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A Lender Holding Two Liens Can Foreclose on the Senior Lien and Sue on the Junior Lien

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By:  Ben Reeves

In Wells Fargo Bank, N.A. v. Riggio, No. 1CA-CV-12-0430 (Ariz. Ct. App. June 4, 2013), the Arizona Court of Appeals held:  (i) that the “merger of rights” doctrine does not “merge” a lender’s first and second lien into a single unitary interest upon the foreclosure of the first lien, and (ii) A.R.S. § 33-814 does not apply to an action on a junior loan.  In other words, Arizona law permits a lender holding two liens against the same property to foreclose on the senior lien, and then sue on the second loan outside of Arizona’s anti-deficiency statutory scheme.

In Riggio, Wells Fargo Bank lent the Riggios $410,000 and secured the loan by a first lien against their house (the “Senior Lien”).  A year later, the bank lent another $350,000 and secured the debt with a second lien against the Riggios house (the “Junior Lien”).  The Riggios defaulted, Wells Fargo Bank initiated a trustee’s sale of its Senior Lien, and purchased the home at the trustee’s sale with a credit bid of $416,474.57.  The Junior Lien was extinguished by the trustee’s sale.  Nevertheless, twenty-two (22) months after the trustee’s sale, Wells Fargo Bank filed suit against the Riggios to recover the debt owed under the second loan. 

The Riggios made two arguments in defense of the suit.  First, they argued that the suit was a deficiency action governed by A.R.S. § 33-814, which requires deficiency actions to be filed within ninety (90) days of the trustee’s sale and entitles the Riggios to a “fair market value” hearing.  Second, the Riggios argued that the “merger of rights” doctrine barred an action on the second loan under Mid Kansas Federal Savings & Loan Ass’n of Wichita v. Dynamic Development Corp., 167 Ariz. 122, 804 P.3d 1310 (1991).  The Court of Appeals rejected both arguments.

First, the Court of Appeals concluded that A.R.S. § 33-814(A) specifically provides that it applies only to the “contract for which the [lien] was given as security” (i.e., the Senior Lien).  The Junior Lien was not foreclosed, and A.R.S. § 33-814(A) did not apply.  Thus, even though the Riggios argued that the home was worth $700,000 (compared to the $416,474.57 received at the trustee’s sale), neither the ninety (90) day statute of limitations, nor “fair market value” protections applied to the suit on the junior loan.

Second, the Court of Appeals rejected application of the “merger of rights” doctrine to the facts of this case.  In the Mid Kansas opinion, the Arizona Supreme Court held that when a lender holding two liens forecloses on the second/junior lien, its interest as owner and interest as first lien holder are “merged” such that the first lien is “extinguished.”  In other words, a lender cannot foreclose, become the owner of the property, and retain its lien on the same property.  The Riggios argued that a similar merger/extinguishment happened when Wells Fargo Bank foreclosed on its Senior Lien.  The Court of Appeals disagreed.  Because Wells Fargo Bank foreclosed on the Senior Lien, the doctrine of merger did not apply. 

The distinction between Riggio and Mid Kansas at first blush seems superficial.  However, it makes sense.  In Mid Kansas, the lender attempted to recover the property and a lien (a situation which required “merger”).  By contrast, in Riggio, Wells Fargo Bank was left with the property and an unsecured claim (a situation which does not require “merger”).

The opinion is noteworthy for two (2) reasons.  It confirms that an action on a second note is an independent action under Arizona law and that A.R.S. § 33-814 does not apply to the action.  It also provides some clarity on the application of the merger doctrine to holders of first and second liens.