As followers of my Blog know, I have long stated that our current market crash was caused by a lending industry taking advantage of a government deregulation intended to make home ownership available to more Americans. In a classic example of the Law of Unintended Consequences, the deregulation allowed lenders to sell virtually any loan they created regardless of whether or not the borrower was qualified for the loan. This house of cards eventually crashed when original teaser rates re-set and millions of borrowers could no longer afford the loans.

In 2008, Congress created a Commission to investigate the cause of the crash and appointed Sacramentan, Phil Angelides, to head it. In a blistering report that followed 18 months of testimony and fact-gathering, Angelides and his Financial Crisis Inquiry Commission blamed a wide cast of characters for the epic meltdown, including executives of insurance giant AIG and Goldman Sachs and government policymakers like Alan Greenspan, Timothy Geithner and Ben Bernanke. The report said human error created the crisis. The Report blamed mortgage lenders for the flood of risky subprime loans that ignored “a borrower’s ability to pay.” Wall Street investment banks recklessly packaged the loans into toxic securities that exposed the entire financial system to melt down, the report concludes.

The panel held four field hearings, all in communities that were among the hardest hit by the real estate crash: Sacramento, Las Vegas, Bakersfield and Miami. In Sacramento, commissioners heard about the Central Valley’s vulnerability to the housing price bubble. One witness testified that appraisers were pressured by lenders to make inflated appraisals so shaky loans would go through. The final report mentions Sacramento numerous times, noting that housing prices more than doubled in a five-year stretch.

All the while, government watchdogs were asleep. For more than 30 years, lawmakers and presidents bought into the free-market ethic backed by the likes of Greenspan, the former Federal Reserve chairman. “The sentries were not at their posts,” the report said. However, following the release of the report, government officials lost no time in getting to finger-pointing. The crisis commission’s findings were caught up in immediate partisan bickering. While the report was endorsed by the six Democrats on the commission, the four Republicans refused to sign off on its conclusions.

At the press conference introducing the report, Mr. Angelides made no bones about where he stood on this question: This was an avoidable crisis, he said bluntly. As the report puts it, “The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. If only regulators had been willing to regulate; if only Wall Street had done proper due diligence on the mortgages it was securitizing; if only subprime companies had acted more honorably; if only the credit ratings agencies had said no when asked to slap triple-A ratings on subprime junk. If only, if only, if only”.

Now comes the real test of whether our leaders will put back in place the economic regulations necessary to prevent irresponsible lending while not stopping the economic recovery which is just beginning. We need to have a thriving lending system for our nation to continue to grow and prosper. But that lending system owes a duty to us all to act reasonably and responsibly… a duty sadly lacking in causing this market crash.

If you have specific questions about landlord-tenant law in California or about short sales, foreclosure, or any legal issues, feel free to contact us at sjbeede@bpelaw.com We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260.

The information presented in this Article is not to be taken as legal advice. Every persons situation is different. If you are upside-down on your loan(s), especially if youre facing a lender lawsuit, get competent legal advise in your State immediately so that you can determine your best options.

As we enter this New Year, our economy remains in serious condition and millions remain in default and uncertain about their housing futures.  Yet in the midst of this mess, there is both Good News and Bad News.

First the Good News - 2011 should see some improvement in the general economy as the damage from the real estate and financial market collapse begins to resolve.  We’re already witnessing climbing values in the stock market and record prices for commodities such as gold and silver.  This may not mean confidence but at least people with money to invest aren’t keeping their money under their pillow.  Interest rates are edging up but are still historically low. Retailers have reported strong sales during the Christmas season and, in general, despite all of the political battles between Republicans and Democrats, consumers are feeling somewhat upbeat.  They’re still in pain but most can feel the healing taking place.

