Recent Arizona Case Law and Legislative Developments Affecting Real Estate Lending
The following information accompany a presentation Mike gave to members of the Arizona Commercial Mortgage Lenders Association (ACMLA) on March 8, 2016. A summary of legislative amendments enacted during the most recent session (the First Regular Session) of the 52nd Arizona Legislature that (to varying degrees) affect real estate and real estate lending. The general effective date of all legislation enacted during the session is July 3, 2015. The text of these amendments can be found on the Arizona Legislature's website (http://www.azleg.gov).
Recent Arizona Case Law
Steinberger v. McVey (AZ Court of Appeals 2014). Perkins obtained a loan from IndyMac Bank to buy a house. After Perkins died, his daughter inherited the home and tried to negotiate a loan modification. She supposedly stopped paying because IndyMac advised her she needed to be in default for it to consider a note modification. Following about a year’s worth of confusing communications with various servicers of the loan, IndyMac noticed a trustee’s sale while it considered the modification request, and the daughter filed suit against IndyMac and others to enjoin the trustee’s sale.
The Court of Appeals held that the borrowers may challenge the authority of their lenders to foreclose by making an affirmative good faith allegation that the trustee or beneficiary is not the “true” trustee or beneficiary (akin to the so-called “show me the note” defense). This case appears to contradict the Arizona Supreme Court’s Hogan v. Washington Mutual Bank decision, which held that Arizona’s trustee’s sales statutes do not require the beneficiary to prove its authority or show the note to the trustee before commencing a trustee’s sale. The Court of Appeals distinguished the Hogan decision in that Hogan did not affirmatively allege that the defendants lacked authority to conduct a trustee’s sale.
The Court of Appeals suggested the foreclosure was improper absent an unbroken chain of assignments from the originator of the loan to the present beneficiary (which is inconsistent with the common law rule and Arizona statute that the mortgage follows the note). The Court of Appeals also found that loan servicers can be liable to borrowers for negligent performance of an assumed duty (negligent administration of a loan modification). Borrowers may cite this decision in the future to slow down a foreclosure, particularly in the case of loans sold into a trust pool or loans that have come through an FDIC receivership, where the trail of endorsements and assignments is often incomplete.
Rigoli v. 44 Monroe Marketing, LLC (AZ Court of Appeals 2014). Corus Bank made a construction loan for the 44 West Monroe high-rise condo project in downtown Phoenix. The lender required the developer to have at least 100 presold units and to collect and deposit with the Bank unit down payments of approximately $4.4 million, which were used to fund project construction costs prior to advances of loan proceeds. The developer defaulted on the loan, and the FDIC became the receiver for Corus Bank. During the receivership, the loan was transferred to a new entity, Corus Construction Venture, LLC, which took the project back at a trustee’s sale with the apparent intention that the trustee’s sale would extinguish any remaining rights of the unit buyers so the property could be free and clear and remarketed as rental apartments. Corus Construction then transferred the project to 44 Monroe Marketing, LLC, which was sued by some of the unit buyers who had lost their down payments. The unit buyers claimed that their equitable vendees’ liens were senior to the later recorded construction DOT and therefore survived the trustee’s sale.
The Court of Appeals held that the unit buyers acquired valid vendees’ liens for the amounts they paid on the unit purchases when the purchase contracts were signed and down payments were made, without the need to record a document asserting the lien. The Court found that language in the purchase contracts providing that the buyers’ sole remedies for a seller breach were either contract termination or specific performance were insufficient to waive the vendees’ liens. As Corus Bank not only knew of the purchase contracts, but required the down payments to be held by the Bank, it was held to have notice of the existence of the unit purchase contracts and the resulting liens, and the Bank’s DOT was subordinated to the vendee’s liens.
Takeaways from this case include (i) the lender likely needs to have heavy input in the form of the unit purchase contracts to ensure that they include specific unambiguous waivers of vendees’ liens (which may have the effect of scaring off unit buyers); and (ii) courts will likely try to find a way to protect unit buyers at a construction lender’s expense, particularly where the lender has required presales and holds the buyer deposits.
Weitz Company v. Heth (AZ Supreme Court 2014). In April 2005, FNBA recorded a DOT to secure its acquisition loan before construction started on The Summit at Copper Square high rise condo project near Chase Field in downtown Phoenix. Construction started in November 2005. In December 2005, FNBA recorded an amended DOT to secure the developer’s construction loan. In September 2007, the developer began selling condominium units and FNBA agreed to release the owners from both DOTs when unit loans were paid off. In May 2008, the contractor recorded a $4,000,000 mechanic’s lien, and in November 2008, it filed a foreclosure lawsuit claiming that its November 2005 lien rights were senior to FNBA’s December 2005 amended DOT and the individual unit owners and their lenders. The Arizona Court of Appeals had held, contrary to the law in Arizona and most other jurisdictions, that the 2005 amended DOT was not subrogated to the original DOT (meaning that the later lender could not claim the priority of the earlier DOT for the benefit of its later DOT).
