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Do Obligations in a Deed of Trust Survive a Trustee’s Sale of Property?

Financial Institutions Law Alert Scott A. Klundt

On Tuesday, April 25, the Arizona Court of Appeals issued an Opinion, reversing the entry of a deficiency judgment in favor of a lender on the grounds that the lawsuit was time-barred. The Opinion is a good reminder of the importance of understanding which law governs your loan documents. However, the Opinion also goes too far in apparently declaring that provisions in a deed of trust no longer are enforceable following a trustee's sale.

Background

In 2004, the bank made a loan that was used by the borrowers (who resided in California) to purchase commercial real property in Missouri. Repayment of the loan was secured by a deed of trust on the property. Both the promissory note and the deed of trust recited that they were governed by the laws of Utah, but the deed of trust also provided that "procedural matters related to the perfection and enforcement of Lender's rights and remedies against the Property" would be governed by Missouri law. In 2012, the borrowers defaulted on their payment obligations. The bank foreclosed on the property via a trustee's sale, which resulted in a deficiency balance in the amount of $147,000.

In 2014, the bank sued the borrowers, who had moved to Arizona, to collect the deficiency balance. The borrowers moved to dismiss the lawsuit, claiming that it was barred by Arizona law, which requires a deficiency lawsuit to be filed within 90 days following a trustee's sale. The trial court denied the motion, finding that Missouri's 5-year statute of limitations applied, thus making the lawsuit timely. The borrowers filed a second motion to dismiss, arguing that Utah law should be applied and that, under Utah law, a deficiency action was required to be filed within 90 days following the trustee's sale of the property. The trial court denied the second motion for the same reasons set forth in its ruling on the first motion. The trial court later entered summary judgment in favor of the bank, and the borrowers appealed.

The Court's Opinion

The Court of Appeals held that the trustee's sale of the property was a procedural matter, and so was governed by Missouri law, as dictated in the deed of trust, but that the deficiency action was a substantive matter and, as such, was governed by Utah law. The Court held that, under Utah law, the deficiency action was time-barred because it was not filed within 90 days following the trustee's sale. Accordingly, the Court of Appeals reversed the trial court's judgment and remanded the case with instructions that the trial court enter judgment in favor of the borrowers. The Court also awarded the borrowers the fees and costs they had incurred on appeal. Presumably, the trial court will do the same, awarding to the borrowers the fees and costs that they had incurred at the trial court level.

Of potential greater interest is the Court's discussion of the continuing validity of deed of trust provisions following a trustee's sale of the property. The bank argued that because the deed of trust contained a provision permitting the lender to recover any deficiency following a trustee's sale, Missouri law should govern the time in which the deficiency action could be filed. The Court rejected that argument, but in doing so, appears to be taking the position that the provisions contained in a deed of trust no longer have any force or effect following a trustee's sale:

"[T]he deed of trust serves only to secure the performance of a loan contract, which allows trust property to be sold and transferred after a breach or default of the underlying loan contract. . . . Once that purpose was served through the trustee's sale, the deed of trust and its choice-of-law provision no longer had effect. . . . . The deed of trust is effectively extinguished after a trustee's sale of the security property. Contrary to [the bank's] argument, then, the remedial provisions do not survive after the successful sale of the property."

[¶17 (emphasis supplied).]

The Lesson

In reaching its conclusion that the provisions of the deed of trust do not survive a trustee's sale of the property, the Court relied on an earlier Arizona Court of Appeals case, Long v. Corbet, 181 Ariz. 153, 157, 888 P.2d 1340, 1344 (App. 1994), in which the Court stated that a junior deed of trust had been "extinguished" as the result of the property having been sold at a trustee's sale held in connection with a senior deed of trust. Unfortunately, it is common for courts to not distinguish between the deed of trust itself and the lien imposed on property by the recording of a deed of trust. Although it is correct to say that the lien of a deed of trust is extinguished as a result of a trustee's sale, it is not correct to say that the deed of trust itself no longer exists. The deed of trust is a separate contract between a lender and borrower, which sets forth the parties' rights and obligations. Those rights and obligations are not necessarily extinguished by a trustee's sale.

For example, a deed of trust typically imposes a duty on the borrower not to commit waste on the property and to ensure that use of the property complies with all environmental laws. Such obligations may not be included in a promissory note or in other loan documents. If the lender conducts a trustee's sale of the property, will Arizona courts now hold that the lender is barred from recovering damages owed as a result of the borrower's breach of those obligations?

In light of the Arizona Court of Appeals' declaration that provisions in a deed of trust no longer exist following a trustee's sale, lenders doing business in Arizona may want to make sure that important obligations contained in a deed of trust are also included in the promissory note, loan agreement, or other loan document in order to avoid an argument by the borrower that such obligations cannot be enforced following a trustee's sale.

For more information, please contact Scott Klundt at (602) 229-5212 / [email protected] or your local Quarles & Brady attorney.