Recovery on
Secured Lien Positions in Real Estate:
Dear Attorneys, Please Tell Your Lender
Clients to Beware!
To seek a recovery
the lender may only look to the judgment debtors, who may or may not be
collectible and may have the option of filing for bankruptcy protection to limit
their exposure to the deficiency
When it comes to litigating defaulting loans,
transactions secured by real property pose a wide array of complexities
regarding valuation of the underlying real property. Lenders are well aware of
the already depressed and rapidly declining real estate market. Yet, these
lenders bank on the hope that they can recover the maximum value of the
indebtedness owed to them upon foreclosure of the underlying real property, and
that they can seek recourse against borrower(s) and/or guarantor(s) for a
deficiency on their loans where applicable.
The Key to Recovery on a Secured Lien
Position Is Understanding the Foreclosure Process
As attorneys may know, under Arizona law a lender
can foreclose on real property by two methods:
-
The lender can foreclose through a power of
sale under its deed of trust instrument securing the real property by
complying with the proper noticing procedures under Arizona law (the
“Non-judicial Foreclosure”).
-
The lender can file a complaint with the
Superior Court of Arizona, requesting that its lien position be judicially
foreclosed, and that the real property be sold at a sheriff’s sale (the
“Judicial Foreclosure”).
In its complaint for Judicial Foreclosure, a lender
also may seek to be awarded a judgment against the borrower(s) and/or
guarantor(s) for their claimed deficiency on their indebtedness if permitted by
applicable law. Typically, where there are no disputes regarding the validity
and/or priority of other liens against the real property, lenders prefer the
cheaper and more efficient method of the Non-judicial Foreclosure.
In both the Non-judicial Foreclosure and the
Judicial Foreclosure, the lender, in good faith, is permitted to credit bid on
the real property. Instead of paying cash like other purchasers, the lender can
bid some or all amounts loaned to the borrower as a “credit” against amounts due
the lender, a process commonly referred to as offering a “credit bid.” The
lender will typically start with a credit bid that is reasonable given, the
market value of the real property, and the lender’s ability to recover a
deficiency balance on its indebtedness against the borrower(s) and/or the
guarantor(s). The lender also can protect the recovery on its claim against the
real property by placing higher credit bids, up to the total amount of its
indebtedness, in the event that other real estate investors try to snatch the
subject property at a discount.
Credit Bid on the Property with
Caution to Avoid Unnecessary Litigation
However, under Arizona law, borrower(s) and/or
guarantor(s) are entitled to an offset against the indebtedness they owe to the
lender for either the sale price at the foreclosure sale, or the fair market
value of the real property on the date of the foreclosure sale, whichever is
higher. Accordingly, when the lender chooses to seek recourse against the
borrowers and/or guarantors for a deficiency in State Court, the borrowers
and/or guarantors may very well decide to request the Court for a fair market
value determination of the real property in the hope that the real property was
worth more than what it sold for at the foreclosure sale.
If successful, the borrowers and/or guarantors will
owe less than the deficiency balance as claimed by the lender. And therein
arises a slew of valuation fights between the lender and the borrower(s) and/or
guarantor(s), with the use of appraisals, brokers’ opinions of values, and other
documents, often including testimony and cross-examination of the appraisers and
brokers who issued them.
On more than one occasion, our attorneys have seen
lenders take a more aggressive approach to recovery by offering credit bids that
are often thirty to forty percent less than the lenders’ own fair market value
determinations. These lenders anticipate that they can pursue the borrower(s)
and/or guarantor(s) for the deficiency balance after the foreclosure of the real
property. The lenders then re-sell the real property and reap additional
recovery, often obtaining a double-recovery. Hence, there exists a thin line
between good-faith bids by lenders and the real fair market value of the subject
property. Luckily, knowledgeable borrower(s) and/or guarantor(s) can protect
themselves against the deficiency by requesting a fair market value
determination of the subject property as mentioned above.