Now the Bad News -  This recession will not be over in 2011, particularly as it affects real estate.  While the economy may be slowly improving, businesses are being slow to expand and so unemployment remains very high.  Without greater certainty of stable employment, people are hesitant about making major purchases such as homes.  This uncertainty is causing economists to predict that California could be looking at another 10-11% drop in housing prices during this year fueled both by high unemployment and enormous State budget deficits. Millions of homeowners still face possible foreclosure as loan modifications remain unavailable to most. Further, the impact of the real estate bubble collapse is expanding:

1) Subprime Loan Borrowers - This was the first phase of damage from the recession. Although most of these sub-prime loans have by now been foreclosed or short-sold, 2011 will see another wave of defaults on those 2006-7 loans with 5 year adjustments.  As these move from interest-only to fully amortized, borrowers could see their loan payments double removing any capacity to pay;

2) Economy Impacted Borrowers - This is the second phase of the recession and it’s where we are today and will likely be for at least another year.  The tough part about a collapsing bubble is that it also causes “collateral damage” to those with good loans.  Millions have lost their jobs, or had cut backs or government furloughs that leave them unable to pay their loans. And with California’s record budget deficits, no-one has any confidence that State spending will improve.  Significantly, many economy-impacted borrowers may have other assets that they could spend to cover their loan deficiencies, but with no end in sight and further value losses predicted, many are finding it wise to “strategically default” rather than disclose their other assets to their lenders as part of a loan modification or short sale application.  For these borrowers, letting a foreclosure occur may make more financial sense.

3) Commercial Borrowers - This is the third phase and the one with the largest economic consequences.  One doesn’t have to look far to see empty store fronts of businesses that have closed terminating their jobs in the process.  Each of these also means a loss of income for the owner of the property and, added together, can cause the property owner to default resulting in a possible loss of all businesses. 2010 saw foreclosures nationwide of shopping centers and office complexes and large manufacturing companies.  Unlike home foreclosures, the failure of commercial loans often involves tens of millions of dollars in debt, loss of hundred or even thousands of jobs, and the loss of tax dollars for communities.  These problems together could bankrupt the lenders and even the communities where the businesses are located.  As a result, we’re now seeing commercial loan workout programs coming together with owners, lenders, accountants, community leaders, and others seeking to find a way to prevent the wide-spread losses that failure would bring.  We’ll likely be working on this area through 2014 and this will be the key in finally turning the corner from recession to real recovery in the real estate market.

Meanwhile, lenders are picking up the pace of foreclosures and filing lawsuits to recover loan deficiencies. In response, borrowers and governments are fighting back.  I’ll cover this in more depth in my next posting along with how you can protect yourself.

If you have specific questions about your liability in California or about short sales, foreclosure, or any legal issues, feel free to contact us at sjbeede@bpelaw.com.  We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260.

The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are upside-down on your loan(s), especially if you’re facing a lender lawsuit, get competent legal advise in your State immediately so that you can determine your best options.

The wave of possible lender lawsuits against borrowers has started, primarily by junior lenders whose seconds (often HELOCS) were wiped out when a senior lender foreclosed.  We presently are representing borrowers in a number of these lawsuits and have already settled several. The most important points to remember if you are served with a lawsuit are: 1) don’t panic and ignore it. Get competent legal counsel in your State to advise you how and when to respond; and 2) almost all such lawsuits will resolve without going to trial.

There are several defenses that can be raised in defense to any lender lawsuit that may reduce or even eliminate their claim. These include:

1. Lender does not own the loan - In order to file a lawsuit against you, the lender must actually “own” the loan, that is they own and have possession of the Promissory Note.  Loans change ownership all the time and it is possible that the lawsuit has been brought by a loan “servicer” or collection company, not the actual owner. If they cannot prove ownership, they do not have “legal standing” to file the lawsuit and they should lose.

2. Loan was predatory - One of the key reasons why we had this market collapse was that from 2000 through 2006, lenders made loans to borrowers who in reality could not afford the loan.  Sometime this was done by misstating income on “stated income” or “no document” loans and often this misstatement was done by the lender, not the borrower. Other times the loan was unrealistic, such as a 1% interest rate on which the borrower qualified for the loan but which jumped up much higher after the first month.  So the buyer only qualified on month one but would never qualify on month two.  Failure was inevitable unless the buyer could quickly flip the property.  If the lender should never have made the loan, they likely will not recover against the borrower in court.

