Dr. Leevil, LLC, vs. Westlake Health Care Center

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

SUMMARY:

The California Supreme Court has held that a foreclosure purchaser cannot serve a three-day notice to quit on a commercial tenant until the foreclosure trustee’s deed is recorded, despite a statute providing that the sale is “deemed perfected” on the sale date if the deed is recorded within 15 days. The decision may inadvertently imperil foreclosure sales followed by bankruptcy petitions filed in the gap between the sale date and the recording date. [Dr. Leevil, LLC, vs. Westlake Health Care Center, 2018 Westlaw 6597341 (Cal.).]

Facts: A small corporation owned a nursing home property. It executed a lease of the property in favor of another corporation controlled by the same shareholders. Six years after the lease was executed, the corporate landlord borrowed money from a lender, secured by a deed of trust on the property. After the borrower defaulted, the lender assigned the note and the deed of trust to a successor. The new creditor conducted a nonjudicial foreclosure sale and was the successful bidder at that sale, thus becoming the new landlord.

The day after the sale, the landlord served the corporate tenant with a three-day written notice to quit. Several days later, the landlord recorded the trustee’s deed. Forty days after service of the notice to quit, the landlord brought an unlawful detainer action. Over the tenant’s objection, the trial court ruled in favor of the landlord, and the Court of Appeal affirmed.

Reasoning: The Supreme Court reversed, holding that under Code of Civil Procedure §1161a(b), a landlord cannot serve a notice to quit until the landlord has perfected the title to the property. Here, the trustee’s deed was not recorded until several days after the notice to quit was served, and the notice was therefore void. The landlord argued that under Civil Code §2924h(c), it perfected title within 15 days of the foreclosure sale; thus, the title was deemed perfected as of the sale date. That statute provides:

For the purposes of this subdivision, the trustee’s sale shall be deemed final upon the acceptance of the last and highest bid, and shall be deemed perfected as of 8 a.m. on the actual date of sale if the trustee’s deed is recorded within 15 calendar days after the sale, or the next business day following the 15th day if the county recorder in which the property is located is closed on the 15th day.

But the court reasoned that “deemed perfection” is not the same as actual perfection; and as of the time the notice was served, the landlord had not yet met the condition of holding record title. The court noted that allowing retroactive perfection would create uncertainty: “A tenant would be forced to choose between vacating the property without assurance that title will ever actually be perfected or remaining in possession of the property and potentially incurring damages as a holdover tenant if title is, in fact, perfected.”

The landlord argued that the court’s reading of the statutes would cause delays in service of notices to quit and would therefore delay commencement of unlawful detainer suits, thus increasing the landlords’ measure of damages. But the court was unmoved: “[O]ur task is to read the statute as written . . . .”

Author’s Comment: I am very concerned about the effect that this decision will have on foreclosure sales. A little background: the foreclosure trustee issues a deed after a foreclosure sale. That deed cannot be recorded by the successful bidder at the moment of sale; aside from the usual delays in the county recorders’ offices, the trustee must wait until the purchaser’s check clears (in the case of a third party bidder, rather than a credit bidder). There is always a gap of a few days.

Bankruptcy lawyers who represent debtors are aware of that gap. If they file a bankruptcy petition during that gap, they can claim that the recording of the trustee’s deed is a violation of the automatic stay under the Bankruptcy Code, thus putting the title to the property into a prolonged state of uncertainty. Those “gap petitions” were a significant problem, chilling the bidding at almost all California foreclosure sales. Third-party cash purchasers were discouraged by the risk of getting stuck in limbo. The absence of lively competition from third-party bidders enabled lenders to submit low-ball partial credit bids, thus exacerbating the deficiency liabilities of guarantors.

Speaking as someone who was peripherally involved in the drafting of Civil Code §2924h(c) back in the early 1990s, I can confidently say that it was specifically designed in order to protect foreclosure purchasers from strategic “gap” bankruptcies. And since its enactment, the statute has largely worked as intended: the bankruptcy courts have enforced the statute, and the problem of “bid chilling” has been reduced. Now, however, the California Supreme Court has inadvertently cast doubt on the meaning of the statute:

[U]nder section 2924h(c), the sale is not “deemed perfected” on the original sale date until the deed is recorded. Before the deed is recorded, the sale is neither “perfected” . . . nor “deemed perfected” . . . — it is just a sale . . . .

If we can restrict that unfortunate phrase (“it is just a sale”) to the narrow context of unlawful detainer cases, the problem is solved. But that broad language seems to reject the doctrine of “relation back.” And if “deemed perfection” is not “perfection” until recording, then a bankrupt who files a “gap petition” could argue that as of the moment of the foreclosure sale, the purchaser’s title is not perfected, the bankrupt still has a property interest, and the recording of the trustee’s deed is a violation of the automatic stay. Worse yet, the bankruptcy courts are likely to show great deference to the California Supreme Court’s construction of §2924h(c).

Perhaps there is a legislative solution to this problem. Here are two possibilities: first, the California Legislature could conceivably repudiate the holding in this case and amend the unlawful detainer statutes to dovetail seamlessly with §2924h(c). Second, if the Legislature wishes to ratify the holding in this case, the Legislature could amend §2924h(c) to provide that relation-back under that statute is applicable in every context other than unlawful detainer cases.

In the meantime, foreclosure purchasers should still rush to record the trustee’s deeds and should not attempt to serve three day notices until the deed is recorded.

For a discussion of the earlier appellate opinion in this case, see 2017-11 Comm. Fin. News. NL 21, Automatic Subordination Clause in Lease Extinguished Tenancy When Creditor Foreclosed, Despite SNDA Clause Contained in Separate Provision; Purchaser May Serve Notice to Quit Before Recording Trustee’s Deed.

For discussions of cases dealing with related issues, see:

• 2016-05 Comm. Fin. News. NL 10, Foreclosure Purchaser’s Eviction of Holdover Homeowner Does Not Violate Automatic Stay in Bankruptcy Because Unlawful Detainer Judgment Terminated Former Homeowner’s Possessory Rights.
• 2017-15 Comm. Fin. News. NL 30, Due to Four Month Delay in Recording Foreclosure Documents and Intervening Bankruptcy Petition, Trustee May Avoid Sale Purporting to Terminate Borrower’s Equity of Redemption.
• 2011 Comm. Fin. News. 69, Deed Issued by Foreclosure Trustee Following Filing of Bankruptcy Petition is Void, Since Title Did Not Pass to Foreclosure Purchaser Prior to Petition.

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.