As any real estate lender or investor can testify, holding a junior lien on real estate security can be perilous. Sure, the yields are higher (and in this low interest rate environment, the “search for yield” is a persistent theme). But standing behind the senior in the “recovery line” presents many problems.
Nowhere is this more evident than with purchase money loans. If the borrower defaults and the senior lienholder’s foreclosure sale does not generate sufficient funds to pay the debt owed to the junior, then the junior’s only hope for recovery lies with additional security or guarantors (if any) — the junior cannot enforce the debt personally against the borrower.
None of the above is new.
But a recent decision from the California Court of Appeal (Second District in Los Angeles) — Alborzian v. JPMorgan Chase Bank, N.A. — shows that a junior lienholder can always make its situation worse, and expose itself to civil liability, by simply refusing to admit defeat.
The loan and foreclosure sale
Borrowers Afsheen and Fabiola Alborzian took out two loans to buy their home in 2005. Each loan was secured by a deed of trust on the home.
Wells Fargo held the senior lien. JPMorgan Chase Bank (“JPM”) held the junior lien.
The borrowers defaulted. Wells foreclosed, but the foreclosure sale proceeds were insufficient to pay off JPM’s loan.
Defeat by anti-deficiency
At this point, JPM’s odds of a legal recovery on its debt was nonexistent.
Under the longstanding “purchase money” anti-deficiency policy embodied in California Code of Civil Procedure section 580b, a junior lienholder whose loan is used to purchase a real property and is secured by that property cannot enforce its debt against the borrower personally if the senior lienholder’s foreclosure sale generates insufficient funds to satisfy the junior debt.
The junior lienholder can still resort to additional security or pursue a guarantor. If there are any. In this case, there were not.
But that didn’t stop JPM.
Persistence, at a cost
Rather than write off the loss, JPM pursued the borrowers.
A year after the foreclosure sale, JPM sent the borrowers a letter entitled “Opportunity for Assistance.” The letter stated that the borrowers still owed $67,002 on the (wiped out) junior debt, and offered to accept $16,750 as full “settlement.”
JPM sent a second letter to the borrower entitled “Let’s Settle,” which reaffirmed that $67,002 was “currently due” and offered to accept $10,050 to satisfy the debt and stop all “efforts to collect the amount owed.”
JPM followed up its two letters with debt collection phone calls to the borrowers.
The borrowers sued JPM (on behalf of themselves and a potential class), alleging that section 580b extinguished JPM’s right to enforce its loan against them personally, and that JPM’s letters and calls were misleading for implying that the debt was still enforceable.
The borrowers sought recovery against the lender under several theories, including the Rosenthal Fair Debt Collection Practices Act (“Rosenthal Act” at Cal. Civ. Code sections 1788 et seq.) and the Unfair Competition Law (“UCL” at Cal. Bus. & Prof. Code sections 17200 et seq.).
The trial court sustained JPM’s demurrer and dismissed the case.
The Court of Appeal’s Opinion
The Court of Appeal reversed in substantial part, and restored the borrowers’ claims based on the Rosenthal Act and the UCL.
The Court described the borrower’s claims as turning on “whether a junior lienholder’s attempts to collect on a foreclosed debt is actionable if the attempts inaccurately imply that the debt is still enforceable.”
The Court started by citing section 580b and saying there was “no question” that JPM’s had no legal right to enforce its debt against the borrowers personally. The Court acknowledged that it wasn’t until 2013 — well after JPM made its loan — that the language expressly barring “collection” of a legally unenforceable debt was added to section 580b. For loans made prior to those amendments, the Court held, a lender is not absolutely barred from trying to get the borrower to pay the loan balance voluntarily, but faces liability for violating any other law in doing so.
The Court held that the borrowers stated valid claims under the Rosenthal Act and the UCL. Both of those statutes adopt the standards set forth in the federal Fair Debt Collection Practices Act (“FDCPA” at 15 U.S.C. section 1692 et seq.), and under those standards, a debt collector cannot misrepresent the “character, amount or legal status of any debt” or threaten to take any action that “cannot legally be taken[.]”
Moreover, whether these standards have been violated is determined from the perspective of the “least sophisticated debtor.”
The Court concluded that the borrowers had sufficiently alleged that the letters sent by JPM were actionable because the “unspoken but unmistakable premise of these letters is that plaintiffs’ debt is still valid, due, and owing — in a word, enforceable.”
As a side note, the Court also rejected a bit of “nice try” lawyering by JPM. JPM’s first collection letter contained a legal disclaimer stating that the letter wasn’t really attempting to collect any debt “to the extent” the debt had been discharged, and that the borrowers should seek an attorney’s advice. The Court held that despite this language, the letter still clearly implied that the debt was enforceable, and the average borrower would have “no idea” that the debt had been discharged “unless he or she happened to be familiar with section 580b.” (I can assure you that few debtors — let alone “least sophisticated debtors” — meet this criteria.)
As a holder of a junior lien on real estate security, recognize your inherent weaknesses.
If the senior’s foreclosure sale doesn’t produce sufficient funds to pay the junior debt, then hopefully you have additional security or a guarantor to pursue.
If not, know when to quit and swallow the write-off.
Failing to admit defeat can result in the ultimate reversal of fortune: the borrower becoming your judgment creditor, based on violations of fair debt collection and other laws.