Opinion
INTRODUCTION
Plaintiff CADC/RADC Venture 2011-1 LLC brought this deficiency action to enforce commercial guaranty agreements executed by defendants Richard J. Bradley and G. Reynolds Yates. Defendants argued the guaranties were shams, and therefore unenforceable, due to their close relationship with the borrower on the subject loan, Nohea Napa Gateway, LLC (Nohea). Defendants in turn brought a counterclaim against plaintiff, as well as its servicing
Under California law, a lender may not pursue a deficiency judgment against a borrower where the sale of property securing a debt produces proceeds insufficient to cover the amount of the debt. Lenders may pursue deficiency judgments against guarantors, but only true guarantors. Where the borrower and the guarantor are the same, however, the guaranty is considered an unenforceable sham.
Here, the jury found in favor of defendants on the sham guaranty issue, and the trial court rejected defendants’ UCL counterclaim. Plaintiff now appeals on the ground that substantial evidence does not support the jury’s finding that the guaranties were shams. 1 We agree and reverse. Additionally, defendants appeal, contending the trial court erred in entering judgment in favor of plaintiff on their UCL claim. We find defendants’ contentions on this issue without merit and affirm .the trial court’s ruling on the counterclaim.
FACTUAL BACKGROUND AND PROCEDURAL HISTORY
The loan and guaranties that give rise to this action were executed in connection with the purchase of a 7.38-acre parcel of undeveloped land in Napa (the Napa property). Defendants Bradley and Yates initially discussed purchasing the property as part of an exchange under Internal Revenue Code section 1031 (1031 exchange). Through a 1031 exchange, a taxpayer can defer taxes on gains from the sale of a property by using those gains to purchase a second property. (26 U.S.C. § 1031.) Where the exchange property is purchased first, an exchange accommodation titleholder (EAT) may temporarily hold the property and then transfer it to the taxpayer. In this case, defendants considered using the Napa property as an exchange property in which they could invest proceeds from the sale of the Interurban building, a Seattle property owned by No Boundaries, Ltd. (No Boundaries). No Boundaries is a Washington corporation of which defendants each own 50 percent, and which they share with their spouses as community property. In its loan application documents, No Boundaries submitted financial statements reflecting assets during the period of 2003 through 2005 in excess of $6.5 million, along with other information indicating corporate financial activity.
In March 2006, No Boundaries submitted a loan application to Charter Oak. After reviewing the financial information of No Boundaries and defendants, Charter Oak approved the loan on May 31, 2006. The loan approval documents indicate Charter Oak expected an EAT would initially assume the loan and then transfer its obligations to No Boundaries for the purposes of a 1031 exchange. These documents also indicate Charter Oak considered the primary source of repayment to be No Boundaries and the secondary source to be defendants, who would guaranty the loan. Charter Oak policy required loan guaranties from any individuals owning more than 20 percent of a borrowing entity. Ledwich indicated the purpose of this policy was to “pierce the corporate veil of the borrower.”
On June 6, 2006, two days before the loan agreement was executed, defendants decided to switch the borrowing entity from No Boundaries to Nohea. A tax consultant hired by defendants to assist with the 1031 exchange indicated the change was necessary to avoid California withholding tax consequences. Nohea was just an idea at this point, but on June 13, 2006, it filed with the California Secretary of State limited liability company articles of organization. Defendants were later appointed as managers of Nohea.
Charter Oak was informed of the change in borrowers on June 7, 2006. It did not request any financial information from Nohea. Ledwich understood Nohea’s only asset would be the Napa property. He testified Charter Oak was willing to allow Nohea to assume the loan because defendants had enough money to justify an extension of credit, and the name of the borrower was not a critical component of the deal.
On June 8, 2006, two days after the idea of Nohea was conceived, Nohea and Charter Oak executed a business loan agreement for $2.1 million. The loan was secured by a deed of trust against the Napa property executed by Nohea in favor of Charter Oak. Both defendants executed commercial guaranties for the full amount of the loan. As part of the guaranty agreements, defendants waived all their rights and defenses under California’s antideficiency statutes.
