From the PERSONAL LIABILITY FILES: Can you be liable for a deficiency judgment following a foreclosure sale in Arizona?

FORECLOSURE ISSUES: CAN A LENDER PURSUE A DEFICIENCY JUDGMENT IN ARIZONA?

GENERAL LEGAL PRINCIPLES BY STEVE VONDRAN ATTORNEY. Mr. Vondran is licensed to practice law in California and Arizona and maintains an office in Newport Beach, California and Phoenix, Arizona. He currently practices in the area of Real Estate, Foreclosure Defense, and Bankruptcy. He can be reached at (877) 276-5084.

The following is general legal information only and is not to be relied upon as legal advice or a substitution for legal advice. As law frequently change, and as new cases interpret the law, the following may be inaccurate, out-of-date or missing law pertinent to you case. Therefore, do not rely on the following and seek the assistance of a qualified real estate and foreclosure attorney to assist you in your case. Where tax issues are involved, you should also seek the advice of a tax attorney or CPA.

1. WHAT IS A “DEFICIENCY JUDGMENT” IN ARIZONA?

Let’s say you have a first mortgage for $500,000 and your house is worth $350,000. If the lender/loan servicer refuses to provide a meaningful loan modification, or any modification for that matter, and if they will not permit a short sale (yes, lenders and loan servicers can and do frequently deny both), then your house gets scheduled for a foreclosure sale.

Most properties in California and Arizona are sold via a Private Trustee Sale (partially so they can get away with whatever they want), but let’s say the private sale only generates a bidder who bids $350,000 and let’s say this represents fair market value and the lender decides to sell the property for this amount.

Following the sale, the lender will recoup its $350,000, but will obviously be short $150,000 from the $500,000 it was originally owed. For most lenders, they want the homeowner to pay the difference (the $150,000), and if the lender persists they can seek to file a lawsuit seeking a “deficiency judgment” against you, as homeowner.

Obviously the only thing worse than being foreclosed on is having the lender try to come back after you for the $150,000 they feel they are owed pursuant to the terms of the note you signed.

As a homeowner, this can keep you up at night wondering “can they come back at me?” This is a question we get all the time as real estate foreclosure defense and loan modification counsel.

The routine answer we give is “the lenders can try anything they want and don’t be surprised to see them pull anything.” Now, we also tell them that in Arizona, if you have a “purchase money” loan there is a good chance the lender can get NOTHING from you following a foreclosure sale that does not net the full value of the outstanding loan balance owed. That is good news for you. But then, the big question becomes, what is a purchase money loan? And what if I have a first and second mortgage? Let’s take a look at these issues.

1. WHAT TYPES OF ARZIONA PROPERTY ARE PROTECTED FROM DEFICIENCY JUDGMENTS? A REVIEW OF A FEW OF THE ARIZONA CASE LAW DEALING WITH THE TOPIC OF DEFICIENCY JUDGMENT.

As we discussed above, purchase money loans in Arizona are protected against deficiency judgments. But does this cover residential AND investment properties or one or the other?

Arizona protects people who purchase property. If you had to worry about losing both your down payment, and facing a deficiency judgment if the loan goes bad, many potential Arizona home buyers may choose to rent instead. This would prohibit new developments.

Under the Arizona Revised Statutes (A.R.S. 33-729(A)), when a mortgage is 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 of a residential property TWO AND ONE HALF ACRES OR LESS that is limited to and utilized for either a SINGLE ONE FAMILY OR SINGLE TWO FAMILY RESIDENCE the mortgagee cannot collect a deficiency judgment out of any of the other assets of the homeowner (the lien of the property shall not extend to any other property of the judgment debtor).

Here is what this section says:

Note: this section says only the “judgment debtor” is not liable, but it does not mention any co-guarantors of the loan. Therefore, it is quite likely a guarantor on the loan could still be liable for a deficiency judgment.

What about investment properties? The statute above says there is no deficiency judgments if the property is a “single one family” or “single two family” but it says nothing about whether this property must be owner-occupied. In the case of Northern Arizona Properties v. Pinetop Properties Group, 151 Ariz. 9, P.2d 501 (App. 1986) the court held that an “investment condominium” was protected against a default judgment even though the unit was not utilized as a dwelling by borrower. The Court held that the investment condo unit was nevertheless a “shelter where people live.” This case is good for owners of residential investment property in Arizona that is deemed purchase money as there would be no deficiency judgment under these circumstances.

