SECURITY PACIFIC NATIONAL BANK v. WOZAB

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Court of Appeal, Second District, Division 1, California.

SECURITY PACIFIC NATIONAL BANK, Plaintiff and Appellant, v. Anton J. WOZAB et al., Defendants and Respondents.

No. B031943.

Decided: April 26, 1989

Lillick McHose & Charles, Robert L. Morrison and Scott W. Carlson, Los Angeles, for plaintiff and appellant. R. Blair Reynolds and Christopher Chenoweth, San Francisco, for amicus curiae California Bankers Ass'n on behalf, of plaintiff and appellant. Wise, Wiezorek, Timmons & Wise, Anthony F. Wiezorek and Richard P. Dieffenbach, Long Beach, for defendants and respondents.

INTRODUCTION

Plaintiff Security Pacific National Bank appeals from a summary judgment in favor of defendants Anton J. and Dorothea Wozab.

STATEMENT OF FACTS

Defendant Anton J. Wozab was president and majority shareholder of Anco Fire Protection, Inc. (Anco);  defendant Dorothea Wozab, his wife, was a director of the corporation.   Anco had an accounts receivable line of credit with plaintiff in excess of $1,000,000.   Anco also had demand deposit accounts with plaintiff.   Defendants had a term savings account and demand deposit accounts with plaintiff.

Defendants executed general continuing guaranties for loans or advances to Anco.   In April 1984, plaintiff began to suspect Anco may have submitted fraudulent invoices to obtain advances from plaintiff.   Defendant Anton Wozab discussed the matter with plaintiff and, as a result of the discussions, defendants executed a deed of trust on their residence as security for their guaranties.

Plaintiff attempted to work out a repayment program for Anco but in August 1984 was informed Anco intended to file for bankruptcy.   In an effort to recoup part of its losses prior to Anco's filing for bankruptcy, plaintiff set off $110,635.19 in Anco's demand deposit accounts and $2,804.82 in defendants' demand deposit and term savings accounts against Anco's indebtedness of $1,090,015.96, leaving a balance due of $976,575.95.   Anco filed for bankruptcy shortly thereafter.

Plaintiff entered into settlement discussions regarding defendants' liability under their guaranties.   However, defendants' attorney informed them that under the recently decided case of Bank of America v. Daily (1984) 152 Cal.App.3d 767, 199 Cal.Rptr. 557, plaintiff, by taking the setoff, had waived any claim against them under their guaranties;  the attorney also informed plaintiff about the Daily case.   Plaintiff reconveyed the deed of trust to defendants and filed the instant lawsuit for breach of defendants' general continuing guaranties.

CONTENTIONS

I

Plaintiff contends this court should not follow Bank of America v. Daily, in that the decision was poorly reasoned and based on case law which has been overruled by subsequent judicial decisions and legislative action.

II

Plaintiff further contends its setoff should not waive defendants' guaranties.

DISCUSSION

I

 Plaintiff contends this court should not follow Bank of America v. Daily, in that the decision was poorly reasoned and based on case law which has been overruled by subsequent judicial decisions and legislative action.   We disagree.

The trial court decided this case on the basis of Bank of America v. Daily, supra, 152 Cal.App.3d 767, 199 Cal.Rptr. 557.   Although the trial court found Daily to be harsh in its results and did not like the decision in the case, it recognized it was bound by the case.  (Auto Equity Sales, Inc. v. Superior Court (1962) 57 Cal.2d 450, 455, 20 Cal.Rptr. 321, 369 P.2d 937.)   Of course, this court is not bound by the Daily case, decided by the Fourth District, although it normally follows decisions of the other courts of appeal.  (9 Witkin, Cal.Procedure (3d ed. 1985) Appeal, §§ 772–773, pp. 740–742.)   We are, however, bound by decisions of the Supreme Court.   (Id., § 768, p. 735.)   The decision in Daily was based on a Supreme Court case which the appellate court felt bound to follow.  (152 Cal.App.3d at p. 771, 199 Cal.Rptr. 557.)

