The purpose of selling a property by way of a short sale is to protect the seller from a possible deficiency judgment in connection with a recourse loan. A recourse loan is a loan with respect to which the lender may recover from the borrower the difference between the amount of proceeds received at a foreclosure sale and the amount owed at the time of the foreclosure. That amount is called a “deficiency.” Laws which prohibit a lender from obtaining a deficiency judgment are called “antideficiency” laws.
California has strong antideficiency laws on the books. One example is that a purchaser has antideficiency protection with respect to any obligation to the seller which constitutes part of the purchase price. This applies to all properties, not just residential properties. It also applies to a purchase-money loan made by a third-party lender such as a bank, if the property purchased with the funds was a dwelling with four or fewer units, and the purchaser resided in the property immediately following the purchase.
California’s short-sale antideficiency rule (found in California Code of Civil Procedure ยง 580e) operates against the antideficiency background discussed above. Section 580e is aimed at situations in which homeowners with so-called “underwater” non-purchase money recourse loans find themselves vulnerable to a lender’s claim for a deficiency. Under its terms, if a loan is secured solely by a trust deed for a residential one-to-four unit property, the creditor may not recover a deficiency judgment if the borrower sells the property for less than the amount owed on the loan, with the lender’s written consent. This applies to both first trust deeds and junior trust deeds.
There are many nuances and complications to antideficiency protection. For instance, a purchaser may have moved into the property only briefly, and then moved out of it and rented it out. Is the loan protected by antideficiency law? Or, a purchaser may have had a nominal co-purchaser (and co-borrower) who actually was involved only because his or her borrowing power enabled the primary purchaser to purchase the property. Is the nominal co-purchaser protected by antideficiency law? If the co-purchaser executed a “guaranty,” rather than the promissory note itself, is he or she protected. Sorting out the answers to questions these is complicated. It is wise to have an attorney carefully consider these issues based on the particular facts of the situation. Sometimes it may prove to be impossible to analyze the situation with certainty.
Other provisions in section 580e provide that the lender may not require the borrower to pay any additional compensation, aside from the sale proceeds, in exchange for its written consent to a short sale, and that any waiver of the protections of the section is unenforceable.