Purported Consumer Protection Measure Tramples Borrower’s Rights, Incentivizes Institutional Investors
by Kevin Gould, EVP/Director of Government Relations
A measure working its way through the California Legislature makes sweeping reforms to how real property in foreclosure is sold. Applicable to all real property, including commercial and residential, Senate Bill 1323 bifurcates the methodology for the sale of property at foreclosure by requiring that properties where there is equity, defined as debt not exceeding 90 percent of appraised market value, be sold by a licensed real estate agent on the open market. Property that does not have equity, defined as debt exceeding 90 percent of appraised value, would proceed to be sold under the existing trustee auction sales process authorized under the power of sale terms found within most uniform deeds of trust. To level set, in today’s real estate market, the measure would apply to the vast majority of properties that are in foreclosure.
For equity sales, which is the measure’s focus, the bill dictates that the initial open market price must be set at the appraised value for at least 30 days. If not sold within that time-period, the price may be reduced by five percent and listed for another 30 days. As proposed, this process repeats itself four times, or 120 days, at which point the unsold property may be sold at a trustee’s auction.
While aligned with the overall goal of trying to maximize owner’s equity in the sale of the property, CBA and other real estate trade associations have argued that the approach envisioned by the measure is conceptually flawed and mechanically unworkable.
Fundamentally, the measure appears to trample on borrower’s rights. Under the terms of the measure, the trustee is required to hire a real estate agent. But, under this established relationship, the real estate agent’s client is the trustee, not the borrower. The legality of a trustee hiring a real estate agent to sell a home that the borrower still owns is questionable. Here the Legislature is setting a policy that once the foreclosure process reaches the point of filing a notice of sale, that the borrower’s rights with respect to the property they still own, and perhaps occupy, cease to exist and that a third party will be making decisions that may not be in the best interest of the borrower.
In what has historically been a ministerial role, trustees would now be burdened with significant discretion leading to legal liability and potentially clouding future transactions. In fact, it’s questionable that a title insurance policy would be issued on transactions under this scheme making these properties toxic.
The measure also applies retroactively to existing contracts. Standard uniform instruments establish a power of sale but do not contemplate the approach envisioned by the bill. Ultimately, applying the bill retroactively may raise legal arguments pertaining to impairment of contract.
Setting aside whether the approach taken in SB 1323 is legal, the measure prompts a number of very basic questions, such as how a trustee would escape criticism from the borrower who would ordinarily be in control of the sale of their own property. For example, how does the trustee select a real estate agent and was it the right one, pick from competing purchase offers, show the property to prospective purchasers if the borrower isn’t cooperative, or make representations as to the condition of the property?
Proponents think they have solved these concerns through recent amendments. One amendment establishes a process for the trustee to “randomly” select a real estate agent from a “statewide database” made available by the California Department of Real Estate (DRE), or if not available by the DRE, then from a database maintained by “a statewide trade association of realtors”.
Another amendment dictates how a trustee picks between competing offers by establishing a waterfall test. First, the trustee must accept the highest value offer. However, if there are multiple offers at the same amount, the trustee must pick the offer where the purchaser intends to occupy the property. If these factors are equal, the trustee must accept, in descending priority: the offer with a waived inspection contingency; the offer requiring the least third-party financing; and, the offer with the soonest closing date. Interestingly, given the waterfall established in the measure, it prioritizes institutional investors that may be situated to offer the highest price, have the fewest contingencies and/or rely on the least amount of financing. This result is counter to the Legislature’s more recent focus of discouraging institutional investors and prioritizing first-time, owner-occupant homebuyers.
Just stepping through a standard sales transaction, under SB 1323, who signs seller’s disclosures or a grant deed? In fact, a trustee would be unable to accurately make representations as to the condition of the property required in typical seller’s disclosures. Further, given that the measure requires the property be listed at appraised market value, questions have been raised on how to establish that value if the borrower isn’t cooperative. Proponents think they have resolved that concern too by requiring the appraisal be based on an exterior only appraisal if a complete visual inspection of the interior and exterior is impossible because the borrower denies the appraiser access.
Given the trend over the past many years where mortgage borrowers rights have been strengthened, it’s astonishing that the Legislature is poised to strip borrowers of their rights through this proposal. Instead, why not advance a public policy solution that incentivizes the borrower to take action and control, particularly when they have equity in the property?
CBA and other real estate trades have been trying to find common ground with the proponents. While we don’t think the current approach is workable, we have offered an alternative that puts the borrower in control. The counterproposal postpones a trustee’s sale if the borrower provides a valid listing agreement, gives the borrower time to close escrow if there is valid purchase agreement and establishes a minimum bid requirement aimed at preserving the borrower’s equity if a trustee’s sale occurs. Unfortunately, the proponents have rejected this counterproposal and is moving forward with their approach.
At this stage, the measure has passed the Assembly Committee on Judiciary and is pending action on the Assembly Floor. Since the bill was amended in the Assembly, it will return to the Senate for a concurrence vote. Should it pass at each of these points, the measure will be sent to the governor for consideration.