California
Real Property Reporter, May 2007
Attorney Fees and Lien Priorities; Statute of Frauds
Roger Bernhardt
[I have really written two Midcourse Corrections columns for this issue, but have hidden them under one heading so that the CEB publishers would not realize I was breaking their rules. This first one is on offsets, attorney fees, and lien priorities; below it is a second column on the Statute of Frauds.—RB]
Behniwal v Mix
Until I read the decision in Behniwal v Mix (2006) 147 CA4th 621, 54 CR3d 427, reported on p 84, I had always innocently believed that a purchaser who was successful in a specific performance action, and who had an attorney fees clause in his contract, could deduct what he was awarded by the court for those fees from the amount that he would have to pay. Now I have learned that the rule is otherwise, but I have to say that I regret that and I would like to find some way to get around it.
The Behniwals finally prevailed in their action to compel the Mixes to honor their contract to sell their condominium unit to them for $540,000 and, in addition, were awarded over $250,000 in attorney fees. (The matter had gone to the court of appeal on at least three prior occasions, and I have commented on two of its previous opinions—see 29 CEB RPLR 222 (Jan. 2006) and 28 CEB RPLR 83 (May 2005).) The trial court ordered the attorney fees to be deducted from the purchase price, but that order was reversed on this appeal. According to Justice Sills, who had authored all of the opinions in this interesting saga, the attorney fees award ranks below two deeds of trust on the seller’s property as well as the seller’s homestead declaration. Since those three other claims by themselves exceed the purchase price, if attorney fees were taken off the top, it would play “absolute havoc with the law of liens and lien priorities.” 146 CA4th at 632.
Justice Sills reached this conclusion by some very elegant reasoning. He first determined that an attorney fees award in a specific performance action by itself does not reduce the price in the same way that an equitable adjustment might. (The older cases that seemed to say that were doing so only as a kind of “rough justice” in contexts where priority did not matter.) The fee award is not mere incidental relief to a specific performance decree, but rather an additional right—created by the attorney fees clause in the contract—with no special claim to any lien superpriority. Attorney fees are just a money judgment that will function like a lien (with concomitant lien priority) only after it has been recorded.
Offsets and Priorities
It is hard to disagree with any of that reasoning, but the legislature may have superseded it by its treatment of offsets. The statement in CCP §431.70 that cross demands “are compensated so far as they equal each other” does not seem to make an offset depend on any particular priority status. If the Behniwals’ attorney fees are treated as though they had already been paid to Mix (see Murphy v FDIC (9th Cir 1994) 38 F3d 1490), any lien inferiority on their part would not matter because the cross demands were “deemed compensated.” See Murchison v Murchison (1963) 219 CA2d 600, 33 CR 285.
In fact, the judicial principle that offset is more appropriate when the cross party may be insolvent (and thus less likely to be able to honor its half of the burden; see Erlich v Superior Court (1965) 63 C2d 551, 47 CR 473) seems also to run contrary to the notion that offsets are controlled by lien priority principles. In those cases, giving a litigant an offset right certainly worsens the position of its adversary’s other creditors.
Nor would offset necessarily wreck our system of priorities, as Justice Sills seems to fear. No preexisting deed of trust on the seller’s property would be pushed down by a buyer’s offset because a third party lender, not being a party to the specific performance litigation, would find its instrument unaffected by it—only the identity of the trustor would change. The successful purchaser would take title to the property, subject to whatever balance there was on existing deeds of trust, and no attorney fees award would trump those liens. If the balance of cash the purchaser then pays isn’t enough to retire the preexisting liens entirely, they just stay on the title. Sooner or later, the purchaser will have to pay them off.
Priority Against Later Claims
In Behniwal, the lien priority that had to be dealt with concerned three interests that were created after the purchasers had filed their lawsuit and recorded their lis pendens. Even if the right of offset was subject to the rules of priority, why did the attorney fees award have to go behind those three later claims?
