Deficiency Judgments after Foreclosure Sales

In an apparent attempt to bring a greater degree of certainty to the law in Tennessee with respect to the matter of deficiency judgments after real property foreclosure sales, the legislature enacted what has been codified as Tenn. Code Ann. § 35-5-118, effective Sept. 1, 2010 (the “Deficiency Statute”).

We will briefly examine the state of the law both before and after the enactment of the Deficiency Statute and let the reader decide whether the legislature did indeed achieve its goal.

Context

Although not required by law, but often required by the mortgage document, it seems that the majority of foreclosure sales in Tennessee are held on the steps of the courthouse in the county where the property lies. The date and time of the sale is specified in a foreclosure notice. The sale is conducted by the deed of trust trustee or its agent after publication of the foreclosure notice.

Anyone can bid and purchase at a foreclosure sale. However, the Deficiency Statute targets primarily those numerous situations where (a) there is no competitive bidding, and the only serious bidder is the secured creditor, the beneficiary of the deed of trust who instigated the foreclosure, (b) the foreclosure sale price is less than the unpaid balance of the secured debt, and (c) the secured creditor is seeking a judgment against the obligor(s) for the deficiency

The basic question is whether the noncompetitive foreclosure sale price (the amount credited to the secured debt) is so low that it adversely affects the secured creditor’s ability to obtain a deficiency judgment against the secured debt obligors. It seems that each state addresses the issue differently,[1] and while many states have dealt with the matter statutorily, in Tennessee, until 2010, there was no applicable statute.[2] Of course, even with a statutory framework, judicial interpretation still supplies many of the details.

History

In 1983, citing, among others a 1936 decision of the Eastern Section,[3] the Western Section of the Tennessee Court of Appeals in Duke vs. Daniels[4] summarized the Tennessee case law to be that where the foreclosure sale is properly held, the sale price is conclusively (emphasis added) presumed to be the value of the property sold, and that the value of the property sold at a foreclosure sale is not looked to in a deficiency case unless there is a charge of fraud in the manner of sale or the sale price is so grossly inadequate as to shock the conscience of the Court. The key words are “fraud” and “grossly inadequate.”

While the principles enunciated in Duke may have been muddled a bit by several cases in the interim[5] and by a series of bankruptcy cases involving alleged fraudulent transfers,[6] at least until 2006 many practitioners assumed that if a foreclosure sale was properly published and conducted, the fraud/grossly inadequate test was applicable, and there was wide latitude as to the amount of the secured creditor’s bid and the foreclosure sale price that could be the basis for a deficiency judgment.

However, it is noteworthy that in a 1984 decision by the Tennessee Supreme Court in Holt v. Citizens Central Bank,[7] not a deficiency case but one to set aside a foreclosure, the court stated the rule in that context to be that “If a foreclosure sale is legally held, conducted and consummated, there must be some evidence of irregularity, misconduct, fraud, or unfairness on the part of the trustee or mortgagee that caused or contributed to an inadequate price for a court of equity to set aside the sale” (emphasis added). Twelve years later, “unfairness” was the touchstone for a change in the deficiency recovery case law landscape in Tennessee.

In 2006, in the case of Lost Mountain Development vs. King,[8] the Tennessee Court of Appeals, Middle Section, a fascinating opinion authored by Judge Patricia J. King (that also incorporated an analysis of other states’ laws) stated the following: We see no need to attempt to alter or tweak the Duke v. Daniels standards. That approach is similar to the one adopted by the Restatement of the Law of Property. The applicable Restatement provision defines the deficiency as the difference between the mortgage obligation and the “fair value” of the foreclosed real estate. (Citation omitted.)

In our review of Duke, we find no reference to fair value in connection with the determination of a deficiency; only the fraud/grossly inadequate standard. Likewise, we do not see that “fairness” is a concept endorsed by Duke. Notwithstanding, the Lost Mountain court went further and concluded,

Mr. Smith raised as a defense the allegations that (1) the foreclosure sales price was grossly inadequate and (2) that the creditor unfairly bid that low price, acquired the land, and sought a deficiency judgment that would inequitably provide him a windfall. According to Duke v. Daniel, Mr. Smith then had the burden of overcoming the presumption that the price was fair. Duke v. Daniels, 660 S.W.2d at 795. We think the material he provided in support of his opposition to summary judgment raised a dispute of fact as to the actual fair value which was sufficient to foreclose summary judgment for the creditor. (Emphasis added.)