3. Loan was result of fraud - Similar to predatory loans, many borrowers obtained loans through actual fraud where the loan agent altered information supplied by the borrower or made false representations to the borrower such as:  “take this adjustable rate now and we’ll convert it to a fixed rate within a year”. For most borrowers, that loan agent was never to be found within the year, the fixed rate was not obtainable, and the increasing adjustable rate forced the borrower into default.   If the lender’s loan agent defrauded the borrower into getting the loan, they likely will not recover against the borrower in court.

4. Lender failed to do diligence - One of the biggest causes of the market collapse was that the lenders failed to exercise any diligence in checking to make sure the information on the loan application was true, such as checking tax returns and confirming the borrowers employment and income.  The banking deregulation in the late 1990’s created a flood of money in the market for new loans to be made and lenders accepted virtually any application without checking whether the loan was good. The result was billions of dollars of bad loans secured with property that was not worth the debt.   If the lender should never have made the loan, they likely will not recover against the borrower in court.

5. Lender knew the market was inflated in a bubble - The combination of banking deregulation and easy money created a huge increase in demand by possible homeowners and investors which drove up the prices on available properties, often increasing by $10,000 or more in a single month.  Developers rushed in with new subdivisions everywhere trying to fill the demand as competition for homes kept driving prices upwards.  This inflationary bubble was almost entirely fueled by high-risk loans, speculative appraisals, and the lack of real underwriting and diligence by the lenders. It was completely foreseeable to lenders that this bubble would burst but they made the loans anyway because they earned commissions and could sell the loans in the secondary mortgage market.  It was no real surprise to lenders when the borrowers started defaulting in 2005 on the increasingly expensive loans which led to the collapse starting in 2006.  If the lender should never have made the loan, they likely will not recover against the borrower in court.

6. Lender has insurance for the loss - Many of the loans made were 100% of purchase price and even more. Generally, if the loan was for more than 80% of the property value, mortgage insurance (PMI) was required. Although paid for by the borrower, this insurance paid the lender for any loss on a default. The lawsuit may be an attempt by the lender to collect on a loss that they have already recovered on through the insurance. If the lender has already been compensated for any loss, they likely will not recover against the borrower in court.

7.  Lender has been bailed out by the taxpayers - Between 2008 and 2009, Federal bailout monies paid by taxpayers (including the borrower) provided protection for lenders damaged because of loan losses.  Our government guaranteed billions of dollars in lender bad debt, guarantees that we and our children will be paying for years to come. Many consider these bailouts to be a reward for bad business practices instead of the punishment that might be deserved. If the lender has already been compensated for any loss, they likely will not recover against the borrower in court.

How Should You Prepare? - In California, the deadline for a lender to bring a claim against a borrower is four years from the date the borrower defaulted. With hundreds of thousands of borrowers just now in default, these lawsuits will be a constant threat for many years to come.  These may be joined by deficiency lawsuits following short sales to which the same defenses can be raised in addition to several other defenses unique to short sales which I’ll cover in subsequent Blogs.

Before you make any decision concerning your upside-down home or investment property, be certain to get tax and legal advice from qualified professionals in your State who can look at your specific situation and advise you on how these rules apply to you, particularly on how to identify and minimize the risks of a lender lawsuit.  This Article is solely intended to give you an introduction to key legal concerns affecting borrowers today but you should not rely on it to apply to your financial circumstances.

If you have specific questions about your liability, short sales, foreclosure, or any legal issues, feel free to contact me at sjbeede@bpelaw.com.  We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260. Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.

As home owners throughout our nation have struggled to either retain their properties or minimize the damage in losing them, they have looked towards a patchwork of government programs for help.  These programs such as Hope for Homeowners, HAMP, and now HAFA have promised a lot but delivered very little results so far.  The one effective relief program has been the Federal Debt Foregiveness Relief Act and comparable State laws which enables homeowners to avoid taxes on the forgiven debt on their principal residence.  No such program has been created to protect investors but… relief from these taxes may be available anyway.

