Fall is football time. And as every football fan knows, not every player on the line of scrimmage is an eligible receiver. Imagine how dramatically it would change the game if the entire offensive line were eligible to catch forward passes.
Well, on Friday (9/28/15), the NC Supreme Court made a change which is every bit as dramatic and signals a brave new world for lenders seeking to recover on post-foreclosure deficiencies. In High Point Bank & Trust Co. v. Highmark Properties, LLC, the Court instituted a major change to the lender/guarantor relationship. The Court overruled at least 35 years of Court of Appeals decisions in holding that guarantors can seek an offset of the deficiency amount by contesting the fair market value of the property sold at foreclosure. Lenders beware! That offensive tackle just got a whole new section in the playbook.
High Point Bank (“Bank”) made two loans ($4.7 million and $1.75 million) secured by real estate owned by a real estate development company. The loans were guaranteed by the principals of the borrower. When the loans went into default, Bank filed a lawsuit against the borrowers and guarantors and simultaneously instituted power of sale foreclosure proceedings. Bank was the only bidder at the foreclosure sales, paying $2,578,000 for one property and $720,000 for the other.
Bank then filed a motion for summary judgment seeking to recover the deficiencies from the guarantors. Bank argued that guarantors were not entitled to raise any defense based upon the fair market value of the collateral properties, but the trial court disagreed and held that a jury needed to decide the value of the properties. At trial, the jury concluded that Bank bid far less than the fair market value of the properties, and therefore, the deficiency amount owed by guarantors was significantly reduced. Thus, instead of being able to collect a deficiency in excess of $1.5 million, the trial court held that Bank could only collect just over $300,000. The Court of Appeals and NC Supreme Court affirmed.
N.C.G.S. § 45-21.36 permits a person whose property has been purchased by the lender at foreclosure sale to assert that the property was worth more than the amount bid by the lender. If a jury finds that lender bid less than fair market value, the deficiency amount can be reduced or eliminated. Since most foreclosure sales end with the lender taking title to the property and a deficiency owed, N.C.G.S. § 45-21.36 comes up a lot.
Since at least 1979, the North Carolina Court of Appeals held that N.C.G.S. § 45-21.36 did not apply to guarantors and was limited “to those persons who held a property interest in the mortgaged property.” This distinction became crucial for lenders since it meant pursuing a post-foreclosure deficiency judgment against a guarantor was often much easier than pursuing that same judgment against a borrower. In High Point, the North Carolina Supreme Court rejected those 35 years of decisions from the Court of Appeals, and held that because N.C.G.S. § 45-21.36 was passed in 1933 as part of depression era laws designed to protect debtors, it must be construed “more broadly.”
Noticeably, the Supreme Court also held that:
(a) N.C.G.S. § 45-21.36 is not really a defense but “an equitable method of calculating the indebtedness;” and
(b) the protections of the statute are “not subject to waiver.”
It’s hard to overstate the major effect that the High Point decision will have for lenders trying to collect post-foreclosure deficiencies. Among those lessons are these:
(1) N.C.G.S. § 45-21.36 will now be raised in every post-foreclosure deficiency case in which the lender takes title, whether the action is against borrowers or guarantors.
(2) The Court’s characterization of the statute as an unwaivable method of calculating the indebtedness (rather than a standard defense) indicates that a defendant does not need to raise it as an affirmative defense (on which the defendant bears the burden of proof) but that the lender must address it as part of its burden at trial.
(3) Jury trials in post-foreclosure deficiency actions will become the norm as (a) jury trial waivers are unenforceable in NC and (b) the question of value of real estate is almost always a question of material fact not subject to determination at the summary judgment level.
So, what’s a lender to do? On the front end, lenders should give more thought to the value of arbitration provisions in their loan documents. There are certainly risks to arbitration (e.g. the lack of appeal), but the process is generally faster and less cumbersome than a jury trial. On the back end, lenders should consider options to avoid the provisions of N.C.G.S. § 45-21.36 entirely. Those options include (a) obtaining a judgment on the note/guaranty prior to foreclosing on the collateral (since the statute only kicks in when dealing with a post-foreclosure deficiency); and (b) pursuing a judicial foreclosure rather than a power-of-sale foreclosure (since the statute only applies to cases involving the latter).
So for all you lenders out there, this is your heads-up: The rules have changed and new players have become eligible. Talk with your counsel now to rewrite the playbook so you are not left flat-footed.