Receiver's Sales -- Mirage and Major Hazard for Both Lenders and Receivers
By Hansen, Charles & Brodehl, Kevin *
The first part of this two-part article will explore case law and statutory authorities to develop the case why “receiver’s sales” are improper under California law, and why case and statutory authorities concerning sales by general equity receivers have no applicability in California mortgage and trust deed litigation and receiverships. In the second part of the article—to be published in the next issue—we will detail more fully the hazards and potential consequences of receiver’s sales, attempted or completed.
Receiver's Sales Are Unlawful And Fraught With Risk For A Variety Of Contractual, Conceptual, And Statutory Reasons
The reasons why “receiver's sales” are both unlawful and dangerous are legion.
The best starting point to evaluate most commercial litigation remedies is in the language of the applicable contract. A review of the language of customary commercial and proprietary forms of deed of trust used in California (and of the occasional mortgage) will establish that the security document creates an assignment of rents as security (often couched as an “absolute” assignment) and often contains provisions for the appointment of a receiver to take possession of the security, to collect the rents, and to preserve the property against waste pending foreclosure. What is conspicuous by its absence from such "rents and profits" clauses is language providing for the receiver’s sale of the security or for the imposition of a receivership over the person of the borrower. Since secured lenders typically seek appointment of a receiver by way of request for specific performance of the provisions of the deed of trust, the absence of language about a receiver selling the security is a critical omission. See Turner v. Superior Court, 72 Cal. App. 3d 804, 812 (1977) (the “contractual agreements” between lender and borrower show “the purpose for which the receiver was appointed;” in the absence of consent from the borrower the court “exceeds its jurisdiction” by purportedly authorizing a rents and profits receiver to exercise control over “property which is not hypothecated in the deed of trust”). In asking the court to authorize a receiver sale, the lender is typically asking the court to specifically enforce something for which the contract does not provide.
The distinction between a receivership over identified property, on the one hand, and a receivership over the person of a corporation or other legal entity, on the other hand, is a critical one. The former is a rents and profits receivership, and the latter is usually referred to as a "general equity" receivership. The distinction between “rents and profits” receiverships and “general equity” receiverships is far from a merely semantic or minor one Rather, the distinction describes fundamental conceptual and legal differences between an arrangement for dealing with the preservation of identified property, on the one hand, and an arrangement for handling and resolving the business affairs of a legal person. See Turner, supra, 72 Cal. App. 3d at 813, 817 (twice rejecting proposition that “a receiver is a receiver regardless of the purpose for which he was originally appointed”). Given the profound difference in the nature and the objectives of the two types of receivership, it should come as no surprise that the role and powers of the two types of receiver are markedly different.
When borrowers resist imposition of a receivership based on a defaulted deed of trust by citing receivership cases treating the remedy of receivership as “harsh” and “extraordinary,” lenders frequently emphasize and take advantage of the distinction between the concepts of a rents and profits receivership and a general equity receivership. Lenders and their attorneys argue—correctly—that the appointment of a rents and profits receiver following a trust deed default should be more or less routine when the trust deed or other loan documents contain a valid "rents assignment" provision, and that cases setting exacting standards for the appointment of a general equity receivership are inapposite to the appointment of a rents and profits receiver under a defaulted trust deed. Lenders will commonly argue—again correctly—that case law holding that the appointment of a receiver is a harsh and extraordinary remedy to be applied sparingly (see e.g., City & County of San Francisco v. Daley, 16 Cal. App. 4th 734, 745 (1993)) is inapplicable to a rents and profits receiver both because the borrower has already agreed to the appointment in the loan documents and because the purpose of a rents-and-profits receiver is a limited one focusing on the preservation of the property and the collection and preservation of rents. See e.g., Turner supra, 72 Cal. App. 3d at 812-814 (a rents and profits receiver is “limited and special;” the rents and profits emanating from the property are impounded for the benefit of the mortgagee, but the debtor retains its other property).
Having obtained the appointment of a receiver, however, many lenders and their attorneys quickly change their tunes and assert that the rents and profits receivership is not limited and that the receiver can do anything a general equity receiver can do. This common reversal of position argument on the nature of a rents-and-profits receivership is a revealing one.
Since the trust deed rarely, if ever, contains language authorizing the receiver to actually sell the security, the lender must rely on statutes and case law that apply to the power of receiver for an entity or corporation to sell that corporation's assets. But this argument disproves itself. A general equity receiver (or, for that matter, a state law trustee, a bankruptcy trustee, or an attorney in fact) can sometimes sell a corporation's or other person’s property, real or personal, based on the power and authority to act on behalf the person that is the owner of the property and thus has the right to sell it on a consensual basis. But property cannot sell itself. A receiver that is acting only as a rents and profits receiver for identified property rather than as a receiver for the person of a corporation or legal person can no more sell the property than the property can sell itself.
