Buying Notes and Deeds of Trusts:
Bank Buys Worthless Note, Borrower Awarded Attorney Fees
By: Julia M. Wei, Esq.
Investors, collection agencies, scavenger funds and institutional lenders buy promissory notes all the time. If the note is secured by a deed of trust against real property, the buyer takes the risk of collection of the debt, but hopes that the value of the collateral will be sufficient. Those notes are discounted because the buyer takes the note subject to all defects that occurred in the origination or underwriting and may not be able to foreclose in an expedient fashion.
The risk premium goes up (and correspondingly, the discount increases) when the collateral has already been foreclosed upon and the purchaser is just buying the debt instrument. In the recent case of Bank of America v. Mitchell, the bank bought a 2nd position note after the 1st position lienholder had already foreclosed on the borrower.
The case law in California is clear, if the same bank originates two loans, and non-judicially forecloses on the senior deed of trust, the borrower is protected from that lender suing for a deficiency judgment on the 2nd Note.
This has been true since the Simon v. Superior Court holding. [4 Cal.App.4th 63 (1992).] The reasoning is straightforward, the bank (holding the senior lien) controls whether to sue for a judicial foreclosure, or whether to non-judicially foreclose. Further, the bank determines whether to memorialize the debt with one note and deed of trust or ten notes and deed of trust. The Simon Court made it clear that manipulation by the lender could not circumvent the anti-deficiency protections available to the borrower (§580d) or the One Action Rule (§726).
The Mitchell case has a slight twist from Simon in that Mitchell involved a re-sold loan after the foreclosure. Dr. George Simon was the borrower on two loans from Bank of America where Bank of America (original lender) still held both notes. Mitchell actually addresses the secondary market for notes.
Facts: In 2006, Michael Mitchell borrowed $315k from GreenPoint Mortgage Funding to buy his house.*** The debt was memorialized by two promissory notes and secured by two deeds of trusts against one property ($262k and $63k respectively). GreenPoint foreclosed on the senior loan in 2009, and then sold the junior loan to Bank of America in 2010—more than a year later. BofA then sued Mitchell for the $63k.
BofA was obviously taking the position that it was the "sold out junior lienholder" as a result of the first lender's foreclosure. Mitchell brought a demurrer and won, the bank appealed.
Appeal: The appellate court affirmed, ruling in favor of the borrower, finding the case to be squarely in line with Simon vs. Superior Court. B of A argued that Mitchell had different facts from Simon, since the purchaser at the first foreclosure sale was a third party, rather than the foreclosing bank. The court did not find persuasive Bank's argument the presence of a bidders at the sale protected the borrower. The Court noted that the assignee bank bought the second note subject to all defenses that would have been available to the borrower against the original holder of the note. Since the borrower could have successfully asserted the Simon ruling against Greenpoint, it was still available to the borrower to assert against BofA. Caveat emptor (buyer, beware)!
The court also affirmed the award of attorney fees in favor of the borrower, $8,400. [Bank of America v. Mitchell, 2012 Westlaw 1177866, April 10, 2012]
Special thanks to Professor Dan Schechter of Loyola Law School for his Commercial Finance Newsletter article on this case. Professor Schechter noted that Mitchell is distinguishable from National Enterprises, Inc. v. Woods, 94 Cal.App.4th 1217, 115 Cal.Rptr.2d 37 (2001) based on the timing of the assignment (when the note was sold). In NEI, when the senior assignee foreclosed, the court held that the junior assignee was not affected by the senior's behavior. However, in Mitchell, the foreclosure on the senior deed of trust occurred prior to the assignment.
***The opinion states: “Appellant Bank of America’s (Bank) predecessor in interest loaned respondent Michael Mitchell (Mitchell) $315,000 to purchase a home, secured by two notes and first and second deeds of trust.” I find it puzzling that the case does not discuss the fact that the loans were purchase money loans and that there is no discussion of CCP §580b. The facts make it clear that the loan in dispute was a piggy back second, used to purchase the property. Since it was used to pay part of the purchase price, the statute should apply and there is no need to delve into the reasoning of Simon and 580(d).