Lawyers 101

Receivers have recently been in the Sacramento news concerning the status of the Senator Hotel, a situation where the loan was in default and the lender had a receiver appointed.. With distressed properties at record levels, an increasing number of Lenders are turning to receivership to help salvage troubled properties.

The appointed receiver is an officer of the court and is accountable to the judge. A receiver’s primary duty is to secure the property, prevent waste, and collect rents. In general, the receiver is required to follow the court’s order, which may include specific authority to manage the property, collect rents, and provide monthly accountings. In some instances, the court may grant the receiver authority to enter into leases and position the property for sale. Once appointed, the receiver takes custody of the property, changing locks, securing operating accounts, and retrieving property-related documents from the borrower. The receiver itemizes personal property of the borrower, notify tenants the change in control, transfer of utility bills, place property insurance, hire a third-party management company, maintain or entering into new service contracts with vendors, and other issues concerning the property’s overall operation and security. The receiver must act quickly so that the borrower does not harm the property.

This blog addresses only California state law, and not US Bankruptcy law, which has its own procedure. In California, appointment is made under Code of Civil Procedure section 564. The two most common lawsuits in which a receivers are appointed under section 564 are:
paragraph (2) In an action by a secured lender for the foreclosure of a deed of trust or mortgage and sale of property …and that the property is probably insufficient to discharge the deed of trust or mortgage debt.; or
paragraph (11) In an action by a secured lender for specific performance of an assignment of rents provision in a deed of trust, mortgage, or separate assignment document…

Paragraph 2 can create a problem for the lender, however, in that making the argument that the value of the property is less than the loan balance is an admission that the lender ‘s claim is undersecured, with bad results if the borrower ends up filing bankruptcy. It is important that the lender consult with an experienced California Real Estate attorney before proceeding.

There is no clear authority for the receiver to sell the property outright, and there are decisions to the contrary. However, appointment of a receiver can go hand in hand with a foreclosure, either by trustee sale or judicial foreclosure sought in the same action as the appointment of the receiver. The receiver can manage and preserve the property and collect the rents while the foreclosure proceeds, which can take a long time in a judicial foreclosure.

A benefit under the law is that appointment of a receiver does not run afoul of the “one action” rule (CCP 726) because it is expressly exempted under Civil Code section 2938. Thus, the lender can get hold of the rents and profits without losing their security due to the one action rule. Still of concern, however, is the collection by the receiver of rents already received by the borrower- at some point they can conceivably lose their character as “rents and profits,” and thus taking possession of them could violate 726.

California adverse possession and prescriptive easement law has undergone some evolution in California since its rural beginnings. Now commonly claimed in urban areas, the courts had modified the available remedies.

Adverse possession is the process in which someone acquires ownership of another’s land. The claimant must prove:

(1) possession under claim of right or color of title;
(2) actual, open, and notorious occupation of the premises constituting reasonable notice to the true owner;
(3) possession which is adverse and hostile to the true owner;
(4) continuous possession for at least five years; and
(5) payment of all taxes assessed against the property during the five-year period.
Mehdizadeh v. Mincer @ 1305

A prescriptive easement is the process by which one acquires only the right to use the land of another. To establish an easement by prescription, the claimant must meet the following four tests:

(1) The claimant must occupy or utilize the land in circumstances providing reasonable notice to the owner.

(2) The occupancy or use must be continuous and uninterrupted for five years. The period for both is established in the Code of Civil Procedure. (Occasional use of a road, e.g. on weekends, would create a right to use it with the same frequency.)

(3) The use must be under color of title (a written or deeded easement, though it may be incorrect or in the wrong location) or claim of right (claiming a right to use the property, though not founded on a written instrument; the claim need not be based on a good faith belief in the title.)

(4) The claimant’s use must be exclusive and “hostile” to the owner’s title (not in the common sense of hostility, but rather unaccompanied by recognition of the right of the true owner to bar the claimant from use.) Mehdizadeh @ 1305.

Experienced Sacramento real estate attorneys often see the problem arising in the case of residential neighbors with a fence between them. For some reason, one party, we’ll call the surprised neighbor, finds that the fence encroaches on their side of the property line- the encroacher has gained another foot or two in their backyard. The encroacher has had a garden in this area, or a driveway, for twenty years. The sad neighbor complains, the neighbors are at arms, and someone files suit.

