Californians have a vested interest in ensuring that homes and commercial businesses do not fall into a state of disrepair because substandard properties are more prone to criminal activity, vagrants, and fire damage. The appointment of a health and safety receiver is one practical solution regularly relied upon by cities and counties to help prevent blight from taking over their neighborhoods and commercial centers. These types of receivership cases can revitalize neighborhoods and bring a sense of pride back to a community.

A receiver in a health and safety case is appointed to rehabilitate a substandard home or commercial building. To be effective, the receiver must have a number of resources at his or her disposal: a litigation team to navigate through the various pleadings; a transactional team to draft an extensive number of contracts (construction contracts, property management contracts, lending contracts, and sales contracts, to name a few); access to money to fund the rehabilitation work and tenant relocation expenses; access to a title insurance carrier willing to provide a lender’s policy on first-priority liens and a title insurance policy on selling properties free and clear of liens (when there are insufficient funds in the receivership estate to pay off all recorded liens); and a property management company to oversee the extensive rehabilitation work necessary to repair the substandard home or commercial building.

Unlike a rents and profit receivership case, the only asset in a health and safety receivership case is the substandard home or building, which is often encumbered with liens. To rehabilitate a substandard property, the receiver must have the ability to borrow funds using first-priority receiver certificates or be able to sell the property free and clear of all liens. For years, receivers in this field cited to Title Insurance & Trust Company v. California Development Co. (1915) 171 Cal.2d 227, 231 as the primary authority to sell property free and clear of liens. In City of Chula Vista v. Gutierrez (2012) 207 Cal.App.4th 681, the appellate court, in dicta, called into question these powers, noting as follows: “If the Legislature had intended to impose direct liability or provide the receiver with a priority lien, it would have done so . . . .” Id. at 694. This was immediately used by lienholders to threaten the ability of health and safety receivers to effectively continue their work.

Recently, in the City of Riverside v. Horspool (2014) 223 Cal.App.4th 670, the appellate court unquestionably restored the power given to receivers to sell real property free and clear of recorded liens. That court affirmed the receiver’s plan to sell a substandard home to an investor-buyer – free and clear of the bank’s mortgage – with an agreement that the investor-buyer complete the rehabilitation work under the receiver’s supervision. As a result of the work on that property (and the court’s approval of a receiver’s priority status), the home is no longer a public nuisance.

The following insider’s history of the Horspool case offers a practical view of what health and safety receivers encounter on a daily basis.

I. THE BEGINNING OF THE RECEIVERSHIP

On December 10, 2008, the City of Riverside received a complaint from a neighbor regarding the property at 4720 Mt. Vernon Avenue (the “Property”). The City observed a dilapidated shingle roof, overgrown weeds in the front yard, peeling trim around the windows and porch, large cracks in the driveway, and what appeared to be the start of construction on a second story without any permits. The City notified the owners and the secured lienholder (JP Morgan) of the serious health and safety code issues. No steps were taken to the repair the Property.

Over the next eighteen months the City issued multiple notices and citations, obtained an order from an administrative law judge imposing daily civil penalties, and conducted a number of site inspections in an attempt to convince the owners and JP Morgan to repair the Property, all to no avail.

On August 2, 2010, the court appointed a receiver to take over the Property in order to correct the serious health and safety code violations.

II. STEPS TAKEN BY THE RECEIVER TO REHABILITATE THE PROPERTY

After taking possession of the Property, the receiver identified forty-eight health and safety code violations, including holes in the roof, holes in the exterior walls, trash and debris in and around the home, hazardous and exposed wiring throughout the home, no interior plumbing, defective flooring, an unpermitted room addition, and the presence of mold throughout the home. The receiver developed a rehabilitation plan to correct all of the violations.

There are three primary ways for a receiver to rehabilitate a substandard property: (1) secure private financing to fund the rehabilitation work; (2) secure private financing to demolish the home and sell the vacant land; or (3) sell the home to an investor-buyer who is willing to purchase the home as-is and complete the rehabilitation.

Since demolition was not a viable option (the cost to demolish the home was more than the Property was worth as vacant land), the receiver identified an investor-buyer willing to purchase the Property in its as-is condition. On April 29, 2011, the court approved the receiver’s request to approve the sale of the Property to the investor-buyer for $75,000 and the investor-buyer’s secured obligation to complete the rehabilitation of the Property under the receiver’s supervision. The buyer took title free and clear of JP Morgan’s lien. The court also approved the receiver’s request for fees and costs, holding the homeowners liable for the deficiency.

Within a few months, the investor-buyer corrected all forty-eight code violations. As a result, the Property is now a decent, safe, and habitable dwelling. The homeowner appealed the receiver’s appointment, the sale, and the receiver’s approved fees and costs.

III. THE RECEIVER’S APPOINTMENT, AUTHORITY TO SELL THE PROPERTY FREE AND CLEAR OF LIENS, AND FEES AND COSTS WERE AFFIRMED ON      APPEAL

On January 16, 2014 (i.e., three years and five months after the receiver was appointed), the appellate court affirmed the trial court’s orders, holding that the receiver was properly appointed, that the receiver had the authority to sell the Property free and clear of all recorded liens, and that the receiver’s fees and costs were reasonable and recoverable. City of Riverside v. Horspool, 223 Cal.App.4th at 673-74. The following is a brief summary of the appellate court’s holdings on these issues.

