After The Foreclosure Sale
Q 9. If the borrower is an occupant of the property, and the lender forecloses judicially (not trustee’s sale), can the lender evict the borrower?
A If the borrower occupies one of the units in the rental property and the lender has foreclosed judicially, then the borrower is entitled to possession throughout the statutory redemption period (either three months or one year depending on the amount received at the judicial foreclosure) (Cal. Civ. Proc. Code § 729.030). The foreclosing lender can charge the borrower rent for this occupancy equal to the value of use and occupation (Cal. Civ. Proc. Code § 729.090(a)).
However, if the occupant/borrower fails to pay rent, the lender probably lacks the ability to evict during the redemption period. After the redemption period, the lender should be able to pursue an action for collection of unpaid rents. (Cal. Civ. Proc. Code § 729.090(a).)
Q 10. If the borrower is the occupant of the property, and the lender forecloses through a trustee’s sale, can the lender evict the borrower?
A Yes. If the lender has foreclosed by way of a trustee’s sale, the borrower can be evicted immediately following a three-day Notice to Quit. (Cal. Civ. Proc. Code § 1161a(b).)
B. Lender Issues with the Tenants
1. Before The Foreclosure
Q 11. Prior to the foreclosure sale, is the tenant required to turn rent directly over to the foreclosing lender?
A No. A lender may request that a tenant make payments directly to the lender rather than the borrower in an attempt to create a voluntary exercise of a rents and profits clause or to establish the lender as a mortgagee in possession. The tenant may comply but is not required to do so.
If the lender goes to court and has a receiver appointed with the power to collect rents, a tenant will be obligated to pay the receiver. There is no apparent right in California law permitting a lender, or receiver, to evict a tenant for a breach of a lease. Indeed, there is a danger in doing so if, in fact, the borrower reinstates the loan prior to a foreclosure sale and is damaged by the loss of a tenant.
2. After The Foreclosure
Q 12. Following a foreclosure sale, what are the tenant’s obligations to the lender?
A Following a judicial foreclosure sale, the tenant, after receiving notice of the sale, must pay rent to the lender or the appointed receiver from the time of the sale until a redemption by the former owner (Cal. Civ. Proc. Code § 729.090(a), Cal. Civ. Code § 1111).
Following a trustee’s sale foreclosure, the tenant must also pay rent to the lender (or a receiver if one had been appointed) from the time of the sale (Farris v. Pacific States Auxiliary Corp. (1935) 4 Cal. 2d 103, 105). There is no period of redemption after a trustee’s sale; however, some refer to the right to “cure the default” any time prior to five business days before the date of the trustee’s sale as a “right of redemption” (see Tomczak v. Ortega (1966) 240 Cal. App. 2d 902).
a. When the Lease is Senior to the Lender’s Deed of Trust
Q 13. If the lease is senior to the deed of trust of the foreclosing lender, what are the tenant’s rights after the foreclosure?
A When the lease is senior to the deed of trust (i.e., the deed of trust was recorded after the date of the lease) or the lender had knowledge of the tenancy at the time the loan was made, the lender takes the property subject to the rights of the tenant (Cal. Civ. Code §§ 1214, 1215, Dover Mobile Estates v. Fiber Form Products, Inc. (1990) 220 Cal. App. 3d 1494, 1498.) The tenant becomes obligated to the lender as if the lender were the former owner (Cal. Civ. Code §§ 821, 1111).
b. When the Lease is Junior to the Lender’s Deed of Trust or Tenant is on a Periodic Tenancy
Q 14. If the deed of trust of the foreclosing lender is senior to the lease, (i.e., the deed of trust was recorded prior to the date of the lease) or the tenant doesn’t have a lease, what are the tenant’s rights after a foreclosure?
A The foreclosing lender or the immediate successor-in-interest at foreclosure (e.g., the purchaser at the trustee’s sale) who wishes to terminate the tenancy must give the tenant the following notice to terminate the tenancy:
3 days: If the tenant is the mortgagor (borrower), then s/he must receive a 3-day Notice to Quit prior to termination of the tenancy. Also, if the tenant is a party to the mortgage note, then s/he must receive a 3-day Notice to Quit to terminate the tenancy. (Cal. Civ. Proc. Code §§ 1161a, 1161b, P.L. 111-22.)
60 days: If the tenant is the child, parent or spouse of the mortgagor (borrower), then s/he must receive a 60-day Notice to Quit prior to eviction. If the tenancy is not the result of an arms-length transaction or the rent is substantially lower than fair market rent, then s/he must receive a 60-day Notice to Quit to terminate the tenancy. (Cal. Civ. Proc. Code § 1161b, P.L. 111-22.)
90 days: If the tenant is not the mortgagor (borrower) or is not a child/parent/spouse of the borrower or the tenant is on a periodic tenancy and the tenancy is the result of an arms-length transaction and the rent is not substantially lower than fair market rent, then the tenant is entitled to a 90-day notice to terminate the tenancy. (P.L. 111-22.)
