How to Fight Bad Faith Waste

THOUSAND OAKS, CA—In some situations, lenders do have legal recourse against property damages. When a foreclosed property has damages made in malice that affect the property's value, lenders can file a bad faith waste claim to recoup losses. Bad faith waste is different from waste claims, and often involve siphoning money away from a property to avoid paying for damages. To learn more about bad faith waste claims and what lenders should know to pursue these claims, we sat down with James C. Fedalen, managing partner of HFL Law Group, for an exclusive interview. Here, he talks about the legal definition of bad faith waste, how this affects rental properties, siphoning money from a property and when lenders should take action.

GlobeSt.com: Tell me about the legal concept of bad faith waste. 

James C. Fedalen: The major difference between claims for “waste” and “bad faith waste” is that waste is generally in the nature of a breach of contract while bad faith waste is a tort. Tort claims allow a broader range of damages, including the possibility of punitive damages.

Waste generally means a change in condition of real estate, which damages or destroys its value.  The most common form of waste occurs through a failure to properly maintain the property.  While waste can occur in a number of ways, it most commonly occurs from either intentional or negligent conduct and can occur by commission or omission.

Most deeds of trust have provisions pursuant to which the property owner agrees not to let waste occur.  However, once a lender has foreclosed, the right to pursue claims from breach of the deed of trust conditions is extinguished.  After that, the foreclosing lender may still recover the cost to correct waste from the former owner if the waste was allowed to occur in bad faith, even after the owner has lost the property to foreclosure.

Bad faith waste is defined as reckless, intentional or malicious conduct, which resulted in waste to the property, and has been described by one court as "milking" productive property by retaining all revenue and/or diverting its cash flow to other uses and then allowing waste to occur. To be bad faith waste, the money had to be available to avoid the waste yet the owner chose to use the money for the owner's own purposes instead. If the property is not generating enough money to prevent waste and the money that is being generated is being used to at least reduce the waste, then the waste is not in bad faith.

The courts have held that failing to pay the property taxes or to adequately maintain the property can constitute bad faith waste.  Economic necessity is a defense to a claim of bad faith waste.  However, diverting the proceeds from one property to support another property owned by the same owner is not an economic necessity.   

GlobeSt.com: How does this concept affect the owners of rental properties? 

Fedalen: Rental property is the type of property in which a bad faith waste situation most commonly occurs.  To have bad faith waste you must have income-producing property, as it is the taking of the money from the property and using it for something other than to prevent waste to the property, which generated the income.  So, an owner of rental property must use the money from the rental property to protect the value of the rental property before using it for something else or putting it into their own pocket.

GlobeSt.com: What should lenders know about how and when they are able to pursue bad faith waste to recoup losses? 

Fedalen: If the lender feels that there has been bad faith waste, which has resulted in a loss to the lender, then the lender should consider filing a lawsuit for bad faith waste.  Bad faith waste applies only when the property will not sell for enough to cover the debt as a result of the waste.  If the property will sell for more than is owed despite the waste to the property, the lender is also made whole and bad faith waste will not be found.  If the lender enters a full credit bid at auction, then they are deemed to have been made whole by recovery of the property no matter the condition of the property.  When this is the situation, the most important thing is that the lender must not enter a full credit bid at the foreclosure sale.  If it appears that the property, because of waste, cannot be sold for enough to cover the debt, the lender must enter a bid for less than what is owed. A strategy for the amount of the bid and how to proceed at the sale is different in every case.

Also, the lender must be able to show that there was sufficient income from the property to prevent the waste.  This can be done after the foreclosure sale and starts with an analysis of the net income generated from the property after payment of all expenses and debt service for the period during which the waste occurred. 

GlobeSt.com: You also have counseled against siphoning money from a property. Tell me how this works and has become an issue. 

Fedalen: Siphoning, or as one court has called it "milking" the property, occurs when rent money is used by the owner for something other than preventing waste to the property.  In one case the owner used the rent money to recover their investment rather than paying property taxes.  In another case the owner used the money to support another building rather than using it to maintain the building generating the rent.  If the money generated by the property is used to maintain the property, the owner should be safe from a bad faith waste claim.

GlobeSt.com: How can siphoning money incur problems in the future? 

Fedalen: If bad faith waste is shown, the owner is personally liable for the bad faith waste as well as potentially for court costs and punitive damages. The fact that the property was lost to foreclosure is not a defense. The fact that the loan was a non-recourse loan is not a defense. If the owner is found liable for bad faith waste, the lender can go after any assets of the owner and is not limited to merely recovering the property.