County of Sonoma v. U.S. Bank N.A. (Cal. App.)

The following is a case update by Michael J. Gomez analyzing a recent case of interest:

Summary

In County of Sonoma v. U.S. Bank N.A., ___ Cal.App.5th _____ (2020), a California Court of Appeal affirmed a trial court’s subordination of a lender’s lien to a receivership certificate and confirmed the receiver’s sale of the property free and clear of the lender’s lien.  To read the full published decision, click here.

Facts

James Quail owned a 47,480 square foot lot with two houses, garages, and several outbuildings in an unincorporated area of Sonoma County.  An inspection in May 2013, revealed hazardous and unpermitted electrical wiring, hazardous decking and stairs, unpermitted kitchens and plumbing, broken windows, and a lack of power.  A report following a December 2013 fire at the property described the property as “a makeshift, illegal mobile home park and junkyard.  The list of unaddressed violations is extensive.”

The County was unable to gain access to the property for a full inspection on multiple occasions.  In support of a request for an ex parte inspection warrant, the County noted the sheriff’s department had responded to 412 “events” concerning the property from 2008 to 2014, and the fire department had responded to over 30 calls for medical aid at the property.  Following the issuance of the inspection warrant in July 2014, the inspection disclosed a litany of code violations and hazardous conditions.

In September 2014, the County filed a complaint to enjoin the code violations and abate the public nuisances on the property.  The parties entered into a stipulated judgment in December 2014 that permanently enjoined Quail from maintaining the violations and mandating that Quail abate the nuisances in 90 days.  Another inspection from June 2017 disclosed that the violations had not been abated, with more occupied trailers and recreational vehicles and more individuals living in uninhabitable structures.  The County notified Quail and all lienholders of its intent to seek the appointment of a receiver to oversee the abatement work and to “record a lien against the [p]roperty for the amount of those cleanup efforts” if Quail was unable to pay them.  No one responded to the notice over the next five months.

The County next filed a petition in November 2017 seeking the appointment of a receiver under Health and Safety Code (HSC) § 17980.7 and Code of Civil Procedure (CCP) § 564.  The petition sought to give the receiver the authority to finance the repairs and clean up with a loan secured by a lien with priority over all other previously recorded liens on the property.  The petition also asked for receiver and County fees and expenses to be granted super-priority status to be paid first from the proceeds from a sale.  In early January 2018, the County served the pleadings and all supporting materials on U.S. Bank National Association, as Trustee, Deutsche Alt-A Securities Mortgage Loan Trust, Series 2007-2 Mortgage Pass Through Certificates Series 2007-2 (U.S. Bank).

On January 19, 2018, the court granted the County’s petition and authorized the receiver to exercise powers granted to receivers by HSC § 17980.7 and CCP § 568.  The court also authorized the receiver to borrower funds to pay for the remediation and to fund a $30,000 receivership certificate to cover initial costs.  The order further authorized the County to recover its attorneys’ fees and costs, and that such expenses would be afforded the same priority as the receiver’s expenses.  The court denied the County’s request to issue the receiver’s certificate on a super priority basis.  No appeal was taken from the appointment order.  U.S. Bank had appeared at the hearing and had only objected to the court issuing a super priority receiver’s certificate.

In May 2018, the receiver filed a motion requesting authority to issue a receiver’s certificate for $115,000 on a super priority basis to improve the conditions at the property.  The receiver reported he had tried to negotiate a resolution with the owner and occupants and with U.S. Bank, but the occupants would not vacate and the bank would not foreclose.  The receiver noted that U.S. Bank had caused notices of default and notices of sale to be issued in 2012, 2013, and 2016, but had not foreclosed.  The receiver could not obtain financing for the $30,000 certificate the court had previously authorized because no lender would loan the funds on a nonpriority basis given the debt already secured by the property.

The receiver laid out three options with the motion and recommended the intermediate option.  Under that option, the receiver would remove the junkyard conditions, demolish the most damaged structure, relocate the occupants, and sell the property as is to a buyer with resources to complete the remaining remediation.  The receiver estimated the costs would be $61,000 and, once completed, the property would be worth $249,000.  U.S. Bank’s lien against the property was $669,000.

A second option involved a complete demolition and selling the property as vacant land was not as favorable because the property would be worth $250,000 and the costs would be higher.  A third option was a complete remediation which would yield an estimated final value of $450,000, but it appeared infeasible due to low property values and a lack of lenders willing to fund that level of work. 

U.S. Bank opposed the motion arguing there was no statutory authority for issuance of a priority certificate and that granting super priority status would be inequitable.  The bank also argued the motion was premature in that a formal appraisal was necessary before a determination could be made on super priority status. 

