FROLAND v. NORTHEAST SAVINGS

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Court of Appeal, Second District, Division 5, California.

Kenneth Stanley FROLAND, Plaintiff and Appellant, v. NORTHEAST SAVINGS et al., Defendants and Respondents.

No. B090159.

Decided: October 02, 1995

Friedemann & Maurer, Michael T. Maurer, and John F. Friedemann, Marina Del Ray, for Plaintiff and Appellant. Stroock & Stroock & Lavan, Julia B. Strickland, Erik A. Christiansen, and Scott M. Pearson, Los Angeles, for Defendants and Respondents.

I. INTRODUCTION

Plaintiff, Kenneth Stanley Froland, trustee of The Froland Family Trust of 1980 appeals, from a judgment after a demurrer to his complaint to quiet title and cancel instruments against defendant, Northeast Savings, F.A., a federal savings and loan association, was sustained without leave to amend. For the reasons stated below, we reverse the order sustaining the demurrer without leave to amend. We hold that an offset included in a federal court judgment is an “action” within the meaning of Code of Civil Procedure1 section 726.

II. BACKGROUND

The complaint, which factual allegations must be assumed as true (Aubry v. Tri-City Hospital Dist. (1992) 2 Cal.4th 962, 967; Blank v. Kirwan (1985) 39 Cal.3d 311, 318), sought to quiet title to real property commonly known as 2675 Nottingham Avenue, in Los Angeles. The complaint requested a determination that plaintiff was entitled to cancel a note in the amount of $720,000 and deed of trust. The $720,000 trust deed on the subject property which secured the note. The determination was sought as of September 27, 1994, on the ground that defendant had collected a portion of the debt secured by the trust deed on the Nottingham property by means of a judicial offset in a federal action entitled Kenneth Stanley Froland, Trustee of the Froland Family Trust of 1980 v. Northeast Savings, F.A., U.S. Dist. Court, Cen. Dist. of Calif., No. CV-94-746-RAG (BCC) (the “federal action”). According to the complaint in this lawsuit, the federal action arose because defendant had allegedly improperly adjusted the variable interest rate of the $720,000 note secured by the trust deed on the subject real property. The federal action contained causes of action for breach of the terms of the note and violations of the National Affordable Housing Act. (12 U.S.C. § 2605(e). On May 26, 1994, plaintiff moved for a summary judgment in the federal action which was granted. Plaintiff submitted a proposed judgment which included a statement of damages in the amount of $4,812.60. Defendant objected to the amount of the proposed judgment. Defendant requested that any judgment entered in the federal action be credited against the delinquencies under the note. Defendant also filed a proposed alternative judgment which provided in part: “[S]ince Plaintiff is in default on his loan, and in accordance with Fannie Mae's ARM Correction Policy Guidelines, Plaintiff shall receive a credit of said sum to be applied toward the delinquent payments Plaintiff owes to Northeast Savings.” In response to defendant's objections, plaintiff filed a second proposed judgment which was signed by the court and entered on July 27, 1994. The judgment provides in part: “IT IS ORDERED AND ADJUDGED that plaintiff recover from Defendant Northeast Savings, F.A., actual damages in the amount of $4,804.92, with interest thereon at the rate of 5.31 percent from the date hereof until the date of offset on the records of Northeast Saving[s], F.A., and his costs of action. [¶] IT IS FURTHER ORDERED AND ADJUDGED that the amount of $4,804.92, with interest, shall be offset by Northeast Savings, F.A., against delinquencies owed by plaintiff to Northeast Savings, F.A., under the promissory note dated February 23, 1989, and that Northeast Savings, F.A., shall send to plaintiff by U.S. mail written notice of such offset and the outstanding amount of the remaining delinquencies ․” On August 8, 1994, defendant applied the amount of the judgment against the delinquencies owed by plaintiff to it under the note. On August 11, 1994, defendant filed a notice of appeal of the judgment in the federal action but did not request a stay of the judgment.

On August 12, 1994, American Custody Corporation, trustee under the deed of trust, filed a notice of default. Plaintiff filed this action on September 28, 1994, and alleged the deed of trust was invalid and unenforceable because as a result of the offset contained in the federal court judgment. Plaintiff alleged defendant exercised its one form of action to recover the debt secured by the deed of trust and violated California's security first rule. Accordingly, plaintiff alleged defendant could not foreclose on the deed of trust without violating section 726 and California's anti-deficiency statute. Hence, plaintiff alleged the trust was entitled to have the deed and note canceled.

