Short sales – a sale of property for an amount less than the balances owed on loans against the property, occur regularly in today’s economy. By some estimates, more than 30% of all Arizona homeowners owe more on their home than their home is worth. Rather than go through foreclosure (a non-judicial trustee’s sale or judicial foreclosure), many homeowners and lenders agree on a short sale.
Many people misunderstand the application of Arizona’s anti-deficiency statutes to short sales. [For an explanation of when the anti-deficiency statutes apply, read our article about Arizona’s Anti-Deficiency Statutes As Applied to Deeds of Trust on Qualifying Properties.]
There are no reported Arizona court decisions regarding whether Arizona’s anti-deficiency statutes specifically apply to short sales where no foreclosure has occurred.
Arizona Revised Statute (“A.R.S.”) § 33-814(G) applies to trustee’s sales (non-judicial foreclosure) and provides as follows:
If trust property of two and one-half acres or less which is limited to and utilized for either a single one-family or a single two-family dwelling is sold pursuant to the trustee’s power of sale, no action may be maintained to recover any difference between the amount obtained by sale and the amount of the indebtedness and any interest, costs and expenses.
Similarly, A.R.S. § 33-729(A) governs judicial foreclosure actions and provides that:
Except as provided in subsection B, 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 lien of judgment in an action to foreclose such mortgage shall not extend to any other property of the judgment debtor, nor may general execution be issued against the judgment debtor to enforce such judgment, and if the proceeds of the mortgaged real property sold under special execution are insufficient to satisfy the judgment, the judgment may not otherwise be satisfied out of other property of the judgment debtor, notwithstanding any agreement to the contrary.
(Emphasis added.) Pursuant to A.R.S. § 33-807(B), a deed of trust may be foreclosed by judicial foreclosure, rather than trustee’s sale.
As shown by the emphasized language of each statute, they contemplate a completed trustee’s sale or judicial foreclosure in order for the anti-deficiency protections to apply. Since a short sale is not a completed trustee’s sale or judicial foreclosure, one could argue that the anti-deficiency protections would not apply to a short sale.
But, the analysis may not stop there. There is case law, albeit in a different context, holding that a purchase money loan on qualifying property is a non-recourse loan, meaning that the lender is limited to pursuing the property, and cannot waive the lien on the property and sue on the debt. Arguably, that holding would apply in the context of a short sale because in a short sale a lender releases the collateral. As a result, the lender may not then be able to sue for the balance of the debt IF the debt is a purchase money loan on qualifying property.
On the other hand, if the debt is not a purchase money loan, the lender is entitled to waive the collateral and sue on the debt. Thus, in the event of a short sale, a non-purchase money lender is likely entitled to pursue a claim for the deficiency. Also, if the property is not qualifying property, the anti-deficiency protections would not apply in the event of foreclosure or a short sale. Even if the anti-deficiency statutes would not otherwise apply, the lender may waive the right to collect a deficiency in the loan documents or short sale agreement.
So, what can a borrower/seller in a short sale do to protect himself/herself from a deficiency action? And, what can a lender do to ensure that it can pursue a deficiency resulting from a short sale?
If the seller/borrower wants to avoid the risk that the lender may pursue a deficiency resulting from a short sale, he/she should have the lender sign an agreement that the lender releases the collateral and cancels the debt in exchange for the agreed upon proceeds from the short sale. (Of course, this may have tax and other implications, which are beyond the scope of this article. Anyone contemplating a short sale should consult his/her legal and tax advisors before entering the transaction.)
A lender desiring to preserve the right to pursue a deficiency that is otherwise collectible after a short sale can have the borrower sign an acknowledgment to that effect. But, a lender likely cannot create more rights to pursue a deficiency than would otherwise exist under Arizona law since A.R.S. § 33-729(A) governs, “notwithstanding any agreement to the contrary.”