As the nation’s financial crisis nears the end of its third year, there are lessons to be learned from which solutions seem to work for reoccurring challenges. Cooper, White & Cooper’s Real Estate Solutions Group sees these challenges, and the ways in which a trusted legal advisor can help a client sort through them, as grouped roughly into the following general categories:


A.   Landlords

On the landlord side, numerous developers and landlords have experienced extraordinary fallout in the form of failing tenants, leading to vacancies, decreased rental rates, and worse.  There have been instances of “opportunities” – replacing a failing tenant with a more viable one – but those are (far and away) exceptions.  Landlords are now faced with attempting to “lure” tenants, but must be wary of their means and methods: for example, is a long-term (say, ten year) lease with a fixed rent (or a rent with nominal increases) too great a price to pay to secure a tenant in this market?  The questions – and decisions – facing landlords today will shape their returns on investment for years to come.

B.   Tenants

Tenants, on the other hand, are “making hay” in leases – at least to the extent that their businesses are succeeding.  Those tenants that can afford to expand are doing so, as rental rates can be extremely attractive.  And, in many cases, the longer the term the better, as “locking in” rents at current rates may be particularly advantageous to tenants.  Market conditions have also enabled some tenants to enter markets (or sub-markets) previously out of their price ranges.  In addition, sophisticated tenants have taken advantage of the market to negotiate more favorable terms and conditions in their leases – e.g., option rights, termination rights, expansion and contraction rights, and increased flexibility in assignment and subletting (to name a few).

Landlords and tenants alike face challenges and opportunities in the current climate and should be well-versed in the specifics of such challenges and opportunities in order best to protect and advance their respective interests.


Almost every financial transaction will have a tax consequence, and with proper planning a potential adverse consequence can be eliminated or at least minimized.  The following brief discussion is an example of ways in which the tax laws may aid a taxpayer in either a personal or an investment difficulty. 

A.   Residential Foreclosure

In many cases of foreclosure, the mortgage amount may exceed the taxpayer’s basis in the property, as well as its fair market value.  This may be particularly true if the property has been owned for many years and has frequently been refinanced to obtain cash.  If the property has declined significantly in value because of the recession, the mortgage debt may well be in excess of its present value.  Thus, a foreclosure, which is treated as a sale for the mortgage amount, could have various adverse tax consequences, such as:

  • Recognizable gain equal to the difference between the taxpayer’s basis in the property and the mortgage amount.
  • Realization of taxable income equal to the mortgage amount, if forgiven, in excess of the fair market value of the property.

Fortunately, the taxpayer may qualify under various provisions in the tax code for relief to exclude all or part of the paper income from tax, particularly for debt forgiven in years 2007 through 2012 under the Mortgage Forgiveness Debt Relief Act of 2007.  Similar exclusions may also be available under Internal Revenue Code §121 for the gain on the sale of the residence, and under IRC §108 in cases of bankruptcy or insolvency.  In any event, serious tax analysis is warranted.

B.   Investment Failure

Many investors in real estate development entities have experienced the loss of their investment because of market conditions or, in far too many cases, misappropriation of the funds by the promoter/manager.  In either case, the loss may be partially recovered through appropriate tax planning.

For example, individual taxpayers may deduct losses incurred in a trade or business or a transaction entered into for profit under IRC §165(c)(1) and (2), or if such loss arises from a theft, under IRC §165(c)(3).  Because of timing issues, the taxpayer should consult with a tax expert as to the most advantageous approach.

Once it is determined that the taxpayer has suffered a deductible loss under IRC §165, further inquiries should be made to determine if all or any part of the loss may be carried back to a prior year to facilitate an immediate benefit by recovering previously-paid taxes.  IRC §172 provides for carry back of net operating losses incurred in the current year, and has been periodically amended to specifically benefit taxpayers incurring losses in the recent recession, as was done in the American Recovery and Investment Act of 2009.

The application of the tax laws to assist taxpayers experiencing financial difficulties, such as those mentioned above, may yield significant benefits to the distressed taxpayer, and should be explored in every situation where a significant amount is at stake.


A.   Fraudulent Consent

As with any other contract in California, if consent is obtained under false pretenses, an issue can arise as to whether it was a true meeting of the minds, as required for any enforceable contract.  While most loan instruments and associated guaranties have standard integration clauses reciting that there have been no other representations made outside the four corners of the contract itself, if fraudulent circumstances can be proven, such clauses are much less helpful.  The contractual recitation is then simply evidence which the jury is free to reject if it is troubled by extraneous trickery.

For example, if a non-managing member of an LLC signs a guaranty based upon misrepresentations of a dishonest managing member, an argument can be made that the guarantor’s consent was not voluntary.  The inquiry should then focus on whether there are circumstances under which a reasonable lender should have concluded that the managing member was not being straightforward.  In short, it is clear in California that a guarantor may use fraud as a defense against liability under a guaranty.

