EFFECTS OF SECURED TRANSACTIONS

EFFECTS OF SECURED TRANSACTIONS

As previously indicated in this Chapter, the terms “debtor”, “borrower”, “trustor”, and “mortgagor” may be
used together, separately, or in some combination. Unless specifically noted, they are interchangeable terms
describing the person or entity who has borrowed money, the repayment of which is secured by real property.
Further, the terms “creditor”, “lender”, “beneficiary”, or “mortgagee” may be used together, separately, or in
some combination. Unless specifically noted, they are interchangeable and are intended to describe the person
or entity that has loaned money, the repayment of which is secured by real property.

Having subjected property to the lien of a deed of trust or mortgage, the debtor/borrower/trustor/mortgagor
should be aware of some of the effects of these security instruments. Among the more important effects are:

1. Assignment of the debt by the creditor;

2. Transfer of the property by the borrower;

3. Acceleration due to breaches and default (including due-on-sale and due on further encumbrance);

4. Offset/Estoppels Statements and Certificates;

5. Lien priorities; and,

6. Purchase Money vs. Non-Purchase Money Deeds of Trust or Mortgages.

Assignment of Debt by the Creditor

The assignment of a debt secured by a mortgage carries with it the security. An attempted assignment of the
mortgage without the note transfers nothing to the assignee, but a transfer of the note without the mortgage
gives the assignee the right to the security (Civil Code Section 2936).

An assignment of a deed of trust or mortgage may be recorded and recordation gives constructive notice to all
persons (Civil Code Section 2934). After the promissory note has been transferred (assigned or endorsed) and
the assignment of the deed of trust or mortgage has been recorded, the debtor is not protected if he continues
making payment to the original lender/creditor. Failing to record the assignment would prevent constructive
notice being transmitted to all persons regardless of notice of transfer of loan servicing. Recent amendments to
federal and state law require notice to the debtor/trustor/mortgagor of any transfer of servicing agent (Civil
Code Section 2937 and 24 CFR Section 3500.21).

Business and Professions Code Sections 10233.2, 10234, 10234.5 and 10 CCR, Chapter 6, Section 2841.5
require every licensee negotiating a loan secured by a deed of trust or mortgage, or where the promissory note
or interests therein are being sold or assigned, to cause the deed of trust or mortgage or the assignment thereof
to be recorded. When delivering these instruments to the lender or assignee (including private
investors/lenders), the licensee is to in writing recommend that the deed of trust or mortgage or the assignment
thereof be immediately recorded, if the licensee has not already recorded such instruments on behalf of the
lender or assignee thereof.

Should the licensee be acting as an MLB and be servicing the loan secured by real property, the MLB may
retain the original promissory note and deed of trust or mortgage but perfect delivery to the lender and/or the
assignee or assignees thereof by recording the required instruments in the office of the County recorder in
which the security property is located. A conformed copy of the promissory note and deed of trust or mortgage
should be delivered by the MLB to the lender (or to each of the private investors/lenders). The ability of the
MLB acting as a servicing agent under a written agreement with the lender (including private investors/lenders)
or assignees thereof to retain the promissory notes and security instruments is authorized in applicable law
(Business and Professions Code Sections 10233.2, 10234, and 10234.5).

Transfer of the Security Property by Borrowers

When encumbered real property is transferred, the buyer either obtains new financing (and the existing loan is
paid off), buys the property “subject to” the existing loan, or “assumes” the loan. Buyers may not take title to
the security property “subject to” and existing loan when the deed of trust or mortgage securing the loan
includes a due-on-sale clause. Taking title “subject to” the existing loan may result in no personal liability to
the buyer; however, the advice of knowledgeable legal counsel should be obtained prior to proceeding with
such transactions.

Despite the transfer to the buyer of the security property, the seller will (except in purchase money mortgage
fact situations) remain personally liable to the lender for the loan repayment. Even in purchase money fact
situations, the seller may remain liable to the lender to the extent of collateral actions that may be pursued by
the lender, including actions for fraud. Further, the credit worthiness and financial standing of the seller
remains at issue if the buyer fails to timely perform each of the obligations set forth in the promissory note or
mortgage. The purchase money exception limits the availability of pursuing a money claim that results from a
deficiency judgment. The lender would be required to look only to a sale of the security property to recover the
amount of the debt/loan.

