Anti-Deficiency Laws: a Guide to Navigating Uncertainty
the two statutes and the various considerations that must be taken into account,
no strategy works every time
The distressed residential real estate market has prompted some lenders to ask us about
possible foreclosure strategies in the context of Arizona’s anti-deficiency
statutes. Many of these questions have not been easy to answer, due to the
language of the statutes, the amount of discretion left to the courts, and the
scarcity of applicable case law attributable to our recent history of favorable
market conditions. What follows is a brief discussion of Arizona’s
anti-deficiency statutes and how they affect a lienholder’s foreclosure
In Arizona, protection
for residential borrowers is set forth in two anti-deficiency statues: A.R.S. §§
While by its plain
language, § 33-729(A) applies only to purchase money mortgages, Arizona courts
have construed it to apply also to purchase money deeds of trust that are
foreclosed judicially. Mid Kansas
Federal Savings & Loan Association v. Dynamic Development Corp., 167 Ariz. 122, 126, 804
P.2d 1310, 1314 (1991). The statute defines a purchase money mortgage (or deed
of trust) as 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.” Thus, the
statute would not protect borrowers who have assumed the mortgage on the
property, mortgaged one home to purchase another, or obtained home equity lines
In turn, § 33-814(G)
applies to deeds of trust foreclosed by trustee’s sale, whether or not they are
deeds of trust. The statutory scheme,
however, does not provide for non-purchase money mortgages.
Regardless of which
statute is applicable, the threshold for obtaining anti-deficiency protection is
the same: the property securing the loan must be “two and one-half acres or less
which is limited to and utilized for either a single one-family or a single
two-family dwelling.” A.R.S. §§ 33-729(A) and 33-814(G). The Arizona Supreme
Court interpreted this language to require that the dwelling be built and at
least occasionally occupied. Mid Kan. Fed.
Sav. & Loan Ass’n, 167 Ariz. at 129, 804
P.2d at 1317. However, whether the property is occasionally occupied by the
owners or rented to third parties, it will qualify under the statute for
anti-deficiency protection. Northern
Arizona Properties v. Pinetop Properties Group, 151 Ariz. 9, 725 P.2d 501
(App. 1986). In addition, for purchase money mortgages (or deeds of trust
judicially foreclosed), anti-deficiency protection will not be provided to the
extent of any diminution in value of the property due to voluntary waste
committed by the debtor. A.R.S.
If the secured property
does not qualify under the anti-deficiency statutes, the lender may obtain a
deficiency judgment against the debtor and/or guarantors. For judicial
foreclosure of purchase money instruments, obtaining a deficiency judgment is
part of the foreclosure proceedings. A.R.S. § 33-729. To obtain a deficiency
judgment after a trustee’s sale, an action must be brought within 90 days after
the sale; otherwise, any right to a deficiency is lost. A.R.S. § 33-814(D). The
deficiency judgment is the amount due the lender, which includes interest from
the date of the sale and any costs for bringing the action, less the fair market
value of the property as of the date of the sale or the sales price, whichever
is higher. Id. The debtor must
file a written application for a special hearing as to the determination of the
fair market value of the property within 30 days of the sale of the property;
otherwise, the trustee or sheriff sale’s price will stand. § 12-1566(C).
When the decision to
foreclose on a borrower’s property seems imminent, the first question to ask is
whether the anti-deficiency statute applies. If it does not, further discussion
is unnecessary. As discussed above, for anti-deficiency protection, the property
two and one-half
acres or less;
a completed, single,
one or two family dwelling; and
at least occasionally
occupied by the owner or another party.
Thus, for many lenders
with liens on raw land or partially developed properties, the anti-deficiency
issue is not a concern.
anti-deficiency statute applies will influence the lender’s strategy regarding
the method of foreclosure. This assumes, of course, that the lien came into
existence via a deed of trust; obviously, there are no choices when it comes to
mortgages, which is one reason we recommend that lenders use a deed of trust.
foreclosure has a few very important benefits. First, the anti-deficiency
statute for judicial foreclosures does not apply to non-purchase money
instruments. Thus, if the lender has a non-purchase money deed of trust for
which the anti-deficiency protection may apply, the lender can avoid it, and
pursue a deficiency, by judicially foreclosing. Also, even if it is a purchase
money deed of trust, a judicial foreclosure is advisable if the loan guarantors
are solvent. Perhaps due to a legislative drafting error, the mortgage
anti-deficiency statute protects only the “judgment debtor”, i.e. the borrower.
