Secured Guaranties and Third Party Deeds of Trust 2010

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OFFICIAL PUBLICATION OF THE REAL PROPERTY LAW SECTION STATE BAR OF CALIFORNIA

Vol. 28, No. 3, 2010 www.calbar.ca.gov/rpsection

DISTRIBUTED AT NO EXTRA CHARGE TO MEMBERS OFTHE REAL PROPERTY LAW SECTION OF THE STATE BAR OF CALIFORNIA

The statements and opinions herein are those of the contributors and not necessarily those of the State Bar of

California, the Real Property Law Section, or any government body.

California Real Property Journal

Secured Guaranties and Third Party Deeds of Trust . . . . . . . . . . . . . . . . . . . . .3By Michael T. Andrew

This article examines issues raised when a third party encumbers its real property to support credit extended to a borrower, in the form ofeither a deed of trust directly securing the borrowers obligation or a guaranty secured by a deed of trust. The article focuses on suretyshiplaw and the one-action and antideficiency rules.

California Law on Contract Zoning, Conditional Zoning, and Spot Zoning: An

Analysis of Recent Case Law and Contours of Permitting Agencies' Powers toSettle Land Use Disputes Without Contracting Away Their Police Powers . . . . 15By Mark A. Rothenberg

An explanation of unlawful contract zoning and its impact on the ability of developers and local governments to settle land use disputes.

MCLE Self-Study Article: When Real Property Can Mean Real (Prison) Time:A Brief Overview of the Federal Prosecution of Real Estate-RelatedWhite Collar Crimes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23By Jeffrey Rabkin

This article provides a broad overview of the basic statutory framework for the federal prosecution of white collar cases, briefly describesemerging trends in fraudulent real estate schemes and finally reviews several federal cases involving real estate-related crimes recently

charged in the Northern District of California.

Arbitration: Determining the Collateral Estoppel Effect of a Private ArbitrationAward On Non-Parties In Subsequent Litigation . . . . . . . . . . . . . . . . . . . . . . 33By Zachary D. Schorr

California is one of the few jurisdictions that does not recognize the collateral estoppel effect of a private arbitration award on non-partiesto the arbitration in subsequent litigation. This article discusses the nuances of the res judicata and collateral estoppel effect of privatearbitration awards on subsequent litigation.

Black Hills Revisited: Repercussions and Defenses . . . . . . . . . . . . . . . . . . . . .39By Robert Miller

The 2007 decision in Black Hills Investments, Inc., v. Albertsons , Inc. established that a purchase contract was void if it permitted eitherparty to waive a condition requiring that any portion of the subject parcel be made into a separate legal parcel prior to closing. Thisarticle explores the impact of that case in the wake of the dramatic decline in real estate prices since it was decided and how contracts canbe structured in the future to comply with the requirements of the Black Hills decision.


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Q4: WHY DOES SURETYSHIP STATUS MATTER?

A guarantor or surety has special rights and defenses underthe Civil Code. These include the right to recover from the prin-cipal obligor through reimbursement and subrogation, the rightto recover contribution from cosureties, and several rights anddefenses against the creditor.17For example, a guarantor or sure-ty has the right to require that the creditor first proceed againstthe principal obligor.18And a guarantor or surety is exonerated

by a material modification of the principal obligation to whichit does not consent, even if, in California, unlike in many states,the modification is not prejudicial to the guarantor or surety.19These rights and defenses are triggered in both of the structuresdescribed in Q1 abovethe third party deed of trust structureand the secured guaranty structurebecause in each the thirdparty is a guarantor or surety.20

Civil Code section 2856(a) broadly validates waivers by aguarantor or surety of these and all of the Civil Codes othersuretyship rights and defenses.21 That section also enables aguarantor or surety to waive any defense arising directly or indi-rectly out of the one-action or antideficiency rules, to the extentthat those defenses would be available to the guarantor or surety

because the principals obligation is secured by real property,22and to waive any defense arising by reason of any election ofremedies by the creditor.23

From the creditors standpoint, it is essential to obtain thesewaivers in any suretyship transaction. Without them, seriousadverse enforcement consequences may result. The waivers areroutinely obtained in a guaranty agreement. But if a creditor failsto recognize the suretyship status of a third party deed of trustdirectly securing the borrowers obligation, it will also likely failto obtain the waivers.

Q5: IF A THIRD PARTY DEED OF TRUST DIRECTLY

SECURES THE BORROWERS OBLIGATION, DOES

IT AFFECT THAT OBLIGATION IN ANY WAY?

Yes, significantly. When a third party encumbers its real prop-erty to secure the obligation of the borrower, that triggers applica-tion of the one-action and antideficiency rules to enforcement ofthe obligation against the borrower. The relevant statutes apply bytheir literal terms because the borrowers obligation is secured byreal property, and the statutory language (except for the purchase-money antideficiency rule) makes no distinction based upon

whether the encumbered real property is owned by the borroweror a third party.24The borrower cannot waive the one-action andantideficiency protections, at least at the outset of a transaction,25and the creditor cannot unilaterally waive the collateral.26So, as

a consequence of the third party deed of trust securing the bor-rowers debt, the creditor cannot enforce that debt as an unsecuredobligation, even if the borrower itself has provided no security.

This application of the statutes appears to have originated inthe California Supreme Courts 1912 decision in Gnarini v. Swiss

American Bank,27 in which a third party had encumbered its realproperty to secure the borrowers obligation to repay a loan. Theborrower had funds on deposit in an account at the lender bank.The lender took a setoff against the bank account to recover theloan. The court held that because the loan was secured by real prop-erty, the lenders setoff violated the security-first aspect of Code ofCivil Procedure section 726(a), and the setoff could be recovered:

[I]f a bank has mortgage security for a debt it mustexhaust that security before it can apply in reductionor cancellation of the debt any money on deposit withit belonging to the debtor.

This is the doctrine, too, where the mortgage was notgiven by the debtor himself but by a third party. Ineither case the debt is secured by mortgage, and as only

one action may be maintained to enforce a debt thussecured, it follows that the mortgage security mustbe exhausted before recourse can be had to the bankaccount or personal responsibility of the debtor. Norcan the mortgage be waived, and an action brought onthe indebtedness.28

Gnarinis security-first ruling was cited with approval by theCalifornia Supreme Court in 1990, in Security Pacific NationalBank v. Wozab,29although without specific mention of the thirdparty mortgage aspect.

The same principle has been applied when a deed of trustis provided by one of several principal obligors, thereby protect-ing even the other, non-trustor obligors. The Court of Appealso held in Pacific Valley Bank v. Schwenke30 in 1987: the one-action rule plainly applies to all notes secured by deeds of trustin California, without regard to whether the mortgagor and thedebtor are one and the same.31

In Indusco Management Corp. v. Robertson32(discussed fur-ther in Q9 below), the Court of Appeal in 1974 took the sameapproach to the antideficiency rule of Code of Civil Proceduresection 580d, which precludes recovery of a deficiency after non-

judicial foreclosure on real property securing a note. The courtconsidered section 580d to be applicable to the borrower even

when the real property collateral foreclosed upon was the third

partys, not the borrowers.It is difficult to rationalize applying the one-action andantideficiency rules to the borrower as a consequence of the thirdpartys collateralization of the debt. That point is discussed in theConcluding Comment at the end of this article, together with apossible alternative approach to the statutes. Present law, though,is as reflected in the cases above.

