Court of Appeals Issues New Ruling Regarding Anti-Deficiency Statutes

The Arizona Court of Appeals has been busy: after extending the protections of Arizona’s anti-deficiency statutes to vacant lots in December 2011, the Court of Appeals handed down a new decision today that answers previously unanswered questions regarding construction loans and “cash-out” refinances.

According to the new decision, Helvetica Servicing, Inc. v. Pasquan, 1 CA-CV 10-0418 (App. 2012), the anti-deficiency statute now applies to construction loans in certain situations. The Court of Appeals reasoned that “construing the anti-deficiency protection to apply to construction loans furthers [the] legislative policies [behind the anti-deficiency statutes]” (the anti-deficiency statute allocates the risk of inadequate security to lenders, thereby discouraging overvaluation of the collateral). Id. at ¶ 31. The Court of Appeals further commented that the application of the anti-deficiency statutes to construction loans will “tend to discourage construction [lending] which is ‘unsound’ because the [construction project] is overvalued.” Id.

Perhaps more important, the new Pasquan decision addresses the issue of a “cash-out” refinance. Everyone agrees that a purchase money mortgage used to purchase a single or two family residence, situated on 2.5 acres or less, that has been “utilized as a dwelling,” is non-recourse under Arizona’s anti-deficiency laws. And following the Bank One v. Beauvais, 188 Ariz. 245, 945 P.2d 809 (App. 1977) decision, everyone agrees that even the refinance of a purchase money loan is protected. But great debate has ensued over whether a “cash-out refinance” is protected. For example, borrower purchases a single-family home in 2003 with a purchase money loan for $100,000. Two years later, the home appreciates in value and the borrower refinances the original purchase money loan for $150,000. Borrower subsequently defaults. Is the $50,000 “cash-out” portion of the refinance protected by the anti-deficiency statute?

According to the new Pasqual decision, the answer is “no.” It is “inappropriate to shield borrowers from deficiencies for loan disbursements unrelated to the acquisition or construction of a qualifying residence.” Id. at ¶ 37. Thus, “to the extent a judicially foreclosed mortgage includes both purchase-money and non-purchase money sums, a lender may pursue a deficiency judgment for the latter amounts.” Id. at ¶ 37.

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