How does federal bankruptcy law affect the 90-day deadline to file a deficiency action under Arizona real estate law after a trustee sale (non-judicial foreclosure)?  That was the question addressed in In re Rader.

Under Section 33-814 of Arizona real estate statutes, in order to pursue collection of a deficiency, a lender must file or maintain a lawsuit within 90 days after the trustee sale.  Otherwise, the debt is deemed satisfied/paid in full for the amount for which the property was sold at the trustee sale.  Of course, a lender may only file a claim for a deficiency if the claim is not barred by one of Arizona’s two anti-deficiency statutes.

But, what happens if the borrower is in bankruptcy?  The short answer is that bankruptcy law prevails and controls, not state law, if there is a conflict.  Specifically, once a bankruptcy is filed, the creditor must comply with bankruptcy law and, to the extent that conflicts with state law, the creditor is basically excused from abiding by state law.

In Rader, the borrowers filed bankruptcy, thus triggering the automatic stay.  The automatic stay prevents the creditor from taking action to enforce or collect the debt, except as allowed in the bankruptcy, unless the creditor obtains relief from the automatic stay.  Here, the creditor ultimately obtained relief from the stay to sell the property that was collateral for the loan at a trustee sale.  The property was eventually sold for less than the total amount due on the loan; thus, there was a deficiency.

The creditor had timely filed a proof of claim in the bankruptcy, but never filed an action to collect the deficiency as otherwise required by Arizona law.  The bankruptcy trustee objected to the claim since the lender never filed a deficiency action.  The Ninth Circuit Bankruptcy Appellate Panel addressed whether the creditor was excused from doing so based on bankruptcy law.

The Court found that it was legally impossible for the lender to comply with both bankruptcy law (and the automatic stay) and Arizona law (requiring the lender to pursue a deficiency action within 90 days).  Although the lender had obtained relief from the automatic stay, the order for relief was ambiguous, such that the lender was justified in not filing a deficiency action under state law after the sale of the real estate.  Federal bankruptcy law supersedes state law.  Therefore, the court found that the lender’s claim was not barred.

Please note that the Rader court’s analysis was based on the specific facts and circumstances of that case.  Most importantly, the court spent considerable time evaluating and interpreting the order lifting the automatic stay and allowing the lender to sell the property.  Ultimately, the court held that the order did not expressly authorize the lender to also file a deficiency action, such that it was prohibited from doing so under bankruptcy law.  As a result, its proof of claim in the bankruptcy was allowed.

Indeed, how a case turns out under Arizona real estate law almost always depends on the contract, other documents and specific facts of the situation.  Please consult one of our real estate attorneys if you have any questions.

The Arizona Court of Appeals has decided several recent cases interpeting and applying Arizona’s anti-deficiency statutes.  Watch this short video power point presentation to learn about Arizona’s Anti-Deficiency Statutes:

• What constitutes qualifying property?
• The two different types of foreclosures in Arizona.
• The type of loan that qualifies for protection in judicial foreclosure.
• How Arizona’s anti-deficiency statutes apply and protect certain property and certain loans.

The Arizona Supreme Court has resolved a recurring question: does the trustee have to “show the promissory note” in order to be able to foreclose by non-judicial trustee sale.  No, said the Supreme Court in its May 18, 2012 decision in Hogan v. Washington Mutual Bank.

The case involved two properties purchased by the borrower, John Hogan.  When Hogan received loans from Long Beach Mortgage Company (“Long Beach”), the properties were encumbered with deeds of trust.  Hogan defaulted on the loans, so the trustee under the deeds of trust recorded notices of trustee sales, in which it named Washington Mutual Bank and Deutsche Bank as the beneficiaries.

Hogan sued to stop the trustee sales, claiming that the Banks couldn’t foreclose unless they “showed the promissory notes,” unless they could prove that they were entitled to collect the amounts owed on the notes.  The Superior Court dismissed Hogan’s lawsuit, thus allowing the trustee sales to proceed. The Court of Appeals agreed.  The Arizona Supreme Court took up the issue because it involved a recurring question of statewide importance.  After reviewing and evaluating the deed of trust statutes and confirming that the deed of trust is separate from the promissory note, the Supreme Court found for the Banks.  There is no requirement for the trustee to “show the note” in order to foreclose by non-judicial trustee sale.

