anti-deficiency laws
BANK LOBBYISTS CAN’T KEEP STORY STRAIGHT RE ARIZ. SENATE BILL 1271
Bank lobbyists told Arizona’s legislators that our anti-deficiency statutes needed to be revised because spec builders were “gaming the system” by claiming they lived in their spec homes to get anti-deficiency treatment. The Senate’s internal memo on the bill stated that investment properties were “NOT” protected by existing anti-deficiency laws. No one paid attention to the arguments or the law. The bill sailed through both chambers without a fight and was signed into law.
When real estate professionals and consumers realized what had happened, they were enraged, and a little embarrassed that such a spin job had just been orchestrated right under their collective noses. As the complaints rolled in and problem after problem (with the bill) was highlighted, the banking lobby changed its tune. Suddenly, the bill wasn’t just about spec builders, but more about investors and fraud on banks. But remember, the legislature believed that investors didn’t get protection under existing laws. So why in the world would the issue suddenly be about investors when the new law was passed with our lawmakers thinking they didn’t get protection anyway?
Why? Because bank lobbyists knew they had been outed and also knew that placing the blame on “investors” plays well in the media. At least until you stop and ask yourself “who is an investor”. Banks would like you to think we are talking about institutional investors with pockets spilling over with cash. This may be true for some homes purchased as investments, but it is far from the typical profile of an “investor”.
First, most big money home investors buy homes with cash – thus, there is no home loan and no issue of a deficiency. Second, and most importantly, the typical investor I meet is your next door neighbor, your friend, your retired teacher or grocery store manager. They are not ”rich”, are not trying to “game the system” and not void of moral guilt about being unable to pay their mortgage.
The “investors” I meet are hard working, honest, credit worthy individuals that wanted simply to get a piece of Arizona’s real estate profits. In many cases, they were counseled to buy a property by real estate agents, mortgage brokers, appraisers and lenders that all told the same story. You know the fairy tale — prices will continue to rise, you’ll be able to sell the property in a year or 2 for a good profit, or refinance the loan into a better loan and pull money out. Real estate prices never fall, so it can’t go wrong. Nice story huh? Too bad so many of us fell for it and are now holding the bag.
So, the closing occurred and lenders, mortgage brokers, appraisers, title companies and inspection companies all got paid. The investor started making payments on its new found goldmine. The loan was immediately sold, the bank replenshed its pockets and the process started anew with another credit worthy investor. Until the bubble burst and we all realized we had been sold fools gold. The “investor” now held an overvalued asset that couldn’t sell for the loan balance, and couldn’t be rented for anything close to satisfy the monthly payments. Investors started losing jobs, the loan market dried up and lenders wouldn’t (and won’t) work with their borrowers to modify loans to match market conditions (despite Government assistance and lots of pushing).
So it is only logical that after fueling the real estate bubble in Arizona, banks want to change the anti-deficiency law with a minute to go in the game — right before a foreclosure occurs. Selling or taking back the property they took as collateral is not enough they say — they need to take whatever hard earned money the investor may have left – wage garnishment, cash and securities, non-exempt assets. You name it — they want it.
Way to go Arizona’s legislature — keep giving banks another lifeline. They haven’t received enough as it is. Take away the one protection Arizona consumers have in the residential real estate market –they don’t need it. After all, our State and Federal Gov’t will surely be giving consumers their own bailout soon — right???
Marc McCain
McCain & Bursh, PLC, Attorneys at Law
(602) 604-2138
LETTER TO ARIZONA LEGISLATORS re ARIZONA SENATE BILL 1271
Here is a copy of the email correspondence I sent to Senator Sylvia Allen today. If anyone has a stake in the change in Arizona’s anti-deficiency law, I ask that you email me your concerns and opinions at mmccain@mblawaz.com. Although I have my own thoughts on this issue, I would like as much input as possible to take to Arizona’s legislators in the coming days.
Senator Allen:
Thank you for taking the time to meet with me yesterday and hearing my concerns over the passage of SB 1271. I want to stress that, although I support the AAR’s call for a repeal of the statute, I am not currently working on behalf of any one group or association. My concerns are based solely on what I am certain was an incorrect understanding of Arizona law and what I believe is an exaggerated problem of spec builder abuse of existing law (in the overall picture).
