Beginning January 1, private lenders in California will face a dramatically different foreclosure process for one to four family residential properties. Under the new California law SB 1079, what was once the final foreclosure sale won’t necessarily be the end of the story.
The impetus behind SB 1079, which was inspired by Oakland-based activist group Moms 4 Housing, is to reduce the number of vacant homes by giving the first right of refusal to buy a foreclosed property to people who intend to live there — current tenants, prospective owner-occupants, or nonprofits focused on expanding affordable housing options. The changes come into play after delinquency rates this year climbed to levels not seen since 2010. During the Great Recession, high rates of foreclosure inspired corporations to snap up homes in bulk. As a result, home ownership plunged, and the Golden State continues to grapple with high rates of vacancy over a decade later. More than 1.2 million California homes were vacant in the 2018 Census. Now as the pandemic drives another economic downturn, California lawmakers believe SB 1079 will help carve out a bidding advantage for prospective homeowners.
Notable Foreclosure Modifications Under SB 1079
The foreclosure process is modified in a few significant components:
Bulk Sale Prohibition
First, it reshapes the cross-collateralized loan foreclosure process, generally prohibiting trustees from selling multiple properties at the same time in a practice known as a bulk sale. This is particularly problematic when foreclosing on a single Deed of Trust which contains multiple separate properties which is not uncommon. Instead, SB 1079 requires each property, or each lot or parcel within a property, to be sold separately at auction. This process will require mortgage lenders to be certain about their bidding strategies for cross collateralized properties going forward. Specifically, when a lender proceeds with each auction for each property they are necessarily “paying down” their loan at the final auction amount at each auction and could end up being an under-collateralized position if they release remaining properties by initiating too high of an initial credit bid at auction.
No Finality at Foreclosure Auction
The second and perhaps most impactful change brought about by SB 1079 is that it allows certain qualified buyers to bid on the foreclosed property after the auction. This is a major departure from the previous foreclosure process, which ended with the final and highest bid at auction and allowed for the transfer of the property as soon as the trustee’s deed was recorded.
Now, after the auction ends, “eligible bidders” have a second opportunity to bid on the property. Eligible bidders include tenants who occupy the property at the time of foreclosure, prospective owner-occupants who intend to live in the property for at least a year, and specific organizations with the primary mission of preserving and expanding access to affordable housing.
Eligible bidders can submit offers by first contacting the trustee within 15 days of the auction to notify them of their intent to bid, and then submitting a cashier’s check to the trustee for the full bid amount within 45 days of the sale. The law gives eligible tenant buyers a significant leg up — to purchase the property, tenant buyers need only to submit a bid equal to the winning bid at auction. In other words, their offer doesn’t need to top the last, highest bid.
Fines for Failing to Maintain Vacant REO Property
Lastly, the law also establishes hefty fines for mortgage lenders who become REO owners and fail to maintain vacant properties. Owners who allow excessive foliage growth, standing water or squatters, among other violations, could face fines of $2,000 per day for 30 days and $5,000 per day after that.
Practical Implications of SB 1079 For Mortgage Lenders
Administrative and Trustee Changes
To support this new process, foreclosure trustees will be required to add more content to the notice of sale, including a new notice to tenants about their rights to buy the property under SB 1079. Within 48 hours of the auction, the trustee must also set up a webpage with information about the date of the sale and the amount of the winning bid, as well as contact information, including an address to receive documents and a phone number.
Rethinking Bidding Strategies
Because “Eligible Bidders” can now purchase the property by bidding one penny more than the amount sold at auction, lenders must be very careful about their opening bid strategy at auction. Traditionally, mortgage lenders were advised to start bidding at an amount less than their full credit bid as there were tax consequences as well as potential recourse against a personal guarantor after the foreclosure sale. Now, many lenders would benefit by initiating the auction at their “full credit bid” by bidding all amounts due under the loan including past due interest, principal, fees, etc.
There are still multiple instances in which a lender may want to start bidding at a lower amount than their full credit bid. For example, a cross-collateralized loan as discussed above. Additionally, a half-completed construction project or other undesirable real property where the lender may want to cut their losses and hope that a third party bidder will simply purchase the property if offered for a low enough sales price. The key takeaway is that the lender must be absolutely certain of their bidding strategy and should not rely upon their pre-2021 bidding strategies anymore.
Likely Result of Legislation
Because the Eligible Bidder must provide the full amount of their bid within 45 days of the auction it is unlikely that your average prospective homeowner or tenant could ever actually take advantage of the law as intended. Instead, it appears that well operated non-profit organizations which seek to provide homeowners an opportunity to purchase homes at a discount could theoretically take advantage of this new law and only time will tell.
Unfortunately, the likely result of this law is that fraudulent “straw buyers” will likely emerge after the auction, effectively creating a second auction in situations where the lender underbid at foreclosure auction and the lender then loses their collateral in the process. Ohhhh California…
But Wait There’s More
California also passed AB 3088 earlier this year which also modified the foreclosure process. That law was an emergency order and went into effect on August 31, 2020. Mortgage lenders must be careful to comply with both laws as they both effect foreclosure. More information regarding AB 3088 can be found here.