As a result of these agreements, Nohea owned the Napa property, No Boundaries owned Nohea, and defendants were poised to complete the 1031 exchange. There is evidence that both Charter Oak and plaintiff, who would later assume Charter Oak’s interests in the loan, mistakenly believed defendants owned Nohea. Defendants and their spouses did own No Boundaries, but there is no indication they ever held a direct ownership interest in Nohea.
No Boundaries’s tax returns reflect that the company sold the Interurban building in 2006. No Boundaries realized a $6,640,897 gain from the sale, and it was able to defer taxes on that gain through the 1031 exchange.
In July 2009, Charter Oak and Nohea agreed to renew the loan and modify some of its terms. Charter Oak understood Nohea was still a single-asset entity and, thus, did not request any financial information from the company in connection with the 2009 agreements. By this point, only Bradley and No Boundaries were providing Charter Oak with financial information. The bank had abandoned all attempts to collect financial information from Yates in 2008, sometime after he declined to comply with its information requests. Although No Boundaries had been making timely loan payments, Charter Oak found the company was not generating sufficient cashflow to service the debt. The bank concluded Bradley was the financial strength of the loan.
In February 2011, the state closed Charter Oak and the FDIC was appointed as receiver. In June 2011, the loan matured, and Nohea was obligated to pay all amounts owing. Nohea went into default. During this period, defendants communicated with a representative of Midland Loan Services (Midland), which was servicing the Nohea loan on behalf of the FDIC, about the possibility of a loan modification. The Midland representative informed defendants that the FDIC could either take the Napa property or sue and try to enforce the loan, but it could not do both. In July 2011, defendants and Midland discussed the possibility of a deed in lieu of foreclosure, which was conditioned upon the results of a title search and an environmental study for the Napa property.
In March 2012, plaintiff filed this action for breach of written guaranties to recover the deficiency. Defendants asserted a number of affirmative defenses in their answer, including that the guaranties were unenforceable shams. Defendants also filed a cross-complaint against plaintiff for, among other things, violating the UCL by attempting to enforce sham guaranties. Additionally, the cross-complaint asserted a claim against Sabal for conspiracy to violate the UCL. The trial court denied the parties’ cross-motions for summary judgment, and the case proceeded to trial. The jury returned a verdict for defendants on plaintiff’s claims for breach, and found that even if plaintiff had committed a UCL violation, Sabal was not liable for conspiracy. The trial court rejected defendants’ UCL claim against plaintiff. Plaintiff subsequently filed a motion for judgment notwithstanding the verdict (JNOV) and a motion for a new trial, both of which were denied.
DISCUSSION
I. California’s Antideficiency Statutes and the Sham Guaranty Defense
California’s antideficiency statutes are codified at Code of Civil Procedure sections 580a through 580d and
126?
In relevant part, the statutes provide: “[N]o deficiency judgment shall be rendered for a deficiency on a note secured by a deed of trust or mortgage on real property ... in any case in which the real property . . . has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.” (§ 580d, subd. (a).) These protections cannot be avoided by artifice or waived through a private agreement.
(Commonwealth Mortgage Assurance Co. v. Superior Court
(1989)
“[E]nacted during the Depression, [these provisions] limit or prohibit lenders from obtaining personal judgments against borrowers where the lender’s sale of real property security produces proceeds insufficient to cover the amount of the debt.”
(Talbott v. Hustwit
(2008)
The antideficiency statutes do not affect the liability a guarantor might otherwise have with respect to a deficiency. (§ 580d, subd. (b).) Thus, a lender may recover a deficiency judgment from a guarantor who waives his or her antideficiency protections, even though the antideficiency statutes would bar the lender from recovering that same deficiency from the primary borrower.