While the result in Lost Mountain is reasonable, logical and similar to the result that would be achieved in other states, it is difficult to see how the court reached that result while purporting to follow the law as summarized in Duke.[9]

 

Enactment of Deficiency Statute

If we assume that the measure of the foreclosure price/deficiency determination was the Duke standard (fraud/grossly inadequate) until Lost Mountain in 2006 when the standard may have become the “actual fair value,” then in 2009, possibly in response to Lost Mountain, the standard again changed when the legislature enacted the Deficiency Statute that in pertinent part provides the following:[10]

(b) . . . absent a showing of fraud, collusion, misconduct, or irregularity in the sale process, the deficiency judgment shall be for the total amount of indebtedness …, less the fair market value of the property. … The creditor shall be entitled to a rebuttable prima facie presumption that the sale price … is equal to the fair market value. … (c) To overcome the presumption …, the debtor must prove … that the property sold for an amount materially less than the fair market value of property … If the debtor overcomes the presumption, the deficiency shall be the total amount of the indebtedness … plus the costs of the foreclosure and sale, less the fair market value of the property … as determined by the court.

So as one can see, the “how low can you go” test for a noncompetitive foreclosure sale amount in Tennessee has evolved from “grossly inadequate” in 1939 to possibly “actual fair value” in 2006 to the statutory standard of “materially less than fair market value” in 2010. However, it is worth noting that in the legislative history cited by the court in Sterling Ventures (summarized below), in 2009 Rep. Vance Dennis, a sponsor of the proposed statute, expressed the view that the “materially less” standard in the pending legislation would be more “consumer friendly” than the “grossly inadequate” rule that he perceived to be the law at the time. Apparently the representative was unaware of Lost Mountain and what most would perceive to be a more consumer-friendly rule than that in the proposed legislation. Indeed, one could say that the Deficiency Statute went rather far in the other direction as far as consumer friendliness in concerned.

If a defendant proves that the foreclosure sale price is materially less than the fair market value of the foreclosed property, the Deficiency Statute provides that the deficiency judgment will be the amount of the secured indebtedness less the amount of the fair market value of the foreclosed property as determined by the court.[11] If you contrast that result with the law in the State of Georgia that provides that if the foreclosure sale price is less than the “true market value” by any amount, the secured creditor is not entitled to a deficiency judgment, then the Deficiency Statute seems even less consumer friendly.[12]

Since the enactment of the Deficiency Statute there has been a series of reported foreclosure deficiency cases that have given practitioners some guidance as to the location of the guard rails.

A few months after the Deficiency Statute’s effective date, the Tennessee Court of Appeals, Eastern Section, in two opinions authored by Judge John W. McClarty sustained deficiency judgments that were based upon foreclosure sale prices that were within the range of values given in current appraisals of each of the subject properties.[13] In the first case, the court based its analysis upon the Lost Mountain fair market value standard and did not mention the new statute. In the second, the court reached the same result but applied the new statute’s “materially less than fair market value” rule. In neither was the court faced with the “how low can you go” issue since the foreclosure sale amounts were at or near the appraisal values.

In December 2012, the Tennessee Court of Appeals, Middle Section, in the case of Green Bank v. Sterling Ventures,[14] issued the first reported decision post Deficiency Statute in which the foreclosure sale price for the property ($667,400) was less than (89 percent) the amount the court assumed to be the market value ($750,000). After analyzing the new statute and the legislative history[15] and comparing the Deficiency Statute's provisions to the Lost Mountain standard, the court concluded that a foreclosure sale price that was 11 percent less than the fair market value was not materially less. Interestingly, the court also reviewed the earlier State of Franklin decision (the foreclosure price was within the range of high/low values stated in the appraisal), and concluded that since the foreclosure price in that case was 14 percent less than the highest value in the appraisal range (an analysis in which the State of Franklin court did not engage), a discount of only 11 percent should not be deemed to be materially less than the fair market value.

In the next case in this line, FirstBank v. Horizon Capital Partners,[16] the court that found that “the parties necessarily agreed that the foreclosure price was 20 percent below the appraisal price” concluded “that Defendants failed to present sufficient evidence to rebut the presumption that the foreclosure price was equal to the fair market value of the property at the time of the sale.” One could read this opinion to mean that the “materially less than” bar moved from 11 percent down to 20 percent.

