CALIFORNIA COURT OF APPEAL CLARIFIES FORECLOSURE LAW IN FAVOR OF TRUSTEES AND LOAN SERVICERS (Message to third party purchasers: No Deed, No Damages) by Peter J. Salmon and John D. Duncan.

Almost every loan servicer and trustee is familiar with the following nightmarish scenario: A loan servicer agrees with a borrower to postpone a pending foreclosure sale if the borrower does certain things such as enter into a forbearance agreement, make certain payments, or agree to other loss mitigation alternatives. Frequently, this happens a day or two before the sale and the information is not relayed to the trustee resulting in the trustee proceeding to conduct the non-judicial foreclosure sale. Of course, the property is usually sold to a third party purchaser. However, right before the trustee's deed upon sale is issued, the loan servicer calls and says, "don't issue the deed, we weren't supposed to go to sale!" At about the same time, the third party purchaser calls and is screaming for the trustee's deed upon sale. The third party's attorney then calls and says, if my client doesn't get his deed right now, he wants his money back plus the lost equity he would have received if he was able to obtain the property and sell it. Frequently, the amount demanded is between $50,000. to $150,000. above what was paid at the sale. The dilemma faced by the loan servicer and trustee in this type of situation has always been how much to pay the third party purchaser to go away as opposed to defending a lawsuit brought by the third party purchaser as well as causing potential damages to your borrower. Recently, this dilemma was resloved in California.

In a significant decision representing a major victory for lenders, loan servicers, and foreclosure trustees, a California Court of Appeal ruled that accidentally conducting a nonjudicial foreclosure sale after an agreement to postpone the sale was reached between the borrower and lender is equal to a substantial defect in statutory procedure, and if discovered prior to the issuance of a trustee's deed, the third party purchaser at the sale is ONLY entitled to the return of the bid price plus interest. (Residential Capital, LLC v. Cal-Western Reconveyance Corporation et al. (May 14, 2003) 108 Cal.App.4th 807.) The Court further refused to recognize negligence and negligent misrepresentation causes of action against the lender and trustee. The Court held that non-judicial foreclosure sales are governed by the comprehensive statutory framework found in the California Civil Code Section 2924 et seq., and thus are not subject to common law contract principles and remedies or tort based damages. Represented by Moss Pite & Duncan, LLP, the trustee, Cal-Western Reconveyance Corporation; the beneficiary, Bank One; and the loan servicer, HomeComings Financial Network, successfully defended the appeal of their trial court judgment against the third party purchaser and its claims for breach of contract, breach of the implied covenant of good faith and fair dealing, negligence, and negligent misrepresentation.

In this case, the borrowers defaulted on the payments due under the promissory note secured by a deed of trust. The trustee, Cal-Western Reconveyance Corporation ("Cal-Western"), began nonjudicial foreclosure proceedings. Bank One/Homecomings Financial Network ("Bank One") and the borrowers agreed to postpone the sale based upon entry into a repayment agreement. However, Cal-Western did not become aware of the postponement instruction and conducted the nonjudicial foreclosure sale. Residential Capital, LLC ("Residential"), was the high bidder at the sale and tendered payment. The day after the sale, Cal-Western discovered the existence of the agreement to postpone and immediately returned Residential's bid funds with three days of interest, informing Residential that it would not issue a trustee's deed upon sale. Residential accepted the funds, and two months later sued Bank One and Cal-Western on theories of breach of contract, breach of the implied covenant of good faith and fair dealing, negligence, and negligent misrepresentation.

Residential contended that it was entitled to recover breach of contract damages equivalent to the difference between the fair market value of the real property and the price it tendered at the foreclosure sale (lost equity), arguing that the failure to give effect to the agreement to postpone did not constitute an irregularity in the foreclosure process. In finding that Residential could not prevail as a matter of law on contract based claims, the Court relied on the comprehensive statutory framework regulating nonjudicial foreclosure sales set forth in California Civil Code sections 2924-2924k. Significantly, the Court reasoned that the right of the trustor to postpone the foreclosure sale by agreement with the beneficiary is "as important to the protection of the trustor's property from wrongful foreclosure as are the notice requirements" set forth in the Civil Code. Thus, the Court found that the failure to give effect to an agreement to postpone constituted a substantial defect in statutory procedure. Since the Court further found that only a properly conducted foreclosure sale, free of substantial defects in procedure, creates rights in a bidder at the sale, it held that the discovery of the noncompliance with the postponement requirements prior to the issuance of the trustee's deed limited the remedy of the high bidder at the foreclosure sale to return of the sale price plus interest. As a result, the third party purchaser had no entitlement to damages in light of the mandatory postponement under Civil Code section 2924g. While third party purchasers may attempt to contest the fact of whether an agreement to postpone existed in these types of cases, if the trustee, beneficiary, loan servicer and borrower prove that an agreement to postpone existed, the third party's remedy is limited to the repayment of its bid price plus interest.

