short sales
THE TRUTH ABOUT SHORT SALES AND DEFICENCIES IN ARIZONA
Rarely will a consumer find so much contradicting, confusing and downright incorrect information on a legal topic as they currently do when it comes to short sales and related issues. Rarely heard of just 2-3 years ago, short sales now make up a significant majority of current MLS listings in the metro Phoenix market and the trend doesn’t seem to be changing any time soon. Agents, consumers and other professionals are scrambling to get up to speed on the process, strategies and legal issues surrounding short sales. From a legal perspective, there are three (3) main issues I discuss with clients who may be considering a short sale (or other loan workout for that matter): (1) deficiency issues, (2) credit issues, and (3) cancellation of debt income issues.
With respect to issue #1 – deficiencies, short sales present interesting issues and possible outcomes. Arizona has two anti-deficiency statutes that act to prevent a lender from collecting on a deficiency following a judicial or non-judicial foreclosure on certain residential property situated on 2.5 acres or less. Because these statutes deal with foreclosures, many real estate professionals, including attorneys, take the position that Arizona’s anti-deficiencies have no application to short sales. This is categorically false. Either these real estate professionals do not understand the law, or they are trying to create confusion to help attract clients for their services. While a short sale can result in a deficiency situation where a foreclosure on the same property would not (for instance, without a lender’s agreement to not seek a deficiency, a short sale involving a non-purchase money loan on qualifying property will not extinguish a borrower’s liability for a deficiency, while a foreclosure by the same lender at a non-judicial trustee’s sale will result in the lender being barred from seeking a deficiency), for many loans (specifically, purchase money loans on qualifying property), a short sale should never result in a deficiency for a borrower.
Notwithstanding Arizona’s relatively broad anti-deficiency protections afforded to purchase money loans on qualifying property, lenders continue to misrepresent their rights and borrowers’ liabilities in short sale transactions. Lenders continue to demand cash contributions from borrowers to approve short sales even though they would have no right to seek a deficiency if they foreclosed on the property. Borrowers and their real estate agents should never engage in short sale negotiations without knowing exactly what rights and obligations a lender and borrower have under the loan and any particular workout scenario.
For a more detailed analysis of Arizona’s anti-deficiency laws and their applicability to short sale transactions, see my letter to the Editor of Maricopa Lawyer attached.
letter-to-the-editor-of-maricopa-lawyer
Marc McCain, Attorney at Law
McCain & Bursh, PLC
(602) 604-2138
UPDATE ON ARIZONA’S ANTI-DEFICIENCY LAWS
In Arizona, certain loans on residential real property are subject to what are called anti-deficiency laws. These laws limit a borrower’s liability to its lender if certain requirements are met. However, there are many misconceptions about Arizona’s anti-deficiency laws, when they apply, and whey they don’t. Moreover, Arizona’s anti-deficiency laws have been in recent flux, increasing the confusion in the market and borrowers’ anxiety as they try to navigate a very difficult and stressful situation. Arizona Senate Bill 1271 was passed in the summer of 2009 and briefly became the law until repealed, most recently by Arizona Senate Bill 1004. As a result, Arizona anti-deficiency law will remain unchanged, at least for now. For an understanding of the additional requirements that Senate Bill 1271 would have imposed to get anti-deficiency protection, see prior blog posts at www.marcmccain.com.
With the foregoing as a backdrop, set forth below are the general anti-deficiency rules applicable in Arizona now that Senate Bill 1004 has taken effect. However, borrowers must understand these are only general rules — every situation must be analyzed carefully based on the relevant facts and applicable law. And remember, the law can and may change!
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 sale price does not pay a lender what it is owed, the lender may generally seek a deficiency against the borrower for the balance of the loan. However, Arizona has what is called an anti-deficiency law that bars a lender from seeking a deficiency in certain situations. The anti-deficiency laws with respect to real property loans in Arizona 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).
3. In determining if Arizona’s 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 and what law will most likely apply to the lender’s rights under the Promissory Note.
4. Assuming Arizona law applies to the lender’s rights under the note, in both judicial foreclosures and trustee’s sales in Arizona, 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.
5. 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.
6. However, the trustee’s sale statute, A.R.S. § 33-814(G), does NOT require that the loan be a PM loan.
7. Special rule regarding purchase money loans: a PM loan does NOT lose its PM nature when it is refinanced. However, cash out refi’s raise interesting issues.