Deeds of trust and trustee sales are strictly governed by statute.  A.R.S. § 33-801 to 821.  According to the Supreme Court,

When parties execute a deed of trust and the debtor thereafter defaults, A.R.S. § 33-807 empowers the trustee to sell the real property securing the underlying note through a non-judicial sale. Hogan contends that before a trustee may exercise that power of sale, the beneficiary must show possession of, or otherwise document its  right to enforce, the underlying note. Nothing in our statutes, however, requires this showing. Section 33-809(C) requires only that, after recording notice of the trustee’s sale under § 33-808, the trustee must send the trustor notice of the default, signed by the beneficiary or his agent, setting forth the unpaid principal balance.

The Court agreed that the deed of trust and promissory note go together, such that only the lender entitled to enforce the note may foreclose.  But, there is nothing in the deed of trust statutes requiring the lender to show the note in order to foreclose.  And Hogan did not allege or prove that the Banks in this case did not have the right to enforce the notes.  He just claimed that they had to actually show the promissory notes and prove their right to enforce the loans before foreclosing.   The Court rejected that claim based on the absence of any such requirement in the statutes.

That is not to say that borrowers do not have rights if a lender forecloses without having a right to do so or a right to enforce the note.  Indeed, the Court noted that the trustee “owes the trustor (borrower) a fiduciary duty, and may be held liable for conducting a trustee’s sale when the trustor is not in default.”

Trustee sales are designed as an efficient and quick method of foreclosure.  Requiring proof of the right to enforce the note would frustrate those objectives, and impose a requirement not found in the deed of trust statutes.  Thus, the Court affirmed the dismissal of Hogan’s lawsuit to stop the trustee sales.

Read the entire Hogan v. Washington Mutual Bank decision.

Read ARS § 33-814.

Lenders and homeowner borrowers have been waiting for clarification of various questions arising under Arizona’s anti-deficiency laws.  Today, the Arizona Court of Appeals resolved three of the key issues involving Arizona’s anti-deficiency law applicable to judicial foreclosure actions, ARS § 33-729:  (1) whether the refinancing of a purchase money loan destroys the purchase money character of the loan and the borrower loses deficiency protection; (2) whether disbursements from a construction loan to construct a residence that otherwise qualifies for protection are considered purchase money; and (3) the treatment of a construction loan when part of the loan proceeds were disbursed for purposes other than the acquisition of the property or construction of a qualifying dwelling.  Helvetica Servicing, Inc. v. Pasquan (Ariz. Ct. App. 3/20/12).

Under Section 33-729, “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 lender is limited to satisfying the amount owed by foreclosing on the property; the lender may not collect any deficiency (the difference between the debt and the value of the property upon foreclosure) from the borrower’s other assets.  In addressing the three issues presented in the case, the Court relied heavily on the public policies underlying the Arizona anti-deficiency laws – to protect certain borrowers and discourage the overvaluation of property in the lending process.

In the Pasquan case resolved by the Court of Appeals, the borrower purchased an existing residence in Paradise Valley for $935,000.  They paid $335,000 “down” and financed the rest, $600,000, with a loan from Hamilton Mortgage Company, secured by a deed of trust against the property.  Later, they obtained a new loan from Desert Hills Bank for $1.6 million, which was secured by a new first deed of trust against the property.  The Desert Hills loan was used to pay off the balance owed on the Hamilton loan and expenses to demolish the existing home and construct a new home in its place.  The borrowers then borrowed another $100,000 from Desert Hills, secured by the existing first deed of trust.  They later borrowed an additional $400,000 from Desert Hills, secured by a second deed of trust recorded against the property.  According to statement submitted by the borrower, “all of the Desert Hills loan proceeds were used for construction expenses.”

Eventually, the borrowers obtained a new $3.4 million loan (the “Helvetica Loan”), secured by a new first deed of trust.  This was the loan ultimately at issue in the case.  According to the borrower, the Helvetica Loan was used as follows:

Desert Hills Payoff $2,154,038
Stephen Pasquan Loan $225,000 (for construction)
Closing Costs $9,674
Points/Interest $274,894
Interest/Reserves $206,033
Construction Credit Cards $172,575
Net Proceeds to the Pasquans $357,786.15

Of the proceeds to the borrowers, they avowed that approximately $228,000 was used for interest payments on the Helvetica Loan, and that the balance was used for “’improvements, landscaping, maintenance, taxes, utilities and marketing fees for the house.’”