Further, if a lender negligently or in bad faith prevented the borrower from performing under a loan agreement, the guaranty may not be enforceable because each party to a contract has a duty to do everything that the contract requires him or her to do to accomplish its purpose and there is a corresponding duty to refrain from hindering performance by the other party.  A party who prevents fulfillment of a condition of his or her own obligation commits a breach of contract and cannot rely on such a condition to defeat his or her liability.

Finally, a creditor who accepts a continuing guaranty owes a duty to the guarantor to disclose facts that materially increase the risk beyond that which the guarantor intended to assume.  If the creditor fails to disclose crucial information, the guarantor is exonerated of further liability.  To a significant degree, the duty of disclosure arises under the covenant of good faith and fair dealing, implied in all California contracts, and it is unlikely that the duty is waivable.

B.   Exoneration

In California, “a guarantor is exonerated (i.e. released of liability under the guaranty) if, without the guarantor’s consent, the creditor alters, impairs, discharges, or suspends in any respect, the creditor’s rights and remedies against the primary obligator.”  Any material change made in an existing contract without the consent of the surety extinguishes the surety’s liability.  Modifying the obligation without the guarantor’s consent makes the guaranty unenforceable, and any increase in the amount of the obligation is one such material change.

A material change may also occur if there has been lender mismanagement of the construction draw process because, under basic negligence principles, a lender owes a duty to a guarantor to use reasonable care in disbursing a loan.  Even though a lender primarily intends only to protect itself by requiring back up invoices, for example, it is foreseeable to a reasonable man in lender’s position that lender’s negligence in disbursing the loan proceeds could cause a guarantor losses.”

While only material modifications of an obligation exonerate a guarantor, if a modification is material, it does not matter whether the guarantor was “prejudiced” by the modification or not.  A material modification of the underlying obligation may completely exonerate a surety even if the modification is beneficial.

The proper inquiry, therefore, is to determine whether an alteration materially modified the original obligation in a manner not contemplated by the guarantor.  The court must examine both the guaranty and the underlying agreement the performance of which was guaranteed. All pertinent factors must be considered to determine whether some material unforeseen obligation was foisted upon the guarantor.

A guarantor may also be exonerated if a material alteration in the debt occurred by reason of conduct of a third party to the extent the lender knowingly participated.  For example, a lender could be a co-conspirator in respect to a borrower’s managing member’s fraudulent embezzlement and conversion of loan funds.  Here, the lender may be charged not only with knowledge of facts brought to his or her attention, but also of all other facts which a reasonable inquiry would have revealed.  Thus, where the facts and circumstances surrounding the managing member’s requests for advances were sufficient to put a prudent bank on notice of an impropriety, the bank may be charged with knowledge of embezzler’s unlawful intent, and the guaranty would become unenforceable since the debt would have become materially altered as a practical economic matter.  This is true even if the bank obtained no advantage.

C.        Alter Ego Status

A guaranty may also be unenforceable where the obligor and guarantor are alter egos of one another. When debtors personally guaranty their own obligations or obligations of controlled entities, the guaranty adds nothing to the transaction, and is not enforceable  For example, guarantors who are general partners of a primary obligor partnership are themselves principal obligors.  Because a principal obligor cannot “guaranty” his own debt, any purported guaranty under these circumstances will be superfluous and unenforceable.

D.   Validity Of Waivers Of Guarantor Protections

Generally, a guarantor may give advance consent in the guaranty contract to modifications that would otherwise exonerate the guarantor.  This is very typical in a workout situation between the lender and borrower where in exchange for a modification or extension of the underlying obligation, the lender is able to correct any documentation issues in its loan papers.  The guarantor would be part of that arrangement.

On the other hand, there are most certainly limits to contractual waivers.  For instance, it has clearly been established that pre-dispute waivers of a right to complain about lender conduct, whether being negligence or fraud, are not enforceable where public policy is concerned.  Also, California courts can sometimes construe guarantor waivers strictly against the creditor, and courts may also refuse to enforce unconscionable provisions.

In any event, any release of future negligence must be explicit, and exculpatory clauses must be unambiguous. And even then it is arguable that the waivers are unenforceable.

E.   The Threat Of Bankruptcy

Any discussion concerning enforcement of a guaranty must also touch upon collectability, i.e., will a judgment actually be recoverable from the guarantor?  Especially in the current state of the economy, this issue is of critical importance to the lender.  Quite often the guarantor will threaten bankruptcy or claim insolvency.  So in order to proceed, the lender must first get an updated snapshot of the guarantor’s financial situation in order to assess collectability.  Not only a current balance sheet and prospects of future income must be reviewed, but also transfers recently made, and creditors or insiders paid, should also be carefully examined.  Any protests over privacy should be able to be addressed with a confidentiality agreement. Next, the lender will need to get an assessment of its rights and remedies if a bankruptcy is filed, along with a determination of the likely outcome for its claim in the proceeding against the guarantor.  In some circumstances, a bankruptcy filing might be advantageous for a lender, for example the public reporting requirements and court supervision might otherwise prevent the guarantor from transferring or hiding assets.

