California has seen an incredible rise in the number of foreclosures in recent years. According to figures compiled by RealtyTrac, Inc., foreclosure filings in 2007 totaled 2.2 million, up 79% from the previous year. The trend has not changed, with DataQuick reporting a 327% increase in first quarter foreclosures in 2008. The impact of the subprime crisis on struggling homeowners is obvious. What is less apparent is the effect of foreclosure on lessees. California lessees, even those with long term leases, can quickly find themselves without a home should their landlord default on his mortgage. Now more than ever, California lessees need to be aware of their rights and remedies in the event of foreclosure.

The California legislature has recognized the problem faced by lessees and responded with State Bill 1137, which was signed into law by Governor Schwarzenegger on July 8, 2008. SB 1137 contains additional protections for lessees facing foreclosure of their rental property. The first, and possibly most important addition from the lessee’s perspective, is extension of the required notice to vacate from 30 to 60 days, with notice beginning on the date of sale of the foreclosed property. It is worth keeping in mind that if a lessee is ultimately asked to leave before his lease is up, he may have legal recourse against the landlord and should consider suing in small claims court to recover the expenses incurred in finding a new home, such as moving, credit checks, and travel expenses, as well as any increase in rent incurred over their old lease for a comparable rental.

SB 1137 also requires that lessees be given notice of default at least twenty days prior to sale of the property. This notice must read:

“Foreclosure process has begun on this property, which may affect your right to continue to live in this property. Twenty days or more after the date of this notice, this property may be sold at foreclosure. If you are renting this property, the new property owner may either give you a new lease or rental agreement or provide you with a 60-day eviction notice. However, other laws may prohibit an eviction in this circumstance or provide you with a longer notice before eviction. You may wish to contact a lawyer or your local legal aid or housing counseling agency to discuss any rights you may have.”

Prior to this enactment, there was no obligation by the lender to notify a lessee that the property had been foreclosed upon. While a step in the right direction, the lessee is only entitled to an additional twenty days’ notice prior to sale. There is still no requirement that the lessee be notified immediately upon default by the landlord. However, there are steps that may be taken by lessees to ensure they are fully apprised of their landlord’s default status.

If a lessee wants immediate notice of the landlord’s default, he may file a Request for Copy of Notice of Default with the county recorder’s office. This form can be found online or at a local title company. By filing the request, the lessee will receive immediate notice by mail if the landlord defaults on the mortgage. Because the foreclosure process generally takes at least three months to complete, a lessee receiving notice of default gains valuable time to find a new residence. Combined with the generous notice provisions of SB 1137, a lessee with notice of default will have at least five months of continued tenancy before eviction becomes a possibility.

If a lessee is faced with eviction as the result of a foreclosure sale, the chief concern aside from finding a new home is recouping the security deposit. Currently, disposition of security deposits following transfer of rental property is governed by Civil Code section 1950.5(h), which provides that when a landlord’s interest in a property terminates, one of two things must happen: (1) the security deposit must be transferred to the landlord’s successor in interest; or (2) the security deposit must be returned to the lessee. If the landlord fails to abide by this requirement, the landlord and his successor in interest can be held jointly and severally liable for the security deposit. Furthermore, the lessee may recover up to twice the amount of the security deposit in damages if he can prove bad faith.

While section 1950.5(h) covers transfers arising from “sale, assignment, death, appointment of receiver or otherwise,” it does not specifically refer to transfers due to foreclosure. Recently, Governor Schwarzenegger vetoed Assembly Bill 2586, which would have amended section 1950.5(h) to include both voluntary and involuntary transfers of property. AB 2586 would have also defined “successor in interest” to include the purchaser of a property at a foreclosure sale. While the amendment would have finally cleared up any ambiguity associated with transfers resulting from foreclosure, lessees should not be dissuaded from pursuing their security deposit pursuant to section 1950.5(h). Lessees who feel they have been cheated out of their security deposit may sue their landlord or his successor in interest in small claims court to recover their security deposit, assuming the total demand does not exceed $5,000. In the case of larger deposits, or cases of bad faith, it may be prudent for the lessee to retain legal counsel to explore additional avenues of recovery.

The most important advice for a prospective lessee is simply to exercise an abundance of caution before signing a lease. With the economy sputtering, credit markets drying up, and subprime mortgages resetting to unmanageable rates, lessees should do some investigation before leasing a townhome, condo, or single-family residence. The prospective lessee would be wise to determine whether the owner has any risk factors for foreclosure, such as back owed property taxes or homeowner’s association dues, or whether he is involved in any pending lawsuits. By investing a little effort before signing the lease, lessees can greatly decrease their chance of becoming another victim to the foreclosure crisis.

This article appeared in the December 15, 2008, issue of the San Diego Business Journal