BILL ANALYSIS                                                                                                                                                                                                    






                        SENATE COMMITTEE ON BANKING, FINANCE,
                                    AND INSURANCE
                           Senator Ronald Calderon, Chair


          SB 931 (Ducheny)         Hearing Date:  April 7, 2010  

          As   March 25, 2010
          Fiscal:             No
          Urgency:       No
          

           SUMMARY    Would require the holder of a first mortgage or deed  
          of trust that is secured by residential real property to accept,  
          as full payment, the proceeds of a short sale to which it agrees  
          in writing, and would obligate that note holder to fully  
          discharge the remaining amount of the borrower's indebtedness on  
          the deed of trust or mortgage following the sale.  
           
          DIGEST
            
          Existing law
            
           1.  Prohibits a lender from using pursuing a borrower for a  
              deficiency judgment on a purchase money mortgage or deed of  
              trust that is secured by single-family residential real property  
              (Code of Civil Procedure 580b).  Note:  There is some  
              disagreement among legal professionals about the circumstances  
              under which the purchase money protection provided by CCP 580b  
              applies.  However, it is generally believed to provide  
              protection to a purchase money note that becomes the subject of  
              a judicial or nonjudicial foreclosure action or a short sale;

           2.  Prohibits a lender from pursuing a borrower for a deficiency  
              judgment on a note on which that lender exercised its power of  
              sale through the nonjudicial foreclosure process (Code of Civil  
              Procedure 580d).  Note:  There is some disagreement among legal  
              professionals about whether this statute additionally applies to  
              notes that become the subject of a judicial foreclosure;
            
            3.  Defines a deficiency judgment as a personal judgment against a  
              debtor for a recovery of secured debt, measured by the  
              difference between the debt and the net proceeds received from a  
              foreclosure sale (case law);
            
            4.  Defines waste, in the context in which it is used in this bill,  




                                               SB 931 (Ducheny), Page 2




              as any unlawful act or omission, by the tenant or other person  
              in possession of land, that causes a permanent injury to the  
              inheritance, by injuriously affecting the market value of the  
              property.  There must be a permanent diminishment or  
              depreciation in the value of the property for waste to have  
              occurred (case law);
            
            5.  Prohibits any person whose interest is subject to the lien of a  
              mortgage from performing any act that will substantially impair  
              the mortgagee's security (Civil Code Section 2929).
            

          This bill

            1.  Would provide that no judgment shall be rendered for any  
              deficiency under a note secured by a first deed of trust or  
              first mortgage for a dwelling of not more than four units,  
              in any case in which the trustor or mortgagor (i.e., the  
              borrower) sells the dwelling for less than the remaining  
              amount of the indebtedness due at the time of sale, with the  
              written consent of the holder of the first deed of trust or  
              first mortgage;

           2.  Would provide that written consent of the holder of the  
              first deed of trust or first mortgage to that short sale  
              would obligate that holder to accept the sale proceeds as  
              full payment, and to fully discharge the remaining amount of  
              the indebtedness on the first mortgage or deed of trust;

           3.  Would expressly not limit the ability of the holder of a  
              first deed of trust or first mortgage to seek damages or use  
              existing rights and remedies against the trustor or  
              mortgagor or a third party, if the trustor or mortgagor  
              commits fraud, with respect to the sale of, or waste, with  
              respect to, the real property that secures the first deed of  
              trust or first mortgage.


           COMMENTS

          1.  Purpose of the bill   To ensure that a borrower is no worse  
              off financially after a short sale than after a foreclosure.  


           2.  Background   A short sale is a real estate transaction in  
              which a lender allows a borrower to sell his or her home for  




                                               SB 931 (Ducheny), Page 3




              less than the full amount the borrower owes on their  
              mortgage.  For example:  John owes his mortgage lender  
              $275,000.  John's mortgage lender agrees to let John sell  
              his house for $225,000, with the understanding that the  
              lender receives all of the proceeds from the house sale.   
              John avoids foreclosure.  John's lender loses out on $50,000  
              in principal to which it was entitled under the provisions  
              of John's mortgage, but the lender avoids the costs of  
              foreclosure, and has one less bank-owned property on its  
              hands.  It is also likely, given the current housing  
              environment, that John's lender nets a greater return  
              through a short sale of the property than the lender would  
              have received, if it had taken back the property through  
              nonjudicial foreclosure and subsequently sold it to a third  
              party.  

