Appellate Court Clarifies Agricultural Exception to Nonjudicial Foreclosure; Preserves Other Lender Remedies
The first half of 2013 has brought a series of appellate decisions construing the nonjudicial foreclosure remedies under the Deed of Trust Act, including the first instance (Schroeder v. Excelsior Management Group, LLC) where an appellate court vacated a sale because of the agricultural exception to nonjudicial foreclosure. Soon after, the Court of Appeals provided clear parameters when that exception may apply and also clarified the limited nature of a prohibited deficiency judgment. The Stokes Lawrence Creditors’ Rights group represented the lender.
In Gardner v. First Heritage Bank, the Court of Appeals held that the Deed of Trust Act's anti-deficiency provisions do not restrict a lender’s ability to exhaust multiple items of collateral in a series of nonjudicial foreclosure proceedings. There is no impediment to serial foreclosures. Additionally, the court held that in order for property to qualify as "agricultural" under the agricultural use exception, the property must be used principally for agricultural activities both at the time that the deed of trust was granted, and at the time of the trustee’s sale.
The Facts
In the Gardner matter, the borrower, Gardner, along with his partner Sinclair, had granted deeds of trust on three contiguous parcels of land (and a fourth unrelated parcel) to secure payment of a series of loans to build a home and a barn for a horse boarding and breeding business. The land parcels were all subject to restrictive covenants that limited their use to single family residences and limited any commercial activity to "a cottage business." Beginning in 2007, Gardner built a residence on Lot 10 and a barn on Lot 11, and left Lot 12 unimproved. Lot 10 was subject to a deed of trust granted in connection with a loan obtained to fund the construction of the residence, and contained a recital in the deed of trust that Lot 10 "is not used principally for agricultural purposes." Gardner obtained additional loans secured by Lot 10 and Lot 12 and refinanced the various loans. Lot 11 was the subject of a separate Small Business Association guaranteed loan, also secured by a deed of trust. All of the loans were cross-collateralized with deeds of trust on each lot.
Following payment defaults, First Heritage Bank began to foreclose on all of the real property. Gardner then filed a bankruptcy petition under Chapter 11. During the course of the Gardner bankruptcy case, Gardner explained that the horse boarding and breeding business had suffered a significant loss in volume and revenue in the wake of the economic downturn, beginning in the fourth quarter of 2008. After three of Gardner’s four loans matured in April 2009, the bankruptcy court granted relief from the stay to permit foreclosure on Lot 11, Lot 12 and the unrelated property, but the court kept the stay in effect as to Lot 10. In May 2010, trustee’s sales were completed on all of the properties other than Lot 10. Gardner did not seek to enjoin these sales.
Gardner’s Chapter 11 bankruptcy case was dismissed soon thereafter. A new sale date was set for Lot 10, and Gardner filed a new bankruptcy petition, this time under Chapter 13. That petition was dismissed soon after filing, and again, a sale date was set. On the eve of the sale, Gardner’s partner Sinclair, who was also co grantor and co obligor, filed a Chapter 7 bankruptcy petition, which stayed that sale.
Between the dismissal of the Gardner Chapter 13 case and the filing of the Sinclair Chapter 7 case, Gardner and Sinclair, seeking to enjoin the sale of Lot 10, filed suit against the bank and the foreclosing trustee. The principal claims raised in that suit were that the successive foreclosures on multiple parcels constituted an improper effort to obtain a deficiency judgment arising out of a nonjudicial foreclosure. Additionally, Gardner argued that Lot 10 was not subject to nonjudicial foreclosure as it was principally used for agricultural purposes—the horse boarding and breeding business for which the barn on the adjoining lot had been constructed.
First Heritage Bank never sought a deficiency judgment or any other form of affirmative relief in the state court. Due to the absence of any claim for affirmative relief, the trial court had no difficulty rejecting Gardner's claim. The appellate court reached the same result, based on a more detailed analysis.
Deficiency Judgments and Rejecting Arguments Against "Serial Foreclosures"
The court defined a "deficiency judgment" for purposes of the Deed of Trust Act’s (and specifically RCW 61.24.100) anti-deficiency provision as "a money judgment against a debtor for a recovery of the secured debt measured by the difference between the debt and the net proceeds received from the foreclosure sale." The court then held that a deficiency judgment requires a money judgment entered against the debtor, which Gardner conceded had not been sought in this case. Specifically, the court concluded that enforcing a deed of trust against multiple pieces of collateral was not barred by the prohibition on obtaining a deficiency judgment following foreclosure on collateral securing noncommercial loans.
The Agricultural Use Exception to Nonjudicial Foreclosures
The court then turned to Gardner’s argument about agricultural use. In response to Gardner’s argument that foreclosure under the Deed of Trust Act was barred because the property’s principal use was for agricultural activity, the court said:
Under RCW 61.24.030(2), Lot 10 is used for "agricultural purposes" if it is used principally in an operation that produces livestock, i.e., horses. In addition, this principal use must be established as of the date the deed of trust is granted and the date of the trustee’s sale. Before the beneficiary can foreclose nonjudicially, the deed of trust act requires the deed of trust to include in its terms that the real property is not used principally for agricultural purposes. If the nonagricultural use statement is false as of both the date the deed of trust was granted and the date of the trustee’s sale, the property must be foreclosed judicially. Thus, if the deed’s nonagricultural use statement was true on either of those two dates, nonjudicial foreclosure is allowed.
In short, if the property is not principally used for agricultural activity at the time the deed of trust is first granted, there is no statutory bar to nonjudicial foreclosure. Similarly, even if the property was initially used principally for agricultural activity, but no longer used for that purpose at the time of the trustee’s sale, there is no bar to nonjudicial foreclosure. Gardner’s argument was that the property had been used for agricultural purposes during the intervening period between the grant of the deed of trust and the foreclosure, but even if true, that afforded him no relief because the property was not used principally for agricultural purposes at the time of the sale.
In effect, the court protected the secured lender from a change in the character of the property from the time that the loan was first made. A lender who wishes to loan against agricultural land will know that they have to foreclose as a mortgage. But a lender who loans against land used for other purposes should not be so limited—it was not part of the deal that the lender made with the borrower.
In Gardner v. First Heritage Bank, the lender was represented by Thomas Lerner and Theresa Wang at the trial court, and Thomas Lerner and Joan Hemphill on appeal.
