The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:
The California Supreme Court has held that an assignee holding both the senior and junior notes secured by the same parcel of real property may foreclose non-judicially on the senior lien and then recover from the borrower on the junior note. The holding overturns nearly 30 years of precedent. [Black Sky Capital, LLC vs. Cobb, 7 Cal. 5th 156, 439 P.3d 1149 (2019)]
Facts: Two individuals borrowed over $10 million from a bank, secured by a deed of trust on a parcel of commercial property. Two years later, they obtained another loan from the same bank for $1.5 million, secured by a second deed of trust on the same parcel. Later, an assignee purchased both notes from the bank.
After the borrowers defaulted, the assignee conducted a nonjudicial foreclosure sale under the senior deed of trust. The assignee then brought suit against the borrowers on the junior note, seeking a deficiency judgment.
The borrowers moved for summary judgment, citing Simon v. Superior Court, 4 Cal. App. 4th 63, 5 Cal. Rptr. 2d 428 (1st Dist. 1992), for the proposition that California Code of Civil Procedure § 580d prohibits a party holding both the senior and junior liens on a single parcel from first conducting a trustee’s sale on the senior note and then obtaining a deficiency judgment on the junior note. The trial court granted summary judgment in favor of the borrowers. The appellate court ruled in favor of the assignee, and so did the California Supreme Court.
Reasoning: In a unanimous opinion, the Supreme Court held that Simon and its progeny had misconstrued Roseleaf Corp. v. Chierighino, 59 Cal.2d 35 (Cal. 1963). Roseleaf had held that § 580d did not preclude a deficiency judgment for a non-selling junior lienholder, but it did not hold that § 580d necessarily precluded a junior lienholder from seeking a recovery under the junior note when the junior creditor was also the holder of the senior note.
The court relied on the text of the statute to support its result:
The plain language of section 580d, subdivision (a) bars a deficiency judgment on a note secured by a deed of trust on real property when the trustee has sold the property “under power of sale contained in the . . . deed of trust.” The definite article in the phrase “the . . . deed of trust” makes clear that the statute applies where sale of the property has occurred under the deed of trust securing the note sued upon, and not under some other deed of trust. [Italics by the court.]
The borrowers argued, however, that allowing a junior lienholder to collect a deficiency judgment in this situation would be inconsistent with the purpose of section 580d, because a creditor could structure what is functionally a single loan as two separate notes in order to recover under the junior note what it could not recover if it had issued a single note on the same property.
The court was not worried by the specter of potential abuse:
Where there is evidence of gamesmanship by the holder of senior and junior liens on the same property, a substantial question would arise whether the two liens held by the same creditor should — in substance, if not in form — be treated as a single lien within the meaning of section 580d. It is unclear that the Legislature, in enacting section 580d, intended to permit such gamesmanship to affect the amount of recovery under a junior lien.
But we have no occasion here to decide the applicability of section 580d in these or other gamesmanship scenarios. The [borrowers] do not allege, and there is no evidence to suggest, that the two notes in this case arose from intentional loan splitting; they were executed in separate transactions more than two years apart.
The court later summarized its holding:
[I]t does not follow that section 580d’s purpose of achieving parity of remedies between judicial and nonjudicial foreclosures would be served by interpreting the statute to categorically bar a deficiency judgment on the junior lien. Where, as here, there is no allegation of evasive loan splitting or recovery in excess of what any junior lienholder would be able to recover, we see no reason to depart from a straightforward reading of section 580d. Because no sale occurred under the deed of trust securing the junior note in this case, section 580d does not bar a deficiency judgment on the junior note.
The court expressly disapproved of Simon and its progeny, to the extent that those cases were inconsistent with its holding.
Author’s Comment: This is a surprising result, especially since the California Supreme Court had previously cited Simon with approval. See Western Security Bank v. Superior Court, 15 Cal. 4th 232, 258-9, 62 Cal. Rptr. 2d 243, 260, 933 P.2d 507, 524, 32 U.C.C. Rep. Serv. 2d 534 (1997), citing Simon in support of the proposition that “our courts have construed the antideficiency statutes liberally, rejecting attempts to circumvent the proscriptions against deficiency judgments after nonjudicial foreclosure.” Admittedly, that passage was not an endorsement of the specific holding in Simon, but the Supreme Court did adopt the Simon court’s general policy approach to the antideficiency statutes.
Note, too, that Simon has been on the books since 1992. During the intervening 27 years, the Legislature has amended the antideficiency statutes several times but has never repudiated Simon. Arguably, that long silence was an implicit ratification.
But never mind. The rules have changed, and I doubt whether the Legislature will repudiate Black Sky. What now?
- First, this decision makes junior notes more valuable on the secondary market, since the purchaser can take an assignment of both notes, foreclose on the senior position, and then seek a deficiency under the junior note.
- Second, it will make marginal commercial borrowers more “bankable,” since lenders who have already extended credit can provide additional funding, knowing that those new notes are at least theoretically collectible. On the other hand, since most commercial real estate borrowers are single-asset special purpose entities, the ability to collect a deficiency from the insolvent borrower per se (as distinguished from a guarantor) may be of little practical significance. Unlike borrowers, guarantors can waive the ability to invoke § 580d under Civil Code § 2856.
- Third, we can expect that defaulting borrowers will now invoke the newly-created “gamesmanship” exception to § 580d, arguing that the senior lender had artificially split the debt into two packages, in order to conduct a nonjudicial foreclosure under the senior note while seeking a deficiency under the junior note. This question will often involve messy issues of intent, opening the door to parol evidence.
- Fourth, even in the absence of “gamesmanship,” we can expect that the borrowers will argue that since both sets of documents contain “dragnet” and cross-collateralization clauses (which is almost always the case), the two sets of documents are linked and are not really separate at all. Thus, the foreclosure under the senior loan would affect the junior loan. Note that the Black Sky court did not even address this issue, leaving it open for further litigation.
Finally, a pedantic note: since “gamesmanship” is not a politically correct term, and since “gamespersonship” is Teutonically ungainly, may I suggest the word “gaming” as a substitute? It is a noun (a gerund), and it works: “The lender split the loan into two tranches, thus gaming §580d, a practice condemned in Black Sky.”
For a discussion of the intermediate appellate opinion in Black Sky, see 2017-24 Comm. Fin. News. NL 48, Where Originating Lender Held Both Senior and Junior Liens, Assignee Holding Both Notes May Foreclose Nonjudicially on Senior Lien and Then Recover from Borrower on Junior Note.
For discussions of other decisions dealing with this issue, see:
- 2012 Comm. Fin. News. 52, When Originating Lender Assigns Junior Note and Deed of Trust, Subsequent Nonjudicial Foreclosure by Holder of Senior Lien Does Not Affect Junior Assignee’s Right to Recover Deficiency from Borrower.
- 2012 Comm. Fin. News. 32, When Originating Lender Has Nonjudicially Foreclosed On Senior Trust Deed, Assignee Of Junior Note Is Barred From Recovering Deficiency From Borrower.
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.