Legal Question in Real Estate Law in California

The short sale buyer is probably demanding that the second be removed as a lien, and the holder of the second is playing its hand tough because it knows that if there is a foreclosure by the first it will become a "sold-out junior" lender, entitled to sue on its note as your unsecured general obligation, no longer a home loan. All I can suggest is to keep negotiating. Both lenders would rather work with you than sue or foreclose, but neither lender is going to make any important concessions to the other to make your deal with the first, or your buyer, fly.

I disagree with Mr. Whipple to some extent. If your short sale is with the first lender, the first reconveys the deed of trust, which causes your second to become first. The second does not become a frozen out junior lienholder, because a short sale with a reconveyance by the first is not a "foreclosure" but is more similar to a deed in lieu of foreclosure.

Arguably, the new lender who is financing the new buyer's purchase through the short sale would remain in first position, regardless of the recording acts, by operation of Civil Code section 2898. "A mortgage or deed of trust given for the price of real property, at the time of its conveyance, has priority over all other liens created against the purchaser, subject to the operation of the recording laws." (Civ. Code, sect. 2898 subd. (a).)

Confirmation of this doctrine usually involves litigation, and the buyer's lender wants assurance without litigation that his new loan to the buyer will be in first position, and not subordinate to prior deeds of trust. Thus the short sale process in your case is most likely dependent on your second lender also reconveying. By reconveying, your second lender will no longer be secured, and would be prohibited from pursuing you for a deficiency by operation of California's new anti-deficiency prohibition on short sales, contained in Code of Civil Procedure section 580e.

To that analysis, I would add that the new buyer most likely does not want to purchase your property subject to your second deed of trust securing a debt that you have not, and will not pay.

To protect itself, the second lender is asking for a new unsecured note, to evade 580e.