Preserving Deficiency Rights in Nevada Where Deed in Lieu of Foreclosure Is Accepted by the Lender

By: Richard F. Holley, Esq.[1] and Andrea M. Gandara, Esq.[2]

Introduction

Lenders in commercial transactions secured by deeds of trust on real property frequently experience borrower defaults and requests to forebear and amend existing loan documents, rather than foreclosing on real property collateral. Borrower requests often involve the extension of the maturity date and modifications to payment terms. Under these circumstances it is not unusual for a lender to consider as a condition of forbearance, accepting a deed in lieu of foreclosure to be executed by the parties, but held pending a future default and failure to cure. The benefits of accepting a deed in lieu of foreclosure include being able to recover real property collateral without initiating the lengthier foreclosure process. In considering this option, however, commercial lenders often question whether accepting and subsequently recording a deed in lieu of foreclosure precludes pursuing the borrower and guarantors for any unpaid balance owing under a promissory note. This article will address this issue.

Analysis

A deed in lieu of foreclosure is defined by Black’s Law Dictionary as “a deed by which a borrower conveys fee-simple title to a lender in satisfaction of a mortgage debt and as a substitute for foreclosure.” Deed in Lieu of Foreclosure, Black’s Law Dictionary (10th ed. 2014). “This deed is often referred to simply as a ‘deed in lieu.’” Id. Although the typical deed in lieu scenario contemplates satisfaction of a mortgage debt in its entirety, it need not do so. A commercial lender may wish to preserve its rights to pursue the unpaid balance exceeding the value of the collateral through a deficiency action.

Nevada Revised Statutes, Chapter 40

Chapter 40 of the Nevada Revised Statutes provides the framework for pursuing a deficiency judgment. First, the creditor or beneficiary of the deed of trust must submit an “application”[1] for a deficiency within six months after the date of the foreclosure sale or the trustee’s sale held pursuant to NRS 107.080. See NRS 40.455(1), amended by Nev. Rev. Stat. Ann. § SB 453, § 5 (West). Second, there are limitations on the amount of money a court may award as a deficiency judgment. A court may not award a judgment for more than: (i) the difference between the amount of the indebtedness and the fair market value of the property at the time of the sale, with interest from the date of sale; (i) the difference between the amount for which the property was actually sold and the amount of the indebtedness, with interest from the date of sale; or (iii) if the person seeking the judgment acquired the right to obtain the judgment from a person who previously held that right, the amount by which the amount of the consideration paid for that right exceeds the fair market value of the property sold at the time of sale, or the amount for which the property was actually sold, whichever is greater, with interest from the date of sale and reasonable costs. NRS 40.459.[2]

Each of these statutory conditions has a common denominator: a foreclosure or trustee’s sale. The occurrence of a foreclosure or trustee’s sale establishes the bar date by which a deficiency action must be pursued. See NRS 40.455(1). Similarly, the date of the foreclosure or trustee’s sale is the date for establishing the value of the property being foreclosed upon and the amount of the deficiency that may be awarded by a court. See NRS 40.459(referring to “date of sale”). Chapter 40 does not address whether a deficiency judgment may be pursued and obtained where no foreclosure or trustee’s sale occurs such as when a deed in lieu of foreclosure is utilized by a lender to transfer ownership of a commercial property upon an event of default.[3]

Persuasive Authority

Case law from Nevada state court likewise provides no guidance on the subject of deficiency judgments resulting from deeds in lieu of foreclosure. However, two federal court opinions may provide some assistance.

In FH Partners, LLC v. Leany, FH Partners, a successor-in-interest to the FDIC, pursued a deficiency action against guarantors. No. 2:11-CV-0796-LRH-NJK, 2014 WL 3853806, at *1 (D. Nev. Aug. 6, 2014). FH Partners had apparently accepted a deed in lieu of foreclosure from the borrower instead of conducting a foreclosure sale. Id. At issue was the fair market value determination pursuant to NRS 40.457. Id. at *2. In order to make the fair market value determination the court first had to determine the “date of sale” pursuant to NRS 40.459.[4] Id. The court stated “[f]or purposes of determining the fair market value of the property, the date a deed in lieu of foreclosure is recorded may be used as the operative valuation date because a deed in lieu is the functional equivalent of a duly noticed foreclosure sale.”[5] Id. (emphasis added). The court then proceeded to value the property, determine the deficiency amount and ultimately award a judgment in favor of FH Partners. Id. at *3.

Mann v. Glens Falls Ins. Co. was an insurance case; however, the ultimate holding turned on a mortgagee accepting a deed in lieu of foreclosure upon the default by the mortgagor. 541 F.2d 819, 823 (9th Cir. 1976). The property at issue was a residential property. Id. at 820. The deed in lieu of foreclosure expressly stated that the mortgagee was accepting the deed in lieu in “full satisfaction of all obligations secured by the Deed of Trust.” Id. at 823 n.12. Seemingly based on the “full satisfaction” language in the deed in lieu, the Ninth Circuit concluded that by accepting the deed in lieu of foreclosure, the mortgagee discharged the mortgagors of their debt and at the same time wiped out her insurable interest. Id. at 823 and n.12. The Mann opinion arguably stands for the proposition that deficiency rights are preserved where the deed in lieu of foreclosure expressly provides that the deed in lieu is only in partial, as opposed to full, satisfaction of an outstanding indebtedness.

