Transactions and Regulatory Committee Distressed Property Task Force (information only) Federal Committee
April 19, 2011
[This material is for discussion purposes only and has not been approved by the Distressed Properties Task Force, Transaction and Regulatory Committee, Federal Committee, Executive Committee or the Board of Directors.]
Issue: Should C.A.R., in conjunction with NAR, include in sponsored federal short sale legislation a requirement that requires a lender to waive any personal recourse against a borrower when it accepts any consideration for approving a short sale?
Options: 1. Include the provision in proposed legislation. 2. Do nothing. 3. Other
Status/Summary: California protects a short seller from personal liability (recourse) in a default on a purchase money mortgage, and very recently, from recourse by any first mortgage holder in a short sale. C.A.R. is sponsoring legislation to extend the purchase money protection to re-financed purchase money debt. Most other jurisdictions do not provide such anti-deficiency protections, although HAFA attempts to limit personal recourse once a HAFA short sale is approved.
At the January 2011 meetings, the Committee approved Option 1 above. After discussion, the Federal Committee disapproved the motion of the Transaction and Regulatory Committee. The conflict was resolved by the Executive Committee by a referral to the Distressed Property Task Force for additional background materials and further discussion. The Task Force recommends approval of the item in a proposed federal bill and this material implements the direction of the Executive Committee.
Discussion: California borrower protection laws are more protective than most states, and can protect a short seller (and thus, his or her agent) against liability after the sale, and help encourage a short seller to complete a short sale rather than default and allow the property to go to foreclosure.
California law recognizes that if an upside down seller remains personally liable for the balance of debt not covered in a short sale, the seller has much less incentive to maintain the property and transfer it via a sale. Under existing law, a non-judicial foreclosure cannot result in personal liability for the loan balance (a deficiency) nor can even a judicial foreclosure and judgment give rise to liability if the loan was purchase money. Effective 2011, a first mortgage holder cannot seek a deficiency on any loan if it has approved a short sale - whatever compensation was received for the short sale is treated as complete satisfaction. However, the new rule only applies to a "first" mortgage, and not to junior noteholders. Unfortunately, it is junior noteholders that are most often seen as obstacles to closure of a short sale and are most often associated with collection efforts that harass a short seller after the transaction. Most states do not even have these protections for borrowers selling short.
HAFA attempts to limit personal recourse liability after an approved workout, but only a small portion of the market is actually subject to these protections.
C.A.R.'s sponsored anti-deficiency legislation (vetoed by Gov. Schwarzenegger last year as SB 1178) is designed to change the lender's leverage or ability to threaten liability, but is itself limited to refinanced acquisition debt and will not cover other junior loans.
C.A.R. has negotiated a compromise with California lenders over an expansion of last session's SB 931, Ducheny, which now applies only to first mortgages; that compromise (now in SB 458 Corbett) will extend to rule to junior note holders too. While final passage of the legislation is still problematic, C.A.R. has clearly adopted policy to restrict recourse after a short sale.
Potential tax implications exist as well. Both state and federal law contain specific exemptions from tax liability for the imputed income that comes to the short seller as the result of debt forgiveness. The California rule is set to expire after 2012; the Federal rule has a longer life but will still expire unless extended. The taxing authorities have opined that if there is no recourse on the debt, the forgiveness does not confer any income. This issue has largely gone unnoticed in previous discussions, but has policy implications in the long term. Eliminating personal recourse on a short sale would be very important to short sellers, but could result in the bill being tagged as expensive.
Should elimination of personal recourse in short sales be included in proposed federal legislation?