If the loan terms do not include a due-on-sale clause and as long as the buyer makes the loan payments in a
timely manner and holds, keeps, and performs each and every obligation set forth in the promissory note and
deed of trust or mortgage (e.g., cultivates, irrigates, fumigates, and otherwise keeps and maintains the security
property in good and tenable condition), no problem should occur for the original maker of the loan and
trustor/mortgagor. If the buyer defaults and the loan is not a purchase money loan, the lender can look to the
seller/original maker for payment, even years after the transfer was made. The seller may also suffer a loss of

credit status due to the purchaser’s failure to timely make the payments or perform each of the obligations
required of the maker.

Under a loan assumption, the buyer becomes the principal debtor and the seller either may remain liable to the
lender as a continuing maker, or may become liable to the lender as surety for any deficiency resulting after the
sale of the property. The safest arrangement for the seller is to ask the lender for a substitution of liability,
releasing the seller of all liability in consideration for assumption of the debt/loan and of each and every
obligation thereof by the buyer. In such circumstances, the buyer must qualify as though they were the maker of
the loan.

Acceleration Due to Breaches and Defaults

Deeds of trust and mortgages generally contain clauses giving the lender the right to declare the full amount of
debt/loan due and payable upon defined breaches and default, including the failure to timely pay debt service,
property taxes when due, or the happening of a certain event such as failure to maintain the security property or
to proceed with an unauthorized transfer or further encumbrance of the security property, i.e., due–on-sale and
due on further encumbrance clauses.

“Due-on-sale” and due on further encumbrance clauses, are forms of an acceleration clause. These clauses give
the lender the right or option to insist the loan be paid off or renegotiated when the title to the security property
is transferred or further encumbered. When loan funds are available at acceptable interest rates, buyers
ordinarily obtain new financing and the seller pays off the existing loan as part of the terms of the purchase and
sale transaction. In times of scarce money, escalating interest rates, enhanced loan underwriting standards, or
declining property values; buyers may prefer (as previously discussed) to assume or take “subject to” the
existing mortgage. Lenders generally do not want to be “locked” into long-term, lower-than-market-rate loans.
Often, lenders will argue that they must not only watch the value of their existing loans decline, but also are
forced to pay higher interest rates to depositors who otherwise would withdraw funds and seek higher returns in
other investments.

The issue of a lender’s right to automatically enforce a “due-on-sale” provision upon transfer of the mortgaged
property has been resolved in favor of the lender, as a result of the 1982 United States Supreme Court decision,
Fidelity Federal Savings and Loan Association v. de la Cuesta (1982 458 US 141), and the 1982 federal
legislation to which this Chapter has previously referred, the Federal Deposit Institutions Act of 1982 (also
known as the Garn- St. Germain Act). These amendments to the law provide for specified exemptions when the
security property is a single family owner-occupied residence. Of course, loan documents containing no due-
on-sale clause are not affected by the operative changes in applicable law.

Brief Overview of Due-On-Sale and Due On Further Encumbrance Clauses

The California Supreme Court ruled in Wellenkamp v. Bank of America (1978) 21 Cal. 3d 943, that a state-
chartered institutional lender could not automatically enforce a due-on-sale provision in its loan documents to
accelerate payment of a loan when residential property securing the loan is sold by the borrower. Under this
ruling an institutional lender had to demonstrate that enforcement was necessary to protect against impairment
of its security or the risk of default (character and credit considerations).

In its opinion, the court reviewed prior decisions, particularly La Sala v. American Savings and Loan
Association (1971) 5 Cal. 3d 864, and Tucker v. Lassen Savings and Loan Association (1974) 12 Cal. 3d 629.
In La Sala, further encumbering of real property through a second loan in the form of a junior deed of trust or
mortgage was found to be insufficient justification for acceleration of the maturity date. In Tucker, sale of the
property under a real property sales contract (installment contract) was held to be insufficient justification.

A flurry of California court cases followed Wellenkamp addressing issues it left unresolved, such as the
applicability of Wellenkamp to private lenders, commercial as well as residential property, and federal
regulations preempting state laws on due-on-sale and due on further encumbrance provisions. The Wellenkamp
rule was found applicable to California real property and real property secured transactions.

