California Litigation Attorney Blog

When a probate judge cleared the way for the $2 billion sale of the Clippers not only Shelly Sterling came away as a winner. Donald and Shelly’s silent partners, the federal and California governments, were also in for their share of the sale. The Internal Revenue Service and the California Franchise Tax Board will reap a windfall for Donald’s racist comments to his mistress.

Sterling originally bought the Clippers in 1981 for $12 million. At the current maximum federal capital gain tax rate of 25% the sale should generate almost a half a billion dollars for the IRS coffers. In addition, the FTB should get over $200 million, given California’s top tax rate of 12.30%. California, unlike the federal government, does not have a lower rate for capital gain income. That should pay for about 100 yards of Jerry Brown’s bullet train to nowhere.

That is not Donald Sterling’s only tax problem. Sterling also reportedly lavished his girlfriend, V. Stiviano, with a series of gifts including a Ferrari, two Bentleys, a Range Rover and a $1.4 million apartment. Under established federal case law, payments to mistresses are considered “gifts” subject to gift taxes paid by the giver and not compensation income for “services rendered” taxable to the recipient. Currently, every taxpayer has a life time exemption of $5,340,000. Meaning the first $5,340,000 of gifts given are not subject to gift or estate taxes. One wonders whether Donald Sterling reported the gifts to the IRS and whether Shelly agreed to “split” the gift to lower the hit on each of their lifetime exemptions for gift tax.

Lastly, NBA Commissioner Adam Silver fined Sterling $2.5 million. The tax question is whether the fine, if ever paid, would be deductible as a business expense or not deductible as a personal expense. I would argue that it would be a business expense as it is related to the Sterling’s basketball business, but the IRS may think otherwise. In either case Sterling’s silent partners will get their share of proceeds of the sale or Sterling will be in even deeper water.

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The article below appeared in the California Real Property Journal, the Official Publication of the Real Property Section of the State Bar of California. A PDF of the article is available here.

California Real Property JournalVolume 32, Number 2, 2014

Mortgage Shotgunning and the Priority of Trust Deeds

By Scott Talkov

This article reviews recent California case law concerning the priority of trust deeds among lenders targeted by the real estate fraud known as mortgage shotgunning. The cases reveal a district split among the California Courts of Appeal when evaluating cases with identical facts. In these cases, the county recorder’s delay in indexing recorded documents gives rise to a claim from the holder of the second duly recorded interest that it did not receive constructive notice of the first duly recorded lienholder’s interest. The author recommends that the California Supreme Court resolve this circuit split by establishing that the first duly recorded interest by a bona fide purchaser or encumbrancer be declared first in priority pursuant to California’s statutory race-notice recording system.

  1.                Mortgage Shotgunning Fraud

The real estate fraud known as “mortgage shotgunning” or “mortgage slamming” occurs when a homeowner obtains multiple loans secured by the same home in order to receive loan proceeds that, in combination, greatly exceed the value of the real property.[1] The homeowner commits fraud by failing to inform each lender that s/he has obtained multiple loans secured by the same property. The homeowner[2] then absconds with the proceeds of the multiple loans on the same property.[3]

This species of real estate fraud, declared to be an “alarming trend” in 2009,[4] is difficult to detect because of the delay between the trust deed recordation date and the date on which the recorded trust deed is available for discovery by title searchers. Each lender is thereby led to believe that it will have a fully-secured, first-priority trust deed. Indeed, defrauding parties generally use multiple title insurers, notaries, escrow companies and lenders to reduce the chance of fraud detection before the defrauding party can abscond with the funds.

After falling victim to this fraud, lenders find themselves in a dispute over which lender has a fully-secured, first-priority interest in the subject property. Those without a first-priority lien hold a less-secure, potentially worthless interest in the real property.[5]

The resulting litigation between victimized lenders (often funded by their respective title insurers) has been decided differently in California’s Fourth District Court of Appeal (Riverside) and Second District Court of Appeal (Los Angeles). Each district has reached opposite conclusions as to the priority of competing trust deeds recorded by victims of mortgage shotgunning. This district split raises fundamental questions about California’s race-notice recording system. In these cases, good faith purchasers (encumbrancers) without notice of an existing trust deed, have recorded their trust deeds shortly after the recordation of an immediately preceding trust deed. Each case also involved a claim that the date on which the county recorder indexes the trust deed changes the priority of those interests from the assumed priority under the race-notice system. However, the two courts reached opposite conclusions, creating a district split that should be reconciled by the California Supreme Court.

  1.                The Race-Notice Recording System

The recording priority of trust deeds in California (and many other states) is governed by the state’s race-notice recording statutes, which allow a lender or purchaser to obtain an interest in real property that has priority over another interest in the same real property by:

  • Acquiring the interest as a bona fide encumbrancer (i.e., lender) or purchaser for valuable consideration, meaning that s/he pays consideration in exchange for an equity or fee interest in certain real property, while possessing neither actual knowledge nor constructive notice of a previously created interest in that property; and
  • “First duly record[ing]” the interest, meaning that the lender or purchaser records the granting instrument before any competing interest in the property is recorded.[6]

In California, these rules were codified long ago in 1872. Specifically, Civil Code section 1213 states that recorded documents provide constructive notice to third parties, thereby preventing anyone with a subsequently recorded interest from wresting title to the property from the holder of current title without paying value for that interest.

Central to the disputes in mortgage shotgunning litigation, Civil Code section 1107 provides that “[e]very grant of an estate in real property is conclusive against the grantor, also against every one subsequently claiming under him, except a purchaser or incumbrancer who in good faith and for a valuable consideration acquires a title or lien by an instrument that is first duly recorded.”

