deficiency after short sale
BORROWER’S 1, LENDER’S 0
In a recent case handled by local business and real estate attorney Lance Davidson, a borrower prevailed in a lawsuit brought by the borrower’s lender seeking a deficiency after the borrower sold the home at a short sale. In the lender’s approval letter, the lender included a clause that stated it reserved their rights to pursue a deficiency following the short sale. In a Motion to Dismiss, Mr. Davidson convinced the court that such an action was not appropriate under Arizona law and was awarded attorney’s fees. The lender did not appeal the decision, thereby ending the ordeal for the borrower, much to their delight.
This case highlights the hot topic in the Arizona real estate market regarding Arizona’s anti-deficiency laws and their application to short sales. While some counsel may argue otherwise, the apparent predominant view is that short sales will get anti-deficiency protection provided the anti-deficiency requirements are otherwise met and provided the facts do not present the lender with a solid argument otherwise (such as an express waiver of anti-deficiency protection). However, certain issues in this area remain unresolved under Arizona law and aggressive bank counsel argue that short sales get no protection absent an express release by the lender as part of the short sale approval. Given the number of short sales in Arizona, this issue is almost certain to be heard in Arizona courts over the coming years.
Marc McCain, Esq.
Disclaimer: nothing in this article or site is intended to be, nor should it be considered, legal advice. Every situation can present unique facts or circumstances that must be analyzed. An attorney-client relationship exists only after a client has a signed fee agreement with McCain&Bursh, PLC.
TRENDS IN ARIZONA SHORT SALES AND ANTI-DEFICIENCY LAW
I recently attended a seminar that provided very interesting insight into the minds of lenders and why they continue to press rights against borrowers in certain contexts. Below is a summary of issues that lenders and their counsel believe are unsettled in Arizona, despite the strong policies behind Arizona’s anti-deficiency statutes as discussed in several reported Arizona cases:
1. Refinances of an original purchase money mortgage where no additional money is distributed to the borrower. Lenders are arguing that no Arizona case clearly addresses whether a refinance of a purchase money mortgage, especially from a new lender, retains its purchase money character. Lenders point to cases from other states that hold a loan loses its purchase money character when refinanced. Of course, even if a loan is non-purchase money, if the trust property is 2.5 acres or less, has been utilized as a dwelling and the lender actually conducts a trustee’s sale, then the lender will be barred from seeking a deficiency since the trustee’s sale statute does not require the loan to be purchase money in order for the borrower to get anti-deficiency treatment. However, for junior loans that are refi’s of prior purchase money loans, lenders could conceivably make this argument and sue a borrower under the Baker Court’s rational (i.e., if a loan is non-purchase money, the lender can sue the borrower on the note). From a borrower perspective, if Arizona courts were to accept this lender argument, consider the practical effect. Many borrowers took advantage of cheap loans over the past decade and refinanced their initial purchase money loans. If all of these borrowers were suddenly deemed to lose purchase money protection, the potential impact on Arizona consumers and the Arizona economy would be huge. Thousands of borrowers would suddenly be subject to potential lawsuits and deficiency actions. Moreover, given the Beauvais decision, coupled with the policy behind Arizona’s anti-deficiency statutes and the reasoning in the Baker decision, I find it hard to believe an Arizona court would strip borrowers of purchase money protection in this context, although nothing is impossible. As I remind clients, anyone can be sued at any time, for any reason. For this reason, an amendment to Arizona’s anti-deficiency laws would provide great clarity on this and other issues.
2. Short sales do not get anti-deficiency treatment since they are voluntary transactions that are not in the foreclosure context. Although consumer counsel like myself could not disagree more, if lenders want to make this argument in a court of law, they can, and a borrower must defend the lawsuit or face a possible default judgment. Moreover, litigation is costly, even if you have the better argument. So, if a lender were to sue a borrower for a deficiency following a short sale, a borrower must make a difficult decision as to how to spend its resources – fighting the lender, attempting to settle, or perhaps seeking bankruptcy protection. As a result, I will continue to stress that it is imperative to seek a lender’s express written waiver or release of any deficiency rights in a short sale. If a lender is unwilling to give such a release, then a borrower must carefully analyze its risks and whether it should go through with a short sale. Moreover, since a lender typically requires a borrower to submit financial information as part of the short sale process, a borrower must contemplate the risk of disclosing its assets to a lender and having that information used against it in subsequent collection efforts (whether after a short sale, or if a short sale is not consummated, in a deficiency action or suit on a note following a foreclosure).
3. Construction loans on residential lots can not get anti-deficiency protection (at least not under the judicial foreclosure statute) because the loan was not made on a single 1 or 2-family dwelling, even if the dwelling is subsequently constructed and utilized as a dwelling. Lenders may take the position that a construction loan for a new residence on 2.5 acres or less should not get anti-deficiency protection because the statutes should be interpreted to mean that the dwelling existed and was in use at the time the loan was made. This reasoning seems to runs contrary to the Arizona Supreme Court’s decision in the Mid-Kansas case. Moreover, if a trustee’s sale is actually held, the clear statutory language of 33-814(G) should prevent the lender from seeking a deficiency where the 1 or 2-family dwelling is complete and has been utilized. However, if lenders want to push the issue, like noted above, they can, and a borrower will have to weigh its options and their respective costs and risks.
