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From Banking and Finance Law Daily, January 5, 2015

Advance waiver by debtors, guarantors of rights in deficiency recovery unenforceable

By Thomas G. Wolfe, J.D.

In connection with a creditor’s action to recover a deficiency judgment after a sale or foreclosure on property under trust deed, the Supreme Court of Arizona has ruled that a prospective waiver by a debtor or guarantor of the statutory right to have the fair-market value of the property credited against the amount owed on the promissory note is unenforceable. In reaching its decision, the Arizona high court determined that the state’s public policy of preventing artificial deficiencies and protecting borrowers, underpinning the particular Arizona statutory provision, clearly outweighed a creditor’s interest in enforcing the terms of a prospective waiver contained in mortgage loan documentation (CSA 13-101 Loop, LLC v. Loop 101, LLC, December 31, 2014, Bales, S.).

While ruling against a routine prospective waiver of the rights afforded a debtor or guarantor under Arizona law concerning an action for a deficiency recovery in the trust-deed context (Arizona Revised Statutes §33-814), the court clarified that its ruling “does not preclude a borrower from agreeing, after a non-judicial foreclosure commences, not to seek a fair market value determination.” A party may still forgo enforcing its rights in litigation.

Background. In February 2007, a commercial entity, Loop 101, LLC (Loop) borrowed $15.6 million from MidFirst Bank to construct an office building. As part of that construction loan, a promissory note was secured by a deed of trust, and payment was guaranteed by four individuals. Notably, under the loan documentation—including the promissory note, deed of trust, and guarantee—Loop, as the borrower, and the four guarantors all expressly waived their statutory fair-market-value offset rights under Arizona law in an action by the creditor to recover a deficiency judgment.

In June 2009, Loop defaulted on the construction loan, and MidFirst initiated a non-judicial foreclosure under the deed of trust. According to the court’s opinion, nearly $11.2 million remained outstanding on the construction loan. Eventually, the bank assigned its rights under the loan and deed of trust to CSA 13-101 Loop, LLC (CSA). Accordingly, CSA purchased the pertinent property at a trustee’s sale for a “credit bid” of $6.15 million.

Procedural context. After acquiring the property, CSA filed an action in Arizona state court against Loop and the guarantors to recover a deficiency judgment of approximately $5 million plus interest. In response, Loop and the guarantors raised a counterclaim against CSA, and filed a third-party claim against MidFirst Bank for breach of the implied covenant of good faith and fair dealing.

In turn, CSA and MidFirst Bank asked the state trial court to dismiss the counterclaim and third-party claim on the ground that Loop and the guarantors had waived their right under Arizona law (A.R.S. §33-814(A)) to a fair-market-value determination. Ruling that Loop and the guarantors could not waive this statutory right, the court denied CSA’s and the bank’s request.

In addition, the state trial court held an evidentiary hearing and found the fair market value of the property to be $12.5 million. Ultimately, the trial court ruled that no deficiency existed because the property’s fair market value exceeded the amount owed on the promissory note. After the Arizona appellate court affirmed that decision, CSA appealed to the Arizona Supreme Court. The Arizona Bankers Association contributed to the appeal as amicus curiae.

Arizona statute, principles. The Arizona Supreme Court examined the Arizona statutory provision governing deficiency recovery actions against parties liable on debts secured by deeds of trust. Among other things, the provision (A.R.S. §33-814(A)) provides: “In any such action against such a person, the deficiency judgment shall be for an amount equal to the sum of the total amount owed the beneficiary as of the date of the sale, as determined by the court less the fair market value of the trust property on the date of the sale as determined by the court or the sale price at the trustee’s sale, whichever is higher.”

The court noted that the “fair market value” provision “applies equally to guarantors and borrowers…Moreover, the statute does not draw distinctions based on the resources or sophistication of the parties, nor does it distinguish between commercial and residential transactions.”

In surveying Arizona law, the court stressed that the deed-of-trust framework in general, and the “fair market value” provision in particular, reflected Arizona’s “long-recognized public policy” of protecting debtors and the general public “by protecting against artificially increased deficiency judgments.”

Court’s ruling. In deciding that the public policy of preventing artificial deficiencies and protecting borrowers outweighed a creditor’s interest in enforcing the waiver provisions in the case before it, the Arizona Supreme Court held that “consistent with the statute’s purpose and the overall statutory scheme, we hold that A.R.S. §33-814(A)’s fair market value provision cannot be prospectively waived.”

In support of its decision, the court determined: (i) CSA elected to foreclose and seek recovery under Arizona’s deed-of-trust scheme, rather than electing to sue on the note alone for the entire outstanding debt; (ii) although the Arizona statutory provision (A.R.S. §33-814) is silent on the issue of advance waiver, that omission should not be construed, as CSA would have it, as indicating the Arizona legislature’s implied endorsement of it; (iii) Section 8.4 of the Restatement (Third) of Property and its accompanying commentary seek to ensure that the “primary goal of preventing unjust enrichment of the mortgagee is not subverted by the routine exaction of waivers from guarantors and sureties”; (iv) while some other state jurisdictions have ruled differently, the applicable Arizona statute is distinguishable; and (v) unlike Texas, whose Supreme Court requires that its legislature “speak clearly” to prohibit these type of waivers, Arizona “can instead find that a statute impliedly prohibits it as a matter of public policy.”

The case is No. CV-14-0029-PR.

Attorneys: Sean K. McElenney, J. Alex Grimsley, and Gregory B. Iannelli (Bryan Cave LLP) for CSA 13-101 Loop, LLC. Timothy Berg, Carrie Pixler Ryerson, and Kevin M. Green (Fennemore Craig, P.C.) for Loop 101, LLC, Paul Anton, Valerie Christie, Oscar Swanky, and Helen Swanky. Scott B. Cohen and Bradley D. Pack (Engelman Berger, P.C.) for amicus curiae Arizona Bankers Association.

Companies: Arizona Bankers Association; CSA 13-101 Loop, LLC; Loop 101, LLC; MidFirst Bank

MainStory: TopStory ArizonaNews Loans Mortgages StateBankingLaws

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