March 13, 2018

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2017-18 Arizona Case Law Affecting Commercial Real Estate and Lending

The following information accompanies a presentation Mike gave to members of the Arizona Commercial Mortgage Lenders Association (ACMLA) on March 13, 2018.

Arizona Case Law – Trustee’s Sale Statute of Limitations; Revocation of Acceleration

Andra R. Miller Designs v. U.S. Bank (AZ Court of Appeals 2-13-2018)
Davis signed a Note and DOT against a residence in favor of Washington Mutual (“WAMU”).  The Note and DOT allowed WAMU, at its option, to accelerate the debt upon the occurrence of and failure to cure a default.  Davis missed the monthly payment due on 9-01-2008 and failed to cure the default after receiving a Declaration of Default from WAMU, which Declaration included a reference to the acceleration clause.  In January 2009, WAMU recorded a Notice of Trustee’s Sale, but no trustee’s sale was held.  In March 2012, the trustee recorded a Cancellation of Notice of Sale, which also purported to rescind, cancel and withdraw the previous Declaration of Default and Notice of Breach.

In February 2013, the HOA governing the property obtained a judgment and decree of foreclosure for unpaid assessments of about $16,000.  The property was to be sold at a sheriff’s sale, but a sheriff’s sale was not held at that time.  

In May 2013, the trustee recorded a new Notice of Trustee’s Sale, and in January 2014, the loan servicer sent Davis a Notice of Default - Right to Cure notifying Davis that he had the right to cure his default by paying a stated amount and stating that the lender could accelerate the debt if Davis failed to cure the default.1 In June 2014, the trustee recorded a Cancellation of Notice of Sale to cancel the 2013 Notice of Trustee’s Sale.  The 2014 cancellation notice contained the same acceleration revocation language as the 2012 cancellation notice.  

In December 2014, the trustee recorded a new Notice of Trustee’s Sale.  In February 2015, Miller purchased the HOA judgment, and on 3-26-2015, a sheriff’s execution sale was held on the HOA judgment and Miller purchased the property for $41,000.  The next day, Miller filed to enjoin U.S. Bank [the apparent successor to WAMU] from foreclosing on its DOT and conducting its trustee’s sale, contending that the Bank’s claim and ability to enforce the DOT were barred by the statute of limitations (which Miller contended expired on 1-21-2015 based on the Bank’s acceleration of the debt in its 2009 Notice of Trustee’s Sale), and the trial court agreed.

Note in this regard that Arizona law requires an action to collect a debt evidenced by a written contract to be commenced to be within six years after the cause of action accrues.  Under Arizona law (A.R.S. § 33-816), a trustee’s sale must be made [which presumably means completed], or an action to foreclose a trust deed as a realty mortgage must be commenced, within the statute of limitations for the commencement of an action on the contract secured by the trust deed.2

The Bank argued that the trial court erred in finding that the statute of limitations expired on 1-21-2015 because Miller did not have standing to raise the statute of limitations defense as it was not in privity to the Note, the DOT or the borrower. The Court of Appeals noted that when real property is sold under execution at a sheriff’s sale, the foreclosure purchaser is substituted to and acquires all right, title and interest of the judgment debtor.  Therefore, when Miller foreclosed on the HOA judgment and purchased the property at the sheriff’s sale, Miller acquired the same right as the judgment debtor to invoke the six-year limitation period of A.R.S. § 33-816; no additional contractual privity is required.

The Court of Appeals noted that, when a creditor has the power to accelerate a debt, the six-year statute of limitations begins to run on the date the creditor exercises that power.  The Court held that, to exercise its option to accelerate a debt, the creditor must undertake some affirmative act to make clear to the debtor that it has accelerated the obligation, even if the parties had contractually agreed that the option to accelerate a debt did not require a notice to the debtor.  Demand of payment in full before all installments fall due constitutes a sufficiently affirmative act of acceleration, as does the commencement of a foreclosure.  Recording the 2009 Notice of Sale was an affirmative act of the debt’s acceleration that triggered the statute of limitations on the Bank’s right to foreclose its DOT. 

