By: Phillip M. Adleson

Adleson, Hess & Kelly, P.C.
577 Salmar Avenue, Second Floor
Campbell, California 95008
408-341-0234 (voice)
408-341-0250 (fax)
email: P_Adleson@ahk-law.com
Webpage: www.ahk-law.com

The Problem

I will admit the title of this article is misleading. Actually I am only going to address the first two of potentially 50 ways to chill the bidding at a trustee's sale. In particular, the two ways discussed by the California Court of Appeal in its recent decision in South Bay Building Enterprises, Inc. and Riviera Lend-Lease, Inc. (June 9, 1999) 85 Cal.Rptr. 2d 647 ("South Bay Case"). This case is particularly important for all parties involved in nonjudicial foreclosures as a guide on what not to do.

A large majority of borrowers, trustees and beneficiaries want the trustee's sale to be fairly conducted as directed by the Civil Code and for it to bring in the highest and best bid possible under the circumstances. While trustors ( particularly abusive debtors i.e., those abusing their rights or not exercising them in good faith) and professional third party bidders frequently attempt to disrupt the nonjudicial foreclosure process, it is far more rare to find a lender (beneficiary) or trustee attempting to fix or disrupt the sale. The rationale for this behavior is simple, trustors have nothing to lose by disrupting the sale as they can extend the time they use and possess the property without paying. Professional third party purchasers often want to take advantage of the disruption to limit competition and obtain a valuable property. Most beneficiaries merely want to have their loans paid back (i.e., they do not want the property) and trustee's simple want to process the sale and avoid become involved in a legal dispute between the other parties (i.e., an increasingly difficult task).

However, when real property values rise, a small minority of lenders (usually private lenders), will change their focus from getting the loan paid off to obtaining the secured property. While this, in and of itself, is not unlawful (or even morally wrong), when combined with unlawful conduct that chills the bidding at a trustee's sale, the wrongdoer can be sued civilly and charged with a misdemeanor carrying a fine of not more than $10,000 and a county jail term of not more than one year.

Bid chilling is problematic for trustees who generally have nothing to gain from such conduct. That is, trustee's fees and costs are severely limited by statute, the trustee usually has no interest in the property (before or after the sale) and the trustee may be drawn into a lawsuit that costs more than it makes on hundreds of files even if, as often happens, the trustee prevails in the lawsuit. As can be seen in the South Bay Case, the same conduct (e.g., postponements and overbidding by the beneficiary) may in one instance be totally legal and other instances the conduct is illegal as Civil and Criminal liability turns upon the purpose for the conduct not the conduct itself (e.g., postponing to prevent third parties from bidding as opposed to postponing for a legitimate reason). The trustee really can draw no conclusion or inference from the fact that the beneficiary may well want the security as this alone does not prove that the beneficiaries purpose is wrongful. It is not uncommon for trustors to assert that the beneficiary wanted to steal their property even where the property has no equity and the lender suffers a loss from have to foreclose on the property and resell it.

This biggest problem for trustee's is that many parties and their attorneys do not understand, the trustee is not a judge or jury and is not generally in a position to resolve claims of bid chilling. Rarely does anyone attempting to chill bidding express their purpose. Even if they did, the trustee's only remedy is to resign. It is not infrequent for a beneficiary to threaten to sue a trustee if damages occur due to an eleventh hour resignation because of the delay causes combined with the increase costs cause by having to renotice the sale (i.e., incurring posting, publishing and mailing costs). If a trustee were to resign simply because some accuses another party in the nonjudicial foreclosure process of some wrongdoing or wrongful purpose, no foreclosure would ever be concluded as this would create an incentive for trustors and others to make baseless and unsupportable accusations to disrupt the process.

In the South Bay case, the California Court of Appeal addressed both bid chilling and a related issue of phantom surplus (i.e., the beneficiary credit bidding money in excess of that which is actually owed by the borrower).

Both South Bay Building Enterprises, Inc. (South Bay) and Riviera Lend-Lease, Inc. (Riviera) were lending institutions, each of whom made a loan to James Archer (Borrower). Both South Bay and Riviera's deeds of trust were both secured by the Borrower's home in Palos Verdes Estates. Riviera's approximately $127,000 loan was secured by a first deed of trust and South Bay. approximately $116,000 loan was secured by a second deed of trust.