Debt Forgiveness Tax arises anytime a lender is not paid in full on a loan. Typically, this is measured by the lender issuing an IRS 1099 for miscellaneous income showing what was owed and what was paid. You get taxed on the difference as income unless some exemption applies. There are several.

1.  Capital Loss Offset - When you buy a property, your purchase price generally establishes your “taxable basis”, ie: what you invested. This is increased by capital improvements you make, such as a new roof, and it is decreased by your depreciation write off.  For many investors, your taxable basis may be much higher than the current market value and higher still than the amount owed on the property. For example, if you purchased for $500,000 with a $400,000 loan and the property sells or is foreclosed at a price of $250,000 (not uncommon); then you would have a debt forgiveness of $150,000 (amount of loan unpaid in the sale) but you would also have a capital loss of $250,000 (amount invested less sale price).  Accountants are generally in agreement that you can offset the debt forgiveness tax with the capital loss. In this example, the result would be elimination of the debt forgiveness tax and a carry-over remaining capital loss of $100,000 which could be applied against other investment losses. 

2.    IRS Insolvency Exclusion - In my February 19th posting, I wrote about how the Insolvency Exclusion works as detailed in IRS Publication 4681 “Cancelled Debts, Foreclosures, Repossessions, and Abandonments”. http://www.irs.gov/pub/irs-pdf/p4681.pdf.  The important point is that this Exclusion applies equally to homeowners as well as investors.  In short, you list all of your liabilities and below that list all of your assets. If your liabilities are greater than your assets, you are “Insolvent” for debt forgiveness purposes and can avoid the debt forgiveness tax. Many States, including California, have adopted the IRS Exclusion to apply to State debt forgiveness taxes as well.

3.  Bankruptcy - although this is a last resort for owners and investors alike, if a property is lost during the pendency of the Bankruptcy there will be no debt forgiveness tax applied. You cannot use BK to avoid taxes already incurred before the Bankruptcy is filed.

Before you make any decision concerning your upside-down home or investment property, be certain to get tax and legal advice from qualified professionals in your area who can look at your specific situation and advise you on how these rules apply to you.  This Article is solely intended to give you an introduction to what might be available for you but you should not rely on it to apply to your financial circumstances.

If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.

 has been the investor market

California law requires that property owners must return the tenant’s security within three weeks from the time the tenant vacates and document any deductions. When ownership is transferred to another, the former owner is required to either transfer the deposits to the new owner or return them to the tenant.  But what happens when the property is foreclosed and the former owner that collected the security deposits is gone or even bankrupt?

Under California Civil Code Section 1950.5, a successor owner is jointly liable with the former owner to retun the deposits once the tenant vacates. The idea is that the innocent tenant’s right to the deposit should be protected and that any disputes over this are between the current and prior owner, not then tenant.  There is an ambiguity being argued by lenders that this obligation is extinguished by the foreclosure just as is the rental agreement itself.  This may be held to be true where the post-foreclosure owner treats the rental agreement as extinguished. In that case, the tenant similarly has no obligation to pay the rent and so the situation may become a wash.  But the result is reasonably different where the new owner treats the rental agreement as continuing and actually collects rent.  There, most likely, the law will protect the tenant.

Despite the above-stated ambiguity, all perties acquiring property through a foreclosure must anticipate that they will likely be liable for the tenat’s security deposit that was collected by the former owner. Further, they should make sure that they have a new rentail agreement signed by the tenant if the rental is to continue.

If you have any questions concerning your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at sjbeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.

Many people are confused as to what happens if the property in which they live has been foreclosed. Most fear that a Sheriff will come knocking on the door to suddenly kick them out. In California (an likely most other states) that cannot legally occur.  A foreclosure simply creates a change in the ownership of the property. The rights of the occupants in the property are determined by what their status was before the foreclosure and now, Federal and California has made these rights even clearer.  This creates more protection for tenants and a possible trap for unaware foreclosure buyers.