Miller argued that the Bank failed to revoke the 2009 acceleration and, because no trustee’s sale was held within six years after the acceleration, the statute of limitations expired on 1-21-2015.  The Bank countered that its recorded cancellations of the trustee’s sales containing the acceleration revocation language restarted the statute of limitations in 2012 and 2014.
 
Significantly, the Court held (in reliance on a 1994 New York case) that both the acceleration of the debt and the acceleration’s revocation have equally important effects on a debtor’s financial decision-making based on its knowledge of the actual amount due, and that the unilateral revocation of the debt’s acceleration also requires an affirmative act by the creditor that communicates to the debtor that the creditor has revoked the debt’s acceleration.  The Court held that the mere recordation of a cancellation notice is not, by itself, an affirmative act sufficient to revoke the acceleration of the debt, even though it cancels the trustee’s sale.  For the cancellation of the trustee’s sale to become an affirmative act by the creditor sufficient to revoke the debt’s acceleration, the notice of cancellation must also contain a statement that the acceleration of the debt has been withdrawn.  The Court held that the insertion of the acceleration revocation language in the recorded 2012 and 2014 Notices of Cancellation sufficiently communicated to Davis, and to any third party investigating title to the property, that the Bank also intended to revoke the debt’s acceleration, and effectively restarted the statute of limitations on the default.3

Lender takeaways:  This somewhat surprising decision could significantly affect the way lenders and trustees address cancellations of trustee’s sales in connection with reinstatements or loan workouts.  Unfortunately, it isn’t clear from this decision whether the trustee’s sale cancellations described in the decision resulted from reinstatements under A.R.S. § 33-813(A), from negotiated workouts or from something else, so lenders may need to assume that the acceleration revocation rule set forth in the decision could apply to any factual setting where an acceleration right has previously been exercised. This decision also appears to erroneously assume that the recorded Notice of Trustee’s Sale is the document that actually accelerates the loan, whereas acceleration typically occurs by a separate unrecorded notice of default or demand letter. Applying this decision to reinstatements calls into question exactly what a reinstatement payment reinstates [I believe the only sensible construction of A.R.S. § 33-813(A) is that reinstatement effectively decelerates the secured debt].  A negotiated workout generally includes the recording of a modification agreement, deed of trust amendment or some similar instrument to provide constructive notice that the terms of the secured loan have been modified.  If you intend to revoke the acceleration of the secured debt when you cancel a trustee’s sale, consider adding (or having the trustee add) language to the Cancellation of Notice of Trustee’s Sale [which typically follows the statutory form set forth in A.R.S. § 33-813(G), which includes no mention of revoking the acceleration of the secured debt] revoking the acceleration so you do not get a statute of limitations defense sprung on you years later.  It has not previously been general lending practice in Arizona to formally advise borrowers or guarantors (or provide constructive notice by recording) of the revocation of an acceleration following the lender’s acceptance of a reinstatement or the agreement of the parties to a workout.  If an existing credit has previously been accelerated, or noticed for trustee’s sale and thereafter cancelled, but not paid off, consider whether you need to give acceleration revocation notices to the borrower and guarantors [and, if you read the Miller decision to also require notices to be given to potential third-party title searchers (see footnote 3 below), to record the appropriate notices as well]. Exercise caution to specifically identify in your demand letters the point at which acceleration occurs (i.e., does it occur immediately, subject to deceleration by tendering the requested cure within the permitted cure period, or does it occur only after the cure period has expired?).  Consider stating in your demand letter that a timely tender and acceptance of the requested cure will revoke the acceleration.  Be aware of any provisions in your loan documents that characterize a failure to timely pay or perform as an automatic default, regardless of whether the lender takes further action to declare the default.  Query whether a forbearance agreement or reservation of rights letter identifying known defaults is sufficient to commence the statute of limitations.  It is somewhat unfortunate that the Bank ultimately prevailed in this case, as it now has little reason to appeal a decision that includes the new acceleration revocation rule and lapses in logic that this one does.
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It is unclear from the opinion why the loan servicer sent a Notice of Default – Right to Cure eight months after the Notice of Trustee’s Sale had been recorded.  The typical Arizona practice would be to include the borrower among the five-day notices mailed out shortly after the recording of the Notice of Trustee’s Sale.  It is also unclear from the opinion whether the sales were cancelled in 2012 and 2014 due to a reinstatement or a loan workout.

