In today’s economy, banks all too commonly find themselves foreclosing on real property collateral. As a result, banks are regularly in the position of having to determine the starting bid in foreclosure proceedings. This determination can be complicated by North Carolina General Statute § 45-21.36, which enables borrowers to defend or offset subsequent deficiency judgments by showing “that the property sold was fairly worth the amount of the debt secured by it at the time and place of sale or that the amount bid was substantially less than its true value . . .” (emphasis added).
Until recently, it was not entirely clear whether this statute applied in bankruptcy proceedings — when, following foreclosure, banks are left with unsecured, deficiency claims instead of deficiency judgments. In addition, North Carolina courts had not explicitly prescribed what constituted a bid for “substantially less” than the real property collateral’s “true value,” or even exactly what “true value” meant. However, two recent North Carolina bankruptcy court opinions have shed substantial light on these questions, and provide valuable guidance for banks that are negotiating the foreclosure bid process.
First, in In re Stutts, American National Bank & Trust Company obtained relief from the automatic stay, foreclosed on the real property collateral, and, as the highest (and only) bidder at the foreclosure sale, obtained title to the property through the foreclosure. See No. 11-11728, slip op. (Bankr. M.D.N.C. December 3, 2013). American National then filed an unsecured deficiency claim in the amount of $104,917.83 for the remaining balance. The debtors objected to American National’s deficiency claim on the grounds that the amount American National bid was substantially less than the property’s true value under section 45-21.36. In ruling on this objection, the United States Bankruptcy Court for the Middle District of North Carolina clearly established that N.C.G.S. § 45-21.36 does apply to bankruptcy proceedings since a deficiency claim is “tantamount to a deficiency judgment.” American National, slip. op. at 5 (citing Hyde v. Taylor, 320 S.E.2d 904, 906 (N.C. Ct. App. 1984)). The Court also made it clear that, in the context of section 45-21.36, “true value” means “fair market value.” Id. at 10. The Court ultimately held that American National’s bid of $205,200, which was 30% less than the bank’s most recent appraisal value for the property, was substantially less than the property’s true value. As a result, the Court allowed the debtors to offset and reduce the deficiency claim by $91,800, which represented the difference between the property’s true value and the bid amount.
More recently, in In re Greco, Capital Bank, N.A. obtained relief from the automatic stay to foreclose on the real property collateral securing the Bank’s claim and, as the highest (and only) bidder at the foreclosure sale, obtained title to the property through the foreclosure. See No. 12-51497, slip op. (Bankr. M.D.N.C. March 21, 2014). The Bank subsequently filed an unsecured deficiency claim in the amount of $267,948.64 for the remaining balance. The debtors objected to the Bank’s deficiency claim, arguing that the Bank’s bid of $350,000 at the foreclosure sale was substantially less than the property’s true value. After hearing the testimony of the male debtor and three appraisers at a hearing on the matter, the United States Bankruptcy Court for the Middle District of North Carolina found that the bank’s bid was not substantially less than the property’s true value and overruled the debtors’ objection. In doing so, the Court relied on a guideline previously established by the North Carolina Court of Appeals in concluding that a bid must be at least 20% less than the property’s fair market value in order for the bid to be “substantially less” than the property’s true value under section 45-21.36. Id. at 7-8. The Court also relied on its conclusion that the Bank did not receive a “windfall” when it purchased the property for $350,000 in overruling the debtors’ objection. Id. at 8.
Now the ultimate question: how does this affect me? In light of these two opinions, banks should be mindful of the reality that a debtor in a bankruptcy proceeding can defeat or offset the bank’s deficiency claim by showing that the amount the bank bid on property at a foreclosure sale was substantially less than the property’s fair market value at the time of the foreclosure sale. In addition, a bank establishing a starting foreclosure bid amount should consider whether the bid amount is well within 20% of the subject property’s appraised value — in addition to the usual array of considerations factored into calculating the bid amount — because North Carolina bankruptcy courts have defined this as “substantially less” than the property’s true value.