Deficiency Liability after Foreclosure
by Valerie Marciano
Residential Owners can be Liable for a Deficiency
Following a Foreclosure or Trustee Sale
While the global economy is waiting for the recession to abate
and real estate values to find their bottom, many Lenders are
deciding whether, and to what extent, to look for deficiency
payment from their borrowers after they foreclose on the borrowers'
residential property. The term "anti-deficiency" has been tossed
around in financial news for months as the recession has been
endlessly reported on and even the non-financial community is
becoming familiar with the term. Also, Lenders are realizing that
the road to full or even partial recovery of their loans is rocky
and uncertain, and not just because the borrowers do not have the
money to repay the loans.
One of the rockiest of roads the Lender must navigate is the one
that leads to the residence itself. Arizona's "anti-deficiency"
statute operates to prohibit the Lender from recovering against the
borrower's assets, such as bank accounts, after the Lender
forecloses on the residence. Technically, when a residence is
pledged as collateral for the loan and the residence is located on
2 ½ acres or less, Arizona's "anti-deficiency" law could apply.
Essentially, if the Arizona's "anti-deficiency" law applies, the
residence may be foreclosed on by the Lender. However, the
borrower's other assets, again, the borrower's bank accounts,
cannot be used to satisfy the debt, or in other words, the
deficiency remaining between the foreclosure sale proceeds and the
outstanding loan amount.
- The residence must be limited to a single or two family
dwelling, and "utilized" for dwelling purposes.
- To be classified as a "dwelling", the property must be "wholly
or partially occupied by persons lodging there at night or intended
for such use."
- Property is not "utilized" as a dwelling when it is unfinished,
has never been lived in, and is being held for sale to its first
occupant by the owner who does not intend to live in the residence,
or in other words, some of the newly constructed homes still owned
by the developer.
If the residence is still under construction, or is not complete
at the time of the trustee sale or foreclosure, it is likely that
the Lender will be entitled to satisfy the debt and any resulting
deficiency out of other assets of the borrower. However, if the
residence is completed, and even if it is held for investment and
used occasionally (see the description defined in the above
paragraph) by the borrowers when it is not rented out to others,
the Lender may be limited to the foreclosure of the residence and
will not be able to look for other assets of the borrower such as
bank accounts to satisfy the debt and any deficiency.
Prudent Lenders should begin evaluating the percentage of
construction completion of the residence in deciding when to
foreclose on the residence, if the Lenders expect to recover
against other assets of the borrower. On the other hand, the
borrower may find a way to complete the residence, move in (at
least temporarily) or find tenants if the borrower then cannot pay
the mortgage and allows the residence to be foreclosed. In such
event the borrowers may avoid risking the borrower's other assets
for repayment of the debt and any deficiency. For Lenders, it is
essential that they monitor their loan collateral closely.
About the author:
Valerie Marciano is a partner at the Phoenix law firm of Jaburg
Wilk. She practices in the areas of real estate litigation,
creditor's rights, and bankruptcy litigation. Val has assisted
various lenders with workouts of distressed real estate assets and
foreclosures, and subsequent deficiency actions.