have more to say about the case. It is interesting to non-Californians primarily for the human element - the battle between the court here and the legislature. If other courts mirror the attitude of this one, the "devil will be in the details." Lenders will have to be very certain that they have fashioned letter of credit documents that contain all the necessary waivers in all the right places, or they'll be right back in the judicial soup.
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