8. In judicial foreclosures, if the loan on qualifying residential property is a non-purchase money (“NPM”) loan, then the lender is not prevented from seeking a deficiency following a foreclosure or from suing borrower on the note. Only lenders that made PM loans on qualifying residential property are prevented from seeking a deficiency or suing the borrower on the note. However, for several reasons, judicial foreclosures on residential property in Arizona are relatively rare — most lenders foreclosure via a trustee’s sale.
9. 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.
10. 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.
11. Arizona’s Supreme Court has ruled that a PM lender on qualifying property can NOT waive its security and sue directly on its note. This rule should prevent a PM lender on qualifying property from suing a borrower on the note before or after a foreclosure or after a short sale. However, other Lender claims are not barred – e.g. voluntary waste of the property. Moreover, many lenders are ignoring Arizona law in collection efforts and short sale approvals and negotiations.
12. Under the 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 or rental properties qualify for anti-deficiency treatment, even if they are not owner occupied properties.
13. However, Arizona’s Supreme Court has held that commercial properties and loans secured by residential homes being developed for sale but never utilized as dwellings do NOT qualify for anti-deficiency treatment under the statutes.
14. In addition, Arizona’s 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.
15. 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.
16. Real property taxes are NOT an owner’s personal obligation, but only a lien against the real property.
17. However, HOA assessments ARE an owner’s personal obligation and if not paid can result in credit damage, lawsuits and other collection efforts.
18. Arizona’s rules governing foreclosures and deficiency issues may apply to short sales, but a borrower must understand the law and its loan and realize that the outcome can be different in a short sale vs. a foreclosure, e.g., a short sale on a NPM loan will generally permit a lender to collect the balance due on its note whereas a trustee’s sale on the same loan will prevent the lender from seeking a deficiency. Short sales also present the parties with the chance to negotiate terms of the short sale and deficiency issues.
19. 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!
LENDER’S IGNORING ARIZONA LAW IN SHORT SALES
More and more I am seeing lenders be aggressive and unreasonable in demanding money from borrowers during the short sale approval process. Lenders are doing this even where AZ law prohibits them from waiving their security and suing on the note (i.e. where the loan is a purchase money loan on qualifying residential property). As a result, I am stressing the need to be careful about agreeing to terms of a short sale that are not reasonable or contrary to Arizona law – read and understand your documents. Also understand that just because a lender may not have a right to sue on its note based on well settled AZ authority, they may try, whether out of ignorance, arrogance, aggressiveness, or who knows anymore.
What is needed in Arizona is a law that would prohibit lenders from receiving funds in a short sale (over the short sale net proceeds) that would not be permitted by our anti-deficiency statutes and our Courts’ interpretation of the law. Nothing short of a statutory restriction against the type of lender abuses we are seeing will work — we’ve already seen the debacle of the Federal Governments’ loan mod and refinance program. The support for such a bill would be tremendous, the question is whether any groups have the time and money to marshall the effort needed to raise the issue with our legislature and get it through the political process quickly enough to make a difference in this market . . .
BANKS SUE ARIZONA GOV. BREWER TO STOP REPEAL OF CHANGE TO ANTI-DEFICIENCY LAW
Looks like the threat was real. Banks hired one of Arizona’s most seasoned attorneys to block a portion of HB 2008 from taking affect. Among its many provisions, HB 2008 repealed Senate Bill 1271, which made significant changes to Arizona’s anti-deficiency law related to trustee’s sales. Senate Bill 1271 became the law September 30, 2009 and impacted investors and second home owners of residential property on 2.5 acres or less. Before passage of Senate Bill 1271, lenders could not seek a deficiency judgment against owners of such property following a trustee’s sale. However, with the passage of Senate Bill 1271, an owner has the burden to prove it lived in the dwelling for at least 6 consecutive months and that a certificate of occupancy was issued for the residence. See prior blog posts on SB 1271 and its myriad of problems.
Banks pushed SB 1271 through the legislature in a hurried fashion and presented inaccurate information to Arizona’s legislators. In fact, virtually all assumptions and statements of existing law and practice containted in the legislative summary for SB 1271 were WRONG (the summary is circulated to legislators and their staff to assist in considering the merits of a bill). Of course, the errors created sympathy for the banks and their bill and it passed with ease. When the local real estate community and consumers figured out what had happened, they were outraged. The outrage was channeled into quick and effective lobbying of our legislators to repeal SB 1271 and its terribly drafted language and unfair ramifications to tens of thousands of Arizona homeowners.
