January 6, 2012

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Arizona Court of Appeals Ruling on Anti-Deficiency Statute A Concern for Lenders

Arizona Court of Appeals Holds that Anti-Deficiency Statues Protect a Borrower Who Intends to Construct Qualifying Residential Property

On December 27, 2011, the Arizona Court of Appeals (Div. 1) ruled that the Arizona anti-deficiency statute prohibits a lender from pursuing a deficiency judgment after conducting a trustee's sale on an unoccupied, partially completed residence.  M&I Marshall v. Mueller, 624 Ariz. Adv. Rep. 23 will have a sweeping impact on a lender's right to obtain a deficiency judgment in Arizona. 

A.R.S. § 33-814(G) - known as the anti-deficiency statute - prohibits an action for a deficiency judgment on trust property that is (i) less than two and one-half acres;  (ii) limited to and utilized for either a single one-family or a single two-family dwelling; and (iii) sold pursuant to the trustee's power of sale.  Before Mueller, it was generally understood that the anti-deficiency statute only applies when the lender conducts a trustee's sale on property actually utilized as a dwelling.

In Mueller, the borrower obtained a construction loan from M&I Bank to build a single family residence on their vacant lot.  Subsequently, the borrowers defaulted under its loan and M&I Bank conducted a non-judicial trustee's sale under A.R.S. § 33-814.  After the trustee's sale, M&I Bank timely filed a lawsuit seeking a deficiency judgment.  The borrowers moved to dismiss the lawsuit based on the protections afforded by the anti-deficiency statute.  M&I Bank asserted that the borrowers were not entitled to the anti-deficiency protection because the home was never completed and, therefore, never utilized as a dwelling.  The trial court judge ruled in favor of the borrowers and M&I Bank appealed. 

On Appeal, the Court upheld the trial court's decision.  The Court opined that the primary purpose of the Arizona anti-deficiency statutes is to protect "homeowners" from deficiency judgments, and that such protections should apply universally to homeowners who actually reside at their property as well as those who intend to take up residence upon completion of a newly constructed home.       

Mueller is a disturbing opinion that ignores the express language of the anti-deficiency statute and past case law interpreting it, and suggests that the controlling factor in deficiency litigation is the borrower's intended future use of the property.  We question the logic in the opinion, and believe that it may be the subject of further review by the Arizona Supreme Court.  Nevertheless, the Mueller opinion is now judicial precedent in the State of Arizona, and lenders should be aware of the limitations it now places on lenders seeking to pursue a deficiency judgment. 

For more information on the effect of Mueller on pending deficiency litigation and outstanding loans secured by real property, please contact a member of the Creditors Rights and Bankruptcy or Lending practice groups.