Last year the Legislature passed Senate Bill 931 adding Section 580e to the California Code of Civil Procedure. This new Section established that the beneficiary on a loan secured by a first deed of trust on 1 to 4 unit residential property could not pursue a deficiency judgment after a short sale which they had approved. The law applies equally to purchase money, hard money and refinance loans.
This year the Legislature passed Senate Bill 458 which amended Section 580e by making it applicable to junior liens as well. It also applied additional limitations to the loans subject to the section. In addition to not being able to get a deficiency judgment it provides at Section (a)(1) that after a short sale no deficiency shall be owed or collected and no deficiency judgment shall be requested or rendered provided the short sale closed escrow and the lender was paid the amount they agreed to accept.
Although the law does not specifically say so it is likely the courts will interpret that section to mean that it applies to a short sale closing either before or after July 15, 2011, the effective date of the new section. That analysis is based on the provision that the short money cannot be collected and no deficiency can be requested. It also will bar lenders from turning these loans over to a collection company which some lenders were doing even though the earlier section barred a deficiency judgment.
The amended law provides at Section (b) that the holder of a note shall not require the seller to pay any additional compensation, aside from the proceeds of the sale, in exchange for their consent to the short sale.
Some people have taken the position that, since only the seller is prohibited from providing additional compensation, the 2nd lender can request the buyer or real estate brokers to pay them additional money above that the 1st has agreed they can receive from the sale.
That might be true if only this code section applied. But if the 1st lender has based their approval on their consent to the 2nd only receiving a specified amount then any attempt to pay the 2nd more without the consent of the 1st would likely be considered loan fraud. If the 1st finds there is more money available in the transaction they will rightly feel it should go to them rather than to the 2nd. That is the purpose of being in 1st position.
Section 580e (c) provides that if the borrower commits loan fraud the limitations of the section would not apply. The lender would then be able to pursue the entire unpaid balance. If you are the broker in a transaction where the 2nd lender requests the broker or buyer to pay them some additional money either within or outside escrow you need to make sure that either the 1st lender specifically approves the additional money being paid to the 2nd or you run away from that transaction as quickly as possible. Participating in a fraudulent transaction can expose you to monetary liability to the lender, revocation of your license by DRE and criminal prosecution.
The real question remaining to be answered is whether this new law will be a great protection of the seller from liability after a short sale or whether it will lead to lenders denying short sales in favor of pursuing foreclosure where a deficiency by a junior lien holder may be possible.
If you have any questions on this article or any other aspect of real estate law please contact the Hanson Law Firm at 916 447-9181 or log on to our website at www.HansonLawFirm.com.