The encroacher claims an exclusive prescriptive easement; after all, it’s fenced, he has had 100% use for more then five years. But California courts do not agree. An exclusive prescriptive easement, which as a practical matter completely prohibits the true owner from using his land, has no application to a simple backyard dispute. As stated in Silacci v. Abramson, an easement is merely the right to use the land of another for a specific purpose–most often, the right to cross the land of another. An easement acquired by prescription is one acquired by adverse use for a certain period. An easement, however, is not an ownership interest, and certainly does not amount to a fee simple estate.

Thus, the courts are not inclined to grant exclusive rights in the usual case. However, they do have the power to reach an “equitable” or fair solution that is technically different from a prescriptive easement. It can grant the trespasser some legal rights, and also require them to pay for them.

Lenders on commercial properties usually require a Deed of Trust that gives them an assignment of rents and profits. The idea is that, if the borrower defaults, the lender is entitled to all rents and profits which have accrued and are collected after the default. Profit is short for” profit-à-prendre”, middle French for right of taking, meaning a right to go on property and take natural resources, such as timber, crops, or minerals.
This assumes that the borrower has leased the property and has something to collect. The frustration of small and moderate commercial lenders is with the knowledge that, while they are not getting paid, the defaulting borrower is collecting cash from its tenants. Enforcement of the assignment of rents clause can provide some satisfaction.

The enforcement of the rents and profits assignment is governed by California Civil Code section 2938. It requires that the assignment must be perfected by recording. And it provides lenders four ways to enforce assignments of rent, summarized as:
(1) The appointment of a receiver,
(2) Obtaining possession of the rents, issues, or profits,
(3) Delivery to any one or more of the tenants of a written demand
for turnover of rents, or
(4) Delivery to the assignor of a written demand for the rents.

The statute also protects the lender enforcing its rights under the statute by providing that such enforcement does not violate the one action rule of Civil Procedure section 726; the lender may still foreclose, and if it does so judicially, may seek a deficiency judgment. However, it provides that rents collected by the lender are to be credited against amounts required to reinstate the loan (Civil Code 2924(c). The unwary lender collecting rents and profits directly may accidentally reinstate the loan, taking the borrower out of default. The lender needs to calculate the risk of this happening; an alternative is to have a receiver appointed, in which case the lender does not usually receive rent until after completion of a foreclosure, thus avoiding risk of triggering a reinstatement.

Another concern for the lender is that, under subdivision g, the borrower or any of its other assignees can demand that the collecting lender use those rents for the “reasonable costs of protecting and preserving the property”, including payment of taxes and insurance and compliance with building and housing codes. The collecting lender then becomes obligated to do so, and that obligation continues until the lender either ceases to collect the rents or has a receiver appointed to do so. Lenders considering collection should consult with an experienced California real estate attorney.

California statutes and legal decisions characterize rents and profits as real property collateral, not personal property, even after the borrower landlord collects them. However, for the creditor to collect, they must take one of the statutory steps, otherwise, the borrower-landlord is free to do what they want with the cash.

A recent decision granted a judgment to a neighbor for a fire in Santa Clara County. The plaintiff owned several original documents written by Albert Einstein; the plaintiff’s father & Einstein were friends. To go through the papers, the plaintiff had brought them to his get-away trailer parked on rural land near Henry Coe State Park. The defendants were co-owners of the 400 acre property where the fire started. On this property they had a 55 gallon drum they used as a burn barrel. The naughty party started a trash fire in the barrel, left it unattended, and started the 48,000 acre Lick fire.

There were numerous owners of the 400 acres; one defendant, who suffered a $750,000 judgment, owned only 2% and claims he did not know he owned an interest until he was served with the lawsuit. Apparently the jury was convinced that all the owners were aware of the burn barrel and the dangerous condition it created, and that owners other than the fire-starter should be liable.

What are the legal principals involved in such a decision? As summarized in a 1955 decision, Reid & Sibell v. Gilmore & Edwards, the general rule is that ‘A possessor of land is required to make reasonable use of his premises which causes no unreasonable harm to those in the vicinity, either by reason of the character of the use itself or because of the manner in which it is conducted.’ A landowner has a right to be free of unreasonable risk in the enjoyment of his property. This places a duty on others to not cause such unreasonable risk. Here, a finding that the fire starter acted negligently established that the risk of interfering with the neighbor was unreasonable.

