by John L. Hosack, Esq. & Joffrey Long

The delays are over. Your foreclosure is going to sale. The total amount due on your loan (a first trust deed) is $575,000. The value of the property is $500,000. Would you open the bidding at $575,000? Many would – but it could be a mistake. A surprisingly large number of loan servicers, lenders, even major banks – would open their bidding at $575,000, unaware of potential problems in making the full credit bid.

Or, the other challenge: The lender/servicer who is owed $575,000, does not make a full credit bid, but opens the bidding at a minimal sum, such as $5,000, an amount having no relationship to the equity being auctioned.

There could be problems with either approach. The good news; some of the problems can be avoided with relatively simple procedures.

Full Credit Bids – The Problem:

After loaning money, not getting your payments, then going through all the difficulty and expense to finally get to a trustees sale, opening the bidding at any amount less than what we’re owed may be contrary to our thinking.

At a trustees sale, any amount that you “receive” at the sale, (even if it is received in the form of collateral reverting to you as a result of your credit bid) is deducted from the amount that you are owed.

If $575,000 is the total of your principal and accrued interest, late charges and other fees and costs, you set your opening bid at $575,000, there are no other bidders and the property reverts to you for your $575,000 bid, (a “full credit bid”) you’re deemed to have been “paid in full.”

Even if the property that you foreclosed on is worth less, for example, only $300,000, because you bid the full amount owed to you, you’re still seen as having “received” the “full payoff,” (a bid that matched your required minimum bid) which may affect you where there are other amounts/methods of collecting funds.

The other amounts that you might collect could include insurance proceeds in the event of a loss at the property, proceeds from rents, personal property, or payments from any guarantor. Although there is some case law limiting their ability to deny claims on this basis, title insurers have pointed to the full credit bid in denying an insured’s claim. If you have been the “successful” bidder, by virtue of your full credit bid, you may provide title companies, hazard insurance companies, guarantors, and anyone else from whom you intend to pursue recovery of losses, an opportunity to point to the fact that you were already “paid in full,” because the bidder at the sale (you) paid the full amount due. (your full credit bid).

If you had opened the bidding at a lower figure, and the highest amount bid by a third-party bidder was $399,000, then you bid $400,000 and acquired the property, you have now preserved $175,000 ($575,000 debt less $400,000 “received” from the bid) for a potentially recoverable loss of $175,000.

It’s easier to understand if you separate the two, underlying, and somewhat different concepts at work here: One, the process of non-judicial foreclosure, where a trustees sale is used to force an auction and possible recovery of the collateral. The other concept, the debt owed to you, less any amounts you “have been paid,” functions somewhat independently from the trustees sale procedure. Under the second concept of how much debt is owed to you and how much you’ve already received in “payments,” a bid at a trustees sale, (even if it was your credit bid) is seen as a “payment” against the balance you are owed, regardless of the value of what you acquired in exchange for your bid.

The Other Problem – “Minimal Opening Bids”

When opening their bidding, some lenders/servicers instruct the trustee to open the bidding with a “minimal opening bid,” or a bid sufficiently low so as to have no relationship to the value of the property or the equity being sold at the trustee’s sale, such as an opening bid of $2,000 on our $500,000 property.

Although starting with a lower (but realistic) opening bid is part of a possible bidding strategy, there is a challenge with bids that are unrelated to the value of the equity/property being sold at auction. The “Restatement of the Law-Property Mortgages” (Fn1) states that if it is determined there were any irregularities with the sale, and the opening bid was for less than 20% of the equity being auctioned, a court may invalidate the foreclosure sale. Opening your bidding at a minimum of 20% of the equity being auctioned may create some protection for a beneficiary in the event an irregularity with the sale is later discovered.

Strategies to consider:

First, consult with qualified counsel when foreclosing, and when determining and carrying out your foreclosure and bidding strategy. The original structure and present circumstances of your note(s) and trust deed(s), the borrower(s), the investor or beneficiaries, and your specific business operation, among other factors, may vary greatly.

