Clearing Up A Black Sky, California Supreme Court Expands Creditors’ Deficiency-Judgment Rights
By Brian L. Bloom and Gerrick Warrington
The law is often complex and convoluted. But in some cases, the law is remarkably simple and straightforward. In Black Sky Capital, LLC v. Cobb, decided on May 6, 2019, the California Supreme Court opted for simplicity and followed a straightforward interpretation of California’s anti-deficiency statute, California Code of Civil Procedure section 580d, to provide relief to a creditor who, holding two deeds of trust secured by the same property, foreclosed on the senior deed of trust and, in a separate action, sought to recover a money judgment as to the amount still due and owing on the junior deed of trust, which was extinguished due to the creditor’s foreclosure. The Supreme Court’s intervention resolved a deep conflict amongst the California Courts of Appeal.
Facts and Background
In August 2005, Citizens Business Bank (the “Bank”) extended a loan to Michael and Kathleen Cobb (the “Cobbs”) in the amount of $10,299,250.00 (the “Senior Loan”), which was evidenced by a promissory note and a deed of trust (the “Senior Deed of Trust”) secured by commercial property located in Rancho Cucamonga, California (the “Property”). More than two years later, in September 2007, the Bank extended a second loan to the Cobbs in the amount of $1,500,000.00 (the “Junior Loan”), which was evidenced by a promissory note and a deed of trust (the “Junior Deed of Trust”) secured by the Property. Subsequently, the Bank sold both notes and assigned the Senior Deed of Trust and the Junior Deed of Trust to Black Sky Capital, LLC (“Black Sky”) in January 2014.
The Cobbs defaulted on the Senior Loan, and on June 10, 2014, Black Sky sent a notice of default and election to sell the Property under the Senior Deed of Trust (the “Senior NOD”). After failing to cure the defaults that gave rise to the Senior NOD, Black Sky foreclosed the Senior Deed of Trust and acquired the Property at a trustee’s sale for the sum of $7,500,000.00 on October 28, 2014. As a result of the foreclosure of the Senior Deed of Trust, the Junior Deed of Trust was extinguished.
One week after completing the foreclosure of the Senior Deed of Trust, Black Sky brought suit against the Cobbs in San Bernardino County Superior Court to collect the amounts due and owing under the Junior Note. In resolving the case, the trial court’s focus was on California Code of Civil Procedure section 580d(a) (“Section 580d”), which states, in relevant part, as follows:
“[N]o deficiency shall be owed or collected, and no deficiency judgment shall be rendered for a deficiency on a note secured by a deed of trust or mortgage on real property or an estate for years therein executed in any case in which the real property or estate for years therein has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.”
The trial court ruled in favor of the Cobbs, holding, based on prior Court of Appeal precedent from 1992, that Section 580d precludes a deficiency judgment for a junior lienholder who was also the foreclosing senior lienholder. Specifically, the trial court relied upon the so-called “Simon rule,” which originated from the Court of Appeal case Simon v. Superior Court (1992) 4 Cal.App.4th 63, which found that this situation—creditor forecloses on senior deed of trust, but still holds junior note—comes within California law’s prohibition against collecting a “deficiency judgment” against the borrower. California’s anti-deficiency statutes provide, among other things, that a creditor holding a note secured by a deed of trust or mortgage on real property may not collect a “deficiency judgment” (i.e., the difference between the amount owed to that creditor less the fair market value of the real property) if the real property is sold at foreclosure for less than the full amount of the debt.
On appeal by Black Sky, the Court of Appeal reversed the trial court’s decision. Reviewing Supreme Court precedent in this area from 1963, the appellate court concluded that Section 580d does not preclude a deficiency judgment for a nonselling junior lienholder who also holds the senior lien. As noted by the Court of Appeal, the Supreme Court had ruled, in Roseleaf Corp. v. Chierighino (1963) 59 Cal.2d 35, that where a creditor foreclosed a senior deed of trust by a borrower, Section 580d did not prevent a different creditor from seeking a money judgment against the same borrower. The Court of Appeal did not find a reason, under the circumstances presented in the Cobbs’ matter, to distinguish between junior liens held by the same creditor and a different creditor under the Roseleaf Corp. decision. By doing so, the Court of Appeal declined to follow the Simon rule and three other Court of Appeal decisions that adopted the Simon rule.
Supreme Court Ruling
In order to resolve a conflict amongst the Courts of Appeal on the issue, the Supreme Court agreed to weigh in and heard oral arguments in February 2019. Three months later, the Court unanimously concluded that Black Sky was not barred from pursuing a money judgment against the Cobbs as to the Junior Loan. In analyzing the text of Section 580d, the Supreme Court stated that the plain language of the statute compelled the result: “The plain language of the statute bars a deficiency judgment ‘when the trustee has sold the property ‘under power of sale contained in the…deed of trust.’” (Slip Op. at 9; emphasis in original). The definite article (i.e., the word “the”) in the phrase “the…deed of trust” makes clear that the statute is referring to the deed of trust under which the power of sale has been exercised, and not another deed of trust. Thus, Section 580d did not bar Black Sky from seeking to collect against the Cobbs with respect to the debt due and owing on the Junior Loan: “Because no sale occurred under the deed of trust securing the junior note in this case, section 580d does not bar a deficiency judgment on the junior note.” (Slip Op. at 12). The holding in Black Sky thus represents a significant change in California law as to the scope of Section 580d.
The Supreme Court’s decision also makes practical sense. Were Section 580d to be interpreted as barring deficiency judgments under these circumstances, lenders would be disinclined to extend additional credit to borrowers secured by the same property. Borrowers would then be forced to turn to other creditors, but the extension of credit on a second position lien by a different creditor normally costs borrowers more due to the additional risks being assumed by the junior lender.
The Court’s analysis did come with an important caveat: “Where there is evidence of gamesmanship by the holder of the senior and junior liens on the same property, a substantial question would arise whether the two liens held by the same creditor should – in substance, if not form – be treated as a single lien within the meaning of section 580d.” (Slip Op. at 10-11). For example, Section 580d may be applicable in a scenario where a creditor extended multiple loans days apart and secured by the same property, were the loans a part of the same transaction. However, that was not the case before the Court, as the two loans held by Black Sky were made more than two years apart involving separate transactions.
The Supreme Court’s decision in Black Sky Capital, LLC, v. Cobb puts to rest an issue that has vexed trial courts and the California Courts of Appeal for years, as its simple and straightforward decision provides benefits to both lenders and borrowers.
Feel free to contact us at (323) 852-1000 if you have any questions concerning these types of issues.
By Brian L. Bloom
Associate at Frandzel Robins Bloom & Csato, L.C.
By Gerrick Warrington
Associate at Frandzel Robins Bloom & Csato, L.C.