AB 130 – Foreclosure on Junior Liens

By T. Robert Finlay, Esq., Wright, Finlay & Zak

The California legislature passed AB 130, a budget bill rider, on July 1 and it was immediately signed into law. Slipped into this budget bill was language that had nothing to do with California’s budget. This section, intended to protect borrowers with junior liens that are described as “Zombie Mortgages,” can severely impact the ability of a junior lienholder from prosecuting a foreclosure. Under the bill, a “Zombie Mortgage” is one which the borrower believed was forgiven, primarily due to a lack of communication from the lender. Read below for CMA General Counsel, Robert Finlay’s, Fact Sheet on the effects of this law and CMA’s plans to fight its implementation. – Ed.

• When does AB 130 become effective: July 1, 2025.
• Does AB 130 apply retroactively?  In many ways, yes.  The requirements apply to existing and newly created mortgages or deeds of trust that were subordinate at the time the loan was created.  If your loan was created in a first lien position and you later agreed to subordinate it to another lien, this law would arguably not apply.  On the flip side, if you originated a subordinate lien that is now in first position, the loan would still be a subordinate lien subject to AB 130.
• Does AB 130 only apply to consumer loans?  Unfortunately, not.  AB 130 applies to all subordinate loans secured by residential property, regardless of the number of units (1-4 and 5 and over) or the nature of the loan (i.e., business purpose loans are still covered).
• Does the law protect successors to the borrower?  Shockingly, yes.  AB 130 relies on the definition of borrower found in Civil Code 2929.5(e)(1), which includes a successor-in-interest to the original borrower.
• Does the law apply to subordinate loans to entities (as opposed to natural persons)?  Again, AB 130 relies on the definition of borrower found in Section 2929.5(e)(1), which includes borrowing entities.
• Does the new law apply to HOA liens (which are almost always subordinate)?  No.  HOA liens do not fit within the definition of borrower.
• Does the new law apply to subordinate seller carry-backs?  Yes, under the definition of borrower.
• Does the new law apply to subordinate reverse mortgages?  Yes.  Most reverse mortgages are in 1^st lien position.  However, if the reverse mortgage is guaranteed by HUD, HUD usually records a 2^nd lien behind the lender’s DOT.  It appears that AB 130 would apply to HUD if it tries to enforce its 2^nd lien.  It should be fun to see how HUD handles that when it becomes an issue.
• Exactly what conduct does AB 130 prohibit?  AB 130 is now codified into Civil Code Section 2924.13.  Subsection (b) provides that the following conduct constitutes an “unlawful practice” in connection to a subordinate lien:
• The servicer (including all prior servicers) did not provide the borrower with any written communication for at least 3 years;
• The servicer failed to provide a servicing transfer notice that was required by law;
• The servicer failed to provide an ownership transfer notice that was required by law;
• The servicer conducted or threatened to conduct a foreclosure sale after providing a “form” to the borrower indicating that the debt had been written off or discharged, including, but not limited to, an IRS 1099;
• The servicer conducted or threatened to conduct a foreclosure sale after the applicable statute of limitations expired; and
• The servicer failed to provide a periodic statement that was required by law, investor, or guarantor requirements.
• What if monthly statements were not required by law?  Section 2924.13(b)(6) identifies as unlawful conduct, the failure to send monthly statements that are required by law, the investor or guarantor requirements.  The law on whether monthly statements are required by law is complex and depends on items like – what law was in effect at the time the statement would have been sent, whether the loan was charged off or not, whether the loan was a HELOC or a non-TILA loan or whether you are a small or large servicer, whether it’s a consumer vs. business purpose loan, whether the borrower was in bankruptcy, among other variables.  If none of the other actions identified as “unlawful conduct” apply and you intend to argue that monthly statements were not required, we recommend discussing the specific circumstances for that loan with your counsel.
• Can a servicer do any collections on subordinate loans?   Yes, but, be careful. Section 2924.13(c) prohibits the servicer from “threatening” to non-judicially foreclose a subordinate security instrument without first recording the newly required Certification (discussed below) “simultaneously” with the Notice of Default.  The statute’s language does not appear to prohibit a servicer from declaring the loan in default, accelerating the loan, issuing reinstatement or payoff demands, etc., so long as the servicer does not “threaten” foreclosure.  Servicers choosing to proceed with normal, non-threatening, collection activity will need to revise their collection letters and training policies to avoid anything that could be deemed to “threaten” foreclosure.