(Cadle Co. II v. Harvey
(2000)
A threshold issue in sham guaranty cases is whether the guarantor of a loan is also obligated as a borrower. In
Riddle v. Lushing
(1962)
Similarly, in
Valinda Builders, Inc. v. Bissner
(1964)
Alter ego principles were also relied upon in
Torrey Pines, supra,
In contrast, in
Talbott, supra,
In assessing sham guaranty claims, several courts have also considered whether the
lender
structured the transaction to circumvent the protections of the antideficiency laws. For example, in
Union Bank v. Brummell
(1969)
A
similar conclusion was reached in
River Bank America
v.
Diller
(1995)
Brummell
and
River Bank
were distinguished in
California Bank & Trust v. Lawlor
(2013)
From these cases the following principles may be derived: A guaranty is an unenforceable sham where the guarantor is the principal obligor on the debt. This is the case where either (1) the guarantor personally executes underlying loan agreements or a deed of trust or (2) the guarantor is, in
II. Substantial Evidence Does Not Support the Jury’s Verdict on the Sham Guaranty Defense
Plaintiff argues we should reverse the trial court’s denial of its JNOV motion because the verdict is not supported by substantial evidence. On substantial evidence review, we “must view the whole record in a light most favorable to the judgment, resolving all evidentiary conflicts and drawing all reasonable inferences in favor of the decision of the trial court.”
(DiMartino v. City of Orinda
(2000)
There is no dispute that defendants executed guaranty agreements in connection with the subject loan, or that they waived their antideficiency protections in the process. The principal question on appeal is whether defendants’ guaranties were shams. As discussed above, a guaranty is a sham where the guarantor is the principal obligor on the debt, either because he or she personally executed the note or deed of trust, or because the guarantor is liable for the debts of the borrower by operation of some legal principle. (See, e.g.,
Torrey Pines, supra,
A. Defendants were not the primary obligors on the loan or deed of trust
It is undisputed that defendants did not personally execute the deed of trust against the Napa property. Nohea was the borrower on the loan. Defendants assert they are nevertheless the primary obligors on the loan because Nohea is merely a shell and they are its alter ego. Looking at the facts in the light most favorable to defendants, the argument fails as a matter of law. In light of the legal separation between defendants and Nohea, we cannot conclude there is an alter ego relationship or that defendants are directly liable for Nohea’s debts.
Though there is no litmus test to determine alter ego liability, there are two general requirements: “ ‘(1) that there be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist and (2) that, if the acts are treated as those of the corporation alone, an inequitable result will follow.’ ”
(Mesler
v.
Bragg Management Co.
(1985)
Here, defendants do not have a direct ownership interest in Nohea. The company was originally owned by an EAT and later transferred to No Boundaries. Moreover, No Boundaries, not defendants, made Nohea’s payments under the loan. Defendants contend direct ownership is not required, pointing out that they own No Boundaries with their wives, and that Bradley made the initial down payment on the Napa property. But even if Nohea is merely a shell controlled by No Boundaries and alter ego principles allow for the simultaneous piercing of two corporate veils, defendants still need to establish that we should disregard No Boundaries’s corporate form. They have failed to do so. The evidence shows No Boundaries observed the necessary formalities, including passing corporate resolutions, holding corporate meetings, and maintaining separate bank accounts and assets.
Defendants also assert that, at the time the loan agreement was executed, Nohea was still without an owner, indicating the entity merely existed to serve their interests. As defendants point out, in some situations, a corporation’s failure to allocate ownership or stock may support an alter ego finding.
(Automotriz etc. De California v. Resnick
(1957)
Defendants also make much of the fact that Ledwich, the Charter Oak vice-president who managed the loan, was under the impression defendants owned Nohea directly. Ledwich’s misunderstanding suggests defendants held
Because defendants own Nohea through No Boundaries, and because No Boundaries is legally distinct from defendants, we cannot conclude defendants are directly liable for Nohea’s obligations. To the extent the jury’s verdict was based on such a finding, it cannot be squared with the law.
