Another UTA Amicus Curiae Victory!

Where the Trustee Followed the Provisions of Cal. Civil Code § 2924j, a Trustee Has No Duty to Search for, Prioritize and Distribute Surplus Funds to a Judgment Lien Holder Who Failed to Record a Request for Notice of Default.

By Phillip M. Adleson, Esq., Adleson, Hess & Kelly, Corporate Counsel for the United Trustees Association

In a big victory for UTA’s amicus curiae (friend of the court) program, on December 19, 2009, the California Court of Appeal (4th District, Division 3) handed down it opinion in Banc of America Leasing & Capital, LLC, v. 3 Arch Trustee Services, Inc. (2009) 180 Cal.App.4th 1090 (“Banc of America case”).  The court of appeal opinion adopted substantially all of the positions contained in  UTA’s amicus curiae brief and in the briefs filed by counsel for 3 Arch Trustee Services, Inc. (“3 Arch”).

Facts:  On June 3, 2004, the borrower obtained title to real property in Costa Mesa, California (the “Property”).  On that same day, a first and a second deed of trust were recorded to secure the lender’s purchase money loans in the respective amounts of $469,800.00 and $150,000.00.

The borrower defaulted on the second deed of trust, and 3 Arch, as substituted trustee, commenced a nonjudicial foreclosure by recording a notice of default was recorded on December 23, 2004.  The Trustee Sale Guarantee (“TSG”) did not show any information identifying an interest of Banc of America Leasing and Capital, LLC (“Banc of America”) or its predecessor in interest Fleet Business Credit, LLC (“Fleet”) in the Property.  There was no dispute that neither Banc of America nor Fleet ever recorded a request for notice of default under Civil Code §2924b.

On March 28, 2005, 3 Arch caused a Notice of Trustee’s Sale to be recorded.  Fleet obtained a judgment against the borrower on May 13, 2005, and on June 6, 2005, Fleet recorded an abstract of judgment creating a judgment lien against the Property.  On July 21, 2005, the Property was sold at a trustee’s sale to a third party purchaser.  On August 15, 2005, a Trustee’s Deed was recorded.  After deducting the amount of the foreclosed debt, costs and trustee fees, the remaining amount (“surplus proceeds”) was $114,797.77 which was distributed to the borrower Wong as there were no other claimants pursuant to Civil Code § 2924j.

Thereafter, Banc of America (as successor to Fleet) sued 3 Arch contending that 3 Arch had an absolute statutory duty to search for, verify, prioritize, and distribute the surplus funds to junior lien holders before distributing anything to the property owner.  Banc of America’s position was based upon the recording and judgment lien statutes and on Civil Code § 2924k.  Under Civil Code § 2924k, if read in isolation, 3 Arch would be obligated to distribute surplus proceeds to junior lien holders, in order of their priority, before distributing anything to the property owner (e.g., borrower).  The trial court ruled in favor of Banc of America and 3 Arch appealed.  UTA filed an Amicus Brief in support of the trustee.

In the late 1980’s, it became clear to many trustees that a court interpleader action was not an economical or efficient method for distributing surplus proceeds generated by a trustee’s sale, especially where the sum in question was relatively small.  On the other hand, trustees were not willing to accept further risk and liability potentially arising from unilaterally making the decision regarding who should receive surplus proceeds.

To resolve this problem, in 1989 the California Trustee’s Association, UTA’s predecessor, proposed a bill to create a nonjudicial system for the handling and distribution of surplus proceeds generated by a trustee’s sale.  That bill resulted in the initial version of Civil Code § 2924j (Stats 1989 ch. 849 § 1.)  The concept was to create a statutory nonjudicial process whereby the trustee would send notices to certain statutorily entitled persons, receive claims from those persons and either determine the claims and distribute the surplus proceeds or, if the trustee could not reasonably determine the priority to the funds, simply pay the surplus proceeds to the court allowing the claimants to pursue their claims in court.

As often happens in the legislative process, the original statute had flaws that prevented trustees from utilizing this new nonjudicial surplus proceeds process.  The following year, the legislature amended Civil Code § 2924j and added Civil Code § 2924k which primarily restated existing law.  With the amendment to 2924j, trustees, over time, started to use the nonjudicial surplus proceeds procedure.

At first blush, the amendment to § 2924j and the adding of § 2924k appeared to create a conflict.  That is, unless an interpleader action was filed within 30-days after the trustee’s sale, Civil Code § 2924j required that the trustee send written notice of surplus funds to all persons with recorded interests in the real property as of the date immediately prior to the trustee's sale who would be entitled to notice pursuant to subdivisions (b) and (c) of Section 2924b.  Under this definition, a number of persons with a recorded interest in the secured property or who had recorded a request for notice of default after the notice of default was recorded would not be entitled to have the trustee mail them a notice of surplus proceeds.