Full term of the lease: If the tenant is not the mortgagor (borrower), or is not a child/parent/spouse of the borrower, and the tenancy is the result of an arms-length transaction and the rent is not substantially lower than fair market rent and the tenant has a lease, then the tenant is allowed to occupy the property until the end of the lease term. However, if the foreclosed property is sold to a buyer who will occupy the property, then the lease can be terminated with a 90-day notice. (P.L. 111-22.)
Q 15. Why is there no 30-day notice option in Question 14?
A A 30-day Notice to Terminate a Tenancy can be used when the property is not a foreclosure property and the tenant has resided in the property for less than one year (60-day notice if the tenant has resided in the property for one year or longer) (Cal. Civ. Code § 1946.1).
Q 16. Do the notice periods in Question 14 still apply if the tenant is not paying any rent at all?
A It depends. If the lender foreclosed by judicial foreclosure and the tenant is the mortgagor (borrower), the lender probably lacks the ability to evict during the redemption period. After the redemption period, the lender should be able to pursue an action for collection of unpaid rents. (Cal. Civ. Proc. Code § 729.090(a); Bernhardt, Section 5.37.) For other tenants who aren’t paying any rent, after the judicial foreclosure the lender may give a 3-day Notice to Quit (Cal. Civ. Proc. Code § 1161(2)).
If the lender has foreclosed by trustee’s sale (and, thus, there is no period of redemption), the lender may evict a non-paying tenant or mortgagor (borrower) by giving a 3-day Notice to Quit (Cal. Civ. Proc. Code § 1161(2)).
Q 17. If the deed of trust of the foreclosing lender is senior to the lease, (i.e., the deed of trust was recorded prior to the date of the lease), can the lender enforce the lease if the tenant wants to terminate it?
A No. When the deed of trust of the foreclosing lender is senior to the lease, the lender who finds that the lease is favorable and wishes to continue to enforce it may be disappointed to discover that the tenant has the right to terminate the lease after foreclosure. (Dover Mobile Estates v. Fiber Form Products, Inc. (1990) 220 Cal. App. 3d 1494.)
c. Security Deposit Issues
Q 18. After foreclosure, what party is responsible for returning the tenant’s security deposit?
A Upon termination of the borrower’s interest in the property, security deposits which are not returned to a tenant should be transferred to the borrower’s successor-in-interest, the lender (Cal. Civ. Code §§ 1950.5 (g), 1950.7(d)). In the event the owner fails to comply with this requirement, and the rental is residential, the owner remains jointly responsible with the lender for repayment of security to the tenant.(Cal. Civ. Code § 1950.5(i)).
Q 19. After foreclosure, to whom does the tenant go to get the security deposit back?
A An owner who is about to lose property through foreclosure is unlikely to either:
(1) Transfer any security deposits to the foreclosing lender; or
(2) Return the security deposits to the tenants as is required by law.
(Civil Code Sections 1950.5(g), 1950.7(d).)
In the event the owner who has lost the property through foreclosure has not done either option above, and the rental is residential property, the foreclosing lender is jointly and severally liable, along with the former owner, for repayment of any security to which the residential tenant is entitled (Cal. Civ. Code § 1950.5((i)).
Possibly this express statement of joint and several liability can be used by the lender to bring a legal action against the borrower for recovery of any sums properly paid to residential tenants for security deposit claims by the lender without violating the one action or anti-deficiency rules. (See California Real Estate, Miller & Starr § 19:143 (online).)
Q 20. Upon foreclosure, must the lender return the tenant’s security deposit?
A Regardless of the form of foreclosure used, a residential lender becomes obligated to return unused security deposits to any residential tenants unless the borrower returned these sums to the tenants prior to the transfer of title. (Cal. Civ. Code §§ 1950.5, (i) and (j).)
Commercial lenders who acquire the property through foreclosure do not have the same statutory obligation to return deposits to tenants if the lender does not receive the security deposit money from the former owner (Cal. Civ. Code § 1950.7).
III. Owner Issues with the Tenant
A. Before the Foreclosure
Q 21. After the owner’s default but prior to foreclosure, what are the tenant’s obligations to the owner?
A The borrower is contractually entitled to receive rent from the tenant even though in default on the note. A default on the note, in and of itself, does not create a breach of the covenant of quiet enjoyment of the leased premises or a denial of possession to the tenant. Thus, the tenant who ceases payment of rent can be evicted by the owner or sued for breach of the lease. (Cal. Civ. Proc. Code § 1161.)
B. After the Foreclosure
Q 22. Following foreclosure, what are the owner’s/borrower’s obligations regarding the tenant’s security deposit?