In Bank of America v. Daily, supra, defendants obtained money from plaintiff in exchange for a promissory note secured by stock;  when the stock declined in value, plaintiff asked for additional collateral and defendants gave it a deed of trust on real property.   Defendants defaulted on their note.   Plaintiff sold the stock at a private sale and applied the proceeds to the balance due on the note;  it also set off the amount in defendants' checking account against the amount owed.   There still remained a balance due, so plaintiff brought suit to foreclose on the deed of trust;  the trial court found the setoff did not waive plaintiff's right to foreclose and entered a judgment of foreclosure.  (152 Cal.App.3d at pp. 770–771, 199 Cal.Rptr. 557.)

Code of Civil Procedure section 726 provides in pertinent part:  “There can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property, which action must be in accordance with the provisions of this chapter.”  (Subd. (a).)   Plaintiff claimed its setoff of defendants' checking account was not a judicial action and did not constitute the one action allowed by section 726, therefore they could bring an action on their deed of trust.  (152 Cal.App.3d at p. 771, 199 Cal.Rptr. 557.) 1  The court responded:  “If this were an original question [plaintiff's] argument might have some merit.  Section 22 [of the Code of Civil Procedure] defines ‘action’ as ‘an ordinary proceeding in a court of justice by which one party prosecutes another for the declaration, enforcement, or protection of a right, the redress or prevention of a wrong, or the punishment of a public offense.’   Thus, in the classic sense of a judicial proceeding initiated by complaint, a checking account setoff is not an ‘action.’

“Our Supreme Court, however, has long since put this issue to rest.  McKean v. German–Am. Savings Bank (1897) 118 Cal. 334 [50 P. 656] ․ held a bank setoff against a general deposit account is an ‘action’ within the meaning of section 22 for the purpose of applying the one-form-of-action rule of section 726.  (Id., at pp. 340–341 [50 P. 656];  accord, Gnarini v. Swiss American Bank (1912) 162 Cal. 181, 184 [121 P. 726] ․;  Woodruff v. California Republic Bank (1977) 75 Cal.App.3d 108, 110 [141 Cal.Rptr. 915]․)”  (152 Cal.App.3d at p. 771, 199 Cal.Rptr. 557, fn. omitted.)   Thus, the Daily court concluded plaintiff's setoff was an action for recovery of defendant's debt within the meaning of section 726.  (Id., at p. 772, 199 Cal.Rptr. 557.)

Plaintiff in the instant case contends McKean v. German–Am. Savings Bank, supra, 118 Cal. 334, 50 P. 656, on which Daily was based, did not hold a setoff was a judicial action within the meaning of section 726, was overruled by legislative amendment in 1927 and is thus no longer good law, is inconsistent with recent Supreme Court cases and is no longer justified by policy considerations.   In McKean, Schwickert deposited $400 with defendant and the money was later assigned to plaintiff.   Schwickert also owed money to defendant under a promissory note secured by a mortgage.   Defendant applied the $400 to reduce Schwickert's indebtedness before the assignment to plaintiff.   The question presented to the court was whether the holder of a debt secured by a mortgage could apply in reduction or cancellation of the debt a claim due by the holder to the debtor.  (At p. 334, 50 P. 656.) 2

The court noted in Bartlett v. Cottle (1883) 63 Cal. 366, 367 and Biddel v. Brizzolara (1883) 64 Cal. 354, 362, 30 P. 609, it held an action on a note secured by a mortgage must be taken according to the provisions of section 726.  (118 Cal. at pp. 335–336, 50 P. 656.)   Further, “ ‘[w]hatever the form of the debt, the mortgagor can be legally compelled to pay no part of it until [a] decree is entered for the sale of the premises mortgaged, and the liability which shall then accrue to him is a liability to pay only a deficiency, which shall appear on the sheriff's return.   The liability of the mortgagor is, therefore, contingent on the fact that a sale of the mortgaged premises shall satisfy the debt and costs.   It is against this contingency that the purchaser indemnifies him.’ ”  (Id., at p. 336, 50 P. 656, quoting from Biddel, supra, 64 Cal. at p. 362, 30 P. 609.)

