Appellate Court Ruling for Setting Aside a Foreclosure Sale

Can a foreclosure sale be set aside because the underlying loan was unconscionable?  If so, what conditions might be required to determine that a loan had such characteristics?  The answers to questions such as these are liable to have a great influence on lending practices in California for years to come.  While it might overstate matters to say that California courts are clogged with foreclosure challenges, it is certainly true that a formidable number are winding their way through the system.  Some contrary, if not contradictory, decisions are coming down.  Inevitably, there will be final Supreme Court rulings.  They will have a long-term effect.

Today we look at a recent decision of California’s Court of Appeal for the Sixth Appellate District.  The ruling in Lona v. Citibank was filed in December of 2011. 

The case involved Jonas Z Lona who, in January of 2007, refinanced his home through First Franklin Financial.  Lona’s home was located at 1143 Stony Brook, Hollister, California.  There were two loans, totaling $1.5 million.  The first was for $1.125 million and the second was for $375,000.  The first was a thirty year loan with a fixed interest rate of 8.25 percent for the first five years.  After five years it adjusted annually based on LIBOR (London Interbank Offered Rate) plus 2.25 percent.  The initial monthly payments were $8,451.75.  The second was a fixed rate of 12.25 percent for 15 years.  Monthly payments on the second were $3,929.61.  Total monthly payments on the first and the second were $12,381.36

Mr. Lona, though married, owned the property as his sole and separate property.  He was approximately 50 years old.  He came to the United States from Mexico at the age of 15.  He had received an education through eighth grade in Mexico.  He testified through an interpreter at his deposition.  At the time he received the loans he worked for Monterey Mushrooms as a mechanic.  He had an income of $40,000 per year, averaging $3,333 per month.

Franklin Financial assigned its interest in the loan to CitibankEMC became the servicer and Quality Loan Service Corporation became the trustee.  In June, 2007, five months after signing the loan documents, Lona defaulted.  In September the Trustee recorded a notice of default.  The default was never cured and, after postponements, a sale took place and a trustee’s deed was recorded in August of 2008.

Lona filed his original complaint in November of 2008.  An amended complaint was filed in July of 2009.  It named Citibank, EMC, and Franklin.  The complaint sought to set aside the foreclosure sale. The defendants asked for summary judgment – essentially, a dismissal.  They argued that Lona had failed to make a valid tender offer (of the full loan amount) which is generally required to set aside a trustee’s sale and that he had failed to show that there was any irregularity in the sale procedure.    The summary judgment was granted on behalf of the defendants.

Lona appealed.  Typically, a foreclosure sale may be set aside if there had been some irregularity of procedure.  But that was not the issue here.  According to the court, “Lona’s primary contention was that the trustee’s sale was void because the underlying loan and deed of trust was unconscionable, illegal, and void at the inception.”

The appellate court noted that “unconscionability has both a ‘procedural’ and a ‘substantive’ element”.  Both must be present “in order for a court to exercise its discretion to refuse to enforce a contract…but they need not be present in the same degree.”  The procedural aspect has to do with whether one party has a superior position and presents a contract on a “take it or leave it” basis.  Certainly, this was the case with respect to Lona’s loan.  He did not bargain and was not given choices.  Moreover, the court noted, this procedural aspect of unconscionability was of less importance than “the harshness or unreasonableness of the substantive terms themselves.”

The appellate court found that the loans were probably substantively unconscionable and illegal because they “were made to [Lona] without reasonable consideration of his ability to repay the loans…”

The trial court’s summary judgment was reversed.  That is, the case was sent back for trial.  The appellate court emphasized, “Our holding does not mean that a borrower may defeat a motion for summary judgment in an action to set aside a trustee’s sale merely by alleging that he or she did not understand the terms of the loan documents signed or could not afford the loan.”  Ultimately, evidence will have to support such claims.  But, what is clear is that the appellate court has widely opened the door for such arguments to be heard.

Some will applaud the Lona decision, and will hope that many other foreclosures may be set aside for similar reasons.  Others will deplore it, believing that people who get themselves into such predicaments ought to suffer the consequences.  Whatever happens, it is clear that decisions about such cases are going to influence the lending environment in California for years to come.