After the Borrower's default, Riviera nonjudicial foreclosed and Riviera was the only bidder at its trustee sale held on February 4, 1992. South Bay's deed of trust was wiped out and it received no surplus proceeds from Riviera's trustee sale.

South Bay (i.e., the junior lienholder) sued the Borrower, Riviera (i.e., the foreclosing senior lienholder), Riviera's two owners and one of its managers alleging that they engineered a fraudulent scheme to acquire the Borrower's property without having to pay South Bay.

South Bay alleged that plaintiff committed fraud when it represented to it that Riviera would foreclose and pay the surplus to South Bay; that these representations were false in that Riviera never intended to perform, but rather made the representations merely to keep South Bay from taking any action to enforce its lien; and that Riviera postponed (when bidders with funds to bid were present) and inflated its claim to chill the bidding and acquire the property for itself. Plaintiff presented evidence that defendants postponed the foreclosure sale several times in order to preclude others from bidding against Riviera (i.e., the wrongful purpose); Apparently, the at the first scheduled trustee's sale a potential buyer was present with a $225,000 cashier's check; and that defendants falsely represented that the secured obligation was larger than it actually was in order to deter other bidders. The conspiracy cause of action involved essentially a conspiracy to engage in the same wrongful conduct. Riviera's own manager, who attended the postponements and sale testified that while he was aware of the fact that Riviera had overstated the amount of the secured obligation, it did not really matter "because under no circumstance was Riviera going to permit a third party to buy the realty at any trustee's sale."

Finally, with no other bidder's present, Riviera purchase the property at its own trustee sale by credit bidding $225,487.03 (i.e., almost $100,000 over what was actually owed to Riviera). Riviera never paid the trustee any of the phantom surplus (i.e., the amount included in a beneficiary's successful credit bid that exceeded the actual amount of his secured obligation). Riviera's manager attempt explained the difference between the amount owed on the obligation and the amount actually bid as being the result "a failure to properly credit [the Borrower] for payments he had already made on his debt."

The Borrower testified that he had entered an agreement with Riviera's manager that Riviera would not conduct the foreclosure until there were no bidders present so that Riviera could acquire it and that Riviera would sell it back to the Borrower (i.e., evidence of a conspiracy between the trustor and the lender). The Borrower also testified that the inflated amount of Riviera's obligation was not a mistake but was intended to scare away bidders because of a much greater opening bid (i.e., evidence of an unlawful purpose).

After the trustee's sale, Riviera allowed the borrower to continue to live in the secured property, but ultimately evicted the borrower when he stopped paying rent. Riviera then resold the secured property for $800,000.00 and Riviera's share of the proceeds (after senior liens and expenses) was a net $214,450.31. Riviera claimed it had actually suffered a loss due to extensive repairs made to the property prior to resale.

At the end of the trial, South Bay attempted to amend its complaint to conform to proof to add causes of action for conversion (of surplus) and for claiming money due (surplus proceeds) under Civil Code § 2924k. The trial court denied South Bay's motion to amend on the ground that it would prejudice the defendants at that late stage. The trial court granted Riviera's motion for a directed verdict and South Bay appealed. The court found that since South Bay's owner testified that defendants had not made a representation to him regarding the trustee's sale, there could be no fraud. There could be no conspiracy as the fraud was the wrongful act upon which the conspiracy was based.

Undoubtedly, this case is as much about poor lawyering as anything else. That is, in plain English, the trial court through out South Bay's case because its attorney did not figure out what the lawsuit was about until the trial was almost over. Even though there was an abundance of facts showing bid chilling, Southbay's attorney in his initial complaint tried to characterize the case as ordinary fraud and conversion (i.e., taking personal property that does not belong to you) instead of one for bid chilling and failure to disburse surplus funds (albeit phantom surplus).

