Court Opinion

ID: 8898419
Source: CourtListenerOpinion
Date Created: 2022-11-27 00:31:44.06202+00
Date Added: 2024-06-11T17:07:39.376422
License: Public Domain

HUFSTEDLER, Circuit Judge
(dissenting):
The Stewards had the burden of proving their ownership of the proceeds of the bank stock in their reclamation proceedings. (4A Collier on Bankruptcy ¶ 70.39, at 476.2—477 (14th ed. 1975).) They did not and could not carry their burden because they never had a legal interest in the stock or its proceeds and their equitable claims to the stock or its proceeds were at all times inferior to that of Forester’s trustee in bankruptcy.
To set the equitable stage, I state the essential relevant facts.1 Forester’s trustee succeeded to all of Forester’s nonexempt assets on the date that he filed his bankruptcy petition in June 1971. (Bankruptcy Act § 70a, 11 U.S.C. 110; 4A Collier, supra, ¶ 70.05, at 65-66.) On that date, Forester owned his redemption right in the pledged bank stock. He owned no interest in the ranch, which he had earlier conveyed to Great Western. The Stewards had second deeds of trust on the ranch to secure Forester’s purchase money notes to them. The Stewards owned no interest of any kind in the stock. The bank held the pledged stock and the first deed of trust on the ranch. Both secured Forester’s $140,000 note to the bank. He had used the proceeds of the loan as part of the $260,000 purchase price of the ranch. Forester’s notes to the bank and to the Stewards were in default.
In December 1971, with the assent of the bankruptcy court in Great Western’s reorganization, the Stewards bid in the property at a nonjudicial sale under their power of sale in their second trust deed. They bid in for an amount less than the unpaid balance of Forester’s notes to them. Their junior lien thereupon disappeared by merger, and they became owners of the ranch, subject to the bank’s first deed of trust. (E. g., Anglo-California Bank v. Field (1905) 146 Cal. 644, 80 P. 1080.)
The Stewards found buyers for the ranch in late December 1971 at a gross sales price of $242,500. The sale could not be completed and escrow closed until the Stewards removed the encumbrance of the bank’s first trust deed. Shortly before the escrow was set to close in April 1972, the bank told the Stewards that Forester’s trustee in bankruptcy had made a written demand upon it to liquidate the stock and turn over the proceeds to him. On April 11, 1972, the Stewards made a written demand on the bank to apply the value of the stock to reduce Forester’s indebtedness or, in the alternative, to pay the proceeds of the stock to them after the bank retired the stock. The bank refused the Stewards’ demand, citing the trustee’s demand.
The bank insisted that the Stewards pay it the full amount of Forester’s indebtedness before it would relinquish its first trust deed. The Stewards closed their sale of the ranch on April 19, 1972. On April 21, 1972, the Stewards paid the entire indebtedness to the bank, using funds from their sale of the ranch. On May 15, 1972, the bank sent the trustee $7,000, representing the proceeds from the liquidation of the stock. The Stewards filed their reclamation petition on January 18, 1973.
Upon the Stewards’ payment to the bank and the completion of their sale of *318the ranch to third persons, the Stewards had a deficiency of almost $100,000, representing the difference between the unpaid balance of Forester’s purchase money notes and the net amount that they realized on the sale. The majority opinion softens the Stewards’ financial blow by affirming the district court’s order upholding their reclamation petition. Neither the facts of this case nor the applicable law sustains the majority’s conclusion.
The majority holds the Stewards entitled to the proceeds of the stock under two different theories, the doctrine of equitable subrogation and that of marshaling assets, also with equitable antecedents. Under both headings the majority neglects or treats as ancillary aspects of the relevant law that undermine its reasoning and that express legislative assessments of the relative equities contrary to its own.
A basic premise of the majority opinion is that “the trustee” and through him the general creditors merely stand in Forester’s shoes.” Majority Op’n at 315.) If the premise were sound, the majority’s conclusion would be persuasive because the Stewards’ equitable position was superior to Forester’s throughout these proceedings. However, the premise is erroneous. The trustee in some respects represents the general creditors, but neither the creditors nor the trustee stand in Forester’s shoes. The creditors and Forester are adversaries and for reasons discussed later, the Stewards’ status is inferior to that of the general creditors. The trustee does not fit Forester’s last. “Under § 70a the trustee is vested with the title of the bankrupt to all of his property of whatever kind and wherever located at the date of the filing of the petition except that which is exempt. . . . The trustee takes such property not as a bona fide purchaser but in the dual role of a successor to the title of the bankrupt himself and of a creditor with a judgment, with an execution returned unsatisfied and one with a lien acquired through legal or equitable proceedings.” (4A Collier, supra, ¶ 70.04, at 60.) Proper treatment of the appropriate equities, then, does not begin with the Stewards in a superior position. Other considerations further reduce their equitable stature.
The majority’s subrogation rationale overlooks the unique nature of the contested asset — stock in a Federal Land Bank — and the bankrupt’s relation to it. (See infra at 321.)

