California’s New Anti-Deficiency Statute for Short Sales

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Effective January 1, 2011, California’s newest anti-deficiency statute applies to short sales. Newly enacted Code of Civil Procedure section 580e prohibits a deficiency judgment where: (1) the obligation is a note secured by a first deed of trust; (2) the property is a dwelling of not more than four units; (3) the short sale is made with the written consent of the note holder; and (4) the borrower/trustor is not a corporation or a political subdivision of the state.

Except for situations involving borrower fraud or waste, the statute provides the following protection: “Written consent of the holder of the first deed of trust or first mortgage to that sale shall obligate that holder to accept the sale proceeds as full payment and to fully discharge the remaining amount of the indebtedness on the first deed of trust or first mortgage.”

This new statute is particularly noteworthy in the following respects: (a) by fully discharging the debt, in addition to precluding a deficiency judgment, it may preclude any recourse against a third party guarantor; (b) it excludes application to a trustor corporation, but not to a partnership or limited liability company (an odd distinction); (c) it includes no requirement that the dwelling be owner occupied; and (d) it only applies to notes secured by a first deed of trust.  Legislative intent with respect to some of these issues might be clarified by future amendment.

As for a second trust deed, if the anti-deficiency statute in CCP section 580b does not apply (for a seller’s note secured by a deed of trust, or a purchase money loan on an owner occupied dwelling), because section 580e does not address the issue, the borrower should make clear that any shortfall on repayment is waived as part of the short sale, or the lender should make clear that it reserves its rights to recover the deficiency.

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