However, as the court of appeal noted in the Banc of America case, the persons to whom mandatory notices are to be sent, as well as other aspects of the nonjudicial foreclosure system, is a result of careful legislative balancing of the interests of the various parties to nonjudicial foreclosures.  As such, this comprehensive legislative scheme should not be disturbed by the courts.  As part of the history of the comprehensive legislative scheme regulating nonjudicial foreclosures, certain persons with a junior interest are not automatically entitled to receive a notice of default or notice of sale. (Perez v. 222 Sutter St. Partners (1990) 222 Cal.App.3d 938).  For example, a trustee foreclosing on a senior deed of trust need not mail notices of default or notices of sale to the holders of junior judgment liens, holders of mechanic’s liens, licensees, attachment lien holders or holders of easements created after the foreclosing deed of trust unless, prior to the recording of the notice of default, these persons record a request for notice of default.

Civil Code § 2924j was designed to follow the same pattern as notices of default.  Therefore, not everyone with a junior recorded interest in the property is intended to automatically be entitled to have a notice of surplus proceeds mailed to him/her.  As with notices of default and notices of sale, there is a gap period where, even if a judgment lien holder were to record a request for notice of default, such interest holder would not be entitled to notice of surplus funds under Civil Code § 2924j.

The court of appeal held that trustee’s duties relating to surplus proceeds are limited to those set forth in the deed of trust and in the comprehensive state legislative scheme regulating nonjudicial foreclosures.  While the general legal principal is not new, the court of appeal for the first time applied it to the distribution of surplus funds, interpreting the alleged ambiguity between Civil Code § 2924j (nonjudicial interpleader statute) and Civil Code § 2924k (dealing generally with persons who are entitled to surplus proceeds).  The court of appeal held that where a trustee follows the procedures in Civil Code § 2924j (i.e., regarding notices and claims), the trustee has no further legal duty to search for, prioritize and distribute surplus proceeds to other persons named in 2924k (i.e., judgment lien holders, mechanic’s lien holders etc. who have not timely filed a request for notice of default pursuant to Civil Code § 2924b.)

The Banc of America decision clarifies the claimed ambiguity between Civil Code §§ 2924j and 2924k.  If a trustee carefully follows Civil Code §2924j, it should have no further legal obligation with respect to the distribution of surplus funds.

What the Banc of America case does not resolve is: how to handle claims made by persons not entitled to statutory notice of surplus funds and whether to send a courtesy notice of surplus funds (i.e., notices not required by statute) to such persons when the trustee actually knows of the existence of the judgment lien holder.  Each trustee will have to consult with their own counsel.  For many years, the experience with courtesy notices was that “no good deed goes unpunished”.  Some trustees routinely mail courtesy notices; others never mail them.

How do persons not automatically entitled to statutory notice of surplus proceeds protect themselves?  Counsel for plaintiffs who have filed a lawsuit against a defendant who holds real property subject to mortgages and deeds of trust should consider filing a request for notice of default early in the litigation before the judgment is obtained.  This is particularly true if the defendant’s primary ability to respond to damages is based upon ownership of the real property, and not insurance coverage.  If a notice of default has already been recorded by the foreclosing deed of trust holder, the judgment lien holder, prior to the trustee’s sale, should consider writing a letter to the trustee advising the trustee that the junior lienholder exists and that it is requested that a notice of surplus fund be sent to the judgment lien holder at a designated address should the sale result in surplus proceeds.  

Neither Civil Code § 2924j nor the court of appeal’s decision in the Banc of America case addresses how trustees should respond to a timely surplus funds claim from a person not entitled to notice of surplus funds.  Logic and equity would lead one to believe that the claim should be handled just like any other junior claim as junior lienholders should be paid before the trustor. (See, Civil Code § 2924k).  Unfortunately, Civil Code § 2924j(b) provides that “[t]he trustee shall exercise due diligence to determine the priority of the written claims received by the trustee to the trustee's sale surplus proceeds from those persons to whom notice was sent pursuant to subdivision (a) [i.e., those who were entitled to notice].  It could be argued that this creates a problem for the trustee because, if the trustee distributes surplus proceeds to a person not entitled to notice of surplus proceeds, a person entitled to notice of surplus proceeds (e.g., a junior deed of trust beneficiary or the trustor) who did not receive a distribution of surplus proceeds could theoretically sue the trustee, arguing that the trustee failed to comply with § 2924j(b).  This creates an inequitable situation, as the trustor should never receive surplus proceeds before those holding sold out junior liens on the foreclosed property.  There is no telling how a court may rule on this variation to the Banc of America facts. This problem may have to be remedied by legislation.

Where there is a conflict between claims of those entitled to have a notice of surplus funds mailed to them under Civil Code § 2924j and those not entitled to such notice, trustees should consider filing an interpleader action with the court. Civil Code § 2924j(e) expressly allows a trustee to file an interpleader action at any time to resolve disputes over surplus proceeds.  Once an interpleader action has been filed, the provisions of Civil Code § 2924j do not apply.  As such, Civil Code § 2924k would apply to the distribution of proceeds.  Therefore, when in doubt or in fear of unnecessary liability, the trustee should consider filing an interpleader action at least until the legislature corrects this problem.  Hopefully, UTA will have an opportunity to address this remaining issue in the upcoming year.

UTA’s effort and successful result in the Banc of America case is a prime example of why UTA members and others should dig into their pockets and contribute to the UTA Amicus Fund. Your support is needed now more than ever.