Then, in Barbieri v. Ramelli (1890) 84 Cal. 154, 23 P. 1086, plaintiff brought an action on a note secured by a junior mortgage which was valueless, in that the value of the property was not equal to the indebtedness secured by the prior mortgages.  (McKean, supra, 118 Cal. at p. 336, 50 P. 656.)   The court reiterated the position plaintiff was bound by law to pursue the statutory remedy and further held plaintiff was not authorized to waive the security and bring an action on the indebtedness.  (Ibid.)

Defendant in McKean nonetheless claimed the right to a setoff under Code of Civil Procedure section 438, contending under that section in an action on a contract “the defendant may set up any cause of action arising upon contract by way of counterclaim, and that counterclaim under the code includes both recoupment and setoff.”  (118 Cal. at p. 337, 50 P. 656.)   The court examined the cases cited by defendant and found none to be on point;  in none was “a note secured by mortgage ․ allowed as a setoff to an action at law where such a statute as [section 726] exists.”  (Id., at p. 339, 50 P. 656.)

The court then observed defendant's claim it had a right to such setoff “presents a defense, perhaps, in a form not necessarily involving an action or a right of action, but rather as showing no indebtedness of defendant to plaintiff.   But does the right of a bank to apply a deposit to the matured indebtedness of the depositor to the bank apply in this state to the case where that indebtedness is secured by mortgage on real estate?”   (Ibid.)  As the court read its prior decisions, “they mean that the mortgagee, whether a banking corporation or a private individual, must first look to the mortgaged premises as constituting the primary fund out of which the debt secured by the mortgage must be paid [citation];  that the security must be first exhausted;  if there be a deficiency it may be docketed, but this deficiency judgment does not become a lien on any other real property, and execution will not issue upon it until after the sale under foreclosure.   [Citations.]

“ ‘The liability,’ as was said in Biddel v. Brizzolara, supra, [64 Cal. at p. 362, 30 P. 609,] ‘is contingent on the fact that a sale of the mortgaged premises shall satisfy the debt and costs.’  [¶] The reason of the rule that gives to banks the right to appropriate a deposit to the payment of the depositor's matured indebtedness does not apply where the bank has security for that indebtedness.   The depositor's matured note, payable to the bank, is equivalent to a check drawn by him on the bank, and the right to charge up his note is practically only exercising the right to charge up his checks, for it is a presumption of law that it was his intent to have the note discharged from his deposit;  and there is the reciprocal right of the depositor to have his deposit applied to the payment of the note in the event of the bank's insolvency.  [Citation.]  But could there be a presumption of such intent when he had secured his note by mortgage?”  (McKean, supra, 118 Cal. at pp. 339–340, 50 P. 656.)

The court declared if the bank were allowed such a setoff where the indebtedness was secured by a mortgage, such a rule “would compel a depositor, who is a borrower, to avoid keeping a credit account with a bank that held his note secured by mortgage;  and if he kept his account elsewhere it would be imperiled by a possible transfer of the secured note to the bank where his credits were, and by this short cut payment would be enforced wholly ignoring the mortgage, and ․ enlarging the rule above stated to an unauthorized extent.   It would also seem but reasonable that, when the legislature declared that there should be but one action to enforce a debt secured by mortgage, it did not mean that payment could be enforced against the consent of the mortgagor by giving a bank the right to enforce payment under a general banker's lien upon some other property, and that, too, without any legal proceedings whatever.   The lien given on the mortgaged premises ․ was intended to be in lieu and exclusive of all implied liens.  [There is no reason], either, why a bank should be given a right to forcibly, and against the consent of the depositor, appropriate his money, when, if it came into court to do so, the action would not lie, and we have seen it would not lie as counterclaim, setoff, or in whatever other form it may be presented.

