Daily Development for
Monday, January 12, 1998

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

MORTGAGES; DEFICIENCY; ANTI-DEFICIENCY STATUTES; PURCHASE MONEY: Where buyer acquires two properties from same group of sellers in related closings a few days apart, note given to one of sellers in the second transaction for purchase of second property but secured by property acquired in first transaction will be regarded as a "purchase money mortgage" and no deficiency judgment is available even when mortgage is "sold out" by senior foreclosure.

Conley v. Matthes, 66 Cal. Rptr. 2d 524 (Cal. App. 1997)

Buyers agreed to buy two apartment buildings from Sellers. The buildings were near one another, and Buyers intended to operate the buildings as a single business. The closing of the First Street Building was made contingent upon the opening (but not closing) of escrow on the Second Street Building, and indeed an escrow on the Second Street Building was opened, and the parties amended the escrow instructions on the First Street Building to remove that contingency. Thus, ultimately, notwithstanding any indications of intent by the parties, there were two escrows on two separate buildings closing independently of one another.

Buyers closed on the First Street Building, but a few days later informed Sellers that they were short of cash for closing the Second Street Building. They sought a second mortgage on the Second Street building to fund a portion of the cash down requirement. Seller counter proposed that place a mortgage on the First Street Building, which had a higher value and in which Buyers already had invested a substantial amount of cash for the purchase. Buyers agreed. The testimony was conflicting as to the understandings of the parties as to the impact of this switch. Seller testified that he made the switch specifically to avoid California's purchase money antideficiency laws. Buyer testified that Seller told him that the two mortgages were legal equivalents.

The 80's ended, and Buyers suffered foreclosures on senior mortgages on both buildings. The foreclosure on the First Street Building wiped out Seller's junior lien, and Seller sued for a deficiency. The trial court granted Seller summary judgment.

On appeal: held: reversed. Because the loans, in the court's view, were part of an interrelated series of purchase transactions, the loan to acquire the Second Street Building was a "purchase money mortgage" and immune from deficiency claims under California CCP580b even though it was secured by property - the First Street Building - that was not purchased with the loan proceeds, pursuant to a loan arrangement negotiated after the closing of the First Street Building, and even though the sale agreement did not interrelate the closings.

As to the relationships, interestingly, the court held that parole evidence was admissible to evaluate the parties' objectives here because the side of the escrow instruction agreement that had bene provided to the court did not include an integration clause, even though the court acknowledged that the back side of the same agreement likely did include such a clause as "boiler plate." (Is there a lawyering lesson there?)

In analyzing the basic premise that the loan, although not secured by the property purchased, was nevertheless a purchase money loan, the court had to contend with one of the most often cited of all cases in the long and erratic line of California cases dealing with anti-deficiency laws - Roseleaf v. Chierighino. In Roseleaf, a lender with a junior lien on property other than that acquired with the loan proceeds was held not to be a purchase money lender. But the Roseleaf court, to the everlasting confusion of the California real estate bar, attempted to explain its conclusion by summarizing its view of the basic policies between the California anti-deficiency statutes and by showing that the facts of this case did not fit the model "targeted" by the legislature.

Of course, an interpretation such as that in Roseleaf invites the courts to "custom tailor" the statute to each and every case, and California courts over the years have been up to the task, rendering fact driven interpretations and applications of the California anti-deficiency statutes in ways that not even Ross Perot could explain.

Here, the court pointed that a major factor driving the Roseleaf result was the Roseleaf court's notion that there was no evidence that the seller there had used the purchase money mortgage incentive to drive up the values of the involved properties. The Roseleaf seller took his deed of trust on properties separately acquired by the buyers at an earlier time. He had no special knowledge of their value. In the instant case, on the other hand, the court concluded that the fact that the two related properties were involved might have given the Seller the opportunity to overvalue the Second Street Building to the Buyer's disadvantage, using the purchase money loan to "leverage" the Buyer in. Certainly the Seller arguably did have superior knowledge as the value of both the First Street Building and the Second Street Building.

Comment 1: The court apparently ignores the fact that the Buyer originally agreed to buy the Second Street Building with 20% cash to a third party loan, and that the third party lender in that transaction apparently saw an 80% loan to value ratio based upon its appraisal of the property. The court also ignored the fact that the parties left the cash price the same when the Seller agreed to provide financing to assist the Buyer in closing.. It is difficult to see how the purchase money loan negotiations played a part in setting the price for the land when there was no talk about a purchase money loan at the time the price term of the contract was finally set.

The court also suggests that the Seller somehow had inappropriately "covered himself" by shifting the purchase money loan to the First Street Building, taking advantage of the superior knowledge that the Seller had of the values of these buildings. The court ignores the facts that, based upon the sale arrangements alone, the First Street Building was worth almost $166,000 more than the Second Street Building, and that Buyers had over $30,000 more equity it - reason enough for most lenders to prefer the First Street Building as security, whatever their "special knowledge."

Comment 2: As happens all too often in California, this commercial real estate transaction appears to have been engineered by real estate brokers without the involvement of attorneys. They circumvented any rules relating to unlawful practice by using as their "contract" the escrow instructions in the respective transactions. So, of course, we wound up with a very sloppy and uncertain record of the transaction, to the ultimate loss to the seller of approximately $250,000 in his sold out lien.

Comment 3: California's labyrinthine anti-deficiency laws have provided full employment to generations of that state's commercial real estate lawyers. But the major lobbying victory of the lending community in the recent flap over the application of the related "one action rule" to letter of credit guarantees suggests that the time may be coming when the California legislature will take a new look at all of these provisions. As controls on commercial real estate finance, the rules are cumbersome, confusing, and difficult to avoid; and they likely retard, rather than promote, the health of the real estate marketplace in California.

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