My Lender Has Initiated a Deficiency Lawsuit

Against Me – Now What?

By: Patrick MacQueen, Attorney, Mack Drucker & Watson P.L.C.

When discussing today’s distressed real estate market, many Arizonans focus on foreclosure, strategic default, and/or the short sale of residential real estate. Rightfully so, as these issues permeate the real estate landscape and affect everyone. What many Arizonans do not likely realize, however, is that although Arizona’s anti-deficiency statutes afford deficiency protection under specific circumstances, the statutes do not protect commercial borrowers or owners of raw land – thereby subjecting these borrowers to liability for the monetary deficiency that will exist following the trustee’s sale. Although a deficiency action by a lender may seem daunting, borrowers do have options.

Generally speaking, a deficiency lawsuit is an action initiated by a lender following a foreclosure in which the lender seeks to obtain a judgment holding the borrower liable for the monetary remainder of the loan. In asserting such an action, the lender seeks to recover the difference between the value of the secured real estate and the amount of the loan. For example, Borrower obtains a $350,000 loan secured by raw land. Borrower defaults, following which Lender initiates a trustee’s sale and obtains $150,000 for the land at auction. In such a case, following the trustee’s sale, Lender would likely assert an action for a deficiency judgment in the amount of $200,000.

Arizona’s anti-deficiency statutes and the case law interpreting the statutes are complicated. Despite this complexity, it is quite clear that neither Arizona statutes nor case law “protect" loans secured by commercial property (such as restaurants, office buildings, strip malls, or other businesses) or unimproved real property (i.e. raw land). In other words, a lender may seek to recoup its losses by asserting a deficiency action on a post-foreclosure basis in situations involving loans secured by commercial property or raw land. For various reasons, however, it is unlikely that the lender will be able to recoup its entire loss. Those reasons are explained below.

Although the lender may initiate a deficiency action against the borrower and seek a judgment for a sum certain does not mean the lender will prevail. For one, a deficiency lawsuit must be filed by the foreclosing lender within ninety (90) calendar days after the date of the Trustee’s Sale. See A.R.S. §33-814. This 90-day statutory deadline will therefore serve to time bar a foreclosing lender from filing a deficiency action if not commenced within ninety (90) days of the Trustee’s Sale. For instance, using the example above, if the hypothetical lender completes its Trustee’s Sale on May 1, 2011, but does not file its deficiency lawsuit until October 15, 2011, the lender’s action would be time barred by statute.

Similarly, just because our hypothetical lender above seeks a $200,000 deficiency, does not mean it is entitled to $200,000. Pursuant to Arizona law, Borrower is entitled to request an evidentiary hearing to determine the “fair market value" of the property as of the date of sale. See A.R.S. §33-814. More particularly, the deficiency amount is limited to the difference between the loan balance owed on the date of the foreclosure sale less the greater of the foreclosure sale price or the “fair market value" of the property on the date of the sale. In determining the value of the property on the date of the sale, the court may entertain, among other things, appraisals, pending purchase offers, the testimony of appraisers, the testimony of real estate agents, and/or the testimony of property owners. Id. In many instances, the borrower’s threat to request such an evidentiary hearing (or the request itself) provides a strong impetus for the lender to “settle for less" than demanded in the lawsuit.

Finally, the borrower’s current financial condition can provide an additional incentive for the lender to “settle for less" than the amount of the deficiency. More specifically, in settling deficiency lawsuits, lenders typically request personal and/or corporate balance sheets, prior tax returns, and/or recent bank account statements. A borrower’s poor financial status may signify to a lender that: (1) the borrower may seek to discharge the debt in bankruptcy; and (2) it will be difficult to collect any deficiency judgment that it may obtain. In such cases, lenders are often willing to “take something" as opposed to nothing, or having to chase a borrower that has little financial wherewithal to satisfy a judgment.

In sum, all is not lost when a commercial borrower or owner of raw land is sued for a deficiency. In fact, lenders may lose their right to pursue a borrower entirely by untimely asserting an action. In addition, there exist several mechanisms by which a borrower can seek to reduce their exposure to a lender on a post-foreclosure basis. [1]

[1] Of course, there are a number of other defenses a borrower could assert, but each would depend upon the facts of the particular case. Further, the content of this discussion is NOT intended to address every possible scenario and should not be used as a substitute for legal advice.