Los Angeles Lawyer Magazine Features “Bankruptcy Shelters” by John C. Keith

John Keith

Attorney John C. Keith, who recently joined the Editorial Board of Los Angeles Lawyer Magazine, the Los Angeles County Bar Association’s official publication, authored “Bankruptcy Shelters: Public policy continues to weigh against the absolute effectiveness of bankruptcy remote entities,” which was featured in the magazine's July/August 2013 edition.

Mr. Keith’s article examines the effectiveness of “bankruptcy remote” special purpose entity borrowers, a tool used by lenders in recent years to protect them against bankruptcy filings.  Typically, lenders will insert themselves or their designees into the borrower’s management as nominally “independent” directors or managers, with the expectation of wielding veto power over the borrower’s ability to file bankruptcy. 

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Lender Cannot Pursue Borrower For Deficiency Judgment After Short Sale

By Laurie Murphy 

Laurie Murphy

In a case decided on July 23, 2013, the court of appeal held that a lender cannot pursue a borrower for a deficiency judgment after a short sale.

When a borrower defaulted on her payment obligations under a purchase money note secured by a deed of trust on her residential property, the lender served a notice of default.  The borrower was able to negotiate a short sale with a third party prior to the foreclosure sale but the agreed to price was less than the amount outstanding on the loan.  The lender consented to the short sale with an agreement that they were only releasing the security, not any deficiency.  The borrower then sued the lender after it attempted to collect on the amount of the deficiency it claimed she still owed. 

The trial court sided with the lender.  On appeal by the borrower the court of appeal held that any lender who either forecloses or agrees to a short sale of residential property secured by a deed of trust cannot pursue the borrower for any deficiency after either a foreclosure sale or a short sale.  Coker v. JP Morgan Chase.

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California Supreme Court Overruled a Long Standing Parole Evidence Rule

by Laurie Murphy

The California Supreme Court has just overruled a long standing ruling in a seminal case (Bank of America v. Pendergrass (1935) 4 Cal.2d 258, 263. 

Under Pendergrass, evidence of alleged oral promises, which conflicted with the written terms of a fully integrated written contract, were barred – referred to as the parol evidence rule.  The effect of the Pendergrass rule was that a plaintiff could not argue that promises the defendant with whom he contracted made before or at the time of contracting that varied with the terms of a fully integrated written agreement, i.e. that the defendant would not take certain action if the Plaintiff defaulted on his payment obligations.  This rule has been a mainstay in the arsenal that lenders had to protect themselves against disgruntled borrowers. 

Under Riverisland Cold Storage v. Fresno-Madera Production Credit Association dated January 14, 2013, the Supreme Court examined the parol evidence statute (Code of Civil Procedure section 1856) and many of the cases decided under it both pre- and post-Pendergrass as well as case law from other jurisdictions and held that the fraud exception to the parol evidence rule as codified in CCP  §1856 basically holds that if the defendant defrauded the Plaintiff into signing a fully integrated agreement, the agreement itself is not valid and the courts can no longer bar evidence that goes to prove fraud, including promissory fraud, which Pendergrass had heretofore prohibited. 

It is expected that this will greatly increase lender's exposure to fraud claims by borrowers.  Indeed, all a borrower would have to allege is that the lender orally misstated the terms of the loan, promised that the lender would not foreclose if the borrower did not make timely payments, said that the interest rate would be lower than the loan actually provides, etc.  Up until now, the Pendergrass rule could be used at summary judgment or even demurrer. Under Riverisland these cases will be allowed to proceed to trial.

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