Tuesday, April 24, 2012

Recent Decision by Arizona Court of Appeals Impacts Anti-Deficiency Statute

Arizona's anti-deficiency statute provides that, for certain types of qualifying residential loans, a borrower's liability - and a lender's corresponding claim - is limited to the value of the real property that secures the loan.  The breadth and scope of the statute, which was enacted in 1971, have been the subject of many judicial decisions.  The Arizona Court of Appeals recently decided three important issues under the anti-deficiency statute.  In Helvetica Servicing, Inc. v. Pasquan, the court held that (i) a borrower who refinances a purchase money loan that is afforded anti-deficiency protection does not lose that protection to the extent that the refinance proceeds are paid to satisfy the original purchase money obligation, regardless of whether the refinancing involves a different lender and a different deed of trust than did the original loan; (ii) a borrower who uses loan proceeds to construct a qualifying residence may receive anti-deficiency protection under certain circumstances; and (iii) a lender who disburses sums in a loan transaction for non-purchase money purposes may trace, segregate, and recover these sums in a deficiency action.  

In Helvetica Servicing, the borrower obtained a $600,000 loan, secured by a deed of trust, to purchase real property.  The borrower thereafter received from a different lender a refinance loan and a construction loan to build a residence for a combined $2.1 million; these loans were secured by new deeds of trust on the same property.  Approximately three years later, the borrower obtained the loan that eventually became the subject of the litigation.  The proceeds of that third loan were disbursed as follows: (i) $2.2 million paid off the loans secured by the existing first and second deeds of trust; (ii) $398,000 repaid unsecured loans and credit cards that were purportedly used to finance construction of the residence; (iii) $491,000 paid off alleged "closing costs," "points/interest," and "interest/reserves;" and (iv) $358,000 was paid directly to the borrower.  After the borrower defaulted on this third loan, the lender commenced a judicial foreclosure action, in which the lender eventually acquired the property for a credit bid.  The court later concluded that the fair market value of the property was $2.3 million.  The lender then argued that it was entitled to a deficiency judgment based on full amount of the loan, which was approximately $3.7 million.  The borrower disagreed, contending that the entire loan was subject to anti-deficiency protection.  The trial court sided with the lender.  The borrower appealed.

Refinance Loans 
The borrower argued that the third loan remained a purchase money obligation.  The lender maintained that by refinancing a purchase money loan in the manner that the borrower did, the borrower "destroy[ed] the purchase money status, and forfeit[ed] anti-deficiency protection."  The lender's principal argument was that the loan was no longer entitled to anti-deficiency protection because the original deed of trust had been replaced by new deeds of trust and the subsequent lenders were different than the lender for the original loan used to purchase the property.  

The Court of Appeals agreed with the borrower, holding that the anti-deficiency statute was intended by the legislature to "place the risk of inadequate security on the lenders rather than borrowers" and "to 'protect consumers from financial ruin' and 'eliminate ... hardships resulting to consumers who, when purchasing a home, fail to realize the extent to which they are subjecting assets besides the home to the legal process."   Invoking this intent and relying on a 1997 case that held that anti-deficiency protection is not lost when the borrower enters a refinancing with the same lender under the same deed of trust, Helvitica held that the character of a purchase money obligation is not changed simply because it is refinanced by a new lender with a new deed of trust.  

Therefore, to the extent that refinance loan proceeds are used to satisfy a purchase money loan that qualifies for protection under Arizona's anti-deficiency statute, those proceeds will be afforded the same anti-deficiency protection. 
Construction Loans
Helvitica noted that "[n]o Arizona appellate decision had addressed whether ... 'construction loans' used to build a residence are purchase money obligations entitled to anti-deficiency protection."  The court looked to California case law for guidance, and observed that the terms "purchase" and "purchaser" in the California anti-deficiency statute have been interpreted broadly to include borrowers who obtain a construction loan to construct a residence.  Helvitica found the California "analysis and conclusion equally applicable to and consistent with Arizona's legislative scheme."  

Accordingly, a construction loan qualifies as a purchase money obligation if: (i) the deed of trust securing the loan covers the land and the dwelling constructed thereon; and (ii) the loan proceeds were in fact used to construct a residence that meets the size and use requirements set forth in the anti-deficiency statute.

Non-Purchase Money Funds 
The last issue that Helvitica addressedis what happens when a purchase money transaction includes non-purchase money loan funds.  The court identified three possible answers to the question, ranging from the two extremes (making the entire loan a recourse obligation vs. affording anti-deficiency protection to the entire amount) to the middle ground of permitting non-purchase money sums to be traced, segregated, and included in a deficiency.  Helvitica adopted the middle ground, and holds that allowing a lender to obtain a deficiency judgment for non-purchase money loan funds that can be segregated and traced as such is most consistent with the underlying goals of Arizona's anti-deficiency legislation. 

Thus, to the extent that a borrower's liability includes both purchase money and non-purchase money sums, a lender may pursue a deficiency judgment for the latter amounts, to the extent that they can be segregated and traced.
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Helvitica touched on but does not specifically address a number of related issues, including whether loan funds used to remodel a residence or add on to it qualify for anti-deficiency protection for the same reasons that construction loans do. 
Finally, it should be kept in mind that the lender in Helvitica brought a judicial foreclosure action.  If the lender had instead non-judicially foreclosed, it would not have been entitled to recover a deficiency regardless of whether the loan  was purchase money, if all of the other anti-deficiency requirements were met (as they were in Helvitica).  Thus, although Helvitica does not expressly make this point, it bears reminding that if a creditor believes its loan consists wholly or in part of non-purchase money funds and that all of the other anti-deficiency requirements do or may exist, then the safer course to recover such funds is to bring a judicial foreclosure action, rather than foreclosing non-judicially and subsequently bringing a deficiency action.
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