What about a “Blanket” Deed of Trust that secures the repayment of six individual condo units and their 6 separate promissory notes? The Court addressed this situation in PNL Credit v. Southwest Pacfiic Investments, Inc. 179 Ariz. 259, 877 P.2d 832 (App. 1994). In this case, the lender held ONE (1) blanket deed of trust over 6 individual condo units. The owner wanted to be deficiency judgment free and argued that the Arizona deficiency judgment statute protected him from personal liability for the deficiency balance. The Court disagreed saying that the plain meaning of the statute was to protect “single one family” and “single two family” dwellings, and that in this case, the owner was trying to protect “multiple single family dwellings” (which was not protected given the plain meaning of the statute. Had their been a deed of trust for each of the individual condo units, each would have been protected, but there was only one blanket deed of trust covering all 6 properties and this did not qualify for deficiency judgment protection.

Here is some language from the case for your reading enjoyment:

Applicability of the Arizona Anti-Deficiency Statute:

PNL argues that the trust property encumbered by its deed of trust is not protected under the anti-deficiency statute because it consists of four condominium units and is thus not limited to a single one-family or a single two-family dwelling. We agree. That statute reads in relevant part:

“If trust property of 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 is sold pursuant to the trustee’s power of sale, no action may be maintained to recover any difference between the amount obtained by sale and the amount of the indebtedness and any interest, costs and expenses.”

PNL’s loan to SW Pacific’s predecessor was secured by a single blanket deed of trust originally encumbering six separate condominium units. At the time of the trustee’s sale, four units remained encumbered by the deed of trust. Although the loan was evidenced by multiple promissory notes, A.R.S. section 33-814(G) focuses on the nature of the “trust property,” not the number of underlying obligations. Courts generally must follow a statute’s language when that language is plain and unambiguous. Mid Kansas, 167 Ariz. at 128, 804 P.2d at 1316.Thus, the anti-deficiency statute protects “trust property” that is “limited to and utilized” as “ single one-family or single two-family dwellings.”

In contrast to this case, in Mid Kansas the lender sought to waive its security and sue on four separate construction loans, each secured by four separate deeds of trust, and each encumbering a single substantially completed home. 167 Ariz. at 124-25, 804 P.2d at 1312-13. The lender had previously conducted a trustee’s sale on a second-position blanket deed of trust on the four properties. The borrower in Mid Kansas argued that the anti-deficiency statute prevented the lender from suing on the first-position notes after having non-judicially foreclosed the second-position blanket deed of trust. The supreme court held that the anti-deficiency statute did not apply because the uncompleted, unoccupied homes did not constitute “dwellings.” Because the court concluded that the borrower was not protected by the anti-deficiency statute, the court did not consider the issue of whether trust property consisting of multiple single-family homes falls within the protection of the anti-deficiency statute. In the court of appeals’ Mid Kansas opinion, however, this court did reject the lender’s argument that the four lots combined were not “trust property of two and one-half acres or less,” stating that, if the four lots had been owned by four individual homeowners as opposed to the one developer, this court would construe the anti-deficiency statute broadly enough to protect the homeowners from deficiency judgments. 163 Ariz. at 239, 787 P.2d at 138.

The Orians claim that there were in effect four separate but concurrent trustee’s sales. We do not agree. There was but one deed of trust and, consequently, one trustee’s sale. The Orians also claim that the trial court made specific findings that the four condominium units involved were four single family dwelling units. However, PNL does not challenge the finding that the condominium units constitute “dwellings,” which is what the trial court focused on. As PNL correctly argues, the anti-deficiency statute requires the trust property to not only be utilized as a dwelling, but also be limited to a single one-family or a single two-family dwelling. The trust property here consisted of four single-family condominium units. Interpreting the statute to protect trust property consisting of multiple single-family dwellingswould violate the language of the statute.

The Orians further argue that PNL is attempting to exclude commercial developers from the protection of the anti-deficiency statute. The supreme court in Mid Kansas held that the anti-deficiency statute’s protection extends to commercial owners of qualifying residential property. 167 Ariz. at 128, 804 P.2d at 1316. PNL’s argument correctly focuses on the type of property protected, not the type of borrower protected. The trust property here simply does not qualify as protected property.

What about mortgaging one home (a borrowers primary residence) to purchase another (second home in Oregon)? Many people have purchased second homes in the housing boom, especially given the availability of stated income loans, ARM loans, option arm loans with teaser rates, etc.. The case of Cely v. Deconcini, McDonald, Brammer, Yetwin, and Lacy, P.C., 166 Ariz. 500, 803 P.2d 911 (App. 1997) answered this question holding that the borrower who used their primary residence as collateral for a second home was not protected by the Arizona anti-deficiency statute. Here are a few golden nuggets from that case:

“In Baker v. Gardner, our supreme court held that the holder of a note and security device may not waive the security and sue on the note to hold the maker personally liable for the unpaid balance when the security falls within the limited class of purchase money mortgages and deeds of trust described in Arizona’s anti-deficiency statutes. We hold in this case that when one home is mortgaged to secure the purchase of a second home, the mortgage is not a purchase money security interest and the mortgage anti-deficiency statute does not apply.”