“The difficulty with [defendant's] argument is that it ignores the force and effect of section 726․  Whether as counterclaim, or setoff, or recoupment, or whatever other form the defense may assume, it is, for the purpose of the defense, an action against the plaintiff pro tanto.”  (Id., at pp. 340–341, 50 P. 656.)   Thus, the court concluded defendant's defense to plaintiff's suit was “ ‘an action for the recovery of a debt’ which was secured by mortgage” within the meaning of section 726, and defendant had no right to plead its mortgage notes by way of setoff.  (Id., at p. 341, 50 P. 656.)

 McKean stands for several principles.   First, under section 726, a creditor holding a note secured by a mortgage must first bring an action to foreclose the mortgage and only after the security is exhausted may it seek out other assets of the debtor to satisfy the deficiency.   Second, it may not waive the security and bring an action on the indebtedness itself.   Third, for the purposes of a section 726 defense, a setoff may be considered an action against the plaintiff pro tanto.   Thus, if the creditor takes the debtor's assets by setoff and does not proceed against the security, that is considered the one action allowed by section 726 and the creditor cannot raise the mortgage as a counterclaim in an action against it by the debtor.

Commercial Bank v. Kershner (1898) 120 Cal. 496, 52 P. 848, decided by the Supreme Court the following year, is consistent with McKean and applies to actions brought by, rather than against, the creditor.   There the court held plaintiff's prior attachment suit waived its right to foreclose on a mortgage on real property securing defendant's indebtedness.  (At pp. 498–499, 52 P. 848.)

McKean was followed by the Supreme Court in Gnarini v. Swiss American Bank, supra, 162 Cal. 181, 121 P. 726.   In Gnarini, Cain and his wife executed a mortgage to defendant to secure a personal loan and to secure repayment of advances made by defendant to the firm of Cain, Boyd & Corriea.   Defendant thereafter loaned money to the firm and received a promissory note.   The firm later declared bankruptcy;  at the time, it had an account with defendant.   Defendant closed the firm's account and applied the funds to the amount due on the note;  Cain paid the remaining balance.   Plaintiff, the firm's trustee, sued defendant, claiming the firm's indebtedness was secured by the mortgage and therefore defendant had no right to apply the funds in the firm's account to the note.  (At pp. 183–184, 121 P. 726.)

The court observed, if the note was secured by the mortgage, then defendant had no right to apply the firm's funds to payment on the note but first must have exhausted the security, under McKean.  (Id., at p. 184, 121 P. 726.)   The defendant could not waive the mortgage and bring an action on the indebtedness, under Barbieri v. Ramelli, supra.  (Ibid.)  And under section 726, only one action could be maintained, and that must be on the mortgage before there was any recourse to the bank account or the personal responsibility of the debtor.  (Ibid.)  The court concluded the note was secured by the mortgage and held in favor of plaintiff.  (Id., at pp. 184–187, 121 P. 726.)

Two cases deal with the interplay between the principles set forth in McKean and Code of Civil Procedure sections 438 and 440 (now sections 428.10, subdivision (a), and 431.70 (stats.1971, ch. 244, §§ 23, 29, 41, 43, pp. 380, 386, 389);  plaintiff contends the amendment of section 438 in 1927 overruled McKean.   In Moore v. Gould (1907) 151 Cal. 723, 91 P. 616, plaintiff sued on a note and mortgage and defendants set up as counterclaims an indebtedness from plaintiff's deceased husband to defendants.   The court noted the counterclaims, if set up in independent actions, would have been barred by the statute of limitations.  (At p. 730, 91 P. 616.)   The court considered whether they could be raised by treating them as partial payments of the mortgage debt under section 440.  (Ibid.)