In addition, there appears to have been little to no discussion of the many serious consequences this legislation will have on thousands of Arizona property owners. These include garnishment of assets and wages, forced bankruptcies and cancelled debt taxes that could be substantial. All of these issues do not bode well for the average Arizonan at a time when they are struggling to stay afloat. For many people, this bill will either take whatever funds they have left, or push them into bankruptcy and neither result is good for Arizona’s economy.
Moreover, the wording of the statute and each change to the statute will create tremendous ambiguity in the courts and force potentially thousands of helpless property owners to litigate deficiency lawsuits against lenders and their counsel. In such litigation, the owner will now have the burden to establish the requirement that the property was lived in for 6 or more months. Since many lenders have no idea of how the property has been used, homeowners will face “fishing” lawsuits where lenders force them to satisfy their burden of proof in court or face a judgment – even if they in fact lived in the property for countless years. This is a David vs. Goliath scenario waiting to happen.
The certificate of occupancy (C of O) requirement is simply bad law and does not further the intent behind the change to the law. As I have indicated in my prior correspondence, not all cities issue C of O’s, some cities (like Phoenix) only started issuing them in more modern times, and even if a C of O can be obtained where one was not issued, this will tax local governments and their building departments at a time when resources are scarce, and can result in inspections of property and required upgrades to bring a property current (in order to get a C of O).
If this law is not repealed, it will most certainly result in a constitutional challenge by one or more consumer groups. The law was written to have retroactive effect – meaning it will be used against borrowers that entered into contracts long before the law was changed, and before foreclosure proceedings even commenced. In short, it will be used in an effort to change the rules governing the loan agreement and the borrower’s obligations thereunder after the contractual obligations were entered into. Given the vagueness in the law, the impact it will have on existing contractual rights and obligations, the problems with the C of O requirement, and the fact that the premise of the law was flawed, I expect a court to determine the law to be unconstitutional as written.
I am receiving numerous calls from owners and lenders asking about the new law. So far, the lenders I have spoken with are not calling about spec builders in default, but investors of qualifying residential property that will no longer get anti-deficiency treatment if the change in the law stands (despite the fact that the property has been used as a dwelling, albeit perhaps not by the borrower). Since the premise for the need to change the law was incorrect (which it most certainly was), the resulting legislation was inherently flawed. If lenders wanted to change the law to their benefit, they should have done so by presenting an accurate account of the law and with ALL impacts properly discussed and analyzed. I urge you to do what is necessary to repeal this law and bring the lenders and their lobby back to the table during the next normal legislative session to have a well rounded and accurate discussion of the issues at play.
Sincerely,
Marc McCain
Attorney at Law
PROBLEMS WITH AZ’S NEW ANTI-DEFICIENCY LAWS
The major premise for the Senate Bill 1271 was that the existing anti-deficiency statute was being manipulated by borrowers that were sleeping on floors or moving into a residence with little belongings so they could claim the property was used as a dwelling and then get anti-deficiency treatment.
The 2 main new requirements of the anti-deficiency statute are:
(1) the property must be used as a dwelling by the trustor for 6 or more consecutive months; and
(2) a certificate of occupancy must have been issued for the property.
The problem with the premise for SB 1271 is that it applies predominantly to those borrowers that are building a home with the loan for resale or don’t complete the property and then claim anti-deficiency protection. The current statute already provides that the home must be used as a dwelling – it just doesn’t say that the borrower has to use it as a dwelling. Arizona courts have interpreted the statute to mean that as long as the residence is on 2 ½ acres or less of land and is used by anyone as a dwelling (e.g. a renter, the home owner or family member, etc.) it will get anti-deficiency treatment. However, Arizona courts have also said that the statute does not apply to borrowers who are building the residence for resale. Thus, the premise presented was targeting those people who, the story went, had really got the loan to build and sell the home but couldn’t sell it or complete it and then manipulated the statute to say they used it as a dwelling because they camped out in the living room for a short period.
Presumably, the certificate of occupancy requirement was related to this alleged problem since it would prevent those borrowers who may have been close to having completed construction of a home but didn’t get all final work done and inspected from trying to manipulate the statute by camping out in a home and then claiming they should get anti-deficiency protection (for example, a home that didn’t have water or sewer facilities, but could be alleged to have been used as a dwelling).
