K. Michelle Lind, Esq.
Michelle is general counsel to the Arizona Association of REALTORS®
(“AAR”) and a State Bar of Arizona board certified real estate
specialist. She serves as the primary legal advisor to the association,
provides legal direction in the development of standard forms, is
involved in legislative advocacy, and assists in the association’s
educational efforts.
Please note that this article is of a general nature and may not be
updated or revised for accuracy as statutory or case law changes
following the date of first publication. Further, this article reflects
only the opinion of the author, is not intended as definitive legal
advice and you should not act upon it without seeking independent legal
counsel
Most real property loans in Arizona are
evidenced by a promissory note and deed of trust. The promissory note
is the promise to pay the loan signed by the borrower in favor of the
lender. The deed of trust is a separate document that secures the loan
with the property. The deed of trust is recorded against the property
and contains three parties: the trustor, who is the borrower/property
owner; the trustee, who is a person or entity that holds “legal” title;
and the beneficiary, who is the lender. There are many types of loans
that are secured by real property. These may be purchase loans,
refinanced loans, home-equity loans, or one of the various other types
of loans.
Lender Options upon Loan Default
The type of loan
and type of property will determine what remedies a lender may have if
the borrower fails to make the agreed upon payments. The available
remedies, the borrower’s overall current or potential future financial
strength, the lender’s cost in acquiring the loan and any shared-loss
or similar agreement if the loan was acquired by purchase or merger,
are some of the many factors that the lender may consider in deciding
how to proceed when a loan is in default.
The lender may offer the borrower the option of a loan modification or
loan work-out agreement. The lender may agree to a short sale and
either discharge the debt or require a promissory note for the
remaining balance. In the alternative, the lender may decide to
foreclose by exercising the rights in the deed of trust and conduct a
non-judicial trustee’s sale or judicial foreclosure. In the majority of
foreclosure cases, the lender will conduct a trustee’s sale. The lender
may have the option to sue the borrower for the entire unpaid debt
without instituting a foreclosure action or sue the borrower for a
deficiency after foreclosure.
Deficiency Judgment after Foreclosure
In some cases, a lender is entitled to sue a borrower for any losses,
known as a “deficiency,” after a foreclosure. For example: A lender
loans a person $200,000 to purchase a property. The property owner
fails to make the loan payments and the lender forecloses. When the
lender sells the property, it is only able to sell it for $180,000,
which results in a $20,000 loss to the lender. If the lender is
entitled to sue the ex-property owner to recover that loss, the lender
can obtain a deficiency judgment for the amount the ex-property owner
owed the lender, minus either the fair market value of the property on
the date of the sale or the sale price at the trustee's sale, whichever
is higher. A.R.S. §33-814. When permitted, a deficiency action must be
instituted within 90 days after the foreclosure sale. A.R.S. §33-814.
Suing Directly on the Promissory Note
If a
deficiency action is permitted, the lender is entitled to waive its
security by choosing not to foreclose and sue directly on the
promissory note instead. A.R.S. §12-1566(E). In Resolution Trust Corporation v. Segal,
173 Ariz. 42, 839 P.2d 462 (1992), the court held that a non-purchase
money lender who made four loans secured by deeds of trust on
residential property was entitled to waive its security and sue
directly on the promissory notes. Further, the court held that the
lender's right to sue on the promissory notes was not affected by fact
that beneficiaries under first deeds of trust encumbering properties
had exercised their right to conduct a trustee’s sale.
Collecting on the Judgment
Once the lender obtains a money judgment, the lender is called the
judgment creditor and can collect from the borrower, now called the
judgment debtor through various legal means, such as: garnishment of
wages and bank deposits; writ of execution in which the sheriff sells
non-exempt personal property at public auction to satisfy the judgment;
and judgment liens on real property (currently owned or later
acquired). See, A. R.S. §12-1570 – 1598; A.R.S. §33-961 et. seq.
In the case of a deficiency judgment, A.R.S. §12-1566(D) requires the
judgment creditor to proceed first against all other real property of
the judgment debtor before proceeding against the debtor’s primary
residence.
A judgment is valid for five years and can be renewed for an additional
five years. A.R.S. §12-1611. These actions by the judgment creditor can
result in the judgment debtor filing for bankruptcy protection. Chapter
7 is the most common form of bankruptcy and is a liquidation proceeding
available to individuals, married couples, partnerships and
corporations.
Arizona Anti-Deficiency Statutes
If the property is a residential property, the borrower may have
protection against a deficiency lawsuit after foreclosure due to two
anti-deficiency statues, A.R.S. §33-729(A)1
(which applies to judicial foreclosure of mortgages) or A.R.S.