F.   California Anti-Deficiency Protections

Whenever a guaranty is part of a transaction that has any connection to real property in California, a lender must take additional steps to review and assess how the unique anti-deficiency law in California will affect the ability to pursue the guarantor.  Issues over purchase money obligations, the “one-action” rule and the ability to pursue any deficiency after a non-judicial foreclosure are just some of the concerns that the lender will have to assess.  Ignoring them might result in a bar to recovery.  For example, a loan made to five borrowers may appear to allow the lender to pursue any of the borrowers for the full amount of the obligation.  However, four of the borrowers may claim that they are only “investors” and in effect, are only guarantors to the one primary borrower.  If the lender’s loan documents do not provide for the appropriate waivers of the guarantors’ rights and defenses, the lender might not be able to successfully pursue all the co-borrowers on a defaulted loan.

G.   Conclusion

In practice, even the most carefully crafted personal guaranties may face challenges in the courtroom and at the settlement table.  In front of a jury, personal guaranties of commercial loans are not likely to be taken at face value because emotion often works to reframe evidence.  By no means does that suggest that guarantors always have the upper hand, but clearly good lawyers on both sides of a case will seek to couch their arguments in terms of equity and fairness rather than on the cold written word.  So, if an individual guarantor was mistreated by a lender, either directly or through the lender’s participation in wrongdoing by others such as the guarantor’s managing member, a material modification and a disregard of applicable waivers can be found even in the presence of lender-friendly language.

However, if the lender’s attorneys can paint the guarantor as someone who is relying on a technicality, and who was knowledgeable about the risks he or she was taking while the lender was simply trying to collect what is rightfully due, equities could easily shift  in favor of the lender.

In the end, perhaps the best overall practical advice for both lenders and guarantors is to retain seasoned trial counsel early as they try to resolve their disputes because attorneys who rely primarily on the written word may not be handicapping the risks appropriately.


As we move into 2011, it may be helpful to review new laws that may affect California real estate brokers and salespersons.  The following laws were enacted by the California legislature and signed by Governor Schwarzenegger during the 2009/2010 legislative session.

A.   Prohibition on a Broker’s Ability to Collect Advance Fees

Prior existing law restricts a California real estate broker or salesperson’s ability to collect advance fees for services that require a real estate license.  Brokers seeking to collect advance fees must first get DRE approval of the fee contract.  Assembly Bill 1762 clarified that the restrictions do not apply to (1) residential rental security deposits; (2) residential rental applicant screening fees; (3) fees to cover advertising expenses; and (4) certain written “limited service” contracts which are presented as stand-alone services, to be performed on a task-by-task basis, and for which compensation is received as each separate, contracted-for task is completed.

B.   Foreclosure Consultant Law

Prior existing law requires foreclosure consultants to register with the Department of Justice before providing foreclosure consulting services, and precludes them from charging or receiving any compensation before fully completing their services.  Assembly Bill 2325 extends these restrictions to forensic loan audits, whereby a person arranges an audit of any obligation secured by a lien on a residence in foreclosure.  A forensic loan auditor is thus prohibited from collecting fees prior to performing all services.  Licensed real estate brokers, lawyers, mortgage brokers, lenders and other specified professions are exempt from the Foreclosure Consultant Law.

C.   Limits on Short-Seller Liability to First Lenders

Under prior law, homeowners who sell their homes by short-sale could be required to pay their lenders the balance due on the loan after short-sale proceeds were deducted.  Senate Bill 931 limits a lender’s ability to collect this deficiency from the homeowner.  The lender may not pursue the homeowner for the balance owed where (1) the dwelling consists of four or fewer units; (2) the lender is a first lien holder; and (3) the lender consented to the short-sale in writing.  Once the first lien holder gives its written consent, the homeowner is released from any obligation to pay the remaining loan deficiency.  The law does not apply if the borrower committed fraud with respect to the short-sale or intentionally damaged the property.

D.   Criminal Penalties for Unlicensed Mortgage Origination Services

SB 1137 makes it a crime for any person to act as a mortgage loan originator (MLO) without a MLO license endorsement from the Department of Real Estate.  The bill also makes it a crime to advertise that you are a real estate salesperson if you do not hold a real estate license, or to advertise MLO services if you do not hold a MLO license endorsement.  In addition, the bill precludes a real estate broker from employing or compensating any real estate licensee for engaging in any activity for which a (MLO) license endorsement is required, if that licensee does not have a MLO license endorsement.  Loan servicing is not considered a MLO service for purposes of this law.

E.   Tenant Rights in Foreclosed Properties

In 2008, the Governor signed a law that when a residential property is foreclosed upon, any tenants must receive sixty days notice before they may be evicted.  In 2009, the United States Congress passed the Protecting Tenants at Foreclosure Act, which requires that after foreclosure, the new owner must generally honor the tenant’s lease until the end of the lease term.  SB 1149 provides that tenants who are living in foreclosed homes must be informed of these rights in a cover sheet attached to any eviction notice served within one year of a foreclosure sale.

For further information, please contact CWC’s Chair of the Real Estate Solutions Group, Bill Norman:; 415-765-6236.

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