Defendant demurred to the complaint on the ground it contained insufficient facts to constitute a cause of action. The demurrer reasoned no action by defendant could constitute a violation of section 726. Defendant argued it had never brought any action against plaintiff in the federal litigation. Defendant argued the sole issue raised in the federal action was the interpretation of language in the note which provided that in calculating the applicable interest rate defendant would use the “‘the last [index] value received prior to the date of calculation by [defendant] from the U.S. Government through the U.S. Mail.”’ Defendant asserted that it never sought to adjudicate any other aspect of the loan or any issue regarding the enforcement of its rights pursuant to the trust deed. Defendant requested the trial court to judicially notice specific provisions of the guidelines issued by The Federal National Mortgage Association (“Fannie Mae”) which provide that “credits” rather than refunds should be given when a mortgage is delinquent. Defendant also contended that in the federal action it was plaintiff who characterized the request for a “credit” as an “offset.” Plaintiff opposed the demurrer on the grounds: the complaint contained sufficient facts to state a cause of action under section 726; the demurrer was improperly based on extrinsic evidence; defendant incorrectly relied on Fannie Mae guidelines because there is no evidence in the complaint that the guidelines are applicable; and defendant's claim that plaintiff acted in bad faith or waived his right to assert a violation of the one form of action rule or security first rule are affirmative defenses of fact which cannot be decided on a demurrer. The trial court sustained the demurrer without leave to amend and entered judgment on the complaint in favor of defendant from which plaintiff filed a timely appeal.

III. DISCUSSION

A. Standard of Review

On appeal from a judgment of dismissal entered after a demurrer has been sustained without leave to amend, we apply the following standard of review: “The judgment must affirmed ‘if any one of the several grounds of demurrer is well taken. [Citations.]’ [Citation.] However, it is error for a trial court to sustain a demurrer when the plaintiff has stated a cause of action under any possible legal theory.” (Aubry v. Tri-City Hospital Dist., supra, 2 Cal.4th at p. 967.) Plaintiff must establish the trial court abused its discretion in sustaining the demurrer without leave to amend because there is a reasonable possibility that the defect in a complaint can be cured by amendment. (Hendy v. Losse (1991) 54 Cal.3d 723, 742; accord, Blank v. Kirwan, supra, 39 Cal.3d at p. 318; E.L. White, Inc. v. City of Huntington Beach (1978) 21 Cal.3d 497, 511.)

B. The Demurrer to the Complaint

The primary issue in this appeal is whether plaintiff is entitled to any relief based upon his claim that defendant's request for an “offset” or “credit” in the federal lawsuit was a violation of the one form of action rule which is set forth in section 726, subdivision (a) which provides in 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 shall be in accordance with the provisions of this chapter.” In Security Pacific National Bank v. Wozab (1990) 51 Cal.3d 991, 997, our Supreme Court explained the rule as embodied in section 726 as follows: “This provision was first enacted in substantially similar form more than a century ago, and its general operation has long been clear. A secured creditor can bring only one lawsuit to enforce its security interest and collect its debt. Moreover, section 726(a) is part of a broader statutory scheme designed to protect debtors. ‘Under California law “the creditor must rely upon his security before enforcing the debt.” ․ However, since under section 726 “[t]here can be but one form of action for the recovery of any debt” secured by a mortgage or deed of trust on real property, where the creditor sues on the obligation and seeks a personal money judgment against the debtor without seeking therein foreclosure of such mortgage or deed of trust, he makes an election of remedies, electing the single remedy of a personal action, and thereby waives his right to foreclose on the security or to sell the security under a power of sale ․ [¶] [S]ection 726 is susceptible of a dual application--it may be interposed by the debtor as an affirmative defense or it may become operative as a sanction. If the debtor successfully raises the section as an affirmative defense, the creditor will be forced to exhaust the security before he may obtain a money judgment against the debtor for any deficiency ․ If the debtor does not raise the section as an affirmative defense, he may still invoke it 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.’ [[[[Citations, fn. omitted.]” The one form of action rule has been described as follows: “In operation, the ‘one form of action’ rule ‘applies to any proceedings or action by the beneficiary for the recovery of the debt, or enforcement of any right, secured by a mortgage or deed of trust. The only “action” that is permitted is foreclosure; any other “action” is a violation of the rule that invokes severe sanctions.’ [Citations.]” (Shin v. Superior Court (1994) 26 Cal.App.4th 542, 545, italics added in original.)

