The Problem, Part 2
Welcome to Part Two, addressing the second of 50 possible ways to chill the bidding at a Trustee’s Sale Auction. If you missed Part One, you can read it now (“50 Ways to Chill the Bidding at a Trustee Sale, Part 1″ in the Related Links box).
Here we have two problems discussed in terms of the law by the California Court of Appeal in its recent decision in South Bay Building Enterprises, Inc. and Riviera Lend-Lease, Inc. (June 9, 1999) 85 Cal.Rptr. 2d 647 (“South Bay Case”). This case is particularly important for all parties involved in non-judicial foreclosures as a guide on what NOT to do.
In another case, referenced here as the FPIC case a junior lienholder was wiped out because they failed to present evidence of fraud that had evidently occurred and had simply tried to have the sale set aside.
The court of appeal in the FPCI case, concluded that setting aside a trustee’s sale is not plaintiff’s only remedy and that a junior lien-holder could sue for fraud or other misconduct such as “fraudulent conduct to ‘chill the bidding’ or other misconduct resulting in the ‘washing out’ of junior liens. . .” (Id. at p. 1022, 255 Cal.Rptr. 157.)
However, the result in the FPCI case (i.e., the junior lienholder lost) was different than in the South Bay case because the junior lienholder in theFPCI case did not present any proof that anyone was ready willing and able to bid sufficient sums at the trustee’s sale to pay the senior lien and create a surplus. (Id. at p. 1024, 255 Cal.Rptr. 157.)
That is, unlike the South Bay case, there was no evidence that a qualified bidder had attended any of the postponements or the sale, ready, willing and able (i.e., qualified) to bid on the secured property or that the defendants’ conduct caused such a person not to attend the sale and bid. Thus, no damage or harm was shown to have been caused by the wrongful conduct or by the unlawful purpose. The court of appeal in the FPCI casefurther concluded that without such proof damages would be too speculative.
In the South Bay case it was alleged and proved at trial that Riviera (the senior lienholder) and the Borrower agreed that no one except Riviera would be permitted to purchase at the trustee’s sale. To achieve that wrongful purpose, the trustee’s sale was postponed two times when other ready, willing, and able to bidders were present and Riviera knowingly instructed the trustee that approximately $100,000 more than was actually owed was part of the obligation being foreclosed, and was to be part of Riviera’s credit bid.
This resulted in the trustee misrepresenting (overstating) the amount owed on the foreclosing obligation. The court of appeal concluded that these facts, if believed by the jury, “constitute substantial evidence of wrongful conduct.” In addition, the junior lienholder present evidence that a third party purchaser was present one of the postponements with a $225,000 cashier’s check and ready to bid on the property.
In the South Bay case the court of appeal concluded that South Bay presented substantial evidence to establish liability even though the evidence did not support the theory that defendants had committed common law fraud (i.e., made a misrepresentation to South Bay upon which it detrimentally relied). Rather, the court of appeal concluded that the evidence supported a theory of liability based upon a violation of Civil Code § 2924h(g), which creates a statutory duty the violation of which is a tort.
The court of appeal concluded that: “violation of a statutory duty to another may therefore be a tort and violation of a statute embodying a public policy is generally actionable even though no specific civil remedy is provided in the statute itself. Any injured member of the public for whose benefit the statute was enacted may bring the action.” [Ct. Om.]” The court of appeal further reasoned that since Civil Code § 2924h(g) criminalizes “any act … which would operate as a fraud or deceit upon any beneficiary … or junior lienholder….”
The court of appeal found that South Bay had established the necessary fraudulent conduct: by showing the agreement between the senior lender and the borrower to postpone the trustee sales when bidders ready and able to purchase were present; and by misrepresenting the amount owed to the senior lienholder. Without commenting on who else may be entitled to sue, the court of appeal concluded that South Bay, as a junior lienholder, “clearly falls with the class for whose benefit the statute was enacted and therefore may use defendants’ violation of the statute to establish civil liability.”