How can a landowner avoid this kind of liability surprise? Of course fire safety is the obvious answer; but this case had the aspect of the co-owner who did not know he owned any interest in the property. This is the likely result of several generations of inheritance. As each generation passed, the succeeding generations inherited smaller and smaller fractionalized interests. Part of clearing an estate includes contacting all express and potential heirs; maybe this owner did not pay attention to a notification he received, or perhaps the estate administration was sloppy. Though a deed must be “accepted” by the grantee to be effective, but once it is recorded it can be presumed effective, unless there is evidence otherwise. An experienced California Real Estate Attorney might make such an argument in this situation. This case just shows it is important to pay attention to who your relatives are, and what is going on when they pass away.

An illusory contract, or illusory promise, is one where the person making the promise has a free pass not to perform. For example, if the duty of a party to performed is subject to his own approval, without conditions, then there is no legal detriment, and no contract at all. If you promise to sell me your apples at 20 cents each, and I promise to buy as many as I decide to order, we do not have a contract. If my promised is conditioned on the apples not having worms, we have a deal.

In a recent California commercial lease decision, the tenant argued that the rental agreement was illusory. Thrifty-Payless Inc. leased space in an undeveloped shopping center to operate a drug store. The Landlord was to spend lots of money up-front to develop the site and obtain numerous government approvals first, and then Tenant’s obligations would began. The lease contained 2 relevant provisions- 1, that the Landlord could terminate if, acting with due diligence (a requirement- not illusory) it could not obtain the permits. And 2, Either the Landlord or Tenant could terminate if the property was not ready by a specified date.

During the process the Landlord proposed what it refers to as a “lease amendment” and what Rite Aid refers to as a “campaign of deception and threats” to increase the rent. The Landlord said that construction costs had increased, and referred to a “2-way termination right” if the lease did not begin by the deadline. The tenant was not interested. From the tenant’s perspective the Landlord misrepresented that it could not currently complete construction by the deadline, including “alter[ing]” construction schedules. Meanwhile the landlord continued to represent to other potential tenants that the property would be open by the deadline. The Landlord terminated under provision 2. The lawsuit commenced.

The tenant argued that the mutual termination provision (2 above) made the lease illusory. The court disagreed. The lease required the Landlord to act diligently to obtain the approvals. Even if the “campaign” was an attempt at repudiation, the Landlord did not cease efforts to complete the store until the State denied approval of a required traffic light. The landlord incurred legal detriment, and attempted performance under an enforceable contract.

I can feel some sympathy for the Tenant’s position. Thought it probably got a great deal on the rent, the landlord probably benefitted in obtaining financing by having it pre-leased. And there is an incentive for the Landlord to delay completion, then terminate and seek higher rent. The original drafts of the lease allowed only the Tenant to terminate after the deadline- making it mutual significantly changed the motivation. Also, with the Landlord seeking term extensions and a rent increase, pointing to the termination clause, while telling other potential tenants that the property would be ready in time, would raise the hackles of any tenant. Maybe the landlord sought advice from a commercial lease attorney, because the key for the court seemed to have been that they kept spending money on the project. There is no record in the decision of how much, but at lease enough to appear to be moving forward. But that was in their own interest, and they were probably going to develop the property no matter what.

The average length of unemployment is now nine months, according to the Treasury Department, but Federal foreclosure help for the unemployed only lasts for three months. The Treasury Department was given $46 billion to spend on keeping homeowners in their houses; to date, the agency. Big Deal.

Meanwhile, the Keep Your Home California program, using $2 Billion in Federal Money, has enlisted lenders servicing about 80% of California Residential Mortgages. The California program requires the participation of lenders, and for the unemployed, will provide mortgage payments of up to $3,000 per month for up to six months. If you are looking to participate in the program, go HERE.

The program is run by the California Housing Finance Agency, created as the state’s affordable housing bank to make low interest loans for low and moderate income Californians.

There are four different programs under “Keep Your Home California”,
including the Unemployment Mortgage Assistance Program. In this program, the homeowner qualifies if their household income is 120% or less of the Housing & Community Development Area Median income.

Median household income, family of 4, for several counties:
Amador $67,900
Calaveras $64,100
Contra Costa $90,300
El Dorado $73,100
Placer $73,100
Sacramento $73,100
San Mateo $99,400
Sierra $57,400
Tuolumne $59,700
Yolo $72,500
Yuba $56,300

The loan CANNOT be more then three payments behind.

Another program is for reinstating a loan temporarily delinquent due to hardship, by payment of up to $15,000. There is a principal reduction program for owners with severely negative equity. Lastly, there is a transition assistance program, used in conjunction with a short sale or deed-in-lieu.