Several months later in an opinion that contains a rather exhaustive examination of the cases both pre and post Deficiency Statute, the Tennessee Court of Appeals in Capital Bank v. Oscar Brock concluded that “the 15.8 percent difference between the appraised price and the foreclosure sale price, with nothing more, is insufficient to establish that the Property was sold for an amount materially less than its fair market value.”[17]

The following year, in the decision in Robert W. Halliman v. Heritage Bank, the Tennessee Court of Appeals noted, among other things, that in Sterling Ventures the court found that a 20-percent difference, without other evidence, was not materially less than the fair market value of the property, so the Halliman court took two steps further down the slippery slope and held that “Although Mr. Halliman’s personal valuation of the property is approximately 22 percent more than the aggregate of the foreclosure sales, we find his opinion, without other competent and relevant evidence to support it, fails to rebut the statutory presumption.”[18] It does seem that the court was underwhelmed by Mr. Halliman's opinion as to value, and a foreclosure sale price that is 22 percent less than the fair market value may not be a safe bet when the fair market value is supported by a comprehensive, independent appraisal.

Later in 2015, after another rather thorough review of the case law and the definition of “fair value,” the Tennessee Court of Appeals in Cutshaw v. Hensley, with relative ease, found that a $20,000 foreclosure sale price was approximately 78 percent less than the property’s fair market value of $89,000 and held that the defendants had proven that the property sold at foreclosure for materially less than its fair market value, thereby overcoming the statutory presumption.[19]

The judicial gap between that which is and that which is not deemed to be “materially less” was narrowed the next year when the Tennessee Court of Appeals decided Eastman Credit Union v. Bennett.[20] Eastman argued that the evidence submitted by Bennett was insufficient to establish a fair market value of $158,900 and even assuming a fair market value of $158,900, the 40-percent difference between the fair market value and the foreclosure sale price did not constitute sale at an amount materially less than fair market value. The court disagreed, and in doing so may have established that a 40-percent discount is too low to go.

While there is language in Commerce Union Bank v. Bush, the most recent of the reported opinions in this line of cases,[21] that would tend to lead one to conclude that a 46-percent foreclosure sale price discount may not be materially less than the fair market value, a closer reading makes clear that the appellate court approved the trial court’s analysis and rejection of the defendant’s higher appraisal and the endorsement by the trial court of the bank’s lower appraisal in an amount equal to the bank's foreclosure bid and purchase price. Consequently, under the court’s finding of facts there was no discount.

 

Summary

Secured creditors and others who are foreclosing on real property frequently ask counsel to specify how much the foreclosing party should bid at the sale if there is no other serious, potential purchaser present and bidding. While each reported decision analyzing the Deficiency Statute stresses the importance of the specific facts of each case, the Tennessee Court of Appeals appears to have established fairly clearly that absent unusual circumstances a foreclosure sale to the foreclosing secured creditor for an amount that is 20 percent less than the fair market value of the property on the date of sale is not materially less than the fair market value. On the other hand, under the same circumstances, a sale to the foreclosing secured creditor that is 40 percent less than the fair market value clearly is materially less than the fair market value. As one can see, there is a 20 percent “no man’s (person’s) land.”

While the uncertainty as to “how low can you go” has been significantly reduced, there remain a number of questions for which there is no clear answer. Among those are the difficult issue of how one determines with any degree of certainty the fair market value as of the sale date when there are competing, credible appraisals. Add to that the unknown effect or admissibility of the secured creditor’s re-sale of the property for a significantly (materially?) higher price one month, two months, three months, etc. after foreclosure but before the court rules in the pending deficiency action. Another unresolved issue is whether the Deficiency Statute is applicable if the secured creditor acquires the property at the foreclosure sale after an active auction where there are several, capable prospective purchasers bidding, but the sale price is 20+ percent below the fair market value as reflected in a credible appraisal? And, how does one document and preserve that event for purposes of introducing evidence at the hearing in the deficiency action. Another question is whether a judicial foreclosure be structured so that the court determines the fair market value before the foreclosure sale? And on and on.

It does appear that the Deficiency Statute and its case law progeny have established relatively clear guidelines as to the minimum amount that absent unusual circumstances a secured creditor must bid at a noncompetitive sale to preserve its right to a judgment in the full amount of the deficiency, but there remain a number of open issues that require the advice and wise counsel of experienced practitioners.

