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Preforeclosure Sales in California
The primary California law governing Preforeclosure Sales is Civil Code
Sections 1695-1695.17. (In addition there are other California statutes
governing foreclosure consultants in Civil Code Sections 2945-2945.11 and
predatory lending in Financial Code Sections 4970-4979.6.) Federal bankruptcy
law can also have an impact. Finally, there are practical considerations.
California Law
The California preforeclosure sale statutes are relatively intricate. They
apply to any residential real property consisting of one-to-four family dwelling
units, one of which the owner occupies as his or her principal place of
residence, and against which there is an outstanding notice of default. Here are
the high points.
Every equity purchase contract must be written in at least 10-point bold
type and must be fully completed and signed and dated before execution of any
instrument of conveyance of the residence in foreclosure. The contract must
include the entire agreement of the parties, including but not limited to the
terms of any rental agreement. See Section 1695.3 for the full requirements
list. In addition, each contract must contain the following notice in at least
14-point boldface type, if the contract is printed or in capital letters if the
contract is typed, and completed with the name of the equity purchaser,
immediately above the notice of cancellation:
NOTICE REQUIRED BY CALIFORNIA
LAW
Until your right to cancel
this contract has ended, (Name of Equity Purchaser) or anyone working for
__________(Name of Equity Purchaser) CANNOT ask you to sign or have you sign any
deed or any other document. The equity seller has the right to cancel any contract with an equity
purchaser until midnight of the fifth business day following the day on which
the equity seller signs the contract or until 8 a.m. on the day scheduled for
the sale of the property pursuant to a power of sale conferred in a deed of
trust, whichever occurs first. Immediately before the equity seller’s signature, the contract must
contain a conspicuous statement in a size equal to at least 12-point bold type,
if the contract is printed or in capital letters if the contract is typed, as
follows:
You may cancel this contract
for the sale of your house without any penalty or obligation at any time before
________________________________________ (Date and time of day). See the
attached notice of cancellation form for an explanation of this right. The contract must be accompanied by a completed form in
duplicate, captioned
"notice of cancellation" in a size equal to 12-point bold type, if the
contract is printed or in capital letters if the contract is typed, followed by
a space in which the equity purchaser must enter the date on which the equity
seller executes the contract. The form must be attached to the contract, must be
easily detachable, and the text
of the form must be in type of at least 10-points, if the contract is printed or
in capital letters if the contract is typed. See Section 1695.5(b) for the
wording of the cancellation notice. Until the time within which the equity seller may cancel the transaction
has fully elapsed, the equity purchaser cannot
do any of the following:
Obtain or induce the equity seller to execute
any instrument of conveyance of any interest in the residence. Record with the county recorder any document,
including, but not limited to, any instrument of conveyance. Transfer or encumber or purport to transfer or
encumber any interest in the residence in foreclosure to any third party. Pay the equity
seller any consideration. An equity purchaser cannot make any untrue or misleading statements
regarding the value of the residence in foreclosure, the amount of proceeds the
equity seller will receive after a foreclosure sale, or any other untrue or
misleading statement concerning the sale of the residence. Whenever the equity seller is given an option to repurchase the residence,
the equity purchaser cannot cause any encumbrance to be placed on the property
or grant any interest in such property to any other person without the written
consent of the equity seller. Where the equity seller is given an option to repurchase, the presumption
is that the transaction is a loan transaction unless
there is "clear and convincing evidence to the contrary". Unfortunately, no
one yet knows what would be sufficient evidence. For example, is it enough if
there are no monthly payments (for rent or otherwise) due from the equity
seller? One has to assume that any attorney later representing the equity seller
would argue that the presumption applies, since then certain loan statutes
apply. Still, language should be inserted in the agreement that will help
prove the transaction is not a loan.