At that time, section 440 provided:  “When cross-demands have existed between persons under such circumstances that, if one had brought an action against the other, a counterclaim could have been set up, the two demands shall be deemed compensated, so far as they equal each other, and neither can be deprived of the benefit thereof by the assignment or death of the other.”   Section 438 provided a counterclaim “must be one existing in favor of a defendant and against a plaintiff, between whom a several judgment might be had in the action, and arising out of one of the following causes of action:  [¶] 1. A cause of action arising out of the transaction set forth in the complaint as the foundation of the plaintiff's claim, or connected with the subject of the action;  [¶] 2. In an action arising upon contract;  any other cause of action arising also upon contract and existing at the commencement of the action.”

The court concluded the case before it was not a case of cross-demands which could be mutually compensated under section 440:  “The plaintiff was suing on an indebtedness secured by a mortgage, an indebtedness which could be recovered only by means of the action of foreclosure prescribed by section 726 of the Code of Civil Procedure.   In such action the mortgaged premises must first be applied to the satisfaction of the debt, and there is no personal liability on the part of the mortgagor unless the security shall prove insufficient to satisfy the debt․  For this reason it has been held that in an action upon a simple contract debt (a bank deposit) the defendant cannot set off against such debt a liability of the plaintiff secured by mortgage.  (McKean v. German–American Sav. Bank [sic ], [supra,] 118 Cal. 334 [50 P. 656]․)  The two claims, said the court, could not be deemed compensated under section 440, because ‘the action of respondent for the deposit, and the right of action of appellant to foreclose its mortgage, are not cross-demands as contemplated by that section.’ ”  (151 Cal. at p. 731, 91 P. 616.)   The reason was that one debt was secured and the other unsecured.  (Ibid.)

Section 438 was amended in 1927.  (Stats.1927, ch. 813, § 1, p. 1620.)   Added was a provision “that the right to maintain a counterclaim shall not be affected by the fact that either plaintiff's or defendant's claim is secured by mortgage or otherwise, nor by the fact that the action is brought, or the counterclaim maintained, for the foreclosure of such security.”

In Nelson v. Bank of America (1946) 76 Cal.App.2d 501, 173 P.2d 322, defendant held plaintiff's matured note secured by a chattel mortgage on a boat;  plaintiff also had money on deposit with defendant.   Defendant sold the boat pursuant to the terms of the mortgage then applied plaintiff's deposit to the balance due on the note.   Plaintiff sought to withdraw the money but defendant refused.   Plaintiff sued in assumpsit for the money;  defendant pleaded plaintiff's indebtedness on the note as a counterclaim.  (At pp. 502–504, 173 P.2d 322.)

The court noted, citing McKean and Gnarini, “It was true, prior to the amendment of section 438 of the Code of Civil Procedure in 1927, that while the counterclaim of the bank remained secured by mortgage, the bank was precluded from applying the customer's deposit credit to that indebtedness.”   (Id., at p. 507, 173 P.2d 322).   After amendment, section 438 allowed the bank to set up a counterclaim as a defense even if it was secured by a mortgage.  (Id., at pp. 509–510, 173 P.2d 322.)   In this respect, McKean has been superseded by the amendment of section 438.   However, in all other respects the decision remained effective, as the court in Nelson observed.

The Nelson court continued, “In [McKean and Gnarini ] ․, it appears that the mortgage securities of indebtedness due to the banks had not been foreclosed, but were held by the banks at the times they sought to apply customers' deposits to their indebtedness․  Those cases hold that such application of deposits in banks may not be made to debts which are secured by mortgages unless and until the mortgages are first foreclosed and the property sold in accordance with their terms.   The clear inference is that when the securities have been exhausted by foreclosure and sale, and a balance of the indebtedness remains unpaid, a bank has the right to offset the unpaid balance of the then unsecured debt by application of the debtor's credit on deposit in the bank.”  (Id., at p. 507, 173 P.2d 322.)   Since the chattel mortgage had been foreclosed and the unpaid balance on the note was not then secured, defendant properly applied plaintiff's deposit toward paying the unsecured balance.  (Id., at p. 508, 173 P.2d 322.)   Additionally, because the balance was unsecured, section 726 had no application.  (Id., at pp. 508–509, 173 P.2d 322.)