Another pivotal statute in these disputes is Civil Code section 1214. This statute reads in relevant part, “[e]very conveyance of real property . . . is void as against any subsequent purchaser or mortgagee of the same property . . . in good faith and for a valuable consideration, whose conveyance is first duly recorded.”[7] The essence of Civil Code section 1214 lies at the heart of mortgage shotgunning litigation. It “renders an unrecorded conveyance void as to subsequent bona fide purchasers who record their title first.”[8]

When lenders record their secured interests in real property and fund a loan with hundreds of thousands of dollars (or more) in consideration, only to later find that their interests may be worthless, litigation frequently ensues. In such litigation, lenders with a “duly recorded” deed of trust often assert that a recorded document does not provide notice to third parties until it is indexed by the county recorder, perhaps several days after recordation. This argument tests the very purpose of the race-notice recording system.

  1.                Simultaneously Recorded Trust Deeds Are Equal in Priority

The California Court of Appeal has been called upon twice in recent years to determine the priority of simultaneously recorded trust deeds.[9] Although neither case mentions “mortgage shotgunning,” the fact that they involve bona fide encumbrancers disputing the priority of their lien rights in the same real property suggests that that this form of mortgage fraud gave rise to the disputes.

In 2011, the California Second District Court of Appeal in Los Angeles issued a published opinion in First Bank v. East West Bank in which lenders with loans secured by the same residential real property dropped off their trust deeds at the Los Angeles County Registrar-Recorder/County Clerk before it opened, causing both trust deeds to be file stamped as if they were recorded at 8:00 A.M. the same morning.[10] One lender claimed that its trust deed was first in priority because its deed had been indexed first.[11] The court rejected this argument, finding that it “would disrupt the statutory scheme to make priority turn on the random act of indexing,” a process that allows the county recorder to find instruments in its computerized database.[12] Instead, the court deemed the lenders to hold interests of equal priority in the subject property. This decision drew considerable attention among mortgage attorneys, including Golden Gate University Professor of Law Roger Bernhardt, who wrote an article advising lenders on how to deal with tied priority.[13]

In 2012, the California Fourth District Court of Appeal in San Diego authored an unpublished opinion in Baer v. Douglas.[14] In Baer, two trust deeds were time and date stamped as though they were recorded at the same moment in time. One lender contended that its lower recording number indicated an earlier priority, and should break the tie. The court rejected this argument, finding that neither the sequence of the recording numbers stamped by the recorder on the parties’ simultaneously recorded trust deeds nor the sequence of the page numbers where the trust deeds appear in the official records, determined the relative lien priority of each trust deed. Instead, the court upheld the holding and reasoning in First Bank,that the time of recordation is the only relevant factor in determining priority.[15] In other words, indexing plays no role in the court’s analysis.

These cases highlight the unwillingness of courts to disrupt the conclusion dictated by the race-notice system, that the first, duly recorded interest maintains priority over others, even when two trust deeds are both recorded “first.” While each of these cases involved a determination that each of the defrauded lenders would share in the loss, a more difficult problem arises when courts must decide which defrauded lender will take no loss whatsoever, with all other defrauded lenders bearing the full loss.

  1.                Districts Are Split as to Which Trust Deed Has Recording Priority Among Trust Deeds Recorded at Different Times by Good Faith Purchasers Without Notice

Although simultaneous recording raises fascinating legal issues, more frequently, multiple interests in the same real property are recorded close in time, but not concurrently, and neither interest holder has actual or constructive notice of the other interest at the time its deed records. Courts addressing this fact pattern in two unpublished cases have reached opposite conclusions as to which trust deed has priority over the other, an issue due for resolution by the California Supreme Court.

  • Simental: The First Duly Recorded Interest Wins

In 2010, the California Fourth District Court of Appeal in Riverside decided the case of Simental v. Inyo-Mono Title Co. Profit-Sharing Plan.[16] In Simental, two bona fide encumbrancers paid value for what they each thought was the trust deed in first lien position on a parcel of real property. The later-recording party argued that it did not have constructive notice of the first-recorded trust deed because that deed had not been indexed by the county recorder when the later-recording party recorded its interest. The Simental court determined that “the question is not whether [the later-recording party] had constructive notice” of the first-recorded trust deed, but rather, who recorded first.[17]

            Simental made the rule quite clear, concluding that the first-recorded trust deed “won the race to the recorder’s office.” Hence, the lender under the first-recorded trust deed held the lien in first priority on the subject property.[18]

  • Bank of East Asia: The Second Duly Recorded Interest Wins

In 2013, the California Second District Court of Appeal in Los Angeles came to the opposite conclusion in Bank of East Asia U.S.A. N.A. v. Javaherian.[19] The facts of that case were identical to those in Simental:

The [Javaherian] deed of trust was recorded in the recorder’s office on March 2, 2005. The Bank’s deed of trust was recorded in the recorder’s office on March 3, 2005. The [Javaherian] deed of trust was indexed in the recorder’s office records on March 5, 2005, and the Bank’s deed of trust was indexed on March 7, 2005.[20]

Based on these facts, the Bank argued that its deed of trust had priority over the Javaherian deed of trust, because the Bank had no actual or constructive notice of the Javaherian deed of trust.

After quoting First Bank v. East West Bank extensively, the Court of Appeal reasoned that “[a]lthough the [Javaherian] deed was recorded first, it failed to provide subsequent purchasers and encumbrancers with constructive notice until it was indexed. Therefore, when the Bank’s deed of trust was duly recorded, the Bank was not charged with constructive notice of the prior deed of trust and the Bank’s interest is not subject to the [Javaherian] deed of trust.”

The court concluded that the second-recorded trust deed had priority, reasoning that “[b]etween the two innocent parties in this case, Javaherian was in the best position to protect her interest by promptly recording the [Javaherian] deed of trust and verifying that it had been properly indexed.”[21] Apparently, the court was critical that Javaherian did not record her deed of trust upon execution on February 7, 2005, but recorded her deed of trust nearly a month later, on March 2, 2005. In contrast, the Bank executed its deed of trust on February 28, 2005, and recorded it three days later, on March 3, 2005.

No statute or precedent provides a balancing test in a situation involving two innocent lenders, nor does any test determine which party is in the “best position” to protect its interest by promptly recording and/or verifying the indexing of its trust deed. Either party could have done so here.