Consequently, a lender whose loan is directly secured bya third partys real property must proceed in enforcing its loanagainst the borrower just as if the borrower itself had providedthe real property collateral. That may well be at odds with whatthe lender intended. The lender may have obtained the thirdpartys deed of trust with the expectation that it only added to

the lenders enforcement options, taking nothing away. But thatis not the case. Assuming that the borrower itself has not alsoprovided real property collateral, the third party deed of trusteliminates the lenders ability to take such actions as setting offagainst a borrowers unpledged bank account, obtaining a money

judgment and enforcing it against other assets without judiciallyforeclosing under the deed of trust, and exercising other rem-edies denied a lender whose loan is secured by real property.33

Q6: CAN THOSE LIMITATIONS ON ENFORCEMENT

AGAINST THE BORROWER BE AVOIDED BY

USING THE ALTERNATIVE STRUCTURE OF A

SECURED GUARANTY?


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Very likely yes. If the third party executes a separate guar-anty, and the deed of trust secures that guaranty rather than theborrowers underlying obligation, then the borrowers obligationis not secured by real property (assuming that the borrower itselfhas not provided real property collateral). The limitations trig-gered by real property collateral will not apply to enforcementof the borrowers obligation.

That conclusion assumes, of course, that securing theguar-antywith real property does not somehow cause the underlyingobligation to be considered secured by that real property. Passingcomments in dicta in two California Supreme Court cases,Security Pacific National Bank v. Wozab34in 1990 and Bayless v.

Ames35in 1929, are consistent with that assumption, although,as discussed in Q7 below, those cases were focused on a differ-ent issue.36

One might argue to the contrary that a guaranty shouldbe conceived of as obligating the guarantor with the principalobligor on the underlying obligation, rather than constitutinga truly separate obligation, and therefore that security for theguaranty also effectively secures the underlying obligation. TheNevada Supreme Court took that view in a 1985 case, applying

what the court believed to be California law to conclude thatthe personal guaranties and the underlying corporate debts areto be treated as one obligation.37

However, reported California cases have very consistentlytreated guaranty and surety obligations as separate from theprincipal obligation for purposes of the one-action and antide-ficiency rules.38With the exception of a 1995 Court of Appealopinion subsequently depublished by the California SupremeCourt,39the cases uniformly reflect the view, in holding or indicta, that if a borrowers real property secures the borrowersobligation, the one-action and antideficiency rules do notdirectly protect a guarantor of that obligation.40So, conversely,it seems highly unlikely that a California court would hold that

if the guarantors real property secures the guarantors obligation,the one-action and antideficiency rules protect the borrower. Noreported California case appears to have taken the approach of,and none has mentioned, the Nevada case.41

As a result, absent a significant change in the law inCalifornia, the secured guaranty structure offers greater flexibil-ity to a lender than a third party deed of trust directly securingthe borrowers obligation, because the secured guaranty preservesmore enforcement options against the borrower. If the intent isthat the third party will have no personal liability beyond thereal property collateral, that can be accomplished by simplyincluding a non-recourse provision in the guaranty.

Q7: IN THE SECURED GUARANTY STRUCTURE, DOTHE ONE-ACTION AND ANTIDEFICIENCY RULES

APPLY TO THE THIRD PARTY?

Code of Civil Procedure section 726(a), with its one-action,security-first and one-form-of-action rules, clearly applies by itsexpress terms to a guaranty secured by real property, becauseit governs the recovery of any debt or the enforcement of anyright secured by mortgage upon real property. That was the casein Security Pacific National Bank v. Wozab,42in which a guaranty

was secured by a deed of trust. The bank took a setoff againstthe guarantors deposit account. The California Supreme Courtheld that this violated the security-first rule, which requires that

the creditor first proceed against the real property security beforeenforcing the debt personally against the borrower.

In Bayless v. Ames,43the California Supreme Court held tosimilar effect in 1929 that when a creditor obtained a judgmenton the secured guaranty, omitting the guarantors real propertycollateral from the action, the one-action rule prohibited subse-quent foreclosure. This is an application of what is referred toas the sanction aspect of the one-action rule, discussed furtherin Q8 below.44

Although section 726(a) clearly applies to a secured guar-anty, the guarantor may not be protected by the antideficiencyrule of section 580d, which normally precludes recovery of adeficiency after nonjudicial foreclosure. Unlike section 726(a),

which applies to any debt or right secured by real property,section 580d by its terms applies only to a note secured byreal property.45No reported case appears to have addressed theapplicability of section 580d to a secured guaranty in actualholding. In Union Bank v. Gradsky,46the Court of Appeal com-mented in dicta that an action on a guaranty would not con-stitute an action on a note within the meaning of section580d, even though the underlying obligation was evidenced by

a note.47

A few cases in other contexts have held section 580dinapplicable to non-note obligations.48Because of the note limitation in section 580d, a creditor

might be able to foreclose nonjudicially under a deed of trustsecuring a guaranty, then obtain a deficiency judgment againstthe guarantor. If that is the case, however, the fair-value rule ofCode of Civil Procedure section 580a clearly would apply.49Section 580a, unlike section 580d, applies to any obligationsecured by real property, not just a note. Under section 580asfair-value rule, recovery of a deficiency judgment against theguarantor would be limited to the difference between the guar-antors total obligation and the greater of the foreclosure saleprice and the propertys fair market value. In addition, under

section 580a the action must be brought within three monthsafter the foreclosure sale.

To the extent that one-action and antideficiency rules applydirectly to a guarantor by virtue of its deed of trust securing theguaranty, they are not waivable by the guarantor, just as they arenot waivable by a borrower when the underlying obligation issecured by real property.50Civil Code section 2856(a)(3), thebroad authorization of one-action and antideficiency waivers bya guarantor or surety, is by its terms inapplicable. It applies to[a]ny rights or defenses the guarantor or other surety may havebecause theprincipalsnote or other obligation is secured by realproperty.51Here it is the guaranty, not the principals obliga-tion, that is secured by real property. The normal prohibitions

on one-action and antideficiency waivers apply.

Q8: IF THE THIRD PARTYS DEED OF TRUST

DIRECTLY SECURES THE BORROWERS

OBLIGATION, RATHER THAN A SEPARATE

GUARANTY, DO THE ONE-ACTION AND

ANTIDEFICIENCY RULES BENEFIT THE THIRD

PARTY?

As discussed in Q5 above, a third party deed of trustsecuring the borrowers obligation triggers application of theone-action and antideficiency rules with respect to enforcementof the obligation against the borrower. The question here is



whether it triggers those rules only as to the borrower, or as tothe third party as well.

To the extent that the one-action and antideficiency rulesprohibit or limit a deficiency judgment, they are simply moot

with respect to the third party in this context. When the thirdparty has given only a deed of trust to secure the borrowersobligation, the third party has not undertaken any liability fora deficiency.52As a result, regardless of one-action or antidefi-ciency rules, and regardless of whether foreclosure is judicial ornonjudicial, the creditor cannot recover a deficiency judgmentagainst the third party.

However, there are some ways in which a third party mightargue that the one-action or security-first rules of Code of CivilProcedure section 726(a) impact the enforceability of its deed oftrust, directly or indirectly.