The Court of Appeals noted that, when the statute of limitations expires on the debt, the debt is not extinguished, but the remedy for an action on the debt is barred.  The Court did not expressly indicate whether, in its view, the DOT securing the debt would remain as an unforeclosable lien on the property following the expiration of the six-year statute of limitations if not foreclosed in a timely fashion.

It is not clear whether the Court of Appeals is requiring in all cases that a notice of acceleration revocation be communicated to any third party that may be investigating title to the property, or whether it was merely addressing the particular facts at issue in the Miller case.  It had previously been assumed that the burden was on the title searcher to inquire as to the status of the loan if the title searcher located a recorded lien, rather than the burden being on the lender to affirmatively advise third parties of the status of the loan in addition to the existence of the lien.

Arizona Case Law – Public/Private Projects; Competitive Bidding Requirement

Rodgers v. Huckelberry (AZ Court of Appeals 12-14-2017)
In January 2016, Pima County entered into a 20-year lease-purchase agreement, which called for the County to construct a 135,000 square foot facility on 12 acres of County-owned land to accommodate World View’s near-space-exploration operations.  The County also agreed to construct a publicly available launch pad on an adjacent parcel that World View agreed to operate and maintain.4   World View promised to employ specific numbers of employees at defined benchmarks and certain salary levels.  In entering the lease-purchase agreement, the County did not follow the statutory competitive bidding process normally required when a county leases property [A.R.S. § 11-256(B)–(D)].  Instead, the County relied on its economic development authority [see A.R.S. § 11-254.04] to directly negotiate and enter the lease-purchase agreement with World View.

In April 2016, three Pima County resident/taxpayers brought an action to invalidate the agreement for failure to follow the competitive bidding processes.  The trial court, at the urging of the Goldwater Institute, determined that the County should have followed the competitive bidding process when it entered into a lease for the purpose of economic development, and found in favor of the taxpayers.  The Court of Appeals was asked to determine whether the County was required to use competitive bidding when it leased property pursuant to A.R.S. § 11-254.04 [for the sake of simplicity, I will call this the “economic development statute”].

The Court of Appeals noted that the economic development statute specifically authorizes county boards to appropriate and spend public monies for and in connection with economic development activities, including those that will assist in the creation or retention of jobs or will otherwise improve or enhance the economic welfare of the inhabitants of the county. The Court noted that, in practical terms, the economic development statute grants a county the power to lease county-owned property for less than market value, inasmuch as a discounted lease is equivalent to spending public monies by subsidizing a portion of the tenant’s rent.  The economic development statute contains no competitive bidding requirement. The Court of Appeals found that, to assist in the creation or retention of jobs, the board may need to offer a favorable lease to a particular employer, and that to require competitive bidding of the lease in that circumstance would frustrate the purpose of the economic development statute by driving up the price and nullifying the power granted in the economic development statute to spend monies for economic development.  The Court of Appeals likewise noted that competitive bidding would substantially frustrate the board’s ability to negotiate directly with private employers to incentivize them to locate within the county by offering a below-market lease, as competitive bidding would introduce the risk that another buyer might supplant the target employer and derail longer-term goals that would ultimately benefit county residents.

In contrast, A.R.S. § 11-256(A) generally authorizes county boards to lease lands or buildings owned by or under the control of the county, subject to a competitive bidding procedure that includes appraisal of the subject property, auction and publication of notice of the proposed lease.  The competitive bidding statute is designed to produce maximum revenue for a county-owned or controlled property with a definite floor below which the county may not enter into a lease.  Section 11-256 does not specify that whenever the county leases property, it must follow the competitive bidding procedures.  Rather, A.R.S. § 11-256(F) provides that the statute is supplementary to and not in conflict with other statutes governing or regulating powers of county boards of supervisors; the Court of Appeals interpreted this to mean that Section 11-256 should be construed to avoid conflict with other statutes addressing county powers.  The Court of Appeals construed that limitation to mean that not every power granted to county boards is constrained by the competitive bidding requirement and that, when the power to lease is not otherwise conferred, Section 11-256(F) provides that a board may lease county property in combination with another power.  Insofar as the competitive bidding process would frustrate the ability of county boards to pursue economic development under the economic development statute, particularly concerning job retention and creation, the competitive bidding requirement does not apply to that exercise of power.

