Kirk M West's Blog

Wow!  We recieved over 250 emails after yesterday's Blog Post.  Thank you for all of the great questions.   Your emails have sparked today's comments.  The most widely asked question yesterday was, "What happens next?"  "Will my lender come after me?" 

One of the most critical and least known questions facing sellers, agents and lenders is whether the lender can really come after a borrower for a deficiency after a Short Sale. While the answers may vary according to the laws of your State, here in California the answer is a solid "maybe". Meanwhile, lenders will continue to seek to put deficiency recourse language in their Short Sale Consent Agreements and the borrowers and their agents will continue to seek the removal of that language like we do.  While the presence or absence of recourse language may be enough for the Courts, that remains unclear for the reasons set forth below. This lack of certainty causes many short sales to fail and, until this issue winds its way through the legal system, no-one can know for sure whether a lender has any rights to collect a deficiency . But there are good arguments for both sides.

A. BORROWER ARGUMENTS AGAINST RECOURSE:

1. Short Sale is an "Accord and Satisfaction" - The short sale is inherently an agreement for resolution of a dispute between the borrower and the lender as to how much must the borrower pay. In completing the short sale and receiving money they otherwise would not have received, they have arguable settled all claims. The "Accord" is the agreement; the "Satisfaction" is the money the lender received.

2. Seeking Deficiency Violates the "Single Action Rule" - California only allows a lender one shot at collecting a debt. Arguably, the negotiation of the short sale and the lender's acceptance of money from the Buyer is a collection action. If so, then the lender would be legally barred from filing a lawsuit against the borrower to collect anything else.

3. Seeking Deficiency Violates the "Anti-Waiver Rule" - California real estate law provides that, if there is a default, the lender must take the security first (foreclose on the property) before going after the borrower for anything else. There are only a few exceptions to this Rule which could allow a lender to "waive" the security and sue the buyer, ie: such as bringing hazardous waste onto the property; or destroying the property's value by stripping out the plumbing or electrical systems. These conditions do not exist in a short sale. Yet arguably what the lenders are doing is waiving the security to allow the short sale to be completed. If that is in fact a legal "waiver", then the lender may be legally barred from coming after the borrower for a deficiency.

4. No "Consideration" for waiving or modifying - Any contract or any modification requires that there be an equal trade of benefits and burdens. The borrower gets the benefit of the loans to buy the property but also gets the burden of having to repay what they received. The value of what is exchanged by each of the parties is called the "legal consideration". When only one side gets a benefit, there is what is called a "failure of consideration" and the contract may not be enforceable. Arguably, this same requirement exists in a short sale: the lender is getting money now and that's a benefit but what is the benefit to the borrower? They're losing their property: that's not a benefit; they're getting no money out of the deal: that's not a benefit; they're going to get taxed on any debt forgiveness: that's not a benefit; If the lender does have a right to pursue deficiency recourse against them, that's definately not a benefit. So, what benefit does the borrower get out of a short sale that would be sufficient consideration fore remaining liable for a deficiency? Not much, if anything at all. Arguably then, if the consideration is insufficient, then the lender's right to waive the security and pursue a deficiency should fail for lack of consideration.

5. Additional Arguments - Creative attorneys will find a fertile field of additional legal arguments to be raised in defending borrowers against lender deficiency claims. These can include a) the loan should never have been made; and b) the lenders caused the crash, why should they profit from it.

B. LENDER ARGUMENTS IN FAVOR OF RECOURSE:

1. It is a Modification not a Release - A short sale is in effect a modification of the terms of the loan. The lender has agreed to release their lien on the borrowers property so the property can be sold. The lender agrees to do this without getting paid in full. Arguably, the Short Sale agreement only modifies the terms referenced in the agreement. Unless the short sale agreement expressly waives recourse against the borrower for the unpaid balance, the lender may argue that they still possess the right to collect on the deficiency after the short sale is completed.

2. Unfair to penalize lender if Borrower is otherwise liable - In California, some loans are non-recourse such as a loan obtained to buy the home you live in. However, these "anti-deficiency" protections kick in when there is a foreclosure. These rules might not apply in a voluntary transfer such as a short sale. When there are no such protections, ie: non-purchase money or refinance or investor loan, the lender could have recourse against the borrower through the foreclosure method used. So, lenders would argue it is not fair to deny them the recourse that the borrower already agreed to in the loan.

Who's arguments prevail will be determined in the Courtrooms across our Country in the next few years to come. Initially rulings will be made by Judges in the local courts and they could vary greatly. In time, these inconsistent rulings will be challenged in the Courts of Appeal until a clear legal answer becomes apparent. Of course, Congress could pass a law and give us an answer now but I wouldn't hold my breath waiting for that to happen. Meanwhile Lenders will seek to put language in their Short Sale Consent Agreements requiring the borrower to agree to deficiency liability

If you have specific questions about your liability, short sales, foreclosure, or any other real estate or mortgage issues, feel free to contact me at kirk@kirkmwest.com. We offer a FREE consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-893-9666.