Marshaling

Forester’s trustee had both the right and the duty to compel the bank to marshal assets for the benefit of the bankrupt’s estate. The trustee had succeeded to Forester’s redemption right in the stock, but the trustee had no lien on or interest in the ranch. Under California Civil Code Sections 2899 and 3433,2 the trustee having an interest in the stock, but not in the ranch could require the bank first to resort to the ranch before it reached the stock because the bank had liens upon both assets. The trustee fulfilled his duty in March 1972, by demanding the bank to turn over the proceeds of the stock to him.
The Stewards also had a potential right to demand that the bank marshal assets for their benefit because they had an interest in the ranch, but not in the stock. Before they bid in the property, their right to demand marshaling rested on their status as junior lienors; thereafter, their right depended upon their ownership of the ranch subject to the first trust deed. I assume, arguendo, that they retained enough interest in the ranch after they had contracted to sell it *319to demand marshaling. Nevertheless, they made no demand of any kind to marshal until after the bankruptcies of both Great Western and Forester had intervened; they made no formal demand to marshal until April 1972, approximately three weeks after the trustee had made his demand and after they had contracted to sell the ranch.
The Stewards lose the marshaling contest because their demand for marshaling was later in time than the trustee’s and their equities were inferior to those of the trustee.
Contrary to the suggestion of the majority, the Stewards’ right to marshal did not “vest” when they demanded marshaling in April 1972. A demand serves two purposes: (1) it gives the lienor or creditor notice of the claim, and (2) the date of the demand affects the relative priorities of those persons with whom the person making the demand is equitably competing for the same asset. The demand is an essential step in perfecting a right to marshal, good against a superior lienor or creditor upon whom the demand is made and against others who are also entitled to marshaling, but the demand does not itself create a lien or interest in any asset. A right to marshal does not ripen into an interest in the nature of an equitable lien until the court, applying equitable principles, enforces it. (See Harrington v. Taylor (1917) 176 Cal. 802, 807, 169 P. 690, 692; cf. Victor Gruen Associates, Inc. v. Glass (9th Cir. 1964) 338 F.2d 826.)
If the equities of the Stewards were equal to the trustees, the trustee would prevail over the Stewards because the trustee first asserted his claim to marshaling. (Smitton v. McCullough (1920) 182 Cal. 530, 189 P. 686; cf. Cal.Civ.Code § 2897.) If the bank had set off the value of the stock or paid the Stewards the proceeds after notice of the trustee’s prior claim, the bank would have subjected itself to a risk of loss in an action against it by the trustee for failure of the bank to honor the trustee’s marshaling demand and thus losing assets that should have been turned over to the trustee. Of course, the bank could have filed an interpleader action to protect itself, but the filing of such an action would also cause the bank to incur expenses. The marshaling doctrine will not be applied when to do so will cause a risk of loss to the person upon whom the demand to marshal has been made. (Victor Gruen Associates, Inc. v. Glass, supra, 338 F.2d 826.)
Apart from the prior demand by the trustee, and overcoming any expectation of the Stewards, the equities are unequal between Forester’s general creditors, who are represented by the trustee, and the Stewards. California Code of Civil Procedure sections 580b and 580d prevented the Stewards from ever having had any expectation of reaching any asset to satisfy their purchase money notes other than the ranch. Their security was confined to the ranch, and, as vendors of the ranch holding Forester’s purchase money notes, they were prevented by section 580b from seeking any deficiency judgment from him. More importantly, once they elected to bid in the property, they were foreclosed by section 580d from enforcing the notes.3
As holders of then unsecured notes, the Stewards were general creditors of Forester’s, but they were general creditors who could not have filed a claim upon the notes in Forester’s bankruptcy. If they were permitted to assert their claim to the proceeds of the stock, they would be allowed to accomplish in equity a circumvention of California’s antidefi-ciency statutes, a situation that equity *320would not countenance. The principal purpose of section 580b is to protect debtors in a falling real estate market by forcing creditors to look only to the property as security, leaving other assets of the debtor untouched. (Roseleaf Corp. v. Chierighino (1963) 59 Cal.2d 35, 42, 27 Cal.Rptr. 873, 877, 378 P.2d 97; see also Cornelison v. Kornbluth (1975) 15 Cal.3d 590, 125 Cal.Rptr. 557, 542 P.2d 981.) Similarly, section 580d prevents holders of deeds of trust who bid in and sell at a private sale from seeking a deficiency, putting judicial and non judicial sales on an approximate parity, while giving the vendor the chance to acquire a nonredeemable title. Allowing second lienors like the Stewards to reach assets like the stock herein would contravene the purpose of these antideficiency judgment statutes.
Finally, the effect of allowing the Stewards to compel marshaling would be to reduce the indebtedness against the land by resort to security for which they never expressly bargained at the expense of general creditors who were entitled to share in any of Forester’s general assets.4

