A loss payee who owns both a first loan and a second loan, and who forecloses on the second loan by making a “full credit bid,” cannot recover from an insurer for property damage that occurred before the foreclosure sale. ( Najah v. Scottsdale Ins. Co. (2014) 2014 WL 4827882)
Facts
Orange Crest Realty Corporation (Orange Crest) purchased commercial land that was improved with a building. Orange Crest financed part of the purchase price with a first loan from the Lantzman Family Trust (Lantzman Trust), and financed the remainder with a second loan from Jamshid Najah and Mark Akhavain, the sellers. The first loan was secured by a first trust deed, and the second loan was secured by a second trust deed. (Under California law, a “trust deed” arrangement is essentially the same as a “mortgage” arrangement.)
Orange Crest ultimately defaulted on the first loan, and the Lantzman Trust commenced foreclosure proceedings. In order to protect their interest, Najah and Akhavain purchased the first loan for $1.749 million (the full amount Orange Crest owed to the Lantzman Trust) and obtained an assignment of the first trust deed held by the Lantzman Trust. As a result, Najah and Akhavain owned both the first and second loans.
Later, Najah and Akhavain discovered that Ronald Shade (Orange Crest’s principal) had caused extensive damage to the building, and had stolen various building components. After discovering the damage and theft, Najah and Akhavain instituted foreclosure proceedings on the second trust deed. At the foreclosure sale, Najah and Akhavain re-acquired the property by bidding $2.878 million, which was the full amount of the unpaid debt on the second promissory note, including interest, fees, and the costs of foreclosure. (As will be explained, this is known as a “full credit bid.”)
Najah and Akhavain then submitted a claim to Scottsdale Insurance Company (Scottsdale), which had issued a policy on which Orange Crest was named as the insured and on which Najah and Akhavain were named as loss payees pursuant to a “standard” lender’s loss payable endorsement. Scottsdale denied coverage for numerous reasons, and Najah and Akhavain filed suit for breach of contract and bad faith.
At trial, the court found in favor of Scottsdale. Among other things, the court ruled that because Najah and Akhavain had made a “full credit bid” when Najah and Akhavain foreclosed on the second loan, this eliminated their right to recover on the policy. Najah and Akhavain appealed.
Holding
On appeal, Najah and Akhavain did not dispute that their full credit bid at the foreclosure sale on the second trust deed extinguished that debt. However, they contended they should still be able to recover from Scottsdale because, before the foreclosure sale, they held two trust deeds that secured two separate debts, and after the foreclosure sale, they still held the first loan. More specifically, they contended that, even though they had made a full credit bid, a recovery from Scottsdale would not provide them with an unfair windfall, as they had invested a total of $4.627 million to acquire the property – the $1.749 million they paid to the Lantzman Trust for the first loan and the $2.878 million they bid at the foreclosure sale when they foreclosed on the second loan. Thus, Najah and Akhavain argued that all liens held by a single loss payee should be aggregated to determine whether a full credit bid extinguished a loss payee’s right to recover from an insurer.
The Court of Appeal rejected all of these arguments, and held that when Najah and Akhavain made a full credit bid at the foreclosure sale regarding the second loan, that bid established that, at the time of the foreclosure sale, the property was equivalent to the value of the total debt they held. Therefore, their full credit bid barred any claim against Scottsdale for damage that occurred before the foreclosure sale.
Comment
Generally, when a lender forces a foreclosure sale, anyone – including the lender – can bid at the sale. At the foreclosure sale, the lender has “credit” that is equal to the sum of the unpaid principal, accrued interest, late charges and costs of sale. Because it would be a pointless exercise for a lender to tender cash or a check to itself to satisfy the unpaid debt, the courts recognize that the lender can use some or all of this “credit” to bid at the foreclosure sale.
If the property sustains damage before the sale and the lender then acquires title at the sale, the lender often will make a claim against any property insurance policy on which the lender was named as a loss payee. However, in many instances, the “credit bid” rules will limit or even altogether eliminate the lender’s recovery against the policy. ( Track Mortgage Group, Inc. v. Crusader Insurance Company (2002) 98 Cal.App.4th 857.)
A loss payee’s recovery for damage that occurred before the sale is limited to the difference between the amount of the debt and the amount of the lender’s credit bid at the foreclosure sale. Two examples illustrate application of the credit bid rules.
Suppose the full amount of the debt is $100,000 and the lender acquires title at the foreclosure sale by making a credit bid of $50,000. (This generally is known as a “partial credit bid,” because the lender used only part of its “credit” to acquire title.) However, after acquiring title, the lender discovers that, prior to the foreclosure sale, the property sustained damage of $75,000 caused by a peril covered by the policy on which the lender is named as the loss payee. Although the property has damage of $75,000, the carrier is obligated to pay the lender only $50,000 (i.e., the difference between the debt of $100,000 and the lender’s partial credit bid of $50,000).
Alternatively, suppose the full amount of the debt is $100,000 and the lender acquires title at the foreclosure sale by making a credit bid of $100,000. (This generally is known as a “full credit bid,” because the lender used the full amount of its “credit” to acquire title.) However, after acquiring title, the lender discovers that, prior to the foreclosure sale, the property sustained damage of $75,000 caused by a peril covered by the policy on which the lender is named as the loss payee. Although the property has damage of $75,000, the carrier is obligated to pay the lender nothing (i.e., the difference between the debt of $100,000 and the lender’s full credit bid of $100,000).
In order to determine the possible effect of California’s credit bid rules, it is first necessary to determine whether the damage occurred before or after the foreclosure sale. Importantly, the credit bid rules apply only to damage that occurred before the sale.