“Sign of the Times…For Now: An Update on ‘Excess Proceeds’ Litigation in Arizona”
Quarles & Brady Financial Institutions Law Update 01/01/14 By David E. Funkhouser
In Arizona, when a piece of real property sells at a trustee’s sale for more than the amount owed to the lender who initiated the sale, so-called “excess proceeds” are generated. Otherwise put, following the foreclosure and sale of a piece of real property, and after the trustee uses a portion of the proceeds from that sale to satisfy the foreclosing lender’s deed of trust, the trustee may be left holding the proverbial “bag” of surplus funds. As Arizona’s real estate market continues to slowly improve and property values continue to rise, trustees are increasingly finding themselves in this position.
While Arizona’s laws governing the distribution of such proceeds have not changed in several years, the sudden change in the real estate market has left some trustees and lenders puzzling over how exactly to properly handle these proceeds. This is not particularly surprising given that, particularly in recent years, and during the Great Recession, it was not uncommon for foreclosing senior lienholders to see liens only partially satisfied, and for junior lienholders to see their liens extinguished entirely.
The proper distribution of excess proceeds stemming from a trustee’s sale is governed, in specific detail, by Arizona Revised Statute § 33-812 (the “Statute”). According to the Statute, a trustee can distribute excess proceeds in essentially two ways. First, the trustee can choose to distribute the proceeds itself, abiding by the order of priority set forth in subsection A of the Statute. Most trustees seem to avoid this alternative in order to avoid any follow-on liability or priority disputes.
Alternatively, a trustee can, in its discretion, deposit the balance of the proceeds with the pertinent county treasurer by way of naming the treasurer in a civil lawsuit. This amounts to essentially an action in interpleader. In that instance, the trustee then washes its hands of the situation and leaves it up to the treasurer, the courts and, primarily, the remaining parties to oversee the proper distribution of the excess proceeds.
The second option also provides significant advantages to a trustee. Not only does it allow the trustee to push the responsibility of distributing the proceeds onto the backs of others, it also absolves the trustee from any responsibility for acts performed in good faith under the statute. It comes as no surprise, then, that many trustees are choosing this method of distribution.
The process for depositing the excess proceeds with the county treasurer is not, however, as simple as it sounds. As noted before, the Statute requires the trustee to commence a civil action in the superior court in the county where the sale occurred. The complaint in that action must name the applicable county treasurer as the defendant, and must incorporate or provide a wide array of items, such as a copy of the trustee sale guarantee, a detailed description of any disbursements made by the trustee, a narrative description of the liens and encumbrances on the property including an analysis of the apparent priority of the potential claimants, as well as other pieces of information. While this process can seem expensive and daunting, the Statute allows the trustee to withhold from the sale proceeds both a trustee’s fee, and reasonable attorneys’ fee and costs incurred in connection with the preparation and filing of the complaint. Following the filing of the complaint, the trustee must then mail a conformed copy to the county treasurer and all other parties who are legally entitled to notice.
Then comes the application process. Once the trustee has mailed the complaint, the Statute allows those who received it — typically junior lienholders and the trustor under the foreclosing deed of trust — to file “applications for distribution in the civil action that was filed by the trustee . . .” The purpose of these applications is to allow potential claimants to explain to the court and the treasurer why they believe they are entitled to the proceeds — i.e., why they believe they have priority under subsection A of the Statute. Any person who receives an application for distribution can then file a response to that application. Importantly, and to assist the court and treasurer in their task of distribution, the Statute requires that each applicant or respondent acknowledge the existence of any apparent lien or encumbrance that could potentially have priority over that applicant or respondent.
If the court finds that a person other than an applicant or respondent has a superior right to receive the proceeds, the court is prohibited from issuing an order distributing those proceeds until 180 days has passed since the filing of the complaint. During that 180-day period, any applicant or respondent can move for a hearing to determine which party has the superior rights to the proceeds. It is critical to note that a junior lienholder can potentially lose any rights it may have to the excess proceeds, even if it would otherwise be entitled to them, if that junior lienholder fails to properly move through the application process in a timely manner. Finally, after this process takes place, the court determines which party is entitled to receive the proceeds and enters an order directing the county treasurer to disburse those proceeds to the proper party.
It is important that trustees, lienholders, and legal professionals who practice in this area have a detailed understanding of this complicated statute — particularly now, when more and more trustee’s sales are resulting in excess proceeds. The Statute provides trustees with an attractive and inexpensive option for handling excess proceeds following a sale, and requires junior lienholders to go through the application process if they want to recover any of those proceeds.