The Supreme Court reversed the Court of Appeals decision and held that (i) nothing in Arizona’s mechanics’ lien statutes suggests that the Legislature intended to preclude equitable subrogation (which allows a lender who pays off the borrower’s obligation to a prior lender to step into the shoes of the prior lender) in a mechanic’s lien context, (ii) because the equitably subrogated lien attaches when the superior lien was recorded, the laborers’ and materialmen’s rights are not prejudiced when the senior lien is assigned from one party to another, and (iii) partial subrogation (unit by unit) is permitted prior to payment of the senior loan in full if it would not cause the security to be divided between the original lender and the later lender.
Great Western Bank v. LJC Development (AZ Court of Appeals 2015). The bank entered into an A&D loan with Cedar Ridge Investments. The bank and borrower also entered into a construction loan agreement to provide funds to construct homes on the property, which expired on December 1, 2008. In July 2008, the Bank decided to cease all construction financing in Arizona, and advised the borrower that it was withdrawing from the agreement, but the borrower was unable to find alternative financing. The bank foreclosed and then sued the guarantors to recover a $2.6 million deficiency. The guarantors filed a counterclaim asserting that the bank’s refusal to fund the agreement constituted an anticipatory repudiation of the agreement, breached the covenant of good faith and fair dealing, and gave rise to damages for lost profits that would have otherwise have been used to pay off the loan.
The bank argued at trial that the loan agreement was merely a “guidance line” that did not obligate the bank to fund home construction, but allowed the bank to decide whether or not to fund the construction of any individual home upon the borrower’s submission of certain additional information to the bank. The Court of Appeals held that the loan agreement committed the bank to continue funding loans and that the bank’s breach of the agreement caused damage to the guarantors in the form of lost profits. The Court noted that, notwithstanding the December 1, 2008 expiration of the agreement, it would have been in the bank’s economic interest to extend the loan if the parties were performing, and found that the bank would have continued its arrangement with the borrower such that the borrower would have had sufficient time to sell all the homes but for the bank’s breach of the agreement. The Court held that the amount of lost profits exceeded the amount of the claimed deficiency and awarded damages and attorneys’ fees to the guarantors.
Arizona Bank & Trust v. James R. Barrons Trust (AZ Court of Appeals 2015). The Court of Appeals held that, while borrowers cannot waive in advance the protection of Arizona’s anti-deficiency statutes [which preclude a lender from suing for a deficiency after a trustee’s sale of trust property of 2½ acres or less which is limited to and utilized for either a single one-family or single-two family dwelling], guarantors can do so. The Court of Appeals reasoned that the guarantor does not risk losing a home to foreclosure, but only risks the funds needed to cover a deficiency.
This decision is a bit surprising in light of the Arizona Supreme Court’s December 2014 decision in CSA 13-101 Loop, LLC v. Loop 101, LLC, which invalidated an advance waiver (as to both borrowers and guarantors) of the right to a fair market value hearing and fair market value credit as a violation of Arizona public policy. The Barrons case reaffirmed that the Arizona statute providing for a fair market value credit cannot be waived in advance by guarantors. Until the Barrons decision is overturned, perhaps the wisest course of action in dealing with anti-deficiency properties would be to have your most creditworthy party be a guarantor (which canwaive the anti-deficiency protections) instead of a direct borrower (which cannot waive those protections).
Recently Enacted Legislation
Sales Taxes. Before 2015, nearly all construction activity was taxed as prime contracting, with contractors paying transaction privilege taxes (TPT) on 65% of the gross receipts and purchasing materials without retail TPT using a resale number. The prime contracting TPT statutes were amended, effective January 1, 2015, to exclude service contracting from prime contracting TPT. Service contractors must instead pay retail TPT at the point of sale on materials used. A project will quality for the service contracting exclusion if (i) the construction contract is between the owner and the contractor, and (ii) the project is for the maintenance, repair, replacement or alteration of existing property. [For the foregoing purposes: (a) maintenance is the upkeep of property or equipment, such as re-staining a wood deck; (b) repair activity returns property to a usable state from a partial or total state of inoperability or nonfunctionality, such as clearing a blocked pipe; (c) replacement activity involves removing one component of a property, such as a roof, and installing a new component that provides the same, similar or upgraded design or functionality; and (d) alteration causes a direct physical change to existing property and each of the following conditions is met with commercial property: (x) the contract price is $750,000 or less, (y) the scope of work directly relates to 40% or less of existing square footage, and (z) the scope of work expands the existing square footage that is 10% or less of the pre-existing square footage.]
Before 2015, business purchased materials without retail TPT for incorporation into construction projects by presenting ADOR Form 5000 to their suppliers, and general contractors issued Form 5005 to their subcontractors to establish the general contractor’s responsibility for remitting prime contracting TPT. Businesses may continue to purchase materials free of retail TPT if they hold a current TPT license and submit a current Form 5000, whether or not the project is classified as prime contracting or service contracting. For service contracting projects, general contractors may, but are not required to, issue Form 5005 to their TPT-licensed subcontractors, and doing so will make the general contractor responsible for remitting retail TPT on materials purchased by its subcontractors. The ADOR issued new Form 5000 and 5005 templates for use in and after 2015. To reign in the abuse of exemption certificates, the ADOR now issues project-specific exemption certificates for use by contractors in purchasing TPT-free building materials.
Effective January 1, 2015, each real property owner is required to have a TPT license per location, and property managers and management companies may no longer obtain a TPT license on behalf of their clients. If the owner wishes to have a property manager or management company file and pay their TPT, they must file a POA (Form 285) with the ADOR.
Property Leased to Religious Tenant. In 2015, a new Section 42 11132.01 was added to the Arizona Revised Statutes to classify property, buildings and fixtures that (regardless of ownership) are leased to a non-profit church, religious assembly or religious institution and primarily used for religious worship as Class 9 property for property tax purposes (an assessment ratio of 1%, which is the same given to charter schools). If only part of the parcel or improvements is leased to such a tenant and primarily used or held for religious worship, only the portions so leased and held qualify for Class 9 status. The organization, institution or association that owns the property must file with the County Assessor evidence of the organization’s tax exempt status under Section 501(c)(3) of the Internal Revenue Code and an affidavit from the tenant that it uses or holds the property primarily for religious worship.
Proposed 2016 Legislative Amendments
Following is a summary of significant legislative amendments proposed thus far during the current session of the 52nd Arizona Legislature that (to varying degrees) affect real estate and real estate lending. The text of these proposed bills can be found on the Arizona Legislature’s website (http://www.azleg.gov).
H.B. 2555. This bill requires recording of certified copy of any judgment (except for a civil judgment in favor of the State of Arizona) requiring the payment of money and a separate judgment debtor information statement to create a judgment lien against the judgment debtor’s real property. This bill attempts to clarify the confusion created about by the appellate court decisions inLewis v. DeBord with regard to the effect of a judgment creditor’s failure to record a judgment debtor information statement with the certified copy of the judgment.
S.B. 1006. Current law exempts an institutional investor from licensing as a commercial mortgage banker provided that the institutional investor (i) originates or directly or indirectly makes, negotiates, or offers to make or negotiate commercial mortgage loans that are all exclusively funded from their own resources, (ii) does so in the regular course of business, (iii) makes only commercial mortgage loans, (iv) makes each loan on the security of commercial property, and (v) makes only loans of more than $250,000. If the institutional investor makes a single commercial mortgage loan that does not satisfy the foregoing criteria, it is not exempt from the licensing requirement.
This bill modifies the term institutional investor by (a) removing the restriction that the institutional investor make only commercial mortgage loans of more than $250,000, and (b) classifying any person who makes “commercial business purpose loans” that are funded exclusively from their own resources as an institutional investor. For this purpose, commercial business purpose loan means a loan that has a commercial business purpose and that may be directly or indirectly secured by a mortgage, deed of trust or any lien interest on a property that is established with the property owner’s consent. This bill also modifies the institutional investor exemptions from licensing as mortgage brokers, mortgage bankers and advance fee loan brokers to include institutional investors making commercial business purpose loans.
S.B. 1409. This bill amends a large number of Arizona statutes, including the community property statutes, to replace “husband”, “wife” and gender-specific pronoun references with references to “married couples”, “spouses” and other gender-neutral terms.
H.B. 2263. This bill excludes the requirement for a “supervisory appraiser” to personally inspect each property with a “registered trainee appraiser” for purposes of ARS § 32-3601.
H.B. 2047. This bill provides for electronic trademark registration renewal on the Arizona Secretary of State’s website.