One possibility arises out of the one-action rules sanctionaspect, mentioned in Q7 above. If a creditor sues the borroweron a debt secured by real property and omits from that actionany real property security for the debt, the borrower can assertthe one-action rule as a defense and require that the creditorinclude the real property in the action. That is the rules affir-

mative defense aspect. But if the borrower does not assert thedefense and the creditor obtains a judgment on the debt, therules sanction aspect is triggered. At least when the encum-bered real property is the borrowers, the sanction aspect extin-guishes the creditors lien on the omitted real property.53

InMurphy v. Hellman Commercial Trust & Savings Bank,54the Court of Appeal in 1919 held that a different result fol-lows when the real property securing the borrowers obligationis a third partys, rather than the borrowers own. Even thoughthe creditor had obtained a judgment on the debt against theborrower, the court held that the third partys deed of trustremained enforceable. The court considered this situation to begoverned by the broader principle, referred to in Q6 above, that

a guarantor or surety does not directly benefit from the one-action rule by virtue of the underlying obligation being securedby real property.55

However, an 1898 case in the California Supreme Court,Commercial Bank of Santa Ana v. Kershner,56which pre-dated

Murphy, did apply the one-action rule to extinguish a mortgageon which both the borrower and the third party were mortgag-ors, encumbering jointly owned property, because the creditorhad obtained a judgment on the debt against the borrower. Thecourt in Kershnerdid not discuss, and perhaps was not presented

with, the question whether the sanction aspect of the ruleshould have been limited to extinguishing only the borrowersencumbrance of her interest in the property, and not the third

partys. Oddly, Kershner was cited in Murphy, on a differentpoint, without mention of Kershners treatment of the thirdpartys mortgaged interest in the property.57

If the sanction aspect of the one-action rule does apply inthis context, its protection appears to be waivable by the thirdparty. Civil Code section 2856(a)(3) enables a guarantor orsurety to waive [a]ny rights or defenses the guarantor or othersurety may have because the principals note or other obligationis secured by real property, including any that are based upon,directly or indirectly, the application of section 726. The thirdparty deed of trust secures the principals obligation, and section2856(a)(3) draws no distinction based upon who provided the

real property security, so long as it secures the principals obliga-tion. Such a waiver would apply only to the third partys protec-tion from section 726(a), of course, not to the borrowers.

In addition to that possibility for direct application of sec-tion 726(a), two potential indirect applications, arising out ofsuretyship law, might be relevant to a third party deed of trust.

First, under Civil Code section 2845, one of the Codessuretyship provisions, the third party as surety has the right torequire that the creditor proceed first against the borrower asprincipal obligor,58unless the third party has waived that right.However, because the third partys deed of trust secures theborrowers obligation, thereby making the protections of sec-tion 726(a)s security-first rule applicable to the borrower (Q5above), the creditor cannotproceed against the borrower withoutfirst proceeding against the third partys real property collateral.

As a result, it is impossible for the creditor to comply with bothsection 2845 and section 726(a).

That conundrum was addressed by the California SupremeCourt in the 1898 Kershner case mentioned above. Althoughnot citing section 2845 specifically, the court made clear thatthe creditors compliance with the security-first rule was not

excused by the need to protect the third partys mortgage,that in any event the third party who encumbers property tosecure the borrowers obligation is charged with knowledge ofsection 726(a), and that the creditor should have prosecuted aforeclosure action under the mortgage rather than taking a judg-ment against the borrower on the debt.59Effectively, then, thesecurity-first rule trumps the third partys section 2845 right torequire first pursuit of the principal obligor. The creditors dutyto comply with the security-first rule is inherent in what thethird party agreed to when it encumbered its property to securethe borrowers obligation.

A second possible indirect effect of section 726(a) arisesfrom the impact it might have on the third partys ability

to recover reimbursement from the borrower if the creditorforecloses on the third partys real property. Such a reimburse-ment right clearly exists under suretyship law, because the saleproceeds of the third partys property at foreclosure go towardpayment of the borrowers obligation.60 However, reimburse-ment in one-action and antideficiency contexts in California isuncertain.

Under one view, associated most prominently with the1968 Court of Appeal opinion in Union Bank v. Gradsky,61if acreditor is precluded from recovering an amount from the bor-rower by an antideficiency rule, a guarantor or surety who paysthat amount is also precluded from recovering reimbursementfor it from the borrower.62Antideficiency rules are not directly

at issue in the present context (because the third party has noliability for a deficiency), but section 726(a)s security-first rulemight be considered to have similar effect: Because the creditorcannot recover from the borrower personally amounts that mustbe recovered first from the third partys collateral, the third partymight also be precluded from obtaining reimbursement fromthe borrower for those amounts.63 If that is indeed the law,however, it does not provide a defense to enforcement of thedeed of trust. As with the third partys inability to exercise thesection 2845 right, discussed above, the inability to obtain reim-bursement would be an inherent consequence of the creditorscompliance with the security-first rule, which the third party is



charged with knowledge of when encumbering its property tosecure the borrowers obligation.64

It is not at all clear, though, that the security-first rule doespreclude a third partys reimbursement right. The Gradskyviewof reimbursement was specifically criticized by the CaliforniaSupreme Court in 1997, in dicta, in Western Security Bank v.Superior Court, as unnecessary to the cases determination andsuggesting a much broader rule than its holding and analysis

warranted.65The full significance of that criticism remains anopen question, but it obviously signals that the reimbursementrights of a guarantor or surety in one-action and antideficiencycontexts may not turn solely upon whether the creditor couldhave recovered the same amount from the borrower. In thepresent context, denying reimbursement when the third partyhas encumbered its property to secure the borrowers debt

would result in an outright windfall to the borrower from thethird partys collateral. If the third partys collateral had secureda guaranty instead, the right to reimbursement for amountsrecovered from the property would be clear, because one-actionand antideficiency rules would not apply to the borrower (Q6above). As discussed further in the Concluding Comment

below, there is little to justify a difference in result.If the third party does have a reimbursement right, and ifthe third party has not waived its rights and defenses as discussedin Q4 above, then the creditor must be mindful that its actionsdo not impair reimbursement. Impairing the right of reimburse-ment could impact enforceability of the deed of trust.66

Q9: WHAT HAPPENS IF THE THIRD PARTY

EXECUTES NOT ONLY A DEED OF TRUST

SECURING THE BORROWERS OBLIGATION

BUT ALSO A SEPARATE, UNSECURED

GUARANTY OF THAT SAME OBLIGATION?

Ostensibly, this structure gives the creditor two indepen-dent sets of remedies with respect to the third party: foreclosureremedies as a secured creditor under the third partys deed oftrust, and the remedies of an unsecured creditor under thatpartys separate guaranty. The question is whether that dual-remedy arrangement runs afoul of the one-action and antidefi-ciency rules.

This structure was at issue in Indusco Management Corp.v. Robertson,67a 1974 Court of Appeal case. Third parties hadgiven a deed of trust to directly secure the borrowers obligation,and also executed a separate unsecured guaranty of that sameobligation. The lender nonjudicially foreclosed under the deedof trust. It then sought a personal judgment against the thirdparties under their guaranty for the deficiency.

The Indusco court approached the situation exactly thesame as if the borrower, rather than the third parties, hadencumbered the real property. In particular, it applied UnionBank v. Gradsky,68 in which a borrowers real property securedthe debt and the creditor, after foreclosing nonjudicially, soughta deficiency recovery against the guarantor on an unsecuredguaranty. Consistent with the principle that a guaranty obliga-tion is distinct from the underlying principal obligation, dis-cussed in Q6 above, Gradskyheld that the antideficiency ruleof Code of Civil Procedure section 580d, which is triggered bynonjudicial foreclosure, does not directly protect a guarantor.

But it also held that the creditors election of the nonjudicialforeclosure remedy exonerated a guarantor by estoppel, becauseit impaired the guarantors rights of subrogation and reimburse-ment against the borrower.69

In Indusco, the court determined that the guaranty in ques-tion did not include a sufficient waiver of the Gradskyestoppeldefense. For that reasonand not because the guarantors werealso the trustors on the deed of trust securing the borrowersobligationthe court held that the guaranty could not beenforced. The courts clear implication was that if the guarantyhad included a Gradskywaiver, it would have been enforceable,

just as if the deed of trust had been given by the borrower. Thus,the Indusco court did not view the third parties deed of trustas somehow making one-action or antideficiency rules directlyapplicable to enforcement of their unsecured guaranty. Thisis consistent with viewing the borrowers obligation and theguarantors obligation as distinctthe former secured by realproperty, the latter not.

