Commercial Foreclosures (Non-Judicial) (CA)

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PRACTICE NOTE

by Marc A. Liverant, Paul M. Williams, and Jung W. Han, Morgan, Lewis & Bockius LLP, with Practical Law Real Estate

Status: Maintained | Jurisdiction: California

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A Practice Note discussing commercial foreclosure procedures and proceedings under California

law. This Note outlines the primary considerations, requirements, and processes for non-judicial

foreclosures of commercial real property secured by deeds of trust. This Note also addresses the

appointment of receivers, deﬁciency judgments, the borrower’s right to reinstate the loan, and the

borrower’s right of redemption for commercial real property.

Foreclosure is the legal process by which a lender

(beneﬁciary or mortgagee) liquidates secured real

property to obtain payment following the borrower’s

(trustor’s or mortgagor’s) default on the underlying debt.

This Note outlines California law governing non-judicial

commercial foreclosure proceedings including:

• Redemption rights.

• Deﬁciency judgments.

This Note also provides step-by-step guidance for

conducting non-judicial commercial foreclosures under

California law.

Available Methods of Foreclosure

inCalifornia

Lenders in California use the following instruments to

secure loans against real property:

• Deeds of trust.

• Mortgages.

Deeds of trust are the most common security instruments

in California. California recognizes mortgages, but lenders

rarely use them. This Note assumes the foreclosing lender is

the beneﬁciary under a deed of trust. For more information,

see State Q&A, Real Estate Finance: California: Question 1.

Under California law, a lender may foreclose a loan

secured by commercial real property by either:

• Non-judicial foreclosure. Foreclosure is authorized

under a deed of trust or other contract containing a

power of sale clause and is conducted at a public auction

without judicial assistance. Non-judicial foreclosures

are the most commonly used form of foreclosure in

California and are governed by the California Civil Code

(Cal. Civ. Code §§2923.3 to 2944.10).

• Judicial foreclosure. Foreclosure of a mortgage or other

contract by court order after a judgment in a lawsuit.

Judicial foreclosure is rarely used with deeds of trust

due to its lengthy and expensive nature and is governed

by the California Code of Civil Procedure (Cal. Civ. Proc.

Code §§725a to 730.5).

A lender may also initially choose to pursue both

foreclosure processes simultaneously. This gives the

lender some time to weigh the pros and cons of both

processes before ultimately choosing one.

For information on judicial foreclosures, see Practice Note,

Commercial Foreclosures (Judicial) (CA).

Pre-Foreclosure Requirements

andConsiderations

Counsel for the lender should review the terms of the note

and deed of trust for any contractually required notiﬁcation

requirements before beginning the foreclosure process.

Most California lenders provide defaulting borrowers with

a demand letter. The demand letter should include:

• The terms of the loan.

• A description of the default.

• A statement that the lender intends to strictly enforce

the loan documents if the borrower does not cure the

default.

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Commercial Foreclosures (Non-Judicial) (CA)

Order a Title Search

Before beginning foreclosure, the lender must conduct a

title search to identify liens and other encumbrances that

affect title to the real property. The title search may also

reveal parties that have recorded a request for notice of

foreclosure.

Liens for property taxes and certain other prior liens, should

be paid to protect the lender’s interest in the real property.

The lender should also conduct a search of the bankruptcy

court records to determine whether the borrower has ﬁled

for bankruptcy protection. If the search reveals that the

borrower has ﬁled a bankruptcy petition, the foreclosure

action must stop until the lender applies for and is

granted relief from the automatic stay (11 U.S.C. §362).

Consider Appointing a Receiver

To the extent a property is in danger of waste or

deterioration, a lender may move for the appointment of a

receiver to protect and preserve the property. Seeking the

appointment of a receiver does not constitute an action

under California’s “one-action” rule (Cal. Civ. Proc. Code

§564(d)). For more information on California’s one-action

rule see Practice Note, Navigating the One-Action Rule in

California: Overview.