          Short sales have begun to increase in popularity among both  
              lenders and borrowers, since California's mortgage troubles  
              first became apparent in early 2007.  According to the  
              California Association of Realtors, there were approximately  
              90,000 short sales in California during 2009, up from only a  
              few thousand in 2008, and a negligible amount in 2007.  

          Some of the advantages of short sales are summarized above.  One  
              of the other key advantages:  negative equity is wiped out.   
              The new property owner is not saddled with a mortgage worth  
              far more than the house; if the new owner even holds a  
              mortgage (some short sales are paid fully in cash), the size  
              of that mortgage is in line with the fair market value of  
              the property.  

          However, as short sales have become more popular, lenders have  
              become more creative in what they require from borrowers, as  
              a condition of agreeing to the short sale.  Several lenders  
              are now requiring borrowers to agree that the lender may  
              pursue them for the difference between the sales price of  
              their home and their unpaid mortgage balance (to agree, in  
              other words, to a sort of hybrid short sale, where the  
              lender temporarily agrees to accept less than the amount  
              they are owed on the mortgage, but reserves the right to  
              pursue that borrower for the full amount at some point in  
              the future).  

          These types of agreements are morally repugnant to some, and are  
              legally questionable in cases where the property being sold  
              secures a purchase-money mortgage.  They can also place  




                                               SB 931 (Ducheny), Page 4




              certain borrowers in the unexpected position of being worse  
              off financially, following a short sale, than they would  
              have been if they had simply walked away from their home and  
              let their lender foreclose.  An explanation of the logic and  
              mathematics behind these unexpected scenarios is provided  
              below.

           3.  How Can A Short Sale Be Worse For A Borrower Than A  
              Foreclosure?   A quick primer on recourse loans, nonrecourse  
              loans, and deficiency judgments is necessary to answer this  
              question.   Four different scenarios then follow, to  
              demonstrate the operation of existing law and the way in  
              which this bill would interact with existing law.  

          California Code of Civil Procedure Section 580b and case law  
              provide that  original, purchase money loans are  
              non-recourse  .  A non-recourse loan is one on which the  
              borrower is not personally liable.  If the borrower defaults  
              on a non-recourse loan, the lender can seize the collateral  
              securing the note, but the lender's recovery is limited to  
              the collateral.  If the value of the collateral is  
              insufficient to cover the outstanding loan balance, the  
              difference between the value of the collateral and the  
              unpaid principal balance of the loan becomes a loss for the  
              lender.

          Some borrowers (particularly those who purchased homes during  
              the boom years of the early to mid 2000s) took out both a  
              first mortgage and a second mortgage when they purchased  
              their homes.  If both loans were taken out at the time of  
              purchase, both are purchase money loans, and both are  
              considered non-recourse.

           Refinanced loans are typically recourse  in nature (the one  
              exception is a scenario in which the borrower refinances a  
              purchase money loan with the same lender and takes out no  
              additional money, other than money to pay closing costs).   
              Thus, in most cases, if a borrower refinances one or more of  
              their purchase money loans, the refinanced mortgage(s) are  
              considered recourse loans.  Recourse loans give the lender  
              the right to pursue a debtor's personal assets, to collect  
              the unpaid principal balance of the loan.  

          California also has what is known as the "one form of action  
              rule," which is found in Section 726(a) of the Code of Civil  
              Procedure.  The one form of action rule is complex and  




                                               SB 931 (Ducheny), Page 5




              embodies a variety of related, but distinct rules and  
              principals, all of which have been litigated.  However, for  
              purposes of explaining the impact of this bill, the one form  
              of action rule may generally (and simply) be described as  
              follows.  Under the one form of action rule, a lender may  
              take only one action to collect on a mortgage or deed of  
              trust.  Thus, if a lender chooses to foreclose, that lender  
              may not pursue the borrower in court to collect the  
              difference between the foreclosure price and the loan  
              amount; the lender's "one form of action" was foreclosure.


