Lenders and homeowner borrowers have been waiting for clarification of various questions arising under Arizona’s anti-deficiency laws. Today, the Arizona Court of Appeals resolved three of the key issues involving Arizona’s anti-deficiency law applicable to judicial foreclosure actions, ARS § 33-729: (1) whether the refinancing of a purchase money loan destroys the purchase money character of the loan and the borrower loses deficiency protection; (2) whether disbursements from a construction loan to construct a residence that otherwise qualifies for protection are considered purchase money; and (3) the treatment of a construction loan when part of the loan proceeds were disbursed for purposes other than the acquisition of the property or construction of a qualifying dwelling.
Under Section 33-729, “if a mortgage is given to secure the payment of the balance of the purchase price, or to secure a loan to pay all or part of the purchase price, of a parcel of real property of two and one-half acres or less which is limited to and utilized for either a single one-family or single two-family dwelling,” the lender is limited to satisfying the amount owed by foreclosing on the property; the lender may not collect any deficiency (the difference between the debt and the value of the property upon foreclosure) from the borrower’s other assets. In addressing the three issues presented in the case, the Court relied heavily on the public policies underlying the Arizona anti-deficiency laws – to protect certain borrowers and discourage the overvaluation of property in the lending process.
In the Pasquan case resolved by the Court of Appeals, the borrower purchased an existing residence in Paradise Valley for $935,000. They paid $335,000 “down” and financed the rest, $600,000, with a loan from Hamilton Mortgage Company, secured by a deed of trust against the property. Later, they obtained a new loan from Desert Hills Bank for $1.6 million, which was secured by a new first deed of trust against the property. The Desert Hills loan was used to pay off the balance owed on the Hamilton loan and expenses to demolish the existing home and construct a new home in its place. The borrowers then borrowed another $100,000 from Desert Hills, secured by the existing first deed of trust. They later borrowed an additional $400,000 from Desert Hills, secured by a second deed of trust recorded against the property. According to statement submitted by the borrower, “all of the Desert Hills loan proceeds were used for construction expenses.”
Eventually, the borrowers obtained a new $3.4 million loan (the “Helvetica Loan”), secured by a new first deed of trust. This was the loan ultimately at issue in the case. According to the borrower, the Helvetica Loan was used as follows:
Desert Hills Payoff $2,154,038
Stephen Pasquan Loan $225,000 (for construction)
Closing Costs $9,674
Construction Credit Cards $172,575
Net Proceeds to the Pasquans $357,786.15
Of the proceeds to the borrowers, they avowed that approximately $228,000 was used for interest payments on the Helvetica Loan, and that the balance was used for “’improvements, landscaping, maintenance, taxes, utilities and marketing fees for the house.’”
The borrowers defaulted on the Helvetica loan. Helvetica filed a judicial foreclosure action and the court granted it a judgment for judicial foreclosure. Helvetica was the successful bidder at the subsequent sheriff’s sale, based on its $400,000 credit bid. Helvetica then claimed that it was entitled to a judgment for some $3.2 million (the “deficiency” against the borrowers that Helvetica could/would then collect from the borrowers’ other assets. Essentially, the Court addressed whether Helvetica was entitled to a judgment for all, part or none of that deficiency balance. Setting aside other issues that may be further litigated, it found that Helvetica was entitled to a judgment for a portion of the deficiency balance and that a portion is uncollectible under the anti-deficiency statute.
Refinancing: The Court first reaffirmed a prior Arizona decision that the extension, renewal or refinancing of a purchase money loan does not destroy the purchase money character of the original loan. ”To hold that refinancing a purchase money obligation with a new lender and executing a new deed of trust on the same property destroys anti-deficiency protection would contravene the legislative intent to “’abolish the personal liability of persons who give trust deeds encumbering properties that fit within the statutory definition.’” Thus, the Court held that the mere refinancing of a purchase money loan does not change the character of the loan as purchase money. The Court also noted that it would be incongruous to prevent the original purchase money lender from collecting a deficiency, but allow the refinancing lender to do so.
Construction Disbursements: The Court next addressed whether disbursements to construct a residence that otherwise is qualifying property constitute purchase money under the anti-deficiency statute. The Court discussed a California court’s decision finding that a borrower who obtains a loan to purchase the materials and labor to construct a residence is just as much a purchaser of the residence as is a borrower who obtains a loan to purchase a completed dwelling. So long as both loans are secured by qualifying real property, according to the Court, both are entitled to protection. ”We hold that a construction loan qualifies as a purchase money obligation if: (1) the deed of trust securing the loan covers the land and the dwelling constructed thereon; and (2) the loan proceeds were in fact used to construct a residence that meets the size and use requirements set forth in A.R.S. § 33-729(A).” The Court explained that applying the anti-deficiency statute to protect such construction loans advances the legislative goals of placing the risk of insufficient collateral on the purchase money lender and preventing the expansion of the decline in the economy that would occur if the defaulting purchaser/buyer was also saddled with “large personal liability,” in addition to the loss of the home.
Non-Purchase Money Disbursements: Finally, the Court discussed the impact and treatment of disbursements from a loan for purposes other than the acquisition or construction of the dwelling.
There are three possible outcomes when a judicially foreclosed mortgage secures both purchase money and non-purchase money sums: (1) the entire loan is a recourse obligation; (2) the entire amount receives anti-deficiency protection; or (3) non-purchase money sums may be traced, segregated, and included in a deficiency judgment. Arizona’s statutes offer little guidance regarding this issue. Relevant legislative history, though, persuades us that the third option is the most rational way of harmonizing the competing interests of borrowers and lenders and of giving effect to legislative intent.
The Court found that it would be inequitable to preclude the borrower from receiving any deficiency protection simply because some funds were used for non-purchase/construction purposes. On the other hand, the Court agreed that it would be unfair to the lender and would exceed the legislative purpose of the statute to extend deficiency protection to non-purchase money disbursements just because the proceeds were part of a loan that was also used for construction. Such a result would also encourage homeowners to engage in reckless borrowing. So, the Court concluded that a lender that judicially forecloses may pursue a deficiency for non-purchase money amounts.
The Court remanded the case back to the trial court to apply the rulings and to decide other factual and legal issues presented in the case.
If you would like to learn more about Arizona’s anti-deficiency laws, you can watch our anti-deficiency statute video presentation or read our anti-deficiency statute article. Please realize that some of the information in those materials has been clarified/changed by the Court in the Pasquan case. The Arizona courts are sure to render additional decisions resolving and clarifying the numerous issues raised under the Arizona anti-deficiency laws.
Berk & Moskowitz, P.C. handles a wide-variety of real estate disputes, including deficiency collection, judicial foreclosure, appraiser liability and other matters. Please let us know if you have any questions.