Litigation

Preforeclosure Problems for the Licensee Acting as a Principal

April 1, 2018 By William Kozub

Preforeclosure Problems for the Licensee Acting as a Principal

Arizona has moved through the short sale era. The Arizona real estate investors are once again finding distressed properties, many facing foreclosure, that present attractive investment potential. These opportunities present great potential to those individuals with the skill and knowledge to locate such distressed and foreclosure properties, as well as an understanding of what it takes to close these nontraditional transactions. However, as many real estate investors who are also real estate licensees know, the pre-foreclosure transaction can present unique risks.

In today’s pre-foreclosure transaction, the licensee, acting as an investor, approaches the homeowner either prior to or during the pendency of the trustee sale and negotiates a purchase of the property that allows the homeowner to avoid foreclosure, and allows the licensee to make a profit for the effort involved.

Regrettably, a pre-foreclosure transaction has many characteristics that differ from a traditional real estate transaction. First, the transaction does not fit nicely into the AAR documents so commonly used today. Moreover, the timing of the transaction and the goals of the homeowner are often radically different from a traditional home sale transaction. Finally, the very nature of the pre-foreclosure transaction will often result in both the homeowner being unrepresented by either an attorney or a real estate broker, and dealing with a real estate licensee who is acting as a principal. These are all ingredients for a disaster.

Avoiding Inadvertent Agency

A common problem with a real estate licensee engaging in pre-foreclosure purchases made on behalf of the real estate licensee is the inadvertent creation of an agency relationship with seller of the real property who is facing foreclosure. Arizona law is very permissive in the creation of an agency relationship. An agency relationship can be formed merely by the words or conduct of the parties. A written contract is not required to establish an agency relationship. The mere fact that a real estate licensee is purchasing property on their own behalf, or on behalf of an entity in which they have an interest, does not necessarily mean that the licensee is not also representing the seller. Any real estate licensee may be rendered a dual agent if the licensee conducts himself or herself in such a way, either intentionally or unintentionally, as to be deemed an agent of the buyer.

This problem is compounded in the pre-foreclosure transaction because the only real estate licensee in the transaction is usually the one acting as the principal. Because the Department of Real Estate may suspend or revoke the real estate license of one who represents more than one party in a transaction “without the knowledge or consent of all parties,” caution must be taken. For the licensee’s protection, all conduct during a pre-foreclosure purchase transaction must be conducted with the express purpose of avoiding the inadvertent agency relationship. A well-written agency disclosure form, such as the form available through the Arizona Association of REALTORS, should be used. However, the mere existence of a disclosure form is not conclusive proof that an agency relationship does not exist.

Agency Arising From Written Solicitations

The agency issue is further complicated by the common business practice in the pre-foreclosure industry for individuals engaged in pre-foreclosure home purchases is to send out written solicitations to homeowners facing foreclosure. These solicitations will often contain offers by the licensee to help the homeowner and will request that the home owner contact the soliciting individual or company. Often, the real estate licensee will list the same information used to obtain a listing in this promotional material creating the mistaken belief in the recipient that they will have the same relationship with the licensee as the licensee’s other clients. This is a problem.

While these solicitations are a source of potential liability and can prove to be the document that actually creates the agency relationship, when properly drafted, they can also be used to provide the initial level of protection a licensee needs against an inadvertent agency relationship. Care should be taken to avoid language that appears that the licensee is seeking to represent the homeowner. Indeed, an express disclosure that the licensee is acting as a principal or investor is recommended.

Close Through Escrow

It is advised that the licensee close all pre-foreclosure transactions through escrow. There are several protections afforded the licensee when the transaction is closed through escrow. First, the licensee is able to obtain buyer’s title insurance. Pre-foreclosure deals often occur fast and furiously. Many times, the homeowner facing foreclosure does not being to seek assistance until days before the trustee sale. It is not uncommon for the homeowner to call prospective investors on the weekend before the sale. The homeowner will then be tempted to sell the home several times on one day to every prospective purchaser who comes to the door with a hand full of cash and blank quit claim deed. The Monday morning rush to the county recorder’s office then dictates who is the real owner of the property. Obtaining title insurance prevents the licensee as buyer from being burned by the homeowner who may have been selling his home to every prospective purchaser who has come to the door with a hand full of cash and blank quit claim deed.