As part of Senator Pierce’s drive to repeal his own bill, he expressed a willingness to raise the issues related to SB 1271 in the next legislative session. Apparently not satisfied with addressing this issue on an even playing field, with ACCURATE INFORMATION AND STATEMENTS OF THE LAW as a backdrop to discussions, banks have now decided that paying thousands to attorneys and suing our Governor is the most productive way to move the ball forward.
While the dust settles on the lawsuit filing, perhaps banks can explain a few things to their Arizona customers (and no doubt, to hundreds of thousands of similarly situated customers in the United States):
1. did banks play a role in the (unreasonable) run up of real estate prices and the current foreclosure crisis?
2. did banks and their agents benefit in making questionable loans based on shoddy underwriting and overly optimistic appraisals — were they paid fees, points, commissions?
3. are banks being transparent with their customers in addressing loan workouts — modifications, short sales, deeds in lieu of foreclosure (remember, banks demand full disclosure of a borrower’s financial information to consider a workout — do the banks open their books to ANYONE including our Fed. Gov’t)?
4. are banks approving workouts of distressed loans/properties where it makes sense to both the bank AND THE BORROWER, or only when it is in the bank’s best interest to do so considering all of the behind the scenes deals at play that the borrrower has no idea are impacting its workout request (such as stimulus money, Gov’t guarantees or insurance of losses, private mortgage insurance, etc)?
5. are banks willing to sacrifice their bottom lines NOW, to assist its borrowers avoid financial ruin (remember banks, today’s foreclosure victims and bankruptcy filers won’t be your customers tomorrow — they won’t have any money).
It is anyone’s guess how this will play out in the Court or Arizona’s legislative process. One thing is for sure, the banks aren’t satisfied with playing within the established rules of Arizona anti-deficiency law. When times are tuffest, banks want to change the rules in their favor, on top of the billions they have already received from US taxpayers. Consumers are asking, where is my assistance, when will the banks work with me and do what makes sense? Unfortunately, unless our local and Federal governments stand up to the banks and their hired guns, consumers will continue to take it in the shorts and ask, where do we look for assistance?
Marc McCain, Esq.
McCain & Bursh, PLC, Attorneys at Law
(602) 604-2138
BANKS NOT GIVING UP JUST YET ON AZ’S ANTI-DEFICIENCY LAWS
Investors and second home owners in Arizona should NOT rest easy on the heels of the legislature’s recent repeal of Senate Bill 1271. Recognizing bad law (SB 1271) and bad policy behind it, not to mention the certain backlash from consumers, one might have thought banks would take their defeat in stride and use their resources to work with borrowers to reduce Arizona’s unprecedented foreclosure rate. Unfortunately, the banking industry does not know how to take it lying down. Accordingly to Tom Farley, CEO of the AAR, local banking associations have rounded up a team of overpriced lawyers and have threatened to file a lawsuit challenging the repeal of Senate Bill 1271 unless they get their way with legislation that would change Arizona’s anti-deficiency statute(s) and the protections they bring to Arizona homeowners following a foreclosure or short sale.
My suggestion to Arizona’s homeowners, realtors and lawmakers: don’t let the banks push bad law and bad policy down your throat without taking them to task. Write your legislators – go to www.azleg.gov and make your voice known. Write your local bank president and tell them where your dollars will go if they move forward with their fight on this issue. Ask them if they received TARP or other subsidies on certain loans. Ask them if they are modifying bad loans or approving sensible short sale transactions. Ask them if they played any role in the current real estate mess in Arizona? Did they make money off risky loans based on shoddy underwriting standards? Ask them what they are doing to get this economy moving again – are they lending based on sound standards, will they lend more if they get their way with Senate Bill 1271?
Marc McCain, Esq.
McCain & Bursh, PLC
(602) 604-2138
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 NEW ANTI-DEFICIENCY RULES
On Friday, July 10, 2009, Governor Brewer signed into law a change to Arizona’s anti-deficiency law contained in the trustee’s sale statute – A.R.S. Section 33-814(G).
