California Appellate Court Applies the Full Credit Bid Rule to Deny Trust-Deed Holder’s Insurance Claim

The California Court of Appeal recently issued a real-estate decision that offers guidance to deed-of-trust holders in California that seek to foreclose on a property. Under the full credit bid rule, when a lienholder obtains the property at a foreclosure sale by making a full credit bid—an amount equal to the unpaid debt (including interest, costs, fees, foreclosure expenses)—it cannot later claim that the property was worth less than the bid.

That is because under California law, the lender’s only interest in the property is the repayment of debt. So if the deed-of-trust holder makes a bid for the full amount of the unpaid debt, it cannot later claim that the property is worth less than this amount. Thus, a lender is not entitled to insurance proceeds payable for pre-purchase damage to the property, pre-purchase net rent proceeds, or damages for waste.

The reason for this rule, which exists in other states as well, is to prevent double recovery and protect the integrity of the foreclosure auction. The purpose of a trustee’s sale, i.e. foreclosure auction, is to resolve the question of value through competitive bidding. A lender that makes a full credit bid—but intends to later claim that the value of the property was impaired because of waste, fraud, or insured damages—interferes with the process by impeding third-party bids for amounts between the value the lender places on the property and the amount of the full credit bid.

In Jamshid Najah et al. v. Scottsdale Insurance Company, the California Court of Appeal rejected Plaintiffs’ lienholder insurance claim against Scottsdale Insurance Company by applying the full credit bid rule.

Plaintiffs sold a commercial property in 2006, taking back as partial payment a promissory note secured by a second deed of trust. The borrower fell into default, which caused the holder of the first deed of trust to start foreclosure proceedings. To protect its investment, Plaintiffs—second deed of trust holders—purchased the promissory note secured by the first deed of trust and took assignment of that first trust deed. Plaintiffs then foreclosed on the second deed of trust, taking the property by making a bid equal to the unpaid debt securing the second deed of trust.

Following the purchase from the trustee sale, Plaintiffs sought to collect on the mortgagee aspect of an insurance policy from property damage by the original property holder. Scottsdale Insurance Company rejected the claim and litigation ensued. The California Court of Appeal held that Plaintiffs could not recover on the insurance claim because their full credit bid for the property during the trustee sale precluded them from making a claim that the property was worth less than the amount of the unpaid debt.

This case is a good reminder that a lender that seeks to foreclose on a property should consider the implications of a full credit bid. Such a bid may “foreclose” the trust-deed holder from other available avenues of recovery.

If you are involved in a real-estate dispute or litigation, we may be able to help you. Bona Law PC is a boutique firm that concentrates on real-estate litigation, business litigation, appeals, and antitrust. You can contact us at 858-964-4589.