Lenders may seek a receiver to:

• Collect rents under an assignment of leases and rents.

• Protect and preserve the property.

A receiver is responsible for paying the real estate property

taxes when due and insurance premiums for the real

property.

The California Code of Civil Procedure and Rules of Court

govern receiverships (Cal. Civ. Proc. Code §§564 to

570; Cal. Rules of Court, rule 3.1175 to 3.1184). For more

information on receiverships in California, see State Q&A,

Provisional Remedies: California.

Receiverships are an important tool to consider when the

property is abandoned or is otherwise at risk if left in the

hands of the borrower.

Non-Judicial Foreclosure and

California’s Anti-Deﬁciency

Legislation

Non-judicial foreclosure is a contractual right arising only

where the borrower expressly grants the lender a power

of sale in the subject deed of trust. The power of sale

clause allows a lender to foreclose the security interest

and sell the secured property if the borrower is in breach

of a material obligation under the terms of the promissory

note, the deed of trust, or another contract, without court

proceedings. (Biancalana v. T.D. Serv. Co., 56 Cal. 4th 807,

813 (2013).)

Examples of material breaches that can lead to

foreclosure include:

• Failure to make timely payments on the promissory

note.

• Failure to keep the secured property insured.

• Failure to pay property taxes when due.

• Transfer of title or interest in the secured property to

certain parties without prior written consent of the

lender.

In California:

• Deeds of trust typically contain a power of sale.

• Mortgages generally do not contain a power of sale.

California’s anti-deﬁciency legislation prohibits the

beneﬁciary (lender) under a deed of trust from pursuing

a deﬁciency judgment if it forces the sale of the secured

property in a nonjudicial foreclosure (Cal. Civ. Proc. Code

§580(d)).

Substitution of Trustee

The trustee named in the original deed of trust is

often unqualiﬁed, unwilling, or unable to conduct the

foreclosure sale. In these instances, the lender must

record a substitution of trustee (SOT). In an SOT, the

lender or the appointed attorney-in-fact appoints a party

authorized and willing to conduct the foreclosure sale as

trustee. The SOT must be:

• Signed by the current beneﬁciary or the beneﬁciary’s

power of attorney.

• Recorded in the county where the real property is

located.

Record a Notice of Default

The ﬁrst step to initiating a non-judicial foreclosure sale is

for the trustee to record a notice of default.

The notice of default must include all the following:

• A statement identifying the deed of trust, including

the borrower’s name, recording information and legal

description.

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Commercial Foreclosures (Non-Judicial) (CA)

• A statement that the borrower is in default or has

breached the provisions of the deed of trust.

• A description of the breach or event of default.

• A statement that the trustee intends to sell the property

if the borrower does not cure the default.

• If the default is curable, a description of the steps

necessary and the deadlines for the borrower to cure

the default.

• The contact information for the lender.

(Cal. Civ. Code §2924c(b)(1).)

The trustee must mail a copy of the notice of default by

certiﬁed mail to the borrower and any party that recorded

a request for notice within ten days after recording the

notice of default (Cal. Civ. Code §2924b(b)). Counsel

should consider obtaining a trustee sale guarantee (TSG)

from a reputable title company to provide the lender

with information about the names and addresses of all

parties who are entitled to receive notices relating to

theforeclosure. The cost of the TSG varies by the size of

the loan.

The trustee must mail a copy of the notice of default, by

certiﬁed mail, within one month after recording to all the

following parties:

• The borrower’s successor-in-interest, if any.

• The beneﬁciaries under any junior deeds of trust or

mortgages or their assignees.

• The purchaser (vendee) under a recorded contract of

sale or their successors-in-interest, if any.

• The tenant under a recorded lease or memorandum of

lease.

• The Ofﬁce of the State Controller if there is a recorded

property tax lien.

(Cal. Civ. Code §2924(c).)

