Legal Update

NEW LAW PROTECTS HOMEOWNERS FROM LOAN LIABILITY AFTER A SHORT SALE

  • July 26th, 2011
  • Print

As of July 15, 2011, upon completion of a short sale with lenders’ approval, California law protects homeowners from ALL lenders with unpaid mortgage loan balances on the property after the sale.  The old law provided debt deficiency protection from the primary (1st) lien holder only, but not from junior a (2nd ) lienholder, who could still sue the borrower after the short sale.  New Senate Bill 458 amends Code of Civil Procedure §580e to provide liability protection to qualifying property owners from ALL mortgage lenders, not just the first lender.

Code of Civil Procedure§580e provides significant new protection to homeowners who sell their residential property by short sale.  Thanks to this new statute, the qualifying short seller of a one-to-four-unit residential property will automatically be protected against a deficiency judgment from their mortgage lenders if the short sale closes in compliance with the lenders’ instructions.  This means that a residential property owner who sells their property by short sale cannot be sued by their mortgage lenders after the sale.  This protection applies regardless of whether or not the property was the seller’s primary residence, a rental property, or a vacation home, so long as it has four units or less.  The property need not be owner-occupied for the protection to apply.

There are exceptions.  This protection does not apply if the borrower is a corporation, limited liability company, limited partnership or political subdivision of the state.  Also, if the borrower has committed fraud against the lender or waste against the property, the statutory protection is lost, and the lender may sue the borrower for the deficiency plus damages.

The statute also prohibits the lenders from asking the seller to make a financial contribution to the lenders, aside from the proceeds of the sale, as a condition to approval.  This prohibition will block lenders from requiring the borrower to pay extra cash to the lender for approval of the short sale, but the statute does not clearly state whether a borrower is barred from “volunteering” extra cash to induce short sale approval.

If a borrower cannot contribute extra money to close the short sale and gain statutory protection, then the effect of the new legislation might be to motivate undercompensated junior lenders (with  recourse loans) to reject the short sale, force the primary lender to foreclose, and then sue the borrower for the full amount of their unpaid debt.  In this circumstance, a seller might prefer to “volunteer” the payment of extra cash into escrow to induce short sale approval and avoid liability.  Future litigation will surely provide the requisite certainty that was omitted by our legislature.

Mark L. Strombotne, Esq.

Real Estate Transactions and Litigation

MLS@StrombotneLaw.com

Strombotne Law Firm

16450 Los Gatos Blvd., Suite #110

Los Gatos, CA  95032

phone:  408-971-9540

www.StrombotneLaw.com

***

You should consult legal counsel to evaluate this legal precedent in the context of your specific facts.  The distribution of Legal Update does not by itself create an attorney-client relationship with the reader.