Lender takeaway.  This decision appears to be very permissive compared to other recent Arizona appellate decisions involving public/private projects, such as the 2010 Turken/CityNorth case.  You may recall that, in the CityNorth case, the Arizona Supreme Court required the use of an “adequate consideration” test comparing (i) expenditures to be made and liabilities to be incurred by the County, to (ii) the objective fair market value of the direct, bargained-for benefits that the contracts with the County require the developer or other contracting party to provide.  The “adequate consideration” test does not allow the County to consider the value of indirect benefits that the County contemplates receiving from the transaction that the other contracting party is not obligated to deliver.  The test is satisfied if the public payment is not grossly disproportionate to what is received in return from the private party.

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4
 The Goldwater Institute’s website states that: (a) Pima County intended to borrow $15 million to fund the construction of a balloon launchpad and company headquarters for the private benefit of World View Enterprises, a company that intended to engage in luxury adventure tourism; (b) World View planned to charge wealthy passengers $75,000 per ticket to ride in a capsule strapped to a specialized weather balloon high in the atmosphere; (c) in return for building the balloon facility for World View, the County would receive below-rent payments and a vague and unenforceable promise of jobs if World View could get its tourism business started; (d) County staff negotiated with private firms in secret (using the project code name “Project Curvature”) and awarded the design and construction contracts to preselected favorites; and (e) the County’s agreement violated (i) the “gift clause” of the Arizona Constitution, which forbids the government from giving or lending taxpayer money to private enterprises, and (ii) Arizona’s competitive bidding laws.

Arizona Case Law – Wrongful Foreclosure; Waiver of Trustee’s Sale Objections

Zubia v. Shapiro (AZ Supreme Court 1-12-2018)
Zubia and Pena (her husband) bought a single family residence in 1995 and separated in 2006.  In 2008, Pena obtained a $150,000 loan from Shapiro and Advanced Capital Group (“ACG”), and signed a DOT to secure the loan.  Both the Note and DOT appeared to have been signed by Pena and Zubia, but Zubia contended her signatures on both documents were forged and that she first learned of them in 2013 when she tried to borrow against the property.

The loan went into default in 2013, and ACG assigned its interest to Shapiro.  Shapiro appointed a trustee to conduct a trustee’s sale in February 2014.  In January 2014, Pena quit claimed his interest in the property to Zubia, who recorded the quit-claim deed on 2-10-2014.  Shortly thereafter, Zubia filed a lawsuit against Pena, Shapiro, ACG and others, asserting that her signatures on the Note and DOT were forged.  Zubia sought to quiet title to the property, but did not seek to enjoin the trustee’s sale.

In January 2015, after Zubia’s case was dismissed, Shapiro conducted the trustee’s sale and purchased the property by credit bid.  After the sale, Zubia filed a lawsuit against Pena, Shapiro, ACG and others, reasserting her forgery allegations, and sought damages under A.R.S. § 33-420(A)5  and to quiet title to the property.  Zubia also added a wrongful foreclosure claim, asked the trial court to declare the January 2015 trustee’s sale invalid, and sought to enjoin any further trustee’s sales.  Shapiro moved to dismiss, arguing that Zubia had waived any claim of title to the property and all defenses and objections to the trustee’s sale under A.R.S. § 33-811(C).6   The trial court dismissed Zubia’s complaint, ruling that under A.R.S. § 33-811(C), she had waived her claims by not obtaining injunctive relief before the January 2015 trustee’s sale. The Arizona Court of Appeals affirmed.

