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30 | TH E M R EP O RT FEATURE v. Quackenbush, the Court held that the lender could not recover against an insurer that issued financial guarantee bonds as additional security for a pool of high-risk loans after the lender inadvertently made full credit bids on the properties in ques- tion, even though the originating lender grossly overinflated the property values in a scheme to defraud investors. In Quackenbush, the Court concluded that it was reasonable to hold the lender to the Full Credit Bid Rule because the lender "controlled the timing of the sales and admittedly knew the true value of the properties [and] nothing precluded it from bidding less than the amount it was owed." As a result, the lender ultimately sustained a loss of approximately $12 million, which it could not recoup. Adding insult to injury, lend- ers who have tried to rescind or reform the foreclosure sale in an effort to avoid the effect of the Full Credit Bid Rule, are rarely successful. In Universal Mortgage Co., Inc. v. Prudential Ins. Co., the foreclosing lender made a successful full credit bid based on its agent's external observa- tions of the property. However, it was subsequently discovered that the interior had extensive damage due to the borrower's removal of most of the fixtures and appliances. The lender sued the insurer, who denied the lender's claim under the opera- tive insurance policy in reliance upon the Full Credit Bid Rule. The lender sought to amend its complaint to allege a cause of action for reformation of the trustee's deed to reflect a lower bid; however, the trial court de- nied this request and judgment was ultimately entered in favor of the insurer. On appeal, the Ninth Circuit upheld the judgment and denial of leave to amend, reasoning that reformation was not a proper remedy under the circumstances since "there was no mistake" because the lender intended to make the full credit bid based on its exterior inspection. The court further held that the lender's lack of actual or constructive knowl- edge of a loss at the time of a full credit bid was irrelevant to the policy or application of the Full Credit Bid Rule. Even something short of a full credit bid can have danger- ous consequences. As explained above, the credit bid at the foreclosure sale establishes the value of the property for pur- poses of recovering fire or other additional proceeds. Therefore, a bid of $300,000 when the amount owed is $500,000, effectively limits the lenders' right to recovery insurance proceeds to $200,000 [$500,000 less the established value of the property ($300,000)]. Accordingly, it's important to establish an accurate bid, after fac- toring in the extent of the damage to the property. Exceptions to the Rule D espite the harsh conse- quences of a full credit or other limiting bids, the courts have only carved out two limited exceptions. The first exception applies where the lender's full credit bid is induced by the lender's reliance upon fraudulent misrepresentations. In Alliance Mortgage Co. v. Rothwell, the lender sued a real estate appraiser and a broker, among others, claiming that they fraud- ulently induced the lender to originate several loans secured by properties that were insuffi- cient collateral for the debt. The California Supreme Court iden- tified an exception to the Full Credit Bid Rule, holding fraud claims against third parties who fraudulently induced the lender to make the loans were not barred by the Full Credit Bid Rule. However, this is a limited exception. Absent fraud affect- ing the bid, the Full Credit Bid Rule will apply. The second limited exception applies where the lender incurs damages caused by negligent construction of improvements. Under these circumstances, the lender may be entitled to recover damages even though it has pur- chased the property at a trustee's sale following a full credit bid. In Sumitomo Bank v. Taurus Developers, Inc., the foreclosing lender discov- ered several latent defects on the property due to faulty construc- tion and brought suit against the borrower/developer for failing to adequately oversee the construc- tion and notify the lender of the defects known to him. While the Court held that the lender could not recover based upon fraud, bad-faith waste, or breach of contract, it found that a cause of action for negligence could be maintained by the lender regard- less of its full credit bid. Given the strict nature and application of California's Full Credit Bid Rule and its minimal exceptions, it is imperative that lenders consider every potential source of recovery on the unpaid debt before making a credit bid at a foreclosure sale. A failure to do so will limit or completely deny the lender's ability to recover insurance or other proceeds that would otherwise help offset its loss. Thus, where property values have been affected by natural disasters, such as those destroyed in the recent California wildfires, lenders and their servicers should consider the damage to the prop- erty, the value of the property in its current state and the amount of available insurance proceeds in determining its intended credit bid at the foreclosure sale. K ATHRYN A . MOORER, a Charleston, South Carolina native, was admitted to the California Bar after graduating Magna Cum Laude from Chapman University School of Law in May 2010. While in law school, Moorer served as a Senior Notes Editor for the Chapman Law Review and worked as a research assistant to Professor Celestine McConville. Moorer also held several internship positions while in law school ranging from client liaison at a small private firm to law clerk at a public interest firm. Moorer joined Wright, Finlay & Zak as a law clerk in August 2010 and became an associate attorney at the firm in December 2010. T. ROBERT FINLAY is one of the three founding partners of Wright, Finlay & Zak. Since 1994, Finlay has focused his legal career on consumer credit, business, and real estate litigation and has extensive experience with trials, mediations, arbitrations, and appeals. Finlay is at the forefront of the mortgage banking industry, handling all aspects of the ever-changing default servicing and mortgage banking litigation arena, including compliance issues for servicers, lenders, investors, title companies and foreclosure trustees. Finlay successfully guides clients through the complexities of litigation while being extremely mindful of their core values and business models. A full credit bid extinguishes the debt entirely and precludes the lender from recovering any additional amounts to satisfy the debt.