As an attorney who represents mortgage lenders in defaulted loan situations, I am often confronted with fear and misinformation regarding California’s One Action Rule (“Rule”).
Here are some common questions that I get:
- “If I choose to go to a trustee sale, does that mean I have a Rule problem?”
- “If I have a blanket U.C.C., do I need to judicially foreclose to avoid a Rule problem?”
- “If my loan has a personal guaranty, do I have to choose between going after the property or guarantor?”
- “I have multiple sources of collateral for my loan. If I only choose to go after one piece of collateral, does the Rule stop me from going after any other collateral?”
This article is written to cut through the myths, misconceptions, and other falsehoods surrounding California’s One-Action Rule, and to provide a simple, succinct explanation to creditors in California.
Why Does This Rule Exist?
The Rule exists for two reasons:
- To prevent creditors from opening several concurrent lawsuits against a borrower over the same outstanding balance
- To protect borrowers from being held personally liable from a real estate secured loan prior to the security being exhausted.
What Does a Lender Need To Do To Comply with the Rule?
Application of the Rule is pretty straightforward.
Security First
The creditor must exhaust all security for the loan before initiating a lawsuit to go after the borrower personally. For example, a loan is secured by a single property in California. Before the lender can initiate a lawsuit against the borrower, the lender is required to judicially or non-judicially foreclose on the real property prior to seeking a judgment against the borrower. Making the example a little more complex, assume the loan is instead secured by two properties and a U.C.C. filing on equipment the borrower owns. The Rule would require the lender to foreclose on ALL of the secured property (the two properties and equipment), before they can seek a judgment against the borrower.
One Form of Action
The lender must only choose one-action. Specifically, the lender must only take one judicial action. For example, if a creditor chooses to ignore the security for its loan and simply sue the borrower seeking a judgment due to nonrepayment of its debt, the courts may waive and nullify the secured collateral because the creditor was required to exhaust the security first.
What Happens if a Lender Fails to Comply with the Rule?
Borrower Shield
If a lender pursues a personal judgment against a borrower before a judicial or non-judicial foreclosure of secured property, the borrower can use the security-first principle as a defense. If the borrower is successful in its defense, then the lender must exhaust the security before obtaining a monetary judgment against the debtor for any deficiency.
Waive Secured Interests
If a creditor commences a lawsuit or otherwise successfully attaches unsecured assets of the borrower, the borrower may invoke the security-first principle, and as a sanction the court may waive the lender’s security interest in any of its secured collateral in the loan. This does not invalidate the debt (Note), only the security for the debt.
Mythbusting Time
Now that we have discussed why the Rule exists, how it works, and what happens if you don’t comply, it’s a good time to get rid of some common misconceptions.
Myth 1: A non-judicial foreclosure (trustee sale) is considered an action for Rule purposes.
For purposes of the One-Action rule, there must be a judicial action. More specifically, there must be a judicial action against the borrower that is NOT a judicial foreclosure. It is perfectly acceptable to conduct a non-judicial foreclosure, including a U.C.C. sale of any personal property without ever invoking the One-Action Rule.
Myth 2: I have multiple sources of collateral, including both real and personal property, which means I need to conduct a judicial foreclosure in order to avoid the Rule.
Assuming the loan documents permit the lender to marshal assets in any order they would like (more on that later), a lender is permitted to choose which order to foreclose security in. For example, a bank may have the following security for its loan: (i) a deposit account with $50,000, (ii) real property located on Elm Street, and (iii) a printing press located at the Elm Street property worth $35,000.
Assuming the loan documents were properly written, the lender could seize the funds in the deposit account, initiate a trustee sale of the Elm Street property by filing a Notice of Default in the county recorders office and could either conduct a unified sale to include the printing press with the Elm Street sale or could conduct a U.C.C. sale just for the printing press. The lender could choose to do only one of these actions, or all three at once. The lender could choose to go after the real property first, the deposit account second and the printing press third, or any other order it chose. None of these “actions” are actions for purposes of invoking the Rule. All of these involve the lender going after its security for the loan.
However, if the lender chose to attempt to set-off a deposit account with the bank that was not security for the loan, or otherwise tried to attach other unsecured property of the borrower without exhausting the collateral for the loan, these actions could violate the Rule.
Myth 3: I can’t initiate a breach of guaranty suit against a guarantor of the loan without violating the Rule.
The Rule prohibits a creditor from suing the borrower first without exhausting security under the loan. Assuming the lender’s loan documents are properly written, the Rule does not extend to a bonafide third party guarantor of the loan. What this means is that a lender could initiate a lawsuit for breach of guaranty while also conducting a non-judicial foreclosure sale of the real property security. This breach of guaranty suit is NOT an action for the Rule’s purposes.
Myth 4: If I file a judicial foreclosure lawsuit and seek a receiver for the property, I have violated the Rule.
The Rule only prohibits seeking recourse against the borrower without exhausting all security first. Therefore, a lender may file a judicial foreclosure lawsuit, seek a receiver for any real or personal property and never initiate an “action” for the Rule’s purposes. In fact, I am often counseling our clients to unload the cannon against a difficult borrower by conducting a non-judicial foreclosure sale, filing a judicial foreclosure to implement a receiver, and also filing a breach of guaranty (often times seeking a writ of attachment against the guarantors assets at the outset of litigation), all of which does not constitute an action for the Rule’s purposes. This shock and awe strategy tends to change the litigation paradigm where the lender feels they are playing defense to borrower’s counsel and sets the tone for the lender’s recovery strategy.
Lender, Go Forth with Confidence.
Warren Buffet is often quoted for for his two rules for investing. Rule number one is to “never lose money.” Rule number two is to “never forget rule number 1.” Although my primary practice is counseling creditors at time of origination, particularly with the preparation of loan documents, I believe my greatest duty is making sure the loan is repaid.
A lot of my work protecting clients is done when we are preparing loan documents. Specifically making sure the loan documents are properly drafted with the right security for the loan, language which permits a lender to go after secured assets in the order they choose and documentation properly set up to permit a lender to go after the borrower and guarantor in a myriad of ways after a default.
However, once a default occurs, a lender must know what their options are. Hopefully this article has illustrated the choices are not “file a lawsuit or not.” No matter how many times I counsel clients when their loans are defaulted, I am constantly bombarded with the myths here and many others. A good attorney will present a lender with all of their options, the pros and cons of each, and let the client feel confident that they have an effective strategy to get the money back in the door.