At the June 2018 hearing, the court indicated it had the authority to issue the super priority lien, but needed more information.  U.S. Bank suggested that any remediation be financed by the County or Quail.  The receiver responded that it had explored other options for funding, but there were no public funds or nonprofit monies available.  The court authorized the issuance of a $115,000 receiver’s certificate, but denied without prejudice the request to give the certificate priority over existing lienholders.  The court ordered U.S. Bank to file an appraisal before the next hearing in September 2018.

U.S. Bank did not file the appraisal.  At the next hearing, the receiver advised that the appraiser had just been at the property.  The receiver submitted photos demonstrating the continuing nuisance conditions and explained that though it had sent letters to occupants requesting that they vacate, the receiver had no funds to enforce removal or enable relocation.  The court expressed its concern over the condition of the property and continued the matter to October 8, 2018. 

Prior to the hearing, U.S. Bank advised the court that the property had been appraised for $400,000.  U.S. Bank requested permission to foreclose and either retain the property and make the repairs or sell the property to a buyer who would remediate it.  The County objected, fearing the bank would do nothing or would sell it to someone who would do nothing.  The receiver supported its prior motion from May and noted that the bank had failed to foreclose previously on several occasions.  U.S. Bank replied it had not previously foreclosed because several different bankruptcies had listed the property, compelling it to seek relief from the automatic stay.  The court granted the motion “based on the nature of this property, based on the nature of the current status, based on the history of the inability of the proper authorities” and “based on previous Court rulings.”  The court authorized a receiver’s certificate for $115,000 with super priority status. 

Thereafter, U.S. Bank appealed. 

By December 2018, the receiver reported all occupants including Quail had relocated or been removed.  By January 2019, the receiver reported all demolition work had been completed, all buildings secured, and the property was fetching offers in excess of its $249,000 list price.  In February 2019, the receiver recommended that the court authorize the sale of the property to a group of buyers, including a neighbor to the property, for $315,000.  The neighbor previously acquired an adjoining property from Quail 25 years before and corrected the violations on that property.  The offer was the highest and best offer.  Given the lack of financial resources to Quail or the property, the receiver saw no other option but to sell it as is with the buyer’s assurance the remediation would be completed.  As there was no way to pay off all the liens on the property, which exceed $1 million by that time, the receiver asked that all liens be stripped from the property and attach to the sale proceeds.  The court continued the matter so the receiver could formalize the request to confirm the sale by motion.

The motion was heard in April 2019.  The court remarked on the property’s long history of substandard conditions and concluded that the property “finally reached a stage, through the efforts of the Receiver and the County and others, to be in a position, where finally, it can be marketed for sale and to abate the numerous, ongoing nuisances and problems with the property.”    The court granted the receiver’s motion, confirmed the sale and authorized the receiver to pay outstanding receivership expenses including the County’s demand for fees and costs pursuant to the Court’s earlier receivership appointment order.  The court directed the liens to attach to the remaining proceeds and potential claimants were ordered to file claims with the receiver within 30 days.

U.S. Bank filed an immediate petition for a writ supersedeas, staying the distribution of the funds pending appeal, which was granted.  U.S. Bank also appealed the sale order.  The appellate court consolidated the appeals.

Reasoning

The appellate court began with the standard of review, which for most matters in a receivership is a deferential abuse of discretion standard.  The facts must be viewed in the light most favorable to the order, and, in the absence of fraud, unfairness, or oppression, the court has wide discretion in approving the receiver’s action.  Matters of statutory construction are reviewed de novo, however.

U.S. Bank first argued that as a matter of statutory interpretation HSC § 17980.7 does not authorize a court to issue a super priority lien.  Instead, HSC § 17980.7 is subject to normal rules of lien priority, namely that different liens have priority according to the time of their creation.  The appellate court rejected that argument because: (a) the receiver was appointed under both HSC § 17980.7 and CCP § 564; and (b) nothing in HSC § 17980.7’s statutory language or legislative history suggests the Legislature intended to circumscribe the traditional powers of a receiver recognized under CCP § 568.

A receiver’s CCP § 568 powers include the ability to borrow money to fund the preservation and management of property of the receivership estate and for issuance of a receiver’s certificate to a lender as security for funds loaned to a receiver.  Citing Title Ins. & Trust Co. v. California Dev. Co., 171. Cal. 227 (1915) (“Title Ins. & Trust“), the appellate court noted that for over a century, these powers have included the authority to fund a receivership on a super priority basis in the appropriate circumstances.  U.S. Bank tried to distinguish Title Ins. & Trust on the basis that the case limits the priority of receiver’s certificates for the “necessary care and preservation” of receivership property and is therefore inappropriate in the context of a HSC § 17980.7 receivership which exists solely to improve real property.  The appellate court dismissed this argument, concluding that a receiver’s efforts pursuant to HSC § 17980.7 to improve property conditions which endanger public health and safety are part of the “necessary care and preservation” of receivership property.  The court also rejected the bank’s claim that Title Ins. & Trust is limited to situations where a majority of the existing lienholders request the receivership and agree to subordinate their interests to fund it. 