Justice Sills’s answer was that, as a technical matter, the attorney fees could achieve lien status only after a money judgment had been rendered and recorded, all of which happened after the other three interests went of record. But that only triggered the question: Why shouldn’t the purchasers’ award relate back to the date they recorded their lis pendens, which was before those three interests appeared?
Relation back is what I would have expected, but in Justice Sills’s view, the lis pendens only notifies third parties that the buyer is suing to enforce a sale of the land at the stated contract price (unreduced by offsets) (147 CA4th at 638):
A buyer or moneylender, then, could have reasonably relied on the buyers’ own pleadings to conclude that, should the buyers be successful, the court would force the sellers to convey the property for the contract price of $540,000.... [A] lender could also reasonably rely on the pleadings to conclude that the property could be safely encumbered up to that $540,000 amount.
That the pleadings also gave notice of a potential attorney fee award did not matter because that award would be only a later money judgment that could not relate back to the earlier lis pendens. Justice Sills treats the lis pendens differently than a recorded deed of trust, which puts all subsequent parties on notice that attorney fees in any foreclosure will also come off the top and before them.
That proposition is true only after this decision has made it a correct statement, but before the decision was announced, I believed that the general principle was that a lis pendens
· Puts purchasers and encumbrancers on notice that they will take subject to any judgment thereafter entered in the case;
· Will bind them to any judgment that might be entered (see BGJ Assocs., LLC v Superior Court (1999) 75 CA4th 952, 89 CR2d 693; Ahmanson Bank & Trust Co. v Tepper (1969) 269 CA2d 333, 74 CR 774); and
· Would apprise them of the possibility that an award of attorney fees could be offset against the purchase price.
Despite this opinion, I think attorneys should still caution subsequent takers as to this risk. There remains a real danger that they could be charged with inquiry notice of all plaintiff’s claims, including attorney fees.
Priority Against the Other Claim
I think doubts about priority would be even stronger for the law firm that took the second deed of trust. How can those lawyers claim to be BFPs without notice, entitled to protection of the recording acts against a plaintiff’s attorney fees claim, when they are engaged in representing their client against that claim—and, therefore, surely have actual knowledge of it? We are not told the circumstances of that transaction in Behniwal, but if a law firm’s deed of trust was given to secure payment for services to be rendered, would not those fees have the status of future advances made with actual knowledge of the junior claim? (I second the observation made by Justice Sills that the losing side’s attorney is the only real winner in the case.)
Finally, I would have doubts about assuring the defendant sellers that any homestead they filed after they had been sued would protect them against their buyers. Generally, a later filed homestead can prevail against an earlier filed action, but in this case that earlier action sought attorney fees that the sellers had agreed to in their sales contract (executed before anything else had happened). I would worry that the attorney fees clause in the sales contract could justify treating the fee award as a kind of preexisting consensual claim against which the homestead might not prevail. (Miller & Starr say that the homestead exemption does not apply against an equitable mortgage, whether it is recorded or not. 5 California Real Estate §13:43 (3d ed 2000).)
But all of my speculations turn out to be faulty in light of the decision in Behniwal, which significantly raises the stakes for purchasers contemplating specific performance litigation. Not only must they be prepared to prove that their contract is just and reasonable (as well as merely enforceable) and be prepared to stay ready, willing, and able throughout the entire litigation to pay the purchase price whenever the vendors are ordered or offer to perform, but now they also must be prepared to have their expected award of attorney fees held subordinate to any liens the sellers (involuntarily or voluntarily) impose on the property during the litigation, devastating their ability to offset those fees against the price they will still have to pay.
Justice Sills is too respected, and has thought too hard about this case, to make it likely that any other appellate tribunal will disagree with him. The legislature is certainly not going to bother itself with the small (and difficult) problem this case presents. So I predict that this is going to stay as our rule.
Can Anything Be Done About It?