Perhaps an even greater protection by closing through escrow is the benefit and security that can be obtained when a planned set of escrow instructions are used in the transaction. Often, the pre-foreclosure transaction occurs so rapidly that there is not time to obtain a proper purchase contract. A properly drafted set of escrow instructions should address the following issues:

Any necessary adjustments to the sales price based upon the amount necessary to cure the default.
Disclosure of licensee status.
Disclosure of financial interests in the transaction.
Disclosure of agency status.
Any indemnity and exculpatory language desired by the buyer.
Terms of any new rental agreement or purchase options that survive the closing.
Integration clause addressing any outstanding side agreements.
Disclosure of transaction terms and express acknowledgement the transaction is not a loan transaction.

Careful thought and drafting must go into the documents used in a pre-foreclosure transaction. A real estate licensee acting as a principal in such a transaction must be constantly aware of the issues involved and the potential sources of liability so that they may be avoided. Is it strongly recommended that licensees engaged in the pre-foreclosure industry consult a broker or attorney experienced in such matters so the licensee’s actions can be a source of protection, and not future liability.

What Every Lender Should Know Before Starting A Trustee’s Sale

March 1, 2018 By William Kozub

Introduction

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.

Lender Strategy: Be careful when deciding to sue on the note, know ahead of time what the repercussions are.

Locking Out the Commercial Tenant

February 1, 2018 By William Kozub

The lock-out of a commercial tenant is one of the most powerful remedies available to any party in a real estate transaction. On the other hand, it is a remedy which can lead to catastrophic liability if it is misused by a landlord. The lock-out remedy is available to most commercial landlords under Arizona law. Most lease forms expressly allow the landlord to re-enter and seize possession of the premises. Even absent such language in a lease, as a general rule, the landlord can still lock-out a tenant unless the lease expressly prohibits such action. Also as a general rule, the landlord is allowed to seize personal property belonging to the tenant to hold (and sell) for payment of the rent. This article will discuss concerns of using a lock-out from the landlord’s perspective. Obviously, this article is limited to commercial property because under Arizona law, a landlord may never lawfully perform a lock-out against property covered by the Arizona Residential Landlord & Tenant Act.

When Can the Landlord Lock-Out a Tenant?

Assuming that the lease does not prohibit a lock-out, the landlord may re-take the premises upon any material breach of the lease by the tenant or if the tenant is in arrears on rent for five days. It is absolutely crucial that the landlord not attempt to lock-out the tenant for a breach which may be deemed by a court to be “trivial” (such as a dispute over a CAM charge which is small in comparison to the tenant’s other rental obligations). If the landlord desires to use a lock-out for any reason other than the tenant’s failure to timely pay its monthly rental payments, then the landlord should seek the advice of legal counsel before proceeding with a lock-out. When in doubt, file a forcible detainer action and do not lock the tenant out of the premises.

What Is a Landlord’s Lien?

Under Arizona law, a commercial landlord has the right to enforce a statutory “landlord’s lien” against the personal property of the tenant, subtenant or assignee which is located on the premises to the extent necessary to secure payment of the rent. The landlord has no right to seize property belonging to persons other than the tenant, a subtenant, or an assignee of the tenant. A landlord who performs a lock-out may find it difficult to accurately determine which personal property actually belongs to the tenant.

A lock-out is usually the only practical method for the landlord to seize the tenant’s personal property. Arizona law permits the landlord to sell the tenant’s property and apply the proceeds toward the rent. If the tenant does not pay the rent within 60 days after seizure of the property, the landlord may sell the personal property at a public auction in the manner provided by statute, which requires notice to the tenant, and sometimes, publication. Because the statutory procedure for the sale process is quite ambiguous, the landlord should consider bringing a judicial action to foreclose on the landlord’s lien, or better yet, if the landlord has already obtained a judgment for rent, the landlord could require the sheriff to execute against the tenant’s personal property to satisfy the judgment.