• What about sending the borrower a notice of intent to foreclose (NOI), which is required by many DOTs?  This is a tough one.  The entire purpose of the NOI is to tell the borrower that the lender intends to foreclose.  As a result, the NOI, by definition, threatens to foreclose.  But, if your DOT requires a NOI, the lender has no choice but to send it.  If there is a challenge, we would like to think that a court would hold a lender accountable for sending a contractually required NOT.  But, we will see how the court’s come down on this issue.
• Is it ok to send Payoff or Reinstatement Demands on subordinate loans?  So long as the servicer does not threaten to foreclose non-judicially, AB 130 does not appear to prohibit servicers from issuing payoff or reinstatement demands or collecting and applying funds.
• Can a servicer enter into a modification, extension, or forbearance on a subordinate lien?  As discussed above, AB 130 does not appear to prohibit basic collection activity provided that the servicer does not threaten to foreclose non-judicially.  Accordingly, a servicer should be able to enter into a loan modification, forbearance, or extension with a willing borrower.  In doing so, the servicer should consult with counsel on whether to also include a release and waiver of claims by the borrower, including claims under AB 130.  Such a waiver may be enforceable, if done properly and in exchange for consideration.
• What is the new Certification that must be recorded with the NOD?   Simultaneously with recording the NOD to commence non-judicial foreclosure, the servicer must now record a Certification, signed under penalty of perjury that either:
• The servicer (defined to include prior servicers) did not engage in an unlawful practice as described in subdivision (b); or
• The servicer lists all instances when it committed an unlawful practice.
• Why would a servicer ever admit to committing an unlawful practice?  In most instances, the servicer would likely be better off just not foreclosing than recording a Certification admitting to unlawful practices.  However, there could be rare situations where the violation is so minor and appropriate accommodations are made, i.e., waiving interest, crediting a statutory fine, etc., that the servicer may decide to list the error(s) and proceed with foreclosure.  Before taking this path, we strongly recommend consulting with your counsel.
• Other than the Certification, are there other notice requirements under AB 130?  Yes, section 2924.13(c)(2), requires that the servicer send the borrower notice with the NOD indicating that:
• If the borrower believes the servicer (again, including the prior servicers) engaged in an unlawful practice or misrepresented its compliance history, the borrower may petition the court for relief before the foreclosure sale; and
• A copy of the Certification.
• What should I do with my pending foreclosure?  Generally, new laws are not retroactive.  However, AB 130 appears to have a retroactive effect.  Subsection (c) provides that a lender shall not “conduct” a non-judicial foreclosure without simultaneously recording the Certification with the NOD.  But, in many instances, the NOD was recorded before AB 130 took effect, making it impossible to record the Certification “simultaneously” with the NOD.  This leaves the lender with three options:
• Rescind and re-record the NOD with the Certification.  Safest approach.
• Record the Certification with the NOS or before going to sale, intending to argue that, because the new law was not in effect at the time the NOD recorded, strict compliance was impossible; and that the lender substantially complied by recording the Certification before going to sale.  Risky, but the argument could work.
• Wait to see if the law is enjoined or deemed unconstitutional.  The CMA, coupled with several other industry groups including the CMBA, UTA, CBA and Credit Unions, as well as (hopefully) some impacted investors plan to sue the State to enjoin implementation of the subordinate mortgage provisions of AB 130 on the grounds that the statute is unconstitutional.  Servicers may want to wait to rescind their NOD until seeing how the lawsuit goes.  But note – even if the court enjoins implementation of AB 130, servicers should consult with counsel before proceeding to foreclosure as doing so could expose the servicer to liability if the statute is ultimately deemed constitutional.
• If the Borrower files suit, is the TRO automatic?  Traditionally, to enjoin a foreclosure sale, borrowers must show, among other things, that they are more likely than not going to prevail on their legal claims.  Section 2924.13(d) appears to make an injunction mandatory if the borrower files suit – “Upon a borrower’s petition …, the court shall enjoin” the foreclosure until a final determination on the petition is made.  While this language appears to make granting a TRO mandatory, subsection (f) also gives the court the right to fashion any equity remedy that it sees fit, which arguably could include dissolving a TRO or denying a preliminary injunction.  The key will be to educate the court on its options as borrower’s counsel will undoubtedly point to the apparent mandatory language.