A third party might argue to the contrary based on theCalifornia Supreme Courts reasoning in Freedland v. Greco.70InFreedland(which did not involve a guaranty), the creditor took

two $7,000 promissory notes for the very same $7,000 obliga-tion, together with a deed of trust purporting to secure onlyone of them. The creditor nonjudicially foreclosed, then sued torecover the remaining balance due under the note ostensibly notsecured by the deed of trust. Finding the redundant notes to bea manifestly evasive device,71and simply a form of attempted

waiver of the antideficiency rule of Code of Civil Procedure sec-tion 580d, the court held that section 580d barred a deficiencyrecovery on bothnotes after foreclosure of the deed of trust.

In the present context, a third party might argue that takingan unsecured guaranty for the same underlying obligation thatthe third party has also secured with a deed of trust is analogousto the dual notes in Freedland. This arrangement, it would

be argued, is an attempt by the creditor to have it both ways,obtaining the benefits of real property security but at the sametime trying to retain a separate right to proceed as an unsecuredcreditor, unhindered by one-action and antideficiency rules.

Undoubtedly, Freedland would apply if a third partyexecuted two separate guaranties of the same obligation andpurported to secure only one of them with a deed of trust.Permitting enforcement of the purportedly unsecured guarantyin that situation could have the effect of negating application ofthe one-action and antideficiency rules to the guarantor.

But that is not the case when the third partys deed oftrust directly secures the borrowers underlying obligation. Asdiscussed in Q5 above, under current law such a deed of trust

unwaivably triggers the one-action and antideficiency ruleswith respect to the borrower. That consequence would not benegated by enforcing the guaranty as an unsecured obligationof theguarantor. In addition, a guarantor is authorized by CivilCode section 2856(a)(3) to waive one-action and antideficiencydefenses that apply because the borrowers note is secured byreal property.

The reasoning of Freedland, then, appears to be distinguish-able. But at a minimum it may raise the prospect of confusion,so a lender should be very circumspect about this structure. Ifa lender hopes to recover against other assets of a third party,beyond the third partys real property collateral, another way to



do so is to take a security interest in those assets at the outset.72Indeed, that option should be considered regardless of whetherthe third partys deed of trust secures the borrowers obligationor a separate guaranty.

Q10: HOW DOES THE SHAM GUARANTY DOCTRINE

APPLY TO A THIRD PARTYS DEED OF TRUST IF

THE THIRD PARTY IS, FOR EXAMPLE, A GENERAL

PARTNER IN A BORROWER PARTNERSHIP?

In California it is well established that if a party purports toguaranty a debt secured by real property, but is already liable forthat debt as a principal, the guaranty will not be given effect ifit serves to evade protection of that party by the one-action andantideficiency rules. For example, because a general partner alreadyhas joint and several liability as a principal for the debts of a limitedor general partnership,73 a guaranty by a general partner will notenable the creditor to enforce the debt against the partner free fromthose protections.74Under this doctrine, such a guaranty is oftencharacterized as a sham, a nullity, or a purported guaranty, asdistinguished from a true guaranty.75

If a general partner gives a deed of trust on the partners

real property to directly secure the borrower partnerships obliga-tion, the sham guaranty doctrine should not apply, even if theobligation is also secured by the partnerships real property. Thereason is that, to the extent that the partner is already a principalobligor, the deed of trust is simply not a guaranty or suretyshipobligation. It does not secure the debt of another, as discussedin Q2 and Q3 above. Rather, it secures an obligation on whichthe trustor, the general partner, is already a principal obligor.Thus, the situation should be no different from any other in

which a principal obligor provides collateral, or additional col-lateral, to secure the principal obligation.76No evasion of one-action or antideficiency rules results.

On the other hand, if a general partner executes what pur-

ports to be a guaranty of the partnership debt and secures thatguaranty with a deed of trust, and the partnership obligation isalso secured by partnership real property, the sham guarantydoctrine is obviously implicated. The guaranty is clearly withinthe cases applying the doctrine. A court might readily concludethat the guaranty fails, and the partners deed of trust, whichsecures the guaranty, fails with it.

A more nuanced view of the sham guaranty doctrinemight support a different conclusion, however. Despite the doc-trines rhetoric (sham, nullity, purported guaranty, etc.), itsactual substance is not to void the guaranty agreement per se,but to ensure application of the one-action and antideficiencyrules to all principal obligors on a debt secured by real prop-erty, even if a principal obligor has been purportedly recast as aguarantor. Thus, many cases articulate the doctrine as holdingsimply that where a principal obligor purports to take on addi-tional liability as a guarantor, nothing is added to the primaryobligation.77This is not the same as saying that the guarantyis void for all purposes.

Conceivably, then, the following distinction might bemade. Because the general partner is not truly a third party, thepartners guaranty is unenforceable to the extent that it wouldimpose liability on the partner beyond what would already bethe case by virtue of the partners status. However, to the extentthat the guaranty merely recapitulates that already-existing

liability, it is neither void nor is it in fact a guaranty. Taking thatview, the deed of trust securing the guaranty would be validfor the same reason that a deed of trust directly securing thepartnerships obligation is valid: it simply provides additionalcollateral for the principal obligation, and this does not evadethe one-action and antideficiency rules.

In the absence of reported cases supporting that argument,however, a creditor would be ill-advised to rely on it in structur-ing a transaction. A deed of trust that directly secures the under-lying obligation, rather than a guaranty, avoids the issue.

A CONCLUDING COMMENT

As has been seen, the two approaches to structuring atransaction involving a third partys real property collateraldescribed in Q1 abovethe third party deed of trust structureand the secured guaranty structureboth make the third partya surety (Q2 and Q3 above), and trigger the same suretyshiplaw consequences (Q4 above). However, they have significantlydifferent one-action and antideficiency consequences. That isbecause in one structure the third partys real property securesthe borrowers obligation, thereby attaching the one-action and

antideficiency consequences to that obligation (Q5, Q8 andQ9 above), and in the other structure the real property securesthe third partys guaranty obligation, and thatobligation takesthe one-action and antideficiency consequences (Q6 and Q7above).

It might well be asked whether the resulting difference intreatment of the two structures truly makes sense. For example,it does not seem sensible that there is a difference in the one-action and antideficiency consequences of the following twotransactions, which are functionally identical: (A) the thirdparty executes a deed of trust securing the borrowers obligationdirectly; (B) the third party instead executes a guaranty, securedby a deed of trust, and the guaranty provides that it is non-

recourse (i.e., that the creditors only recourse is against the realproperty collateral). In theA transaction, the creditor could notexercise the remedies of an unsecured creditor against the bor-rower, such as setting off against a bank account or suing on thedebt without judicial foreclosure (Q5), but in the Btransactionit could (Q6). In theAtransaction, if the third partys collateralis foreclosed upon, its suretyship right of reimbursement may beproblematic, but in the B transaction it is not (Q8).