The centerpiece and foundational concept of mortgage law is the borrower’s right or "equity" of redemption. That right of redemption is what makes a mortgage or a deed of trust a security interest instead of an ownership interest. The right of redemption from a mortgage or deed of trust is actually held, in California, both by the owner of property and by those holding a lien or other interest in the property inferior in priority to the deed of trust in question. Cal. Civ. Code §§ 2903-2905; O’Neil v. General Security Corp., 4 Cal. App. 4th 587, 603-605 (1992). It is precisely this equity of redemption that is cut off or “foreclosed” by a valid foreclosure sale. Historically and semantically, that is how foreclosure came to be called foreclosure. Nowhere in California law does there exist a provision that allows a receiver to cut off the equity of redemption, which is the defining feature of a mortgage or deed of trust. And nowhere in California law can one find any right analogous to Bankruptcy Code § 363 permitting the sale of property free and clear of liens or encumbrances or the transfer of the lien to the proceeds of that sale. Coppola v. Superior Court, 211 Cal. App. 3d 848 (1989). Thus, even if a rents and profits receiver’s sale could somehow overcome the absence of authorizing language in the deed of trust, there is no basis in California law to suggest that such a sale would cut off or foreclose junior interests any more than a voluntary deed or a deed in lieu by the borrower.
A general equity receiver who controls the affairs of a legal person or corporation can properly be empowered to sell that person's assets much as can a trustee or a probate representative. That sale by the general equity receiver is, at least in legal theory, a consensual sale by the personal representative of the person who has a right to sell the property. But a rents and profits receiver is not a personal representative of the borrower at all, and is merely an agent of the court charged with preserving and protecting the real property security pending the outcome of a judicial or nonjudicial foreclosure. A court that has appointed a rents and profits receiver has no basis in the customary language of the deed of trust that authorized the appointment and created the interest in rents and profits, or in either statutory law or in equity principles, to authorize the receiver to cut off or foreclose out the equity of redemption enjoyed not only by the owner and borrower but also by all of those junior interests whose rights of redemption would be likewise terminated and “wiped out” by a foreclosure. The purchaser from a rents and profits receiver purportedly authorized to sell the property will, at best, acquire unmarketable and likely uninsurable title, and may well look to both the lender and perhaps the receiver as seller for the resulting loss and breach of both the contractual and the deed-based covenants of marketable title. Karoutas v. HomeFed Bank, 232 Cal. App. 3d 767 (1991).
Anyone suggesting that California Code of Civil Procedure §§ 564 et seq. provide an answer to these fundamental problems should consider the following questions: Is a rents and profits receiver's sale a foreclosure sale? If the answer is “no,” how then does such a sale cut off the fundamental equity of redemption enjoyed by the owner and the holders of junior interests? If the answer is “yes,” then does the sale trigger the deficiency bar of California Code of Civil Procedure § 580d? And, does a rents and profits receiver’s sale trigger a post-sale right of redemption under California Code of Civil Procedure §§ 729.010 et seq? Where in the law do the advocates of “receiver’s sales” suggest we look to find the answers to these questions?
Whatever answers to these questions may be offered, how do we know the answers are correct when there is no basis supporting the answers in either statutory language or the case law? Additionally, why would the California legislature and California courts have spent a century and more refining, balancing, and reconciling the procedures of judicial foreclosure and trustee’s sale as an integrated system by virtue of which the lender must make an election of remedies between these two well-mapped remedial choices, but then allow a secured creditor to opt out of the election and check “neither of the above” in order to pursue a procedure as to which no guidance is available and as to which no checks and balances have been created as concerns titles, procedures, deficiencies, or post-sale redemption rights? See Vlahovich v. Cruz, 213 Cal. App. 3d 317, 321-323 (1989). If secured lenders could use receiver’s sales as a means of opting out of the mandated election of remedies between trustee’s sales and judicial foreclosure and the consequences of that election, they would have been doing so conspicuously for the past century. Yet, there is no evidence in the case law that they have been doing so. That is a sure sign of a mirage.
While California Code of Civil Procedure § 568.5 generically allows for property sales by a receiver, that statute must be treated consistently with (and not as eviscerating) the recognized narrow role and purpose of a “rents and profits” receiver and the language of the deed of trust pursuant to which he is appointed. No California case has applied § 568.5 to justify a sale of property by a rents and profits, as opposed to a general equity, receiver. In Turner, supra, the court observed that cases applying § 568.5 “do not involve rents and profits receivers and are distinguishable on that ground,” and noted the powerful arguments against applying § 568.5 to rents and profits receivers (including the limited scope of contractual authorization, the equity of redemption, and § 726), before ultimately concluding that it need not decide the issue. Turner, supra, 72 Cal. App. 3d at 817-818. A case cited by some receiver sale proponents, Cal-American Income Property Fund VII v. Brown Development Corp., 138 Cal. App. 3d 268 (1982), expressly acknowledged the limited powers of a “rents and profits” receiver, but noted that the specific language of the trial court’s appointment order suggested bases and powers beyond a typical rents and profits receivership. Id. at 273-274. The court, therefore, assumed that the right of sale existed under the facts before it, and focused instead on whether the receiver had established an “immediate necessity” for the sale, finding in the negative. Id. at 274-276. No subsequent California decision has relied on Cal-American to support a sale of property by a “rents and profits” receiver.
Perhaps the lender or
receiver will respond and say that a "receiver's sale" is not a
foreclosure sale at all but a sui generis form of equitable remedy. If
that is the response, the question then presented is whether, or how, the
receiver sale cuts off or forecloses the rights of redemption enjoyed by
both the owner and all juniors. The issue comes full circle and begs the
fundamental question of what a receiver sells and what a buyer acquires in
a “receiver’s sale.”