“Priority” of Interests in Real Property with Tenant Occupied Foreclosure Properties

Earn one hour of General MCLE credit by reading the article below and answering the questions on the Self-Study MCLE test. Send your answers, along with a check ($30 per credit hour for CCCBA members / $45 per credit hour for non-members), to the address on the test form. Certificates are dated as the day the form is received.

“Foreclosure of a first deed of trust wipes out a second deed of trust.” This statement derives from California’s law regarding priority. This law settles disputes between multiple interests in property by granting preference to one over the other. “Senior,” “junior,” “prior” and “subsequent” are labels designating priority. Interests in property have priority from the dates of their creation.[1] For mortgages and deeds of trust this rule applies, subject to the effect of the recording laws.[2]

A senior lien interest has long had priority over a junior lease interest. A foreclosure of said lien extinguishes the lease.[3] Title conveyed by a trustee’s deed relates back to the date when the deed of trust was executed[4] and is free and clear of all interests thereafter created.

Local rent control ordinances exist. On August 20, 1985, the 1st District Court of Appeal issued Gross v. Superior Court, (1985) 171 C.A.3d. 265. Gross, citing Birkenfeld v. City of Berkeley, (1976) 17 C.3d 129 (local rent ordinance which eliminates particular grounds for eviction is a limitation upon a landlord’s property rights under the police power conferred by Cal. Const. Art. XI, Section 7), bars foreclosure purchasers of tenant occupied properties located in rent control jurisdictions from recovering possession through a CCP 1161a(b)(3) eviction.

Gross provides that CCP 1161a does not preempt San Francisco’s Rent Ordinance, which is an exercise of police power that substantively places a limitation on the owner’s property rights. The ordinance by its operation created a tenancy between the trustee’s sale purchaser and the tenant under the junior lease despite the existence of contract and real property principles which would have otherwise precluded the tenancy. The foreclosure purchaser becomes a “landlord” by operation of law. Gross does not state that the terms of the junior lease are binding on the foreclosure purchaser and does not state what the terms of the “created” tenancy are.

Post market crash legislation has been enacted to protect tenants occupying foreclosure properties, including: (1) the 2009 Protecting Tenants at Foreclosure Act (PTFA), enacted as part of the “Helping Families Save Their Homes Act of 2009,” Public Law 111-22 , Division A, Title VII Sections 701-704 (amended in 2010); and (2) 2008’s CCP 1161b, requiring that tenants occupying foreclosure properties be given 60 days notice (amended in 2012, changing 60 days to 90 days).

On January 23, 2014, the 6th District Court of Appeal issued Nativi v. Deutsche Bank National Trust Co., (2014) 223 C.A. 4th 261. Nativi interpreted the above mentioned federal and state statutes in a manner that extends the principles born in Gross statewide. In doing so, Nativi has arguably abolished California’s law regarding “priority” of interests between senior liens and junior leases.

Mr. Nativi was a tenant under a junior lease. After a 2009 trustee’s sale to Deutsche Bank, Mr. Nativi was removed from the property. He sued. Deutsche Bank successfully moved for summary judgment. The trial court concluded that under California law, the 2009 trustee’s sale extinguished Mr. Nativi’s junior lease; that Deutsche Bank did not step into the shoes of the former landlord; and that its obligation under the PTFA was to give a 90-day notice. The Court of Appeal reversed.

Nativi interpreted the PTFA to provide that any “bona fide” junior lease created prior to a foreclosure sale under senior lien survives the foreclosure sale and is binding upon the purchaser for the remainder of the lease term (except where the foreclosure purchaser moves in). Nativi also discussed the California’s enactment of CCP 1161b and the 2012 amendment of same to make it comparable to the PTFA. Under Nativi, a foreclosure purchaser is forced: (1) into the role of “landlord”; (2) to become a successor to the landlord under the junior lease with the tenant; and (3) to assume all of the legal obligations that a landlord has.

The PTFA expires on December 31, 2014. H.R. 3543 and S. 1761 have been introduced, which would make it permanent. If it does expire, CCP 1161b, Gross and Nativi remain.

Gross and Nativi exclude junior leases from extinguishment via foreclosure of senior liens. They alter the rule of priority. Junior leases are elevated above senior liens in importance. As these opinions become widely known, people will realize that they create a new avenue for resisting foreclosure. Relying on Gross and Nativi, people will implement a strategy to keep control of encumbered properties by creating customized, “bona fide” junior leases (i.e., low rent, renewable, assignable and a purchase option at a wholesale price) and arguing that said leases survive foreclosure sales. Whether such a lease is bona fide depends on the facts, however such a lease will likely be considered bona fide even if the effect is to substantially lower the value of the foreclosed property below where it would be if the general rule of priority applied.

Gross and Nativi interpret the law in a manner that protects the interests of tenants and uphold the exercise of police powers in ways that limit private property rights. Both opinions may result in future real property transactions having increased risk. Higher borrowing costs, fewer loans being made and lower prices being paid at foreclosure sales may also result. Whether the benefits of Gross and Nativi are worth their detriments depends on one’s point of view. However, both opinions are here to stay and will have continuing impact on real property transactions.

Earn one hour of General MCLE credit by reading the article below and answering the questions on the Self-Study MCLE test. Send your answers, along with a check ($30 per credit hour for CCCBA members / $45 per credit hour for non-members), to the address on the test form. Certificates are dated as the day the form is received.

Since 1994, Kevin S. Eikenberry has been in solo practice in Walnut Creek. He is a civil litigation practice with an emphasis on real property, foreclosure, judgments and judgment liens.

[1] CC 2897.

[2] CC 2898.

[3] McDermott v. Burke, (1860) 16 C. 580, 589;  Bank of America v. Hirsch Merc. Co., (1944) 64 C.A.2d 175, 184; Hahn v. Riverside County Flood Control, etc. Dist., (1964) 228 C.A.2d 605; Dover Mobile Estates v. Fiber Form Products, Inc., (1990) 220 C.A.3d 1494.

[4] Bank of America v. Hirsch Merc. Co., supra.

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