Priority of the Landlord’s Lien

Generally, a landlord’s lien against the tenant’s personal property relates back to the later of (i) the commencement of the tenancy, or (ii) when the tenant first brings the property onto the premises. Therefore, a landlord’s lien will not have priority against another creditor’s security interest in the tenant’s personal property if that other creditor perfected its lien prior to the time the tenant brought that property onto the premises.

To further complicate matters, the tenant may be able to void the landlord’s lien by filing bankruptcy, unless such lien is based upon some contractual agreement rather than merely the landlord’s statutory right under Arizona law. For these reasons, among others, a landlord is well-advised to require the tenant to execute a separate U.C.C. financing statement granting the landlord a lien for non-payment of rent (and other charges due under the lease) against the tenant’s personal property, including the tenant’s equipment, inventory and accounts receivable. The landlord should then record the financing statement with the Arizona Secretary of State. By obtaining such an agreement in connection with the lease, the landlord should be able to later foreclose on the personal property easier and quicker, and will not lose the priority of its security interest if the tenant files bankruptcy or physically removes the property from the premises before the lock-out.

How to Perform a Lock-out

A landlord cannot exercise its right of lock-out while the tenant is physically inside the premises, or if the landlord has to “breach the peace” to perform the lock-out. Thus, a tenant may avoid a lock-out simply by keeping a person in the premises at all times. In such case, the landlord must file a forcible detainer lawsuit to regain possession. Of course, this may give the tenant an opportunity to remove personal property or to file bankruptcy (which will certainly cause more delays in regaining possession), however, the landlord really has no other choice in that situation.

If appropriate, the landlord should contact the local police prior to the lock-out. A landlord should never perform a lock-out without an adequate number of witnesses in addition to the locksmith, to observe the condition of the premises at the time of the lock-out (and especially to observe the contents inside the premises).

Also, as quickly as possible, the landlord should make a complete itemization of all of the property located in the premises. The landlord should also take photographs and/or make a videotape of each room (it is best to do this at the same time of the lock-out). It is not unusual for a tenant or its employees to claim that property is missing or stolen. It would also be wise for the landlord to make sure that it is covered by insurance against any loss or claim relating to such personal property.

A landlord should post a notice on all of the outside doors, notifying the tenant and others of the lock-out. The notice should not slander or belittle the tenant (as it may be read by persons doing business with the tenant). The language of the notice will vary depending upon the circumstances.

If the landlord desires to hold the tenant liable for future rent, the landlord should be careful to avoid using language in this notice or any other notice that could be interpreted as “terminating” the lease.

Things to Consider Before Using a Lock-Out

A lock-out is an effective but drastic remedy and should be used cautiously, and usually only as a last resort. A lock-out could destroy the tenant’s business, therefore, the landlord’s potential liability for a wrongful lock-out is enormous. The landlord should never perform a lock-out where the tenant may have a valid defense to its breach of the lease. Also, the landlord should be absolutely sure that (i) any default notices required under the lease (or otherwise) have been properly delivered, (ii) all grace periods under the lease have expired, (iii) the landlord has not somehow waived its right to strictly enforce its remedies (e.g., by the landlord previously accepting late payments without reinstating “time is of the essence”), and (iv) that the lock-out can be accomplished without breaching the peace.

Ultimately, the landlord should consider whether or not the lock-out will help achieve the landlord’s goals (whether that goal is obtaining past due rent or simply getting rid of the tenant). For example, in many cases the lock-out will make it more difficult (or impossible) for the tenant to earn income to pay the rent. But on the other hand, by performing a lock-out, the landlord would seem to have made the payment of rent the highest priority of the tenant. Finally, the landlord must also consider whether or not it is really prepared to assume the responsibility of taking control of all of the personal property in the premises, and to possibly litigate issues concerning the tenant’s default as well as the priority of the landlord’s lien against other creditors.