A. The Trial Court Did Not Abuse Its Discretion In Appointing the Receiver.
The first argument on appeal was that the trial court lacked the authority to appoint the receiver based on the City’s alleged failure to properly serve the three-day notice (it was personally served rather than served by posting and mailing as required under the statute). The appellate court rejected this argument, holding that the homeowner waived this argument by appearing at the original appointment hearing.

B. The Trial Court Did Not Abuse Its Discretion in Authorizing the Receiver to Sell the Property Free and Clear of JP Morgan’s Lien.
The second argument was that the trial court lacked the authority to allow the receiver to sell the Property free and clear of JP Morgan’s deed of trust. The appellate court rejected this argument, noting as follows: “A court of equity has the power to order the sale of property free and clear of liens and encumbrances.” Id. at 683. To reach this conclusion, the appellate court went through a detailed analysis, as discussed below.

1. Receivers Have the Authority to Sell Substandard Property.
There is little dispute that a receiver has the right to sell real property in its possession. See Civ. Proc. Code § 568.5. The California Supreme Court has also acknowledged that receivers have the authority under health and safety code receiverships to sell real property in their possession. See City of Santa Monica v. Gonzalez (2008) 43 Cal.4th 905, 930; see also Health & Safety Code § 17980.7(c)(4)(H). The only arguable question is whether the trial court had the authority to authorize the sale free and clear of any liens.

2. Trial Courts Have the Authority to Sell Property Free snd Clear of Liens Provided the Lienholders Are Parties to the Lawsuit.
Health and Safety Code § 17980.7(c)(2) provides that a receiver is appointed to “develop and supervise a viable financial and construction plan for the satisfactory rehabilitation of the building.” In determining the extent of a receiver’s powers to accomplish this goal, a court can look to: (1) the statute underlying the appointment; (2) the receivership order; and (3) case law. City of Santa Monica, 43 Cal.4th at 930. As it should have, the receivership order contained the power to sell real property free and clear of all liens. The remaining two factors (the appointing statute and case law) supported the trial court’s order approving the sale.

a. The Health & Safety Code Authorized the Sale of the Property Free and Clear of JP Morgan’s Lien.
Prior to the appointment of a receiver, the owner and lender are given an opportunity to voluntarily repair the property. Health & Safety Code § 17980.6. If the owner and lender refuse to correct the problems, the city has the authority to petition a court to have a receiver appointed to perform the repairs directly. Health & Safety Code § 17980.7.

As noted above, a receiver has the power to sell the property to pay for the cost of the rehabilitation work. The sale divests the owner of any interest in the property and, logically, the lender’s security interest as well. See Health & Safety Code § 17980.7(c)(4)(H); see also Civ. Proc. Code § 568.5. If this were not so, there would be no logical reason to require cities to provide the lenders with notice. A lender could simply sit back, allow the property to be rehabilitated, and then accept the benefit of its security being greatly increased in value, while maintaining its status as a first-priority lienholder. That is not a reasonable interpretation of the statute and fails to achieve the legislature’s statutory goals. Moreover, the majority of receiverships would fail to proceed since there would be insufficient funds to pay for the repairs and other receivership expenses. Thus, the statute authorizes the sale of the property free and clear of any liens.

b. Case Law Likewise Authorized the Sale of The Property Free and Clear of JP Morgan’s Liens.
In addition to the Health & Safety Code and the Receivership Order, California decisional law and judicial rulings in other jurisdictions support the trial court’s order authorizing the Receiver to sell the Property free and clear of any liens and/or encumbrances.

In 1915, the California Supreme Court first recognized a receiver’s right to borrow funds secured with receiver’s certificates (i.e., a secured debt instrument) that have priority over preexisting liens and other encumbrances such as deeds of trust. See Title Insurance & Trust Company v. California Development Co. (1915) 171 Cal.2d 227, 231. The California Supreme Court understood that by allowing a receiver’s certificate to take priority, the lienholder would eventually lose its security interest in the property when it came time to repay the certificate. That is no different than selling a home free and clear of all liens and encumbrances.

In the City of Riverside v. Horspool, the appellate court removed all doubt by affirming the trial court’s holding, noting as follows: “A court of equity has the power to order the sale of property free and clear of liens and encumbrances.” 223 Cal.App.4th at 683.

c. The Trial Court Did Not Abuse Its Discretion in Approving the Receiver’s Request for Fees and Costs.
The third argument on appeal was that the trial court abused its discretion in approving the Receiver’s request for fees and costs, with the funds to be paid out of the sale proceeds and the remaining balance to be imposed as a judgment against the homeowners. The appellate court summarily rejected this argument, noting as follows: “Nevertheless, on the merits, the amount of fees awarded to a receiver is in the sound discretion of the trial court and in the absence of a clear showing of abuses of discretion, a reviewing court is not justified in setting aside an order fixing fees.” Id. at 685.

IV. CONCLUSION

After the Horspool decision, Health & Safety Code § 17980.7 remains a powerful tool for local enforcement agencies. It provides a direct, court-supervised process for removing blight, abating dangerous conditions, and holding the responsible parties financially accountable.

* Nicholas Firetag is a shareholder at Gresham Savage. Mr. Firetag has served as lead trial counsel in over sixty Health & Safety receiverships.