In many cases nonjudicial foreclosure cases, plaintiff's attorney must look for the smoking gun. Based upon the evidence recited in the court of appeal's written opinion, an entire arsenal exploded, yet the plaintiff's attorney did not figure out the proper causes of action until it was too late. In all fairness to plaintiff's attorneys, as the court of appeal concluded should have been done in this case, many trial courts permit the amendment of the complaint to conform to proof at trial particularly, as here, when it simply involves a different legal theory based on the same conduct. The court of appeal reversed the trial court's directed verdict

The court of appeal noted that generally when there is an irregularity at a sale, the remedy is an action to set aside the sale. However, that is not the exclusive remedy. The court of appeal observed that "[f]raudulent actions by the beneficiary can give rise to tort liability" (i.e., an action for damages). The court or appeal observed that this is often the case when the property cannot be set aside because it is sold to a bona fide purchaser. The court of appeal placed major emphasis on that fact that Civil Code § 2924h(g) imposes criminal liability providing that it is "unlawful for any person, acting alone or in concert with others, (1) to offer to accept or accept from another, any consideration of any type not to bid, or (2) to fix or restrain bidding in any manner, at a sale of property conducted pursuant to a power of sale in a deed of trust or mortgage.... [] In addition to any other remedies, any person committing any act declared unlawful by this subdivision or any act which would operate as a fraud or deceit upon any beneficiary, trustor, or junior lienor shall, upon conviction, be fined not more than [$10,000] or imprisoned in the county jail for not more than one year, or be punished by both that fine and imprisonment."

The court of appeal discussed and distinguished FPCI RE-HAB 01 v. E & G Investments, Ltd., 207 Cal.App.3d 1018, 255 Cal.Rptr. 157 ("FPCI case") which had very similar facts to those in the South Bay case. The court of appeal in the FPCI case, concluded that setting aside a trustee's sale is not plaintiff's only remedy and that a junior lienholder could sue for fraud or other misconduct, "fraudulent conduct to 'chill the bidding' or other misconduct resulting in the 'washing out' of junior liens. . ." (Id. at p. 1022, 255 Cal.Rptr. 157.) However, the result in the FPCI case (i.e., the junior lienholder lost) was different than in the South Bay case because the junior lienholder in the FPCI case did not present any proof that anyone was ready willing and able to bid sufficient sums at the trustee's sale to pay the senior lien and create a surplus. (Id. at p. 1024, 255 Cal.Rptr. 157.) That is, unlike the South Bay case, there was no evidence that a qualified bidder had attended any of the postponements or the sale, ready, willing and able (i.e., qualified) to bid on the secured property or that the defendants' conduct caused such a person not to attend the sale and bid. Thus, no damage or harm could be shown to have been caused by the wrongful conduct or by the unlawful purpose. The court of appeal in the FPCI case further concluded that without such proof damages would be too speculative.

In the South Bay case it was alleged and proved at trial that Riviera (the senior lienholder) and the Borrower agreed that no one except Riviera would be permitted to purchase at the trustee's sale. To achieve that wrongful purpose, the trustee's sale was postponed two times when other ready, willing, and able to bidders were present and Riviera knowingly instructed the trustee that approximately $100,000 more than was actually owed was part of the obligation being foreclosed (i.e., and was to be part of Riviera's credit bid). This resulted in the trustee misrepresenting (overstating) the amount owed on the foreclosing obligation. The court of appeal concluded that these facts, if believed by the jury, "constitute substantial evidence of wrongful conduct." In addition, the junior lienholder present evidence that a third party purchaser was present one of the postponements with a $225,000 cashier's check and ready to bid on the property.

In the South Bay case the court of appeal concluded that South Bay presented substantial evidence to establish liability even though the evidence did not support the theory that defendants had committed common law fraud (i.e., made a misrepresentation to South Bay upon which it detrimentally relied). Rather, the court of appeal concluded that the evidence supported a theory of liability based upon a violation of Civil Code § 2924h(g) which creates a statutory duty the violation of which is a tort. The court of appeal concluded that: "[v]iolation of a statutory duty to another may therefore be a tort and violation of a statute embodying a public policy is generally actionable even though no specific civil remedy is provided in the statute itself. Any injured member of the public for whose benefit the statute was enacted may bring the action." [Ct. Om.]" The court of appeal further reasoned that since Civil Code § 2924h(g) criminalizes "any act ... which would operate as a fraud or deceit upon any beneficiary ... or junior lienor...." The court of appeal found that South Bay had established the necessary fraudulent conduct: by showing the agreement between the senior lender and the borrower to postpone the trustee sales when bidders ready and able to purchase were present; and by misrepresenting about the amount owed to the senior lienholder. Without commenting on who else may be entitled to sue, the court of appeal concluded that South Bay, as a junior lienholder, "clearly falls with the class for whose benefit the statute was enacted and therefore may use defendants' violation of the statute to establish civil liability."