Is there a way for purchasers to reduce the risks this rule creates? I cannot offer much help if the deal has already fallen apart and they are about to sue. They will not receive a fee award until the end, and then it will rank only as a money judgment with no superpriority despite any lis pendens they have earlier filed. Maybe they could file an attachment enabling the judgment to relate back to the lis pendens filing, but can purchasers both attach and lis pendens the very property they are attempting to purchase? Even if they can, our supreme court has held that a later homestead prevails over a prior attachment anyway. Becker v Lindsay (1976) 16 C3d 188, 127 CR 348.
Better language in the agreement, inserted at the drafting stage, is the only hope. Thus, some provision in the contract should give lien status to any attorney fees later awarded and also provide for relation back to the date of contract execution. It would be hard, if not impossible, to negotiate any individualized version of that kind of arrangement, but published forms could do that for everybody.
Since attorney fees clauses occur in most contracts, and are therefore presumably desirable to both sides, a supplemental provision in the same paragraph that gives those fees some teeth might generate little controversy at the early contract formation stage. If the same provision also allowed the prevailing sellers to use their fee awards to include the purchasers’ deposits (even when there is no, or only a lesser, liquidated damages clause), both sides might be better off.
Sterling v Taylor: Is Correction Possible?
Sterling v Taylor (2007) 40 C4th 757, 55 CR3d 116, reported in 30 CEB RPLR 54 (Mar. 2007), was a supreme court decision reported in our last issue, but it came too close to our publication date to allow time for me to comment on it in that issue. Now that there is time, I do not think that there is any constructive way for attorneys to correct their practices based on this decision.
Essentially, Sterling wrote out a handwritten memorandum of her deal with Taylor for her to buy some of his properties for “approx 10.468 X gross income [,] estimated income 1.600.000, Price $16,750.00,” and Taylor later signed another piece of paper acknowledging some of that. When Sterling later discovered that actual income from the properties was only $1,375,404 (not $1,600,000), she thought she should have to pay 10.468 times that, or $14,404,841, whereas Taylor believed she should pay $16,750,000. Sterling sued for specific performance, but the trial court rendered summary judgment against her on the ground that the memorandum did not state the price clearly enough to satisfy the Statute of Frauds. The court of appeal reversed, holding that extrinsic evidence could be admitted to clarify the price and satisfy the statute, but then the supreme court reversed the court of appeal and affirmed the trial court. In doing so, the high court unanimously said that it agreed with the intermediate court about the propriety of extrinsic evidence being used to enable an ambiguous memorandum to satisfy the Statute of Frauds, but then five justices went on to say “but not in this case.” Sterling’s extrinsic evidence was offered to support a $14.4 million price, which was nowhere in the contract, and did not support, for Statute of Frauds purposes, the $16.7 million price that was in the contract, a position that caused two of the justices to dissent to that conclusion and want to leave it for the trier of fact—rather than the supreme court—to decide.
I don’t want to look like I’m siding with the minority, but the problem I have with Justice Corrigan’s majority opinion is that it does not give any guidance to attorneys who are attempting to intelligently predict to their clients the sufficiency of the writings that they have generated. An attorney lucky enough to draft the agreement herself can naturally be expected to assure that the documents she produces will not only correctly express the terms of the deal, but will also satisfy the Statute of Frauds; so, too, when the memorandum sketched out by the clients themselves is given to her to critique or formalize. But if the fight has already started and the memorandum is all there is, and she needs to be able to tell the prospective plaintiff with some confidence whether to sue or give up (or to advise the defendant whether to fight or settle) based on that memorandum, then I fear that she will get no help from this decision. If the supreme court thought it was doing the bar a favor by giving it some guidance, I think it failed.