§33-814(G) (which applies to non-judicial foreclosure of deeds of
trusts). The first anti-deficiency statutes in the U.S. were enacted
during the Great Depression in the 1930s – “with its dearth of money
and declining property values, a mortgagee was able to purchase
property at the foreclosure sale at a depressed price far below its
normal fair market value and thereafter to obtain a double recovery by
holding the debtor for a large deficiency.” Baker v. Gardner, 160 Ariz. 98, 770 P.2d 766 (1988) (citing Cornelison v. Kornbluth, 542 P.2d 981 (CA. 1975). Arizona’s anti-deficiency statutes were enacted in 1971.
The anti-deficiency statutes apply to a specific, limited group of residential mortgages and deeds of trust. Id. The anti-deficiency statutes may not apply to VA or FHA insured loans. See e.g., Shepherd v. Derwinski, 961 F.2d 132 (Ariz. 1992).
The legislature’s objective in enacting these statutes has been
interpreted to abolish the personal liability of those who give trust
deeds encumbering properties of two and one-half acres or less and used
for single-family or two-family dwellings. Baker, 160 Ariz. 98, 770 P.2d 766. Therefore, generally, a lender cannot sue for a deficiency after a trustee’s sale if the:
- Note and Deed of Trust encumbers real property
- Property is single one-family or single two-family dwelling
- Dwelling is limited to and utilized as a residence
- Dwelling is on two and one-half acres or less
(Note: a lender cannot sue for a deficiency
after a trustee’s sale even if the loan was non-purchase money.
However, as noted above, if the loan was non-purchase money, the lender
could elect not to conduct a trustee’s sale and sue the borrower on the
promissory note.)
The dwelling does not have to constitute the borrower’s residence for the anti-deficiency provisions to apply. Northern Arizona Properties v. Pinetop Properties Group,
151 Ariz. 9, 725 P.2d 501 (App. 1986). However, the anti-deficiency
statutes do not apply to loans secured by houses owned by a developer,
where the houses have not yet been used as a dwelling and are not yet
susceptible to being used as a dwelling. Mid Kansas Federal Savings & Loan Ass'n v. Dynamic Development Corp.,
167 Ariz. 122, 804 P.2d 1310 (1991). The Mid Kansas court held that
commercial residential properties held by the mortgagor for
construction and eventual resale as dwellings are not within the definition of properties “limited to” and “utilized for” single-family dwellings. Id. at 129, 804 P.2d at 1317.
Banking Industry Attempts to Change Arizona’s Anti-deficiency Laws
SB 1271 was passed by the legislature in the first regular session of
2009 to change the trustee’s sale statutes to allow a deficiency
judgment unless the property had been utilized “BY THE TRUSTOR UNDER
THE DEED OF TRUST FOR AT LEAST SIX CONSECUTIVE MONTHS AND FOR WHICH A
CERTIFICATE OF OCCUPANCY HAS BEEN ISSUED.” The bill was due to become
law on September 30, 2009. Fortunately, AAR and others recognized the
unintended consequences of the bill. In the third special session, HB
2008, which was signed by the governor, contained a repeal of SB 1271
and its change to the anti-deficiency statute. Thereafter, the bankers
association filed a Petition for Special Action in the Arizona Supreme
Court contending the repeal was invalid. At AAR’s urging, Governor
Brewer included the issue in the fourth special session, and SB 1004 at
the time of printing was awaiting a final vote in the Arizona House of
Representatives to once again repeal the changes included in SB 1271.
The passage of SB 1004 should render the pending litigation moot in
regards to this issue.
Had SB 1271 become law, there could have been a dramatic increase in
deficiency judgment litigation. The banking industry will continue to
lobby for changes to the anti-deficiency laws the next time the
legislature is in session. The Arizona Association of REALTORS®
CEO/Chief Lobbyist Tom Farley, VP of Government Affairs Meghaen Duger,
and members serving on the Legislative Committee will actively monitor
any future proposals and work to make sure that any future changes to
these laws are prospective, fair, and based on sound economic policy.
1 A.R.S. §
33-729(A) applies only to purchase money mortgages; however, the
Arizona Supreme Court construed it to apply to purchase money deeds of
trust that are foreclosed judicially as well. Mid Kansas Federal
Savings & Loan Association v. Dynamic Development Corp., 167 Ariz.
122, 126, 804 P.2d 1310, 1314 (1991). A purchase money mortgage (or
deed of trust) is one “given to secure the payment of the balance of
the purchase price, or to secure a loan to pay all or part of the
purchase price.” A.R.S § 33-814(G) applies to deeds of trust foreclosed
by trustee’s sale, whether or not they are purchase money.
Always Consult Legal Counsel
As discussed above, a lender’s rights and remedies, including the right
to sue for a deficiency, are complex and are affected by a variety of
factors. Anyone with questions about this issue should consult with
knowledgeable legal counsel.