In contrast, the deed of trust anti-deficiency statute states that, if it
applies, “no action may be brought,” which means no action may be brought
against the debtor or guarantor. Finally, there is no 90-day limitation and,
thus, no concern for the lender of losing a deficiency judgment through an
oversight. Of course, it is important to include a claim for deficiency in the
complaint when a foreclosure suit is filed.
The downsides of a
judicial foreclosure include length of time, the statutory right of redemption,
and the election of remedies statute.
benefits of a trustee’s sale include simplicity, efficiency, reduced costs, and
no statutory right of redemption. While there is no election of remedies statute
for trustee’s sales, the Arizona Supreme Court has held that when the
anti-deficiency statute applies, whether it involves a mortgage or deed of
trust, the creditor may not waive the security and simply sue on the note.
160 Ariz. 98, 105, 770 P.2d 766, 773 (1980). However, if the property does not
qualify for statutory protection, the lender can sue on the note and then
conduct a trustee’s sale, or vice versa, or simultaneously sue on the note and
pursue a trustee’s sale. In contrast, with a judicial foreclosure, if the lender
sues on the note, the security is waived.
For a trustee’s sale or
judicial foreclosure, the statute provides that a lender may sue on a guaranty
separately as a contract; however, if the suit is for a deficiency after a sale
the statute’s fair market value limitations apply. A.R.S. § 12-1566(E); In re Five
Flags Hotel Corporation, 179 B.R. 169, 174 (Bankr.
D. Ariz. 1995) (holding that the guarantor is not entitled to a reduction in the
judgment for the fair market value of the collateral property where the lender
did not hold a trustee’s sale and is suing directly on the guaranty).
Credit Bids and Fair Market Value
It is now
the day of sale. The next most asked question, and perhaps the most difficult,
is: What amount should the lender credit bid? This is not a simple question as
there are many, sometimes conflicting, considerations. If the lender bids too
high, it may eliminate the deficiency. In contrast, if it bids too low, the
court may become skeptical and refuse to award a deficiency, finding that the
sale proceeds satisfy the outstanding debt.
The standard answer is to
bid the fair market value of the property. However, in the current volatile
market determining fair market value can be very difficult. The statute, A.R.S.
§ 12-1566(C), defines “fair market value” as:
“… the most probable price, as of the date of
the execution sale, in cash, or in terms equivalent to cash, or in other
precisely revealed terms, after deduction of prior liens and encumbrances
with interest to the date of sale, for which the real property or interest
therein would sell after reasonable exposure in the market under conditions
requisite to a fair sale, with the buyer and seller each acting prudently,
knowledgeably and for self-interest, and assuming that neither is under
lenders, there is little case law explaining or applying this standard.
Recently, the U.S. Bankruptcy Court for the District of Arizona, refused to
award a deficiency judgment to a lender that, over the course of 32 months,
submitted five appraisals of the property with widely varying values. Minute
Entry, In re MCW
Brickyard Commercial, LLC (Bankr. D. Ariz.
Aug. 18, 2004). In light of that decision, we have recommended, when practiced,
that lenders use only one appraiser and if necessary have the appraiser update
his report (since the fair market value is to be measured as of the date of the
sale), or solicit a broker’s opinion first for a more informal valuation of the
property. We also recommend that, before obtaining an appraisal, the lender give
the appraiser the statutory definition of fair market value for inclusion in his
report. The Arizona Supreme Court has also held that a trustee’s sale may be set
aside if it is “grossly inadequate,” which the Court interpreted as less than or
equal to 20% of market value. In re Krohn, 203 Ariz.
205, 214, 52 P.3d 774, 783 (2002).
Given the two
anti-deficiency foreclosure statutes and the various considerations that need to
be taken into account, no single approach or strategy works every time. As
always, it is best to make a judgment based upon all the facts. Even then, in
this area of law, be prepared to make difficult decisions based upon less than
perfect information. ■