While I am not saying that such manipulation has never occurred or is impossible, I would suggest that this scenario represents a miniscule percentage of the problem loans that have gone to foreclosure or are heading to foreclosure. Most borrowers are not building their own homes – they are either buying a home from another or refinancing an existing home loan. Yes, the manipulation cited could also occur where a borrower buys a new residence from a builder and then never uses it or rents it, but again, most investors are able to rent a home at some time for some price, or in fact use the residence as a dwelling for some time (e.g. a second home, vacation home, etc.). Moreover, since the statute already requires the home to be used as a dwelling, and the case law says that builder/sellers do not get anti-deficiency protection, all the lender had to do was prove its case in a deficiency action. Once it presented evidence to show the borrower hadn’t completed the home and/or that it was not really used as a dwelling, the burden of proof would shift to the borrower to rebut this. While I can appreciate the desire to shift the burden of proof to the borrower regarding use as a dwelling, I think the overall summary of the statute is that our legislature just took a chainsaw to a problem that required a scalpel.
Moreover, the certificate of occupancy requirement was completely ill-conceived since many homes were built before certificates of occupancy were issued and some cities and areas in Arizona don’t even issue a formal certificate of occupancy – e.g. Mesa according to its Permits Supervisor.
There are numerous other issues and questions presented by the new law including:
1. does use by the trustor as a dwelling mean the trustor had to live in the property, or merely put it to use by someone as a dwelling — e.g. a renter for instance (note the legislative summary clearly states the intent was that the trustor had to live in the property)?
2. can a borrower use (or live in) more than 1 property as a dwelling at the same time — for instance a vacation home and a main residence?
3. how will a court interpret the 6 consecutive month requirement? if a borrrower that has lived in a home for 3 months goes on an extended vacation, does that stop the clock on the 6 month requirement and require that the borrower use or live in the home for 6 months or more upon return? what about extended illnesses or out of state work assignments?
4. will the new law be applied retroactively to all loans made before the September 30, 2009 effective date but that result in a foreclosure after such date?
5. will courts strictly construe the certificate of occupancy issue?
6. can an entity such as a LLC or corporation that owns a home satisfy the “use as a dwelling” or “lived in” requirement?
I have met with dozens and dozens of clients that are having difficulty making payments on one or more home loans. They are by and large homeowners and relatively small scale investors that bought homes in the boom times believing they could get a share of Arizona’s rising real estate prices. These borrowers were not and are not seeking legal advice to game the system, but to confirm the laws that were in effect when they got the loan — the laws they expected would apply in the unlikely event they lost the home to foreclosure. These clients have presented a consistent story of having excellent credit, never skipping out on a loan and having moral guilt over the prospect of a foreclosure. Now, after making decisions based on what was thought to be a well settled set of rules for borrowers and lenders to play by, our legislature, at the pushing of the banking lobby, just changed the rules of the game with 2:00 minutes to go in the fourth quarter. In Football, it would be like giving the defense an extra 3 players for the offense’s 2 minute drill.
What’s even worse is that none of the foregoing discussion addresses the 1099 cancellation of debt issue that was created for many investors and homeowners that now won’t fall under an exception to cancellation of debt income following a foreclosure. I doubt our legislature or Governor considered or even understood these issues. The potential tax liability created for thousands of Arizona residents and investors could have significant negative consequences for Arizona’s economy and recovery. We already know loan dollars are scarce, now we’ll have fewer investment dollars in Arizona pockets to feed Arizona’s recovery. Given the manner this bill was pushed through (the strike everything amendment) and the trumped up problem presented by the banking lobby, I think Arizona residents should be alarmed and outraged. This is not the way good law is made.
Finally, if manipulation was a concern to the banking lobby, I can’t imagine a statute being more susceptible to manipulation than the one they just helped create. Now, investors who own more than 1 property need merely stagger their foreclosures and move from home to home for a 6 month period to satisfy the new requirement (as intended by the legislature). Most foreclosures take longer than 6 months anyway and during this time the borrower is not paying the lender. So, the new law might slow down foreclosures some, but for many Arizona residents that invested in property and have made the decision that letting it go the bank is the best option, all they did was create some extra steps to get to the same position (assuming the other requirements of the statute are satisfied).
McCain & Bursh, PLC, Attorneys at Law
www.mccain-bursh.com
ARIZONA’S ANTI-DEFICIENCY LAWS ARE CHANGING!
1. In Arizona, if a borrower fails to pay its loan, a lender can foreclose its Deed of Trust lien either judicially per A.R.S. § 33-721 et. seq., or non-judicially by conducting a trustee’s sale per A.R.S. § 33-801 et. seq.
2. If the foreclosure does not pay a lender what it is owed, the lender may generally seek a deficiency against the borrower for balance of the loan. However, certain states, including Arizona, have what are called anti-deficiency laws that bar a lender from seeking a deficiency in certain situations.
