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Beware “Super-Priority” Receivership Liens

In California, lien priority is usually resolved by a straightforward examination of the time of creation or recordation with the County Recorder, which gives “constructive notice” of the lien to the world.

But some liens can have “super-priority,” meaning even if they are created and recorded much later than other recorded liens, they will be first in priority.  Liens created pursuant to a receivership are one example.

A recent opinion from California’s Second District Court of Appeal — City of Sierra Madre v. Suntrust Mortgage, Inc. — illustrates the point.

Facts: receiver appointed to remediate nuisance conditions

Jeffrey and Taryn Hildreth bought a small home in Sierra Madre in 1998.  They began a complete remodel but did not obtain any permits from the city.

The Hildreths also decided to develop the property for commercial use — a wine tasting and sales business.  The city never approved their requested permit, but the Hildreths nonetheless continued developing their property, including excavating a large pit that caused a portion of an adjacent alley to collapse.  The city issued a stop work order in 2005 and ordered the Hildreths to fix the problem.

In 2009, the City discovered that the Hildreths had — again, without permits — excavated another portion of their property which jeopardized the foundation of their house, and issued another stop work order.

Around this time, SunTrust Mortgage refinanced the Hildreth’s mortgage loan of $276,000.  SunTrust’s deed of trust was recorded in March 2009, and was in first priority according to its recordation date.

In 2010, the Hildreths erected a large, unpermitted deck in their front yard that extended over a public sidewalk.  The City issued another stop work order.

The City then sued the Hildreths for nuisance and municipal code violations, among other claims.  The trial court issued a preliminary injunction ordering the Hildreths to remediate the problems.  After the Hildreths failed to comply, the court granted the city’s application for the appointment of a receiver to take custody and control of the Hildreth’s property.  The city and the receiver agreed to wait for the trial court to enter a final judgment before undertaking the remediation work.

Trial Court Judgment and aftermath: super-priority lien for receiver’s certificate

After a 27-day bench trial in 2016, the trial court entered a judgment in favor of the city and against the Hildreths.  The judgment ordered the receiver to oversee remediation of the property.

SunTrust did not participate in the trial, but reserved the right to challenge the issuance of any lien that would displace its position as first lienholder.

After entry of judgment, the receiver presented a remediation plan, which the trial court adopted.  The plan called for the receiver to borrow $250,000 (based on the lowest of three contractor bids) from South County Bank to remediate the nuisance conditions on the property.

The bank required that its loan be secured by a receiver’s certificate with first priority — senior to SunTrust’s lien.  The receiver supported this, as no lender would loan money to the receiver unless it received a super-priority lien.  In its troubled condition, the property had no equity in light of the SunTrust lien.  SunTrust objected to the proposed super-priority lien for the remediation loan.

The trial court authorized the receiver to take the $250,000 remediation loan in exchange for a receiver’s certificate with super-priority, leapfrogging SunTrust’s lien.

SunTrust appealed.

Court of Appeal Opinion: super-priority for receiver’s lien affirmed

The Court of Appeal affirmed the trial court’s decision, holding that the super-priority lien for the receiver’s work was proper.

SunTrust’s main argument was that Health and Safety Code section 17980.7 — one of the statutes under which the receiver was appointed — does not explicitly provide for super-priority liens for remediation work by a receiver.  The Court of Appeal rejected SunTrust’s argument.  The court held that the receiver was also appointed under Code of Civil Procedure sections 564 and 568, which courts have interpreted as providing receivers “very broad powers.”

The court began by noting that “matters related to receiverships rest in the sound discretion of the trial court.”  While this may strike some as a generic proposition, since trial courts generally have wide discretion over many matters, it should be taken very seriously with regard to receiverships.  Receivership law has few black and white areas, and the trial court’s receivership decisions will usually be upheld.

The court went on to observe that trial courts also have wide discretion to authorize a receiver to “borrow money to fund the preservation and management of the property in the receivership estate” and to authorize the issuance of a receiver’s certificate to the lender as security.  “Typically, such a receivership certificate will have priority over all other liens — even preexisting liens.”  The court cited a 1915 California Supreme Court opinion holding that a trial court has discretion to determine that receiver’s certificates “should equitably be given priority” over other liens.

Such super-priority receivership liens, the court noted, “should be infrequent because the disturbance of preexisting liens may bring harsh consequences.”  But here, the super-priority lien was appropriate.  Since no lender would loan money to the receiver without a super-priority lien on the property, the only realistic way to accomplish the necessary remediation work was to authorize the receiver’s request for a super-priority receiver’s certificate.

The court rejected SunTrust’s plea that its lien was “inequitably displaced” by the receiver’s super-priority lien.  SunTrust’s lien had already been rendered worthless due to the nuisance conditions on the property, and SunTrust was extremely limited in its ability to enforce the debt directly against the Hildreths due to California’s anti-deficiency statutes.

The court concluded that:

the imposition of a super-priority lien by the receiver did not substantially prejudice SunTrust because prior to the remediation, SunTrust was the senior lienholder on a property with minimal (or perhaps negative) value and was unlikely to be repaid in any event.  SunTrust’s contention that it should remain the senior lienholder — and benefit from the increased property value provided by the remediation while bearing none of the cost — is simply untenable.

Lesson

Normally, a lien recorded before all others will have first priority.  But receiverships are unique legal devices, driven by equitable considerations and very wide trial court discretion.  Receiver’s certificates may be given super-priority status over prior recorded liens.

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