What the court of appeal did in the South Bay case is to create a tort (remedy) of "bid chilling", which has elements different from common law fraud. The court of appeal held that the operative facts necessary to establish the tort of bid chilling were continuing the sale to prevent others from bidding and falsely inflating the amount owed to the foreclosing lender. Since substantial evidence of such facts were presented at the trial and since these facts were known by all of the parties for some time, the court of appeal concluded that the trial court should have allowed South Bay to amend its complaint after evidence was concluded at the trial.

More confusing and problematic was the courts conclusion that South Bay should have been allowed to amend its complaint to plead a cause of action for money due under Civil Code § 2924k (a) with respect to surplus proceeds. The trustee does not appear to have been a party to the lawsuit. While there certainly phantom surplus should be treated like real surplus to prevent beneficiaries from accidentally or intentionally inflating their obligation to chill bidding, the court is not clear as to the trustee's role and responsibility where it does not know that the beneficiary is credit bidding in excess of the amounts owed to it by the borrower.

South Bay claimed that the trustee breached its statutory duty to collect from the senior lender the full amount of its bid and distribute the excess to it as a junior lienholder. The court of appeal stated that: "[t]he claim is well-taken because [Riviera's manager testified that], the trustee acted as Riviera's agent in conducting the sale. The evidence is reasonably susceptible to the inference that Riviera directed the trustee to ignore the fact that Riviera had placed a bid exceeding the amount owed to it and therefore to not collect from Riviera the excess amount and distribute it to South Bay. The trustee's failure to perform its statutory obligation can be imputed to Riviera based upon the agency-principal relationship." Under this analysis, there is little doubt that the beneficiary is liable for the phantom surplus.

The South Bay case sheds little light, however, on the duty of the trustee regarding phantom surplus. In appears (although it is far from clear), that in the South Bay case the trustee may have known that the beneficiary was credit bidding in excess of the amounts owed on the obligation. Therefore, exercising proper judicial restraint, the court of appeal did not decide the case based upon the normal nonjudicial foreclosure where all that the trustee knows about the amounts owed is from the beneficiary's instructions. The beneficiary (the only person in a position to know what it is owed) customarily instructs the trustee as to the amount owing both at the time the notice of default is recorded, just before publication of the notice of sale and in bidding instructions just prior to the trustee's sale. The trustee has no way of knowing whether such instructions are correct, no known duty to verify the amount claimed by the beneficiary (i.e., to do an accounting) and has neither the ability nor power to determine amounts owed or to resolve disputes over the amounts owed.

From the court of appeal's opinion in the South Bay case, while the beneficiary may be liable regardless of whether the trustee is liable, it does not answer whether the trustee has liability for simply following the instructions of the beneficiary/principal regarding the amount owing. In addition, the court of appeal's opinion does not address the question of what duty the trustee has under Civil Code § 2924k to collect phantom surplus (as opposed to real surplus) from the beneficiary where the trustee is operating solely under instructions from the beneficiary (i.e., the trustee does not know the amount in the instruction exceeds the actual amount owed)? Except where the beneficiary informs the trustee of the beneficiary's intention to bid more than the amount set forth in the beneficiary's instructions, the trustee should not be liable for following the instructions of the beneficiary as this would disrupt the delicate balance necessary to make the nonjudicial foreclosure system work in a prompt, economical and far fashion. Hopefully, future cases or legislation will clarify this point. However, where the beneficiary informs the trustee to bid more than the amount owed on the obligation, the trustee should obtain funds (cash or cash equivalents provided by the Code) from the beneficiary just as it would for any third party bidder.

The South Bay case is the first published opinion to directly address both the tort of bid chilling and the issue of how to handle phantom surplus. The facts in the South Bay case reveal blatant bid chilling and serve as a good basis for the court of appeal's opinion, articulating that tort for breach of a statutory duty (i.e., bid chilling) can be brought by a junior lienholder. Unfortunately, the court of appeal's opinion on phantom surplus is less than clear and raises questions under more normal facts other that differ from those in the South Bay case. Until clarified each trustee may want to consult with its own counsel to determine how its should handle the ambiguities created by the South Bay case.