Together, these federal cases addressing Nevada law indicate that (1) a deed in lieu of foreclosure is the functional equivalent of a foreclosure sale for purposes of valuation of collateral and pursing a deficiency; (2) the relevant date for purposes of valuation of collateral’s fair market value in a deed in lieu scenario is the date the deed in lieu is recorded; and (3) a lender preserves its deficiency judgment rights if the deed in lieu of foreclosure does not expressly state that it is in full satisfaction of indebtedness.

Other Jurisdictions

Jurisdictions outside of Nevada have relied upon contract principals when analyzing deeds in lieu of foreclosure and preserving deficiency judgments.

For example, in Nash Finch Co. v. Corey Dev., Ltd., 669 N.W.2d 546, 550 (Iowa 2003), the Iowa Supreme Court held that “a party may pursue further remedies after filing a deed in lieu of foreclosure in partial satisfaction of a debt” including obtaining a deficiency judgment. The action arose when a borrower breached a secured promissory note by conveying the mortgaged property without prior consent and failing to make payments. Id. at 547. The parties negotiated a forbearance agreement that required the debtor to provide a deed in lieu of foreclosure in partial satisfaction of the promissory note. Id. When the debtor defaulted under the forbearance agreement, the lender recorded the deed in lieu and then filed suit for failure to pay pursuant to the forbearance agreement and for conduct that diminished the collateral’s value. Id. The borrower argued that by recording the deed in lieu of foreclosure, the lender waived its right to a deficiency judgment. Id. at 548. The Iowa Supreme Court concluded that the parties’ forbearance agreement controlled the outcome as to whether the lender was permitted to pursue the portion of debt that was not satisfied by the deed in lieu. Id. at 549. In reviewing the agreement, the Court was persuaded that the operative language reflected the parties’ intent to leave the lender with remedies in addition to the deed in lieu of foreclosure, such as pursuit of satisfaction of the original note. Id. This language included express statements that the forbearance agreement was in “partial satisfaction of the note” and that the lender “reserve[d] its rights to exercise its right under the note and/or mortgage in the event any of the terms and conditions of the forbearance agreement [we]re not fully satisfied.” Id. (emphasis and original alteration omitted). Because the parties’ agreement preserved the lender’s right to pursue remedies in addition to recording a deed in lieu of foreclosure, and there was no Iowa law prohibiting such an agreement, the Court overruled the borrower’s argument. Id. at 550.

A federal bankruptcy court in Virginia similarly overruled an argument made by debtors that they had been released of their liability by executing a deed in lieu of foreclosure in partial satisfaction of a promissory note secured by a deed of trust against real property. In re Wilkinson, 175 B.R. 627, 628 (Bankr. E.D. Va. 1994). The court concluded that the debtors’ personal liability for a deficiency remained even though they executed a deed in lieu of foreclosure because they were not released of all of their liability by the terms of the parties’ settlement agreement or by the deed in lieu. Id. at 629. In reaching this conclusion, the court considered Va. Code Ann. § 55–66.4, which allows for partial satisfaction of liens upon proper recording. Id. at 628.

Finally, in Myler v. Blackstone Fin. Grp. Bus. Trust, 333 P.3d 1251, 1254 (Utah Ct. App. 2014), the appellate court found that a guarantor remained liable under a guarantee even though the lender took a deed in lieu of foreclosure. The court found it significant that the guarantee stated the guarantor would be liable for any deficiency remaining after foreclosure regardless of whether the borrower received a discharge and that the guarantee “could be affected by nothing ‘except full payment and discharge of the [i]ndebtedeness.’” Id. In addition, the parties’ settlement agreement contained language reflecting that a release of the borrower did not affect the outstanding indebtedness as to the guarantor. Id.

Conclusion: Preserving Deficiency Rights

Although preserving deficiency rights in Nevada is unsettled where a commercial lender accepts and records a deed in lieu of foreclosure upon an event of default, there are steps a lender can take to preserve deficiency rights when accepting a deed in lieu of foreclosure.

First, it is critical to include proper language in any forbearance agreement that expressly preserves the lender’s right to pursue a deficiency upon an event of default, which right survives recording of the deed in lieu of foreclosure. For example, the forbearance agreement should contain an express acknowledgement by the borrower and guarantors that the lender’s deficiency rights are not extinguished based on the agreement. Such language may include, “nothing in this Forbearance Agreement, including, but not limited to, the execution and/or recording of a deed in lieu of foreclosure, shall be deemed to impair the priority of, or to extinguish or otherwise impair, either the indebtedness secured by the Deed of Trust or the liens of the Deed of Trust.” It is also beneficial to include a provision in the forbearance regarding how a deficiency will be determined in the event the lender accepts and then records the deed in lieu of foreclosure.