B. Charter Oak did not structure the loan transaction to subvert the antideficiency laws
That defendants are not directly liable for the debts of Nohea does not end our inquiry. We may also take into account equitable considerations, including whether Charter Oak structured the loan transaction to subvert the antideficiency laws. (See, e.g., River Bank, supra, 38 Cal.App.4th at pp. 1423-1424.) In doing so, we consider whether Charter Oak relegated defendants to the position of guarantors or otherwise dictated the structure of the loan transaction. (See ibid.) Viewing the evidence in the light most favorable to the verdict, we conclude these equitable concerns do not support finding a sham guaranty.
Unlike in cases such as
River Bank, supra,
Moreover, the record reflects that defendants were interested in using a corporate borrower — first No Boundaries and then Nohea — so they could take
Defendants argue the 1031 exchange is irrelevant. They assert Bradley testified he was initially interested in purchasing the Napa property in his own name, and the 1031 exchange had been discussed as a mere possibility. Defendants also point out there was a chance the 1031 exchange would not go through, since the Napa property was purchased before the Seattle property was sold. But this merely shows defendants had additional reasons for purchasing the Napa property. Regardless of what those other reasons were, defendants clearly intended to take the steps necessary to complete the 1031 exchange, including selecting the appropriate borrowing entity.
Nor does Ledwich’s testimony show the bank structured the transaction to circumvent the antideficiency laws. As defendants point out, Ledwich stated the purpose of requiring guaranties was to “pierce the corporate veil of the borrower and to get at the guarantors.” Ledwich also agreed with defense counsel’s statements that the purpose of the transaction was “to enable [defendants] to take possession of the [Napa] property,” and “to assist not No Boundaries but [defendants].” But Ledwich’s statements shed no light on whether Charter Oak insisted on the use of a borrowing entity or played any role in its selection.
Defendants also contend their guaranties were shams because Charter Oak looked only to them to maintain the loan, and it never reviewed the financial information of Nohea, the actual borrower. As defendants point out, courts have been inclined to find an attempt to subvert the antideficiency laws where the lender considers only the financial strength of the guarantor, since such facts indicate the lender considers the guarantor to be the true borrower. (See
River Bank, supra,
Ultimately, this issue turns on a question of law: Can guarantors disclaim their antideficiency waivers if they decide to borrow through a shell entity for their own purposes and there is adequate legal separation between the guarantors and the borrower? While the antideficiency statutes and case law do not directly speak to this issue, we believe the answer must be no. Where individuals purposefully take advantage of the benefits of borrowing through a corporate entity, they must also assume the risks that come with it. 6
III. Substantial Evidence Supports the Trial Court’s Ruling on Defendants’ UCL Claim
Defendants’ UCL claim against plaintiff was predicated on the theory that plaintiff’s attempt to enforce their guaranties constituted an unfair and unlawful business practice. The trial court found for plaintiff on the claim. The court reasoned it was a close question whether the guaranty was a sham, and thus plaintiff’s attempt to enforce the guaranty was not in bad faith. As the trial court’s determination of the UCL claim involved disputed facts or inferences drawn from undisputed facts concerning, inter alia, plaintiff’s policies and its prior knowledge of various facts, we review its findings for substantial evidence.
7
(Axis Surplus Ins. Co. v. Glencoe Ins. Ltd.