Some lesser parts of the decision will help practitioners. The holding that extrinsic evidence will be admitted to bolster the claim that the Statute of Frauds has been met is meaningful; an attorney no longer has to tell a plaintiff to abandon his claim because the document alone does not say enough, if there is enough additional supporting evidence to fill the gaps. Additionally, it is helpful to know that street addresses are good enough to satisfy the statute’s requirement for specificity of subject matter (although I suspect that no one ever really doubted that point). Another aspect of the case that looked like it would have been a more serious Statute of Frauds question was that Taylor never signed the memorandum as the party to be charged. He did sign and send a letter 2 days later, but that letter contained no price term (and Taylor disputed that the earlier memorandum was attached to it); he also signed escrow instructions that showed a price of $16.7 million. I wish the court had explained how that took care of the absence of his signature on the memorandum.
But what takes the helpfulness away is the majority’s final point that this extrinsic evidence—testimony that the formula was the real deal and the estimate only an estimate—would not satisfy the statute because the memorandum contained only the estimated number and not the formulaically derived one. The dissenters’ objection—that the formula was as much included in the memorandum as was the estimate—sounds equally correct to me, but more important is the fact that the majority makes it so much harder for a practitioner to predict whether his or her client has a case. Under this new standard, when the writing alone is not sufficient, we must not only decide whether there is enough supporting evidence to get past the Statute of Frauds, but also whether that supporting evidence is sufficiently consistent with the writing—which is, by itself, admittedly ambiguous.
For instance, had Sterling come to me at the outset, I would have predicted that the writing seemed to give greater support to her formula (“10.468 X gross income”), worked out to 3 decimal places, than for Taylor’s number (“Price $16,750.00”), a clearly rounded out figure with its three (rather than four) zeros at the end and no decimals, especially in light of the “approx” and “estimated” in the notes. If I had the luxury of choosing my client on this issue, I would have taken Sterling over Taylor, which would have been a bad call in light of what the majority said. (I should note that my conclusion also happens to be one that none of the justices took, perhaps another argument for requiring that the writing fill in the gaps in favor of one side of the dispute.)
Luckily, we aren’t asked too often whether incomplete writings satisfy the Statute of Frauds. While that issue now confronts more uncertainty than before, I daresay the bar will survive.
California Real Property Reporter, March 2007
Staying In Front
Roger Bernhardt
Wachovia Bank v Lifetime Indus.
How the original financing that led to the trouble in Wachovia Bank v Lifetime Indus., Inc. (2006) 145 CA4th 1039, 52 CR3d 168, reported at p 62, was intended to work is too complicated for any but the attorneys who drafted the original documents 14 years ago to comprehend. The lessons that the court of appeal wanted to impart would have been considerably clearer had it omitted all of those Byzantine facts and, instead, reduced the case to its simpler essentials.
Those essentials are that in 2004, an entity named PAT exercised an option to purchase property from FGHK. Since the option had been created in 1994, PAT claimed that it was free and clear of a mechanics’ lien that had been recorded by Lifetime in 2002. If PAT’s title stemmed from the 2004 deed, then it was subject to Lifetime’s mechanics’ lien; but if the title related back to the 1994 option, then it predated—and was not subject to—that lien.
An option to purchase gives the optionee two significant benefits:
· First, as an internal matter between optionee and optionor, it can compel the property owner (the optionor) to sell the property later on, even though she might otherwise not want to.
· Second, externally, as long as the option is properly recorded, the title later conveyed pursuant to it relates back to the date the option was given and thereby takes priority over any intervening rights.
Thus, leases, contracts of sale, servitudes, and anything else created subsequently will be subject to the option—and may be lost when and if it is later exercised. The same is true for liens: Lifetime’s mechanics’ lien would be eliminated by PAT’s paramount title if that title derived from the previously given option.
There was no doubt that the option itself had been properly created, properly recorded, and, thereafter, properly exercised. (There was some question whether the option constituted a mortgage clog subject to CC §2906 because exercise of it was connected to a default. Full resolution of that issue would have required an exhaustive study of the entire financing arrangement that the court did not want to undertake; nor do I.)
