Nearly three years ago, in M&I Marshall & Isley Bank v. Mueller, the Arizona Court of Appeals held that the Arizona anti-deficiency statute protects a borrower who started, but never completed, construction of a single-family dwelling before defaulting on its loan. This week, the same appellate court limited those anti-deficiency protections by holding in BMO Harris Bank v. Wildwood that a developer of vacant land – land on which no construction has begun – cannot invoke the anti-deficiency statute as a matter of law, regardless of whether the borrower intends to eventually reside on that land.
The new decision is significant beyond just the fact that lenders may now seek a deficiency judgment against borrowers who default very early-on before construction commences. Perhaps more important is Judge Donn Kessler’s concurring opinion, which broke new ground – concluding that even when construction is well underway, courts should not simply take the borrower’s word that he or she intends to eventually occupy the property. A more thorough inquiry is warranted, one that looks at the totality of the circumstances to determine whether the borrower intends the structure under construction to be his or her dwelling.
The facts. Wildwood Creek Ranch, LLC obtained a $296,200 loan from BMO Harris’ predecessor in interest, M&I Bank. The loan was secured by a deed of trust on an unimproved, vacant lot in Scottsdale. Wildwood’s members, the Rudgears, executed a promissory note on Wildwood’s behalf and personally guaranteed the loan. After Wildwood defaulted, BMO Harris foreclosed the property through a trustee’s sale and sued Wildwood and the Rudgears to obtain a deficiency judgment on the unpaid balance.
Seeking protection under the anti-deficiency statute, the Rudgears submitted affidavits avowing it was their intent to build a home on the property and occupy it as their primary residence. The trial court found no reason to disagree and granted judgment in their favor. However, the Court of Appeals reversed on the basis that vacant property cannot be a “dwelling” subject to the protection of the anti-deficiency statute, since construction of that dwelling had yet to begin.
The issues. While the result in this case appears straightforward, the appellate court’s reasoning represents a marked shift in favor of lenders, given where the appellate court was just a few years ago. In late 2011, the appellate court had already addressed how the anti-deficiency statute should be applied when construction is incomplete – in favor of the borrower – and thus the Wildwood court could have simply extended that rationale to the owner of the vacant lot. Yet, in very subtle ways, the court decided to make new law here.
The statute at issue, A.R.S. § 33-814(G), provides that no deficiency action may be maintained “if trust property of two and one-half acres or less which is limited to and utilized for either a single one-family or a single two-family dwelling is sold pursuant to [a] trustee’s power of sale.” The statute is silent as to whether borrowers whose dwellings are under construction at the time of default deserve the same protection as those who lived in a completed home. The Arizona Court of Appeals addressed that question in Mueller and held that a borrower need not physically occupy a completed structure to avail himself of protection under the anti-deficiency statute. Regardless of how far construction had progressed, the salient issue in Mueller was whether a borrower purchased the property with the intent of occupying a “dwelling” upon completion. Thus, by focusing on borrower intent as opposed to stage of construction, the Mueller court avoided potentially thorny line-drawing issues as to how much construction would have been sufficient to merit protection.
The appellate court last week in Wildwood, therefore, could have applied Mueller’s reasoning by holding that 0% construction was no more significant than had 1% been completed, as long as the borrower intended to utilize the property for residential purposes. But obviously the appellate court did not believe shielding completely unimproved land from lender deficiency actions was the right result. The Wildwood court therefore abandoned Mueller’s rationale and held that unimproved, vacant land “cannot properly be challenged as a ‘dwelling.’” Because the Rudgears’ “professed intent to construct a home on the Property was irrelevant,” they could not invoke the protection of the anti-deficiency statute.
Of course, by holding that the status of construction suddenly matters, the Wildwood court potentially opened up the can of worms that the Mueller court had artfully avoided. In his concurring opinion, Judge Kessler wondered aloud: “Should the debtor who cannot avoid default until shortly after a foundation is laid be excluded from anti-deficiency protection, but the debtor who defaults after the frame is up be entitled to protection?” Judge Kessler worried that, if the Wildwood opinion were to be applied literally, “a borrower who takes any number of pre-construction steps toward building a dwelling the borrower intends to occupy, but who defaults just after putting shovel to dirt, would be left unprotected . . . [whereas] a borrower who takes all the same pre-construction steps but manages to stay solvent long enough to reach an undefined level of construction would receive anti-deficiency protection.”
According to Judge Kessler, the way to deal with this problem would be to more carefully scrutinize the borrower’s alleged intent to occupy the property for residential purposes. In this case, Wildwood’s loan renewal documents listed the primary purpose of the loan as “Business,” it purchased several contiguous lots and made plans to develop them simultaneously, and represented in several other deeds of trust that the Rudgears intended to utilize those different parcels as their residences as well. Thus, under Judge Kessler’s proposed test, “the level of construction alone is not determinative, but the type, manner, and extent of development are probative of the borrower’s intent.” In other words, it is the totality of the circumstances shining on the intent of the borrower that matters. While his concurring opinion is not binding, it does establish a marker and perhaps provides a roadmap for how other future anti-deficiency cases might be decided, and not just those involving vacant land.
Lenders and developers, not to mention title insurers and custom homebuilders, should evaluate Wildwood carefully in order to determine whether it will affect their day-to-day operations. Regardless of whether vacant land is at issue, Arizona’s anti-deficiency statute appears to have less bite. It will be up to each affected industry to adjust accordingly.