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Borrowers Can Avoid Liability Even After a Trustee’s Sale

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By:  Ben Reeves

Since a lender must have a valid debt and valid lien to conduct a trustee’s sale, a borrower that allows the foreclosure sale to occur impliedly agrees that the debt and lien are valid.  In Madison v. Groseth and BT Capital, LLC v. TD Serv. Co. of Arizona, 229 Ariz. 299, 301, 275 P.3d 598, 600 (2012), Arizona appellate courts reached that exact conclusion, holding that under A.R.S. § 33-811(C), a borrower that does not obtain an injunction stopping a trustee’s sale waives all defenses to the validity of the sale and all defenses related to the sale.  A recent decision from the Arizona Court of Appeals, however, holds that notwithstanding this case law, a borrower may assert “common law” defenses to the debt even after a trustee’s sale occurs.

In Morgan AZ Financial, LLC v. Gotses, the borrowers defaulted and the lender completed a trustee’s sale of its real property collateral.  The lender then sued for an $850,000 deficiency judgment under A.R.S. § 33-814(A).  The borrowers asserted “fraud-based” defenses to the underlying loan contract, and argued that they were not liable for the debt.  The lender argued, based on Madison, BT Capital, and A.R.S. § 33-811(C), that the borrowers waived all defenses (including the “fraud-based” defenses) to the validity of the loan, contract, and sale.  The trial court agreed, and entered judgment for the lender.

The Court of Appeals reversed, holding that the borrowers’ “defenses under the note remained available in the deficiency action.”  The Court of Appeals reasoned that the trustee’s sale was a completely separate mechanism than a deficiency action and, therefore, “the mere occurrence of a trustee’s sale, though predicated on an allegation of breach, does not constitute a judicial determination that the borrower has breached or that the note is enforceable.”  (Emphasis in the original).

The Morgan AZ Financial holding is somewhat of a setback for secured lenders, and somewhat contradictory of the statutory scheme.  As noted by the opinion, the trustee’s sale statute is designed to afford lenders a speedy and efficient remedy.  The statutory waiver of defenses furthered that objective as recognized by BT Capital and Madison.  Now, however, borrowers can assert defenses in a deficiency action even if they do not object to the trustee’s sale.  This holding conflicts with the purpose of the statute.

The decision also conflicts with the trustee’s sale statute itself.  Per the statute, a trustee’s sale only can occur after breach of a valid loan contract.  Specifically, A.R.S. § 33-807(A) provides, in part, that “a power of sale is conferred upon the trustee of a trust deed under which the trust property may be sold, in the manner provided in this chapter, after a breach or default in the performance of the contract or contracts, for which the trust property is conveyed as security, or a breach or default of the trust deed.”  (Emphasis added).  Under this statute, the trustee can only exercise the power of sale after breach of the contract.  Logically, if the contract was unenforceable (due to a “common law” defense or otherwise), then the trustee could not exercise the power of sale.  Thus, any defense to the enforceability of the underlying contract is a de facto attack on the sale itself….which are barred by Madison, BT Capital, and A.R.S. § 33-811(C).

Unfortunately, the Morgan opinion does not discuss A.R.S. § 33-807(A), and does not spend any time distinguishing BT Capital or Madison.  Thus, the reasoning seems to be somewhat lacking.  Nevertheless, going forward, it appears that “common law” defenses to liability on a loan will survive a trustee’s sale.