California law prescribes the form for the notice of default

(Cal. Civ. Code §2924c(b)(1)).

Prepare the Notice of Sale

The trustee may set a sale date for the trustee’s sale at

least 90 days after recording the notice of default (Cal.

Civ. Code §2924c). The trustee holds a foreclosure sale

between 9:00 a.m. and 5:00 p.m., Monday through

Friday. After setting the sale date and time, the

trustee must prepare the notice of sale for mailing and

publication. The notice of sale must include:

• The time and place of the sale.

• The location where the trustee intends to conduct the

sale.

• The name of the original borrower (trustor) named in

the deed of trust.

• The street address, assessor’s parcel number, and legal

description of the real property.

• The terms of sale.

• The name, address, and telephone number of the trustee.

• The total amount of the unpaid balance of the

obligation secured by the real property.

• An estimate of the costs, expenses, and advances

incurred by the trustee.

(Cal. Civ. Code §2924f(b)(1) to (b)(7).)

Common Errors in the Notice of Sale

Certain mistakes in the drafting of the notice of sale can

lead to the cancellation of the sale. Those errors include:

• The wrong date, time, or place of sale.

• An incorrect legal description that makes it impossible

to identify the property to be sold.

Counsel for the trustee should carefully review the notice

of sale to make sure that all required information is

accurate and complete.

Mail the Notice of Sale

At least 20 days before the sale date, the trustee must

mail the notice of sale to:

• The trustor (borrower).

• Any party with a recorded interest in the property (see

Order a Title Search).

• Any party that recorded a request for notice of sale

with the county recorder for the county where the real

property is located (Cal. Civ. Code §2924b(b)(2)).

Give Notice to the IRS

Review the title report for federal tax liens. If there is

a federal tax lien attached to the property, the trustee

must give notice of the foreclosure sale to the IRS at least

25days before the sale date by certiﬁed mail or personal

service (26 U.S.C. §7425(c)(1)). The foreclosure does not

extinguish the tax lien if the trustee does not give notice

of the sale to the IRS. The IRS has 120 days following the

sale to redeem the property. (26 U.S.C. §7425(a), (d).)

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Commercial Foreclosures (Non-Judicial) (CA)

In practice, while it is rare for the IRS to redeem the

property, an IRS right of redemption creates a post-

foreclosure cloud on title delaying further conveyance

of the foreclosed property acquired by the lender after

foreclosure.

Publish, Post, and Record the Notice

ofSale

The ﬁnal step before conducting the sale is to publish,

post, and record the notice of sale. The trustee must:

• Post the notice of sale at least 20 days before the sale

date in:

– a public place in the city where the real property is

located (if in a city) or in a public place in the county

seat of the county where the real property is located

(if not located in a city) (usually at the courthouse)

(Cal. Civ. Code §2924f(b)(1)); and

– a conspicuous place on the property including, if

possible, on the front door of the property (Cal Civ.

Code §2924f(b)(3)).

• Publish the notice of sale once a week for three

consecutive calendar weeks, with the ﬁrst publication

being at least 20 days before the sale date in a

newspaper of general circulation published in:

– the public notice district where the real property is

located;

– the county where the real property is located (if no

newspaper is published in the public notice district);

– a contiguous county with the highest population of all

contiguous counties (if no newspaper is published in

the public notice district or county).

(Cal. Civ. Code §2924f(b)(2).)

• Record the notice of sale in the ofﬁce of the county

recorder for the county where the real property is

located at least 20 days before the sale date (Cal. Civ.

Code §2924f(b)(4)).

The trustee, lender, and authorized agents of the lender

or trustee have a duty to make a good faith effort to

provide up-to-date information on the sale and any

postponements to any person that wants the information.

Borrower’s Right to Reinstate the Loan

The borrower has the right to reinstate (also known as a

right to cure) the loan at any time until ﬁve business days

before the sale date. To reinstate the loan, the borrower

must pay:

• The entire amount then due, other than the accelerated

portion of the principal due and owing after default (all

installments past due regardless of acceleration of the

loan balance).