Here are the current rules:

1. FORMER OWNER IS OCCUPANT - If the former owner remains as an occupant of the property after a foreclosure, the new owner must give that person only a 3 DAY NOTICE TO QUIT. The theory is that the former owner knew the foreclosure was coming so they should have made arrangements to move.

2. OCCUPANT IS RELATED TO FORMER OWNER - If the occupant is related to the former owner, ie: child, parent, or spouse, and the former owner is not an occupant, then the new owner must give the occupants a 60 DAY NOTICE TO QUIT. In theory related parties should be aware of what is going on. Even so, this change gives these parties more time than they had before.

3.  UNRELATED OCCUPANTS ON PERIODIC TENANCY - If the occupant is not a former owner or related to the former owner and is on a periodic tenancy such as month-to-month (not a Lease), then the new owner must give the occupants a 90 DAY NOTICE TO QUIT. The thought here is that periodic tenants are innocent victims who may be surprised by the foreclosure and will need more time to find a new place to live.

4.  UNRELATED OCCUPANTS ON LEASES -  If the occupant is not a former owner or related to the former owner and is on a fixed-term Lease (such as 6 months, one year, etc.), then the new owner cannot terminate the occupant’s tenancy UNTIL THE END OF THE LEASE TERM unless the new owner intends to occupy the property themseves in which time the new owner must give the occupants a 90 DAY NOTICE TO QUIT. The thought here is that while Lease tenants are innocent victims who may be surprised by the foreclosure, they contracted for a specific term and had no right to expect a longer tenancy. However, as set forth below, they may have to actually pay rent to get the benefit. Despite this however, since the foreclosure extinguished the Lease, the new owner can treat this resulting tenancy as a periodic month-to-month tenancy if they intend to move-in.

Much of the new requirements arise under President Obama’s “Protecting Tenants at Foreclosure Act of 2009’’ which was contained in the ‘‘Helping Families Save Their Homes Act of 2009’’, which was signed into law by the President on May 20, 2009. California amended its laws effective January 1, 2010 in compliance. While any new law becomes a fertile ground for disputes, this one presents an interesting issue concerning tenants on leases seeking to stay the duration of the lease. The Act defines a “bone fide lease” as being a lease which requires the receipt of rent that is not substantially less than fair market rent for the property. But does this mean that the rent must be paid? That remains unclear. If so, this would seem punitive considering that a tenant without a lease would get a 90 day notice with no obligation to pay. But is it really fair to the new owner to let someone live their longer than 90 days without paying? Perhaps the intent was only to establish that the lease was real…not to provide an ability for the new owner to collect the rent. But with no payment, who would ever want to bid at a foreclosure sale? Of course, it It will be up to the court’s to decide who’s interpretation is correct.

If you have specific questions about your loans, liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or call us at (916) 966-2260 for a phone or personal appointment. We offer a $200 flat fee attorney consultation to enable you to evaluate your judgment and tax risks and to plan a strategy to minimize or even avoid them. Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage.

While little has been done at the State or Federal level to provide assistance to upside down homeowners, efforts have been made to give greater protection to tenants in foreclosed properties. 

As a general rule, a foreclosure wipes out all leases and other rental agreements leaving the tenant in a month-to-month situation. For tenants on a lease, this can be a great shock when a Notice to Quit is posted on the front door.  Typically, state law requires the new owner to give the tenant 30 Days to vacate and if they don’t do so an eviction action can be started.  In July, 2008, California has adopted Code of Civil Procedure Section 1161(b) granting all residential tenants or sub-tenants a 60 days written notice to vacate after foreclosure.

In addition, in May, 2009, President Obama signed the “Protecting Tenants at Foreclosure Act of 2009″. The Act establishes a ninety (90) day notice to vacate period and grants additional rights to tenants in foreclosed properties. The central purpose is to provide innocent tenants, whose landlords have lost properties to foreclosure, with additional time within which to secure alternative housing arrangements.

