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On August 19 of this year, the California legislature amended Code of Civil Procedure §580b—its purchase money antideficiency section, so as to include refinancings within its protective ambit. As of this writing, the bill sits in the governor’s office awaiting signature. While California’s rule on this topic is not easy to comprehend, some background explanation may help.
The Original Definition of Purchase Money
The statute, first enacted in 1933 provided:
No deficiency judgment shall lie in any event after a sale of real property for failure of the purchaser to complete his or her contract of sale, or under a deed of trust or mortgage given to secure payment of the balance of the purchase price of that real property. This is very abbreviated (as all quotes will be), but I will add in other parts of this statute as I go.
Part of the significance of the purchase money deficiency restriction derives from our one action rule—CCP 726— which says:
(a) There can be but one form of action for the recovery of any debt secured by mortgage upon real property.
This means that California creditors whose notes are secured by deeds of trust cannot bring money actions on their notes, but must instead foreclose on their deeds of trust (or conduct nonjudicial trustee sales) and go after their debtors personally only by way of deficiency judgment after the foreclosure or trustee sale. Thus barring deficiency judgments in purchase money cases converts deeds of trust (we haven’t used mortgages in California for many years) into nonrecourse security instruments.
This rule affects sold-out junior mortgagees as well as senior lenders, since our supreme court held that a junior’s action for money after the senior has foreclosed amounts to a suit for a deficiency, even though she herself has not foreclosed her own junior mortgage. Brown v Jensen, 41 Cal 2d 193 (1953).
The New “Purposes” of 580b
The reasons for Brown’s holding were repudiated ten years later in Roseleaf v Chierighino, 59 Cal 2d 35 (1963), but the rule itself was left in place, with the sold out junior being specifically held subject to the bar of 580b (despite being held exempted from all of California’s other antideficiency rules and its one action rule. Two new purposes were found behind 580b: discouraging vendors from overvaluing their security and “stabilizing land values during depressions.”
The fact that these explanations made no economic sense might not have bothered the lending industry too much if the supreme court had not held, just three weeks after Roseleaf, that its definition of purchase money and rules concerning it covered not only seller carrybacks, but institutional first loans as well. Bargioni v. Hill, 59 Cal. 2d 121 (1963). The shocked reaction led to the legislative rewording of 580b so as to thereafter bar any deficiency judgment only in the case of:
a deed of trust given to the vendor to secure payment of the balance of the purchase price of that real property, or under a deed of trust on a dwelling for not more than four families given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that dwelling occupied by the purchaser.
(Remember, I am excerpting unmercifully). The net effect of the statutory revision is that vendor paper is always purchase money and lender paper is sometimes so, depending on the kind of property
Standard and Variant Transactions
How Roseleaf’s purposes was to be applied in concrete cases—especially overvaluation with regard to lenders who, unlike vendors, do not set prices — was made somewhat easier (or harder)when the supreme court spoke again nine years later in Spangler v. Memel, 7 Cal. 3d 603 (1972), and told the bar that section 580b was to be “automatically” applied to standard purchase money transactions, making no further analysis necessary in those cases, with a “purpose” analysis being required only in “variant” transactions.1
Finally, in DeBerard Properties v. Lim, 20 Cal. 4th 659 (1999), the supreme court decided that a purchaser may not waive his 580b protection, even during subsequent workout negotiations with his vendor when he is already in default and the alternative is foreclosure.
Those are our California supreme court cases. (If they confuse you, think of what it is like for California attorneys undertaking to advise clients under those doctrine.) One matter especially hard to predict is the status of a subsequent loan that was given to refinance an earlier purchase money loan held by the borrower. Because an earlier court of appeal decision did state that such a new loan would lack the infirmities of the earlier purchase money it replaced (Union Bank v Wendland, 54 Cal App 3d 393, 1976), even though it did so in a rather offhand way, the industry has ever since comforted itself with saying that refinancings lose their 580b disability.
With the housing bubble having led to so many refinanced mortgages, and the burst of that bubble then having led to so many foreclosures, it was not surprising for the California legislature to enact an amendment (pushed for by the California Association of Realtors) that adds to 580b:
For purposes of this section, a loan used to pay all or part of the purchase price of real property shall include subsequent loans, mortgages, or deeds of trust that refinance or modify the original loan, but only to the extent that the subsequent loan was used to pay debt incurred to purchase the real property.
The bill provides that it “shall become operative on June 1, 2011, and shall apply only to actions filed after its operative date.” (SB 1178) But just what does that mean?
Previous Refinancings or Only New Ones?
Certainly if a purchase money loan is not originally created until after June 1, 2011 and then later refinanced with another loan after that, the new second loan will retain the purchase money antideficiency status of the earlier one under this new statutory provision. But what if the original loan was created before June 1 of next year; indeed, what if it was created sometime last year, before the statute was even contemplated?
Earlier cases refused to give 580b a retroactive impact on mortgages that were created before its original enactment. Hales v Snowden, 19 CA2d 366 (1937) and Birkhofer v Krumm, 27 CA2d 513 (1938). (See also Drapeau v Smith, 34 CA2d 84 (1939), holding the same about our fair value antideficiency provision.) But since the continued status of 580b after loan restructuring is not itself that clear, does applying the new amendment to old loans automatically constitute a taking of a clear property interest of lenders or merely a clarification of what was already implicit in the DeBerard bar of subsequent waivers?
But, if the new provision applies only to new loans, does it do borrowers any real good? The bubble has already burst and it is unlikely that there will be much overvaluing or overlending by vendors or lenders in the foreseeable future. And if the bill does not apply to all of the recent refinancings (and if those new loans did rid themselves of the original purchase money characteristics of the old loans they replaced), then the substantial personal exposure of those who borrowed too readily will devastate the fundamental purpose of our “stabilization” policy.
Calculating the Purchase Money Component
Another group of questions are independent of the retroactivity issue. A refinancing is included within the new purchase money definition “only to the extent that the subsequent loan was used to pay debt incurred to purchase the real property.” But how is that to be calculated? The number may be easy enough to know when the original loan was $100,000 and the loan balance at the time of refinancing is the same $100,000, but what is the correct figure if the original $100,000 had been paid down to $70,000 at the time that the property was refinanced (for $125,000)? Is $70,000 or $100,000 the purchase money of the new $125,000 loan? What is the calculation if — because of negative amortization — the original $100,000 loan balance had been increased to $108,000; is the protected number then $100,000 or $108,000?
That is only the first round. When payments are made on the new $125,000 loan balance, are they to be credited to the purchase money part or the nonpurchase money part, or prorated between both? May the borrower dictate the result as he makes his payments or can the note itself provide the answer to that question (or would a clause on that issue be an impermissible attempt at waiver)?
When a New Borrower Enters the Picture
Finally, what if the loan is both modified and assumed because title is transferred? Technically, there should be nothing to assume since the loan was previously nonrecourse, and California follows the theory of equitable subrogation rather than the third party beneficiary as to assumptions. Case v Egan, 57 CA 453 (1922). But it has also been held that existing third party lenders may be recharacterized as vendors, even if they were not so to begin with, when their cooperation was necessary to the success of the transfer! LaForgia v Kolsky 196 CA3d 1103 (1987). Decisions like that make non California attorneys’ eyes pop.
It’s weird out there, and getting weirder.