Further, even if Javaherian had undertaken such an effort, the situation would not have changed. For example, if Javaherian had verified on March 5 or 6, 2005, that the Recorder’s Office had indexed her trust deed, Javaherian would not have had notice of the Bank’s trust deed recorded on March 3, 2005. This is because the Recorder’s Office did not index the Bank’s trust deed until March 7, 2005. Such an analysis of the facts is at odds with the court’s reasoning that Javaherian’s interest should be subordinate because she “was in the best position to protect her interest by promptly recording [her] deed of trust and verifying that it had been properly indexed.”[22] By implication, this case seems to question the race-notice statutes in California.

In light of the district split created by Simental and Bank of East Asia, the California Supreme Court should address this issue to provide clarity for courts, attorneys, lenders and title insurers.

  1.                Author’s Recommended Approach: The First Duly Recorded Interest Should Prevail

The disparate outcomes of the recent mortgage shotgunning cases raise the issue of whether the first duly recorded interest should prevail. The author argues that it should.

Some courts have decided, and many litigants have argued, that later-recording interests should be first in priority because the first-recorded interest did not provide constructive notice to the later-recording parties. These arguments rely upon “[t]he purpose of our recording statutes[, which] is to give notice to prospective purchasers or mortgagees of land of all existing and outstanding estates, titles, or interests in it whether valid or invalid, which may affect their rights as bona fide purchasers and so as to protect them before they part with their money.”[23]

However, the recording statutes further encourage such notice by “penaliz[ing] the person who fails to take advantage of recording.”[24] Indeed, the severe penalty found in Civil Code section 1214 grants priority to the “first duly recorded” interest without regard to whether third parties have constructive notice of that interest at the moment of recordation or at any time thereafter. As such, the statute embodies the “race” of the race-notice recording statutes by encouraging all parties to promptly record their interests. Hence, the statute serves as the tiebreaker in all disputes between interests in real estate because it dictates that the first duly “recorded” interest prevails.

The argument made by later-recording lenders, such as the lender in Simental, that lack of constructive notice is sufficient to obtain priority misses the point. Race-notice recording statutes seek to provide constructive notice. They may not do so instantly or perfectly, but the system aims to provide this type of notice nonetheless. However, whether a subsequently recorded lienholder has constructive notice of an earlier lien on the same real property is not determinative of the priority of a duly recorded interest.[25]

In fact, the modern reality of the title insurance industry is that title insurance companies maintain their own title plants to search recorded instruments. As such, the litigation in this area of law seemingly results from private title searches performed earlier than the date on which the funds were issued or from delays in the indexing of instruments by private title plants—not from reliance on the indexing function of the county recorder.

  1.                Equitable Subrogation as an Alternative Theory to Decide Priority

Lenders facing a complete loss of principal on a secured investment have developed creative arguments in their attempt to avoid the harsh consequences of the race-notice rule. One theory that a recording party may rely upon is the doctrine of equitable subrogation.

In 2012, the Fourth District Court of Appeal in Santa Ana applied equitable subrogation to resolve a dispute between lenders regarding the priority of their trust deeds in J.P. Morgan Chase Bank, N.A. v. Banc of America Practice Solutions, Inc.[26] In Chase, the borrower sought to re-finance his house with a senior lien in favor of Chase. Unbeknownst to Chase, the borrower simultaneously obtained a business loan that was to be secured by a junior lien on his house in favor of Banc of America. Contrary to Banc of America’s understanding and the borrower’s intentions, Banc of America secured its lien first, followed thereafter by Chase paying off the pre-existing deeds of trust and recording what it thought would be a senior deed of trust. California’s “first in time, first in right” system of lien priorities dictated that Chase had a junior lien, absent judicial intervention.

Instead, the court found that this rule “is not without exceptions,” quoting Civil Code section 2897 to find that “[o]ther things being equal, different liens upon the same property have priority according to the time of their creation.”[27] The court found that this exception for equitable subrogation was best stated by the California Supreme Court in 1928:

One who advances money to pay off an encumbrance on realty at the instance of either the owner of the property or the holder of the incumbrance, either on the express understanding, or under circumstances from which an understanding will be implied, that the advance made is to be secured by a first lien on the property, is not a mere volunteer; and in the event the new security is for any reason not a first lien on the property, the holder of such security, if not chargeable with culpable and inexcusable neglect, will be subrogated to the rights of the prior encumbrancer under the security held by him, unless the superior or equal equities of others would be prejudiced thereby, and to this end equity will set aside a cancellation of such security, and revive the same for his benefit.[28]

Because Chase paid off the pre-existing liens except that of Banc of America, the only question for the court was whether Banc of America’s “equities are equal to or greater than Chase’s.”[29]

Finding that “[e]quitable subrogation looks to the intentions of the parties,” the court found that Chase’s later-recorded trust deed was senior to Banc of America’s earlier-recorded trust deed because that order of priority was “exactly what [the parties] bargained for.”[30] Indeed, Chase expected to receive a senior trust deed, and Banc of America expected to receive a junior trust deed.

Although the Chase court noted that “constructive notice, as opposed to actual notice, does not forestall application of equitable subrogation,”[31] it seems unlikely that the court would have reached the same result if Chase had simply relied upon the borrower’s representation that the trust deed would be senior without conducting any title search to find that Banc of America had recorded its trust deed. In this case, the Banc of America trust deed was “intervening” in the sense that it was filed after Chase began its loan process, though it was recorded over two months before Chase recorded its trust deed.

As explained above, equitable subrogation requires that the party claiming the doctrine is “not chargeable with culpable and inexcusable neglect.”[32]  If Chase had delayed too long before recording its trust deed, the excusable neglect requirement in equitable subrogation would suggest that the doctrine should not be applied.