The Arizona Supreme Court confirmed that Zubia had waived any objections or defenses to the trustee’s sale by failing to seek an injunction under § 33-811(C) before the trustee’s sale.  The Court noted that, under § 33-811(C), a person who has defenses or objections to a properly noticed trustee’s sale has one avenue for challenging the sale – filing for injunctive relief.  Zubia argued that a claim for money damages arising out of a sale does not seek to undo the sale and is therefore not a defense or objection to the sale.  The Court held that § 33-811(C) prohibits not only actions to void a trustee’s sale, but also those dependent on the sale and claims for damages that are based on a defective sale.  The Court held that Zubia’s claims were essentially objections to the sale, because they cannot succeed unless the sale was defective, and that allowing a legal challenge based on the invalidity of a trustee’s deed would permit an end run on § 33-811(C). 

Lender takeaway:  Arizona courts have thus far been very hesitant to undo a duly conducted trustee’s sale after the fact, and have been fairly stringent about enforcing A.R.S. § 33-811(C), but continue to wrestle with defining what types of challenges constitute or arise from defenses and objections to trustee’s sales.

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A.R.S. § 33-420(A) allows a claim for damages against any person purporting to claim an interest in, or a lien or encumbrance against, real property, who causes a document asserting such claim to be recorded in the Office of the County Recorder, knowing or having reason to know that the document is forged, groundless, contains a material misstatement or false claim or is otherwise invalid.

A.R.S. § 33-811(C) provides that the trustor (i.e., the owner of the real property collateral), its successors or assigns, and all persons to whom the trustee mails a notice of a trustee’s sale under a trust deed pursuant to § 33-809 waives all defenses and objections to the trustee’s sale not raised in an action that results in the issuance of a court order granting relief pursuant to Rule 65 of the Arizona Rules of Civil Procedure, entered before 5:00 p.m. Phoenix time (MST) on the last business day before the scheduled date of the trustee’s sale.

Arizona Case Law – Garnishments against ERISA Accounts

Shah v. Baloch (AZ Court of Appeals 10-12-2017)
Shah sued Baloch for breach of contract and fraud and obtained a judgment in excess of $400,000.  To collect on the judgment, Shah served a writ of garnishment on Wells Fargo, as trustee of Baloch’s 401(k) account.7   Shah claimed that Baloch had fraudulently transferred several thousand dollars into his 401(k) account after Shah’s judgment had been entered against Baloch.  Wells Fargo objected to the attempted garnishment of 401(k) funds, and the trial court quashed the writ, finding that the 401(k) funds were exempt from garnishment under ERISA. 

Arizona’s Uniform Fraudulent Transfer Act allows a creditor to garnish a transfer made with actual intent to hinder, delay or defraud a creditor.  Shah argued that funds that a participant fraudulently conveys into a 401(k) account should be garnishable because such a transfer is void as a matter of law.  Shah also argued that public policy requires that fraudulent transfers by plan participants be excepted from ERISA’s anti-alienation rule8  (suggesting that courts may create equitable exceptions to the anti-alienation rule).  Baloch argued that Arizona law [A.R.S. § 33-1126(B)] prohibits a judgment creditor from executing on or attaching a judgment debtor’s retirement account. 

The Court of Appeals held that, subject to a few specific exceptions, ERISA preempts state laws (to the extent federal and state laws may conflict) that relate to any employee benefit plan, and therefore preempts any contrary Arizona law that would apply to a qualified pension plan.  Congress has created specific exceptions to the ERISA anti-alienation rule, and courts cannot create additional exceptions, even for criminal conduct, and even when the result is that the funds are rendered immune from otherwise valid collection efforts.  Therefore, the Court of Appeals affirmed the trial court’s order quashing the writ of garnishment.

Lender takeaway:  If you are underwriting a loan that requires guarantor support, or are contemplating enforcement efforts against a guarantor, you should assume that funds held in ERISA plans (and any other exempt property described in A.R.S. § 33-1126), even if shown on the guarantor’s personal financial statements, will be off limits to you and cannot be counted on to provide guarantor support to your deal.

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Baloch had filed a Chapter 7 bankruptcy in 2011, and Shah’s claim was determined to be non-dischargeable.