(2012)
The UCL prohibits any unfair, unlawful, or fraudulent business act or practice. (Bus. & Prof. Code, § 17200.) Only the first two types of practices are at issue here. A practice is unlawful under the UCL where it
Here, defendants argue plaintiff’s attempt to enforce their guaranties after pursuing nonjudicial foreclosure was both unfair and unlawful under the so-called “one-action rule,” which provides that there can be but one form of action for recovery of any debt secured by a mortgage upon real property. (§ 726.) Defendants also assert that Midland, which serviced the loan before it was assigned to plaintiff, specifically stated California law prohibited multiple actions to collect the debt. But defendants waived their antideficiency protections, including the protections embodied in the one-action rule, when they executed their guaranties and, as set forth above, we find these guaranties are valid and enforceable. (See
Cadle Co. II v. Harvey, supra,
Defendants also argue plaintiff’s attempt to enforce the guaranties was unfair because plaintiff had extensive information that Midland, which acted as the loan servicer for both the FDIC and plaintiff, had communicated with defendants about the possibility of a deed in lieu of foreclosure. According to defendants, despite Midland’s representation that plaintiff would be in a position to work with them to resolve the debt once it took over the loan, plaintiff transferred servicing responsibilities from Midland to Sabal, which refused to communicate with defendants and pursued nonjudicial foreclosure and then this deficiency action. Defendants concede their UCL claim is not predicated on plaintiff’s failure to follow through on the deed in lieu of foreclosure, and that they are not pursuing a promissory estoppel cause of action, which was dismissed on demurrer. Instead, they assert their UCL unfairness claim is premised on plaintiff’s “practice of having complete disregard for the representations made by their representative.” We agree with
DISPOSITION
The judgment on plaintiff’s claim for breach of guaranties is reversed, and, given plaintiff’s appeal from a denial of its JNOV motion, we direct the judgment be entered in favor of plaintiff. The judgment on defendant’s claim for violation of the UCL is affirmed. Each party is to bear its own costs on appeal.
The petition of defendants, cross-complainants and appellants for review by the Supreme Court was denied July 8, 2015, S226311.
Notes
Plaintiff also argues the trial court committed reversible error by instructing the jury on sham guaranty law, refusing to bifurcate the trial, and allowing the introduction of evidence relevant to defendants’ counterclaim. The merits of these claims are dubious, but we need not, and do not, reach them.
Sabal is the servicer for plaintiff's entire loan portfolio. Though Sabal is ostensibly an agent, defendants assert that it runs plaintiff.
Hereinafter, all statutory references are to the Code of Civil Procedure unless otherwise specified.
Defendants argue that plaintiff waived its substantial evidence challenge because its statement of facts is “entirely devoid of evidence that supported the jury’s verdict.” However, defendants fail to detail what evidence plaintiff excluded from its brief. Defendants’ primary concern is that plaintiff “spins” the evidence in its favor, and that it “blend[s]” the loan to Nohea with the bank’s actions related to No Boundaries. However, as set forth below, the relationship between No Boundaries and Nohea is central to this dispute. Moreover, the only significant difference between plaintiff’s and defendants’ statement of facts is their discussion of the evidence related to defendants’ UCL claim, evidence which is irrelevant to plaintiff’s appeal.
Because the verdict is not supported by substantial evidence, plaintiff’s arguments regarding the trial court’s sham guaranty instructions are moot. In any event, we agree with defendants that plaintiff forfeited the argument by failing to object at trial. But we observe that plaintiff’s criticism of the instructions have merit. The trial court instructed the jury defendants had the burden to prove that “the purported debtor is nothing other than an instrumentality used by the individuals who guarantied the debtor’s obligation; and ... the instrumentality does not remove the individuals from their status and obligation as debtors.” It also stated: “Even when a corporation is a nominal borrower and the debt is guarantied by its officers and shareholders, the guaranties may nevertheless be sham guaranties. This is true even though the corporation’s debt does not directly obligate the shareholders and officers.” The latter quotation is a close paraphrase of
River Bank, supra,
Defendants also argue that plaintiff failed to prove it was damaged by virtue of any breach of the written guaranties. They reason that an independent professional appraisal conducted in April 2012 showed the property was worth more than the amount due and owing on the debt, and that plaintiff failed to mitigate its damages by waiting to sell the property until August 2012. Even putting aside the vagaries and unpredictability of the real estate market, pursuant to their guaranty agreements, defendants waived their right to a fair value hearing under Code of Civil Procedure section 580a. The guaranties provide that defendants’ “obligation may be reduced only by the price for which the collateral is sold at foreclosure sale, even if the collateral is worth more than the sale price.”
Defendants argue their cross-appeal should be reviewed de novo since the trial court’s application of the UCL was purely a legal question. But as evidenced by defendants’ own brief, the resolution of their counterclaim turns on a number of factual questions. In any event, because we find that the guaranties at issue are not shams, defendants’ claim that plaintiff’s attempts to enforce them are unfair and unlawful would also fail under de novo review.