           ----------------------------------------------------------------- 
          |Scenario 1 (the problem this bill is attempting to fix):         |
          |Borrower has first deed of trust for $300,000 and second deed of |
          |trust for $90,000.  Both loans are recourse loans, due to a      |
          |refinancing.                                                     |
           ----------------------------------------------------------------- 
          |--------------------------------+--------------------------------|
          |Foreclosure Scenario:           |Short Sale Scenario:  Holder of |
          |Holder of first deed of trust   |first deed of trust agrees to a |
          |forecloses; holder of second    |short sale for fair market      |
          |deed of trust takes no action   |value of $250,000, but states   |
          |and becomes a sold-out junior   |in its approval letter that it  |
          |lienholder.                     |reserves the right to pursue    |
          |                                |the borrower for the difference |
          |                                |between what the property       |
          |                                |fetches at sale and the         |
          |                                |outstanding, unpaid principal   |
          |                                |balance of the loan.  Holder of |
          |                                |second deed of trust agrees to  |
          |                                |the short sale (Note:  the      |
          |                                |holder of the second deed of    |
          |                                |trust must agree to the short   |
          |                                |sale, before it may go          |
          |                                |forward).                       |
          |--------------------------------+--------------------------------|
          |Impact on the borrower:  When   |Impact on the borrower:  The    |
          |the holder of the first deed of |holder of the first deed of     |
          |trust forecloses, it has no     |trust may pursue the borrower   |
          |further ability to pursue any   |for $50,000 (the difference     |
          |deficiency under the one form   |between the $300,000 the        |
          |of action rule.  Because the    |borrower owes on the note and   |
          |second deed of trust is a       |the $250,000 the sale           |
          |recourse loan, the sold out     |generates).  Because the second |
          |junior lienholder may pursue    |deed of trust is a recourse     |




                                               SB 931 (Ducheny), Page 6




          |the borrower for a deficiency   |loan, the sold-out junior       |
          |judgment of $90,000.            |lienholder may pursue the       |
          |                                |borrower for a deficiency       |
          |                                |judgment of $90,000             |
          |--------------------------------+--------------------------------|
          |                                |Net result:  Borrower has       |
          |Net result:  Borrower has       |$140,000 in personal liability  |
          |$90,000 in personal liability.  |and is worse off financially    |
          |                                |under a short sale.             |
           ----------------------------------------------------------------- 
           
           ----------------------------------------------------------------- 
          |Scenario 2 (another example of the problem this bill is trying   |
          |to fix):  Borrower has first deed of trust for $300,000 and      |
          |second deed of trust for $90,000.  Both loans are purchase money |
          |loans and thus non-recourse.                                     |
           ----------------------------------------------------------------- 
          |--------------------------------+--------------------------------|
          |Foreclosure Scenario:           |Short Sale Scenario:  Holder of |
          |Holder of first deed of trust   |first deed of trust agrees to a |
          |forecloses.                     |short sale for fair market      |
          |                                |value of $250,000, but states   |
          |                                |in its approval letter that it  |
          |                                |reserves the right to pursue    |
          |                                |the borrower for the difference |
          |                                |between what the property       |
          |                                |fetches at sale and the         |
          |                                |outstanding, unpaid principal   |
          |                                |balance of the loan.            |
          |--------------------------------+--------------------------------|
          |Impact on the borrower:  When   |Impact on the borrower:  The    |
          |the holder of the first deed of |holder of the first deed of     |
          |trust forecloses, it has no     |trust may attempt to pursue the |
          |further ability to pursue any   |borrower for $50,000 (the       |
          |deficiency under the one form   |difference between the $300,000 |
          |of action rule.  The holder of  |the borrower owes on the note   |
          |the second deed of trust        |and the $250,000 the sale       |
          |becomes a sold-out junior       |generates).  The question of    |
          |lienholder but lacks any        |whether such an action is       |
          |recourse against the borrower,  |prohibited by CCP 580b has not  |
          |because the loan is             |yet been litigated, and is thus |
          |non-recourse.                   |unresolved.  The holder of the  |
          |                                |second deed of trust agrees to  |
          |                                |the short sale and becomes a    |
          |                                |sold-out junior lienholder, but |
          |                                |lacks any recourse against the  |




                                               SB 931 (Ducheny), Page 7




          |                                |borrower, because the loan is   |
          |                                |non-recourse                    |
          |--------------------------------+--------------------------------|
          |Net result:  Borrower has $0 in |Net result:  Borrower may have  |
          |personal liability.             |$50,000 in personal liability   |
          |                                |and could be worse off under a  |
          |                                |short sale.                     |
          |                                |                                |
           ----------------------------------------------------------------- 