The ERISA anti-alienation rule requires an ERISA plan to provide that the benefits available to a participant under the plan may not be assigned or alienated, and generally prohibits a creditor from garnishing a qualified plan to collect on a judgment against a plan participant.

Arizona Case Law – Community Property

DiPasquale v. DiPasquale (AZ Court of Appeals 9-7-2017)
Helen and Joseph’s marriage was dissolved in 2001, at which time they entered into a property settlement agreement under which Joseph agreed to pay Helen $2,600 per month in spousal maintenance until her death or remarriage.  Soon after the dissolution, Joseph stopped making spousal maintenance payments.
 
In February 2006, Joseph married Susan.  In September 2006, Helen petitioned the family court to enforce spousal maintenance and arrearages, and in March 2007, the parties agreed to another property settlement agreement that resulted in a judgment in favor of Helen and against Joseph for $122,200 plus interest, and the cessation of ongoing spousal maintenance payments.  Joseph also agreed to pay Helen $200 per month against the spousal maintenance arrearage, maintain a $250,000 life insurance policy for Helen’s benefit and provide Helen with copies of his annual tax returns.

Joseph largely made the arrearage payments, but allowed the life insurance policy to lapse and failed to provide Helen with annual tax returns.  In October 2015, Helen filed a petition to enforce all previous property settlement agreements and sought entry of judgment.  Helen also moved for leave to file a third-party petition asking that Susan be joined in order for the Superior Court to make a finding determining Joseph’s contribution to the community property.  The Superior Court denied the motion to file a third-party petition to join Susan as a party, and found that determining Joseph’s contribution to the community was not an issue for the family court, and that it was premature to join Susan until Helen sought to actually collect against Joseph and Susan’s community property.

The Court of Appeals found that allowing Helen to file her petition to join Susan would not, and as a matter of law could not, convert Joseph’s pre-marital spousal maintenance into community debt.  A.R.S. § 25-215 permits a creditor to collect a premarital debt from community property only to the extent of the amount contributed to the community by the debtor spouse.

The 1992 Flexmaster case had previously established that a non-debtor spouse is a necessary and proper party in a suit to establish the limited liability of the marital community under A.R.S. § 25-215(B) for separate premarital debts.  The Court of Appeals held that collecting community property from Joseph and Susan under A.R.S. § 25-215(B) requires a finding of Joseph’s contribution to the community property, and that Susan’s interest in the marital community conferred a due process right to litigate the extent to which Joseph and Susan’s community property will be liable for Joseph’s premarital debt.

Lender takeaway.  A creditor attempting to collect a pre-marital debt from a party that is now married (or married to a different spouse) should consider bringing the current spouse into the action by appropriate means if the creditor wishes to collect from property that could constitute community property of the current spouses.

Arizona Case Law – Zoning Variances

Pawn 1st, LLC v. City of Phoenix (AZ Supreme Court 8-11-2017)
This dispute concerns the City of Phoenix Board of Adjustment’s grant of a variance on a property at the southwest corner of McDowell Road and 32nd Street in Phoenix.  The parcel was zoned “C-3 – General Commercial”, which generally designates areas for “intensive commercial uses.”  In 1973, the City completed an eminent domain action that altered the parcel’s dimensions and resulted in certain unique characteristics that limited the parcel’s commercial viability (i.e., reducing the parcel size to 12,000 square feet; eliminating the frontage area around the building, resulting in a direct abutment of a public sidewalk; and restricting parking spaces).

In 2010, the property owners evicted their tenants and discontinued using the property as an adult theatre (a non-conforming use) and leased the property to Jachimek (dba Central Pawn) with an option to purchase.  When Jachimek entered the lease, he intended to operate a pawn shop [a permitted use within a C-3 zoned parcel, provided that the building’s exterior walls are at least 500 feet from a residential district and the owner obtains a use permit from the zoning administrator].  Jachimek applied for a use permit for his pawn business and a variance from the 500-foot residential setback requirement.  The zoning hearing officer denied his applications and Jachimek appealed to the Board.  At the Board hearing, Pawn 1st, LLC (a competing pawn shop) opposed the variance.  The Board conditionally approved the variance, requiring Jachimek to operate his pawn shop only during specified hours, to not buy or sell guns or pornography, and to apply for building permits for a promised remodel of the building within one year.  Pawn 1st then filed an action in Superior Court challenging the Board’s variance decision and, after various appeals and remands, the dispute reached the Arizona Supreme Court. 