“Arizona’s mortgage anti-deficiency statute, A.R.S. § 33-729(A), restricts the remedy upon default of creditors with purchase money mortgages. The statute provides that a creditor may not foreclose on a purchase money mortgage and then pursue the debtor for a deficiency. Further, as the Arizona Supreme Court held in Baker v. Gardner, the creditor may not waive the mortgage altogether and sue the debtor personally on the note. 160 Ariz. at 104, 770 P.2d at 772.

A.R.S. § 33-729(A) provides:

Purchase money mortgage; limitation on liability:

If a mortgage is 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, of a parcel of real property of two and one-half acres or less which is limited to and utilized for either a single one-family or single two-family dwelling, the lien of judgment in an action to foreclose such mortgage shall not extend to any other property of the judgment debtor, nor may general execution be issued against the judgment debtor to enforce such judgment, and if the proceeds of the mortgaged property sold under special execution are insufficient to satisfy the judgment, the judgment may not otherwise be satisfied out of other property of the judgment debtor, notwithstanding any agreement to the contrary.”

THE GROPP MORTGAGE WAS NOT ORIGINALLY A PURCHASE MONEY MORTGAGE

Our supreme court has relied on the similarity between Arizona’s anti-deficiency statutes and those in California to interpret our statutes. Baker v. Gardner, 160 Ariz. at 102, 770 P.2d at 770. California case law indicates that in the standard purchase money transaction, the seller retains an interest in the land sold to secure payment of part of the purchase price. Roseleaf Corp. v. Chierighino, 59 Cal.2d 35, 41, 378 P.2d 97, 100 (1963). California’s anti-deficiency statute, Cal.Civ.Proc.Code § 580b (West 1976), provides in pertinent part as follows:

§ 580b. [When deficiency judgment forbidden: Exceptions]

No deficiency judgment shall lie in any event after any sale of real property for failure of the purchaser to complete his contract of sale, or under a deed of trust or mortgage, given to the vendor to secure payment of the balance of the purchase price of real property….

Gropp did not retain an interest in the Oregon home to secure the Celys’ note; he took an interest in the Tucson home, an asset unrelated to the sale. Thus, if Arizona law should follow California in this respect, the mortgage was not a purchase money interest when the Celys gave it to Gropp.

The defendants argue, however, that the California cases discussed in Baker v. Gardner are inapposite because the origin and purposes of the California statute differ from the Arizona anti-deficiency statute. We disagree. The Baker court stated that it read the Arizona and California statutes as similar in purpose. 160 Ariz. at 102-03, 770 P.2d at 771. The California Supreme Court has explained the application and purposes of that state’s anti-deficiency statute as follows:

Section 580b was apparently drafted in contemplation of the standard purchase money mortgage transaction, in which the vendor of real property retains an interest in the land sold to secure payment of part of the purchase price. Variations on the standard are subject to section 580b only if they come within the purpose of that section.

Section 580b places the risk of inadequate security on the purchase money mortgagee. A vendor is thus discouraged from overvaluing the security. Precarious land promotion schemes are discouraged, for the security value of the land gives purchasers a clue as to its true market value. If inadequacy of the security results, not from overvaluing, but from a decline in property values during a general or local depression, section 580b prevents the aggravation of the downturn that would result if defaulting purchasers were burdened with large personal liability. Section 580b thus serves as a stabilizing factor in land sales. Roseleaf Corp. v. Chierighino, 59 Cal.2d at 41-42, 378 P.2d at 100-01 (citations omitted) (emphasis added).

In Roseleaf, buyers purchased a hotel from the plaintiff and financed the transaction with four notes, three of which were secured by a second deed of trust on property other than the hotel. 59 Cal.2d at 38, 378 P.2d at 98. The first note was secured by a purchase money trust deed and was not involved in the case. Id. The court, analyzing the purposes of California’s anti-deficiency statutes, determined that the second trust deed was not a purchase money interest and that the plaintiff could sue the buyers personally on all three notes. The court stated:

To apply section 580b here would mean that the [buyers] would acquire the hotel at less than the agreed price. Furthermore, if there is any merit in the theory that “the vendor knows the value of his security and assumes the risk of its inadequacy,” that theory does not apply here. There is no reason to assume that [seller] had any greater knowledge of the value of the [buyers'] land than did the [buyers].

