Borrower’s Deficiency Protection Limited – Lenders May Pursue Claims for Sold Out Junior Loans


This month, the California Supreme Court affirmed the Fourth District’s decision in Black Sky Capital, LLC v. Cobb (2017) 12 Cal.App.5th 887 (“Black Sky”), ruling that a creditor who holds two deed of trust on the same property may recover a deficiency judgment on a junior lien extinguished by a nonjudicial foreclosure sale on the senior lien.

In so holding, the California Supreme Court applied a strict construction of Code of Civil Procedure section 580d, which reads, in part, “…no deficiency shall be owed or collected, and no deficiency judgment shall be rendered for a deficiency on a note secured by a deed of trust or mortgage on real property or an estate for years therein executed in any case in which the real property or estate for years therein has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.” CCP §580d(a).

Relying on the plain language of section 580d, the California Supreme Court emphasized that the statute precludes a deficiency judgement on a note secure by a deed of trust on real property when the trustee has sold the property “under power of sale contained in the … deed of trust. The court concurred with the Fourth District’s reasoning that the phrase “the … deed of trust” makes clear that section 580d applies only where the sale of the property has occurred under the deed of trust securing the note sued upon, and not some other deed of trust. In the words of the California Supreme Court, “nothing in the text of section 580d indicates that the statute applies where no sale has occurred under the trust deed securing a junior lien, even if the lien is held by a creditor who has foreclosed on a senior lien on the same property.”

The Fourth District’s ruling – and the California Supreme Court’s affirmation of the same – stray from the long followed decision in Simon v. Superior Court, (1992) 4 Cal.App.4th, 63, 66, which held that the anti-deficiency protections of California Code of Civil Procedure 580d barred a creditor in such circumstances from pursuing a deficiency on the junior note. While noting that where there is evidence of “gamesmanship” (e.g. intentional loan splitting, bid rigging, etc.) by the holder of senior and junior liens on the same property, a substantial question may arise whether the liens should be treated as a single lien within the meaning of section 580d, the California Supreme Court concluded that such circumstances were not present in the case before it, as the loans at issue were made more than two years apart. The court did not elaborate on what other factors might be considered in determining the presence of “gamesmanship” by a holder of senior and junior liens on the same property.

Practical Considerations

The California Supreme Court’s upholding of the Fourth District’s ruling is likely to be heralded as a victory for lenders, as the opinion in Simon – which unequivocally rejected a lender’s ability to recover on a junior lien after foreclosing on the senior lien – is now a dead letter. So long as the two loans are truly separate and there have been no improprieties at the foreclosure sale, a lender foreclosing on a senior note should be able to pursue a deficiency judgment on the junior note.

Unfortunately, the California Supreme Court provided virtually no guidance on what would constitute “loan splitting.” In Simon, two loans were signed four days apart with the liens recorded on the same day, while Black Sky involved loans made two years apart. The large delta between the respective timelines of senior and junior loans being made in Simon and Black Sky creates a gray area that will at some point need to be addressed by the courts. When has enough time passed so that a subsequent loan made on the same property would not constitute loan splitting? Six weeks? Six months? A year? What were the motivations behind making the second loan? For now, those questions will remain unanswered at the judicial level. In the meantime, lenders should carefully consider these circumstances when making or buying multiple loans secured by the same property.

Authored by Reuben, Junius & Rose, LLP Attorney, Michael Corbett

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient. Readers should consult with legal counsel before relying on any of the information contained herein. Reuben, Junius & Rose, LLP is a full service real estate law firm. We specialize in land use, development and entitlement law. We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.