It was noteworthy, therefore, when in February the California Court of Appeal delivered a powerful published Opinion in City of Sierra Madre v. SunTrust Mortgage, Inc. (2019) 32 Cal.App.5th 648, 651–652, review denied (May 22, 2019) (“Sierra Madre”), reaffirming the ability of receivership courts to authorize the issuance of super-priority receiver’s certificates. The Opinion handed down by the Court of Appeal provides much-needed guidance to receivers and lenders alike, and underscores the broad discretion California law provides to receivership courts to take drastic actions when necessary based on the facts and circumstances in the cases before them. This case is probably the most important receivership decision since the California Supreme Court handed down City of Santa Monica v. Gonzalez (2008) 43 Cal.4th 905 more than a decade ago.

Background

When my law partner David Pasternak was first appointed as receiver over a small residential property in sleepy Sierra Madre, it seemed at first to be a run-of-the-mill receivership. Fix a property in violation of the Municipal and Health and Safety Codes: simple, right? Wrong. What soon became apparent was that both the homeowners and secured lender on the property had no intention of cooperating with the Court, the City, or the Receiver.

After the receiver’s appointment, my office immediately investigated the property and learned, to our amazement, that the homeowners had personally excavated a massive, unpermitted pit beneath their home in hopes of opening a wine bar. For all we know, underground hooch might still be freely flowing to this day if not for the sudden collapse of a neighboring alleyway due to the unsanctioned dig, alerting the City to danger. Years later, after a lengthy jury trial victory by Bill Litvak on behalf of the City, the Receiver was finally given the greenlight to move forward shoring up the pit. But who was going to pay for the extensive work necessary?

To begin with, it is important to note that Litvak – counsel for the City of Sierra Madre – made two important legal choices at the outset of the case that provided the bedrock for the Court of Appeal's eventual decision: First, Litvak sought the Receiver’s appointment under both the California Health and Safety Code and the general receivership provisions found in California Code of Civil Procedure §564. More about that later. Second, Litvak not only brought suit against the homeowners, but also named the secured lender, SunTrust Mortgage, Inc.

In order to obtain funding for the work, the Receiver first reached out to the secured lender, believing that SunTrust might have an interest in protecting its security. The bank immediately refused, preferring not to be involved in the matter outside of taking first cut at any eventual sale proceeds (assuming the house didn't collapse in the meantime). With no other options available, the Receiver reached out to South County Bank – one of the few lenders willing to fund receivership remediation work – and SCB agreed to fund a loan on the condition that the Receiver provide a first priority lien against the property. At that point, the receivership court gave SunTrust two options: fund the work or accept second position. SunTrust again refused to fund the work, and the Court authorized the Receiver to issue a receiver’s certificate giving SCB first priority. SunTrust appealed, arguing that the California Health and Safety Code does not allow such an issuance of a priority certificate.

The Holding

In affirming the ruling below, the Court of Appeal focused on the fact that the Receiver had been appointed pursuant to CCP §564, not just the Health and Safety Code. Writing for the Court, Justice Lavin explained that Title Ins. & Trust Co. v. California Development Co. (1915) 171 Cal. 227 – decided more than a century prior – established the ability of receivership courts to authorize the issuance of priority certificates, and that decision is still good law and applies to all receivers appointed pursuant to the general receivership law found in CCP §564 et seq. As a result, Justice Lavin determined it was unnecessary “to engage in a lengthy statutory analysis of Health and Safety Code §17980.7.” (Id. at p. 659.) While Justice Lavin did not engage in a lengthy analysis, he did point out that "Health and Safety Code section 17980.7, subdivision (c)(4)(H), specifically gives a receiver appointed under that section the powers of a receiver appointed under Code of Civil Procedure section 564." (Id.) By extension, therefore, a Health and Safety Code receiver should be able to issue priority certificates.

As Justice Lavin put it, "Courts have substantial discretion to authorize a receiver to borrow money to fund the preservation and management of property in the receivership estate, particularly where, as here, the estate does not produce income. In that circumstance, the receiver may ask the court to authorize the issuance of a receiver's certificate to the lender as security for money loaned to the estate. Typically, such a receivership certificate will have priority over all other liens—even preexisting liens." (Id. at p. 657.) But the Court of Appeal advised caution and clarified that the power to issue priority receiver's certificates is not unfettered: “use of super-priority liens should be infrequent because the disturbance of preexisting liens may bring harsh consequences. ‘The authority to disturb existing liens should be exercised with great caution, and should be carried no further than actually necessary to attain the desired protection of the res.’” (Id. at 658.)