Section 22 defines an action as follows: “An action is 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.” By contrast, as special proceeding, which is not an action is defined as follows, “Every other remedy is a special proceeding.”2 Courts have described actions within the meaning of section 22 on various occasions. In Tide Water Assoc. Oil Co. v. Superior Court (1955) 43 Cal.2d 815, 823, the Supreme Court determined a request for injunctive relief in a suit brought by the state to prevent unreasonable waste of gas was an action within the meaning of section 22 and held: “It is a suit by which the People are prosecuting other parties for the enforcement or protection of a right and the prevention of a wrong. Accordingly, it is an ‘action’ and not a ‘special proceeding.”’ (Accord, Agricultural Labor Relations Bd. v. Tex-Cal Land Management, Inc. (1987) 43 Cal.3d 696, 707 [temporary injunctive relief issued in connection with petition to enforce Agricultural Labor Relations Board order]; Maguire v. Hibernia S. & L. Soc. (1944) 23 Cal.2d 719, 733 [declaratory relief claim in connection with membership in savings and loan association is an action]; Coleman v. County of Los Angeles (1919) 180 Cal. 714, 720 [equitable decree issued in suit for reimbursement of moneys paid to tax collector and determinations to whether a sale was void]; Lux v. Haggin (1886) 69 Cal. 255, 267 [action includes suits for equitable relief]; Ex Parte Harker (1875) 49 Cal. 465, 466 [power to arrest in a civil proceeding an action]; Yuba Co. v. North America etc. Min. Co. (1909) 12 Cal.App. 223, 225 [injunctive relief request an action].) In Mark Briggs & Associates, Inc. v. Kinestar, Inc. (1983) 143 Cal.App.3d 483, 486 the Court of Appeal held, “[An action] has similarly been called ‘the judicial means or procedure of enforcing a right.”’ (Ibid. [recordation of abstract of judgment a proceeding]; accord Anderson v. No-Doz (1955) 134 Cal.App.2d 11, 14-15.) In McKean v. German-Am. Savings Bank (1897) 118 Cal. 334, 341, the Supreme Court described the extent of an action, citing section 22 for purposes of whether a “setoff” asserted by lender triggered the provisions of section 726, and held as follows: “The difficulty with [the lender's] argument is that it ignores the force and effect of section 726 ․ Whether as counterclaim, or set-off, 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.” Additionally pertinent to the question of what is an action are the Code Commissioners' Notes to section 22. These were prepared in connection with the 1872 adoption of the Code of Civil Procedure and section 22. At one point in the notes, the following appears: “An action is a lawful demand of a man's right. [Citation.] Any judicial proceeding which, if conducted to a termination, will result in a judgment, is an action.” (See Code Commissioners' com., West's Ann. Code Civ. Proc., § 22, pp. 58-59.)

When we apply the foregoing body of statutory and decisional authority to the present case, we conclude defendant sought a setoff in the federal litigation; hence, it was an action within the meaning of section 22 and 726 based on the facts before the trial court when the demurrer was sustained. The proposed judgment sought damages in the sum of $4,812.60. The objection to the judgment filed by defendant requested, “Based thereon, the Court's judgment should reflect that any money judgment regarding damages be credited to PLAINTIFF'S account to reduce the amount PLAINTIFF owes to NORTHEAST.” The proposed judgment submitted by defendant stated, “However, since Plaintiff is in default on his loan, and in accordance with Fannie Mae's ARM Correction Policy Guidelines, Plaintiff shall receive a credit of said sum to be applied toward the delinquent payments Plaintiff owes to Northeast savings.” The final judgment signed by the Judge Richard A. Gadbois Jr. stated, “IT IS FURTHER ORDERED AND ADJUDGED that the amount of $4,804.92 with interest, shall be offset by Northeast Savings, F.A., against delinquencies owed by plaintiff to Northeast Savings, F.A., under the promissory note dated February 23, 1989, and that Northeast Savings, F.A., shall send to plaintiff by U.S. mail written notice of such offset and the outstanding amount of the remaining delinquencies within 14 days after receipt of this judgment.” The July 27, 1994, judgment twice referred to the reduction in the $4,804.92 judgment as an “offset.” That offset was in response to defendant's argument that it was entitled as part of the judgment to a “credit” against the $4,804.92 because of other sums owed to it by plaintiff.

