Trustee’s Sales and Deficiencies

With the passage and subsequent repeal of legislation that would dramatically impact Arizona’s anti-deficiency statutes, it is clear now more than ever that every owner of real property that is considering or facing a foreclosure should consult with an attorney regarding the real risks inherent with such a process. In light of the struggling real estate market in Arizona and the resultant rise in foreclosures, property owners must pay special attention to the potential for a deficiency judgment.

Arizona is, by and large, a deed of trust state. That is to say, most lenders’ interest in property is secured by a recorded deed of trust and a separate promissory note. The vast majority of “foreclosures” in Arizona occur through non-judicial foreclosures or trustee’s sales.

This article will examine the interplay between these non-judicial foreclosures and Arizona’s deficiency statutes with particular attention to proposed amendments to these statutes that would have had a profound impact on owners of real property.

What Is A Trustee’s Sale?

A trustee under a deed of trust is vested with statutory authority to conduct a non-judicial foreclosure sale in the event of a breach of the duties that a trustor or borrower owes under the deed of trust. See A.R.S. § 33-807. This is most commonly seen in a failure to make payments towards the amount owed. For example, after a borrower fails to make payments of his loan, which is secured by a deed of trust, the lender (beneficiary) initiates the trustee’s sale process through which the trustee conducts the forced sale of the property to obtain payment for the debt.

The first step in this process is the recording of a notice of trustee’s sale. That notice is also required to be posted on the property (if feasible), published, mailed to anyone appearing to have an interest in the property and, if the property is a single-family residential property, to the property address. See A.R.S. §§ 33-808, 33-809.

A trustee’s sale cannot take place before the ninety-first day after the notice of trustee’s sale is recorded. See A.R.S. § 33-807(D).

At the sale, the property is sold to the highest bidder via a public auction for cash. See A.R.S. § 33-810(A). The proceeds of the sale are applied: first, to the costs and expenses of the sale; second, to the payment of the note secured by the deed of trust; third, to the payment of other obligations secured by the deed of trust and paid by the beneficiary prior to the sale; fourth, to a homeowner association or condominium assessment lien; and, fifth, to junior lienholders. If any proceeds are left, a notice is to be sent to the trustor. See A.R.S. § 33-812.

Alternatively, the trustee can deposit the funds with the county treasurer and institute a civil action which will determine who gets what funds from the sale. See A.R.S. § 33-812.

What Is A Deficiency?

A deficiency is any amount that the beneficiary or lender is unable to recover through the trustee’s sale. A deficiency judgment may, in certain circumstances, be obtained by a lender to cover the shortfall in the amount of money it is able to recover through a foreclosure sale. To illustrate, if a person purchases a piece of property and obtains a loan for $400,000.00 in 2005 and then defaults on the loan leading to a foreclosure sale at which the purchase price is only $300,000.00, the lender may be able to obtain a judgment for the $100,000.00 difference or deficiency.

When Can A Deficiency Judgment Be Obtained?

Deficiency judgments are the rule, not the exception. Subject to only two statutory exceptions, deficiency judgments can be obtained by lenders. See A.R.S. § 33-814(A). Fortunately, those exceptions cover a large portion of residential real estate.

The first exception is if the deed of trust specifically prohibits the recovery of a deficiency. See A.R.S. § 33-814(F). Because beneficiaries or lenders draft the trust documents, this exception is rarely seen.

The second exception is for “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” and that property is sold at a trustee’s sale. See A.R.S. § 33-814(G). This exception acts to prevent the lion’s share of residential property sold at a trustee’s sale from being subject to a deficiency judgment.

Let’s breakdown the specific elements in detail:

1. The property must be two and one half acres or less;

2. The property must be limited to and utilized for a single one-family or single two-family dwelling (think duplex); and,

3. It must be sold at a trustee’s sale.

If one of these elements is absent, this exception does not apply. To illustrate, if the property is three acres, single one-family dwelling and was sold at a trustee’s sale with a deficiency, the exception does not apply.