What the court of appeal did in the South Bay case is to create a tort (remedy) of “bid chilling”, which has elements different from common law fraud. The court of appeal held that the operative facts necessary to establish the tort of bid chilling were continuing the sale to prevent others from bidding and falsely inflating the amount owed to the foreclosing lender. Since substantial evidence of such facts were presented at the trial and since these facts were known by all of the parties for some time, the court of appeal concluded that the trial court should have allowed South Bay to amend its complaint after evidence was presented at the trial.
More confusing and problematic was the courts conclusion that South Bay should have been allowed to amend its complaint to plead a cause of action for money due under Civil Code § 2924k (a) with respect to surplus proceeds. The trustee does not appear to have been a party to the lawsuit. While certainly phantom surplus should be treated like real surplus to prevent beneficiaries from accidentally or intentionally inflating their obligation to chill bidding, the court is not clear as to the trustee’s role and responsibility where it does not know that the beneficiary is credit bidding in excess of the amounts owed to it by the borrower.
South Bay claimed that the trustee breached its statutory duty to collect from the senior lender the full amount of its bid and distribute the excess to it as a junior lienholder. The court of appeal stated that: “the claim is well-taken because [Riviera's manager testified that], the trustee acted as Riviera’s agent in conducting the sale. The evidence is reasonably susceptible to the inference that Riviera directed the trustee to ignore the fact that Riviera had placed a bid exceeding the amount owed to it and therefore to not collect from Riviera the excess amount and distribute it to South Bay. The trustee’s failure to perform its statutory obligation can be imputed to Riviera based upon the agency-principal relationship.” Under this analysis, there is little doubt that the beneficiary is liable for the phantom surplus.
The South Bay case sheds little light, however, on the duty of the trustee regarding phantom surplus. In appears (although it is far from clear), that in the South Bay case the trustee may have known that the beneficiary was credit bidding in excess of the amounts owed on the obligation. Therefore, exercising proper judicial restraint, the court of appeal did not decide the case based upon the normal nonjudicial foreclosure procedure where all that the trustee knows about the amounts owed is from the information contained in the beneficiary’s instructions.
The beneficiary (the only person in a position to know what it is owed) customarily instructs the trustee as to the amount owing both at the time the notice of default is recorded, just before publication of the notice of sale and in bidding instructions just prior to the trustee’s sale. The trustee has no way of knowing whether such instructions are correct, no known duty to verify the amount claimed by the beneficiary (i.e., to do an accounting) and has neither the ability nor power to determine amounts owed or to resolve disputes over the amounts owed.
From the court of appeal’s opinion in the South Bay case, while the beneficiary may be liable regardless of whether the trustee is liable, it does not answer whether the trustee has liability for simply following the instructions of the beneficiary/principal regarding the amount owing. In addition, the court of appeal’s opinion does not address the question of what duty the trustee has under Civil Code § 2924k to collect phantom surplus (as opposed to real surplus) from the beneficiary where the trustee is operating solely under instructions from the beneficiary (i.e., the trustee does not know the amount in the instruction exceeds the actual amount owed)?
Except where the beneficiary informs the trustee of the beneficiary’s intention to bid more than the amount set forth in the beneficiary’s instructions, the trustee should not be liable for following the instructions of the beneficiary as this would disrupt the delicate balance necessary to make the nonjudicial foreclosure system work in a prompt, economical and far fashion. Hopefully, future cases or legislation will clarify this point. However, where the beneficiary informs the trustee to bid more than the amount owed on the obligation, the trustee should obtain funds (cash or cash equivalents provided by the Code) from the beneficiary just as it would for any third party bidder.
The South Bay case is the first published opinion to directly address both the tort of bid chilling and the issue of how to handle phantom surplus. The facts in the South Bay case reveal blatant bid chilling and serve as a good basis for the court of appeal’s opinion, articulating that tort for breach of a statutory duty (i.e., bid chilling) can be brought by a junior lienholder. Unfortunately, the court of appeal’s opinion on phantom surplus is less than clear and raises questions under more normal facts other that differ from those in the South Bay case. Until clarified each trustee may want to consult with its own counsel to determine how it should handle the ambiguities created by the South Bay case.