CBA filed an amicus letter with the California Supreme Court in support of a creditor that innocently failed to obtain the consent of co-debtors to a short sale of a parcel of property owned by another co-debtor, and thereby lost its right to a deficiency judgment on the debt.

In First California Bank v. McDonald, a husband and wife defaulted on a loan secured by two parcels of commercial real estate after the husband died. The bank consented to the wife’s request for a short sale of the parcel of property that she individually owned, and after the sale the bank applied the proceeds to the debt. It then judicially foreclosed on the second parcel. Unbeknownst to the creditor, the husband’s children and not the wife became heir to the second, jointly-owned parcel. The husband’s children claimed that the bank lost its right to a deficiency judgment because it failed to obtain their consent to the short sale, violating the “security first principle” arising under California’s “one-action rule” codified at Civil Procedure Code Section 726. Generally, Section 726 requires real property-secured creditors to look first and primarily to the value of collateral to satisfy the debt before seeking the balance from the debtor through judicial foreclosure.

The court in this case held that the penalty for releasing the wife’s separate property without the children’s consent is forfeiture of the bank’s right to seek a deficiency.  CBA supports review of this ruling because, in the absence of prejudice to the co-debtors and bad faith by the creditor (because the bank had applied the proceeds of sale to the debt), the harsh penalty of losing the right to enforce the debt should not be applied for a technical violation of Section 726, as interpreted by the courts. If you have any questions, contact CBA’s General Counsel Leland Chan at lchan@calbankers.com.