Understand That, When Judicially
Foreclosing, Judgment Debtors Can Redeem the Property
In a Judicial Foreclosure action, a judgment
debtor, or his/her/its assignee, has an exclusive six-month statutory right to
redeem real property from the successful bidder who bought the real property at
the foreclosure sale by paying the sale price, plus interest thereon at eight
percent per annum, and any outstanding property taxes and assessments. However,
the judgment debtor or his/her/its assignee cannot exercise the statutory right
to redeem the real property if the judgment debtor chooses to request a fair
market value determination and limit his/her/its exposure to liability for a
deficiency.
Assignee Redemptioners Take the
Property Free of Foreclosing Creditor’s Deficiency Claim
The purpose of this article is not to elaborate or
advise on legal processes and concepts that have been discussed a hundred times
in law magazines and periodicals. Rather, it is to warn lenders about one
particular consequence to taking the aggressive approach in deeply discounting
their credit bids at Judicial Foreclosure sales and thereby acquiring real
property in anticipation of a double recovery.
The Supreme Court of Arizona has held that, where
an assignee of a judgment debtor redeems real property that was judicially
foreclosed, the assignee redemptioner takes the property free and clear of any
deficiency remaining on the foreclosing judgment creditor’s claim. Kries v.
Allen Carpet, Inc., 146 Ariz. 348, 351-52, 706 P. 2d 360, 363-64 (1985). In
Kries, Allen Carpet (“Allen”) obtained a deficiency judgment against
Raymond and Susan Kleinfeld for an amount of $5,705 after it executed on its
collateral real property that it purchased at foreclosure sale for $550.00. Id.
Subsequently, the Kleinfelds sold their redemption right to Utah Valley
Properties, Inc. (the “Company”), which then redeemed the real property and
conveyed it to Linda Kries (“Kries”). Id. Allen then executed on the real
property again, this time for an amount of $5,542.85. In response, Kries sued
Allen to quiet title to the real property in her sole name. Id.
On appeal, the Supreme Court of Arizona reversed
the decision by the Arizona Court of Appeals in favor of Allen’s second
execution, explaining that “[i]f the redemptioner is the judgment debtor, then
... the creditor may execute on the property again. ... [I]f the redemptioner is
an assignee of the judgment debtor, then the property is taken free of any
claims the judgment creditor may have against the judgment debtor.” Id.
(emphasis added). The Kries court reasoned that “a deficiency judgment
represents a judgment debtor’s personal obligation.” Id. (internal citations
omitted).
In reasoning its decision, the Court specifically
cited to the following quotes from other cases with similar facts:
A deficiency judgment represents a judgment
debtor’s personal obligation.
[B]y bidding in the property at less than fair
cash value, in the hope that the mortgagor might redeem, and so afford [the
judgment creditor] an opportunity to levy on the property to satisfy the
deficiency judgment, [the judgment creditor] followed the course of [its]
own choosing.
If the execution creditor fail[s] to bid for
the land sold a just amount, the debtor should be permitted to transfer his
interests to another for fair consideration; and, if his grantee redeem[s],
the execution creditor has no right to complain, for he might have bid for
the land a larger sum.
Id. (internal citations and quotations omitted).
You Only Get What You Ask for When an
Assignee Redemptioner Redeems the Property
The underlying point is that the lender may not be
able to have its cake by judicially foreclosing on real property at a severe
discount in the hope it can reap a double recovery, and eat its cake by
asserting that a lien still exists against the real property when an assignee of
a judgment debtor’s redemption right in fact redeems for the lender’s discounted
purchase price.
Apparently, real estate investors do have a back
door here. Consequently, the lender may lose the real property to the assignee
for the discounted purchase price (plus additional sums as noted), and the
potential to recover any profit from the real property.
In the end, to seek a recovery the lender may only
look to the judgment debtors, who may or may not be collectible and may have the
option of filing for bankruptcy protection to limit their exposure to the
deficiency.
Attorneys, please advise your lender clients to
beware of this particular set of facts if they are not already!
This article was published in the March 2010 issue
of Attorney at Law magazine. |
