In William K. Kirkpatrick v. West American Bank, 98 Daily Journal D.A.R. 8111, the Third Appellate District affirmed a summary judgment in favor of West America Bank ("Bank") in an action to declare that the Bank waived its loan security and forfeited its right to collect a debt of approximately $4 million for violation of the one form of action rule. (Code Civ. Proc., § 726.)
The Case
The Kirkpatrick Family Trust (the "Trust") borrowed money from the Bank and signed a nonrecourse note, secured by a deed of trust on an apartment complex. The Bank filed an action against the Trust for breach of a claimed implied obligation under the loan agreement to sell off apartment units as condominiums. The Trust did not interpose the one form of action rule or the nonrecourse provision of the note as defenses. Rather, it successfully moved for summary adjudication of that count on the merits.
The Trust then filed the separate action for declaratory relief contending that the Bank's failure to foreclose under the deed of trust was an election of remedies which waived the security under section 726, and that it cannot sue on the note because of its nonrecourse provision. The Trust sought a forfeiture of the approximate $4 million debt which it had agreed to repay. The "wrongful action" appears to have been the suit for damages for breach of the claimed implied obligation, rather than a suit seeking judicial foreclosure.
Significantly, prior to judgment in the subsequent action, the Bank amended the complaint to include a claim for foreclosure on the real property.
Sanction Issue
Section 726 does not directly prescribe the sanction for violation of the one form of action rule. Rather, the courts have fashioned various remedies to advance its purposes. The three purposes that are generally cited in favor of the rule are:
- prevention of a multiplicity of suits;
- compelling competitive bidding to test the value of all security for the debt; and
- forcing the creditor to look to the security as their primary fund for payment of the debt before looking to the debtor.
The court cited Security Pacific National Bank v. Wozab (1990) 51 Cal.3d 991, 997, stating the general synopsis of the rule:
[S]ection 726 is susceptible of a dual application -- it may be interposed by debtor as an affirmative defense or it may be operative as a sanction. If the debtor successfully raised the section as an affirmative defense, the creditor will be forced to exhaust the security before he may obtain a money judgment against the debtor for any deficiency.... If the debtor does not raise the section as an affirmative defense, he may still invoke it as a sanction against the creditor on the basis that the latter, by not foreclosing on the security in the action brought to enforce the debt, has made an election of remedies and waived the security.
In the subject case, the Trust argued that a violation of section 726 gives rise to a mandatory sanction of loss of the security. It then argued that because of the nonrecourse provisions of the note, the bank also waived the underlying debt. The Trust further argued that the case had proceeded far enough along the "spectrum," from filing of the complaint to judgment, to trigger the "mandatory sanction." The Bank responded, on the other hand, that the one form of action rule applies only when the case has gone to a "final" judgment. Although the Trust did obtain partial summary judgment on one of the counts, it was not a final judgment and the Bank had thereafter amended its complaint to add the foreclosure count, evading the sanction.
Spectrum Analysis
The Trust's "spectrum" analysis was based on Shin v. Superior Court (1994) 26 Cal.App.4th 542. In Shin, the creditor was found to have violated the one form of action rule where it obtained a prejudgment attachment against Korean real property owned by the debtor, Shin. The creditor then sought to foreclose the deed of trust on property in California. In its analysis, the court discussed the continuum between the filing of the complaint and obtaining judgment. The court suggested that each case needs to be reviewed to determine where along the spectrum a violation of the one form of action rule may exist. The Shin court based its analysis on a citation to Miller and Starr, California Real Estate, a very well-known and respected treatise on real property law.
In the instant action, the court stated that this "analytic scheme," articulated by Miller and Starr, was before the advent of the Wozab decision. Wozab explained that the conduct of the creditor, which did not amount to an "action" under Code of Civil Procedure section 22 (an action is an ordinary proceeding in a court of justice by which one party prosecutes another for the declaration, enforcement or protection of a right, the redress or prevention of a wrong, or the punishment of a public offense), may nonetheless provoke the sanction of loss of the security.
In Wozab a bank's setoff was not considered an action at all. However, the conduct warranted the sanction of loss of the creditor's security under the common law rule that the creditor must proceed against the security before enforcing the underlying debt. The court found that a banker's setoff, because it is not an action, does not, and cannot, lie along the spectrum between the filing of an action and the recovery of a personal money judgment on a debt secured by a mortgage or deed of trust. The court found that it was analogous to an action against property of the debtor, other than that which secures the debt, such as an attachment, which has resulted in a seizure and transfer to the possession of the creditor. The sanction is justified by the policy advanced to Wozab.
Election of Remedies Doctrine
The court then went on to explain that the Trust's "spectrum" theory did not explain the case law and had no application to the case. Rather, the court found that it is explained by another principle, i.e., the election of remedies doctrine. By proceeding to prosecute an action on the debt rather than foreclosing on the mortgage, the creditor has exhausted his remedy as to the note and the security.
In explaining the theory of election of remedies, the court summarized the doctrine based upon two occurrences, the doctrine of res judicata and the doctrine of estoppel. The court found that an estoppel arises when the action is such that permitting the plaintiff to seek an alternative remedy will prejudice or work toward a substantial injury to a defendant. An act typically giving rise to an estoppel is an attachment. In the instant case, the conduct of the Bank in litigating the count of its complaint for damages for breach of a claimed implied obligation to the point of an adverse partial summary judgment did not constitute an election of remedies under the res judicata branch of an election remedies doctrine, which only occurs when the judgment obtains finality. Since it was only summary adjudication of one count, not all, there had been no final judgment.
As to the other branch of the election of remedies doctrine, i.e., estoppel, the only prejudice the Trust attributes to the Bank's litigation is that it incurred attorneys' fees in defense of the claim. This claim did not sufficiently demonstrate the prejudice necessary to invoke the doctrine. The court found that the Bank's change of remedy after the partial summary judgment was not the cause of the inequitable harm to the Trust. Accordingly, the court found that there was no one form of action rule.
In summary, this district court requires that an action, or an event analogous to an action, occur before the doctrine can be invoked. The court explains the application of the sanction effect of the loss of security based on an election of remedies that occurs either through res judicata or through estoppel. To lender clients, this means that you must include a judicial foreclosure action in your lawsuit whenever seeking to enforce claims against borrowers where your debt is secured by real property. You also must make sure that you do not go to judgment before you include that claim. If your lawsuit does not include a foreclosure cause of action, you must amend that cause of action before going to judgment. In addition, you must be sure you do not take any action that can be deemed an election of your remedy to pursue a personal judgment rather than seeking to enforce the security. If you do, the doctrine and its intended sanction effect can be invoked to potentially cause a loss of the security.
*article courtesy of Mitchell Ludwig of Knapp Peterson Clarke, mbl@kpclegal.com