Loan servicers and trustees should take particular note of the significance attributed to issuing the trustee's deed upon sale. The Court recognized that the issuance of the trustee's deed containing the "appropriate recitations" gives rise to a statutory presumption of the finality of the sale to a bona fide purchaser. However, when the discovery of the noncompliance with postponement rights occurs before issuance of the trustee's deed, the successful bidder does not suffer prejudice from the simple return of the bid price plus interest. Consequently, lenders, loan servicers and trustees should ensure that they have strong post-sale review procedures in place, follow each of those procedures prior to issuing the trustee's deed, and immediately communicate with one another upon the discovery of a fact which might impact the validity of the sale.

In another important aspect of the decision, the Court found the third party purchaser could not state a negligence claim against either the beneficiary or the trustee for conducting a sale in contravention of an agreement to postpone. Residential argued that the trustee and beneficiary had a duty to verify the status of the loan prior to conducting the sale, and breached this duty by not recognizing the postponement agreement. The Court rejected this argument on several grounds. First, the Court recognized prior California cases limiting the duty owed by a foreclosure trustee to ensure the sale is fairly conducted, according to proper procedures, so as to achieve the highest possible price. With regard to a bidder at a foreclosure sale, the Court noted that the only duty a trustee has is the duty to not unfairly prevent a bidder from participating in an otherwise valid foreclosure sale. In this case, the Court found this limited duty inapplicable because mandatory postponement requirements applied and precluded a valid sale from occurring.

Second, the Court analyzed other cases which had refused to expand the duty of a foreclosure trustee beyond the specific requirements set forth in Civil Code sections 2924-2924k. Indeed, the Court concluded that it would have to engage in "judicial legislation by grafting a tort remedy onto a comprehensive statutory scheme" in order to recognize a negligence claim under the circumstances. Thus, the Court found Residential could not prevail as a matter of law on a negligence cause of action, as the only rights for the unsuccessful high bidder at a mandatorily postponed sale are the return of the price paid plus interest. The ruling on this claim will significantly reduce, if not eliminate, the value of claims that a third party purchaser might attempt to assert after a mistaken sale when it should have been mandatorily postponed.

Finally, the Court rejected Residential's argument that it could prevail on a cause of action for negligent misrepresentation against the beneficiary and trustee. Residential contended that Cal-Western made implied representations that it was conducting a valid sale by first giving the statutory notices of sale, and then by later remaining silent about the postponement agreement and actually conducting the foreclosure sale. Residential further claimed the beneficiary faced liability on this claim for not communicating to the trustee about the postponement of the sale date in a more effective manner. The Court refused to recognize either of these arguments because a claim for negligent misrepresentation requires proof of a positive assertion by the defendant, and Residential had alleged nothing more than implied representations or omissions by Cal-Western and Bank One in connection with the conduct of the foreclosure sale. As to the pre-sale notices, the Court found Residential could not prevail because such notices were accurate when given. The Court ultimately concluded that the comprehensive scheme of nojudicial foreclosure legislation would not permit the imposition of a misrepresentation-based tort duty under the facts of the case. The Court did leave open the remote possibility that a third party could bring a claim for fraudulent inducement in such a case, but that claim would require proof that the beneficiary or trustee intended to deceive the third party purchaser by conducting the sale, which would prove very difficult to establish. Clearly, there is no reason or motivation for a beneficiary or a trustee to intentionally induce a bad sale and then refuse to issue a trustee's deed upon sale. A foreclosure sale in violation of an agreed postponement only happens by mistake, and mistake does not equate to fraudulent inducement.

While the time period for Residential to petition the California Supreme Court for review has not yet expired, it is highly unlikely the California Supreme Court would overturn the unanimous three judge Court of Appeal decision which is well reasoned and which thoroughly analyzes California foreclosure law in its fourteen page decision. The published decision may currently be cited, and will provide a significant defense to lenders, loan servicers, and trustees to claims for damages by third party purchasers when an agreement to postpone the sale is reached and the trustee's deed upon sale is not issued after a mistaken sale.

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