California has laws which prevent a lender from seeking a deficiency judgment in certain circumstances. These anti-deficiency laws are located in California Code of Civil Procedure (CCP) Sections 580b, 580d, 580e and 726.
CCP 580b: Purchase Money Protection
CCP 580b prohibits deficiency judgments after the foreclosure of a “purchase money loan.” This law applies to both commercial and residential properties, but its most powerful application is for owner-occupied residential homes (with 1 to 4 units only). This protection applies even if the loan is a junior lien (and even if the junior lien is ‘wiped out’ in foreclosure), so long as it is also a “purchase money loan.” In the residential context, a purchase money loan is any loan where the proceeds are used to acquire an owner-occupied residential home. Funds can be used for termite work, roof repairs and closing costs, as long as all of the expenses were necessary to complete the purchase. The determination of whether a loan is purchase money occurs at the time that the loan is originated. If a loan is purchase money when originated, it retains the protections of 580b unless it is refinanced with a “cash out” loan (to the extent of the amount of cash pulled out). The borrower is protected in the event of a refinance of a purchase money loan to the extent the new loan paid off the balance of the purchase money loan, but not for any amounts which would generate cash proceeds above the purchase money debt.
CCP 580d: No deficiency after a non-judicial foreclosure
CCP 580d prohibits a lender from pursuing a deficiency judgment after that lender forecloses on the property through a non-judicial foreclosure process. Wiped out juniors are not subject to this prohibition and could immediately proceed against the borrower.
CCP 580e: No deficiency after a successful short sale
CCP 580e prohibits a lender from pursuing a deficiency judgment after that lender approves a short sale transaction and accepts proceeds from the sale. This applies to junior loans that also approval the short sale and accept proceeds from the transaction. No lender is required to accept the short sale, however, and can reject the transaction outright.
CCP 726: The One Form of Action Rule
CCP 726(a) is the One Action/Security First Rule.
Put simply, the lender must pursue the property first. This is known as “exhausting” the collateral (the “security first” rule). They cannot sue for payment on the loan first. If they foreclose on the home and make all their money back, they can’t go after the borrower.
If the lender ignores this rule, and brings a personal lawsuit against the borrower, or takes any other action to collect upon the debt, without having first foreclosed on the real property security, this gives the borrower very powerful defenses against that lender.