EVEN MORE SIGNIFICANT is a portion of the Act which provides that, in the case of foreclosure on any federally-related mortgage loan or on any residential real property in which a recipient of public housing assistance resides, the immediate successor in interest assumes such interest subject to: (1) the lease between the prior owner and the tenant, and (2) the housing assistance payments contract between the prior owner and the public housing agency for the occupied unit.  Definition of a “federally-related mortgage loan” include any loan that a) is made by a lender that is either regulated by or whose deposits or accounts are insured by any agency of the Federal Government; b)  is made in whole or in part, or is insured, guaranteed, supplemented, or assisted in any way by the Federal Government; or c) is intended to be sold by the originating lender to the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation (or its successors).  This is a very broad spectrum of loans.  A ”housing assistance payments contract” means such Programs as Section 8. 

A thorough statement as to the purpose, import and impact of the Act can be found in a recent Federal Register Notice from the Department of Housing and Urban Development (”HUD”) and in a summary of Senate Bill 896. [Source www.thomas.gov].

The Act is extremely broad and vague and has given rise to more questions than answers, it is abundantly clear that the rights of persons or entities purchasing tenant occupied properties purchased through foreclosure after May 20, 2009, will be significantly impacted.

  If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.

A lot of mis-information appears to be circulating on the web concerning how the debt forgiveness tax relief is applied. “Debt Forgiveness” occurs anytime you don’t have to pay back a debt that you owe someone. In today’s world, that most commonly occurs through a foreclosure or a short sale when a lender or lenders are not paid in full. Unless the lender is pursuing a judgment for the deficiency (which is rare), our IRS Code states that the amount not paid, ie: forgiven, is taxable income to the borrower.  In December, 2007, the Federal government passed the Mortgage Forgiveness Debt Relief Act which provided that if you incur debt forgiveness between 2007 and 2012 on your principal residence there will be no tax. Some States have adopted similar provisions to deal with state taxes.  What has become confusing is what is meant by “principal residence”.

Several writers on the web have stated that the test for Principal Residence is that you lived in the property for 2 of the last 5 years. If this were true, then the forgiveness might be available even if the property is now rented out.  So, this is significant.  The “2 out of 5 years” rule is the test for capital gains tax exclusion and is used to determine whether you would have to pay capital gains tax when the property was sold or foreclosed. But this is a different question from debt forgiveness. Capital gains measures the difference between what you paid for the property (taxable basis) and what it sold for (short sale or foreclosure sale). So, if someone has owned their property a long time and refinanced well above their taxable basis, then the “sale” price could result in a capital gain tax to which the 2 out of 5 year rule would apply.  Ambiguities in explanations of the Mortgage Forgiveness Debt Relief Act have led some to conclude that the determination is made by using the capital gains rule on personal residence.  I do not believe that this is accurate. More importantly, this mis-information could leave debtors exposed to debt forgiveness tax.

When it comes to tax questions, it is valuable to examine what the IRS has to say on the issue because if they disagree with what you claim, you’re in for a nasty and costly fight. Luckily, the IRS appears to have answered this question.

IRS Publication 4681 “Cancelled Debts, Foreclosures, Repossessions, and Abandonment” is available for download at http://www.irs.gov/pub/irs-pdf/p4681.pdf. In this Report, the IRS explains how this is treated. At Chapter 1 “Cancelled Debts”, Page 7, the IRS defines what constitutes “Qualified Principal Residence Indebtedness” which is the criteria to avoid the debt. It clearly defines this as “the home where you ordinarily live most of the time. You can have only one principal residence at any one time”. There is nothing whatsoever that provides for a 2 of 5 year definition.

Based upon this, it seems conclusive to me that the IRS will only grant debt forgiveness on the home where you ordinarily live at the time that the debt forgiveness occurs.  Of course, reasonable people could reach different conclusions.  If you are facing a debt forgiveness event, be certain to get competent legal and tax advice.