The California program seems to be effective for some troubled homeowners. Though it is too late for many, the country is less than a third of the way through the underwater housing, so there are many opportunities to help people ahead. The most important characteristic is that lenders are participating. Every Sacramento and Placer County experienced real estate attorney hears constantly about problems people are having communicating with lenders, be it for home modifications, or other federal programs. In most cases, they are strung along in trial programs, then denied, and in some cases the foreclosure proceeds ahead anyway. The befuddled, now former, homeowner is facing evicting after paying monthly what the lender told them to pay. In contrast, those volunteering to participate in the state program are subject to the program rules. Amazingly, the agency managing the program is not reliant on the troubled state budget- it is self financed.

The California Limited Liability Company (“LLC’) is often used as an entity to limit personal liability in operating a business or holding assets such as real estate. An LLC’s members do not have personal liability for the debts of the LLC, as long as they respect the separateness of the LLC entity. An LCC is governed by the terms of an Operating Agreement Some licensed professions, however, such as real estate brokers and attorneys, are not allowed to use the LLC entity.

Not available under California law however is the “Series LLC”. A series LLC is a single LLC entity which can be composed of a number of ‘series;’ separate sub-entities which can hold different assets, and there is no crossover in liability between the series. Of course, the series have to each be treated as arms-length separate series, without commingling funds, but if they are they provide a unique protection. An experienced Sacramento Business Attorney can assist you in ensuring that you do not risk losing the protection of limited liability company.

As an example of how the series LLC works, suppose the John Doe LLC holds, in Series 1, a commercial property operated as a rifle range. Series 2 holds a 12 unit apartment building. If there is a tragic accident at the shooting range resulting in liability for the owner of the commercial property, a judgment can only be enforced against Series 1 assets, not Series 2 assets. This is equivalent to forming two separate California LLCs for the two properties. Delaware, Nevada, Illinois, Oklahoma, and Iowa all allow for series LLC.

However, there are considerations which make the Series LLC less useful in California. In any state which provides for series LLCs, you will be required to engage a full time agent for service of process in that state. You will pay the state fees annually, and will need a Certificate of Good Standing (or the local equivalent), because you must register the series LLC as a foreign LLC in California. A foreign LLC pays the same annual fee/tax as a domestic LLC of $800. However, most importantly, the California Secretary of State and Franchise Tax Board now take the position that EACH series must register separately, and thus each series must pay $800 annually for the privilege of being an entity legally doing business in California.

The California Civil Code has an extensive pre-lawsuit set of procedures for a homeowner to follow to have their homebuilder make repairs. The builder can opt-out and provide his own pre-suit procedures; a recent court decision shows how risky that can be.

First the procedures- starting at Civil Code section 910, they provide that the owner must make a written claim of violation of construction standards on the builder, who has 30 days to respond. The builder can inspect the property, and offer in writing to repair. The owner can accept or not accept the offer to repair, and demand a mediation. If this process is not successful, or if the builder does not respond within the time limits in the code, the homeowner may file a lawsuit. The goal is to provide a non adversarial framework to resolve the problems before people get too emotionally entrenched in the dispute, so it can only be resolved by a judge.

In Anders v Meritage Homes, the Stanislaus County plaintiffs sued the builder for construction defects. In the sales contract the builder had taken advantage of a provision in the civil code section 914 that allows them to opt-out of the statutory procedure, and use their own selected procedure. At the time of sale, this election is binding on the builder. However, the court found that the builder’s own procedures were unenforceable- they could not require the owners to follow them. So, the builder said, we must then use the statutory procedure. Looks like the builder wanted to avoid court. It was not clear from the opinion why the builder’s procedures were unenforceable, but to this real estate attorney it looks like the builder created a procedure to fit its customer service program, rather that allow their program to fit into the statutory procedure.

The court of appeals said no- section 914 provides that, once the builder elects their own alternate process, they cannot require the owner to comply with the statute; and that the builder’s election is binding “regardless of whether the builder’s alternative nonadversarial contractual provisions are successful in resolving the ultimate dispute or are ultimately enforceable”

Here, where the builder’s own procedure could not be used, the homeowners were allowed to pursue the lawsuit. The decision noted that the trial judge asked the homeowners’ attorney, three different times, what is wrong with requiring the owners to comply with the statutory procedure, pressuring the attorney to concede. Finally the attorney said there was nothing wrong with it, though his clients had a right not to and proceed with litigation. The court of appeals agreed, noting that statutes are clear, and when the legislature establishes policy, ‘it is not for the courts to differ.’

