Dark Sky

California Supreme Court Grants Review of Black Sky Capital v. Cobb

There is a  big ticket item for asset-based lenders in California, and particularly for lenders holding more than one deed of trust on the same property. On September 27, 2017, the California Supreme Court granted review of Black Sky Capital, LLC v. Cobb (2017) 12 Cal.App.5th 887 (“Black Sky“) and is now poised to answer the following question:

Does Code of Civil Procedure section 580d permit a creditor that holds both a senior lien and a junior lien on the same parcel of real property arising from separate loans to seek a money judgment on the junior lien after the creditor foreclosed on the senior lien and purchased the property at a nonjudicial foreclosure sale?

For decades now, California courts have answered this question in the negative, citing the equitable rule created in the case of Simon v. Superior Court (1992) 4 Cal.App.4th 63 (“Simon“).  The Simon rule provided creditors with a bright-line prohibition:  if the lender holds separate notes secured by senior and junior deeds of trust, then the lender is barred from collecting anything on the “sold-out” junior debt after it nonjudicially forecloses on its senior deed of trust.  By contrast, where the senior and junior lenders are different entities, the “sold-out junior” whose lien is extinguished by the unrelated senior’s foreclosure may freely sue the borrower on its (now unsecured) loan, obtain a money judgment, and collect its debt by execution on the borrower’s other assets.

The Simon rule is based upon a perceived need to prevent lenders from opting-out of California’s antideficiency scheme, and in particular Code of Civil Procedure section 580d, which prevents a lender from collecting a deficiency after nonjudicial foreclosure of the deed of trust securing the debt.  The Simon court reasoned that the purpose (if not the text) of section 580d would be subverted if a lender could simply structure one loan into two loans secured by separate trust deeds.  Notably, the Simon rule is quite broad, applying to situations regardless of the lender’s actual motives in structuring the original loan. In other words, under Simon‘s rule, the lender’s intent (to evade antideficiency legislation or not) is simply not relevant and, under Simon, even a lender with demonstrably legitimate reasons for structuring a loan with two separate notes and two trust deeds would be barred from collecting its sold-out junior debt.  This is concerning, since so-called “piggyback” refinancing transactions, where junior and senior liens are created at the same time, are rather common.

In June of 2017, the California Court of Appeal published Black Sky, a case which rejected Simon‘s holding and found that nothing in section 580d prevents any sold-out junior from collecting its debt.  In Black Sky, a bank loaned about $10 million to two individual borrowers secured by a deed of trust on a parcel of commercial real property.  Two years later, the same bank loaned another $1.5 million to the same borrower, secured by a second deed of trust on the same property. The bank later assigned both the notes and deeds of trust to Black Sky.  The borrowers defaulted, and Black Sky nonjudicially foreclosed on the senior lien and acquired the property for a $7.5 million credit bid.  Black Sky then sued the borrowers for on the sold-out junior debt. The trial court granted summary judgment in favor of the borrowers—citing Simon‘s rule: that section 580d prevents a lender from collecting its sold-out junior debt after the same lender forecloses on its senior deed of trust. Black Sky appealed.

On appeal, the Court of Appeal reversed the trial court, finding that section 580d did not apply. (Black Sky Capital, LLC v. Cobb (2017) 12 Cal.App.5th 887, 897 [“By using the singular throughout the statute, the Legislature unambiguously indicated that section 580d applies to a single deed of trust; it does not apply to multiple deeds of trust, even if they are secured by the same property… It makes no difference whether the junior lienholder is the same entity or a different entity as the senior lienholder.”].)

Assuming the California Supreme Court addresses the Simon vs. Black Sky interpretations of section 580d head-on, lenders will finally be provided with certainty on what has, to date, been a murky landscape for lenders trying to protect themselves in strategically structuring financing transactions. We will be monitoring the progress of the Black Sky appeal as it progresses in the California Supreme Court, and will provide an immediate update once a substantive decision is rendered.