Subrogation

California Civil Code section 2904, upon which the majority relies to justify the Stewards’ subrogation to the bank’s interest in the stock is inapplicable. That section applies only to inferior lien-ors’ subrogation rights, and the Stewards had no lien on the ranch when they paid the bank. Their lien vanished when they bid in the ranch, and the lien cannot be revived, as the majority attempts to do, by saying that “[A]ll these steps were taken to protect their second trust deed interest . . . ” and that the “ownership of the ranch by foreclosure of the second lien was but a contemporaneous step toward the payment of the bank loan and sale of the property.” (Majority Op’n at 314.) To be sure, the Stewards were trying to protect themselves from financial loss, but it is wrong to say that they took these steps to protect their second deed of trust. On the contrary, when they elected to bid in the property, they wiped out Forester’s redemption right, and the price of that election was to extinguish their lien and to prevent any remedy on the notes. (Roseleaf Corp. v. Chierighino (1963) 59 Cal.2d 35, 43-44, 27 Cal.Rptr. 873, 878, 378 P.2d 97, 102.) Moreover, the Stewards’ acquisition of the ranch and their payment of the bank were not “contemporaneous”; they bid in the property in November and December 1971, and they did not pay the bank until close of escrow in April 1972.
Assuming, arguendo, that equitable subrogation may apply in California despite noncodification, that doctrine does *321not support the Stewards’ claim to the proceeds of the stock. The Stewards’ theory is that, upon payment of Forester’s debt to the bank, they became entitled to the bank’s security including the stock by equitable subrogation. The fundamental difficulty is that the law of California does not permit a person who acquires land subject to a mortgage or deed of trust to pay the debt and thereby to acquire any additional security that the mortgagor or trustor had received from his debtor. (McCarthy v. Kurkjian (1st Dist. 1924) 65 Cal.App. 569, 224 P. 1016.) The effect of the Stewards’ payment of the bank was to extinguish both the debt and the first deed of trust. The Stewards could not have kept the bank’s first deed of trust alive after they paid the debt, by the same token, they paid the debt; by the same token, the debt was paid. (McCarthy v. Kurkjian, supra, 65 Cal.App. at 574, 224 P. at 1018.) A fortiori, the Stewards cannot trace the proceeds of the stock after the pledge was extinguished, the stock was liquidated, and the proceeds paid to the trustee. Moreover, the Stewards’ equitable situation vis-avis Forester’s general creditors is no better under a subrogation theory than it was under the marshaling theory.