           ----------------------------------------------------------------- 
          |Scenario 3 (how this bill would work, if enacted):  Borrower has |
          |first deed of trust for $300,000 and second deed of trust for    |
          |$90,000.  Both loans are recourse loans, due to a refinancing.   |
           ----------------------------------------------------------------- 
          |--------------------------------+--------------------------------|
          |Foreclosure Scenario:           |Short Sale Scenario:  Holder of |
          |Holder of first deed of trust   |first deed of trust agrees to a |
          |forecloses.                     |short sale for fair market      |
          |                                |value of $250,000 and must      |
          |                                |accept that value as full       |
          |                                |payment.                        |
          |--------------------------------+--------------------------------|
          |Impact on the borrower:  When   |Impact on the borrower:  When   |
          |the holder of the first deed of |the holder of the first deed of |
          |trust forecloses, it has no     |trust agrees in writing to the  |
          |further ability to pursue any   |short sale, it has no further   |
          |deficiency under the one form   |recourse to pursue any          |
          |of action rule.  The holder of  |deficiency against the          |
          |the second deed of trust        |borrower.  The holder of the    |
          |becomes a sold-out junior       |second deed of trust becomes a  |
          |lienholder.  Because the second |sold-out junior lienholder.     |
          |deed of trust is a recourse     |Because the second deed of      |
          |loan, the sold out junior       |trust is a recourse loan, the   |
          |lienholder may pursue the       |sold-out junior lienholder may  |
          |borrower for a deficiency       |pursue the borrower for a       |
          |judgment of $90,000.            |deficiency judgment of $90,000  |
          |--------------------------------+--------------------------------|
          |Net result:  Borrower has       |Net result:  Borrower has       |
          |$90,000 in personal liability   |$90,000 in personal liability   |
          |                                |and is not worse off after a    |
          |                                |short sale.                     |
          |                                |                                |
           ----------------------------------------------------------------- 

           ----------------------------------------------------------------- 




                                               SB 931 (Ducheny), Page 8




          |Scenario 4 (another example of how this bill would work, if      |
          |enacted):  Borrower has first deed of trust for $300,000.  The   |
          |loan is a recourse loan, due to a refinancing.                   |
           ----------------------------------------------------------------- 
          |--------------------------------+--------------------------------|
          |Foreclosure Scenario:           |Short Sale Scenario:  Holder of |
          |Holder of first deed of trust   |first deed of trust agrees to a |
          |forecloses.                     |short sale for fair market      |
          |                                |value of $250,000 and must      |
          |                                |accept that value as full       |
          |                                |payment.                        |
          |--------------------------------+--------------------------------|
          |Impact on the borrower:  When   |Impact on the borrower:  When   |
          |the holder of the first deed of |the holder of the first deed of |
          |trust forecloses, it has no     |trust agrees in writing to the  |
          |further ability to pursue any   |short sale, it has no further   |
          |deficiency under the one form   |recourse to pursue any          |
          |of action rule and CCP 580d.    |deficiency against the          |
          |                                |borrower.                       |
          |--------------------------------+--------------------------------|
          |Net result:  Borrower has $0 in |Net result:  Borrower has $0 in |
          |personal liability.             |personal liability and is not   |
          |                                |worse off under a short sale.   |
          |                                |                                |
           ----------------------------------------------------------------- 


           4.  Support   The Housing Opportunities Collaborative is  
              supporting this bill, for the reasons stated above.  The  
              Collaborative notes that a short sale appears as "settled  
              debt" on a borrower's credit report and helps a homeowner  
              feel like they took responsibility for their mortgage  
              obligation, rather than simply walking away.  Yet, for many  
              homeowners (see scenarios above), a short sale can result in  
              greater personal liability than a foreclosure.  

          According to the Housing Opportunities Collaborative, many real  
              estate licensees who assist homeowners with short sales are  
              not fully aware of how the various scenarios work, and some  
              short sellers are likely to be surprised in years to come,  
              when collection agencies and attorneys attempt to collect or  
              obtain judgments corresponding to the personal liability the  
              short sellers incurred. The Housing Opportunities  
              Collaborative asserts that short sales prevent the vacancies  
              that often follow foreclosures, keep the real estate market  
              moving, and save banks millions in foreclosure costs and  




                                               SB 931 (Ducheny), Page 9




              costs associated with REO properties.  They also observe  
              that on several occasions, homeowners with non-purchase  
              money loans have been surprised and torn by the financial  
              outcomes that can result from a short sale.  After learning  
              of these outcomes, "many decide that a short sale just isn't  
              the smart decision."

           5.  Opposition    None received.

           6.  Prior and Related Legislation  

                  a.        SB 1178 (Corbett):  Would give certain  
                    refinanced loans non-recourse status.  Pending on the  
                    Senate Floor.

           
          POSITIONS
          
          Support
           
          Housing Opportunities Collaborative 
          
          Oppose
               
          None received

          Consultant:  Eileen Newhall  (916) 651-4102