A After the foreclosure sale, the owner must return the security deposit to the tenant or transfer it to the foreclosing lender in order to be relieved of liability for the security deposit to the tenant (Cal. Civ. Code §§ 1950.5 (h), 1950.7 (d)). The owner/borrower who in bad faith fails to return a security deposit to a tenant can be held liable to the residential tenant for up to twice the amount of the security, in addition to actual damages (Cal. Civ. Code § 1950.5 (l)). For a commercial tenancy, the owner/borrower can be held liable to the tenant for bad faith retention of the deposit in statutory damages not to exceed two hundred dollars, in addition to any actual damages (Cal. Civ. Code § 1950.7 (f)).
IV. Property Management Issues
Q 23. Does the owner’s default entitle the property manager to neglect or deviate from the property management agreement?
A No, the default of the owner does not entitle the manager to neglect responsibilities identified in the property management agreement. Prior to a foreclosure sale, the property manager has contractual and fiduciary obligations to the owner of the property. If the management agreement provides for the collection of rent, then such activity, consistent with the terms of employment, is done on behalf of the owner. Honoring a request of the lender for disbursements of rents received, without the express permission of the owner would be grounds for breach of the manager’s contractual and, possibly, fiduciary duties.
Q 24. How does a court-appointed receiver affect the property manager’s rights and obligations to the owner?
A Once a receiver has been appointed by a court, if the power of appointment directs the manager to hand over received rents, then the request of the court-appointed representative should be satisfied. The property manager should request a copy of any court order. If the receiver collects rents directly, and takes over other management functions from the property manager, this would have the effect of terminating the agency and contractual obligations of the manager and establishes probable grounds for a manager’s breach of contract claim against the owner. Monies held by the manager should be disbursed in accordance with the instructions of the owner unless directed otherwise by a receiver who has been granted that authority.
Q 25. Can the property manager make a breach of contract claim against the owner following the foreclosure sale?
A After the foreclosure sale, the subject of the agency–the owner’s interest in the real property– becomes “extinct,” thus terminating the agency (Cal. Civ. Code § 2355(b)). As a consequence, the owner may be liable to the property manager for breach of contract damages. However, disbursement of previously-collected sums still requires direction from the former owner or court.
Q 26. Does the property manager have any obligation to comply with requests from the foreclosing lender?
A The property manager is the agent of the owner and has no obligation to honor any request for disbursement of rents made by a foreclosing lender. Upon receiving such a request, that agent’s duty of full disclosure would impose upon the manager a requirement to inform the owner of the lender’s request. If a lender has a receiver appointed, the manager can presumably enter into an agreement with the receiver to continue performing property management functions, for a fee. Such an agreement would affect rents collected and services performed after the date of the agreement.
Q 27. Following the foreclosure sale, may the property manager enter into a new property management agreement with the lender?
A Yes. After the foreclosure sale terminates the owner’s interest in the property and the agency relationship between the owner and manager, the manager may enter into a new property management agreement with the lender, just as the manager could with any owner of property.
Q 28. Does the property manager have the right to release tenants’ security deposits to the lender?
A No. Should the lender demand that the manager release previously-held tenants’ security deposits, the manager should refuse. These funds are held in a trust account for the benefit of the former owner and are not the property of the manager (Cal. Bus. & Prof. Code §§10145, 10176(e)).
Q 29. Should the property manager inform tenants that the owner is in default and facing foreclosure?
A One issue facing a property manager is whether to inform tenants that the property owner is in default and facing foreclosure. What should the manager do? If during the lease negotiations the manager acted as a dual agent, then the manager’s fiduciary responsibilities would require disclosure of the foreclosure. If there is no agency relationship with the tenant, then the manager needs the owner’s permission to disclose the fact of the foreclosure to the tenants.
Q 30. Following foreclosure, can the tenant establish a claim against the property manager in order to secure the return of their security deposits?
A Once the foreclosure sale has been completed, tenants whose leases have terminated and who desire a return of their security deposits might try to sue the manager. Typically, the property manager is not the owner of the property and is acting solely in an agency capacity. Thus, there shouldn’t be any personal liability. However, that may not discourage the tenant from suing the property manager.
Unfortunately, many areas of the state are experiencing record levels of foreclosures. REALTORS® in these areas, as well as anywhere else where a foreclosure is occurring, are often asked questions by the principals involved with the property. Owners, lenders and tenants of rental property in foreclosure who are, have been or anticipate having a working relationship with a REALTOR® may seek advice from the real estate licensee. While a licensee should avoid giving legal advice, it is helpful for a REALTOR® to have an understanding of some basic issues facing these principals. Such an understanding can help guide the REALTOR® away from problems and toward solutions.
When a rental property is being foreclosed upon, the duties and relationships between and among the principals and agents change depending on the strategies employed by the foreclosing lender, the needs and desires of the property owner, and the type and priority of the tenants’ leases. Another critical factor affecting the relationships is whether or not the default has resulted in an actual sale of the property. This article has identified many of the issues most likely to be faced by a real estate licensee. The purpose is to enable a REALTOR® to identify issues and problems so that appropriate steps can be taken, or appropriate referrals made, to enable the principals and REALTORS® alike to make their way through a difficult situation with as much information and ease as possible.