Bad faith damages awarded in favor of lender are limited by the credit bid rule

In Norwest Mortgage v. State Farm Fire and Casualty Company (March 18, 2002) 97 Cal.App.4th 571, the Fourth District Court of Appeal ruled three months ago that a lender was not entitled to fire insurance proceeds, after it made a full credit bid at its foreclosure sale on a home securing its loan, which had been destroyed in a fire prior to the sale.

On May 28, 2002, following the same reasoning as in the Norwest case, the Second District Court of Appeal held in Track Mortgage v. Crusader Insurance that the same credit bid limitation rule applied to an insurer found to have acted in bad faith. The Court of Appeal held that the lender's tort damages against an insurer are limited by the credit bid rule absent a showing that the insurer's conduct caused the lender to make the credit bid. The lender is entitled, however, to interest and attorneys' fees.

Track Mortgage made a loan secured by a first deed of trust on an apartment building. Crusader insured the building against physical loss or damage. Track was named as a loss payee pursuant to a provision in the trust deed. After making the loan, the property was subject to a nightmarish series of events.

Members of the 18th Street Gang moved into the building. One put a gun to the manager's head while other gang members kicked down doors, threw fire hoses on the floor and turned them on. Outsiders stole copper pipes leading to the toilets, causing plumbing leaks. Water from the fire hoses percolated through the building. The hardwood floors buckled, mold and mildew grew on the lower floors, and fungus and mushrooms grew in some of the doorways. The building manager abandoned the premises.

Track foreclosed purchasing the building at the sale with a credit bid of $472,500 although Track's Vice President testified that the property was worthless. The indebtedness at the time of the foreclosure sale was approximately $528,376.

Track spent $877,935 to repair damage covered under the policy. Crusader delayed payment on the claim. Crusader failed to make inspections and requested information such as tenant lists that Track could not access. Track filed suit for bad faith. Shortly before trial, Crusader paid Track $50,000 on the claim.

The case went to trial. The court found that Crusader acted in bad faith. The court's award of damages was limited to $55,876.75 (the difference between the unpaid balance of the loan and the credit bid). After deducting the $50,000 paid by Crusader prior to trial, the court awarded a total of $5,876.75 due Track under the insurance policy plus prejudgment interest. The trial court awarded Track $80,000 in attorneys' fees plus $52,876.57 for interest paid on the money Track borrowed to fund the repairs. The trial court denied a request for punitive damages.

The Court of Appeal affirmed. The Court of Appeal agreed that contractual damages were limited to the difference between the amount of the debt and the credit bid based on the "well settled" rule that when a lender makes a full credit bid at the foreclosure, it is precluded for purposes of collecting its debt from later claiming that the property was actually worth less.

Track argued that this rule should not apply when an insurer acts in bad faith. The Court of Appeal disagreed. "Unless Track can show Crusader's conduct caused Track's bid to be higher than the actual value of the property, Track's damages will be reduced by its credit bid…. Here, Track has not shown Crusader had anything to do with the amount of Track's bid."

Track also appealed that only $80,000 in attorney's fees was awarded when it contended that $143,458 of $151,371 expended on the case related to obtaining policy benefits. In limiting the award to $80,000, the trial court stated it recognized the "near impossibility" of segregating the billing item by item. The court made a proportional estimate of what the case was worth based upon the results achieved, the complexity of the case, the experience of counsel, and having tried the case for three to four weeks, and recognizing the issues and the sophistication that those issues demanded. The Court of Appeal affirmed, as there was no showing of clear abuse.

Crusader cross-appealed arguing that the evidence did not show it acted in bad faith, as it did not receive the proof of loss information it demanded. The Court of Appeal responded that the "objectively reasonable expectation of the insured is that the insurer would not insist on information the insured did not have and could not obtain. Instead, under such circumstances, the insurer would work with the insured in good faith to find some reasonable accommodation. Here Crusader refused even to discuss the matter with Track." The reasonable conclusion was that Crusader's demand for unavailable information was a ploy to avoid paying a legitimate claim.

Crusader also argued that Track did not segregate covered items of repair from noncovered items of repair. The Court of Appeal noted that given the extensive damage not included in pre-insurance inspection, there was no doubt that Track was damaged in at least the amount awarded by the court and that Crusader's payment of $50,000 shortly before trial confirms it. "Track should have received payment long before it filed suit."

Evidence of cancelled appointments and other actions by Crusader showed that it was more interested in avoiding paying the claim than trying to make a fair settlement.

(Track Mortgage Group v. Crusader Ins. Company (2nd District, May 28, 2002) 2002 WL 1057401.)