Thus, after the amendment of section 438, the predominate principles of McKean remain intact.   A creditor secured by a mortgage must rely on the security before enforcing the debt, under section 726.  (Accord, Roseleaf Corp. v. Chierighino (1963) 59 Cal.2d 35, 38, 27 Cal.Rptr. 873, 378 P.2d 97;  Woodruff v. California Republic Bank, supra, 75 Cal.App.3d at pp. 110–111, 141 Cal.Rptr. 915.)   The creditor may not waive the security and bring an action on the indebtedness.  (Accord, Kaiser Industries Corp. v. Taylor (1971) 17 Cal.App.3d 346, 353, 94 Cal.Rptr. 773.)   If the creditor does bring an action on the indebtedness and the debtor waives section 726 by failing to affirmatively plead it, the debtor may then use section 726 to prevent the creditor from bringing a second action to foreclose the mortgage.   (Ibid.)  The question in the instant case is whether a bank setoff constitutes an action on the indebtedness, bringing into play the protection of section 726.   Both McKean and Daily treat it as such.

Defendant argues two recent Supreme Court cases hold section 726 applies to judicial actions only, overruling McKean and showing Daily was wrongly decided.  Kruger v. Wells Fargo Bank (1974) 11 Cal.3d 352, 356, 113 Cal.Rptr. 449, 521 P.2d 441 holds a bank's setoff of a depositor's charge account debts against the depositor's checking account does not constitute state action which requires the application of due process guarantees.   It has nothing whatsoever to do with section 726 and does not overrule McKean.

In Walker v. Community Bank, supra, 10 Cal.3d 729, 111 Cal.Rptr. 897, 518 P.2d 329, DEI borrowed money from defendant in exchange for a promissory note secured by a chattel mortgage;  as additional security for the same loan, it gave defendant a promissory note secured by a trust deed on real property.   DEI defaulted on the note;  defendant judicially foreclosed on the chattel mortgage and recovered a deficiency judgment.   Before the judgment was entered, DEI sold the real property to plaintiff.   Defendant commenced foreclosure on the real property and plaintiff brought an action to quiet title and enjoin the trustee's sale, contending section 726 barred the action since defendant failed to foreclose on the trust deed in its prior action on the chattel mortgage.  (At pp. 732–733, 111 Cal.Rptr. 897, 518 P.2d 329.)

The court first notes the general rules applicable to an indebtedness secured by a mortgage or deed of trust.   Under section 726, the creditor must rely on the security before enforcing the debt;  where the creditor sues on the obligation without seeking foreclosure on the security, he “waives his right to foreclose on the security or to sell the security under a power of sale.”  (Id., at p. 733, 111 Cal.Rptr. 897, 518 P.2d 329.)   At this point, the court seems to be treating a private sale of the mortgaged property as an “action” within the meaning of section 726, even though it is not a judicial action within the meaning of Code of Civil Procedure section 22.

The court goes on to point out section 726 may have dual application.   It may be used as an affirmative defense to force a creditor to exhaust the security before obtaining a judgment against the debtor or as a “sanction against the creditor on the basis that the latter by not foreclosing on the security in the action brought to enforce the debt, has made an election of remedies and waived the security.”  (Id., at p. 734, 111 Cal.Rptr. 897, 518 P.2d 329.)

