California does not actually have a mortgage exception to the doctrine of merger, but the recent case of Hamilton Court, LLC v. East Olympic L.P[i]. comes close to creating one.
What is merger and why should lenders care about it?
Suppose that the lender forecloses on two pieces of collateral that are next to each other, White Acre and Black Acre. White Acre is only accessible from the main road by crossing over a driveway easement across Black Acre. In real estate parlance, White Acre is the “dominant tenement” and Black Acre is the “servient tenement.” Essentially, while Black Acre is the fee simple owner and pays property taxes, White Acre has a limited real property interest in Black Acre because of the easement. Black Acre would be burdened by this easement until it is extinguished and there are only a few ways to extinguish the easement. One way is under the doctrine of merger.
California has codified the doctrine of merger in Civil Codes Section 811, which is when the person holding the dominant tenement and the servient tenement is the same, all the lesser property interests are merged into the greater fee simple interest.
So back to Black Acre and White Acre. If the lender ends up owning both parcels, usually by foreclosing on the respective deeds of trust, then the doctrine of merger would wipe out the easement over Black Acre and leave White Acre landlocked!
The Hamilton Court looked at this exact scenario. The lender faced this situation on some prime commercial real estate in Los Angeles on East Olympic Boulevard. In that circumstance, the easement was even more critical because an entire building was encroaching on the adjacent lot, and the easement was to address that encroachment. While the trial court concluded that the doctrine of merger did apply, and the easement was wiped out, the appellate court reversed, instead relying on the language in the deed of trust that attempted to carve out this situation.
A reading of the added language in the deed of trust shows that the Hamilton Court went out of its way to apply an equitable result because the deed of trust did not say, “the doctrine of merger does not apply” but instead innocuously stated that transfers (to the joint owner) were allowed only: “”if such transfer is made subject to the Trustor’s promissory note and this Deed of Trust and does not affect the priority of this Deed of Trust in any manner whatsoever.”
TAKEAWAY LESSONè Tighten up the language in the Deed of Trust or else make sure to take title to each property in separate special purpose entities.
[i] Hamilton Court, LLC v. East Olympic L.P . 215 Cal.App.4th 501 (2013)