Further Implications and Important Dicta

While the Opinion focuses primarily on the general receivership law interpreting appointments under Section 564, it also goes a long way to suggest that a receiver appointed solely pursuant to the Health and Safety Code has the ability to issue priority certificates as well. As noted above, the Court was careful to point out that the Health and Safety Code, by its own terms, incorporates all of the powers the general receivership law ascribes to receivers.

Perhaps more importantly, Justice Lavin distinguished and limited to its facts City of Chula Vista v. Gutierrez (2012) 207 Cal.App.4th 681, a case that has troubled many Receivership News readers since it was handed down. In a single dictum offered at the end of the Opinion without any analysis, the Chula Vista court opined that, if the legislature had intended to provide priority liens to receivers appointed under the Health and Safety Code, "it would have done so." (Id. at p. 688.) In Sierra Madre, the Court of Appeal rejected SunTrust's reliance on this dictum, determining that Chula Vista was a case solely considering whether a receiver could prevail on an unjust enrichment theory against a lender and whether the receiver's services there had provided a benefit to the lender. Justice Lavin succinctly distinguished Chula Vista: "that issue is not remotely relevant to the present proceeding." (32 Cal.App.5th at p. 659.)

Finally, the Court of Appeal rejected SunTrust's arguments that the City or the homeowner should have been forced to fund remediation rather than the lender. As the Court put it, "the fact that the court had a variety of options to choose from when it authorized the receiver to obtain funding for the needed remediation is beside the point. SunTrust cites no authority suggesting—and doesn't even argue—the court abused its discretion by authorizing a super-priority lien after considering all the facts and balancing the equities." (Id. at p. 660.) In other words, it is the receivership court's prerogative, based on the facts and circumstances before it, to determine how to fund work necessary to protect receivership estate property.

Why Is Sierra Madre Important?

The California Supreme Court issued Title Ins. & Trust Co. v. California Development Co. (1915) 171 Cal. 227 more than a century ago, and no other case has squarely addressed the power of receivership courts to authorize priority receiver's certificates since. Many litigants have since attempted to chip away at or distinguish the high court's decision. The most common refrain is that the decision is "really old." In rendering its Opinion in Sierra Madre, the Court of Appeal not only reaffirmed this fundamental receivership power, but also went a long way to support the argument that receivers appointed solely pursuant to the Health and Safety Code can issue priority certificates as well. And, when read together with the California Supreme Court's decision in City of Santa Monica v. Gonzalez (2008) 43 Cal.4th 905, Sierra Madre offers a powerful reminder that receivership courts are given extraordinary latitude to manage the receiverships before them and authorize sometimes drastic measures by their receivers.

As a final note, while Sierra Madre plainly stands for the proposition that receivers can issue priority certificates, they would do well not to abuse that power. After the Court of Appeal issued its Opinion, SunTrust filed a petition for review before the California Supreme Court and another lender – Nationstar Mortgage, Inc. – sought to depublish the opinion. While the California Supreme Court rejected both requests, leaving Sierra Madre standing, there was one important takeaway. In its Request for Depublication, Nationstar noted that it "has recently found itself defending against litigation spearheaded by private attorneys and receivers who specialize in what they market as 'zero cost' code enforcement." The author has also heard rumors of receivers and private attorneys who, in an attempt to win appointment in new Health and Safety Code receiverships, offer to pay municipalities' attorney's and administrative fees by issuing receiver's certificates, thereby giving the cities' fees and costs priority. Based on the Court's Opinion in Sierra Madre, this is an abuse and should not continue, as the Court of Appeal pointed out that receiver's certificates are to be used sparingly and only to fund work necessary to protect the res. Sierra Madre is an important Opinion for receivers, and an abuse of that power would only serve to erode the confidence of courts and other stakeholders, and would justify the fears expressed by both SunTrust and Nationstar in the courts.

*Blake Alsbrook is a partner at Pasternak, Pasternak & Alsbrook in Los Angeles. Blake acts as a receiver and partition referee and provides legal services to prominent receivers and other court-appointed fiduciaries throughout California.