CLIENT ALERT: Adherence to 90-Day Rule Crucial For Lenders Seeking Deficiency Judgments

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[author: J. Henk Taylor]

Filing Timely Lawsuit Protects Lenders When Arbitration Fails

Lenders holding loans secured by deeds of trust against real estate in Arizona are likely aware of their limited window of opportunity to seek a deficiency judgment against a borrower or guarantor following a trustee’s sale of collateral. Arizona’s deed of trust statute requires the lender to bring an “action” for the deficiency amount no later than 90 days following completion of the trustee’s sale of the property. A.R.S. § 33-814(A). Knowing this, lenders’ counsel will typically file a lawsuit against the borrower and any guarantor on the loan promptly after a trustee’s sale is completed for less than full payment of the debt.

Arbitration v. Court Determinations

A recent decision from the Arizona Court of Appeals indicates that in some situations, a lender’s right to a deficiency judgment may be determined by an arbitrator and not a court. In National Bank of Arizona v. Schwartz, ___ Ariz. ___, 283 P.3d 41, 2012 WL 2459408 (Ariz. App. 2012), the Court of Appeals enforced an arbitration clause in a note and upheld the borrower’s request that the lender’s claim for a deficiency judgment be referred to arbitration rather than determined by a court.

In Schwartz, the Bank loaned the borrowers $1,360,000 in 2007 secured by a deed of trust against their residence in Scottsdale, Arizona. The borrowers defaulted on their loan; and the Bank conducted a trustee’s sale of the property. The Bank credit bid $675,000 at the sale, which the Bank asserted was the property’s fair market value at the time. This left a deficiency of $764,680.31.

Within 90 days of the trustee’s sale, the Bank filed a lawsuit against the borrowers seeking a judgment for the deficiency1. The borrowers, however, moved to dismiss the lawsuit or in the alternative compel arbitration because the Bank’s promissory note included an arbitration clause. The trial court denied the borrowers’ motion. The Court of Appeals reversed. In doing so, the appellate court examined the language of the parties’ arbitration agreement and rejected the Bank’s argument that a deficiency claim was not subject to arbitration.

Notable Footnote in Case

While the analysis in Schwartz focused on the language of the arbitration clause at issue, the case is perhaps most notable for one of its footnotes. In a footnote, the Court of Appeals disagreed with the trial court’s conclusion that the deficiency claim could not be arbitrated because section 33-814(A) specifically requires a lender to bring an “action” for the deficiency. In litigation parlance, an “action” typically means a lawsuit in court—not an arbitration. In a perfunctory comment, the Court of Appeals said that such a conclusion “begs the question” because the purpose of an arbitration agreement is to avoid litigation and “[t]o require litigation where the parties have explicitly agreed to arbitration is counterintuitive.”

It remains to be seen whether the Schwartz court’s comment in a footnote has recast the meaning of “action” as lenders’ counsel have traditionally understood this term in section 33-814(A). Certainly it is a fair reading of the court’s comment to conclude that a lender can initiate an “action” under Section 33-814 by serving a demand for arbitration on a deficiency claim rather than filing a lawsuit.

It is notable, however, that most promissory notes and guarantees do not contain arbitration clauses. If there is no arbitration clause, the lender has only the option of filing a lawsuit for the deficiency. Moreover, filing a lawsuit does not preclude the parties from arbitrating the merits of a deficiency claim. Arizona’s arbitration statute requires a court to stay a pending lawsuit during arbitration. A.R.S. § 12-1502(D).

Tips for Lenders

But even where the note or guaranty includes an arbitration clause, a prudent lender should, notwithstanding Schwartz’s footnote, file a lawsuit in court within 90 days of a trustee’s sale. Schwartz’s footnote is arguably dicta in the case because the Bank filed a lawsuit rather than simply serving a demand for arbitration. Because a lawsuit is unquestionably an “action” within the meaning of section 33-814(A), the court was not faced with the issue of whether a demand for arbitration qualified as an “action” under this statute. Thus Schwartz’s footnote is of dubious precedential value and should not be relied upon by lenders seeking to collect deficiencies from borrowers and guarantors.

A lender should not risk a court finding a demand for arbitration is not an “action,” and should file a lawsuit within 90 days of the trustee’s sale. If the lender wants to arbitrate—or the borrower moves to compel arbitration—then the court can stay the lawsuit while the parties arbitrate. Once the arbitration is complete, the parties can come back to court and have the court enter judgment on the arbitration award in the pending lawsuit. Following this path will avoid any issue as to whether the lender has complied with the 90-day limitation period of section 33-814(A).

For More Information

Contact a creditors’ rights lawyer if you have questions about this case or related issues.


1It is unclear why, given the collateral appeared to be a residence, the lender’s deficiency claim was not barred by Arizona’s anti-deficiency statute, A.R.S. § 33-814(G). The Court of Appeals noted this point in a footnote.