Foreclosure Part 3: Deficiency Limitations and Prohibitions, The One Action Rule and Post Sale Redemption

Deficiency Limitations and Prohibitions.  The Great Depression underscored just how imperfect the foreclosure sale/auction is.  The Great Depression also put into stark relief the domino effect of falling values and the crushing burden of excess debt over plummeting land values.  The deficiency--the amount by which debt exceeded the amount realized at a foreclosure auction--became the target of legislative action, especially in California.

A foreclosure auction is a pale imitation of a market.  All too often, there is only a handful of bidders, and not infrequently, only one, the creditor.  The creditor has little incentive to bid more for the property than the amount of the debt owed, and if the creditor can go after the debtor for a deficiency, the creditor may be wise to bid substantially less than the amount of the debt.  The debtor is then faced not just with the loss of the mortgaged property, but the burden of a judgment for the amount of the deficiency. 

The Fair Value Limitation.  To address this problem, California limited the deficiency to the amount by which the debt exceeds the fair value of the foreclosed property on the date of the foreclosure sale, and not the amount bid at the foreclosure sale.  This is the fair value limitation on the amount the creditor can recover as a deficiency.  See California Code of Civil Procedure Section 726.

The One Action Rule.  There is a procedural problem with the fair value limitation.  If the creditor has the right to sue on the debt evidenced by the note, ignoring for the time being foreclosure on the mortgage or deed of trust securing the note, the creditor can do an end run around the deficiency limitation, first by obtaining a judgment in the amount of the debt and then by foreclosing on the mortgage.  The foreclosure will reduce the amount of the judgment, but only by the amount bid at the foreclosure auction.  To block this tactic, the California legislature enacted the famous, or infamous, one action rule.  If the creditor has a note secured by real property in California, the creditor must foreclose judicially.  The creditor may not obtain a judgment on the debt and then foreclose.  California Code of Civil Procedure Section 726.

Enforcement of the One Action Rule: The Sanction.  If a California creditor with a mortgage debt ignores the one action rule and sues on the debt, the debtor can have the suit booted out of court.  If the debtor for some reason takes no action to stop the creditor from moving forward to obtain a judgment on the debt, that judgment will hold up, but all is not lost for the debtor.  The creditor may have a judgment, but that is all the creditor has.  By obtaining a judgment in violation of the one action rule, the creditor loses the mortgage on the debtor’s property.  This has come to be known as the sanction for violating the one action rule.  The sanction applies whether the debt is secured by a mortgage or a deed of trust.

Extending the Right of Redemption Beyond the Foreclosure Sale.  The fair value limitation, one action rule and sanction were still insufficient protections for debtors in dire economic times.  To bolster the fair value limitation, the California legislature proclaimed that a debtor had the right to buy back the foreclosed property from the successful bidder for a specified period of time under certain circumstances for the amount of the bid plus certain specified costs.  This is the post-sale (statutory) right of redemption, and it only applies to a judicial foreclosure, not a foreclosure by the trustee under a deed of trust.  See Code of Civil Procedure Sections 729.010 et seq.

Deficiency and the Deed of Trust.  For a creditor, the beauty of the deed of trust is foreclosure without involving a court.  There is a foreclosure, an auction, but all is done without the blessing of a judge or the supervision of judicial or governmental personnel.  As there is no judicial process in a non-judicial foreclosure, there is no process for ascertaining the fair value of the foreclosed property, a pre-requisite for obtaining a deficiency judgment under the fair value limitation of the one action rule.  The legislative solution, the creditor was given a choice: foreclose judicially and the creditor can obtain a deficiency judgment, but foreclose non-judicially, and the creditor is barred from suing the debtor for a deficiency.  See California Code of Civil Procedure Section 580d.  As additional compensation for loss of the deficiency judgment, the creditor foreclosing non-judicially under a deed of trust would not face the debtor’s post-foreclosure sale right of redemption.