59 Cal.2d at 43, 378 P.2d at 101.

The purposes served by Arizona’s mortgage anti-deficiency statute are identical to those served by California’s statute and are equally inapplicable to the transaction between Gropp and the Celys. When the Celys mortgaged their Tucson home, they were in a better position to know its value than Gropp. The anti-deficiency statute could not ensure that Gropp priced the Oregon home appropriately because the mortgage was not taken on that home. Nor did the Celys risk losing their residential purchase in Oregon through foreclosure while remaining liable for its purchase price. See Roseleaf, 59 Cal.2d at 41-43, 378 P.2d at 101. The Tucson home served in the Oregon transaction as non-purchase money collateral-no different conceptually than an art work or an heirloom or the family jewels. We conclude that the anti-deficiency statutes do not apply.

We conclude on the basis of these authorities that a purchase money mortgage is one that encumbers the property being sold. We accordingly conclude that the Celys did not give Gropp a purchase money interest when they bought Gropp’s Oregon home.”

What about a consolidated loan that originally consisted of $240,000 in purchase money funds (but later also adding $75,000 in non-purchase money funds) both of which were later the subject of a loan modification agreement? Can this loan be considered protected purchase money not subject to a deficiency judgment? The case of Bank One (Arizona) v. Beauvais, 188 Ariz. 245, 934 P.2d 809 (App. 1997) addressed this question. In this case the Court held that since most of the funds were purchase money funds (the $75,000 was for the purpose of exercising stock options) that the consolidated loan would be treated as purchase money and protected from a deficiency judgment. The property was a qualifying property as discussed above. The Court held that the loan workout was NOT A NEW LOAN as the bank argued, but that the workout note retained its characteristic as a purchase money loan. You want a fresh snippet? I though you would never ask, here you go:

“In summary, we hold that regardless of whether the workout note was an extension, renewal, or refinancing of the 1989 consolidated loan, it retained its character as a purchase-money note. See Lucky Invs., Inc. v. Adams, 183 Cal.App.2d 462, 7 Cal. Rptr. 57 (1960). (Cancellation and replacement with new notes, secured by the same property, transfers purchase-money status to new notes.). Accordingly, the Bank is prohibited from waiving the security under the deed of trust and suing on the note – Per Baker v. Gardner. We affirm the trial court’s dismissal of the Bank’s complaint.”

What about the Arizona borrower who has both a first and second mortgage? It appears if both the first and second mortgage were taken out at the same time, and the money was borrowed to secure all or part of the purchase price of a single one family, or single two family dwelling on two and a half acres or less, that both the first and second mortgage would be protected from a deficiency judgment. Let’s take a look at the cases.

1. Southwest Sav. and Loan Assn. v. Ludi, 122 Ariz. 226, 594 P.2d (1979). In this case the lender held a security interest on a purchase money first mortgage and a non-purchase money second mortgage. The borrower Ludi defaulted on both. The lender foreclosed on the purchase money first mortgage, and tried to waive the security and sue on the note (like a breach of contract action) on the second mortgage. In this case, the Arizona Supreme Court allowed this action holding that there was nothing wrong with suing on the non-purchase money second (and waiving the security). The Court likened this to an action on the second to enforce the debt, which was permitted. The key here is the 2nd mortgage was NOT PURCHASE MONEY!! The court held that the lender was not prohibited from pursuing for foreclosure on one note and suing on the debt on the second mortgage all in the same action.(2) Wells Fargo Credit Corp. v. Tolliver, 183 Ariz. 343, 903 P.2d 1101 (App. 1995). Wells Fargo was a junior lien holder that was permitted to sue on the note. The property in question was not protected by the Arizona anti-deficiency statutes. The Court held:

“The statute (Arizona anti-deficiency statute) does not apply because Wells Fargo’s action is on the note, not one for a deficiency. This Court has previously held that a junior lienholder who did not institute trustee’s sale proceedings may waive its security and sue directly on its note, provided that it is not precluded by the anti-deficiency statutes. Again, the anti-deficiency statutes protect purchase money mortgages. This holding is consistent with Baker v. Gardner.