The problem in Walker was that the debt was secured by both real and personal property.   In 1963, section 726 was amended to delete the reference to personal property and Commercial Code section 9501 was enacted, which provided in subdivision (4) if a security agreement covered real and personal property, the creditor could proceed under the Commercial Code against the personal property or could proceed against both the real and personal property in accordance with its rights and remedies with respect to real property.  (Walker, supra, 10 Cal.3d at pp. 734–735, 111 Cal.Rptr. 897, 518 P.2d 329.)   The question was whether section 726 still applied where both real and personal property were involved.  (Id., at p. 735, 111 Cal.Rptr. 897, 518 P.2d 329.)

The parties agreed defendant, as creditor, could properly resort to the real property security first by a private sale then judicially foreclose on the chattel mortgage under Commercial Code section 9501.  (Id., at p. 736, 111 Cal.Rptr. 897, 518 P.2d 329.)   The court concurred:  since a private sale under a power of sale “is not judicial foreclosure within section 726;  the subsequent judicial foreclosure of the chattel mortgage, being solely on personal property and being the initial judicial action, would not have offended section 726 (which ․ no longer covers personal property) but would fall clearly within subdivision (4) of section 9501.”  (Ibid., emphasis original.)

Defendant argued, however, the order could be reversed without violating section 726.  (Ibid.)  The court disagreed.   If this were the case, a creditor could foreclose on personal property security and obtain a deficiency judgment against the debtor without first exhausting real property security, which flies in the face of the clear purpose of section 726 to require a secured creditor to exhaust all security first, or the creditor could obtain a deficiency judgment then hold a private sale of the security, which Code of Civil Procedure section 580d seeks to avoid.  (Id., at pp. 736–737, 111 Cal.Rptr. 897, 518 P.2d 329.)   The court concluded where a single debt is secured by both real and personal property and the creditor elects to judicially foreclose on the personal property only, it loses the security interest in the real property under section 726.  (Id., at pp. 740–741, 111 Cal.Rptr. 897, 518 P.2d 329.)

Walker clearly holds a creditor's private sale under a mortgage or trust deed is not a judicial foreclosure within the meaning of section 726.   This would tend to support the conclusion a setoff, as a private action, also would not be an action under section 726.   However, Walker seems to make a distinction where the creditor's first action is not on the real property security, the creditor then seeks to act on the real property security either by judicial action or private sale, and the debtor asserts section 726 as a defense;  in that case, the private action is treated as a judicial action within the meaning of section 726 in order to protect the rights of the debtor.   This can be seen by the court's statement that once a creditor sues on the obligation, he “waives his right ․ to sell the security under a power of sale” (id., at p. 733, 111 Cal.Rptr. 897, 518 P.2d 329), which is a private action.

This is consistent with McKean.  McKean did not hold a setoff was a judicial action for all intents and purposes.   Rather, it held a setoff was, “for the purpose of the defense, an action against the [debtor] pro tanto.”   (118 Cal. at p. 341, 50 P. 656.)   Accordingly, we conclude Daily is correct and “a bank setoff against a general deposit account is an ‘action’ within the meaning of section 22 for the purpose of applying the one-form-of-action rule of section 726” when the bank has not yet foreclosed on the mortgage or trust deed on real property securing the debt against which the setoff was taken.  (Daily, supra, 152 Cal.App.3d at pp. 771–772, 199 Cal.Rptr. 557.)

Plaintiff also argues the policy considerations underlying McKean are no longer valid today.   However, the main policy consideration underlying the case is that contained in section 726—the liability of the debtor is contingent upon exhaustion of the security and the debtor intends for the creditor to look first to the security before personal liability is imposed.   (McKean, supra, 118 Cal. at pp. 336, 340, 50 P. 656.)   This policy has not changed.   If other policy considerations have changed, it is up to the Supreme Court or the Legislature to change the law;  this court is bound by their pronouncements.  (Auto Equity Sales, Inc. v. Superior Court, supra, 57 Cal.2d at p. 455, 20 Cal.Rptr. 321, 369 P.2d 937;  see Code Civ.Proc., § 1858.)

