The courts are filled with cases against guarantors and individual general partners. After foreclosing real estate, lenders are proceeding against the borrowers, general partners and guarantors for deficiency judgments (i.e., the difference between what a borrower owes on an outstanding loan and the amount a lender receives from the sale of the foreclosed collateral). Because of the volume of these cases, the Arizona legislature has enacted new laws regarding the rights of lenders, borrowers, and guarantors, with the most recent legislation attempting to balance the rights of lenders with those of borrowers and guarantors.
Typically, a bank or savings and loan association that finances real estate requires a note from the borrower, a deed of trust on the real estate, and a commitment from guarantors (the borrower’s principals, general partners, or even third parties) to guarantee the loan. When a loan goes into default and the lender forecloses on the real estate, the lender typically files a suit against the borrower and any general partners or guarantors for any deficiency.
Until amendments to the law in 1988 made it clear that guarantors and other third party obligors were not entitled to a defense that the real estate collateral had a value exceeding the debt owed the lender, the rights of guarantors or other third parties were not specified in the statutes.
These changes to Arizona law clarify the fair market value and borrower and guarantor protection issues. For example, the fair market value of a lender’s collateral must now be subtracted from any judgment against a guarantor, a general partner of a partnership borrower or the original borrower.
The amendments also clearly limit the lender’s claim, even after a judicial foreclosure (i.e., when the foreclosure is the result of a lawsuit filed by the lender), to the difference between the debt and either the fair market value or sales price of the collateral, whichever is higher. Before this amendment, the lender could recover a judgment based on the difference between the sale price of the collateral and the debt obligation. Fair market value was not considered.
Creation of valuation hearings is another aspect of the most recent legislative changes. Now, a judgment debtor may ask the court to establish the fair market value of foreclosed collateral by filing an application with the court within 30 days after the foreclosed collateral is sold. The new law provides that all interested parties are notified of the application and that the court must determine the fair market value1 in an expeditious manner. Note that the filing party forfeits his ability to regain his collateral (right of redemption) when he files an application for an evaluation hearing.
The new legislation also prevents a creditor from foreclosing on a judgment debtor’s personal residence unless the judgment remains unsatisfied after foreclosure on all other property of the judgment debtor.
Finally, this legislation makes it clear that a creditor can take independent action against a guarantor or general partner, regardless of the status of the collateral. In other words, a lender can sue a guarantor or partner for the entire amount owed under a contract, regardless of whether the lender’s collateral is tied up in a bankruptcy proceeding or otherwise. The lender can also take a judgment before taking action to dispose of the collateral. (The guarantor or partner will, however, receive a credit for the value of the collateral in the action against him.)
Although the changes to guarantor liability laws enumerated above are intended to clarify the rights of lenders, borrowers, and guarantors under Arizona law, they can be very confusing to the lay person. Therefore, you should take the time to identify and understand your rights before you sign recourse promissory notes or guarantee any loans. We also encourage you to consult with counsel to determine how these guarantor liability amendments affect you.
1 Fair market value is defined as “the most probable price” obtainable on the date of sale for which the real property would sell, after reasonable exposure in the market under the conditions requisite to a fair sale, less the amount of senior liens, and assuming buyer and seller are each acting prudently, knowledgeably, free from duress, and for self interest.
If you have any questions, please email me at mmcgrath@mcrazlaw.com
