Turning a narrow consumer shield into a potentially broad sword, this summer California expanded its anti-deficiency judgment laws to prohibit not only the judicial pursuit of mortgage deficiency balances, but also to declare that post-foreclosure deficiencies can be neither “owed” nor “collected.”
In doing so, the California Legislature may have created a potentially significant compliance headache and increased litigation risks for a wide range of financial service companies – from mortgage servicers and debt collection agencies to credit reporting agencies and those relying on credit reports.
In their prior 70 years of existence, California Civil Code Sections 580b and 580d (the “anti-deficiency judgment statutes”) struck a careful balance between providing lien holders with the remedy of a non-judicial foreclosure, in exchange for giving up their right to sue borrowers in court for the unpaid balance between the amount of the mortgage and the amount of the foreclosure, i.e., to obtain a “deficiency judgment.”
Section 580d, the statute applicable to mortgage loans, stated that “no judgment shall be rendered for any deficiency” upon a secured note after it has been sold. In conformance with that carefully limited scope, for decades California courts have held that deficiencies arising from non-judicial disclosures, while not collectible through the courts, remained due and owing.
In addition, it has been held that because the anti-deficiency statute does not extinguish the debt itself, creditors were permitted under the Fair Credit Reporting Act and the California state analogue to report the existence of the deficiencies to credit reporting agencies.
The amendments were introduced in the California State Legislature in early 2013 with little fanfare or explanation. By late spring, the legislative commentary contended that the amendments were intended to prevent creditors and debt collectors from contacting borrowers seeking repayment of the deficiency balance through non-judicial means. Cal. Bill Analysis, S.B. 426 Sen. (April 23, 2013).
It was further stated that inclusion of the term “owed” was also intended to prevent a creditor from continuing to report a loan as delinquent after foreclosure by eliminating the underlying debt itself.
To date, these amendments have gone relatively unnoticed by the financial services industry and the media, other than to remark on the potentially adverse tax implications for defaulting borrowers.
But that will not last for long.
In light of these amendments, businesses should review their debt collection, credit reporting, and other policies and practices with respect to California foreclosures. Plaintiffs likely will read the amendments broadly and argue that attempts to negotiate the collection of outstanding deficiencies, or to report such balances to credit reporting agencies, violate various federal and California laws and give rise to significant statutory and common-law damages.
Given what appears to be extensive involvement by the plaintiffs’ bar in lobbying for the amendments, as well as previously unsuccessful class-action litigation targeting such practices, a wave of litigation should be expected for those creditors who do not modify their practices to conform with the new requirements.