Deficiency Actions, by Michael T. Denious, Arizona attorney
In an earlier article we discussed the potential effect of the “anti-deficiency” statutes, which apply under certain circumstances to loans secured by residential dwellings consisting of a single or dual-family structure, on a lot consisting of 2.5 acres or less.
In the context of commercial properties, unimproved land, or residential properties with three units or more, those anti-deficiency statutes will not be of any help. In such cases, a borrower whose property has been foreclosed must be prepared for the deficiency action, in which the lender will seek to collect the remaining amounts owed, over and above what was recovered via the trustee’s sale or sheriff’s sale. In many cases, loans involving commercial properties or vacant land may include guarantors along with borrowers, all of whom will be liable for the deficiency.
Typically, the method of foreclosure will be via a trustee’s sale, which does not require the filing of a lawsuit. The deficiency action is a lawsuit, however, and must be filed by the lender / beneficiary not later than 90 days following the trustee’s sale. Where more than one trustee’s sale is conducted (as where more than one deed of trust exists as security for the loan), the 90 days runs from the date of the last sale. If this time period passes without the deficiency action being filed, under Arizona statute the proceeds obtained from the trustee’s sale, regardless of amount, are deemed to be “in full satisfaction of the obligation and no right to recover a deficiency in any action shall exist.” A.R.S. § 33-814(D). There are no exceptions to this deadline.
Assuming a deficiency action is brought within the 90-day period following the trustee’s sale, what does the lender have the right to recover? The difference between the amount recovered at the trustee’s sale and the balance of the loan? No. In 1990, following the last major real estate recession in Arizona, our state legislature imposed additional protections for the benefit of debtors from excessive deficiency judgments resulting from the forced sales of encumbered properties. See A.R.S. sections 12-1566, 33-725, 33-727 and 33-814(A); see generally Wells Fargo Credit Corp. v. Tolliver, 183 Ariz. 343, 345, 903 P.2d 1101, 1103 (App. 1995). One of these protections is the provision under A.R.S. 33-814(A), which governs a deficiency action following a trustee’s sale. Under that statute, the deficiency claim is limited to the difference between the total amount owed, less the greater of (a) the sale price of the trustee’s sale, OR (b) the fair market value of the property on the date of the trustee’s sale. Id.; see also A.R.S. § 12-1566(C).
As anyone familiar with the trustee’s sale process will agree, a trustee’s sale is not an example of a commercially reasonable sale. It is not advertised on the MLS; it does not involve fliers, open-houses, or even a showing to potential buyers. It involves no disclosure to potential buyers regarding the physical or environmental condition of the property (or the status of leases or income in the case of commercial properties). It also requires an up-front deposit of $10,000 by any bidder, along with the requirement that the prevailing bid price be paid in full by 5:00 p.m. on the next business day. Therefore, the sale price of most any trustee’s sale will be (and understandably should be) substantially below the fair market value of the property.
The provisions of A.R.S. § 33-814(A), reflecting these concerns, gives specific guidance on its definition of fair market value:
“Fair market value” shall mean the most probable price, as of the date of the execution, sale, in cash, or in terms equivalent to cash, or in other precisely revealed terms, after deduction of prior liens and encumbrances with interest to the date of sale, for which the real property or interest therein would sell after reasonable exposure in the market under conditions requisite to fair sale, with the buyer and seller each acting prudently, knowledgeably and for self-interest, and assuming that neither is under duress.
Id. (underlines added). Therefore, if the balance of a loan on a commercial property is $1,000,000.00, and the fair market value is $800,000.00, the borrower or guarantor can limit the amount of the deficiency to $200,000.00; even if the property sold at the trustee’s sale for only $400,000.00 (which otherwise would have resulted in a deficiency claim of $600,000.00).
Assuming a borrower (or guarantor, who also has the right to assert this provision) believes the fair market value of the property was higher than the price it sold for, he or she should, and has the right to, apply to the court for a determination of the fair market value of the property as of the sale date. Where the property was sold at a trustee’s sale, the borrower or guarantor may submit the application in the deficiency action, at which point the court is required to schedule a “priority hearing” to determine the fair market value, and hear whatever evidence the court may allow. The borrower or guarantor should be prepared to call a qualified appraiser to appraise the property and testify at the hearing, along with (subject to the court’s allowance) a real estate agent familiar with the relevant market.
Of course, under present market conditions the value of the property in question may be less than the total loan amount; nevertheless, it may also be substantially higher than the sale price at the trustee’s sale, and a borrower or guarantor should take every opportunity to mitigate, and potentially minimize, the amount of the deficiency the lender might otherwise be able to pursue. In addition, in cases where it appears that the fair market value of the property may be substantially higher than the price a trustee’s sale might obtain, a borrower or guarantor may be able to use this information in advance of a foreclosure to better negotiate a loan workout or settlement, such as a short sale or deed in lieu of foreclosure.
 This article focuses on deficiency actions following trustee’s sales – however, deficiency actions may also be brought following a judicial foreclosure, which are governed by A.R.S. § 12-1566, and are subject to the same “fair market value” standard as discussed herein. In cases involving a judicial foreclosure (which is a lawsuit seeking judgment on the loan and following such judgment a sale of the property), the borrower must make the application for determination of the fair market value of the property within 30 days following the sale of the property. A.R.S. § 12-1566(C).