3. In determining if anti-deficiency rules apply, the first step is to confirm what law applies to the loan, particularly the lender’s remedies under the Promissory Note. The applicable law should NOT be assumed. Read your Promissory Note and other loan documents carefully and understand their terms.
4. Assuming Arizona law applies to the lender’s rights under the Promissory Note, Arizona’s anti-deficiency laws are found in 2 places – in A.R.S. § 33-729(A) (regarding judicial foreclosures), and A.R.S. § 33-814(G) (regarding trustee’s sales).
5. Under existing statutes, in both judicial foreclosures and trustee’s sales, anti-deficiency rules apply only if the property being foreclosed meets the following criteria: (a) 2½ acres or less; and (b) limited to and utilized as a single one-family or single two-family dwelling.
However, on July 10, 2009 Gov. Brewer signed into law a change to A.R.S. § 33-814(G). The change takes effect September 30, 2009. In addition to the above requirements, the trustee’s sale statute will require that: (a) the trustor has utilized the property as a dwelling for at least 6 consecutive months; and (b) a certificate of occupancy has been issued for the property. Under the existing trustee’s sale statute, there is NO requirement that the trustor use the property as a dwelling – just that the property be used by someone as a dwelling. Thus, in most cases, residential investment properties currently qualify for anti-deficiency treatment if on 2 1/2 acres or less. Under the new law, a property that has not been used by the trustor as a dwelling for at least 6 consecutive months will no longer qualify for anti-deficiency treatment. This change raises many interesting issues and will add to the confusion surrounding deficiency issues (see back page).
Note: Arizona courts have held that commercial properties and loans secured by residential homes being developed for sale but never used as dwellings do NOT qualify for anti-deficiency treatment under the statutes. In addition, courts have ruled that a deed of trust that is a lien against more than one property will not be subject to anti-deficiency rules – the deed of trust needs to be a lien against a single trust property.
6. For judicial foreclosures under A.R.S. § 33-729(A), there is the additional requirement that the loan be a purchase money (“PM”) loan for the borrower to get anti-deficiency treatment. However, the trustee’s sale statute, A.R.S. § 33-814(G), does NOT require that the loan be a PM loan. A PM loan does NOT lose its PM nature when it is refinanced. However, cash out refi’s raise interesting issues.
7. In judicial foreclosures, only a PM lender on qualifying residential property is prevented from seeking a deficiency; a non-purchase money (“NPM”) lender is not – it can obtain a deficiency following a foreclosure or sue the borrower on the note. For several reasons, judicial foreclosures on residential property in Arizona are relatively rare — most lenders foreclosure via a trustee’s sale.
8. In a trustee’s sale, both a PM and NPM lender that conducts the trustee’s sale on qualifying property will be prevented from seeking a deficiency after the foreclosure and from suing the borrower directly on the note.
9. Junior liens extinguished by a 1st position foreclosure may be able to sue on the note. The issue is whether the junior loan was a PM or NPM loan – if it was a PM loan on qualifying property, the lender can NOT sue the borrower on the note following the foreclosure; if it was a NPM loan, the lender CAN sue the borrower.
10. If a lender can not seek a deficiency, then the lender can NOT waive its security and sue directly on its note. This means that a lender under a PM loan on qualifying property will NOT be able to sue the borrower on the note. This rule also applies to short sales. Note there are gray areas regarding cash out refi’s. Other Lender claims are also not barred – e.g. mortgage fraud.
11. Even if anti-deficiency rules apply, a borrower will be liable to a lender for any diminution in value of the trust property due to voluntary waste. In other words, don’t damage the property, take fixtures, A/C units, etc., or let the Property go to waste.
12. Real property taxes are NOT an owner’s personal obligation, but only a lien against the real property. However, HOA assessments ARE an owner’s personal obligation and if not paid can result in credit damage, lawsuits and other collection efforts.
13. Last, but not least, consult with qualified tax professionals BEFORE deciding to do a short sale or foreclosure. 1099 income, gains, losses and other tax consequences may result from foreclosures, short sales and loan modifications. Know what tax consequences you will face and plan accordingly!
Note:
This article does not constitute legal advice and no attorney-client relationship exists without a formal, written fee agreement with the author. Check with an experienced attorney to review your situation and to confirm the current state of the law – the law can change.
Marc McCain
McCain & Bursh, PLC, Attorneys at Law
mmccain@mblawaz.com
(602) 604-2138