The differing treatment of these two transactions seemscompelled by statutory language that, by its explicit terms,dictates that the one-action and antideficiency rules apply toany obligation secured by real property.78The language drawsno distinction based upon whether the obligor of the securedobligation and the mortgagor of the real property are the same.That straightforward approach to the statutes is, at present, thelaw under the California Supreme Courts 1912 decision inGnarini v. Swiss American Bank,79discussed in Q5 above, whichprotected a borrower under the security-first rule because theborrowers debt was secured by a third partys mortgage. But thecourt in Gnarinidid not pause to ask whether that result madesense, or to take into account the third partys suretyship rightof reimbursement from the borrower.80

Gnarinis approach is not the only possible reading of thestatutes. For example, an alternative view would be that, by itsvery nature, third party hypothecation of collateral for anothers



debt is an implied, non-recourse promise to pay the debt,and thatpromise is what the third partys collateral should beconsidered to secure, not the borrowers underlying debt. Thisconcept, of an implied, separate promise, can be seen in oldercases that characterize a third partys hypothecation as causingthe mortgaged property itselfto become a guarantor.81As theStearns suretyship treatise put it in 1951, [b]y a legal fiction,the pledged or mortgaged property is considered to have prom-ised to pay the debt if the debtor does not.82This, of course, ismetaphor and legal shorthand. It is the owner of the land whois a surety, but his liability is limited to the application of theland to the payment of a debt for which another person, or hisproperty, is primarily liable.83

Under that view of third party hypothecation, as securinga limited-liability promise of the third party to pay the debt,the two structures discussed in this article would become one.Both would be secured guaranties. The third partys collateral

would be considered to secure the third partys promise, expressor implied, recourse or non-recourse, to pay the debt. The one-action and antideficiency rules would simply apply in all casesto the third party, not to the borrower, unless the borrower had

also encumbered its own real property. That approach wouldproduce consistent one-action and antideficiency results, andwould also be consonant with suretyship law, which does notdistinguish in the treatment of a surety who promises to payanothers debt and one who hypothecates property for anothersdebt.84

At present, however, Gnariniis still controlling. It is there-fore essential that, when negotiating or enforcing a transaction,a lender carefully focus on the differing one-action and antide-ficiency consequences of the two structures as discussed in thisarticle. It is also essential that a lender recognize the suretyshipcharacter of both structures, so that, when a transaction is docu-mented, the statutorily-authorized waivers of rights and defenses

are obtained.

I thank Charles Bird, Jerome Grossman and Tony Toranto of LuceForward Hamilton & Scripps LLP, Mikel Bistrow of Duane MorrisLLP, and Brian Hulse of Davis Wright Tremaine LLP, for theircomments on earlier drafts. The views expressed in this Article arethose of the author only.

ENDNOTES

1 California suretyship law is set out primarily in C. C.C 2787-2856. See alsoR (T) S G (1996), and UCC Committeeof the Business Law Section of the State Bar of California,California Commentary on the Restatement of the Law Third,Suretyship and Guaranty, 34 L. L.A. L. R. 231 (2000).

2 This Article uses the phrase one-action and antideficiency

rules as shorthand for several interrelated statutes applica-ble to obligations secured by real property: C. C. P.C 726(a), which, as judicially interpreted, includesa one-action rule, precluding multiple actions on a debtsecured by real property, a security-first rule, requiringthat the creditor proceed first against the real propertysecurity before enforcing the debt as a personal liability ofthe borrower, and a one-form-of-action rule, mandating

judicial foreclosure as the method to judicially enforce adebt secured by real property; id. 580b, an antideficiencyrule applicable to specified purchase-money transactions;id. 580d, an antideficiency rule triggered by nonjudicialforeclosure; and id. 726(b) and 580a, fair-value rulesapplicable after judicial and nonjudicial foreclosure, respec-tively, which limit a deficiency judgment to the differencebetween the total obligation and the greater of the foreclo-sure sale price and the propertys fair value (in 726(b))or fair market value (in 580a).

3 C. C. C 2787 (emphasis added). This sectionwas amended in 1939 to define guarantor and surety thesame, as quoted in text, and to abolish the prior statutorydistinction between guarantors and sureties. See2 RB, C M, D T

F L 9.88A, 9.88C (4th ed.2010).

4 See also R (T) S G 1(1)(a), 1(2)(b)(ii), and 1 cmt. g & illus. 6(1996).

5 See, e.g., Garretson Inv. Co. v. Arndt, 144 Cal. 64, 65-66(1904);Carson v. Reid, 137 Cal. 253, 255 (1902); see alsoC. C. C 2928 (A mortgage does not bind themortgagor personally to perform the act for the perfor-mance of which it is a security, unless there is an expresscovenant therein to that effect.).

6 The hypothecation of property to secure the debt ofanother is sometimes referred to as real suretyship, asdistinguished from the personal suretyship that arisesfrom a promise to pay the debt. SeeS, T L

S 1.3 (James L. Elder rev., 5th ed. 1951). Buteven in the real suretyship context, the principles govern-ing personal suretyship are applied. Id.; see also infranote20 and accompanying text.

7 C. C. C 2792; see alsoR (T) S G 9 (1996).

8 C. C. C 2792.9 See, e.g., Cal. Bank v. Kenoyer, 2 Cal. App. 2d 367 (1934);

see 2 B, supranote , 9.88L.10 Everts v. Matteson, 21 Cal. 2d 437, 447 (1942); see also

R (T) S G1(1) (1996).

Michael T. Andrew (J.D. Stanford Law School1979) is of counsel with Luce, Forward,Hamilton & Scripps LLP in San Diego, prac-ticing and consulting in the areas of real and

personal property secured transactions, realestate lending, business bankruptcy, and com-mercial law. Mr. Andrew has been a frequentlecturer and writer on bankruptcy and commer-

cial law, and has taught at Stanford Law School, the Universityof Colorado School of Law, and the University of San DiegoSchool of Law. Mr. Andrew is a contributing author on two CEBtreatises, California Mortgages, Deeds of Trust & ForeclosureLitigation, and California Real Estate Finance Practice.



11 SeeR (T) S G 1 cmt. p (1996); C. C. C 3419(a) (accom-modation parties to negotiable instruments).

12 See R (T) S G 1(3) (1996), and id. cmt. h (The determination that acontract establishing the secondary obligation gives rise tosuretyship status is based on substance, not form.); see,e.g., Superior Wholesale Elec. Co. v. Cameron, 264 Cal. App.2d 488, 493 (1968) (No particular form of agreement isrequired to establish a suretyship contract. So long as theagreement establishes the intention to create such a con-tract, no set words and form are required.).

13 61 Cal. App. 4th 561 (1998).14 Id. at 568.15 C. C. C 2832;Mead, 61 Cal. App. 4th at 570.16 The last sentence of C. C. C 2832 (It is not

necessary for him to show that the creditor accepted him assurety.) was added in 1939, abrogating prior cases to thecontrary. SeeMead, 61 Cal. App. 4th at 569-71. Thus,[i]f a creditor knows that its obligors have agreed betweenthemselves that one will be the principal and the other will

be the surety, the latter is bound to the creditor as a suretyonly, even though he or she appears from the written instru-ments to be a principal. Id. at 571. The court in Meaddeclined to follow Matthews v. Hinton, 234 Cal. App. 2d736 (1965), in which a lessor who encumbered the fee tosecure a debt of the lessee was held to be a principal ratherthan a surety. Matthewsfailed to take account of the 1939change in section 2832. See Mead, 61 Cal. App. 4th at 569-71.

17 SeeC. C. C 2846-49 (rights against principal),2848 (contribution from cosureties), 2809-10, 2815, 2819-22, 2839, 2845, and 2850 (rights and defenses againstcreditor). Regarding reimbursement, see infranotes 60-66

and accompanying text. Regarding the suretyship rightsand defenses generally, see2 B, supranote , 9.88O-9.88X.

18 C. C. C 2845, and see also id. 2850, bothquoted infranote 58.

19 C. C. C 2819; see, e.g., Driscoll v. Winters, 122Cal. 65 (1898) (reduction of principals purchase obliga-tion exonerated surety); and see 2 B, supranote3, 9.88V; cf. R (T) S G 19 (1996). A different rule applies to accom-modation parties on negotiable instruments, however,under C. C. C 3605(c)-(d) (discharge limited toloss that is caused by the modification with respect to the

right of recourse).20 C. C. C 2787. The Civil Codes suretyship

provisions do not differently treat third parties who acquireguarantor or surety status by a promise to answer foranothers debt and those who acquire it by hypothecatingproperty for anothers debt. Seeid. 2787-2856; see alsoR (T) S G 1(1)(a) (1996) (definition of secondary party includesone whose property is encumbered to secure the debt ofanother, and provisions dealing with secondary partiesapply in the normal fashion).

