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Refinancing, Construction and Arizona's Anti-Deficiency Laws

The Arizona Court of Appeals provides limited clarification on anti-deficiency protection when the foreclosed loan has replaced the purchase money loan

Stephen Aron Benson  
 

It is a sobering sign of the times that, in the past several months, several rulings from Arizona’s appellate courts have involved real estate foreclosure. When the property in these cases is a residence, there is an almost inevitable discussion of the applicability of Arizona’s anti-deficiency statutes (see A.R.S. §§ 33-729(A) and 33-814(G)).

As many financially distressed Arizona homeowners have learned in recent years, Arizona is an anti-deficiency state for loans on most residential properties. This means that, if certain criteria are met, the lender will be able to look only to the property to satisfy the loan, and will be barred from taking further action against the borrower to collect on the unpaid loan balance.

There can be many complexities involved in the analysis of whether the anti-deficiency rules apply. One of the principal issues to consider is whether the loan was a "purchase money loan," which Arizona statutes treat differently from loans in which the proceeds were used for purposes other than purchasing the property.

In Arizona, a lender may pursue its security by having a non-judicial trustee’s sale or judicially foreclosing by going to court (i.e., a “conventional” foreclosure). There are a number of factors for lenders to consider in choosing between a judicial foreclosure and a trustee’s sale. One odd quirk of the statutory framework is that, if a loan was not a purchase money loan, the lender has a better chance of obtaining a deficiency judgment after the foreclosure by proceeding with a judicial foreclosure instead of a trustee’s sale. At the same time, it is in the interest of borrowers who are being foreclosed upon judicially to have their loans characterized as purchase money loans.

A March 2012 Arizona Court of Appeals case, Helvetica Servicing v. Pasquan, involved the judicial foreclosure of a Paradise Valley home. The case considered two important factors – refinancing and construction – relating to whether loans may be considered purchase money loans.

Impact of Refinancing

In the Helvetica case, a couple had refinanced the purchase money loan that they used to buy a residence. When they defaulted on the new loan, the lender foreclosed and attempted to collect for the resulting deficiency from the homeowners. In the ensuing legal action, the lender argued that refinancing a purchase money loan destroys the loan’s purchase money status, thus exposing the borrower to deficiency liability. Predictably, the borrowers argued that a loan that replaces a purchase money loan retains the purchase money status and, thus, the anti-deficiency protection.

Clarifying the ruling in a prior case, the Court of Appeals confirmed that a refinance of a purchase money loan retains its characterization as a purchase money loan to the extent the new funding replaces the earlier loan.

Impact of Construction

The case may be more notable for its handling of another question: whether a construction loan can be considered purchase money. A common scenario in Arizona involves the purchase of an empty lot, with the borrower later obtaining a construction loan to finance construction of a new home. (A similar scenario involves the purchase of a “tear-down” house, where the borrower obtains a subsequent larger loan to finance demolition and construction of a new residence).

The Helvetica court held that a construction loan would qualify as a purchase money obligation (again, for purposes of protection under the anti-deficiency statutes), 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 the residence and meet the size and use requirements set forth in the applicable statute.”

case by case

Reading through the opinion, it is obvious that on both issues the Court of Appeals focused on the Arizona legislature’s intent to protect homeowners from deficiencies where possible.

Again, every scenario requires its own special analysis. Rarely does a contested case fit squarely within the protections afforded by the statutes or prior cases ... or the parties probably would not be in court in the first place.

Steve Benson is a Certified Specialist in Real Estate Law (Arizona Board of Legal Specialization).