• The costs and expenses incurred by the lender resulting

from enforcing its rights under the deed of trust,

including:

– insurance premiums paid by the lender, if any;

– delinquent taxes paid by the lender, if any;

– interest to the date of reinstatement;

– costs of recording and publication;

– costs of service;

– attorneys’ fees; and

– any other expenses necessarily paid by the lender.

(Cal. Civ. Code §2924c.)

Counsel for the lender should ensure that there is a contact

person available to provide the reinstatement amount if

the borrower indicates a desire and ability to reinstate.

Conducting the Sale

The trustee conducts foreclosure sales between 9:00a.m.

and 5:00 p.m. on any business day Monday through

Friday. The foreclosure sale must take place:

• At the time speciﬁed in the notice of sale.

• At the location speciﬁed in the notice of sale (typically at

the courthouse).

• In the county where the real property is located.

(Cal. Civ. Code §§2924f(c)(4) and 2924g(a)(1), (a)(2).)

The trustee or its agent conducts the sale and may

schedule more than one sale for the same time and place.

The trustee cannot bundle properties for sale and must

sell each property separately unless, the deed of trust or

mortgage requires otherwise. (Cal. Civ. Code §2924g(a)(3),

(a)(4).)

The trustee is entitled to a $50 fee for conducting the sale,

in addition to any fees permitted by statute (Cal. Civ. Code

§§2924f(c)(5) and 2924c).

On the date of sale, the trustee must offer the property for

cash sale by public auction. The beneﬁciary may make a

full credit bid equaling the amount owed on the debt.

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Commercial Foreclosures (Non-Judicial) (CA)

The trustee has the right to require:

• Every bidder other than the beneﬁciary to show

evidence of the bidder’s ability to deposit the full

amount of the ﬁnal bid with the trustee and actually

deposit the bid amount to be held by the trustee:

– in cash;

– by cashier’s check drawn on a state or federal savings

and loan association or national bank;

– by a check drawn on a state or federal credit union;

– by a check drawn by a state or federal savings and

loan association, savings association, or savings bank

authorized to do business in California; or

– by cash equivalent designated in the notice of sale.

• The last and highest bidder to deposit, if not previously

deposited, the full amount of the winning bid.

(Cal. Civ. Code §2924h(b).)

If the winning bidder does not deliver the bid amount in

the form designated or fails to deliver the bid amount, the

bidder is:

• Liable to the trustee for all damages, including court

costs and attorneys’ fees.

• Guilty of a misdemeanor punishable by a ﬁne of not

more than $2,500, where failure to deliver was willful.

(Cal. Civ. Code §2924h(d).)

Post-Sale Requirements

The trustee, lender, and successful bidder must complete

several steps after the trustee’s sale to complete the

foreclosure process, including:

• Executing, delivering, and recording the trustee’s deed

to convey title to the successful bidder.

• Taking possession of the foreclosed property.

• Disbursing the sale proceeds.

Trustee’s Deed

After the foreclosure sale and payment of the bid amount,

the trustee has 18 calendar days to execute and deliver

a trustee’s deed to the successful bidder (Cal. Civ. Code

§2924h(c)). Counsel should prepare the trustee’s deed

in advance of sale so that the trustee may execute and

deliver it as soon as possible following payment of the sale

proceeds (or application of the credit bid, as applicable).

A purchaser acquiring property by a trustee’s deed

acquires title that is free and clear of:

• All liens junior to the deed of trust.

• Any title, interest, or claim of:

– the trustee;

– the trustor;

– the beneﬁciary; and

– their respective successors in interest.

The sale is perfected if the winning bidder records the

trustee’s deed within 18 calendar days of the sale date.

Taking Possession of the Property

If the property is abandoned at the time of the sale, the

purchaser may take possession immediately.