Second, appropriate language should be included in the deed in lieu of foreclosure to preserve deficiency rights. Importantly, the deed in lieu of foreclosure should contain an express acknowledgment by the borrower and guarantors that the deed in lieu is only a partial satisfaction of debt and does not extinguish the underlying indebtedness. Such language may read as follows: “The acceptance of this Deed in Lieu of Foreclosure shall not prejudice, limit, restrict, or affect claims of priority under the loan documents over any other liens, charges, claims, or encumbrances of any kind whatsoever, or the validity and enforceability of the loan documents except as set forth herein. This conveyance is made in lieu of foreclosure and in partial forgiveness of a debt.”

Third, in Nevada before a lender may record a deed in lieu of foreclosure, a Declaration of Value Form as prescribed by the Nevada Tax Commission must be completed by the lender and reviewed and approved by an auditor at the Office of the County Recorder. See NRS 375.060(1); http://www.clarkcountynv.gov/recorder/Documents/DV_Packet.pdf. Lenders must include documentation to support the value declared and/or exemption claimed at the time of recording. Failure to provide the supporting documentation may result in the document being returned unrecorded. The Declaration of Value Form is used to determine the amount of real property transfer tax that must be paid by the recording party. One must be careful when completing the Form particularly given the instructions that accompany the Form. When completing section 3(a), which asks for the total value/sales price of the subject property, the Instructions direct the recording party to insert the amount of the unpaid debt where a deed in lieu of foreclosure is the operative document. This instruction is potentially problematic where the deed in lieu expressly provides that “the conveyance is made in lieu of foreclosure and in partial forgiveness of a debt.” Rather than inserting the full amount of the outstanding indebtedness, one may instead insert the estimated fair market value of the property as of the approximate date the deed in lieu was recorded and documentation such as a real property appraisal to support the value. By so doing, a lender can avoid the argument that it tacitly agreed that the deed in lieu was accepted and recorded in full satisfaction of the outstanding indebtedness where the deed in lieu expressly provides to the contrary.

[1] Mr. Holley is a named partner with the law firm of Holley Driggs Walch Fine Wray Puzey & Thompson and has practiced law for nearly 29 years in the areas of bankruptcy and commercial litigation.

[2] Ms. Gandara is an associate with Holley Driggs Walch Fine Wray Puzey & Thompson, primarily practicing in the areas of bankruptcy and commercial litigation.

[3] In Lavi v. Eighth Jud. Dist. Ct., the Nevada Supreme Court stated that “a party seeking a deficiency judgment must file the application particularizing the reasons for the requested judgment within six months after selling the property at a trustee’s sale . . . .” 130 Nev. Adv. Op. 38, 325 P.3d 1265, 1267 (2014); see also Guinn v. Fed. Deposit Ins. Corp., No. 60888, 2014 WL 2957258, at *1 (Nev. June 26, 2014) (stating “in Lavi v. Eighth Judicial District Court, 130 Nev. ––––, ––– P.3d –––– (Nev.Adv.Op.38, May 29, 2014), we addressed when and how an application for a deficiency judgment must be made.”)

[4] See Branch Banking & Trust Co. v. Pahrump 194, LLC, 51 F. Supp. 3d 993, 996 (D. Nev. 2014) (discussing three alternative calculations under NRS (1)).

[5] This is distinguished from the situation where a lender accepts a deed in lieu of foreclosure for a single family residence. In that instance, the lender is prohibited from recovering a deficiency from the borrower and guarantors. See NRS 40.458 and amended by Nev. Rev. Stat. Ann. § SB 453, § 5 (West) (amending Chapter 40 of the Nevada Revised Statutes to define “Sale in lieu of foreclosure sale” to include a deed in lieu of foreclosure sale).

[6] FH Partners incorrectly references NRS 40.469 instead of NRS 40.459.

[7] Cf. 1971 Nev. Op. Atty. Gen. No. 45 (Oct. 7, 1971) (answering the question “Is a deed in lieu of foreclosure subject to tax, and if so, how is the value, for purposes of tax, to be computed.” and stating that “The value attributable to that deed [in lieu of foreclosure] is that which his grantee (the original seller) gives in exchange for the deed in lieu of foreclosure. In substance, what the grantee (the original seller) gives up by avoiding the foreclosure proceeding and accepting the deed in lieu of foreclosure in full satisfaction, is the right to a deficiency judgment against his defaulting buyer.”). FH Partners, which was decided more than 40 years after the Nevada Attorney General’s Opinion regarding taxation of conveyances by deeds in lieu of foreclosure and valuation of collateral subject to deeds in lieu, makes no reference to 1971 Nev. Op. Atty. Gen. No. 45 (Oct. 7, 1971).