Bear Creek Master Association vs. Southern California Investors, Inc.  – Although Third Trust Deed is Recorded Prior to Assessment Lien, HOA Takes Priority Due to Subordination Clause Contained in CC&Rs.

The following is a case update prepared by Professor Dan Schechter, Loyola Law School, Los Angeles, analyzing a recent decision of interest:

SUMMARY:

A California appellate court has held that even though a third deed of trust was recorded prior to an assessment lien, the HOA took priority over the lender due to a subordination clause contained in the recorded CC&Rs. [Bear Creek Master Association vs. Southern California Investors, Inc., 2018 Westlaw 5659789 (Cal.App.).]

FACTS: A developer created a golf course and a housing development; although the golf course was adjacent to the housing, it was not formally part of the development per se and was separately owned. The recorded covenants, conditions, and restrictions (“CC&Rs”) governing the golf course granted the homeowners’ association (the “HOA”) the right to maintain the golf course property, if the owner of the golf course failed to do so.

The CC&Rs also granted the HOA a “claim of lien” against the golf course property to secure those maintenance costs. That lien would “attach and become effective” when it was recorded, which was to happen after the HOA incurred costs in maintaining the golf course. Finally, the CC&Rs provided that the assessment lien in favor of the HOA “shall not be subordinate to the lien of any deed of trust or mortgage, except the lien of a first deed of trust . . . .”

The golf course was eventually sold to a new owner. Roughly 30 years after the adoption of the CC&Rs, the new owner borrowed money from a lender and executed a third deed of trust to secure its obligation. That deed of trust was recorded.

Later, after the new owner failed to maintain the golf course properly, the HOA recorded an assessment lien against the golf course. At around the same time, the owner of the golf course defaulted on its debt; the holder of the third deed of trust foreclosed nonjudicially and purchased the property at the foreclosure sale.

The lender, now the owner of the golf course, planned to sell some of the acreage. The HOA claimed priority and demanded that its assessment lien be paid out of the proceeds of that sale. The sale went forward, but cash was withheld by the escrow company to satisfy the HOA lien. The HOA eventually filed an action for declaratory relief asserting the priority of its lien. The lender filed a cross-complaint; the trial court entered judgment on the pleadings in favor of the lender.

REASONING: The court first noted that this fact pattern was not governed by the Davis-Stirling Common Interest Development Act, Civil Code §4000 et. seq. Perhaps in dicta, the court noted that if §5675 of that act had been applicable, the HOA’s assessment lien would have been subordinate to the third deed of trust. Here, however, the golf course was not formally part of the “common interest development;” thus, the statute was inapplicable. The HOA first argued that its assessment lien was in first position because it was created by the CC&Rs, which were recorded 30 years prior to the third deed of trust. The court disagreed with that argument, holding that the CC&Rs simply authorized the lien but did not create it:

[A]n inchoate “claim of lien” was created and perfected when the [CC&Rs] were recorded in 1984, but no actual “lien” or assessment lien was or could be created or perfected against the golf course property until the claim of lien was reduced to an assessment lien and was recorded.

The HOA’s second argument was that the assessment obligation was analogous to a “future advance” under a mortgage and that the priority of the assessment lien therefore related back to the date of the recording of the CC&Rs. The court distinguished between this fact pattern and the cases dealing with future advances:

The differences between the mortgages for future advances in [those cases] and the [CC&Rs] are readily apparent. The mortgages in [those cases] plainly stated that they would secure future advances, and their terms were sufficiently definite to impart constructive notice to subsequent encumbrancers of the real properties that they would secure future advances against those real properties. In contrast, the [CC&Rs] did not state that they were creating a presently or immediately effective lien in favor of [the HOA] to secure any future costs [the HOA] incurred in maintaining the golf course property . . . . Rather, the [CC&Rs] provided only that [the HOA] would have an assessment lien against the golf course property if and when an assessment lien for a specified amount was recorded against the golf course property.

