In our practice we have consulted with countless clients whose homes are currently worth substantially less than the outstanding balance of their loans and who are having a difficult time paying their mortgage for one reason or another.
During these consultations, we always discuss at length Arizona’s Anti-Deficiency Statute and how it may or may not protect them. During these consultations, we also always discuss the option of a short sale as compared to a foreclosure, or more appropriately, a trustee’s sale.
One question that is commonly raised is whether or not a borrower is protected by Arizona’s Anti-Deficiency Statute if that borrower elects to proceed with a short sale rather than let the house go into foreclosure where a trustee’s sale ssentially strips the borrower of the property. There has been a lot of confusion on this issue with different attorneys and real estate professionals having different opinions.
ARIZONA’S ANTI-DEFICIENCY STATUTE
Arizona’s primary Anti-Deficiency Statute, as it applies to deeds of trust (or most home loans in Arizona), is found in A.R.S. § 33-814. Subsection A of this statute states in pertinent part that
“within ninety days after the date of sale of trust property under a trust deed . . . , an action may be maintained to recover a deficiency judgment against any person directly, indirectly or contingently liable on the contract for which the trust deed was given as security . . . . In any such action against such a person, the deficiency judgment shall be for an amount equal to the sum of the total amount owed the beneficiary as of the date of the sale, as determined by the court less the fair market value of the trust property on the date of the sale as determined by the court or the sale price at the trustee’s sale, whichever is higher.”
Basically, subsection A quoted above states that a lender, after a trustee’s sale, may pursue a deficiency judgment against a borrower and that the amount of the judgment – the “deficiency” – will be equal to the difference between the total amount owed on the loan as of the date of the trustee’s sale minus the sales price of the property at the trustee’s sale or the property’s fair market value, whichever amount is higher.
Again, this provision quoted above states that a lender CAN pursue a deficiency judgment against a borrower if the sales price of the property at the trustee’s sale does not exceed the outstanding balance of the loan that is foreclosed. Of course, there is nothing “anti-deficiency” about this portion of the statute since it specifically authorizes a deficiency judgment.
Rather, the very last subsection of the statute – A.R.S. § 33-814(G) – contains the relevant anti-deficiency language. Subsection G states 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.”
A.R.S. § 33-814(G) – the “anti-deficiency” subsection – is stating that where three criteria are satisfied as they relate to a property (hereinafter referred to as a “qualifying property”), the lender on that qualifying property cannot pursue a deficiency judgment. The three criteria for a qualifying property are as follows:
(1) the property securing the loan is 2 ½ acres or less;
(2) the property contains a single one-family or single two-family dwelling unit; and
(3) the property is actually utilized as a dwelling unit.
As you can tell, these three criteria apply to almost every residential home in Arizona. Arizona’s Anti-Deficiency Statute was enacted as a consumer protection law of sorts to protect home buyers who had lost their homes at trustee’s sales from being pursued personally if the value of their home fell below the outstanding balance of their loan. Essentially, where this statute applies, the only recourse or security a lender has is the actual home itself and the borrower is completely shielded from any personal liability.
THE ANTI-DEFICIENCY STATUTE AND THE SHORT SALE – ARE YOU PROTECTED?
Getting back to the question at hand – whether or not a borrower is protected by the Anti-Deficiency Statute if that borrower elects to proceed with a short sale – it is important to look at not only the language of the statute but also the Arizona court cases that have interpreted the statute and how the statute apples in different factual scenarios.
Those who believe that a borrower is not protected by the Anti-Deficiency Statute when that borrower elects to do a short sale always reference the opening language quoted above in A.R.S. § 33-814(A) which, again, states that “within ninety days after the date of sale of trust property under a trust deed . . . .” Their argument is that the Anti-Deficiency Statute only applies where there is actually a “sale of trust property under a trust deed” (i.e., a trustee’s sale). They claim that because a short sale is not a trustee’s sale, the Anti-Deficiency Statute is not implicated.
While I understand their argument and believe that it is an appropriate literal interpretation of the language of the statute, I do not agree with the conclusion.