Lifetime’s strategy was to acknowledge these points, but declare them irrelevant because PAT’s title assertedly did not derive from the option. It is true that any third party who acquired it from FGHK would take title subject to Lifetime’s lien, without the benefit of any relation back. PAT exercised its option and it acquired title to the property, but did it acquire the title because it had exercised its option? Here, the court paraded some horribles (145 CA4th at 1054):
Suppose, for example, that a condition to exercising an option to purchase property does not occur, or the optionee has breached the terms of the option agreement such that he cannot enforce the option, but the optionee nevertheless purchases title to the subject property in a new transaction wholly unconnected with the option. Under these circumstances, it appears to us that the purchaser should not have the benefit of the relation-back rule and his title should have no effect upon interests in the property that arose after the option and before the optionee’s purchase.
Well, I guess that statement is true, but probably because the scales were loaded by making the new transaction “wholly unconnected.” What if the final deal was only partly unconnected to the original one? In this case, the court was bothered by the fact that PAT took title by a quitclaim rather than a warranty deed, as the option called for, and by the fact that the conveyance was delayed because PAT was fighting with Lifetime over priority. If those two facts can disconnect a deed from its previous option, then holders of options must be extremely careful not to squander their priority. In this case, for instance, the option’s reference to a warranty deed was obviously made by a New York attorney who neither practiced in California nor knew that such an instrument is effectively unknown here. Should California counsel, undertaking to complete the option purchase, attempt to draft such an instrument (with the attendant risks of using a nonform and untested document)? Or should she instead use a recognized California form, perhaps exposing her client to loss of relation back due to noncompliance with the terms of the option? Similarly, if there are deadlines in the option agreement that are jeopardized by external snags (here, the priority fight between PAT and Lifetime), should she advise the optionee to surrender to the third party in order to make the deadline, or dare she tell it that it can perform late as long as the optionor agrees (even if the third party doesn’t)?
The court gives us the rule that relation back applies only when the optionee could compel specific performance, but I find that helpful only in an all-or-nothing context. In this case, for instance, neither party could specifically compel the other to deliver or accept a quitclaim deed, which makes it seem like there should be no relation back. Employing a hypothetical specific performance mini-trial to decide an issue between optionor and optionee seems like a dubious way to resolve a real priority contest between optionee and third party claimant.
The risk of losing relation-back status is not confined to option situations. All (but gift) deeds relate back to an earlier contract of sale, thus raising the issue of the priority of other claims that arise between execution of the contract and close of the escrow. In my experience, deals are more likely to be revised along the way than go from beginning to end without revision. The “relation back/specific performance” test thus puts the security and priority of a lot of transactions in question. Title opinions will have to do a lot of fudging.
I would have preferred a simpler standard. In Meadows v Lee (1985) 175 CA3d 475, 221 CR 22, where a court had to decide whether an original purchase contract that was performed late thereby lost its priority to a later contract sitting in backup position, the court employed a subjective test: Was the completion of the first contract “consummated between the original contracting parties in the absence of any showing of fraud or collusion as against third parties”? 175 CA3d at 483. That test is considerably more subjective than the Wachovia Bank standard. Under it, declarations from the optionor and optionee should be sufficient to warrant relation back unless the third party can show fraud or collusion. (I should note that the dissent in Meadows believed it a mistake to reach such a result “solely from the fact that the original parties are not presently disputing the validity of the second contract” (175 CA3d at 487), but the test clearly has the virtues of simplicity and certainty.)
I suggest that in any transaction, the original parties—optionor and optionee, or whoever they are—accompany their closing with a joint declaration that it derives from their original deal (if that is true). That should matter considerably under the Meadows standard, and will certainly not hurt under what may be the more restrictive Wachovia test.