Finally, however, the HOA’s third argument prevailed: the court agreed that the third deed of trust had been subordinated to the assessment lien by virtue of the language of the CC&Rs themselves:

The language of the [CC&Rs] is clear and explicit. Section 3 provides that an assessment lien “shall have priority over all liens or claims created subsequent to the recordation of this Declaration [of the CC&Rs], . . . except for certain trust deeds as provided in Section 4 below.” Section 4, titled Subordination to Certain Trust Deeds, provides: “The lien for the Assessment provided for herein shall not be subordinate to the lien of any deed of trust or mortgage, except the lien of a first deed of trust or first mortgage . . . . ”

These provisions modified the otherwise-applicable “first in time, first in priority” rule of lien priorities . . . . They constructively notified [the holder of the third deed of trust] that any recorded assessment lien against the golf course property would have priority over [the] third deed of trust—even if the assessment lien was recorded after the third deed of trust was recorded.

The court then explained the purpose behind the subordination provision contained in the CC&Rs:

[T]he [CC&Rs] allow [the HOA] to maintain the golf course property if its owner fails to do so, and to create and record an assessment lien to secure certain costs incurred in maintaining the golf course property. The [CC&Rs] further provide that any assessment lien will have priority over all other liens, including deeds of trust, except a first deed of trust, recorded at any time after the [CC&Rs] were recorded. By these provisions, the [CC&Rs] ensure that the [neighboring] homeowners will not have to live near a poorly maintained golf course property with no means of remedying the situation or of adequately securing certain costs incurred by [HOA] in maintaining the golf course property. [The lender] had constructive notice of the [CC&Rs] when it recorded its third deed of trust against the golf course property . . . , and [the lender] is bound by the [CC&Rs]. Thus, [the HOA’s] assessment lien is prior to [the lender’s] previously-recorded third deed of trust.

AUTHOR’S COMMENT: What a great fact pattern – it sounds like a first-year Property exam question! I think the court reached the right result for the right reasons. As far as I know, this is a case of first impression in California: a subordination clause in the covenants that reverses the priority of a trust deed and a junior HOA lien.

I wonder if the title company that insured the third trust deed picked up the subordination clause buried in the CC&Rs. That clause was poorly worded; it did not say that the HOA lien, regardless of when it was recorded, would take priority. It said that the HOA lien “shall not be subordinate to the lien of any deed of trust or mortgage, except the lien of a first deed of trust . . . .” Yes, those two concepts (outright priority and “non-subordination”) are equivalent, but this is not the way that subordinations are usually drafted.

Note, too, that the third trust deed holder was not in contractual privity with the developer; instead, the lender’s consent to the subordination was implied. Under California law, any grantee of an interest in real property is deemed to have agreed to abide by all recorded covenants. Here, the deed of trust conveyed a lien to the lender, which is an interest in real property.

There is one aspect of this decision that seems a little doubtful. In dicta, the court seemed to say that in cases falling within the scope of Davis-Stirling, §5675 would have subordinated the HOA’s assessment lien to the third deed of trust. But as I read that statute, there is still room for a subordination provision in the CC&Rs, and the result should be the same as in the case at bar.

For discussions of other cases involving priority disputes between HOAs and lenders, see:

• 2014-09 Comm. Fin. News. NL 19, Bank Purchasing Condominium at Foreclosure Sale is Liable for Mortgagor’s Unpaid Assessments, Even Though No Assessment Lien Had Been Filed.
• 2012 Comm. Fin. News. 49, Assessment Lien in Favor of Homeowners’ Association Is Junior to Deed of Trust Executed by Homeowner, Even Though Declaration of Restrictions Is Recorded Prior to Deed of Trust.
• 2012 Comm. Fin. News. 29, Despite Ambiguity In CC&Rs, Assessment Lien In Favor Of Homeowners’ Association Is Junior To Mortgagee’s Lien And Can Be Stripped Off Due To Lack Of Equity.

These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.