As I read the Anti-Deficiency Statute and, more importantly, as I read the case law interpreting and applying the statute, my personal opinion is that where a purchase-money loan is involved and where there is a short sale of qualifying property, that the borrower is protected by the Anti-Deficiency Statute, meaning that the lender will not be able to successfully pursue the borrower for any deficiency after the short sale is completed.
WHAT DOES THE CASE LAW SAY?
In Baker v. Gardner, 160 Ariz. 98, 770 P.2d 766 (1989), the Arizona Supreme Court decided the issue of whether or not a lender could waive its security interest in a property under the deed of trust and sue the borrower directly under the promissory note.
In the Baker case, the Bakers sold the Gardners a single-family home for $131,000. Most of the purchase price for the home was financed by a loan secured by a deed of trust. For the balance of the purchase price for the home, the Gardners gave the Bakers a promissory note for $17,500, which carryback note was secured by a second deed of trust. The Gardners subsequently defaulted on both loans and the first lender initiated a trustee’s sale (a foreclosure).
Before the trustee’s sale, the Bakers brought the action to recover the unpaid balance of the promissory note the Gardners had given them. The Bakers did not exercise their rights under the second trust deed by also pursuing a trustee’s sale. At the trial court, the judge granted the Gardners’ Motion for Summary Judgment, holding that A.R.S. § 33-814(E) (the so-called “anti-deficiency” statute) precluded Baker’s action on the note. The court of appeals reversed, reasoning that A.R.S. § 33-722 (providing for a creditor’s election of remedies) permitted the action. Consequently, the Arizona Court of Appeals held that a deed of trust beneficiary (the lender) can choose either to exercise its rights under the deed of trust or waive the security and file an action for the unpaid balance of the note.
After the Arizona Court of Appeals ruled in favor of the Bakers allowing them to waive their security interest in the property (the deed of trust) and sue the Gardners directly under the promissory note, the Gardners sought a review and decision from the Arizona Supreme Court.
After reviewing the case, the Arizona Supreme Court discussed the separate Anti-Deficiency Statutes, emphasizing that the Arizona legislature enacted both anti-deficiency statutes in 1971 with several other consumer-oriented laws. Importantly, the Arizona Supreme Court concluded that the holder of a purchase money note and a security instrument (i.e., a deed of trust) on premises of two and one-half acres or less which is used for single or two-family dwellings may not, by waiving its security and bringing an action on the note, pursue a deficiency judgment and hold the borrower liable for the entire unpaid balance.
By way of comparison, a lender, in the short sale context, who pursues a borrower after a completed short sale is attempting to do the exact same thing that Baker was attempting to do in the case described above.
In a short sale, the lender is waiving or releasing its security interest in the home (the deed of trust) allowing it to be sold lien free to a third-party buyer. If the lender subsequently pursued the borrower for a deficiency, the lender – like Baker – would essentially be waiving its security interest in the property and attempting to sue directly on the promissory note.
This is clearly not allowed according to the Court’s holding in Baker.
Though there is seemingly much confusion on the issue, it is again our opinion that where there is a purchase-money loan and a short sale of “qualifying property,” that the lender will not be able to successfully pursue the borrower for any amount of money out of the borrower’s pocket.
The one caveat to all of this and the way some lenders have attempted to circumvent their inability to otherwise pursue borrowers personally after short sales is to get borrowers, in the short sale terms and conditions, to agree that they owe the lender additional money if and when the short sale occurs. In this scenario, the short sale terms and conditions would operate as a separate obligation binding the borrower again.
If your home is underwater and if you are potentially facing a foreclosure, or if want or need to short sale your home, or if your short sale has been approved and the terms and conditions have been sent by your lender, please give us a call to set up a consultation to discuss your potential liability and the best course of action for you to limit your liability … Your peace of mind is worth it.
(This link is to a letter written to the Maricopa Lawyer publication which is a more technical analysis of the questions presented herein. Overall, I completely agree with the author’s analysis.)