II

Plaintiff further contends its setoff should not waive defendants' guaranties.   Again, we disagree.

The question presented by plaintiff's second contention is, what is the sanction for taking a setoff before foreclosing on the real property security—is it waiver of the security or waiver of the entire indebtedness?   Plaintiff argues it is the former, defendant the latter.

In Hall v. Arnott (1889) 80 Cal. 348, 22 P. 200, it was held plaintiffs by their prior suit on the indebtedness exhausted their remedy on the security and thus waived any security afforded by the deed they held.   (At p. 354, 22 P. 200.)   The court did not consider whether the indebtedness itself was waived by the prior action.  (Id., at pp. 355–356, 22 P. 200.)   Neither was the question considered in McKean.  (See McKean v. German–Am. Savings Bank, supra, 118 Cal. at p. 341, 50 P. 656.)

In Commercial Bank v. Kershner, supra, 120 Cal. 496, 499, 52 P. 848, the court affirmed the holding in Ould v. Stoddard (1880) 54 Cal. 613, 615 “ ‘that by prosecuting an action to final judgment the plaintiff has exhausted his remedy upon both the note and the security.   To hold otherwise would be to hold that there may be two actions where the statute declares there can be but one.’ ”   Subsequent Supreme Court cases refer to waiver of the security but do not hold the sanction is so limited.  (See, e.g., Salter v. Ulrich (1943) 22 Cal.2d 263, 268, 138 P.2d 7;  Walker v. Community Bank, supra, 10 Cal.3d at pp. 736, 740–741, 111 Cal.Rptr. 897, 518 P.2d 329.)

Bank of America v. Daily, supra, 152 Cal.App.3d 767, 199 Cal.Rptr. 557 notes the “ ‘classic sanction’ ” against the creditor who fails to exhaust all security for the same debt in a single action is waiver of both the balance of the security and the unpaid balance of the debt.  (At p. 772, 199 Cal.Rptr. 557.)   The court thereafter holds, however, plaintiff by taking its setoff waived its right to foreclose on the trust deed.  (Id., at p. 773, 199 P. 557.)

Commercial Bank v. Kershner requires that the sanction be waiver of the entire indebtedness, not merely the security.   This is consistent with the goal of section 726 that there be only one action on an indebtedness secured by a mortgage on real property.

Plaintiff contends this is harsh and unjust, especially here, where the setoff was $2,804.82 and the remaining indebtedness was $976,575.95.   It is true this is harsh, but unjust?  Section 726 has been on the books since 1872.   Since at least 1883, that section has been interpreted to mean a creditor must first bring an action on and exhaust the mortgaged security before compelling the debtor to pay any part of the debt.  (Biddel v. Brizzolara, supra, 64 Cal. at p. 362, 30 P. 609.)   Since 1897, McKean has stood for the proposition a setoff may be considered the one action for purposes of section 726.   (118 Cal. at p. 341, 50 P. 656.)   Yet in 1984, plaintiff took a setoff from defendants without first foreclosing on the trust deed they gave as security for their indebtedness.   It is not unjust to apply such a harsh sanction for plaintiff's violation of such longstanding and well-established law.

Accordingly, we hold by taking a setoff without first foreclosing on defendants' deed of trust, plaintiff took its one form of action under section 726 and thereby waived the balance of defendants' indebtedness.   Therefore, the trial court properly granted defendants summary judgment.

The judgment is affirmed.

FOOTNOTES

1.   Section 726 applies to deeds of trust as well as mortgages.   (Walker v. Community Bank (1974) 10 Cal.3d 729, 733, fn. 1, 111 Cal.Rptr. 897, 518 P.2d 329.)

2.   The court did not specify that the mortgage must be on real property, because at the time section 726 applied to mortgages on both real and personal property.  (McKean, supra, 118 Cal. at p. 335, 50 P. 656.)

SPENCER, Presiding Justice.

HANSON and ORTEGA, JJ., concur.

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