However, federally-chartered banks and savings and loan associations successfully asserted that the validity
and automatic exercise of due-on-sale or due on further encumbrance provisions is applicable to them
notwithstanding state law to the contrary. As previously mentioned, this contention was upheld by the United
States Supreme Court in Fidelity Federal Savings and Loan Association v. De La Cuesta (1982) 458 US 141.

On October 15, 1982, the Federal Depository Institutions Act of 1982 (the Garn-St. Germain Act) became
effective. As mentioned previously with certain limited exceptions, the law makes due-on-sale or due on further
encumbrance provisions in real property secured loans automatically enforceable by all types of lenders,
including non-institutional private investors/lenders.

These amendments to federal law preempted state laws and judicial decisions which restrict enforceability of
due-on-sale or due on further encumbrance provisions in promissory notes and security instruments. In
addition, FHA and VA have since implemented rules and regulations restricting the transferability of the loans
they insure or indemnify.

Enforceability

The following concerns the automatic enforceability of due-on-sale and due on further encumbrance provisions
in loan instruments:

1. Federally-chartered savings and loan associations may automatically enforce due-on-sale and due on
further encumbrance clauses in promissory notes and deeds of trust that they originated while federally
chartered;

2. With certain exceptions of limited application, all loans originated after October 15, 1982 may be
accelerated, upon transfer of the property securing the loan, if the security instrument includes a due-
on-sale clause; and,

3. As of October 15, 1985 with very few exceptions, loan transfers or further encumbrances of the
security property without the consent of the existing lender are no longer possible in California.

Other Exceptions

Where the security is the owner-occupied residence of the borrower, notable exceptions to automatic
enforceability of due-on-sale or due on further encumbrance clauses enumerated under the law include, among
others, the following:

1. Creation of a junior deed of trust or mortgage (liens) on the security property which are not related to a
transfer of the rights of occupancy;

2. Transfer of the property by one joint tenant to another joint tenant;

3. Transfer to a relative or descendent of a borrower resulting from the death of the borrower; and,

4. Transfer into a revocable inter-vivos trust of which the borrower is the settlor and beneficiary, if it
does not relate to a transfer of rights of occupancy of the security property.

Special Provision

As previously discussed in this Chapter, a clause in any deed of trust or mortgage that provides for acceleration
of the due/maturity date upon sale, conveyance, alienation, lease, succession, assignment or other transfer of
property (containing four or fewer residential units) subject to a deed of trust or mortgage is invalid unless the
clause is printed, in its entirety, in both the security instrument and the promissory note or other document
evidencing the debt/loan and the obligations (Civil Code Section 2924.5).

Caution Regarding Due-On-Sale and Due On Further Encumbrance

Proposed loan transfers, whether as the result of assumptions or taking title “subject-to”, must be very carefully
considered in light of the Supreme Court ruling allowing the nation’s federal lenders to automatically enforce
due-on-sale provisions in their loans and the effects of the Garn-St. Germain or Federal Depository Institutions
Act of 1982. This federal law limited, and in California by 1985 eliminated, except in certain fact situations
(regarding single- family owneroccupied security properties), automatic transfers of loans or further
encumbrances of the security property secured by real property with due-on-sale or due on further encumbrance
clauses within the security instruments. Covert transfers, no matter how structured, are not an acceptable

practice and are to be avoided by real estate licensees. Again, the advice of legal counsel is recommended
before proceeding with transfers of the security property while leaving an existing loan in place.

Offset/Estoppel Statements and Certificates

In transactions involving an assignment of an existing mortgage or deed of trust or mortgage to an investor, an
offset statement is customarily obtained for the benefit of the investor. The information included in the offset
statement (often referred to an estoppel certificate) is typically the unpaid balance of the promissory note, the
date to which interest is paid, the interest rate, the payment amount and due date, the maturity date of loan, the
existence of due-on-sale or due on further encumbrance clauses, as well as other forms of acceleration clauses
that are of interest to an assignee or endorsee, and whether the property owner has any claims which do not
appear in the promissory notes and security instruments being purchased by the investor. The offset/estoppel
statement/certificate is in addition to the beneficiary statement of current loan status from the lender. Together
the offset/estoppel and beneficiary statements/certificates confirm to the person/investor purchasing the existing
loan the nature of the obligations of the property owner (trustor/mortgagor) that will inure to the benefit of the
new holder of the deed of trust or mortgage (assignee).