The borrowers defaulted on the Helvetica loan.  Helvetica filed a judicial foreclosure action and the court granted it a judgment for judicial foreclosure.  Helvetica was the successful bidder at the subsequent sheriff’s sale, based on its $400,000 credit bid.  Helvetica then claimed that it was entitled to a judgment for some $3.2 million (the “deficiency” against the borrowers that Helvetica could/would then collect from the borrowers’ other assets.  Essentially, the Court addressed whether Helvetica was entitled to a judgment for all, part or none of that deficiency balance.  Setting aside other issues that may be further litigated, it found that Helvetica was entitled to a judgment for a portion of the deficiency balance and that a portion is uncollectible under the anti-deficiency statute.

Refinancing:  The Court first reaffirmed a prior Arizona decision that the extension, renewal or refinancing of a purchase money loan does not destroy the purchase money character of the original loan.  ”To hold that refinancing a purchase money obligation with a new lender and executing a new deed of trust on the same property destroys anti-deficiency protection would contravene the legislative intent to “’abolish the personal liability of persons who give trust deeds encumbering properties that fit within the statutory definition.’”  Thus, the Court held that the mere refinancing of a purchase money loan does not change the character of the loan as purchase money.  The Court also noted that it would be incongruous to prevent the original purchase money lender from collecting a deficiency, but allow the refinancing lender to do so.

Construction Disbursements:  The Court next addressed whether disbursements to construct a residence that otherwise is qualifying property constitute purchase money under the anti-deficiency statute.  The Court discussed a California court’s decision finding that a borrower who obtains a loan to purchase the materials and labor to construct a residence is just as much a purchaser of the residence as is a borrower who obtains a loan to purchase a completed dwelling.  So long as both loans are secured by qualifying real property, according to the Court, both are entitled to protection.  ”We hold that a construction loan qualifies as a purchase money obligation if:  (1) the deed of trust securing the loan covers the land and the dwelling constructed thereon; and (2) the loan proceeds were in fact used to construct a residence that meets the size and use requirements set forth in A.R.S. § 33-729(A).”  The Court explained that applying the anti-deficiency statute to protect such construction loans advances the legislative goals of placing the risk of insufficient collateral on the purchase money lender and preventing the expansion of the decline in the economy that would occur if the defaulting purchaser/buyer was also saddled with “large personal liability,” in addition to the loss of the home.

Non-Purchase Money Disbursements:  Finally, the Court discussed the impact and treatment of disbursements from a loan for purposes other than the acquisition or construction of the dwelling.

There are three possible outcomes when a judicially foreclosed mortgage secures both purchase money and non-purchase money sums:  (1) the entire loan is a recourse obligation; (2) the entire amount receives anti-deficiency protection; or (3) non-purchase money sums may be traced, segregated, and included in a deficiency judgment.  Arizona’s statutes offer little guidance regarding this issue.  Relevant legislative history, though, persuades us that the third option is the most rational way of harmonizing the competing interests of borrowers and lenders and of giving effect to legislative intent.

The Court found that it would be inequitable to preclude the borrower from receiving any deficiency protection simply because some funds were used for non-purchase/construction purposes.  On the other hand, the Court agreed that it would be unfair to the lender and would exceed the legislative purpose of the statute to extend deficiency protection to non-purchase money disbursements just because the proceeds were part of a loan that was also used for construction.  Such a result would also encourage homeowners to engage in reckless borrowing.  So, the Court concluded that a lender that judicially forecloses may pursue a deficiency for non-purchase money amounts.

The Court remanded the case back to the trial court to apply the rulings and to decide other factual and legal issues presented in the case.

If you would like to learn more about Arizona’s anti-deficiency laws, you can watch our anti-deficiency statute video presentation or read our anti-deficiency statute article.  Please realize that some of the information in those materials has been clarified/changed by the Court in the Pasquan case.  The Arizona courts are sure to render additional decisions resolving and clarifying the numerous issues raised under the Arizona anti-deficiency laws.  Watch our website or subscribe to our RSS Feed for future news and updates.

Berk & Moskowitz, P.C. handles a wide-variety of real estate disputes, including deficiency collection, judicial foreclosure, appraiser liability and other matters.  Please let us know if you have any questions.

Arizona’s law does not require the recording of an assignment of a deed of trust before recording a notice of trustee’s sale where the beneficiary holds a promissory note that was endorsed and payable to bearer.

