Thanks to the North Carolina Supreme Court, guarantors are now permitted to raise the anti-deficiency defense where mortgage lenders purchase a foreclosed property for less than fair market value. Prior to 2015, only the borrower-owner of the property could avail themselves of N.C.G.S. § 45-21.36 and assert the anti-deficiency defense. The statute states as follows:
§ 45-21.36. Right of mortgagor to prove in deficiency suits reasonable value of property by way of defense.
When any sale of real estate has been made by a mortgagee, trustee, or other person authorized to make the same, at which the mortgagee, payee, or other holder of the obligation thereby secured becomes the purchaser and takes title either directly or indirectly, and thereafter such mortgagee, payee or other holder of the secured obligation, as aforesaid, shall sue for and undertake to recover a deficiency judgment against the mortgagor, trustor or other maker of any such obligation whose property has been so purchased, it shall be competent and lawful for the defendant against whom such deficiency judgment is sought to allege and show as matter of defense and offset, but not by way of counterclaim, that the property sold was fairly worth the amount of the debt secured by it at the time and place of sale or that the amount bid was substantially less than its true value, and, upon such showing, to defeat or offset any deficiency judgment against him, either in whole or in part. . . .
The anti-deficiency statute addresses the all too common scenario where the borrower defaults on mortgage payments, the bank forecloses on the property, buys the property at the foreclosure sale for pennies on the dollar, then sues the borrower for the deficiency. This is not a new practice. However, this practice took on added significance when the housing bubble burst in or around 2007 and foreclosures reached record numbers.
Borrowers have been able to assert the anti-deficiency statute as a defense to such predatory tactics for decades. Where the borrower was sued for the deficiency, the borrower could assert the statute and introduce evidence of the true value of the property, thus reducing or even eliminating the deficiency claimed. However, it was not until September 2015, when the North Carolina Supreme Court decided High Point Bank & Trust Co. v. Highmark Properties, LLC, 2015 WL 5655991 (N.C. Sept. 25, 2015), that guarantors could also assert the anti-deficiency defense. This was a landmark decision, as banks frequently request that borrowers have a guarantor execute a guaranty promising to pay the amount of the Note in the event the borrower is unable to do so.
For example, when a real estate developer borrows money to purchase land on which to develop property, banks often require that the developer have a guarantor execute a guaranty so that there will be additional collateral available to secure payment of the Note. The developer may ask a friend or business acquaintance with financial wherewithal to execute the guaranty. In the event of default, the bank could elect to simply sue the guarantor for the deficiency on the Note since the defaulting borrower may be judgment proof. Further, prior to 2015, the ability to assert the anti-deficiency defense belonged to the borrower, not the guarantor. Consequently, banks could sidestep this defense by suing the guarantor only. Such practice avoided extensive litigation over the true value of the property at issue. Lenders were frequently able to win summary judgment against guarantors for the full amount of the deficiency claimed because North Carolina courts had often held that a guarantor could not assert § 45-21.36 as it was not a “mortgagor, trustor or other maker” of the underlying debt.
High Point Bank changed that model. Now, the guarantor may also assert this defense. It is not entirely clear whether the ability of guarantors to assert the anti-deficiency statute is direct or incidental to the borrower’s assertion of the defense. In fact, the Court of Appeals was split on this issue with two judges holding that once Highmark was made a party, the guarantors could then assert the defense. The other judge held that the guarantors could assert the defense even if Highmark were not a party. The best practice for guarantors going forward is to join the borrower as a party. If the borrower is a company, it is important that the company be maintained as a going concern, even if the only reason for doing so is to assert the anti-deficiency defense.
North Carolina law tilts heavily in favor of banks in disputes with borrowers and guarantors. However, High Point Bank serves as a check on the powers of banks to foreclose on properties, only to turn around and buy back those properties at rock bottom prices. Now that guarantors have some measure of protection against these predatory tactics, expect changes in the ways banks go about their lending practices.