If the property remains occupied, the purchaser may

take possession only after successfully completing an

unlawful detainer action (eviction) (Cal. Civ. Code §2924n;

see Practice Note, Landlord’s Rights and Remedies

(Commercial Lease) (CA): Eviction).

Disbursement of Sale Proceeds

Within 30 day following the sale, the trustee must send

a written notice of surplus proceeds to all parties with

an interest in the property, if applicable. The interested

parties have 30 days after the trustee sends the notice to

submit a claim to the surplus proceeds. After reviewing

the claims the trustee may:

• Distribute the sale proceeds in the order determined by

California law.

• Deposit the sale proceeds with the clerk of the superior

court for determination of distribution.

(Cal. Civ. Code §2924j.)

California law prescribes the following order of priority for

disbursement of the sale proceeds:

• To the costs of the sale (including trustee’s fees and

attorneys’ fees).

• To the payment of the obligations secured by the deed

of trust.

• To the payment of any junior liens or encumbrances

secured by the foreclosed property.

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Commercial Foreclosures (Non-Judicial) (CA)

• The balance, if any, to the trustor or the trustor’s

successor in interest. If the property is sold or

transferred to another, to the vested owner of record at

the time of the trustee’s sale.

(Cal. Civ. Code §2924k.)

Deﬁciency Judgments

Deﬁciency judgments are not available for non-judicial

foreclosures in California.

Foreclosure Comparison

Non-Judicial Foreclosure Judicial Foreclosure

Costs Typically, less expensive. Typically, more expensive.

Timeline Minimum of approximately four

months.

18 months or more, but typically

several years.

Any notice requirements

before commencing

foreclosure

There is no statutory requirement for

a pre-foreclosure demand letter. The

lender must comply with any notice

requirements contained within the

loan documents.

There is no statutory requirement for

a pre-foreclosure demand letter. The

lender must comply with any notice

requirements contained within the

loan documents.

Publication

requirements

The trustee must publish the notice

of sale once each week for three

consecutive weeks in a newspaper

of general circulation in the public

notice district or county where the real

property is located. The ﬁrst date of

publication must occur at least twenty

days before the sale date. (Cal. Civ.

Code §2924f(b)(1), (b)(2).)

Counsel for the lender must publish

the summons and complaint only if

alternative service is needed to provide

notice of the lawsuit to a defendant

(see State Q&A, Commencing an

Action: California: Question 12).

The sheriff must publish the notice of

sale following judgment according to

the same requirements for a non-

judicial sale (Cal. Civ. Proc. Code

§701.540).

Declaratory judgment

for loan or title defects

N/A. The lender may include a count for a

declaratory judgment to clear a title

defect in a foreclosure complaint.

Deﬁciency judgment No. The lender cannot sue the

borrower for a deﬁciency after

foreclosing nonjudicially (Cal. Civ. Proc.

Code §580b).

A junior lienholder may sue the

borrower on the debt unless the junior

lien is a purchase money mortgage.

A lender may include a count for a

deﬁciency judgment in the foreclosure

complaint for non-purchase money

mortgages (Cal. Civ. Proc. Code

§726(b)).

Commercial Foreclosures (Non-Judicial) (CA)

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Non-Judicial Foreclosure Judicial Foreclosure

Redemption period N/A. The redemption period is:

• Three months after the sale date if

the proceeds satisfy the debt.

• One year after the sale date if the

proceeds do not satisfy the debt.

(Cal. Civ. Proc. Code §729.030.)

Requirement to conﬁrm

foreclosure sale

N/A. N/A.

One-action rule A beneﬁciary (lender) under a deed

of trust may only pursue one form

of recovery of any debt secured by a

mortgage or deed of trust (Cal. Civ.

Proc. Code §726(a)).

A beneﬁciary (lender) under a deed

of trust may only pursue one form

of recovery of any debt secured by a

mortgage or deed of trust (Cal. Civ.

Proc. Code §726(a)).