Points of Interest Spring 2019 Page 33 reasonable, the Agreement should also include the payment terms, the purpose of the loan, and the allowable amount of fees and other charges. The agreement is subject to the covenant of good faith and fair dealing implied in every contract in California. Whenasellerwhoprovidesfinancingagrees to subordinate to a later construction loan, the requirements for certainty are even morestringent. Absentsufficientspecificity, courts may not specifically enforce an executory agreement of the seller to later subordinate. The reasons for this relate to therisktowhichtheseller’slienisexposed. Prior to completion of construction, the property is over-encumbered since its value without improvements will be less than the total amount of the loans. If the borrower defaults on its construction obligations, sellers generally cannot take over and complete construction or make paymentsontheconstructionloaninorder to avoid foreclosure of the construction loan. Also, although a seller financier who subordinates to a construction loan can pursue a borrower post-foreclosure (an exceptiontothepurchasemoneyloananti- deficiency restriction), the borrower may not have sufficient assets to make pursuit of the deficiency worthwhile. Thus, the courts have required more specificity for specificperformanceofaseller’sexecutory agreementtosubordinatetoaconstruction loan,especiallyasagainstunsophisticated sellers. In general, the courts have looked to the entire circumstances of the financing, the seller’s risk and the seller’s understanding of the risk. Thus cases, considering different circumstance have required 1) even greater specificity as to loan terms, e.g. minimum and maximum repaymentterm;2)maximumloantovalue orconstructioncostratios;3)arequirement that the construction loan funds only be used for construction purposes or for other specific uses; 4) a description of the improvementstobebuiltontheproperty; 5) a requirement that the construction lender be obligated to give the seller notice and opportunity to cure all defaults on the construction loan; and 6) a firm commitment for permanent financing as a condition precedent to subordinating andthetermsofthatpermanentfinancing. Thesellermayalsowanttorequirethatthe buyer/borrower post a completion bond. Thecourtsaregenerallynotasdemanding in the requirements for certainty in Subordination Agreements for other (non- construction) purchase assistance loans and specific performance may be granted where there is less specificity. It is generally advisable that the form of SubordinationAgreementthatwillbelater executed be attached to the executory agreement as an exhibit. Executed Subordination Agreement Executed subordination refers to the statuswhenbothdeedsoftrusthavebeen recorded. Thelegalquestionraisedisasto theeffectofthetermsoftheSubordination Agreement previously entered into between the subordinating lienholder and the borrower. If the terms of the loan that acquired priority as a result of the subordination (e.g. the construction loan) donotmeetthetermsoftheSubordination Agreement and those terms are known to the construction lender, the construction lendercanlosepriorityundercontractlaw as stated above or based on lack of bona fide encumbrancer status. Automatic Subordination Agreement Anothertypeofsubordination,sometimes described as executory and sometimes as executed,isthe“automaticsubordination.” This may be in a separate agreement, a purchase and sale agreement with seller financing or in a deed of trust. The provision states that the lien of the lender will automatically be subordinate to a later executed deed of trust without any further action on the part of the subordinating lienholder. Automatic Subordination Agreements are disfavored by institutional lenders (who will not rely on them to assure priority of their later- createdDeedofTrust)andtitlecompanies (who will not rely on them to insure the priority of the later-created Deed of Trust). Those entities will generally require that a separate Subordination Agreement specificallydescribingthesubsequentloan be recorded at the time the subsequent loan is recorded. The form often used for this is the California Land Title Association SubordinationAgreementthatisfoundon many title companies’ websites. It is noted that “fractionalized” notes and deeds of trust issued in private loan transactions involving multiple investors cannot contain automatic subordination clauses. California Business & Professions Code Section 10238(d). Requirements for Subordination Agreements Involving Loans Under $25,000 Californialaw,inCivilCodeSections2953.1- 2953.5, contain special requirements for Subordination Agreements if either the subordinating lien or the lien acquiring priority is less than $25,000. These requirementsgotorequiredlanguage,font sizes and notices. Covered Subordination Agreements that do not meet these requirements are voidable as specified in the statute. While the statutory language is only required for those under $25,000, it is not uncommon to see the statutory language reflected in non-covered Subordination Agreements. Circuity of Priorities Circuity of priorities is an issue faced by lenders that arises when a senior beneficiary subordinates to a junior lien in a situation where there are intervening junior liens. This issue might arise, for example when lenders who make second mortgages or equity lines are asked to subordinate their liens to later refinance liens. The issue is demonstrated when there are three liens on a property, A, the first, B, the second and C, the third. If A subordinates to C, what are the relative Priority of Liens – continued from page 32