Effective January 1, 2021, California enacted a secondary auction process for residential foreclosure sales.1 Previously, the foreclosure sale was complete, and the highest bidder was deemed the successful purchaser when the “hammer fell” at the conclusion of the auction on the courthouse steps. Civil Code § 2924m created a secondary “auction” whereby defined eligible bidders could outbid the successful purchaser at the foreclosure sale or, in the case of a representative of all eligible tenants, match the successful foreclosure bid.2 As expected, there have been very few legitimate tenant or prospective owner occupant bidders since the law’s enactment. Instead, most participants in the post-foreclosure auction have been non-profits (or, at least, companies claiming to be non-profits).

While significant industry attention has been devoted to understanding the poorly designed bidding process and determining who is, and is not, an eligible bidder, little attention has been paid to the foreclosing lender’s bidding strategy at post-2020 residential foreclosure sales. This will be the focus of this article.

Pre-2021, foreclosing lenders would generally start their bidding low, bidding up the property to the amount of the debt or the value of the property, whichever is less. For example, if the lender was owed $1.1M and property was worth $1M, a lender may start bidding at $750k with instructions to bid up to $1M. If there was no competitive bidding, the lender would take back title for the amount of its $750K specified bid. The lender would then rehabilitate the property and hopefully be made whole from the resale. In that scenario, there was no downside to taking the property back after sale at below debt/value in the amount of $750K.

Post-2020, this historical bidding approach creates risk. Under the same scenario with today’s post-foreclosure auction process potentially in play, a representative of all eligible tenants could grab the $1M property by simply matching the $750K foreclosure bid, or other eligible bidders could grab it for one dollar more. In that scenario, the foreclosing lender would lose roughly $250K of equity. Not ideal to say the least!

To avoid this result, lenders should reconsider starting their bidding well below the property value. Again, assuming that the full debt and property value were roughly $1M, the foreclosing lender would want to start bidding at roughly $1M.3 This way, if an eligible bidder wants to out-bid the lender post-foreclosure, the lender will still maximize its recovery, without leaving any amounts up to the $1M value on the table.

While this new bidding strategy seems fairly obvious, it’s a different approach to what lenders have been doing for decades. In addition, Civil Code § 2924m created some additional complications.

Multi-Collateralized Debt Scenario (all residential):

$1M loan cross-collateralized by two single family residential properties – Property A and Property B. Property A is worth $700k and Property B is worth $500k. The lender opts to foreclose on Property A first, taking the property back after its unopposed opening bid of $700k. Ideally, the lender should wait for the 45-day post-foreclosure auction process to expire before completing a foreclosure on Property B. Otherwise, the lender will not know how much it should bid at the second foreclosure. Assuming the lender ends up with Property A after a $700K unopposed opening bid,4 it can credit bid up to $300k at Property B’s foreclosure sale. But, if the lender doesn’t wait until the 45 days post-foreclosure auction period to expire, an eligible bidder could bid up Property A to, lets say, $750k. Now, the lender can only credit bid up to $250k at Property B’s foreclosure and anything over that amount would be deemed excess proceeds, payable to the next in line, i.e., the junior lienholder or borrower.

Multi-Collateralized Debt Scenario (residential and commercial):

$1M loan cross-collateralized by a $700k commercial building and a $500k residential property. Since the post-foreclosure auction process does not apply to commercial foreclosures, the lender would be better served to foreclose on the commercial property first and thereby, immediately obtain access to the proceeds or title and fix the remaining amount owed. The lender could then
immediately foreclose on the residential property. Foreclosing on the residential property first would involve the 45-day delay while
waiting to see if an eligible bidder would come along and affect your bid at the second foreclosure of the commercial building.

Junior Lien Foreclosure:

Historically, foreclosing junior lienholders always had to worry about being foreclosed out by the senior lienholder. But the new post-foreclosure auction process further complicates matters. Imagine that junior lienholder takes back title at its own foreclosure and is facing a foreclosure by the senior lienholder in less than 45 days. If the junior lienholder advances funds to cure the senior lien during the 45 days and then an eligible bidder outbids the junior lienholder (now property owner) via the post-foreclosure auction process, the junior lienholder has no (easy) way of recouping the funds advanced to cure the senior lien, giving the successful eligible bidder a windfall. The junior lienholder’s lien has been extinguished by its own foreclosure so it cannot use the lien to collect the advance. And nothing in Civil Code § 2924m allows the junior lienholder to recover the advance.5 To avoid this scenario, the junior lienholder has a couple of options. First, the junior lienholder could negotiate a continuance of the senior lien’s foreclosure (ideally in advance of the junior actually foreclosing). However, the continuance will need to be long enough to encompass the conduct of the junior sale, the post-sale 45-day period and a buffer for transmission of reinstatement funds to the senior lender. There is also the risk that if the junior lienholder is required to postpone its sale for any reason, the senior lienholder may not be willing to grant a further continuance. Alternatively, the junior lienholder could advance the funds to cure the senior lien prior to its own foreclosure, adding the advance to its debt prior and then adjust its bid accordingly.6 In sum, with some advance planning, the junior lienholder can avoid any exposure created by the new post-foreclosure auction process.

Again, the post-foreclosure auction process created by Civil Code § 2924m has done very little to put foreclosed properties into the hands of tenants or honest prospective owner-occupants. In fact, the law has merely given investors who used to exclusively buy properties at foreclosure sales, another “bite at the apple” by rebranding as “non-profits.” Fortunately, the 2023 amendments to Civil Code § 2924m in Assembly Bill 1837 should reduce any abuse.

Nevertheless, there will still be eligible bidders using the post-foreclosure auction process to buy properties, so its important that
foreclosing lenders update their bidding strategies accordingly. If you have any questions about Civil Code § 2924m or bidding strategies at a foreclosure sale, please feel free to contact Robert Finlay at rfinlay@wrightlegal.net or Michelle Mierzwa at mmierzwa@wrightlegal.net.