21 C. C. C 2856(a)(1).

22 Id. 2856(a)(3).23 Id. 2856(a)(2).24 See, e.g., C. C. P. C 726(a) (applicable to

the recovery of any debt or the enforcement of any rightsecured by mortgage upon real property or an estate foryears therein); id. 580a (applicable to an obligation forthe payment of which a deed of trust or mortgage withpower of sale upon real property or any interest therein

was given as security); id. 580d (applicable to a notesecured by a deed of trust or mortgage upon real propertyor an estate for years). The purchase-money antideficiencyrule of 580b, however, is only triggered with respect toan obligation of the purchaser secured by the purchasedproperty, either in favor of the vendor or, in the case of anowner-occupied dwelling, a lender.

25 SeeC. C. C 2953; DeBerard Props., Ltd. v. Lim,20 Cal. 4th 659 (1999); Freedland v. Greco, 45 Cal. 2d 462,467-68 (1955); 1 B, supranote 3, 4.60-4.66,5.64-5.70.

26 See, e.g., W. Fuel Co. v. Sanford G. Lewald Co ., 190 Cal. 25,27 (1922); Pac. Valley Bank v. Schwenke, 189 Cal. App. 3d

134, 142 (1987).27 162 Cal. 181 (1912).28 Id. at 184 (citations omitted). Gnarinicited only Commercial

Bank of Santa Ana v. Kershner, 120 Cal. 495 (1898), for theproposition that a third partys mortgage has this effect onenforcement against the borrower. However, in Kershner,the mortgage was also executed by the borrower, on prop-erty jointly owned with the third party. Thus, there wasno occasion in Kershnerto consider, and the court did notdiscuss, whether a third partys mortgage would trigger thesecurity-first rule as to the borrower.

29 51 Cal. 3d 991, 999, 1003 (1990). Wozabis discussed infranotes 34, 36 and 42 and accompanying text.

30 189 Cal. App. 3d 134 (1987).31 Id. at 142. See also Pajaro Dunes Rental Agency, Inc. v.

Spitters (In re Pajaro Dunes Rental Agency, Inc.), 156 B.R.263, 268 (N.D. Cal. 1993), affd, 46 F.3d 1143 (9th Cir.1995) (unpublished table decision).

32 40 Cal. App. 3d 456 (1974).33 See, e.g., C. C. P. C 483.010(b) (preclud-

ing pre-judgment attachment where claim is secured byreal property, except to some extent where the securityhas become valueless or decreased in value to less than theclaim, without fault of the creditor).

However, if the loan is secured by the third partys deedof trust and a security interest in personal property of the

borrower, the lender will be able to exercise its remediesagainst the personal property collateral in accordance withthe mixed-collateral rules of C. C. C 9604(a).Section 9604(a) is triggered when an obligation securedby a security interest in personal property or fixtures is alsosecured by an interest in real property of an estate therein.That language does not distinguish based upon whether thepersonal and real property collateral both came from thesame source. Regarding operation of the mixed-collateralrules, see2 B, supranote 3, 9.12-9.23.

34 51 Cal. 3d 991 (1990).35 207 Cal. 54 (1929).



36 In Wozab, guarantors of a line of credit secured their guar-anty with a deed of trust. The bank set off against the bor-rowers bank accounts and the guarantors bank accounts.The court commented that [the borrowers] line of credit

with the bank was not secured by real property, and thebanks setoff against [the borrowers] deposit accounts is notat issue in this appeal. 51 Cal. 3d at 996, n.1.

Baylessalso involved a secured guaranty. The court observedthat it would have been permissible for the plaintiff credi-tors to sue the underlying obligor without proceeding onthe guaranty (and thus on the mortgage securing the guar-anty): [T]he [guarantors] would not have been necessaryparties to said action, and the prosecution of said actionagainst [the principal obligor] alone might not have been abar to a subsequent action brought by plaintiffs against [theguarantors] on their agreement to answer for [the principalobligors] default. 207 Cal. at 58.

Thus, in both Wozab and Bayless, the court viewed theunderlying obligation as unsecured, notwithstanding thatsecurity had been given for the guaranties. At issue inboth cases, however, was the impact of the creditor having

proceeded against the guarantors (seeQ7), not against theprincipal obligors.37 Component Sys. Corp. v. Eighth Judicial Dist. Ct., 692 P.2d

1296, 1301 (Nev. 1985). The guaranties included Californiachoice-of-law provisions. Real property collateral was locatedin Nevada. Some of the several deeds of trust secured theunderlying debt directly, another secured only a guaranty,and another secured both the underlying debt and a guar-anty. The court applied what it believed to be Californialaw to determine the relationship between the guarantiesand the underlying debt, then applied Nevadas one-actionrule to hold that an action against the underlying borrowerson the debt extinguished the encumbrances. Given . . . the

fact that pursuant to C. C. C 2787 the personalguarantors are co-obligors of the corporate borrowers, allthe transactions under review should be treated as one loanfor the purposes of the one action rule. 692 P.2d at 1300.The two California cases cited by the court in support of itsconclusion are discussed infranote 41.

38 See, e.g., Everts v. Matteson, 21 Cal. 2d 437, 444 (1942);Loeb v. Christie, 6 Cal. 2d 416, 420 (1936); Talbott v.Hustwit, 164 Cal. App. 4th 148, 151 (2008);Mariners Sav.& Loan Assn v. Neil, 22 Cal. App. 3d 232, 235 (1971); Katzv. Haskell, 196 Cal. App. 2d 144, 154-55 (1961).

39 Bank of S. Cal. v. Dombrow, 39 Cal. App. 4th 1457 (1995)(ordered depublished Mar. 14, 1996) (applying C. C.

P. C 580a to a guarantor); see also Talbott v.Hustwit, 164 Cal. App. 4th 148, 154 (2008) (Sills, J., con-curring).

40 See 2 R. B, supranote , 9.88Z-9.89 (collect-ing and discussing cases); see, e.g., Talbott v. Hustwit, 164Cal. App. 4th 148, 152 (2008) (case law is uniform inholding section 580a does not apply to guarantors).It has been argued that the 1939 statutory abolition of thedistinction between sureties and guarantors (seesupranote3) undermined the principle that guarantors are not directlyprotected by the one-action and antideficiency rules when

the underlying obligation is secured by real property, andthat this principle is in any event unsound as a matter ofpolicy. That topic is beyond the scope of this Article, but adetailed discussion of it by the present author can be foundat 2 B, supranote , 9.88Z-9.89C.

41 In support of its conclusion the Nevada Supreme Courtcited only two California cases, Wiener v. Van Winkle, 273Cal. App. 2d 774 (1969), and Am. Guar. Corp. v. Stoody,230 Cal. App. 2d 390 (1964). Component Sys. Corp., 692P.2d at 1300. In Stoody, the guarantor of a debt securedby the borrowers real property sought to overturn a writ ofattachment on the guarantors property, on grounds that theguaranty was, by virtue of the borrowers collateral, a securedobligation. See former C. C. P. C 537(1)(repealed 1974), and current 483.010(b). Holding that theguarantor had enforceably waived its right under C. C.C 2845 (quoted infranote 58) to require the creditorto first pursue the borrower, as well as its entitlement underC. C. C 2849 to the benefit of every securityfor the performance of the principal obligation held by thecreditor, the court upheld the attachment. In Wiener, the

creditor sued third parties as guarantors and indorsers of anote secured by the borrowers real property. They arguedthat the creditor was estopped because the intent was thatthe creditor would first foreclose on the borrowers property.The court held that the third parties had enforceably waivedtheir rights as guarantors under sections 2845 and 2849, andthat this precluded the claimed estoppel.