Moreover, as between lenders in mortgage shotgunning situations, equitable subrogation cannot be asserted. Specifically, equitable subrogation is available “unless the superior or equal equities of others would be prejudiced thereby.”[33] In the context of mortgage shotgunning litigation between lenders, each lender has equal equities as each lender intended to have first priority. Hence, equitable subrogation should not apply, because neither lender intended to hold a junior interest in the property. As such, granting priority to a later-recording interest would violate the principal that equitable subrogation cannot be applied when it would be to the prejudice of a party with equal equities, namely the earlier-recording lender. This situation is contrast to the situation in Chase, where the first-recording party expected to hold a junior lien, but unexpectedly held a senior lien.

Thus, in mortgage shotgunning situations where each lender does not have notice of the other’s security interest in the subject real property, and is unaware that they may hold a junior interest, the first-recording party has superior equity. This alone should prevent application of equitable subrogation.

  1.                Proposal for Electronic Recording

Many of the issues complained of in mortgage shotgunning litigation could be resolved by a publicly-accessible electronic recording system.

Such a system would allow a user to log on, choose the relevant assessor’s parcel number for the applicable property, and upload the document. In addition, the county recorder could instantly produce a receipt showing all documents recorded prior in time to the user’s document, including those that are still pending human review by the county recorder. Under this system, if no such documents exist, a lender could fund loans worry-free, provided that courts uniformly agree that first in time is first in right. If another user submitted a document one second later, that user would see the newly uploaded document preceding his or hers, thereby providing constructive notice to the subsequent lender not to fund the loan.

  1.                Final Lesson: Record Promptly

Until and unless changes are made, lenders, title companies, and their counsel should learn from the existing case law in this area. The lesson is clear: a lender should promptly record its secured interests in real property to protect its priority. Moreover, lenders and title officers may be wise to conduct another title search several days after recording and before funding the loan (if possible), to determine if any earlier-recorded documents have been indexed. Finally, the decision in Bank of East Asia suggests that yet another title search should be conducted several days after the operative trust deed has been indexed, to determine whether a competing trust deed was later-recorded.

 

[1] See Core Logic, Mortgage Fraud Prevention and Detection Resource Guide (2d ed. 2012), available at http://www.corelogic.com/downloadable-docs/mortgage-fraud-prevention-and-detection-resource-guide.pdf.

[2] A homeowner without an existing lien on the property can engage in mortgage shotgunning by simply accepting multiple payments to purchase or refinance their property.

[3] Although mortgage shotgunning raises a number of interesting legal issues, this article focuses solely on the litigation between lenders under the race-notice statutory scheme in California.

[4] Mortgage Fraud News, Fannie Mae Mortg. Fraud Program, Apr. 2009, available at https://www.fanniemae.com/content/news/mortgage-fraud-news-0409.pdf.

[5] California’s anti-deficiency laws would seemingly be unavailable to protect the perpetrator of mortgage shotgunning fraud as “[t]he defense of sections 580b and 580d proscribing deficiency judgments is not available to the trustor as a defense to an action by the beneficiary for fraud.” Glendale Fed. Sav. & Loan Ass’n v. Marina View Heights Dev. Co., 66 Cal. App. 3d 101, 139 (1977).

[6] See Civil Code §§ 1107 and 1214.

[7] Although these two statutes are often cited concurrently, Civil Code section 1107 relates to a “grant of an estate,” which would include grant deeds. On the other hand, section 1214 relates to “[e]very conveyance of real property,” which includes trust deeds.

[8] Burkart v. Coleman (In re Tippett), 542 F.3d 684, 688 (9th Cir. 2008); accord 27 Cal. Jur. Deeds of Trust § 136. See Winding v. NDEX West, LLC, No. 11-16506, 2013 U.S. App. LEXIS 21548, at 2, 2013 WL 5739351 (9th Cir. Oct. 23, 2013) (citing Civil Code section 1214 in noting that “the date of recording determines priority of liens in California”).

[9] Baer v. Douglas, No. D057811, 2012 Cal. App. Unpub. LEXIS 2091, 2012 WL 917190 (Mar. 19, 2012) (unpublished); First Bank v. E. W. Bank, 199 Cal. App. 4th 1309 (2011).

[10] First Bank, 199 Cal. App. 4th at 1311.

[11] Indexing presumably occurs in the order that the interests are numbered, even though such unique identifiers may reflect interests that are deemed recorded at the same moment in time.

[12] No argument was made in this case that lenders or title insurers utilize or rely upon the county recorder’s indexing system, as opposed to the title plants maintained by title insurers.

[13] Roger Bernhardt, Living with Tied Priority (Jan. 3, 2012), http://www.rogerbernhardt.com/index.php/ceb-columns/321-living-with-tied-priority-first-bank-v-east-west-bank.

[14] Baer, No. D057811, 2012 Cal. App. Unpub. LEXIS 2091, 2012 WL 917190.

[15] Id.

[16] Simental v. Inyo-Mono Title Co. Profit-Sharing Plan, No. E048891, 2010 Cal. App. Unpub. LEXIS 4414, 2010 WL 2354225 (Jun. 14, 2010) (unpublished).

[17] Id., No. E048891, 2010 Cal. App. Unpub. LEXIS 4414, at 14, 2010 WL 2354225.

[18] Id., No. E048891, 2010 Cal. App. Unpub. LEXIS 4414, at 15, 2010 WL 2354225.

[19] Bank of East Asia U.S.A. N.A. v. Javaherian, No. B242079, at 7, 2013 Cal. App. Unpub. LEXIS 422, at 10-11, 2013 WL 206127 (Jan. 18, 2013) (unpublished).

[20] Id., No. B242079, at 2-3, 2013 Cal. App. Unpub. LEXIS 422, at 3-4, 2013 WL 206127.

[21] Id., No. B242079, at 7-8, 2013 Cal. App. Unpub. LEXIS 422, at 10-11, 2013 WL 206127.

[22] Id.

[23] City of Los Angeles v. Morgan, 105 Cal. App. 2d 726, 733 (1951) (citation to recording statutes omitted).

