Deed of Trust Is Functional Equivalent of Mortgage for State Foreclosure Purposes

Posted by NCBRC - June 17, 2013

In Cruz v. Aurora Loan Services, No. 11-1133, Adv. Proc. No. 11-90116 (Bankr. S.D. Cal. Apr. 25, 2013), the court was asked to reconsider its earlier determination that the recording requirement of California’s non-judicial foreclosure statute applies to deeds of trust. See Cruz v. Aurora Loan Servs. LLC (In re Cruz), 457 B.R. 806 (Bankr. S.D. Cal. 2011) (“Cruz I“).

The case arose out of a situation in which debtors were paying back their residential loan in accordance with an agreement they had entered into with the trustee, Aurora, when ING, as beneficiary on the deed of trust, foreclosed on the property. The debtors sought to invalidate the foreclosure sale based upon ING’s failure to record its interest in the property prior to the foreclosure. ING moved to dismiss the debtors’ complaint arguing that California’s non-judicial foreclosure statute, Cal. Civ. Code § 2932.5, does not apply to deeds of trust.

Section 2932.5 provides:

Where a power to sell real property is given to a mortgagee, or other encumbrancer, in an instrument intended to secure the payment of money, the power is part of the security and vests in any person who by assignment becomes entitled to payment of the money secured by the instrument. The power of sale may be exercised by the assignee if the assignment is duly acknowledged and recorded.

The court found that the applicability of the statute turns on whether, under a deed of trust, it is the beneficiary of the trust, i.e. the “encumbrancer,” or the trustee who holds the power of sale. If it is the former, the statutory recording requirement applies and the foreclosure sale must be invalidated. If it is the latter, the statute does not apply because the trustee is not an “encumbrancer.” ING argued that, unlike a mortgage, under the conveyance language of the deed of trust, the trustee is conveyed legal title with power of sale. Therefore, the recording requirement of section 2932.5 does not constrain the foreclosure.

The court turned first to state law for guidance but found it insufficient to direct a decision. It acknowledged that the majority of state courts have found that the statute only applies to mortgages, see, e.g., Haynes v. EMC Mortg. Corp., 205 Cal.App.4th 329, 336 (Cal. App. 1st Dist. 2012), cert. denied, 2012 Cal. LEXIS 7371 (Cal. Aug. 8, 2012), but noted that the California Supreme Court had not spoken on the issue except by declining to “de-publish” three lower court opinions to that effect. The court also acknowledged that its previous decision in a separate case which found that the statute applies to deeds of trust was overturned by the District Court. U.S. Bank, NA v. Skelton (In re Salazar), 448 B.R. 814, 822-24 (Bankr. S.D. Cal. 2011), rev’d, U.S. Bank N.A. v. Skelton (In re Salazar), 470 B.R. 557, 560-562 (S.D. Cal. 2012).

Nonetheless, the bankruptcy court conducted a thorough review of the statute, the state and federal law relevant to its interpretation, and treatises instructive on the issue, and again concluded that section 2932.5 applies to deeds of trust.

The court began its analysis by noting that in the absence of a definitive statement by the State Supreme Court, it was not compelled to follow intermediate state court decisions which it found to be wanting in adequate analysis. “All of the contrary authority either directly or indirectly rely upon Stockwell v. Barnum, 7 Cal. App. 413, 416-17 (Cal. App. 2nd Dist. 1908), without evaluating whether its analysis was sound at the outset or changed over time as the law developed. Cruz I, 457 B.R. at 816, analyzed Stockwell and concluded it was no longer viable.” Thus, the court found the state court decisions in Haynes, and similar state cases, unpersuasive.

Because the case turned on the power of the trustee with respect to foreclosures, the court looked to how that power has been interpreted in the Ninth Circuit. In Olympic Fed. Sav. & Loan Assoc. v. Regan, 648 F.2d 1218, 1221 (9th Cir. 1981), the court found that mortgages and deeds of trust are “legally identical,” so that the borrower retains actual title to the property. This conclusion was further supported by the California Supreme Court case of Monterey S. P. P’ship v. W. L. Bangham, 49 Cal. 3d 454, 461 (1989), in which the court found that the beneficiary was the real party in interest under a deed of trust so service of process of a mechanics lien suit on the trustee under a deed of trust was inadequate.

Under the teachings of Monterey, the court found that the actual rights conveyed to the trustee are technical rather than substantive, extending “only so far as may be necessary to the execution of the trust.” The court interpreted the “power” to foreclose under section 2932.5, as being equivalent to the “authority” to foreclose, and found that only the beneficiary has that authority. Limits on the trustee’s power was further supported by other statutory provisions such as Cal. Civ. Code § 2924(a)(6) which provides that trustee may only commence the foreclosure process when acting “within the scope of authority designated by the holder of the beneficial interest. The trustee has no ability to exercise the power of sale unless it is authorized by the beneficiary.”

The court also rejected ING’s alternative argument that the recording requirement of section 2932.5 does not apply to deeds of trust because the involvement of the trustee alleviates the problem of a “gap” in recording assignments of the beneficial interest. The court found that, as a practical matter, deeds of trust are indexed by the names of the trustor and the beneficiary, not by the trustee. The court found that “[s]ince the recorded interest of the trustee need not be indexed in the official records, it cannot provide constructive notice when there is a change in beneficiary.”

Having determined that ING failed to offer sufficient reason for it to reverse its earlier decision, the court went on to note that the case called upon it to determine whether the California Supreme Court would overturn the intermediate state courts on this issue. Moreover, any decision made in this case would involve third parties who were not creditors in the bankruptcy, and would require a district court judgment to be final. The court therefore invited the parties to offer reasons why it should or should not abstain from hearing the adversary case in order to allow the parties to bring the action in state court.

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