The courts in Stoody, 230 Cal. App. 2d at 393 and Wiener,273 Cal. App. 2d at 786, both observed that the 1939abolition of the distinction between guarantors and suretieschanged the pre-1939 concept that guaranties were entirelyseparate obligations. But in each case the court appearedto take that conclusion to mean simply that, post-1939,

guarantors have the same (waivable) rights under sections2845 and 2849 that, prior to 1939, were available only tosureties. Neither case involved or discussed a one-action orantideficiency issue.

42 51 Cal. 3d 991 (1990).43 207 Cal. 54 (1929).44 SeeWozab, 51 Cal. 3d at 997 (1990); Walker v. Cmty. Bank,

10 Cal. 3d 729, 733-34 (1974); and see text accompanyingnote 53 infra.

45 See Freedland v. Greco, 45 Cal. 2d 462, 468 (1955) (othersections of the Code of Civil Procedure which deal withdeficiency judgments (C C. P., 726, 580a,580b) refer to debts, obligations, or contracts secured by

a trust deed may be broader than the word note used insection 580d) (dicta).

46 265 Cal. App. 2d 40 (1968).47 Id. at44; see alsoKrueger v. Bank of Am., 145 Cal. App. 3d

204, 212 (1983).48 See, e.g., Passanisi v. Merit-McBride Realtors, Inc., 190 Cal.

App. 3d 1496, 1508-09 (1987) (creditors attorneys feeaward in prior injunction action brought by trustor); Willysof Marin Co. v. Pierce, 140 Cal. App. 2d 826, 831 (1956)(lease obligations secured by deed of trust).

49 C. C. P. C 580as fair-value rule applies to



deficiency judgments after nonjudicial foreclosure. Itsscope of operation is very limited because the later-enactedsection 580d normally bars a deficiency altogether afternonjudicial foreclosure. See Dreyfuss v. Union Bank, 24Cal. 4th 400, 407 n.2 (2000).

50 See supranotes 25-26 and accompanying text.51 C. C. C 2856(a)(3) (emphasis added).52 See supranote 5 and accompanying text.53 SeeSec. Pac. Natl Bank v. Wozab, 51 Cal. 3d 991, 997 (1990);

Walker v. Cmty. Bank, 10 Cal. 3d 729, 733-34 (1974).54 43 Cal. App. 579 (1919).55 The court inMurphywrote:

If [the creditor] first sued the principal debtor,he was not subsequently barred from bringingsuit in foreclosure [against the third party].Thus the rule in this state as to section 726clearly is that this section applies to the primarydebtor and was enacted for his benefit; thatit does not apply to an individual guarantoror surety, or to a subsequent indorser upon apromissory note, nor in fact to any case where

there is no privity of contract existing betweenthe two obligations that is, where the prima-ry debt and the obligation under the mortgageare separate and distinct obligations.

43 Cal. App. at 586 (citations omitted).In ONeil v. Gen. Sec. Corp., 4 Cal. App. 4th 587, 598 n.6(1992), the court describedMurphy, in dicta,as merely [hold-ing] that when the primary debtors obligation is unsecured,entry of judgment on that obligation does not release a thirdparty guarantor whose guarantee is secured by real property.In fact, the Murphy opinion is very explicit that the thirdpartys real property secured the underlying debt, not a separateguaranty. SeeMurphy, 43 Cal. App. at 580 and 583 ([T]he

question is put squarely in issue whether, the [third partys]mortgage having been taken as collateral security for the pay-ment of the purchase price specified in the lease note, theplaintiff has lost his right to foreclose because of the judgmentagainst the primary debtor on the contract.).

56 120 Cal. 495 (1898).57 Murphy, 43 Cal. App. at 584, quoting Kershner, 120 Cal.

at 498 (A debt may be secured by pledge, mechanics lien,judgment lien, attachment, or otherwise, and yet the secu-rity may be reinforced by a mortgage on the same or otherproperty.). See alsoOuld v. Stoddard, 54 Cal. 613 (1880).

58 C. C. C 2845 provides: A surety may requirethe creditor, subject to Section 996.440 of the Code of

Civil Procedure, to proceed against the principal, or topursue any other remedy in the creditors power which thesurety cannot pursue, and which would lighten the suretysburden; and if the creditor neglects to do so, the suretyis exonerated to the extent to which the surety is therebyprejudiced. See also id. 2850 (Whenever property of asurety is hypothecated with property of the principal, thesurety is entitled to have the property of the principal firstapplied to the discharge of the obligation.).

59 120 Cal. at 500-01. As mentioned previously, the mortgagein Kershnerwas executed by both the borrower and the thirdparty, encumbering jointly owned property. The Court noted

that the third party would have been fully protected by thecourt if she was only a surety by the sale first of [the bor-rowers] interest in the property. Id., citing C. C. C 2850, quoted supra note 58. Of course, if the sale first ofthe borrowers interest left a remaining deficiency, sale of thethird partys interest would then be required before a deficiency

judgment could be taken and enforced against the borrower. The potential statutory conflict between C. C. C

2845 and C. C. P. C 726(a) was notedby the district court in Pajaro Dunes Rental Agency, Inc. v.Spitters(In re Pajaro Dunes Rental Agency, Inc.), 156 B.R. 263,269 (N.D. Cal. 1993), affd, 46 F.3d 1143 (9th Cir. 1995)(unpublished table decision), but the court found that theconflict was not actually present on the facts of the case anddid not address its resolution, noting that it is a problembetter addressed by the California legislature. In its unpub-lished opinion on appeal, however, the Ninth Circuit consid-ered the issue to have been resolved by Kershner: That caseholds that a surety in California is charged with knowledgeof the one-action rule. Pajaro Dunes Rental Agency, Inc. v.Spitters (In re Pajaro Dunes Rental Agency, Inc.), 1995 U.S.

App. LEXIS 734, at *5-6 (9th Cir. 1995).60 See C. C. C 2847 (If a surety satisfies theprincipal obligation, or any part thereof, . . . the principalis bound to reimburse what he has disbursed, includingnecessary costs and expenses . . . .). By application of theforeclosure sale proceeds to the debt, the third party hassatisfied the borrowers obligation to at least that extent.(Alternatively, the third party might pay the debt to free itsproperty from the encumbrance.)

Similar to section 2847, R (T) S G 23(1) (1996) articulates a general rule forthe measure of a suretys reimbursement right as the reason-able cost of performing the secondary [i.e., suretyship] obliga-

tion, including incidental expenses. A comment observes:Performance of the secondary obligation mayinvolve, among other things, the payment ofmoney, the performance of a nonmonetaryobligation, or realization by the obligee fromproperty of the secondary obligor in which theobligee has a security interest or lien. The sec-ondary obligors reasonable cost of performanceincludes the amount of money paid (includingany interest or other charges imposed on thesecondary obligor as a result of the principalobligors default), the reasonable cost of per-forming the nonmonetary obligation, or the

value of the property lost to the obligees realiza-tion as to collateral.

Id. 23 cmt. a.61 265 Cal. App. 2d 40 (1968).62 Id. at 46 (applying C. C. P. C 580d):

It makes no difference to [the borrowers] pursewhether the recovery is by the original creditorin a direct action following nonjudicial sale ofthe security, or whether the recovery is in anaction by the guarantor for reimbursement ofthe same sum.

. . . .



The Legislature clearly intended to protect thedebtor from personal liability following a non-

judicial sale of the security. No liability, director indirect, should be imposed upon the debtorfollowing a nonjudicial sale of the security. Topermit a guarantor to recover reimbursementfrom the debtor would permit circumvention ofthe legislative purpose in enacting section 580d.

