Of the inquiries we receive, I believe one of the more common questions starts something like this:
“I am a tenant renting a home, and today I received a notice from the bank that they are going to foreclose on the house. What is going to happen?”
The answer is a mixed bag of good and bad. At this point, a little background is important.
What Happens to My Lease?
In California, a lease of any kind is considered an “estate” or interest in real property. Even a month-to-month lease is a leasehold interest in the property the tenant is renting. The tenant’s leasehold interest, however, is subject to all of the other interests in that property that proceed the lease. For most property in California, the single largest interest that precedes the lease is going to be the property owner’s mortgage. Technically, it is a “Deed of Trust” that secures the loan the property owner used to purchase or refinance the property. As such, when the homeowner fails to pay the mortgage, and the bank elects to foreclose the home, that foreclosure wipes-out or terminates all other interests in the property. Most importantly, a foreclosure terminates the tenant’s lease.
Upon the conclusion of the foreclosure sale, (for this discussion, we’ll assume that the bank has purchased the property at sale), the bank now owns the home free and clear of the tenant’s lease. However, the tenant is still in possession of the property. Under California law, the bank may now give the tenant sixty days notice to “quit” or leave the property if they do not want the tenant to remain in possession. Cal. Code of Civil Procedure §1161a. Alternatively, if the bank desires to do so, they can begin accepting rent from the tenant, and the tenant now has what is referred to as a “tenancy-at-will” which can also be terminated on sixty days notice. My experience thus far with persons who find themselves tenants in a bank-owned property is that the bank generally will not accept rent, but will immediately serve the tenant with a sixty day notice to quit the property. A tenant should understand that in no event after a foreclosure (absent a new lease with the bank) will they ever have a guarantee of more than sixty day’s notice that they must move. For many, this is a very stressful and tenuous time.
A new wrinkle was added to this recently with the enactment of legislation at the Federal level. The president signed into law on May 20, 2009 Senate Bill 896, a portion of which is entitled the “Protecting Tenants at Foreclosure Act of 2009.” This bill provides, in part, that termination of a tenancy upon foreclosure now requires 90 days notice. There has not yet been a test of this new law, and it contains many exceptions, including situations where State law may provide more protection for the tenant (not the case in California); where the lease is not a bona-fide, arms-length transaction. I have seen thus far at least one law firm in California representing Freddie Mac who has provided a homeowner with a sixty day, not ninety day notice post-foreclosure in spite of this new law.
The good news, if there is any in all of this, is that some banks are now treating the innocent tenants with a bit more dignity and respect than in the early days of this foreclosure crisis. It is not uncommon now for a bank, shortly after serving a sixty day notice, to offer the tenant one of two additional options beyond just moving away in sixty days. The first option is often referred to as “cash for keys,” or in the bank’s vernacular, “relocation assistance.” In this scenario, the bank will give the sixty day notice to leave, but then offer the tenant money if they will leave earlier than the sixty days and leave the property in good condition. From the bank’s perspective, they are simply buying some time (getting the property back sooner), avoiding possible legal fees to evict the tenant after the notice is up and (hopefully) ensuring that the property is left in reasonably good condition and no fixtures are stolen by an angry tenant. From a tenant’s perspective, this can be a potential windfall, as some offers I have reviewed offered as much as $5,000 for a tenant to leave within thirty days of being served with the sixty day notice. Its important to note that (1) the banks are under NO legal obligation to make this offer, and (2) there is no way to predict or know if or how much of an offer will be made.
The second possible option, short of simply having to move after sixty days, is that the bank may offer to enter into a new month-to-month lease with the tenant. This offer is subject to negotiation of appropriate lease terms, and offers the tenant only limited protection from future eviction, as the bank now will have the right to terminate the tenancy again on sixty days notice. Further, these lease agreements will generally require that the property be inspected prior to entering into a lease, that there are no code violations or other problems with the property, that the tenant can prove that they are financially capable of making the rent payments to the bank, that the tenant keep the home in clean and presentable condition, and that the tenant agrees to make the home available for open houses, appraisals, inspections, showings and cooperate otherwise with the listing broker. The window for accepting either of these offers is generally pretty short — in many cases only 10 days, so it is important to respond quickly when a tenant receives these notices.
Now, the next question that comes up is what about the landlord — does he get off scott-free? The answer is “sort of.”
Tenants often question the landlord and what s/he has done that that led to the property being foreclosed. “I paid my rent, but the landlord just pocketed the cash, and didn’t pay the mortgage.” Civil Code § 890 addresses something known as “rent skimming” in California. The act of rent skimming is technically defined as a property owner who, in the first year of ownership of the property, collects rent but does not pay that amount towards the mortgage(s) on the property. Additionally, rent skimming includes a person who collects rent from a property that they do not own. This later scam was really popular in the last foreclosure crisis in the early ‘90s. Civil Code § 891 goes on to provide that the holder of the mortgage and a tenant may bring an action for damages for acts of rent skimming, as defined in § 890. Civil Code § 892 provides that multiple acts of rent skimming can be prosecuted as a crime.