(3) Nydam v. Crawford, 181 Ariz. 101, 887 P.2d 631 (App. 1994) – This case involved a second mortgagee (junior lien holder) trying to sue on the note following a foreclosure sale by the first mortgage holder. The Court declined to allow the sue on the note theory by the second mortgage lender because the second mortgage was also purchase money and protected in Arizona against a deficiency judgment or action on the note. Here the court held:

“Baker is nearly, but not quite, on all fours with this case. In Baker, defendants’ purchase was financed in part by a loan from ICA Mortgage Corporation (“ICA”), and the sellers took a note for the remainder. ICA had a first-position deed of trust, with the sellers’ deed of trust in second position. When the defendants defaulted on both notes, ICA noticed a trustee’s sale. Before the trustee’s sale took place, the second-position deed-holders filed suit on their promissory note. The trial court ruled the action prohibited by the anti-deficiency statute (then numbered A.R.S. § 33-814(F) and (E)), and our supreme court affirmed. The court concluded that the Legislature intended to take away from creditors the option of suing upon the note in [the specified type of] transaction. This construction of the statute not only prevents its evasion, but also gives effect to the Legislature’s intent. Baker, 160 Ariz. at 104, 770 P.2d at 772 (quoting Ross Realty Co. v. First Citizens Bank & Trust, 296 N.C. 366, 250 S.E.2d 271, 275 (1979)).”

“Like the Bakers, plaintiff is a second-position deed-holder, attempting to collect on her note in the face of the first-position deedholder’s trustee’s sale. Plaintiff attempts to distinguish Baker, however, because she filed her lawsuit after the trustee’s sale, whereas the Bakers sued the Gardners before the trustee’s sale. Plaintiff argues that, unlike the Bakers, she did not commit the forbidden act of waiving her security and suing on her note; instead, because the trustee’s sale extinguished her security, she had no security to waive. She adds that she did not seek a deficiency judgment because, in the absence of security, there could be no deficiency.”

“Plaintiff’s argument is defeated by the plain wording of the anti-deficiency statute. Although that statute covers cases under A.R.S. § 33-722 in which one has elected to waive security and sue directly on the debt, it is not restricted to such cases. Nor, as Baker illustrates, is it restricted to cases in which the person seeking the deficiency also conducted the trustee’s sale. Section 33-814(G) provides more comprehensively that no deficiency judgment may be obtained if qualifying “trust property … is sold pursuant to the trustee’s power of sale.” Because this qualifying property was sold pursuant to the trustee’s power of sale, it falls within the express wording of the statute. Section 33-722 provides: “If separate actions are brought on the debt and to foreclose the mortgage given to secure it, the plaintiff shall elect which to prosecute and the other shall be dismissed.”

“Plaintiff’s argument is also defeated by the reasoning of Baker. Our supreme court there defined the purpose of the anti-deficiency statute as protecting homeowners from “the financial disaster of losing their homes to foreclosure plus all their other nonexempt property on execution of a judgment for the balance of the purchase price.” Baker, 160 Ariz. at 101, 770 P.2d at 769. The Baker court expressly contemplated the tandem impact of a first-position deed-holder’s trustee’s sale followed by a second-position deed-holder’s suit on a second note:

“The Gardners presumably lost whatever equity they had in the house on the non-judicial sale noticed by ICA under the first trust deed. Under the court of appeals’ opinion, the Gardners would have faced sale of their other assets on execution of the judgment on the note secured by the Bakers’ second deed of trust. In our view, the legislature would not have protected homeowners from deficiency judgments but still permitted the holder of a mortgage or deed of trust to obtain essentially the same result by waiving the security and bringing action on the note. This statutory construction seems inconsistent with the patent legislative objective.

There are many other scenarios that can be analyzed under the Arizona Anti-Deficiency Statutes. I do not have time to review them all. Each foreclosure case and attempt to collect on the debt is fact-specific, but the foregoing should give you a flavor of Arizona law.

1. CONCLUSION

If you are an Arizona homeowner facing foreclosure, you need to think about whether your first mortgage and second mortgage (if you have one) will be treated as “purchase money” loans and protected from deficiency judgments under Baker v. Gardner.If your loans are purchase money, at least in my opinion, you are in a better position to negotiate a loan modification, deed-in-lieu-of-foreclosure or short sale. Why? Because the lender(s) can take your lousy upside-down property and do what they want with it, but they cannot come after you for the amount of the loan they do not recover following a foreclosure sale. This is one of the rare cases in foreclosure defense when something may be considered good for you and bad for them. Keep in mind, Baker v. Gardner does not prevent a non-purchase money junior lien holder from “waiving the security” and “suing you on the note” where the Arizona anti-deficiency statute does not apply. Another issue that arises often in Arizona is whether construction loans are protected. If you are unsure of your legal standing or the liability you may face, contact our office to discuss your situation. The price you pay for a consultation and some legal research consutling the recent case law could make a huge difference to your pocket-book and future plans.

More information about Arizona Deficiency judgments can be found at www.ArizonaDeficiencyJudgment.com