[24] As the California Department of Real Estate explains to real estate brokers, “[t]he general purpose of recording statutes is to permit (rather than require) the recordation of any instrument which affects the title to or possession of real property, and to penalize the person who fails to take advantage of recording.” Cal. Dep’t of Real Estate, Reference Book: Information Relating to Real Estate Practice, Licensing and Examinations, ch. 5 Title to Real Property 51 (2010), available at http://www.dre.ca.gov/files/pdf/refbook/ref05.pdf.

[25] The absence of notice is a necessary, but not sufficient, requirement for status as a bona fide purchaser or encumbrancer. See First Bank v. E. W. Bank, 199 Cal. App. 4th 1309, 1314 (2011) (“The absence of notice is an essential requirement in order that one may be regarded as a bona fide purchaser.”).

[26] JP Morgan Chase Bank, N.A. v. Banc of Am. Practice Solutions, Inc., 209 Cal. App. 4th 855, 860 (2012). See Adam M. Starr, When “First in Time” Isn’t Early Enough: California Court of Appeal Reaffirms the Doctrine of Equitable Subrogation, Cal. Real Prop. J., vol. 31, no. 2, 2013, available at http://mhgm.com/our-resources/articles/When-First-In-Time-Isn-t-Early-Enough-California-Court-of-Appeal-Reaffirms-the-Doctrine-of-Equitable-Subrogation; see also Roger Bernhardt, Equitable Subrogation: A Sensible Remedy, but Don’t Count on It (Nov. 30, 2012), http://www.rogerbernhardt.com/index.php/ceb-columns/338-equitable-subrogation-chase-bank-v-banc-of-america.

[27] Chase, 209 Cal. App. 4th at 860.

[28] Simon Newman Co. v. Fink, 206 Cal. 143 (1928).

[29] Chase, 209 Cal. App. 4that 862.

[30] Id.

[31] Id. at 861.

[32] Id. at 862 (quoting Simon Newman, 206 Cal. at 146).

[33] Id.

The author would like to thank this Journal’s Editor-in-Chief, Teresa B Klinkner; his real estate law professor, Dale Whitman; Reid & Hellyer, APC Senior Attorney James J. Manning, Jr., Coblentz Patch Duffy & Bass LLP Attorney Misti M. Schmidt, Locke Lord LLP Attorney Allison Harris and Andrade & Associates Attorney Brett K. Wiseman for their suggestions and feedback on this article. This article is dedicated to Doris Warner, whose commitment to education made this contribution possible.

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With many Inland Empire residents hitting hard times, bankruptcy petition preparers have offered their services to help debtors file for bankruptcy. Hiring a bankruptcy attorney may be a much better decision in the long run.

Increased Use of Bankruptcy Petition Preparers

BankruptcyAs reported by the U.S. Courts, there has been an increased use of bankruptcy petition preparers in recent years, which the courts describe as a “concern.” The Bankruptcy Court for the Central District of California, which includes Riverside and San Bernardino counties, even keeps a list of bankruptcy petition preparers that have been enjoined (prohibited) from preparing bankruptcy petitions.

What is a Bankruptcy Petition Preparer?

A bankruptcy petition preparer (often known as a “BPP”) is as a person who is not an attorney or employed by an attorney who prepares a petition or any other document for filing by a debtor in a bankruptcy court or district court. 11 U.S.C. § 110(a).  The charge typically allowed for preparing a bankruptcy petition is no more than $200, which does not include the court filing fee.

A Bankruptcy Petition Preparer Cannot Provide Legal Advice

As the United States Trustee for the Central District of California explains, “a bankruptcy petition preparer may only type forms.” If they go further, they risk violation the prohibition on offering “legal advice,” which includes:

  1. whether to file a file a bankruptcy petition;
  2. whether filing under Chapter 7, 11, 12 or 13 is most appropriate;
  3. whether the debtor’s debts will be discharged in bankruptcy;
  4. whether a debtor will be able to retain their home, car, or other property after filing for bankruptcy;
  5. the tax consequences of filing for bankruptcy, including whether tax claims will be discharged;
  6. whether the debtor may or should promise to repay debts to a creditor or enter into an agreement to reaffirm a debt (e.g. a mortgage on a house or loan on a car);
  7. advice concerning how to characterize the nature of the debtor’s interests in property or the debtor’s debts; or
  8. advice concerning bankruptcy procedures and rights.

See 11 U.S.C. § 110(e)(2).

Why is the Government Concerned About Bankruptcy Petition Preparers?

The courts and the U.S. Trustee’s office are concerned that bankruptcy petition prepapers may not properly serve debtors who need their services. Notably, too many bankruptcy petition preparers provide legal advice by advising debtors which chapter of the bankruptcy code is best for them, the nature and extent of their property, which exemptions might apply and whether a bankruptcy will discharge their debts.  Even the use of “software that prepares bankruptcy petitions” by a bankruptcy petition prepaper is also the unauthorized practice of law.  In re Reynoso, 477 F.3d 1117 (9th Cir. 2007).

The bankruptcy trustees and U.S. Trustee’s office are skilled at detecting petitions that were prepared with the assistance of a bankruptcy petition preparer when they fail to list their name. When these petitions are detected, the remedies can be severe.

Advice to Debtors: Hire a Bankruptcy Attorney

More importantly, why would a debtor want to file a bankruptcy without obtaining proper legal advice from an individual who is legally allowed to provide such advice?

Debtors may believe they are saving money, but too often, this minor savings results in a a legal mess. For example, a debtor may realize after their petition is filed that bankruptcy was not the right solution to their problems because they have property that must be turned over to the bankruptcy trustee or that all of their debts may not be discharged. They may even find themselves accused of lying on their bankruptcy petition, which has serious consequences.

These are all issues that can be addressed before you file for bankruptcy by consulting with a bankruptcy attorney.

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distressed lawyer

Americans enjoy the myth that bankruptcy only happens to other people. We have the top 9 REAL reasons that Americans file bankruptcy, and tips on how to avoid these mistakes.