See also Heckes v. Sapp, 229 Cal. App. 2d 549, 554-55(1964) (same, applying C. C. P. C 580b).The California Supreme Court later criticized Gradskysreimbursement analysis. See infranote 65 and accompany-ing text. Gradskys holding is discussed infranotes 68-69and accompanying text.

63 Under the California Supreme Courts ruling in Gnarini v.Swiss Am. Bank, 162 Cal. 181, 184 (1912), discussed supranotes 27-29 and accompanying text, the security-first ruleof C. C. P. C 726(a) requires the creditor tofirst proceed against the third partys real property collateralbefore making any personal recovery against the borrower.Because of that rule, amounts realized from the third partys

collateral cannot, instead, be obtained by the creditor fromthe borrower. (Thus, in Gnarini, the creditor was requiredto restore amounts it had set off from the borrowers bankaccount in violation of the rule.) Possibly, then, undera Gradsky-like view, this might mean that amounts real-ized from foreclosure on the third partys collateral, whichamounts the creditor could not have obtained from theborrower, also cannot be recovered by the third party fromthe borrower.

64 This situation must be distinguished from Gradskyitself, inwhich the guarantors inability (or what the court thoughtwas the guarantors inability) to recover reimbursementfrom the borrower didgive rise to a defense to enforcement

of the guaranty. In Gradsky, that was because the impair-ment of the guarantors rights was caused by the creditorselection to foreclose nonjudicially rather than judicially,thereby triggering the antideficiency rule of C. C.P. C 580d. 265 Cal. App. 2d at 45-47. Theinability to obtain reimbursement was not an inherent con-sequence of guarantying the debt in the first place.

By contrast, in Heckes v. Sapp, 229 Cal. App. 2d 549(1964), the antideficiency rule in question was C. C.P. C 580b, which barred the creditor from recov-ering a deficiency against the borrower because the debt

was vendor purchase-money financing. The court heldthat because section 580b barred the creditor from recover-

ing against the borrower, the guarantor likewise could notrecover reimbursement from the borrower, but that this didnotprovide a defense to enforcement of the guaranty. 229Cal. App. 2d at 554-55. Here the guarantors inability torecover reimbursement was not because of an election ofremedies by the creditor, but because the antideficiency barof section 580b would apply no matter what enforcementmechanism the creditor utilized. The same would be trueif, as described in text, section 726(a)s security-first rule isconsidered to preclude reimbursement.

65 15 Cal. 4th 232, 249 (1997). W. Sec. Bankitself involved a letterof credit, not a guaranty. SeeC. C. P. C 580.5.

66 See, e.g., Gradsky, 265 Cal. App. 2d at 46 (The creditorhas a duty to the surety not to impair the suretys rem-edies against the principal debtor.); see also C. C.C 2819; R (T) S G 37. If a reimbursement right is recognizedin this context, an important question will be whether themeasure of reimbursement is the same regardless of how thecreditor forecloses.

67 40 Cal. App. 3d 456 (1974).68 265 Cal. App. 2d 40 (1968).69 After nonjudicial foreclosure the guarantor would be unable

to recover the deficiency by subrogation because the guaran-tor would be standing in the creditors shoes, and C. C.P. C 580d would apply directly. Gradsky, 265 Cal.

App. 2d at 45. Reimbursement would be precluded, thecourt believed, because allowing it would impose upon theborrower indirectly the very deficiency that section 580d

was intended to bar directly, and this would impermissiblyundermine the legislative purpose of section 580d. Id. at45-46; see supranote 62. Regarding the California SupremeCourts later criticism of this view of reimbursement, seesupra

note 65 and accompanying text.70 45 Cal. 2d 462 (1955); see alsoW. Fuel Co. v. Sanford G.Lewald Co., 190 Cal. 25 (1922).

71 45 Cal. 2d at 467.72 Recovery from additional collateral does not violate the

antideficiency rule of C. C. P. C 580d andis not limited by the fair-value rule of 580a. Dreyfuss v.Union Bank, 24 Cal. 4th 400, 406 (2000); Freedland, 45Cal. 2d at 466; Hatch v. Security-First Natl Bank, 19 Cal.2d 254, 259-60 (1942).

73 C. C. C 15904.04(a) (limited partnerships) &16306(a) (general partnerships).

74 See, e.g., Riddle v. Lushing, 203 Cal. App. 2d 831 (1962)

(applying C. C. P. C 580b) ; Union Bankv. Dorn, 254 Cal. App. 2d 157 (1967) (applying 580d);Prestige Ltd. Partnership-Concord v. East Bay Car WashPartners(In re Prestige Ltd. Partnership-Concord), 205 B.R.427 (Bankr. N.D. Cal. 1997) (applying 726(a)), affd,164 F.3d 1214 (9th Cir. 1999).

The same rule has been applied to the settlor/trustee ofa borrower revocable trust, see Cadle Co. II v. Harvey, 83Cal. App. 4th 927 (2000), Torrey Pines Bank v. Hoffman,231 Cal. App. 3d 308 (1991), but see Talbott v. Hustwit,164 Cal. App. 4th 148 (2008) (enforcing settlors guaranty

where the settlor was not also the trustee), and in somecircumstances to the shareholder of a borrower corporation,

seeValinda Builders, Inc. v. Bissner, 230 Cal. App. 2d 106(1964). But seeKnowles v. Sandercock, 107 Cal. 629, 641-42 (1895).

The sham guaranty doctrine is discussed in detail in 2B, supranote 3, 9.89S-9.89X.

75 See, e.g.,Cadle, 83 Cal. App. 4th at 929, 931, 934 n.8; RiverBank Am. v. Diller, 38 Cal. App. 4th 1400, 1420-24 (1995);Union Bank v. Gradsky, 265 Cal. App. 2d 40, 42 (1968).

76 See Pac. Valley Bank v. Schwenke, 189 Cal. App. 3d 134(1987); and seesupranote 72.

77 Hoffman, 231 Cal. App. 3d at 319-20 (emphasis added);see also Cadle, 83 Cal. App. 4th at 933; Dorn, 254 Cal.


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App. 2d at 159; Valinda Builders, 230 Cal. App. 2d at 110;Riddle, 203 Cal. App. 2d at 834. In Everts v. Matteson, 21Cal. 2d 437, 450 (1942), the California Supreme Courtdetermined that principal obligors had purported to guar-anty their own obligation in an extension agreement, andconcluded: The extension agreement may not therefore beconstrued as a contract of guaranty.

78 See supranote 24.79 162 Cal. 181 (1912). See supranotes 27-29 and accompa-

nying text.80 If the third party can recover reimbursement from the bor-

rower as a personal liability when the creditor could nothave done so, there is little purpose in applying the security-first rule to the borrower in the first place. If the borroweris immunized from reimbursement liability, the result is a

windfall to the borrower from the third partys collateral.Gnarini also did not consider the relevance, in a judicialforeclosure action, of the post-sale right of redemption, or

how it would function in this context. SeeC. C. P.C 726(e), 729.010(a) (where deficiency judgmentmay be ordered, property shall be sold subject to a right ofredemption), and 729.020 (Property sold subject to theright of redemption may be redeemed only by thejudgmentdebtor or the judgment debtors successor in interest.)(emphasis added).

81 See, e.g., Carson v. Reid, 137 Cal. 253, 255 (1902) (Thelanddescribed in the mortgage became the guarantor of thepayment of the note . . . .).

82 S, supranote 6, 1.3.83 Frederic P. Storke & Don W. Sears, Transfer of Mortgaged

Property, 38 C L. Q. 185, 192 (1953).84 Seesupranotes 6 and 20 and accompanying text.

Secured Guaranties and Third Party Deeds of Trust 2010

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