• Can the borrower set aside a foreclosure sale that violates AB 130?  Section 2924.13(g) gives the borrower the right to petition to set aside the foreclosure sale if the servicer (including prior servicers) failed to record the Certification, engaged in an unlawful practice, or misrepresented its compliance history.  While the borrower clearly has the right to sue, the statute does not require the court to set aside a completed foreclosure sale.  As a result, there appears to be the ability to argue that the statutory violation did not damage the borrower and should not warrant setting aside the foreclosure sale, especially when coupled with the court’s equitable powers under subsection (f).
• Can the borrower set aside a sale to a 3^rd party bona fide purchaser?  No.  Subsection (h) specifically states that nothing in AB 130 will affect the validity of a sale to a bona fide purchaser.  Presumably, that would apply to a sale to a BFP at the foreclosure sale, via the post-foreclosure auction process or an REO sale.  Note – if you took back a property following your subordinate loan foreclosure, either as an REO or to use as a rental property, you may want to consider selling it to a BFP sooner rather than later.
• What about a non-judicial foreclosure sale to a non-BFP?  Oddly, Subsection (h) also states a violation of AB 130 “shall not affect the validity of a trustee’s sale …”.  This language appears to directly conflict with Subsection (g), which gives the borrower the right to petition to set aside a trustee’s sale that violates AB 130.  It will be interesting to see how the court’s come down on these obviously conflicting provisions.
• What is the risk if I just foreclose and take my chances?  If a court sides with the lender, finding that Subsection (h) controls and the sale cannot be set aside, the foreclosing lender may still have exposure.  Arguably, a borrower could sue for damages under Business & Professions Section 17200 for unlawful business practices related to any “unlawful practices” under Subsection (c).  In addition, a borrower could argue that a violation of AB 130 is akin to a violation of Civil Code 2924 et. seq. (CA’s foreclosure statute) and, therefore, gives rise to a wrongful foreclosure claim.  There are some counter arguments to a damages claim under these theories.  We strongly encourage servicers to discuss the risks with going to sale with their counsel before taking the associated risk.
• What if the foreclosure sale was completed before July 1, 2025?  Subsection (g) appears to give the borrower the right to challenge even completed sales that did violate provisions of the law that were not yet even required.  For example, a borrower could sue to set aside a sale where the servicer did not record the Certification because the requirement did not even exist at the time the foreclosure was completed.  We plan to vigorously defend any challenge under AB 130 to a sale that was completed prior to July 1^st.
• What should I do if the 1^st is about to foreclose and wipe out the subordinate lien?  Unfortunately, the new law will create many situations where the subordinate lienholder cannot foreclose, even though it is facing an imminent senior lien foreclosure.  While the subordinate lienholder could payoff or reinstate the senior lien, doing so is risky if the subordinate lien cannot ultimately be foreclosed upon.  As an alternative, the subordinate lienholder may want to consider trying to buy the senior lien, stepping into the senior lien’s shoes.  While expensive, it will avoid the challenges created by AB 130.
• Is the new law preempted by Federal Law?  Small parts may be, but unfortunately, the entire law is unlikely to be preempted by federal law.
• Can I just foreclose judicially to avoid this mess?  Unfortunately, not. The same list of unlawful practices can be used as a defense to a judicial foreclosure action.
• Is there any way to overturn this madness?  Yes, the California Mortgage Association is working with several other organizations and impacted investors to sue the State of California on the grounds that the new law is unconstitutional.  Upon filing suit, we plan to seek an injunction on the implementation and enforcement of AB 130 pending the litigation.  Please contact Robert Finlay at rfinlay@wrightlegal.net if you would like to contribute to litigation.

Disclaimer: The above information is intended for information purposes alone and is not intended as legal advice.  Please consult with counsel before taking any steps in reliance on any of the information contained herein.

T. Robert Finlay, Esq. is CMA General Counsel and a founding partner at Wright, Finlay & Zak, LLP. He can be reached at rfinlay@wrightlegal.net.