Of course, it would also be nice for an optionee or purchaser to give itself additional elbow room by providing in the original contract that it embraces all, e.g., alterations, revisions, extensions thereafter, if any such occur, borrowing from the way that lenders seek to preserve their priority despite subsequent modifications of their loan arrangements. But that takes forethought as well as consent of the other party, neither of which may be easy. Even then, how confident can their attorneys be that the language will work?
There is probably no way to provide 100 percent assurance that relation back will not be lost when the terms of a deal are altered. I guess the best we can do is be alert to the risk and hope for the best.
Evidence that optionee had obtained title to optioned property was not sufficient to extinguish intervening mechanics’ lien absent evidence optionee’s title was obtained under the option.
Wachovia Bank v Lifetime Indus., Inc. (2006) 145 CA4th 1039, 52 CR3d 168
In 1993, Kmart sold an estate for years in property (Property) to Shawmut Bank and deeded the remainder interest (Remainder) to FGHK; FGHK sold Shawmut Bank an option to purchase the Remainder (Option Agreement) on the occurrence of specified events; Shawmut Bank mortgaged its interest in the Property (Deed of Trust) and assigned its interest in the Option Agreement to The Bank of New York.
In 2002, Lifetime Industries, Inc. (Lifetime) recorded a mechanics’ lien against the Property.
In April 2003, The Bank of New York assigned its beneficial interests under the deed of trust to Wachovia Bank as the asset trustee for the property acquisition trust (PAT). At a 2003 foreclosure sale under the deed of trust, PAT purchased the estate for years and the rights of the optionee under the Option Agreement.
In January 2004, Lifetime obtained a judgment against FGHK providing for an award against FGHK, a lien on its ownership interest in the Property for the amount of the award, and an order that FGHK’s interest in the Property be sold at public auction to pay the sums owed. In February 2004, when PAT notified FGHK of its intent to exercise the option to purchase the Remainder, FGHK asserted that PAT had breached the Option Agreement (by failing to protect the Property against the mechanics’ lien) and was not entitled to specific performance.
PAT sued Lifetime and FGHK seeking, among other things, to quiet title. The trial court granted PAT’s motion for summary adjudication of its claims against Lifetime.
The court of appeal reversed. An option to purchase real property is not a sale of the property, but a sale of a right to purchase the property. On exercise, the option is transformed into a contract of purchase and sale. When an option to purchase real property is exercised, the right to purchase the property relates back to the time the option was made. Until title is transferred, the optionee holds only a right to complete the purchase, enforceable by specific performance. Intervening interests, while subject to this right, are not yet extinguished. Furthermore, under the mechanics’ lien law, once a lien is recorded, the lien will relate back to the date the first labor or material was furnished-for the work of improvement, and transferees who take an interest in the property after work has begun, and before the claim of lien is recorded, take subject to the lien. 145 CA4th at 1051.
Here, there was evidence to prove, or Lifetime did not dispute, that PAT held the option to purchase, the option was given and recorded prior to the date Lifetime first provided the labor or material for the work of improvement to which its mechanics’ lien related, and PAT exercised the option to purchase on February 26, 2004. However, the mere exercise of the option without consummation of the purchase and sale transaction did not provide PAT with title to the Remainder. Based on the record, title to the Remainder continued to be held by FGHK. Accordingly, Lifetime’s lien against FGHK’s interest in the remainder had not been extinguished.
The court denied PAT’s CCP §909 motion to take evidence of a quitclaim deed from FGHK to PAT dated after the hearing on the summary adjudication motion. PAT submitted no evidence that its receipt of the quitclaim deed was pursuant to its exercise of the option. If an optionee takes title to property when the optionee would not have been able to compel specific performance of the option, the relation-back rule does not apply, and the title obtained by the optionee does not extinguish intervening interests.
However, the court rejected Lifetime’s argument that, under CC §2906, the exercise of the option, which was used as part of a financing transaction, could not relate back to the date of the option. Because the Remainder was not collateral within the meaning of §2906, the option, although granted to acquire an interest in the Remainder, was not granted to acquire an interest in real property collateral.