Lien Priorities

Ordinarily, different liens or encumbrances upon the same security property have priority according to the time
of their recordation. Notice is an important element in the determination of priority. Notice may be actual or it
may be constructive from recordation, thus giving notice of the lien or encumbrance to subsequent buyers and
encumbrancers for value (including junior lien holders such as deeds of trust or mortgages). Actual notice will
be imparted through an investigation of the occupancy of the security property, including other manners of
receiving specific notice of the liens or encumbrances in question. For example, an occupant of an intended
security property under a lease with an option right, pursuant to a land contract of sale, or in accordance with an
executory purchase and sale agreement, would impart actual notice of the equitable interest in the title that
arises from any one of the foregoing documents/instruments and the equitable interest would be prior to any
subsequently recorded deed of trust or mortgage.

County and municipal property taxes and authorized assessments are “super liens” and retain priority over
deeds of trust and mortgages no matter when recorded. Where there are special assessments affecting the
security property, such assessments impart notice to all persons when recorded. These assessments, whether
bonds or otherwise, are subordinate to all fixed assessment liens previously imposed on the property. These
special assessments would retain priority over all fixed assessment liens that are subsequently recorded against
the same property.

Generally, special assessments are coequal to and independent of the lien for general property taxes, except as
otherwise provided for by applicable law. Special and ad valorem assessments have the same priority as
property taxes, including each installment due as required by the terms of the foregoing. They each retain super
lien status over deeds of trusts or mortgages and other liens and encumbrances no matter when recorded
(Government Code Section 53930 et seq.)

Purchase Money vs. Non-Purchase Money Deeds of Trust or Mortgages

Purchase money mortgages are described in California law to include deeds of trust or mortgages. Two distinct
definitions of purchase money debt exist under applicable law. One definition applies to the issue of priority
over all other liens created against and brought with the buyer to the property, subject to the operation of the
recording laws when the deed of trust or mortgage is given for the price of the security real property. In such
event, the liens created against the purchaser are junior or subordinate to the purchase money deed of trust or
mortgage. This rule protects even third persons who furnished money, but only when it is loaned for the express
purpose of acquiring the security property (Civil Code Section 2898).

For purposes of establishing whether a deficiency judgment may be obtained against the debtor/borrower, the
deed of trust or mortgage must be given to the seller/vendor to secure the payment of the balance of the
purchase price of the security real property. When given to a third party lender to secure repayment of a
debt/loan or obligation, the proceeds of the debt/loan must have been used to acquire the security property and
the borrower must intend to occupy entirely or in part as his/her residence. The security property must consist
of 1 to 4 dwelling units. Third party financing of the purchase of 1 to 4 dwelling units for the purpose of
investment or the production of income does not qualify the deed of trust or mortgage as purchase money.

When the loan is secured by a purchase money deed of trust or mortgage, as defined, and the borrower fails to
pay the debt/loan according to its terms, the lender/creditor/beneficiary can generally look only to the security
property or to the proceeds of sale from the property for payment.

This limitation applies whether the security property is sold through judicial or a non-judicial foreclosure. The
inability to obtain a deficiency judgment may not preclude the lender/creditor/beneficiary from proceeding
against the borrower under a collateral action theory, including an action for fraud (Code of Civil Procedure
Sections 580b, 580d, and 726 et seq.; and Financial Code Section 7460).

Under current applicable law, refinancing the owner-occupied security property alters the character of the
security instrument from a purchase money to a non-purchase money deed of trust or mortgage. Further, if the
security property for the loan is other than 1 to 4 dwelling units (e.g., commercial, income producing property,
or land) and the lender is a third party (the extender of credit was other than the seller/vendor), the deed of trust
or mortgage is characterized as a non-purchase money security instrument.

With a non-purchase money deed of trust or mortgage, the lender/creditor/beneficiary may generally proceed
through the security property and obtain a money judgment for the difference between the amount received at a
judicial foreclosure sale and the total amount of debt/loan owing (including authorized fees, costs, and
expenses). The court may order a fair value hearing to ensure the property is sold at the foreclosure sale in an
amount consistent with its appraised value or as expressly ordered by the court (Code of Civil Procedure
Section 580a).