The question keeps coming up:  What is the deficiency liability of an individual involved in a short sale?

In the current real estate market, short sales are becoming more prevalent as defaulting borrowers attempt to avoid a foreclosure on their property. The risk is whether a borrower after completing a short sale and receiving approval from the lender(s) would then become liable for any deficiency arising out of the difference between the principal amount owed on the mortgage(s) secured by the property and the amount the sale price agreed to during the short sale.

The short answer (in California at least) is that given the current statutory framework and case law available on this issue it is unclear whether there is any liability. California has three interconnected laws that govern lender recourse:  1) the Security First Rule; 2) the Single Action Rule; and 3) the Acquisition Loan Rule. These all limit the ability of a lender to go after a borrower for a deficiency following a foreclosure.  The language of each statute itself is broad enough that arguable they will preclude deficiency liability after a short sale (ie: the lender cannot simply waive the Security First Rule by releasing their security and then suing on the remaining debt).

Lenders have been scrambling to find a way around these Rules and create some recourse against borrowers following a voluntary short sale.  A short sale is a contract between the lender(s), seller/borrower, and buyer. In the contract, the lender is essentially agreeing to compromise their position in order to avoid a foreclosure. The lender is getting something of value in return for their agreement to the short sale. Likewise, the seller/borrower is getting something by way of release from deficiency debt. If the lender were to attempt to pursue a deficiency, against the borrower/seller then the contract likely fails for lack of consideration. Essentially, the borrower/seller in that situation got nothing of value for their participation in the short sale contract.  Whether less credit damage is consideration enough is very questionable.

Taking this to the last step in the analysis, brings us to the theory of accord and satisfaction. Which is a term of art that simply states that when one settles their rights for value and receives that value, then they have compromised their claim and can not pursue it any longer. By agreeing to contract for the short sale, the lender(s) is essentially stating that they are willing to take less in the short sale process to avoid the foreclosure process. Thereby precluding the lender from asserting additional claims for deficiency after the settlement process.

What has been happening with frequency lately, is that some lenders (such as BofA) are requiring borrowers/sellers to sign a document stating that the borrower will remain liable for the deficiency as a condition to the lender consenting to the short sale. The lender(s) are trying to contract around the anti-deficiency statutes prohibitions. While it is permissible for parties to contract around statutory obligations there is not any known reported case law on this particular issue where there is no real benefit to the seller/borrower… especially when it the contract increases the lender’s benefits. Certainly, it seems that by requiring the borrower/seller to sign such a document, there is a lack of consideration as discussed above. Thereby possibly nullifying the documents effect. However, there is no case law on this topic.

The bottom-line reality is if you are confronted with one of these documents, you should seek legal counsel regarding the terms of the particular agreement before executing the document, as you very well could be contracting away anti-deficiency protection and more than likely exposing yourself to costly litigation.

As readers of my Blog are aware, the Federal Government passed a law in December, 2007 allowing debtors to avoid the tax on debt forgiveness which typically occurs through a foreclosure or short sale. Debt forgiveness is considered taxable income by the IRS even though the debtor never had the actual income. The federal Debt Forgiveness Relief Act enables most people who lose their homes between 2007 through-going budget c 2012 to avoid the tax.  Most states including California followed suit although California’s relief expired in December, 2008.

In January 2009, Assemblyman Roger Niello introduced AB 111 to extend California’s law to match the Feds. Unfortunately, in late May the Assembly voted down his Bill… most likely in response to the ongoing Budget crisis. No new Bill appears to be in the works to replace this.  “AB 111 was based on fairness and common sense. The tax revenues from mortgage foreclosures are windfall gains to the state at the expense of California’s most desperate families. The tax revenue exempted by AB 111 would not have been realized if California weren’t at the very epicenter of the mortgage crisis,” said Assemblyman Niello.

If you are burdened by an over-encumbered property that you no longer can afford, be sure to get competent legal advice on your rights and strategies to minimalize or possible eliminate your exposure to a financial judgment and debt forgiveness taxes.  If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/