Priority of Payments at Trustee's Sale

The final step in a non-judicial foreclosure in California is a Trustee's Sale of the real property, and Civil Code § 2924k, subdivision (a), specifies that the proceeds of a trustee’s sale must be distributed in the following order of priority:

(1) To the costs and expenses of exercising the power of sale and of sale,

(2) To the payment of the obligations secured by the deed of trust or mortgage which is the subject of the trustee’s sale (the lien being foreclosed),

(3) To satisfy the outstanding balance of obligations secured by any junior liens or encumbrances in the order of their priority, and

(4) To the trustor or the trustor’s successor in interest (the borrower).

When a junior lienholder forecloses on a second deed of trust at a nonjudicial trustee’s sale, the senior lienholder is not entitled to any proceeds from the sale because the property is purchased at the sale subject to the first deed of trust. If there are any surplus proceeds of the sale, they cannot be recovered by a senior lienholder.

California has adopted a “first in time, first in right” system of lien priorities, under which, as a general rule, liens have relative priorities among themselves according to the time of their creation.  Civ. Code § 2897 provides that “Other things being equal, different liens upon the same property have priority according to the time of their creation" (signing by the borrower).
In the recent case of MTC Financial v. Nationstar Mortgage, the two competing deeds of trust were both signed on December 5, 2003, and the time of their creation did not determine their priority.

The date of recording was not determinative in that case. Generally, liens that are recorded earlier take priority over subsequently recorded liens.  An instrument is deemed to be recorded when, being duly acknowledged or proved and certified, it is deposited in the Recorder’s office, with the proper officer, for record.  In MTC Financial, both deeds of trust were deposited in the recorder’s office at 8:00 a.m. on December 16, 2003.

In MTC Financial, the deed of trust on the home equity line of credit (a HELOC) was assigned instrument number 2003-0603657 and the deed of trust on the mortgage was assigned instrument number 2003-0603658. Therefore, based upon the instrument numbers, the HELOC was in senior position because it was indexed first. However, if two deeds of trust are submitted at the same time for recording, the order in which they are indexed is not determinative of priority.  

Absent evidence of timing that was determinative, the trial court in MTC Financial reasonably relied on the apparent intent of the parties to determine the priority of the two liens. (Civ. Code § 2897 [system of first in time applies only if “[o]ther things being equal.”].)

Given that Countrywide was the original lender on both loans, the reasonable expectation is that it would secure the larger mortgage loan for $205,080 in the primary or senior position to the HELOC for $15.000.  This understanding was further supported by reference to the usual understanding of the relationship between a mortgage and an equity line of credit. The HELOC allows the borrower to access large credit lines that are secured by the existing equity in the home (i.e., the difference between current market value and current indebtedness).

Because the trial court found that the HELOC was intended to be recorded second, and the foreclosure was on the HELOC loan, the larger loan was in a senior position, and the surplus funds of $73,085 were properly distributed to the Homeowners Association on its lien, and the balance to the borrower who was foreclosed upon.  This result did not harm the senior lienholder because it retained its secured lien on the property.

This case illustrates the variety of issues present in real property disputes based upon the law that may seem complicated, and the court's ability to fashion remedies that may be peculiar to the facts of the case.  
Experienced legal advice may assist in clarifying the priority of liens on property, resulting in a recovery by the foreclosed borrower.

Liquidated Damages Clause

A clause in a contract for liquidated damages, which is a specified amount or percentage to calculate, for a contractual breach has a long history in California.  Under some circumstances, the provision can be designed and operate as a contractual forfeiture (a rare finding because "the law abhors a forfeiture"). 

California's Civil Code § 1671 places limits on liquidated damages clauses, especially for certain contracts, such as for consumer goods and services, and leases of residential real property. 

A provision for liquidated damages is valid, unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.

A liquidated damages clause will generally be considered unreasonable and unenforceable if it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would result from a breach.  The amount specified in the contract must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained.

In the standard residential purchase agreement, the liquidated damages clause is in paragraph 21 B,  and it provides that if the buyer fails to complete the purchase because of buyer's default, seller shall retain, as liquidated damages:

            a.         The deposit actually paid, unless

            b.         The property is a dwelling with no more than four units, one of which the buyer intends to occupy, then the amount retained shall be no more than 3% of the purchase price.

            c.          Any deposit in excess of the maximum allowed shall be returned to the buyer.

Any clause in the agreement that specifies a remedy, such as a release or forfeiture of deposit or making a deposit non-refundable, for a buyer's failure to complete the purchase in violation of the agreement is invalid, unless the clause independently satisfies the statutory liquidated damages requirements in the Civil Code. (Paragraph 21 A.)

Because the deposit is limited to 3% for residential homes of 1-4 units in the standard residential purchase agreement, sellers of such properties should always insist on  an initial deposit of 3% of the purchase price to maximize their recovery if there is a breach by the buyer.  For other properties, the seller can attempt to get an increased amount as a deposit in a clause that is part of the agreement, but it has to be reasonable under the circumstances. 

Understandably, buyers would prefer to deposit a sum much less than 3% of the purchase price, or no deposit at all, to minimize their exposure if they breach the contract.

           

A liquidated damages clause is valuable in because it specifies the amount of damages in a breach of contract claim., often leaving only issues of liability to be decided. Consideration should be given to including a liquidated damages clause in every contract as it will simplify determining the amount of damages for any breach.  Typically, it is the seller who benefits from a liquidated damages clause that allows retention of a deposit, but they can be structured as mutual, if it was reasonable for the parties to suffer damages from the breach of the other.

As with most legal matters, it is a best practice to consult with an attorney regarding all contract documents, especially with regard to liquidated damages provisions, in order to avoid expensive lawsuits to resolve contractual disputes.