The California legislature last year passed senate bill 931, which became Code of Civil Procedure section 580e, effective January 2011. It provides that when a residential lender in the first position (i.e., the deed of trust recorded first in time) approves in writing a short sale, the lender cannot later seek payment for the unpaid loan balance. A short sale is one in which the lender agrees to accept less then the balance due to release the property from the deed of trust by recording a reconveyance of the deed of trust.

The purpose of this was to solve the problem of ambiguous short sale agreements in which the unsuspecting former homeowner could find themselves subject to the lenders efforts to collect the balance. Presumably the new law has not had much impact on the pace of short sales, as the savvy lender, and homeowner advised by an experienced real estate attorney, know that if the owner walks away from the property and the lender holds a trustee’s sale (foreclosure by the power of sale), the lender could not get a deficiency judgment, so in agreeing to the short sale the lender avoids the time and expense of foreclosure.

New proposed legislation, SB 458, proposes to do the same thing for ALL loans secured by a deed of trust against the property- first, second, and whatever. Thus, the home equity lender will only approve a short sale if it is willing to write it all off, except the $3-4,000 that the first lender may allow it to receive. Especially galling is the following language, added in the May 16, 2011 amendment:

” (b) A holder of a note shall not require the trustor, mortgagor,
or maker of the note to pay any additional compensation, aside from
the proceeds of the sale, in exchange for the written consent to the
sale.”

Often, a second lender will require the seller to contribute some cash to approve the sale. This proposed law does not allow it. It ties the hands of the junior lenders. I believe this will severely reduce the number of short sales approved in California, and boost the number of foreclosures. As I noted in a March blog post concerning foreclosures and the housing crisis, the country is now only 25% through the housing crisis. This legislation will help ensure the continued decline of the California real estate market.

A California mortgage lender does not owe fiduciary duty to a borrower; a mortgage broker does. The difference is substantial, and a loan officer in Ventura County learned the hard way. A fiduciary duty is a duty of both loyalty and good faith.

Borrower Tonya contacted loan officer Anthony in response to an advertisement. She had existing first & second loans, and wanted a home equity loan (HELOC). Anthony told her could shop the loan. However, he later said she did not qualify for a HELOC because her credit scores were too low. He said he had ‘shopped’ it with more then one lender, and that they looked at every lender that offered a HELOC that they were able to process. (Here’s a key to the story- this was to be a NO DOCS loan). He recommended refinancing into a new $700,000 first, with an interest margin of 3.85 over the indexed rate, which she did. It was agreed that there would not be a prepayment penalty, but one got slipped in on a rider, a surprise every experienced Sacramento Real Estate Attorney has seen in their practice before.

Eventually Tonya got wise and sued. Her expert testified that the interest she paid was astronomical, and she could have obtained a loan with a much lower rate, the present value of the difference being $72,187.17. Plus there would be no repayment penalty. Now she cannot refinance because she cannot provide documentation of income- she needs a no docs loan, but no one does that anymore!

The Court of Appeals in Smith v. Home Loan Funding ruled that the lender acted as a broker, thus invoking a duty to obtain the best loan. Anthony said he would shop the loan, and did look at every lender “that we were able to process.” But that was only the lenders they were affiliated with in-house. On appeal the lender argued that it was error to calculate the damages over the full 30 year term of the loan, as there was not evidence that she would hold the loan for the full 30 years. There are decisions that allow for a reduced term, because the average home is held for only 7-10 years. But here, the court refused to speculate on what Tonya might do; as she is unlikely to qualify to refinance, “she is more likely than anyone to be saddled with a 30-year mortgage.”

The trial court also awarded attorney fees based on provisions the Promissory Note and Deed of Trust, which the lender disputed as the claims were for torts- breach of fiduciary duty and misrepresentation. However, there was also a finding of breach of the implied covenant of good faith and fair dealing, which is implied in every contract. Such a breach can support an attorney fee award under Civil Code 1717, and here the trial court treated the oral agreement (to shop the loan) and the written loan documents as a single agreement. Thus, the court threw the book at the Lender, awarding attorney fees to Tonya.

One way to look at this case is to say the loan officer was trying to be helpful, and no good deed goes unpunished. However, we all (including judges) now have some insight into loan practices that occurred in the last few years. If he was really ‘shopping’ the loan, trying to get her the best deal, he didn’t need to take on the huge interest margin. How helpful was he really? I submit that the margin markup was high, rather than increasing the points, was because borrowers did not understand what was going on, but they did understand points.