Business Law by Tom Ramsey

Bad Faith Waste On Real EstateTom Ramsey - Business Law

September 11th – Generally, one who finances the purchase price for real property gives little thought to whether the lender will be upset about the purchaser/borrower’s efforts to alter the improvements on the property.

As will be seen below, the lender’s interest in post-purchase activities can be very important. In 2005, New Faze Holdings and another entity purchased improved real property located in Sacramento from the Fait Trust. The purchase price was $525,000.00. The balance after a 10% down payment was evidenced by a secured note in favor of the Fait Trust.

At the time of the purchase, the improvements consisted of a building housing two tenants. The building was in usable condition.

New Faze envisioned redeveloping the property, which would require termination of the existing tenancies and the demolition of the existing improvements.

Although the demolition took place, the new construction never commenced. Subsequently, the taxes were not paid and New Faze defaulted on the note.

In 2009, the note holders purchased the property at a private foreclosure sale (no court involvement) for $14,097.

Next, the note holders sued New Faze and others for bad faith waste and intentional and negligent impairment of security (the real property) by demolishing the improvements and by failing to pay the taxes against the property. In response, the defendants argued that they did not intend to harm the property and did not act maliciously or recklessly by demolishing the improvements. Their activities were based on their good faith belief that the property could be developed into a legitimate mixed use commercial project.

The defendants moved the trial court for a summary judgment (asking the court to rule in their favor, short of a trial, based on the facts before the court). The holders of the note responded by asserting that their claim of “bad faith” was based on the fact that the demolition of the building was intentional and not primarily or solely as a result of economic pressures of a market depression. Had it been the latter, there would have been no bad faith. The trial court found that defendants’ conduct in demolishing the building was not reckless, intentional despoilment or malicious. The demolition was based on a good faith belief that the property could be developed. With one exception, the trial court found in favor of the defendants. The only claim remaining was based on the defendant’s failure to pay taxes on the property.

The note holders appealed.

The Court of Appeal reviewed the rules prohibiting a deficiency judgment by the holder of a promissory note signed by the purchaser of real property which is secured by a trust deed against the property. In general, the holder of such a note cannot obtain a deficiency judgment against the purchaser when the proceeds of a private foreclosure sale by the note holder do not cover the balance due on the note. With that in mind, the ability of the note holder to sue the purchaser for waste must not amount to an end run around the antideficiency law in California: Here, the waste committed must amount to “bad faith waste.”

The applicability of such a concept is as follows: If the value of the property is decreased due to the economic pressures of a market depression, the lender has no claim against the purchaser based on bad faith waste. If, on the other hand, the conduct of the purchaser is not solely or primarily a result of the economic pressures of a market depression, then damages can be assessed.

Unfortunately, the trial court never determined the reason for the decrease in the value of the property. For example, the note holders could obtain damages against New Faze if it demolished the improvements before it had the financial means to complete the development. The purchasers are liable for a fall in value of the security (the property) for such acts. On the other hand, if New Faze could show that the demolition was the result of economic pressures of a market depression, they could prevail.

The judgment of the trial court was reversed and the case was remanded (returned) to the trial court for a full blown trial.

(Tom Ramsey is a Long Beach attorney who has specialized in business law for more than 40 years. He may be reached at bizlawwiz@aol.com.)