The appellate court dispensed with the bank’s argument that HSC § 17980.7 did not include within its enumerated powers the ability for a receiver to borrow on a super priority basis and that it prioritizes paying debts secured by an interest in the real property before borrowing funds and securing the debt with a lien on the real property.  The court disagreed with the argument because the statute allows the receiver to proceed by another manner when “the court otherwise permits” and because the section incorporates the traditional powers of receivers under CCP § 568.  In short, courts may authorize a super priority lien in appropriate circumstances. 

The legislative history showed that the original draft of the bill for the section included a provision for super priority borrowing, but that was removed following opposition from the California Bankers Association.  The amendment to the bill only gave the lien the priority of a judgment lien.  A subsequent amendment deleted the reference to judgment lien priority.  The removal was explained by the author as “I have added author’s amendments . . . to delete a first priority for a lien secured by a receiver.  Such blanket authority may not be appropriate in certain cases, so the bill now specifies that any financing arrangement by a receiver would be subject to court approval.”  According to the appellate court, this legislative history did not foreclose the use of super priority liens to fund HSC § 17980.7 receiverships.  The appellate court also gave short shrift to the bank’s constitutional arguments that the super priority lien was an unconstitutional taking or an impairment of a contract.

With this backdrop, the appellate court concluded the trial court had not abused its discretion in granting priority status to the lien.  The property was not capable of generating income and it was underwater, making traditional secured borrowing impossible to finance the remediation.  The property also posed significant health and safety hazards, which persisted for years.  The appellate court rebuffed the bank’s argument that the trial court abused its discretion because it had offered to foreclose and remediate the problems.  Based on the record, the court found the bank had exhibited a history of indifference and inaction in that the bank had notice of the issues since June 2017 and took no action prior to the receiver’s appointment in January 2018, or before the request for super priority financing was renewed in May 2018, or before the trial court granted the request in October 2018. 

U.S. Bank then argued that the sale process failed to comply with statutory requirements in that the sale was not performed in accordance with the Enforcement of Judgments Law because CCP § 568.5 states that all sales must be in the “manner prescribed by Article 6” of the Enforcement of Judgments Law.  The appellate court turned down this argument as well, highlighting that section 568.5 actually states a receiver may, pursuant to court order, sell real or personal property upon notice and in the manner prescribed by the Enforcement of Judgments Law.  Furthermore, section 568 provides broader authority to “do such acts . . . as the Court may authorize.”  When read together, these provisions permit a court to tailor the method of the sale to the circumstances before it, and several cases support that conclusion.  There was no abuse of discretion either because there was ample evidence to support the sales price, and there was no evidence of fraud, unfairness, or oppression.  Moreover, other considerations may outweigh the need to maximize the sales price and it was important here that any potential purchaser be able to complete the remediation. 

Finally, the appellate court did agree with one of the bank’s arguments that the County was not entitled to super priority for its attorney fees and costs because there is no statutory or decisional authority for such an authorization. 

Author’s Commentary

This case has an excellent collection and summary of cases dealing with receivership sales.  The case also adds to the growing body of authority that receivers can borrow funds on a super priority basis, displacing existing liens to improve the assets of the receivership estate.  The problem is that these cases arise in the health and safety context and it is not guaranteed that they will be extended to the commercial context.  Junior, unsecured or partially unsecured lienholders will continue to argue that Title Ins. & Trust prevents the displacement of their liens because the super priority financing is not planned to be used for the “necessary care and preservation” of the receivership estate as opposed to its improvement, and that the case is limited to its facts where all lienholders agreed to subordinate their liens.  If that can be overcome outside of the special circumstance of the health and safety context, then receiverships will be a much more effective tool to resolve insolvency problems.

What is also remarkable about the decision is the weakness of the evidence that was held up on appeal as the basis for why there had been no abuse of discretion in certain instances.  The fact that someone corrected remediation problems 25 years ago and has not had any similar problems ever since is not strongly indicative that they will successfully rehabilitate a new property they acquire.  Nor is the fact that a bank failed to foreclose within a year based on a nonmonetary default dispositive that the lender sat on its hands and had no actual intent to remediate the problems following foreclosure when the owner of the property had an extensive track record of litigation. 

These materials were written by Michael J. Gomez of Frandzel Robins Bloom & Csato, L.C. in Fresno, California (mgomez@frandzel.com).  Editorial contributions were provided by Aaron E. de Leest of Danning, Gill, Israel & Krasnoff, LLP.  Mr. Gomez and Mr. de Leest are members of the Insolvency Law Committee.