Special Character of the Stock

The additional barrier to the Stewards’ recovery is the peculiar nature of the stock that is in issue. Forester did not own the stock held by the land bank. The Association owned the bank stock, and the bank held it as security for its loan. Forester, as borrower, owned association stock, which was held by the Association as security. The land bank had no authority to assign its interest in this stock. (See generally 12 C.F.R. §§ 613-16 (1974), 12 C.F.R. § 610 (1970-72).) Because the bank’s security interest was not assignable, the Stewards could not have acquired it by subrogation. (Cf. Fifield Manor v. Finston (1960) 54 Cal.2d 632, 639-40, 7 Cal.Rptr. 377, 381-82, 354 P.2d 1073, 1077-78.) The Stewards could not have acquired Forester’s interest in the bank stock because he owned none. Since the Stewards could not be subro-gated to the stock, they obviously have no basis at all to claim subrogation to the proceeds of the stock.
No injustice is done by depriving the Stewards of the $7,000. When they sold the ranch to Forester, they did not bargain for this additional security. As vendors, they had to be aware that Forester had no personal liability to them on the transaction, and they were obliged to take the risk that, on default, the proceeds of any sale would not be enough to satisfy their purchase money notes. The risk proved to be greater than they may have anticipated, but their loss cannot be passed along in whole or in part to Forester’s general creditors.
I would reverse.

. For the purpose of this phase of the discussion, I treat the Association and the bank as if they were a single entity, the bank, and the stock as if it were owned by the bank.

. Cal.Civ.Code § 3433 (West 1954) provides:
“Relative Rights of Different Creditors. Where a creditor is entitled to resort to each of several funds for the satisfaction of his claim, and another person has an interest in, or is entitled as a creditor to resort to some, but not all of them, the latter may require the former to seek satisfaction from those funds to which the latter has no such claim, so far as it can be done without impairing the right of the former to complete satisfaction, and without doing injustice to third persons.”

. Cal.Code Civ.P. § 580d (West 1954) provides:
“No judgment shall be rendered for any deficiency upon a note secured by a deed of trust or mortgage upon real property hereafter executed in any case in which the real property has been sold by the mortgagee or trustee under power of sale contained in such mortgage or deed of trust.”
The purposes and effects of section 580d are discussed in Hetland, “Deficiency Judgment Limitations in California — a New Judicial Approach,” 51 Cal.L.Rev. 1, 28-34 (1963).

. The marshaling rule itself affects the Stewards’ equities. Section 580b of the California Code of Civil Procedure (see supra) prevents purchase money lenders from seeking a deficiency judgment after the sale of the real property securing the debt. This provision has as one goal the imposition of the burden of risk of overvaluation of the property on the seller. (Roseleaf Corp. v. Chierighino (1963) 59 Cal.2d 35, 42, 27 Cal.Rptr. 873, 877, 378 P.2d 97, 101.) The purchase money lender with a first trust deed negotiates the terms of the sale, including the interest rate, which reflects his estimate of the probability of loss. The marshaling doctrine may slightly alter the calculation for holders of junior trust deeds who are also vendors. To the extent that this lienor is concerned about nonpayment on the first trust deed, thereby throwing the burden of paying the notes on the one who bids in, the expectation of aid from additional collateral should lower the interest rate. The lienor may thus rely on the doctrine in setting the terms of the sale. This reliance factor, which may be disproved in a particular case, entitles the lienor to some equitable consideration.
The majority, relying on Freedland v. Greco (1955) 45 Cal.2d 462, 289 P.2d 463, state that “[a] mortgagee may pursue additional security given by the mortgagor if the primary security is insufficient to satisfy the obligation.” The question is given to whom: In Freedland, the additional security was given to the first lien- or; Forester gave only the trust deed to the Stewards unless they are subrogated to the bank’s rights. We show infra that they are not. Additionally, the Freedland court denied the creditor the right to a deficiency judgment on the additional security after he had bid in and sold the real property and foreclosed on the personal property.