The Myth of the Medical Bankruptcy

NerdWallet.com claims that “medical bankruptcy accounts for a majority of personal bankruptcies.” President Obama furthered this myth in defending ObamaCare, claiming that “no one should go broke just because they get sick.”

This myth was debunked by TheHill.com, which found that “among Americans who cited medical debt as a contributing factor in their bankruptcy filing, only 12 to 13 percent of their total debts were medical. ”

So where did the other 87 to 88 percent of debts come from? The experienced bankruptcy attorneys at one California law firm have advice that may save you from needing their services!

 1. Mortgage Debt

Americans love their homes, but too many have followed the myth that an expensive house (purchased on credit) equates to wealth. As long as you are living in your house (rather than renting it out), you are consuming its value. Bankruptcy courts have explained that “[s]helter is certainly a higher priority than the possibility of realizing a profit.” In re Grover, 2013 WL 3994608 (Bankr. N.D. Iowa Aug. 2, 2013). Stay within your means by purchasing a modest house to minimize the risk of foreclosure and bankruptcy.

2. Cars

Cars are an expense. Other than certain classic cars, they depreciate over time. After years of making principal and interest payments, your car will likely have little value. Check the true cost of ownership to determine you really need an expensive car, or if a modest vehicle will keep you out of financial trouble.

3. Student Loans

Even though student loans are generally not dischargeable in bankruptcy, those monthly payments will make it harder to meet your other obligations. Be wary of taking on student loan debt that you won’t be able to afford.

4. Spending Money You Don’t Have & The Optimism Bias

Spending on credit cards can be a acceptable if you are paying the card in full every month. If not, you’ll end up paying exorbitant interest rates for the money you borrowed to eat at a restaurant, buy clothes, take a vacation or something else you didn’t have the money for. Steve Martin explained it best on Saturday Night Live: Don’t buy things you can’t afford. If you’re buying things you can’t afford under the belief that you’ll have the money tomorrow (after you get that promotion at work, the stock market goes up, etc.), you may have fallen victim to the optimism psychological bias. Plan your finances as though tomorrow will be just like today (or potentially worse) to avoid these problems. The only good news is that unsecured credit card debt is usually dischargeable in bankruptcy.

5. Taking on Other People’s Problems

Too many Americans are willing to take on the financial or personal problems of other people. Does your friend or family member not qualify for a lease, mortgage, credit card or student loan on their own? Maybe the lender knows something that you don’t, namely that this friend or family member is a high risk. Be very careful in co-signing or becoming the guarantor on loans, and know when to pull the plug if you’re paying for someone else’s problems as you may get pulled under as well.

6. Excessive Leverage & Risk-Taking

Leverage is the financial principle that borrowing to purchase an investment can multiply the gains and the losses. For example, if you borrow money at 5% to buy an investment that generates enough income to pay the interest, you have positive leverage. However, if that investment does not generate enough income to cover that interest, you’ve obtained negative leverage and may find yourself going broke as you pay out of pocket to keep that investment, which may lead to a bankruptcy filing. Other forms or risk-taking can include not purchasing title insurance, homeowners insurance or health insurance.

7. Litigation

Most Americans cannot afford the attorney’s fees of a protracted court fight. If you’re being sued, there is always the possibility that the other side may obtain a judgment against you, and potentially obtain an award of their attorney’s fees. This may come up in the context of a nasty divorce, an unpaid credit card or breach of contract. If you can settle a lawsuit early for a reasonable sum, you may be able to avoid bankruptcy. Of course, consult with an attorney about these complex matters.

8. Spending Uncle Sam’s Money

When times get tough, too many Americans borrow by decreasing their tax withholdings (employees), failing to pay taxes that will be due (contractors), or borrowing from the employee trust fund- money that was deducted from employee payroll for taxes for the purpose of being paid to the government (employers). Whether or not bankruptcy will discharge such taxes is a complex issue that requires consultation with an experienced bankruptcy attorney.

9. Catastrophes

Contrary to common perceptions, serious life catastrophes are the least common reason that Americans file bankruptcy. Such catastrophes can include prolonged job loss, divorces involving significant debt and serious medical bills. Although these do occur, do not fall into the trap of believing that these are the common way to find yourself in bankruptcy.

If you’ve found yourself unable to pay your debts, bankruptcy may provide you with the fresh start that you need. Consult with an experienced bankruptcy attorney to determine if you qualify for bankruptcy and whether it will provide you with the relief that you may need.

Disclaimer: This blog post provides commentary based on the personal observations of a California bankruptcy attorney. No statistical analysis has been used.

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For those employers who had all but given up hope of receiving relief from the courts, the California Supreme Court recently provided a glimmer of hope with its holding in Duran v. U.S. Bank.

Duran involved a class of 260 business banking officer (“BBO”) employees who sued U.S. Bank to recover unpaid overtime wages.  U.S. Bank contended that each BBO was subject to an “outside salesperson exemption,” which was met when an employee spent more than half of his or her time away from the employer’s business.  The prime issue in Duran, therefore, was whether the BBO’s were properly classified as exempt (and therefore not entitled to overtime). 

 In order to answer that question the trial court conducted a mini-trial of 20 randomly selected employees.  During the course of the mini-trial, the trial court determined that U.S. Bank had misclassified 19 of the 20 randomly selected employees.  The trial court then decided it could extrapolate from the mini-trial results that all 260 employees had been misclassified because the Plaintiffs’ expert statistician testified that he had calculated  “with 95% confidence that all 260 employees” have been misclassified.  The trial court refused to allow U.S. Bank to put forth evidence that at least 70 of the 260 employees were not misclassified. 

