Last week, the Washington Court of Appeals, Division One, ruled that, notwithstanding the anti-deficiency provision in the state's Deeds of Trust Act, a lender can pursue a deficiency judgment against a guarantor following a non-judicial foreclosure of the property securing the underlying borrower's obligation. The decision, Washington Federal v. Gentry, Case No. 70004-9-I, 2014 Wash. App. LEXIS 379 (Wash. Ct. App. Feb. 18, 2014), comes in the wake of a contrary decision by the Washington Court of Appeals, Division Two, less than three months ago. This Division One decision appears to be a triumph for lenders and creates a split among the divisions of the Washington Court of Appeals that may warrant consideration of the issue by the Washington Supreme Court.
Washington Federal (as successor to the original lender) loaned $7,252,680.47 to three companies owned by Kendall and Nancy Gentry (the "Borrowers"); the loans were secured by two deeds of trust on properties owned by the Borrowers. Kendall and Nancy Gentry guaranteed the loans. The Borrowers failed to pay the loans back when they matured, and the Gentrys failed to honor their obligations under the guaranties. Washington Federal conducted a trustee's sale of the two properties securing the loans (i.e., a non-judicial foreclosure), at which Washington Federal was the successful bidder. Washington Federal's credit bid was less than the full amount of the outstanding obligations under the loans and a deficiency remained. Washington Federal commenced an action against the Gentrys to enforce their guaranties and recover the amount of the deficiency. The Gentrys moved for summary judgment, contending that the Deeds of Trust Act barred the deficiency action. The trial court ruled in favor of the Gentrys, finding that the suit on the guaranties was barred; Washington Federal appealed.
Washington's Deeds of Trust Act ("Act") represents a compromise of sorts between lenders and borrowers. The Act permits lenders to conduct non-judicial foreclosures of deeds of trust, a much quicker and less expensive process than judicial foreclosure. In exchange, lenders are prohibited from seeking deficiency judgments after a trustee's sale has occurred, subject to certain exceptions. The Gentry decision concerns the scope of two of these exceptions, RCW 61.24.100(3) ("Subsection 3") and RCW 61.24.100(10) ("Subsection 10").
Subsection 3 provides certain enumerated exceptions to the general prohibition against deficiency actions, including the following: "(c) Subject to this section, an action for a deficiency judgment against a guarantor if the guarantor is timely given the notices under RCW 61.24.042." RCW 61.24.100(3). Subsection 3's exception for deficiency actions against guarantors remains subject to the other provisions of the section. The Gentrys maintained that one such other provision, Subsection 10, barred Washington Federal's deficiency action.
Subsection 10 reads: "A trustee's sale under a deed of trust securing a commercial loan does not preclude an action to collect or enforce any obligation of a borrower or guarantor if that obligation, or the substantial equivalent of that obligation, was not secured by the deed of trust." RCW 61.24.100(10). The Gentrys asserted that this language, which is permissive in nature, served to effectively bar any action against a borrower or guarantor where that party's obligation was secured by a deed of trust. The argument was that because the original loans were secured, the Act precluded Washington Federal from pursuing the guarantors after the non-judicial foreclosure. The Gentrys relied on a recent decision of the Washington Court of Appeals, Division Two, to support their argument. In First-Citizens Bank & Trust Co. v. Cornerstone Homes & Development LLC, 314 P.3d 420 (Wash. App. Ct. 2013), the court accepted a similar argument, reasoning that Subsection 10 is the only exception to the statute's general prohibition against deficiency actions, and thus, if the only exception is for actions where the obligation was not secured by the deed of trust, then actions where the obligation was secured by the deed of trust must necessarily be barred.
However, the Gentry court disagreed, ruling in favor of Washington Federal on two grounds: (1) Subsection 10 is not the only exception to the Act's prohibition against deficiency actions (e.g., Subsection 3), and the reasoning employed by both the Gentrys and the Cornerstone court to conclude that Subsection 10 precludes all deficiency actions where the obligation is in fact secured by the deed of trust is therefore fatally flawed; and (2) the Gentrys' guaranties were not secured by the deeds of trust in any event and therefore fell within Subsection 10's exception.
In light of the split among the appellate court divisions in Gentry and Cornerstone, observers should wait and see if the Washington Supreme Court will resolve these competing interpretations. In the meantime, lenders should be aware that they may be precluded from making a deficiency claim should they pursue a non-judicial foreclosure. Lenders may wish to have legal counsel review relevant loan documents and should consider the judicial foreclosure route—though lengthier and more expensive—in order to preserve a deficiency claim.