The difficulty with the rent-skimming statute presently on the books is that it only addresses rents collected during the first year of ownership. If the landlord has owned the property more than one year, and then stops paying the mortgage, but collects rent, then s/he is not liable for rent skimming, and shall have no civil liability to the tenant. Further, if the landlord was paying all rent collected to the mortgage company, but it simply was not enough to service the debt, then s/he is also not liable for rent skimming.
Security Deposits and Rent.
While the landlord may get off without any liability for skimming rent, but not within the narrow definition of the statute, s/he is not so lucky when it comes to the security deposit and pro-rated rent after the foreclosure sale. As discussed above, the landlord will no longer own the property upon the foreclosure sale conclusion. Assuming the bank did not conduct its foreclosure sale on the last day of the month, then the tenant is entitled to reimbursement of pro-rated rent for the days that the landlord no longer owned the property. By way of example, if the tenant paid rent to the landlord for the month of July, but the property was foreclosed by the bank on July 15th, then the landlord must refund the tenant 1/2 of that month’s rent. The reason the rent must be refunded is simple — the landlord did not own the property the entire month, and therefore is not legally entitled to collect rent for the entire month. That would then become actionable rent skimming under the portion of Civil Code § 890 that deals with collecting rent for a property the landlord does not own.
In addition to the refund of any rent collected but not earned, the landlord is still holding the tenant’s security deposit and as such, must return the security deposit within 21 days of the foreclosure sale, or pay it over to the new owner — the bank. As the landlord will almost never turn the security deposit over to the bank, they themselves are still responsible under the provisions of Cal. Civil Code § 1950.5. As described above, the landlord upon transfer of title (be it by sale or involuntary means such as foreclosure), the landlord must either turn the security deposit over to the new owner, or must refund it to the tenant. There is a provision in this part of the code that seems to indicate that the landlord can lawfully make deductions from the security deposit for damages allowed under § 1950.5, however, I believe that there is a very strong argument to be made that in the case of a foreclosure, the landlord is not entitled to take any deductions, with the possible exception of unpaid rent and unreturned personal property, from the security deposit.
Civil Code § 1950.5 is an effort to balance the need of the landlord to have some security for the repayment of costs associated with repairing damage caused by a tenant and unpaid rent, with the tenant’s right not to be charged additional “hidden” fees and costs, such as non-refundable deposits. Toward that end, the legislature limited the landlord in what they may lawfully deduct from a security deposit. Sections 1950.5(b)(1-4) provide that the landlord may only claim from the security deposit those amounts reasonably necessary to reimburse the landlord for a tenant’s default of rent, damages to the property that exceed normal wear & tear, cleaning of the property to restore it to the condition in which it was rented to the tenant and for future defaults by the tenant in any obligation to replace, restore or return personal property provided for under the lease. In subsection (h) of 1950.5, the code allows the landlord to deduct from the security deposit the foregoing amounts at the time of a transfer of the property to another owner. Presumably, this is to compensate the landlord for the reduced price s/he may have received in the sale of the property due to damages or unpaid rent. In the case of a foreclosure, however, there is no such off-setting credit, and I believe a very strong argument can be made that no such deduction is appropriate by the landlord, with the exception of the first and last provisions — unpaid rent through the foreclosure date, and/or return of personal property. Compensation to the landlord losing the property in foreclosure for damages to the property and/or cleaning simply don’t make any sense, and though I could find no reported cases on point, I believe most Courts would rule in favor of a tenant seeking full and complete refund of their security deposit from a landlord.
Finally, if the tenant had a term lease — something other than a month-to-month lease, and that lease is cut short by virtue of the bank’s foreclosure, then the tenant would likely have a claim against the landlord for breach of the lease, and further, for breach of the covenant of quiet enjoyment. Damages for such claims would have to be analyzed on a case-by-case basis. Further, tenants have to analyze the cost versus the benefit of pursuing an individual who may well be insolvent as a result of whatever economic force caused them to default on their mortgage to begin with.
David L. Gibbs is an attorney with The Gibbs Law firm, APC. The firm’s practice focuses on issues related to Bankruptcy, Business Law and Manufactured Housing; including community subdivision, pre-purchase diligence and analysis as well as advising community owners on operational, financial and enforcement issues. The firm also represents manufactured home dealers in a wide range of issues. David L. Gibbs is admitted to the Federal Courts for the Central and Southern District of California, and also holds a California real estate broker’s license. The firm continues to offer a wide range of real estate and business related services as it has done for 34 years from its offices in San Clemente. Mr. Gibbs can be reached at (949) 492-3350.