The California Supreme Court ultimately held that while statistical sampling can in some instances be used to determine both liability and damages, the employer must be given a chance to present proof of all of his or her affirmative defenses and must be given the chance to impeach any statistical model which plaintiff proffers.  Because the trial court did not allow the employer to present his affirmative defenses and impeach the plaintiff’s statistical model, the case was remanded back to the trial court for a new trial.  Thus, although the California Supreme Court has given its tacit approval to the theoretical use of statistical sampling to prove liability (which was a setback for employers), in practice this will likely be difficult to achieve.

Hopefully, Duran will rein in class action plaintiffs and will slow down the onslaught of class action litigation.   If nothing else, Duran provides employers with a few more arrows with which to defend class actions.  If you are presently involved in a class action lawsuit, make sure to discuss this case with your California employment attorney  to determine if there are portions of the decision helpful to your defense.

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Friends:

 This month’s employer tip concerns an employer’s ability to seek reimbursement from an employee for the cost of education or training.   

 Many employers train or educate employees at considerable expense. Can employers be reimbursed if an employee leaves shortly (within a few years) after completing the training/education?  Can you deduct the cost of training/education from an employee’s wages?

 The good news is that employers can require employees to execute training/education cost repayment contracts if the employees are contractually obligated to repay the cost of education/training in the event that the employee leaves employment before a certain date. (See Hassey v. City of Oakland (2008) 163 Cal.App. 4th 1477.) In order to increase the chance that such a repayment contract will be upheld in the event of a legal challenge, the amount of repayment should be based upon the actual and realistic estimated expenses and should be pro-rated based upon the total time worked. For example, an employer might forgive 20% of the cost each year for a five year period.  To the extent the training/education involves the employer’s trade secrets or intellectual property, the employer may also want to include a paragraph or two in the contract that the employee agrees not to disclose trade secrets or intellectual property to third parties.

 The bad news is that employers cannot deduct the cost of the education/training directly from an employee’s wages.  Instead, the contract must be treated like a loan where the employee provides reimbursement to the employer. Employers should not make the mistake of withholding any amount owed under the contract as that could subject you to penalties which far exceed the amount actually owed. In the event an ex-employee does not repay the loan, the employer’s remedy will likely be found in small claims court or a limited civil action, depending upon the amount owed.

 Of course, always consult a qualified employment attorney to determine the lawfulness of any actions taken in the scope of an employee training/education cost repayment contract.

 

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Anonymous Internet SurferCompanies commonly spend substantial resources in developing information that allows for profitable operation. Valuable information may take many forms, such as customer lists, pricing formulas, product specifications and business plans. A challenging problem that must be addressed by any employer is how to protect those trade secrets from being used by former employees after they leave to work for a competitor.

Like most states in the United States, California has adopted the Uniform Trade Secrets Act (“UTSA”), found at Civil Code sections 3426.1-3426.11. Under the UTSA, if a company takes reasonable measures to protect its information, and if steps are taken to maintain the secrecy of the information, California Courts will protect the information as a trade secret.

The protection afforded to trade secrets under the UTSA is not limited to recorded versions of information, such as documents or electronic data. In California, it is not a requirement that an employer establish that the employee physically took trade secret information. Rather, the UTSA also affords protection of the contents of an employee’s memory. Therefore, the misappropriation of a trade secret can be shown simply by establishing that the employee used or disclosed the content of his or her memory regarding a trade secret.

The most prudent approach for an employer is to minimize the risk of loss of trade secrets by taking all reasonable measures available to protect the trade secrets. The measures taken by the employer should include:

  • Use a confidentiality agreement that is signed when an employee is hired. The agreement should clearly state that the employee will come into possession of company trade secrets and that the trade secrets are not to be disclosed both while employed by the employer and after the employment ends. If possible, list specific items that are deemed trade secrets, such as customer lists, pricing information and business strategies.
  • Update the confidential agreements on an annual basis to include any new areas of important information and have the employees sign a confidentiality agreement on an annual basis.
  • Have detailed internal policies regarding the use of electronic storage devices, internet use, and use of the company’s email system.
  • Have secured networks with limited employee access with firewalls, multi-character passwords, or other ways to limit access or to track employee network activity.
  • Conduct exit interviews with all departing employees and remind them of the confidentiality agreements they signed and attempt to obtain signed confirmation from the departing employee that they received and agreed to the confidentiality agreements.

In summary, the best way to avoid protracted and expensive litigation against a former employee for the misappropriation of trade secrets is to protect the information before the employee leaves.

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Most employers know that they will have to begin paying their employees a minimum of $9.00 an hour as of July 1, 2014. In addition to effecting their hourly/non-exempt employees, this change may also effect some of their salary/exempt employees.

Presently, exempt employees (for many businesses, its managers) must be paid at least $2,774 per month/$33,288 a year due to California’s requirement that exempt employees make at least twice the minimum wage for a standard 40 hour work week. After July 1, 2014, employers will need to pay those same employees at least $3,120 per month/ $37,440 per year, or a raise of $4,152. After January 1, 2016, when the minimum wage increases to $10.00 an hour, employers will have to pay those same employees at least $3,467 per month/$41,604 per year.

Employers must take these cost increases into account when thinking about their strategic planning for 2015 and beyond.

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Contract picOver the many years I have practiced law in California, I have dealt with a wide array of disputes involving written contracts. In some instances, my clients’ have asserted that prior to signing a written contract (whether it was a business contract, real estate contract, construction contract etc.) they and the other contracting party had both orally negotiated and agreed that certain terms were to be included in the written contract. However, as is sometimes the case, after the written contract was prepared (either by an attorney for one of the parties, or by using a generic form such as an AIA construction contract or California Association of Realtors form) the parties fail to closely review the written contract to ensure that all bargained for terms were included, before they both signed the contract.

In some instances, as performance of the contract ensues, a dispute later arises between the parties when one of the parties contends that the other party failed to perform a condition and/or term that they had earlier “orally” agreed to perform. If the parties are unable to informally resolve the contract dispute, it may lead to litigation and a detailed legal analysis (by an attorney) of what rights a party has to enforce “oral” terms that were intentionally or inadvertently omitted from the final written contract.