Arizona law authorizes cities and towns to establish boards of adjustment to consider appeals from zoning administrators’ decisions concerning zoning ordinance enforcement.  Those boards primarily decide whether “special circumstances” exist to relieve owners of parcels with unique characteristics from strict application of zoning laws.

The Phoenix zoning ordinance authorizes a zoning administrator to issue a variance when a literal enforcement of any provisions of the zoning ordinance would result in “unnecessary property hardship”.  A variance is authorized only if the applicant can establish that: (a) special circumstances apply to the land, building or use referenced in the application that do not apply to other properties in the same zoning district; (b) the owner did not create the special circumstances; (c) the variance is necessary for the “preservation and enjoyment of substantial property rights”; and (d) the variance will not be materially detrimental to the area.

Arizona law distinguishes between area variances and use variances.  An area variance relieves an owner from having to comply with a zoning ordinance’s technical requirements, such as setback lines, frontage requirements, height limitations, lot size restrictions, density regulations and yard requirements, while a use variance permits a use not expressly allowed by a zoning ordinance.  Arizona statute prohibits boards of adjustment from changing the “uses permitted,” thus confining their authority only to area variances.

An area variance requires a showing of “peculiar and exceptional practical difficulties,” while a use variance requires a showing of “exceptional and undue hardship.”  The difference between the two standards is one of degree, but the area variance standard is considered to be a less stringent standard than the use variance standard (because the area variance does not affect the character of the community).  The use variance requires a more stringent showing –– that compliance with the zoning regulations precludes any reasonable use of the property.  An inability to put the property to a more profitable use or loss of economic advantage does not constitute “undue hardship” and is insufficient to justify a use variance.

The Court of Appeals had determined that Jachimek’s requested variance was an area variance (rather than a use variance) because a pawn shop is a permitted use in a C-3 zoning district, irrespective of the 500-foot distance requirement, and likened the 500-foot distance requirement to a setback or frontage requirement, not a use regulation.  The Supreme Court noted that a variance that allows a pawn shop in an existing commercial district does not fundamentally alter the nature of the area [and was therefore an area variance, which was within the Board’s power to grant].

Boards of adjustment may grant area variances only if, due to special circumstances, the strict application of the zoning ordinance will deprive the property of privileges enjoyed by other property of the same classification in the same zoning district.  As used in the zoning ordinance, “special circumstances” is the functional equivalent of “hardship”.  The Supreme Court agreed that special circumstances arising from the property’s physical characteristics applied to the subject parcel (compared to other properties in a reasonably close radius), and that those circumstances justified the area variance. 

A finding of special circumstances does not justify a variance if the circumstances are self imposed by the parcel owner.  The Court of Appeals had held that any special circumstances were self-imposed by Jachimek or his landlord by selecting the particular property for a pawn shop.  The Supreme Court determined that, in the context of area variances, it needed to consider whether strictly applying the zoning requirements would deprive the owner of the same privileges owners of other similarly zoned properties enjoy, and held that special circumstances are not self-imposed when the owner wants to use the property in a way permitted to other similarly situated properties, but cannot do so because of externally imposed circumstances.  Although Jachimek voluntarily acquired the property with knowledge of the special circumstances, he did not create them.  

The Supreme Court therefore held that the Board acted within its discretion in finding that (a) special circumstances applied to the property, (b) the variance required was an area variance, (c) Jachimek did not create the special circumstances, (d) the variance was necessary for the preservation and enjoyment of substantial property rights, and (e) the variance would not be materially detrimental to the surrounding area.

Lender takeaway.  Lenders should be aware of the foregoing standards if they are lending on a property that requires a zoning variance.

Michael P. Ripp
ACMLA Legislative Chair
602-440-4823
mripp@rcalaw.com

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