Before starting a trustees sale, the lender under a deed of trust should carefully consider numerous issues. This article will focus solely on lenders (also known as beneficiaries) who hold a deed of trust, rather than a mortgage or agreement for sale. As a general rule, the lenders remedies under a deed of trust will include all of those remedies available to a lender holding a mortgage, but also give the lender the option to perform a non-judicial private power of sale (better known as a trustees sale). The trustees sale method of foreclosure is not available with mortgages (which may only be foreclosed through the courts); however, the lender under a deed of trust may treat the deed of trust like a mortgage and then bring a judicial foreclosure.
Lender Strategy: Always use a deed of trust, never use a mortgage.
Since the Arizona legislature adopted the deed of trust statutes in 1971, the deed of trust has replaced the mortgage as the most common real property security instrument used in Arizona. There are two important advantages for a lender when using the trustees sale method rather than a judicial foreclosure: (1) the lender may foreclose without filing a lawsuit, which is almost always quicker and less expensive than a judicial foreclosure; and (2) if the lender acquires title at the trustees sale, the borrower has no right after the sale to redeem the property (whereas with a judicial foreclosure, the borrower has redemption rights after completion of the sale). If a judicial foreclosure is filed, the borrower then has the opportunity to file an answer to delay the foreclosure for months, even years. Even then, the property must be sold through a sheriff’s sale, with a six-month redemption right. On the other hand, the trustees sale may be completed approximately ninety days after the trustee records the notice of the sale and there are only three events which will stop or delay a trustees sale: (i) the borrower or a junior lienholder reinstates the lien by paying the past-due balance; (ii) the borrower obtains an injunction in court; or (iii) the borrower files bankruptcy.
Reinstatement and Acceleration
Pursuant to Arizona law, a borrower has the right to reinstate a loan during the trustees sale (by curing the default). Even if the lender purports to accelerate the balance of the note, the borrower still has the right to reinstate up until the last business day before the trustees sale. But if the lender files a judicial foreclosure, the acceleration is effective. This is really the sole advantage of a judicial foreclosure. Obviously, if the loan has ballooned on its own terms, then there are no reinstatement rights short of paying off the entire balance of the note.
Lender Strategy: Use a judicial foreclosure only if there is a compelling reason to accelerate the debt.
Pursuing a Deficiency Lawsuit After a Trustee’s Sale
If the proceeds of the trustees sale of the property secured by the deed of trust are insufficient to pay the full loan balance, the beneficiary may be entitled to a personal judgment against the borrower, known as a deficiency. If a lender desires to obtain a deficiency judgment after a trustees sale, Arizona law requires the lender to file a lawsuit within ninety days after completing the trustees sale. The amount of the deficiency is determined by the total debt at the time of the trustees sale (which includes principal, interest, late charges, attorneys fees, trustees fees and other costs allowable under the note), less the greater of either (i) the trustees sale bid price or (ii) the fair market value of the property at the time of the sale.
If the lender places a full credit bid at the trustees sale, there will be no deficiency even if the total debt exceeds the fair market value of the property. Therefore, before making a credit bid, a lender should carefully consider whether it wants to keep open the option to later pursue a deficiency lawsuit. Further, the possibility of a deficiency claim can give the lender leverage if the borrower claims some type of lender liability after the trustees sale. In the vast majority of trustee’s sales, the lender is the only bidder and therefore has the luxury to place a lower credit bid and still be assured that it will prevail at the trustee’s sale. If other persons show up to bid at the sale, the lender can always begin with a lower credit bid (i.e. a portion of the debt) and then bid higher if such higher bid becomes necessary to obtain the property.
Lender Strategy: Never bid the full credit bid unless necessary to outbid others at the trustee’s sale.
Arizona’s Anti-Deficiency Statutes
In 1971, the Arizona legislature enacted two “anti-deficiency” statutes barring the right of certain beneficiaries (lenders taking a deed of trust as security), and certain “purchase money” mortgagees (lenders taking a purchase money mortgage as security) to seek deficiency judgments on certain types of residential loans. These anti-deficiency statutes apply only when the security does not exceed two and one-half acres, and when it is utilized as, and limited to, either a single one-family or single two-family dwelling. The statutes do not protect borrowers on commercial properties, raw land, tri-plexes, four-plexes, or apartments with more than two units. Both anti-deficiency statutes expressly limit the recovery available to a lender who completes a foreclosure. However, the statutes do not specifically prohibit the lender from electing to waive the security of the mortgage or deed of trustin favor of suing the homeowner directly on the debt.
In the 1988 court decision entitled Baker v. Gardner, the Arizona Supreme Court held that Arizona’s anti-deficiency statutes prohibit a secured lender from suing a homeowner who has borrowed money on those types of loans protected by the anti-deficiency statutes. Essentially, the end result of Baker is that a lender who takes a mortgage or deed of trust to secure all or part of the purchase price of a home may only take the residence back at a foreclosure. A lender of a non-purchase money loan may elect to waive the security and sue directly on the note. These rules may not apply to VA guaranteed loans or FHA insured loans, or where the lender is wiped out by a senior lender’s foreclosure.
Lender Strategy: If a non-purchase money deed of trust lender of residential real property desires to pursue a deficiency action after a foreclosure, the lender must bring a judicial foreclosure. The purchase money deed of trust lender of residential property has no right to pursue a deficiency after a foreclosure.
Suing on the Promissory Note Before or During the Trustee’s Sale
One of the more complex issues for a lender to consider is whether the lender should bring a lawsuit on the note against the borrower or a guarantor, while at the same time conducting a trustees sale on the property secured by that note. Although Arizona law (A.R.S. ’33-722) clearly prohibits a lender from simultaneously maintaining a lawsuit on the note and a judicial foreclosure, this election of remedies statute is contained only in the mortgage statutes, and no similar election of remedies statute appears in the chapter governing deeds of trust. In a 1995 decision, the Arizona Court of Appeals allowed Valley National Bank to bring a lawsuit on the note before completing a trustees sale. However, we believe that a lender still takes a risk if it sues the borrower directly on the note before completing the trustees sale. The borrower could argue that the lender has waived its deed of trust once it obtains a judgment against the borrower, this could drastically affect the lenders priority on the property, as well as any of the lenders other remedies.