Nothing in this blog is intended as legal advice. Every borrower and owner should consult independent legal counsel to review their situation and evaluate their risks and issues. Any opinions expressed herein are based on the author’s interpretation of existing law, anti-deficiency policies and practical experiences working in the area. However, the facts of each case can be different and different facts can result in different outcomes. Moreover, the law can change and courts will continue to shape the interpretation of statutes addressing these and related issues.
Marc McCain, Esq.
McCain & Bursh, PLC
SHORT SALE TIPS FOR ARIZONA RESIDENTIAL PROPERTIES
1. Know what leverage you have, if any. If Arizona’s anti-deficiency statutes apply to your loan(s), use this fact to reject any lender demand for a seller/borrower contribution at close of escrow. Most junior lenders will ask for a contribution from the borrower, sometimes a significant one. If the loan is covered by Arizona’s anti-deficiency laws, the lender would be barred from seeking a deficiency if the home goes to foreclosure. A savvy borrower or his short sale negotiator will use this fact as leverage to get an approval without a borrower contribution, or at least not a significant one. Of course, each loan can be different, so know the law and how it affects each of your loans on a property before the short sale process begins.
2. Always ask for the lender’s express release of liability as a condition to the short sale – even if your loan(s) would be covered by Arizona’s anti-deficiency laws. The short sale proceeds should be taken by the lender as full satisfaction of all indebtedness under the loan(s). Attempt to get this in writing from each lender. If the lender is unwilling to provide such an express release, understand what liability you may have as a borrower following the short sale before you agree to the sale. In some cases, Arizona law prohibits a lender from waiving its security and suing a borrower on its note. As a result, if a lender in such a case releases its security in a short sale, a strong argument exists that Arizona law should prevent the lender from seeking any recourse against the borrower following the short sale. However, lenders and their counsel may have a different view on the topic and could elect to sue (or threaten) if they want to press the issue, forcing a borrower to defend or consider options.
3. Understand the process and information the lender will require for a short sale before starting the process. Nearly all lenders require a borrower to submit current financial information – bank statements, tax returns, W-2’s, company profit and loss statements, etc. In addition, lenders typically require a borrower to establish a hardship as a condition to approving a short sale. What constitutes a hardship can vary from lender to lender, and how a borrower portrays the hardship can make a difference. If a borrower may be liable for a deficiency following a short sale, that borrower may want to think twice about providing a lender with a snapshot of its current financial condition. Since a borrower must accurately disclose its income and financial condition, doing so may provide a lender the information it needs to ask for a larger contribution, pursue any deficiency rights following a short sale, or in an action on the note (if available).
4. Use a skilled, experienced negotiator to process your short sale. The short sale process can be lengthy, time consuming and frustrating. Without help from an experienced real estate agent and/or attorney, the process can be overwhelming for many borrowers. Despite the difficulties, if a short sale is right for you, don’t give up if met with initial resistance or delay from your lender and don’t necessarily blame your negotiator. Even the best real estate agents and attorneys run into unreasonable lenders and their legion of inexperienced and uncaring loss mitigation representatives.
5. Know what you are agreeing to in the short sale process and approval. The standard ARR Short Sale Listing Agreement and Short Sale Addendum require a seller to provide all information requested by a lender in the short sale application process. For reasons noted above, some borrowers may not want to agree up front to provide all information a lender requests. Moreover, the Short Sale Addendum requires the seller to work in earnest to get the short sale approved. As a result, a seller should not enter into a short sale contract unless it truly intends on seeking its lender’s approval and consummating the sale.
6. Read and understand your lender’s approval terms. Most lenders require a seller to sign and return the short sale approval or agreement. The approval conditions and agreements used by lenders vary widely. Some lenders are silent on deficiency issues, others attempt to get borrowers to agree that they will be liable for a deficiency following a short sale, even in instances where such an agreement may be contrary to Arizona law and its anti-deficiency provisions. Some approvals require a borrower to sign an unsecured promissory note. Whatever the conditions, a borrower must understand what potential obligations and liabilities it is taking on in the lender’s short sale agreement and related documents.
7. Stay apprised of changes in the law and short sale programs. Commencing on April, 5 2010, the Federal Government’s Home Affordable Foreclosure Alternatives program will implement changes to short sale and deed in lieu workouts for participating lenders and loans. Among the many requirements of the program, a lender will not be able to seek a deficiency following a qualifying short sale or deed in lieu. Moreover, many cases will be tried in Arizona’s courts over the coming months that may further shape Arizona’s anti-deficiency laws and whether certain loans should get anti-deficiency protection.
8. Understand what tax liabilities may result from a short sale. If a deficiency is not permitted or if a lender writes off any loss on a short sale, the lender should issue a 1099 C to the borrower to report the amount of the cancelled debt. Unless the borrower falls under a recognized exception to cancellation of debt income, a borrower must recognize the income and pay and associated tax liability. A prudent borrower will always understand the probable tax impact of a short sale (or other workout) before the transaction is consummated.
Marc McCain
McCain & Bursh, PLC, Attorneys at Law
(602) 604-2138
Nothing in this blog is intended as legal advice. Every borrower and owner should consult independent legal counsel to review their situation and evaluate their risks and issues. Any opinions expressed herein are based on the author’s interpretation of existing law, anti-deficiency policies and practical experiences working in the area. However, the facts of each case can be different and different facts can result in different outcomes. Moreover, the law can change and courts will continue to shape the interpretation of statutes addressing these and related issues.