Daily Development forWednesday, December 1, 1999

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

The editor acknowledges the assistance received from O'Melveny & Myers Executive Brief discussion of this case.

MORTGAGES; DEFICIENCIES; ANTIDEFICICIENCY STATUTES; WAIVERS: California prohibits post mortgage waivers of anti-deficiency protection in purchase money situations, limits application of Spangler to subordinated purchase money cases.

Deberard Properties v. Lim, 85 Cal. Rptr. 2d 292 (Cal. 1999)

This important California case resolves several important questions concerning the continued viability of anti-deficiency legislation in California - largely in favor of the legislation. Note that although the original 1930's-era anti-deficiency protections were legislative in character, California courts have twisted and turned them through elaborate policy analysis so that the statutes are now something close to common law doctrines. Recently, however, the California legislature did step in to help banks where difficulties arose in the case of the application of antideficiency and "one action rule" doctrines to unrestricted letters of credit. Perhaps we'll see a similar development here.

The case involved a junior seller's purchase money mortgage. The seller, DeBarardo, apparently sold the property to the buyers, the Lims, subject to an existing $1.9 million mortgage that the Lims assumed. In addition, the Lims put down $1.1 million and gave a promissory note to the sellers for $170,000, secured by a second deed of trust.

Within three years, despite the substantial equity apparently in the property, the center was in trouble. The Lims negotiated a loan workout with DeBerard that resulted in a subsantial reduction in interest rate and monthly payments. DeBerard also agreed to subordinate its deed of trust to any modifications of the bank loan and to fobear from exercising remedies. In return, the Lims specifically waived the anti-deficiency protection of CCC 580b, which otherwise would have protected the Lims, as borrowers under a seller financed purchase money mortgage, from any deficiency claim by DeBerard.

Despite these restructuring efforts, the Lims ultimately defaulted on the Bank loan. The Bank foreclosed, and DeBerard , not surprisingly, ended up as a "sold out" junior lender. DeBerard then attempted to collecte the deficiency, and the Lims argued that their waiver of section 580b protection was invalid.

There had been a split in the lower California courts concerning the validity of post-mortgage waivers of Section 580b. Such waivers are not prohibited specifically by statute, but some California courts had taken the position that the policy supporting antideficiency legislation also supports the prohibition of waivers at any time. The courts had talked about debtors making "ruinous concessions" in negotiating with sellers over workouts. Other courts, however, had concluded that post mortgage waivers were permissible, relying partly upon statutory analysis and partly upon the notion that some of the purposes behind the prohibition of deficiencies for purchase money mortgages are not served when a waiver is made at the time of renegotiation.

The Supreme Court concluded that the policies behind California's antideficiency scheme did apply as well at the time of workouts. It noted that the purchase money lender was even more likely to be the "only game in town" for the borrower now that the borrower was in difficult economic straits, and it was just as likely that the lender would take advantage of this position to the debtor's disadvantage.

In an ancillary ruling, the court also concluded that Spangler v Memel, 102 Cal. Rptr. 807 (Cal. 1972) did not apply to these facts. Spangler is a well known California case that permitted a purchase money lender to avoid the andidefiency laws (even when there was not 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 "non-traditional" lending scenarios where arguably the purchase money creditor had a better argument that circumstances justified its being able to collect a deficiency. The DeBarard court, however, limits 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.

The Supreme Court also held that it mattered not whether the borrowers in the purchase money situation were as sophisticated or more sophisticated than the sellers. They still were entitled to the antideficiency protection.

Comment 1: The issue should not be whether the junior lender is in a position to exact "ruinous concessions" from the borrower. The issue should be whether the junior lender is in a *better* position to do this than another similarly situation lender would be. At time of workout, the junior purchase money lender seems to be more like any other lender. It is not trading on inflated value. It theoretically would not have pumped up the mortgage amount to begin with since it was denied the right to a deficiency when it negotiated the original loan. The borrower, it is true, may have few other choices for lenders, but this is not because of the purchase money situation, but because the borrower is in default.

Comment 2: In its excellent analysis of the case, O'Melveny & Myers also suggests that the case is relevant to waivers of section 580d - the "private sale antideficiency statute." Should a borrower be able to waive protection under this statute in a post mortgage workout? The editor thinks that the issues here are more clear than in the case of the purchase money loan, and that they favor the borrower. If antidefiency protection in the context of private foreclosures means anything, it means the same when the parties are negotiating a workout as it did when the parties first made the loan. If it can't be waived at time of loan, there is no reason to permit it to be waived later. The O'Melveny authors don't address these policy issues, but suggest that the language of 580b and 580d regarding the waivability of protections is so similar that future courts are likely to read them alike.

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

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