A financial institution's right to an offset is premissed on general principles of equity. (Security Pacific National Bank v. Wozab, supra, 51 Cal.3d at p. 996, fn. 3; Kruger v. Wells Fargo Bank (1974) 11 Cal.3d 352, 357; Bank of America v. Daily (1984) 152 Cal.App.3d 767, 772.) Our Supreme Court described the right of setoff as follows: “The English chancery courts allowed setoff to be raised as a defense as early as the 17th century. [[[[Citations.] ․ It was founded on the equitable principle that ‘either party to a transaction involving mutual debts and credits can strike a balance, holding himself owing or entitled only to the net difference, ․’ [Citation.] Setoff, as it applies to this case, is now codified as section 431.70 ․, which provides in pertinent part: ‘Where cross-demands for money have existed between persons at any point in time when neither demand was barred by the statute of limitations, and an action is thereafter commenced by one such person, the other person may assert in the answer the defense of payment in that the two demands are compensated for so far as they equal each other, ․’ The quoted statute, however, does not create a substantive right to raise setoff as a defense to a claim for monetary relief, but merely describes the procedures to be followed in raising this defense. [Citations.]” (Granberry v. Islay Investments (1995) 9 Cal.4th 738, 743-744.) In Haskins v. Jordan (1898) 123 Cal. 157, 160, the Supreme Court noted: “While the right to adjust the conflicting claims of its suitors in the mode indicated was originally exercised only by equity as an incident to its powers, courts of law later came to adopt the same procedure, and in this state where in the same forum the litigant is entitled to such relief, legal or equitable, as his showing justifies, the particular distinction between the powers of courts of equity in this regard and courts of law ceases to be important. In every case the suitor has the right to ask for the set-off, and in every proper case as of right the motion should be granted.” (Accord, Harrison v. Adams (1942) 20 Cal.2d 646, 648; Machado v. Borges (1915) 170 Cal. 501, 502.) Since an equitable procedure is an action, the setoff in the present case is subject to section 22 and 726. In the federal action defendant secured the “enforcement, or protection of a right” (§ 22) which resulted in an offset, a traditional and well established equitable remedy. Because the use of a setoff in a judicial proceeding is an “action” within the meaning of section 22, section 726 may bar defendant's rights to utilize the trust deed. (Security Pacific Bank v. Wozab, supra, 51 Cal.3d at pp. 999-1000, fn. 7; McKean v. German-Am. Savings Bank, supra, 118 Cal. at p. 341.)3

IV. DISPOSITION

The judgment is reversed. Each side is to bear its own costs on appeal.

FOOTNOTES

FN1. All further statutory references are to the Code of Civil Procedure..  FN1. All further statutory references are to the Code of Civil Procedure.

2.  A special proceeding, as distinguished from an action, has been described by the Supreme Court as follows: “The distinction between the two is well recognized. ‘The term “special proceeding” is used in the codes of practice of many of the states in contradistinction to “action.” It may be said, generally, that any proceeding in a court which was not under the common law and equity practice either an action at law or a suit in chancery, is a special proceeding.’ [Citations.]” (In re Central Irrigation District (1897) 117 Cal. 382, 387.) Examples of special proceedings include: probate proceedings (Estate of Quinn (1955) 43 Cal.2d 785, 787); motions to quash a writ of execution (Van Denburgh v. Goodfellow (1941) 19 Cal.2d 217, 225); or adoptions. (Adoption of Thevenin (1961) 189 Cal.App.2d 245, 251.)

3.  The parties dispute the effect of Aplanalp v. Forte (1990) 225 Cal.App.3d 609, 614 and Bank of America v. Daily, supra, 152 Cal.App.3d at page 771, footnote 5, disapproved in Security Pacific National Bank v. Wozab, supra, 51 Cal.3d at pages 999-1000, footnote 7 on the complaint in this case. We decline to become involved in that debate. Rather, we resolve the narrow issue of whether plaintiff has stated a cause of action at the pleading stage solely in connection with the effect of the offset on the trust deed utilizing the established decisional authority discussed in this opinion. There are other issues we need not address. We do not address the effect of the offset in the federal action on the underlying debt. (Cf. id. at pp. 1004-1006.) Further, the demurrer alleges that on October 5, 1994, within seven days of the date suit was filed on September 28, 1994, defendant tendered the $4,860.91 offset plus interest imposed on July 27, 1994, by Judge Gadbois back to plaintiff. This claim of a tender of the offset plus interest involves non-judicially noticeable factual allegations of facts outside the scope of the complaint which may not be considered in connection with a challenge to the pleadings at the demurrer stage. (Lane v. I.U.O.E. Stationary Engineers (1989) 212 Cal.App.3d 164, 168; Fuhrman v. California Satellite Systems (1986) 179 Cal.App.3d 408, 422-423, overruled on another point in Silberg v. Anderson (1990 50 Cal.3d 205, 217.) No doubt, prompt tender of moneys taken “inadvertently, but in technical violation of section 726,” subdivision (a) by a financial institution can result in saving a security interest. (Security Pacific National Bank v. Wozab, supra, 51 Cal.3d at p. 1001, fn. 8.)

TURNER, Presiding Justice.

GRIGNON and GODOY PEREZ, JJ., concur.