## Facts

- Plaintiffs agreed to buy Sonoma County real property and specified ranch equipment from defendants Gates for $16,000.
- Plaintiffs received a deed to the realty and executed a promissory note secured by a second deed of trust; the trustee was Sonoma County Abstract Bureau and the beneficiaries were the Gateses.
- The property was also subject to a first deed of trust held by Exchange Bank of Santa Rosa with $65 monthly payments.
- Plaintiffs allegedly missed installments due under the note and second deed of trust.
- Plaintiffs alleged the Gateses failed to deliver promised ranch equipment valued at $987.50, which allegedly exceeded the installments then due.
- Plaintiffs alleged they offered to pay the overdue installments if the Gateses returned the equipment, but the Gateses refused.
- The Gateses and trustee recorded a notice of breach and election to sell on December 11, 1950.
- The trustee conducted a nonjudicial sale on April 12, 1951, selling the property to defendant Chalmers for $5,025.
- Plaintiffs alleged Chalmers had notice of the above facts, was not a good-faith purchaser for value, and held the property in trust for the Gateses.
- Plaintiffs sued to set aside the trustee’s sale, alleging a setoff/counterclaim under Code of Civil Procedure § 440 that eliminated any default.

## Issues

1. Whether a trustor’s pleaded contractual setoff arising from the same transaction, and exceeding arrearages, can negate “default” and state a cause of action to set aside a trustee’s sale.
2. Whether allegations that the foreclosure purchaser had notice and was not a bona fide purchaser are sufficient, on demurrer, to permit equitable relief against the sale.

## Decision

- The California Supreme Court held the second amended complaint stated a cause of action.
- The trial court erred by sustaining defendants’ demurrers without leave to amend.
- Plaintiffs’ theory that an offsetting claim exceeding the installments due could show no default was legally sufficient at the pleading stage.
- The allegations regarding the purchaser’s notice and lack of good faith were sufficient, on demurrer, to avoid dismissal based on bona fide purchaser protections.

## Legal Principles

- On demurrer, the court assumes the truth of well-pleaded factual allegations and tests only legal sufficiency.
- Under Code of Civil Procedure § 440, a contractual setoff/counterclaim may be asserted where mutual obligations arise from the same transaction.
- A trustor may plead a setoff exceeding arrearages to allege absence of net indebtedness and, therefore, absence of default supporting exercise of a power of sale.
- A trustee’s sale may be subject to being set aside where the complaint adequately alleges no default and alleges the purchaser took with notice and without bona fide purchaser status.

## Conclusion

A borrower may state a claim to set aside a nonjudicial foreclosure sale by pleading a contractual setoff under Code of Civil Procedure § 440 arising from the same sale transaction that exceeds the alleged arrearages, thereby negating default, particularly where the purchaser is alleged to have taken with notice and without good-faith purchaser status.


Hauger v. Gates, 42 Cal. 2d 752, 269 P.2d 609 (Cal. 1954)