Many written contracts (drafted by attorneys or included in some of the form contracts referenced above) include a short paragraph usually entitled “Entire Agreement” or “Integration Clause.” Although brief in nature, this paragraph has huge implications to both contracting parties, especially if one of the parties is attempting to enforce a term that was orally agreed to between the parties, but omitted from the final contact. Integration clauses generally read as follows:

All understandings between the parties are incorporated in this Agreement. Its terms are intended by the parties as a final, complete and exclusive expression of their Agreement with respect to its subject matter and supersede and replace all prior or contemporaneous discussions, negotiations, letters, memoranda or other communications, oral or written, with respect to the subject matter hereof and may not be contradicted by evidence of any prior agreement (either written or oral).

Integration clauses are strictly enforced by courts in the State of California. Although some exceptions may exist to enable a party to enforce an oral term that was omitted from the final contract, the party seeking to enforce such a term faces an uphill and very difficult battle. The exceptions to this rule are rare, and parties should immediately contact legal counsel to determine if such an exception may apply in their case. Consequently, a party signing a written contract involving a substantial financial commitment or a significant legal obligation, should closely review the contract and may wish to retain legal counsel to review the contract and ensure it includes all essential terms before the contract is signed.

The California business attorneys at Reid & Hellyer have extensive experience in construction, real estate and contract law.

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Contract picIf you have ever purchased or sold a home, or seen a medical doctor, no doubt you were presented with a proposed written agreement, possibly on a preprinted form, that contained an arbitration provision. The typical arbitration provision requires any dispute arising under the subject agreement to be arbitrated, as opposed to having it decided by a jury. Some of these agreements also contain provisions that require the parties to mediate their disputes (essentially have a settlement conference) prior to arbitrating it. The rationale behind arbitration provisions is that it’s quicker, and in many cases, more cost effective than going to court.

Although one of the rationales for an arbitration provision is to keep costs down, arbitrators can be very expensive and generally charge by the hour for ALL work performed. In addition to presiding over the hearing, arbitrators will often charge for reviewing materials and for the time it takes them to draft their ruling. In some cases, the out of pocket costs can be thousands to tens of thousands of dollars. Whereas, in civil court, for the one time cost of a filing fee or answer fee, the parties have an arbitrator (the judge) for the duration of the dispute. Accordingly, when dealing with a lawyer or a medical office in the context of an arbitration provision on one of their forms, ask who pays the initial costs of the arbitration and whether or not the prevailing party can be reimbursed by the losing side.

In the context of real estate transactions in California, there are several kinds of form contracts that I have come across in my practice. The difference between one of these contracts and the ones you might get if you transact with a law firm is that the person on the other side may be just as uninformed about the arbitration provision as you are. Although you stand little chance of convincing a law firm or a medical office into scratching out the arbitration provision in their contracts, when you deal with another lay person in a real estate transaction, undertake to determine whether or not arbitration makes sense in the context of the transaction and consider the possibility with the other side of the transaction of crossing out the provision. Depending on the specifics of the transaction, a court of law might actually be cheaper than an arbitration and you will preserve your right to have your matter decided by a jury.

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Newspaper of General Circulation

When a publication believes it meets the requirements to be adjudicated as a newspaper newspaper of general circulation (NGC), it can file a petition with the Superior Court requesting the right to run legal notices in compliance with various statutes (e.g., publishing fictitious business name statements).

However, what happens when a newspaper files for adjudication, but it doesn’t meet those requirements? The answer is that the legislature created a system that is largely self-effectuating since there is no government body (other than the courts) that scrutinize such petitions.

Instead, it is up to any individual (or individual on behalf of an entity) to file a a contest to a petition for adjudication. (Gov. Code section 6022.) In filing this contest, a contestant can obtain the facts through formal or informal discovery, then present the evidence and the law at a formal hearing in court. (Gov. Code section 6023.)

Obviously, if the facts support the adjudication, don’t bother. But, if they don’t, then go for it. A lawyer with experience in adjudications can advise if the contest stands much chance of success, as the criteria for adjudication are subject to evolving judicial interpretations. Some cases are clear, some are not.

Recently, we filed a contest to an adjudication order that had been obtained by misrepresenting the facts to the court. We were able to present the true facts and the other side decided to toss in the towel by ceasing publication.

In another recent case, we deposed the petitioner (the person seeking adjudication) and exposed the weakness of the facts he’d presented to the court. His petition was denied.

In a third case, the petitioner testified that the newspaper had certain subscribers. During the noon recess, we called some of them and learned that they had not paid for their subscriptions (a requirement). We presented this fact to the petitioner’s lawyer, who withdrew the petition after conferring with his client. (Thankfully, the lawyer was ethical and was not going to present false “facts” to the court.)

Every case is different and the facts matter. Assemble the facts, compare them to the law (see Gov. Code sections 6000 and 6008) and then decide if a contest makes sense or not, especially since they are so expensive to mount in court.

Given the importance of an adjudication, it is always wise to consult with an attorney experienced in California newspapers of general circulation, as the law is not as simply as it may appear.

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Ninth Circuit Court of AppealsThe Ninth Circuit Court of Appeals provides an outline that all attorneys practicing before it should read when filing or responding to an appeal.

The document, entitled “Ninth Circuit Appellate Jurisdiction Outline,” reviews the numerous grounds that the Ninth Circuit will consider in rejecting an appeal on procedural grounds. For example, did you or your opposing counsel properly raise the issue below? Is the order appealable? Was the appeal filed timely?

The Ninth Circuit covers the largest geographic region of any circuit in America. It is also the busiest circuit in America. Its hard-working judges may be glad to rule on the merits of a case that has been properly brought before its jurisdiction, but may be equally glad to dispose of a case without considering the merits where jurisdictional issues exists.

Attorneys and self-represented litigants are wise to review the Ninth Circuit’s outline to advocate for their position.

For more information, review the Ninth Circuit Appellate Jurisdiction Outline and visit ca9.uscourts.gov.

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