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Part II: Receiver's Sales - Mirage and Major Hazard for Both Lenders and Receivers By Hansen, Charles & Brodehl, Kevin* In the second half of this article, we address in
greater detail the position that a “receiver’s sale” flies in the face of
California Code of Civil Procedure § 726 - a key provision of California
mortgage law for over a century and a half. Section 726 says, in pertinent
part, that “…there can be but one form of action for the recovery of any
debt or the enforcement of any right secured by mortgage upon real
property…” and that action shall be in accordance with Title 10, Chapter 1
of the Civil Code. Advocates of “receiver’s sales” would graft onto this
clear statutory language the codicil: “…well, except for this other form
of judicial sale the mortgage statutes and the secured transactions case
law forgot to mention.” It has been the clear and unambiguous law of California since 1872 (and actually before then prior to adoption of the Field Code) that there can be only one action and one form of action for the foreclosure of California real property. This rule is embodied in California Code of Civil Procedure § 726 (which originally contained "one action" wording that was amended during the Great Depression to read "one form of action"). Those who have tilled the mortgage vineyards for years know that § 726 is not only firmly established law, but that violations of § 726 can result in extremely harsh sanctions imposed against creditors who violate the statute. See e.g., Security Pacific National Bank v. Wozab, 51 Cal.3d 991 (1990); Walker v. Community Bank, 10 Cal.3d 729 (1974); Pacific Valley Bank v. Schwenke, 189 Cal. App. 3d 134 (1987); Aplanalp v. Forte, 225 Cal.App.3d 609 (1990); Shin v. Superior Court, 26 Cal. App. 4th 542 (1994); O’Neil v. General Security Corp. (1992) 4 Cal. App. 4th 587; In re Pajaro Dunes Rental Agency, Inc., 142 B.R. 383 (Bankr. N.D. Cal. 1992). What may be less well known is that the concept of a real property sale by a “rents and profits” receiver was held in 1991 to violate § 726. In Great American First Savings Bank v. Bayside Developers, originally published at 232 Cal. App. 3d 1546, the court observed that “rents and profits” referred to “the income derived from the property,” but “not to the property itself or to its proceeds on sale,” and held that the rents and profits receiver’s sale of townhomes on the property “was beyond the authority of the receiver, and beyond the power of the court to authorize.” Id. at 1555-1557. Further, the bank’s application of the proceeds from the sale to the secured debt violated § 726. Id. at 1558-1559. While a petition for rehearing was pending before the Court of Appeal in Bayside, the case was removed to federal court under the “removal at any time” provisions of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), and as a result the Bayside decision was ordered de-published by the California Supreme Court in 1992 (1992 Cal.LEXIS 1265), and can no longer be cited as precedent. Nevertheless, the reasoning in Bayside has been discussed extensively in California mortgage law treatises, and that reasoning is a now well-entrenched among practitioners. Moreover, the federal courts that took over the case paid lip service to the “security first” aspect of § 726, but inexplicably and improperly ignored the express “one form of action” language of that statute. See Resolution Trust Corp. v. Bayside Developers, 817 F. Supp. 822 (N.D. Cal. 1993); Resolution Trust Corp. v. Bayside Developers, 43 F.3d 1230 (9th Cir. 1994). Under California Code of Civil Procedure § 564(d) and recently amended California Civil Code Section 2938(e)(2)-(3), the mere appointment and conventional functioning of a rents and profits receiver is not a violation of § 726, but rather a legitimate interlocutory measure to collect and preserve rents and the security pending foreclosure. But the notion that a rents and profits receiver could be authorized to sell the security as an alternative to judicial foreclosure or trustee’s sale can be found nowhere in the statutory scheme. If the Legislature intended to repeal the time-honored “one form of action” provisions of § 726 and provide a new type of foreclosure, one would think that it might have said so. Two salient features of § 726 sanction cases are:
first, that the conduct triggering the sanction need not be intrinsically
improper; and, second, the fact that a court has blessed or even assisted
in the conduct does not insulate the creditor from the resulting sanction.
See e.g., Walker, supra, 10 Cal.3d 729; O’Neil, supra, 4
Cal. App. 4th 587; Aplanalp, supra, 225 Cal. App. 3d 609; Shin,
supra, 26 Cal. App. 4th 542; Pajaro Dunes, supra, 142 B.R. 383.
After the California Supreme Court's decision in Wozab, it is clear
that the sanction incurred under § 726 may include not only loss of the
security but—if the lender has been cautioned against the conduct and goes
forward despite the warning—loss of the debt as well. Wozab, supra,
51 Cal.3d at 1006. Thus, borrowers and juniors who are facing a receiver's
sale and who are not able to persuade the lender to desist (or the court
to withdraw an ostensible grant of authority) should consider a Wozab
warning letter challenging the propriety of the "receiver's sale" and
cautioning the secured lender of the dramatically negative consequences
under the sanction aspect of § 726 if the sale goes forward. Receivers and their counsel need to make an independent and self-protective analysis of any lender request that they sell the security. The receiver, after all, is expected to be a neutral agent of the court. A claim by a rents and profits receiver that pursuit of such a sale was the lender’s idea and that the receiver was merely implementing a remedy selected by the lender could quite plausibly be viewed as an admission of a lack of independence. And a receiver's sale later found to be ultra vires might subject the receiver and the receiver's bond to potential liability both to the borrower and to the purchaser. After all, such a sale, if found to be contrary to law, would have resulted in an unauthorized sale of someone else’s property. Further, and as discussed above, the receiver is purporting to sell property to a buyer who reasonably expects to receive good title in a valid and authorized transaction, and who can be expected to be very unhappy and in a litigious mood when the title resulting from the sale turns out to be questionable, unmarketable, and uninsurable. Serious questions are also presented by a receiver’s sale with regard to potential prejudice to and exoneration of guarantors of the secured debt. While full development of this issue is beyond the scope of this article, it is absolutely clear that guarantors have rights of reimbursement and subrogation to the secured lender’s position when they make good on their guaranties. See Cal. Civ. Code §§ 2847-2848. A secured lender’s election of remedies can prejudice those rights, and such prejudice has caused secured lenders no end of grief under cases like Union Bank v. Gradsky, 265 Cal. App. 2d 40 (1968). While Gradsky waivers are permitted under Civil Code § 2856, the validity of the waiver turns on the language and wording of the waiver. Few, if any, “Gradsky” or “2856” waivers in existing guaranties contain language contemplating “receiver’s sales,” or waiving the potentially prejudicial consequences of those sales for the guarantor. Thus, the risk of compromising or exonerating guarantors and their guaranties needs to be added to the litany of problems that may result from “receiver’s sales.” Lenders and their attorneys know - or at least
should know - that their every move in foreclosing on a defaulted loan
will be scrutinized closely by the borrower, guarantors, and their
attorneys. There are, in short, some highly-motivated and very serious
people just waiting out in the open desert for the caravan to head for the
receiver’s sale mirage. Lenders, receivers, and their attorneys who insist
on pursuing “receiver’s sales” because of the real or perceived benefits
of such sales - such as avoiding the addition or more “REO” to a bank’s
inventory and directly channeling foreclosed property to preferred third
party buyers—should pay heed to those who may well be waiting for them out
there in the desert with less than friendly intent. If lenders and
receivers listen closely, they will realize that well-informed borrowers
and their attorneys might be whispering “…come on, come on, lovely shade
and sweet water is waiting for you just here at the mirage…er, oasis.” |