If the property is one half acre of vacant land and sold at a trustee’s sale with a deficiency, the exception does not apply. The property was not utilized for a single one-family or single two-family dwelling because it is raw land.

If the property is one acre and used for a single four-family dwelling (fourplex) and sold at a trustee’s sale with a deficiency, the exception does not apply.

In considering the ramifications of a foreclosure or trustee’s sale, it is critical for a property owner to obtain the advice of legal counsel to analyze the potential ramifications of that sale. Often, property owners will assume that after a trustee’s sale, they will have no further liability for a debt. That is not always true. Not only are Arizona’s anti-deficiency statutes limited with respect to trustee’s sales, if a debt is not “purchase money” (if a loan was not used to purchase property, for example a home equity line of credit), the lender may choose to proceed with a judicial foreclosure or to sue on the note in order to obtain a deficiency judgment that may not be available if it proceeded with a trustee’s sale.

With the difficult real estate market that we have endured for the past three years, more and more property owners are facing potential deficiency judgments as land values decline.

Recent Developments In Arizona’s Anti-Deficiency Exceptions.

Most investors are aware that during this past legislative session a bill was passed and signed by the governor that would have dramatically impacted the anti-deficiency exception discussed above for certain types of residential properties (Arizona SB 1272). The changes disproportionately impacted investors by largely removing the exception with respect to them. Although that bill and its new language was effectively repealed by a later bill (Arizona HB 2008), the prior legislation is instructive in that it shows the legislature’s tendencies on these issues and the ever-changing nature of anti-deficiency exceptions.

Arizona SB 1272 changed the anti-deficiency statute language in A.R.S. § 33-814(G) to apply only if the property is “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 by the trustor under the deed of trust for at least six consecutive months and for which a certificate of occupancy has been issued”. (Emphasis added). Further, “[t]he trustor is responsible for demonstrating that the trust property was used by the trustor as a one-family or a single two-family dwelling for at least six consecutive months.” See A.R.S. § 33-814(G).

Let’s look at what changed:

1. The trustor must have used the property as a single one-family or single two-family dwelling for the anti-deficiency exception to apply. This generally means that if the trustor (i.e. borrower) was an investor and did not live in the property, the anti-deficiency exception would likely not apply.

2. Further, the trustor must have used the property for at least six consecutive months. In other words, the trustor must have been using the property for a considerable amount of time and could not, for example, move in after the notice of trustee’s sale for a limited period of time to obtain anti-deficiency protection as an owner-occupant.

3. A certificate of occupancy must have been issued. Some areas of Arizona and some older homes do not have certificates of occupancy. This requirement would have obliterated the anti-deficiency protections for those areas. This requirement would also place an additional burden on the trustor. The apparent intent of the requirement was to limit the application of the anti-deficiency statutes with respect to new builds.

4. The burden of proving that the trustor used the property for at least six consecutive months is on the trustor. This would mean that an action to obtain a deficiency judgment could be brought in every case, except for those in which the deed of trust prohibits it, and the trustor would have to prove that the anti-deficiency statute applied. Arizona courts would be overwhelmed with litigation and many property owners would be subjected to unnecessary and vexatious litigation with consequences if they are either unaware of their defenses, cannot prove that the anti-deficiency statute applies to them, or simply fail to answer. In other words, property owners that were protected by the anti-deficiency statutes could possibly get deficiency judgments entered against them.

There are no guarantees that this anti-deficiency issue will not be re-addressed in the future. For now, the original anti-deficiency laws are back on the books and can provide protection to owners who qualify.  But, investors and, in fact, every property owner should be concerned about the potential risks and ramifications with deficiency judgments and trustee’s sales.

This article is not intended to be specific legal advice. It only provides general legal information. You should consult an Arizona licensed attorney if you have a legal issue. The attorneys at The Lynch Law Firm, L.L.C. are experienced in this area of law and are available for consultation. You may contact our Scottsdale office at 602-274-6369.