If the transaction is deemed to be a loan, the
California usury laws apply. That means the interest rate cannot exceed the
greater of a) 10% per year or b) 5% per year plus the rate established by the
Federal Reserve Bank of San Francisco on advances to member banks. As of
December 2004 the federal reserve rate was 3.25%. Presumably the interest in an
equity purchase situation would be calculated by comparing the buy-back amount
to the purchase amount – and attributing the difference to interest. The
contract could presumably designate a reasonable portion of that amount to costs
and fees. Note that there is an exception for loans made or arranged by any
person licensed as a real estate broker by the State of California and secured
in whole or in part by liens on real property. For this reason, paying a real
estate agent to handle the transaction should exempt it from the California
usury laws. Also, if the transaction is deemed to be a
loan, the requirements set out in Financial Code Sections 4970-4979.6 to avoid a
predatory loan must be met. Actually, those provisions should not apply if
the right to repurchase lasts for one year or less so that it falls in the
"bridge loan" category. As a result, if possible, any option to
repurchase should last for no more than one year. If the right lasts for
more than one year, then numerous requirements regarding the interest rate,
amount of points and fees and the option holder’s ability to pay to exercise
the option come into effect. If any of these provisions are violated, the equity seller may be able to
rescind the agreement and/or to recover actual damages, attorneys’ fees and
costs, and exemplary damages in an amount equal to the greater of three times
actual damages or $2,500. Fraud or deceit may additionally be punished by a fine
of $25,000, by imprisonment in the county jail or in state prison for not more
than one year, or by both for each violation. Other remedies may apply as well. In addition, potential equity purchasers are forbidden from taking
"unconscionable advantage" of the property owner in foreclosure. This would
certainly apply if the seller were incompetent or did not understand the
transaction, and might apply in other situations as well. If "unconscionable
advantage" is taken, the transaction may be rescinded within two years of the
date of the recordation of the conveyance of the residential property. Any provision of a contract which attempts or purports to limit the
liability of the equity purchaser is void and, at the option of the equity
seller, renders the equity purchase
contract void.
Bankruptcy Law
If the seller is already in bankruptcy, any contract will be very likely be
void unless the bankruptcy court approves it. You should call the bankruptcy
court that has jurisdiction over the seller’s residence to check for a
possible filing. Of course, if the seller filed bankruptcy in another bankruptcy
court, you probably won’t be able to find it. The contract should have the
seller state that he/she/they are not in bankruptcy; this may not solve the
problem – though it can only help – and at least you are far less likely to
be accused by the Court of trying to subvert the bankruptcy process.
Because the seller may go into bankruptcy immediately after the transaction,
the deed should be recorded as soon as legally allowed (meaning, as soon as
possible after the cancellation period). Otherwise you may have to get
bankruptcy court approval to record the deed – which might or might not be a
problem.
Unfortunately, even if the seller is not in bankruptcy at the time but goes
into bankruptcy after the transaction has been completed, the bankruptcy trustee
may be able to require you to deed back the property for up to three years after
the transaction. This falls under the bankruptcy term "fraudulent
transfers", which includes a transfer by an insolvent debtor for less than
"reasonably equivalent value" even
when there is no fraudulent intent. If the equity purchaser does not
realize that the seller is a financially troubled debtor, then the equity
purchaser at least gets a lien on the property equal to the amount that the
equity purchaser invested. Ideally, the contract should have the seller
represent that he/she/they are not insolvent and do not expect to become
insolvent – assuming that is true.
Practical Considerations
The practical considerations are mostly a matter of common sense, but here
are some for what they are worth.
The following are often included in equity purchase agreements:
A "Subject to" clause that allows you to
exit the deal under specified conditions. This could be for undisclosed damage,
general condition of the property, undisclosed liens, termite damage, etc. A provision that allows you to show the
property to others. A provision indicating that the property has to
appraise at a certain value. A requirement that the property must be vacant,
with all tenants and possessions out by a specified date. An agreement that the payments for the current
loans total a specified amount. A provision indicating the sale is subject to
the condition of the loan and/or encumbrances against the title being as
represented. A provision indicating the buyer will pay all
closing costs. . Provisions indicating the seller:
Will deed the property to the buyer.
Authorizes the buyer to record said deed at the appropriate time.
Is aware that the buyer may resell the property.
Is aware that the purchase price may be below market value. Will leave the premises in good condition and pay
for damages incurred after the contract has been signed and before the seller
has left. Will pay for any damages or repairs necessary as
discovered by termite and roof (and possibly other) inspections. Will vacate the premises on the date specified.
Agrees that all net proceeds paid to seller will be paid at closing.
If you have negotiated a settlement with a lien holder, you should record a
Release of Lien (signed by the lienholder) just prior to closing.
A preforeclosure seller may be desperate and lie about the condition of the
property, so have inspections done if at all possible. (Often the seller will be
judgment-proof, so one cannot expect to sue and recover any money.) Check the
title report because there may be another person on the title or liens on the
property that the seller "forgets" to mention. Check to see if there are
large outstanding utility bills or large amounts of unpaid property taxes.
If you do not arrange new financing to pay off the existing lender, the
existing lender can exercise its "due on sale" rights and foreclose on that
basis even if you have brought the loan current. Most mortgage lenders do not
want to foreclose on property – they generally lose money on it – and they
are unlikely to do this unless interest rates have gone up (or go up)
significantly. Still, they can do this at any time during the life of their
loan, even if the equity purchaser makes payments for years.
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