In the case referenced above, the total balance of all amounts due on the note was $575,000 and the property value was $500,000. You could consider opening the bidding at $100,000. (20% of the equity of $500,000 being sold at the auction) Should there be overbids (bids in amounts higher than your opening bid of $100,000) then your credit bid would be increased in small increments ($2,000, for example) until either:

  1. The bidding reached an amount acceptable to you, in which case you would stop increasing your bid, and allow the satisfactory bidder to acquire the property
  2. You acquire the property
  3. Or, in the event the bidding by a third party did reach an amount equal to, or greater than the total you are owed, you allow that bidder to acquire the collateral

In our example of the $500,000 house, you may determine that any sale at the auction at an amount of $420,000 or more is better than acquiring the real estate. This is another possible advantage in a less than full credit bid. In a good real estate market, there may be surprisingly high bids at the trustees sale, making it a possible opportunity to get “cashed out” quickly without acquiring, holding, repairing and marketing the property. If, for example, $420,000 was a satisfactory price at the sale, you would keep increasing your bidding until the bidding reached $420,000, the $420,000 bidder would acquire the property, you would receive $420,000 (less trustees sale/foreclosure expenses) and you would have preserved the sum of $155,000 ($575,000 amount owed, less $420,000 amount received) to potentially collect from other sources, should those exist.

This requires someone to actually bid at the trustees sale on your behalf. Some lenders/servicers instruct the trustee to bid on their behalf at the auction. The reality of this is that it isn’t the trustee, but the posting and publishing company who conducts the trustees sale. You may want to consider if you prefer to send your own representative to the sale or your level of confidence in having a posting and publishing company auctioneer bid on your behalf.

A procedure for setting your credit bids might look like this:

  1. Take the market value (Fn2) of the secured property and subtract any senior liens.
  2. Determine the equity being transferred at the foreclosure auction.
  3. Calculate 20% of the equity being transferred as a minimum opening bid.
  4. Determine who will actually bid on your behalf and instruct them as to how to bid.
  5. If you or your representative are going to bid at the sale, you may consider contacting the trustee before the sale, letting them know you or your representative will be bidding on behalf of the beneficiary, and then notify the auctioneer upon your arrival that you (or your representative) are present and that you will be bidding.

Also critical, any manner in which you instruct the trustee to bid, (full credit bid or less than full credit bid) could be challenged by your investors. Again, check with qualified counsel. You may have provisions in your loan servicing agreement that cover this and may consider obtaining investor authorization to proceed.

Fn 1: The “Restatement of the Law-Property Mortgages is a scholarly treatise published by The American Law Institute that is highly regarded and often followed by the courts. (American Law Institute Publishers, 1997)

Fn 2: In determining the market value of the property, remember that any appraisals you order could be discoverable in litigation with the borrower, an investor, or other parties to the transaction. Having your attorney order the appraisal and then sharing information with you keeps the appraisal under the “attorney-client” privilege, making it generally nondiscoverable by other parties.

Fn 3: In cases where a right of redemption exists, (including, but not necessarily limited to Internal Revenue Service liens) this may factor into your bidding strategy, to the extent that certain creditors may be able to “buy out” your interest for the amount that you paid.

This article is an updated version of a similar article published in Points of Interest in Spring, 2009. It has been edited / updated for current publication. Nothing in this article represents a standard of care for the industry or recommends any specific procedures to be followed. The article is general in nature and is only for consideration, but may not apply to numerous specific loan, borrower, lender/investor, loan servicer, or foreclosure circumstances.

John L. Hosack is an attorney with Buchalter in Los Angeles and was designated a “Super Lawyer” from 2006 to 2017, by Los Angeles Magazine. He can be reached at Jhosack@buchalter.com.

Joffrey Long is President of Southwest Mortgage, a Member of the CMA Board of Directors, the CMA Education Committee, and is a CMA Past President / Past Education Chair. Joffrey also serves as an expert witness in mortgage origination and loan servicing related litigation matters. He can be reached at Joffrey@asksw.com or at www.MortgageExpertWitness.net.