In Vasquez v. Saxon Mortgage, Inc., the borrower, Julia Vasquez, refinanced her home loan by signing a promissory note and deed of trust in favor of Saxon Mortgage, Inc. (“Saxon”).  Later, Saxon transfered the Note to Deutsche Bank National Trust Company as Trustee for Saxon Asset Securities Trust 2005-3 (“Deutsche Bank”).  Saxon simply endorsed the Note in blank, but the assignment of the Note was not recorded, and an assignment of the Deed of Trust was not recorded.  After Vasquez defaulted on the loan, Deutsche Bank appointed a new trustee under the Deed of Trust.  The new trustee then recorded a notice of trustee’s sale.  Thereafter, Saxon recorded an assignment of the Deed of Trust to Deutsche Bank.

The Arizona Supreme Court was called upon to answer the question of whether “’the recording of an assignment of deed of trust [is] required prior to the filing of a notice of trustee’s sale under A.R.S. § 33-808 when the assignee holds a promissory note payable to bearer.’”  The Court answered “no; Arizona law imposes no such requirement.” 

The Court noted that it was ”mindful of the human costs attendant to home foreclosures. Our task today, however, is simply to answer two purely legal questions . . .  Because the ‘deed of trust scheme is a creature of statutes,’ our role is entirely one of statutory construction.  Put differently, we are called upon not to determine whether there ought to be a law providing relief to Vasquez, but what current Arizona statutes provide.”  (Citation omitted.)  The Court held that “trustee’s sales are governed by A.R.S. § 33-808. That statute expressly requires that a notice of trustee’s sale be recorded. A.R.S. § 33-808(A)(1). The statute, however, does not require that an assignment of a deed of trust be recorded before recording the notice of trustee’s sale.”

The Court explained that the recording statutes are designed to protect subsequent transferees and creditors who do not have actual notice of the lien or transfer.  But, “consistent with this general purpose, Arizona law expressly provides that ‘[u]nrecorded instruments, as between the parties and their heirs . . . shall be valid and binding.’ A.R.S. § 33-412(B).  Thus, while the failure to record an assignment of a deed of trust might leave an assignee unprotected against claims by some purchasers or creditors, it does not affect a deed’s validity as to the obligor.”

The Court supported its decision with “Arizona law [that] expressly provides that the transfer of a contract secured by a deed of trust ‘shall operate as a transfer of the security for such contract.’ A.R.S. § 33-817. When the note signed by Vasquez was assigned to Deutsche Bank in 2005, the deed of trust was therefore also transferred by operation of law. Because § 33-817 does not require separate documentation of an assignment of the deed of trust when the secured note is transferred, it would make no sense to imply into § 33-808 a requirement that the assignment be recorded.”

In 2005, Trevis and Lisa Mueller purchased raw land.  In 2006, they borrowed $444,000 from M&I Bank to construct a single family home for their own use.  In 2007, they began construction.  Unfortunately, construction fell behind schedule and was mostly defective.  The Muellers requested that M&I advance them loan disbursements to remedy the defects.  When the Bank refused, the Muellers abandoned the property and defaulted on their loan.  In 2009, M&I foreclosed upon the property at a trustee sale.  M&I then filed suit against the Muellers for some $68,000, the deficiency balance on their loan.

The trial court dismissed the lawsuit on grounds that the Muellers were protected by Arizona’s anti-deficiency statute – Arizona Revised Statute § 33-814(G) even though M&I argued that the property was never “utilized” as otherwise required by the statute.  (That statute provides that “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.”)  M&I then filed an appeal.

On appeal, the Arizona Court of Appeals held that because the Muellers purchased the property with the purpose of occupying a single family home for their own use, they were protected by the anti-deficiency statute, never mind that the residence was never constructed or actually occupied.  The Court’s rationale was that such a holding was consistent with the legislative intent of the statute – to protect homeowners.  The Court wanted to avoid what it called a blurry artificial line that would be created if the Court adopted a “physically inhabit” standard.  For example, such a standard could result in statutory protection of  a homeowner who camped out on the property or moved into the home for one day, but no protection for a homeowner who did not camp out or was just a day or so away from moving into the property. 

The Court also distinguished prior Arizona case law in which a residential commercial builder who had not completed construction on the subject property was held not protected by the anti-deficiency statute.  The Court distinguished that case because the Court in that case limited its holding to the facts of that case and because the debtor in that case was a residential commercial builder, not a homeowner.  The Court reiterated the legislative intent of the statute is to protect homeowners, not commercial builders.   

Click here for a copy of the M&I Bank v. Mueller decision.

A.  No criminal, civil or administrative action may be brought against a transferor or lessor of real property or a licensee for failing to disclose that the property being transferred or leased is or has been: