Borrower’s Defense to Deficiency Action Where Lender Purchases Secured Property at Less than True Value Now Available to Guarantor

The guaranty agreement is a common security mechanism lenders utilize to increase the likelihood of repayment of a commercial loan in the event of default.    This is especially true in situations where the borrower is a limited asset or one asset business.  In such circumstances, the lender often looks to the member/manager(s) of the business to guarantee the debt obligation.

In the event of default, the lender will typically foreclose the property serving as collateral for the loan and then institute a deficiency action seeking to recover the remaining balance.  Often the borrower – if it is a limited or single asset corporation – has no remaining assets to satisfy the debt and the lender looks to the guarantors for repayment.  

Historically, actions against the guarantors to collect the deficiency amount were relativity simple.  The defenses were limited as guarantors could not challenge the foreclosure process, specifically the sale price of the property at the foreclosure sale, even if the lender purchased the property at the foreclosure.   N.C. Gen. Stat. Stat. § 45-21.36 provides that when a property sold at a foreclosure sale is purchased by the lender, mortgagee, or note holder that a “mortgagor, trustor, or other maker of such obligation whose property has been so purchased” can assert as a defense to a deficiency action “that that property sold was fairly worth the amount of the debt secured by it… or that the amount of the bid was substantially less than its true value… [in order] to defeat or offset any deficiency judgment against him, either in whole or in part…..”  In application, courts interpreted the statute to mean that a guarantor is not among those eligible to utilize the statute; therefore, leaving guarantors unable to challenge the deficiency amount. 

To further limit exposure, lenders often include language in the guaranty agreement in which the guarantor expressly waives any right to the statutory defense provided for in N.C. Gen. Stat. § 45-21.36.  

However, a recent North Carolina Supreme Court decision, High Point Bank and Trust Company v. Highmark Properties, LLC, 776 S.E.2d 838 (N.C. Supreme Court 2015), has upended this longstanding position.   The High Point court expanded the interpretation of N.C. Gen. Stat. § 45-21.36 holding that “[g]uarantors are permitted to stand in the shoes of the principal borrower and thus raise the section 45-21.36 anti-deficiency defense in their own right…” and challenge the purchase price of the property at the foreclosure.  Id, at 844.  The Court in High Point went even further and determined that since guarantors are in the class intended to be protected by the anti-deficiency statute, it would violate public policy to require a waiver of the statutory protection thus voiding any waiver of the protection of § 45-21.36 contained in the guaranty agreement.  Id.

The effect of this decision will likely be a significant reduction in successful post-foreclosure deficiency actions against guarantors, for several reasons.  Firstly, as explained above, guarantors are now entitled to raise the same statutory defense as the borrower.  Secondly, the recent North Carolina appellate decision in United Community Bank v. Wolfe, 2015 WL 4081940 (N.C. Ct. App., July 7, 2015), will allow guarantors to call former borrowers to the witness stand to testify as to their opinion of the value of their former property.  As the Wolfe court held, a foreclosed property owner is entitled to offer his own opinion of the value of his former property in his defense of a deficiency action, and need not rely on expert or extrinsic evidence of the value of the property to defeat a motion for summary judgment in favor of the lender.  If a borrower, and by extension a guarantor, can avoid losing at the summary judgment stage, the lender will have to proceed to a full trial in order to try to secure its deficiency judgment, often at considerable additional cost in time and money.

From a practical stand point, this decision will more than likely result in commercial lenders seeking to enforce the note and obtaining a judgment prior to instituting an action to enforce the deed of trust.

Published on June 15, 2016.