The following additional requirements must now be satisfied by the borrower in order to qualify for anti-deficiency treatment:
1. THE TRUSTOR (BORROWER) UNDER THE DEED OF TRUST MUST HAVE USED THE PROPERTY AS A DWELLING FOR AT LEAST SIX (6) CONSECUTIVE MONTHS; AND
2. A CERTIFICATE OF OCCUPANCY (“C of O”) MUST HAVE BEEN ISSUED FOR THE PROPERTY.
In addition, the statute provides that the Trustor (Borrower) is responsible for proving that the property was used as a dwelling for the required six (6) consecutive months.
The second new requirement (a C of O must be issued) would not seem to change the application of the anti-deficiency statute to most borrowers. However, in some cities C of O’s are not issued for homes that do in fact comply with building codes. For instance, historic residences in the City of Phoenix were built before C of O’s were issued. Moreover, some cities don’t even issue C of O’s for residences. According to Trevor Howell, Permits Supervisor at the City of Mesa, Mesa does NOT issue C of O’s for residences as a standard practice. Did the legislature mean to exclude all historic homes and virtually all homes located in the City of Mesa from anti-deficiency treatment? I would think not, yet based on a strict reading of the new statute, that is exactly what our legislature did! As a result, the C of O requirement may result in thousands of homeowners being subject to a deficiency judgment notwithstanding that they occupy their home. Thus, it would be wise to check with the applicable governmental entity with jurisdiction over your property to confirm a C of O was in fact issued (such as your City building, zoning or development services department).
If a C of O was not issued on a home, the borrower could face a deficiency action by its lender following a foreclosure. If a lender attempted to seek a deficiency because a C of O was not issued, but if the home was in fact completed, I recommend gathering as much evidence as possible to establish that plans for the home were permitted, the constructed improvements were inspected and approved, and that the home and all systems were completed and in use (e.g. water, electric, etc.). Assuming the borrower can demonstrate the foregoing, I would argue that the intent of the new requirement is satisfied. Of course, the court hearing the deficiency action would have to agree with this line of reasoning.
The first new requirement in the statute (that the borrower used the trust property for at least six (6) consecutive months) may change the applicability of Arizona’s deed of trust anti-deficiency statute for many borrowers facing foreclosure. Although the statute reads only that the property must have been used as a dwelling, the legislative summary of the bill explains that the bill was intended to require a borrower to have lived in the dwelling for at least six (6) consecutive months. This means that for many investment properties, the anti-deficiency rule that formerly prevented a lender from seeking a deficiency or suing its borrower directly on the note will no longer apply (assuming a court interprets the new language consistent with the stated legislative intent) – the lender will be able to sue the borrower for the balance owed on its loan following a foreclosure if the borrower did not live in the property for at least six (6) consecutive months.
One issue that needs clarification is whether the six (6) month requirement means that the dwelling must have been a primary residence, or whether a second home used as a dwelling by the borrower for six (6) or more months would qualify under the new statute. For instance, what if a Phoenix resident has a second home in Flagstaff that it does not rent out, but uses as a vacation home or weekend getaway? Assume the home has been owned and used in this fashion by the borrower for more than six (6) consecutive months. Will this property get anti-deficiency treatment following a trustee’s sale assuming the other requiremens of the statute are satisfied?
In addition, some practitioners I am consulting with on the new law are taking the position that the law is not clear and that use as a dwelling could include a rental property that was not actually lived in by the trustor. While I agree that the legislature did not fully understand the current state of AZ anti-deficiency law, I find this argument a stretch given a plain reading of the statute and coupled with the legislature’s stated intent. I certainly expect lenders to take the position that the trustor/borrower had to live in the property.
Other questions include whether the law will be applied to all loans that were originated before the September 30, 2009 effective date, or just to foreclosures on loans that originated after the effective date of the new law.
Of course, whether a lender decides to seek a deficiency will depend on many factors. In many cases, a lender may forego its right to seek a deficiency and simply cancel the balance of its debt following a foreclosure. However, the cancelled debt may no longer qualify for an exception under the tax code to the recognition of cancelled debt income. Any potential foreclosure or short sale should also be analyzed from a tax perspective so the borrower understands the tax consequences before proceeding with the foreclosure or short sale.
If you need to consult with me based on the change in the law, please call or email me as soon as possible to schedule an appointment so you understand your rights and obligations in connection with any pending foreclosure or short sale. Note that the particular facts of your situation will determine whether a lender can seek a deficiency.
Marc McCain
McCain & Bursh, PLC, Attorneys at Law
mmccain@mblawaz.com
(602) 604-2138