Notes

1. Alabama Code, Title 35, Articles 1, 1A, 2, 3 §35-10-1 et. seq.; Georgia O.C.G.A. 44-14-161; Kentucky Revised Statutes, Chapter 426; Mississippi Title 11, §11-5-93 et. seq.; North Carolina General Statutes, Sections 45-21.1 through 45-21.38C, and 45-100 through 107.

2. See “Simple Real Estate Foreclosures Made Complex: The Byzantine Tennessee Process,” Tennessee Law Review, Winter, 1995, John A Walker.

3. Union Joint State Land Bank vs. Knox County, (1936 E.S.) 20 Tenn. App. 273, 97 S.W.2d 842.

4. Duke v. Daniels, 660 S.W.2d 793, 795 (Tenn. Ct. App. 1983).

5. See Holt v. Citizens Central Bank, 688 S.W.2d 414 (Tenn. 1984); McDill Columbus Corp. v. the Lakes Corporation, 1992 WL115576 (Tenn. Ct. App. June 1, 1992); and B&H Investments v. Brooks, 2000 WL 1141566 (Tenn. Ct. App. Aug. 10, 2000).

6. See Durrett vs. Washington National Insurance Co., 621 F.2d 201 (5th Cir. 1980).

7. Holt v. Citizens Central Bank, id.

8. Lost Mtn. Dev. Co. v. King, No. M2004- 02663-COA-R3-CV, 2006 WL 3740791 (Tenn. Ct. App. M.S., Dec. 19, 2006).

9. Duke Id. at 794. “First, since no irregularity in the sale is raised, the presumption is that the price brought at the public sale is the cash market price of the property. Union Joint State Land Bank vs. Knox County, supra. Second, if the defendant desired to overcome that presumption by showing gross inadequacy, that burden of proof was on the defendant.”

10. Tenn. Code Ann. § 35-5-118.

11. Tenn. Code Ann. § 35-5-118(c).

12. O.C.G.A § 44-14-161(b); Cartersville Developers v. Georgia Bank & Trust, 292 Ga. App. 375, 376 (2008).

13. Greenbank v. Thompson, 2010 WL 5549231, (Tenn. Ct. App. Dec. 29, 2010); State of Franklin Bank v. Riggs, No. E2010-01505-COAR3-CV, 2011 WL 5090888 (Tenn. Ct. App. Oct. 27, 2011).

14. GreenBank v. Sterling Ventures LLC, No. M2012-01312-COA-R3-CV, 2012 WL 6115015, (Tenn. Ct. App. E.S. Dec. 7, 2012).

15. Id. at p. 8, “… Representative Vance Dennis, the Sponsor of this Bill … states [that if] … after a foreclosure, say, a property that you owed $100,000 on was foreclosed and it was sold for $50,000, you’ve got a $50,000 shortfall in what you owe the bank. Right now, if you're the debtor, [and] you can prove that the $50,000 was ‘grossly inadequate’ from the actual value of the property, then the court can allow an offset [of] that $50,000. This Bill actually pulls back from that standard a little bit and creates a rebuttable presumption that you've got to show a ‘material difference’ instead of ‘gross inadequacy.’ So, the bottom line is that it is a little bit more consumer friendly in that regard …’ [but] It’s a very difficult burden for the debtor to overcome… . You have to show a ‘strong’ difference, a ‘material’ difference.’”

16. FirstBank v. Horizon Capital Partners LLC, No. E2013-00686-COA-R3-CV, 2014 WL 407908 (Tenn. Ct. App. E.S., Feb. 3, 2014) (another opinion authored by Judge McClarty).

17. Capital Bank v. Brock, No. E2013-01140-COA-R3-CV, 2014 WL 2993844 (Tenn. Ct. App. E.S., June 30, 2014).

18. Halliman v. Heritage Bank, No. M2014-00244-COAR3-CV, 2015 WL 1955448 (Tenn. Ct. App. Apr. 30, 2015).

19. Cutshaw v. Hensley, No. E2014-01561-COA-R3-CV (Tenn. App. July 29, 2015).

20. Eastman Credit Union v. Bennett, No. E2015-01339-COA-R3-CV, 2016 WL 1276275 (Tenn. Ct. App. Mar. 31, 2016).

21. Commerce Union Bank v. Bush, No. M2015-00396-COA-R3-CV (Tenn. App. M.S. June 29, 2016).

 

RICHARD B. GOSSETT is senior counsel in the Chattanooga office of Baker Donelson, practicing banking, business bankruptcy and reorganizations and creditors’ rights law. He received his law degree from the University of Tennessee College of Law.

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