The following information accompanies a presentation Mike gave to members of the Arizona Commercial Mortgage Lenders Association (ACMLA) on February 12, 2019.

Arizona Case Law – Judgment Lien Enforcement Against Homestead Property

Pacific Western Bank v. Castleton (AZ Court of Appeals 12-27-2018)

In 2002, the Sepics purchased a home in Mesa to use as their primary residence. In 2007, they borrowed $937,500 from Washington Mutual Bank, and WAMU later assigned its DOT to Chase Bank. In a separate transaction, the Sepics borrowed money to buy a Phoenix apartment complex. That loan was later assigned to PWB.  After the Sepics stopped paying on the apartment loan, PWB sued them for breach of contract and obtained a $5.2 million default judgment against them. PWB recorded the judgment in 2011 and thereafter timely renewed it.

After losing the apartment complex to foreclosure, the Sepics defaulted on the loan secured by their home. Chase Bank approved a short sale of the home and, as part of the short sale, the Sepics conveyed the home to the Fairbrook Trust. (The Sepics were the original trustees and beneficiaries of the Fairbrook Trust and, as part of the short sale process, they transferred their beneficial interest in the Fairbrook Trust to a representative of a short-sale dealer.)  A few weeks later, in February 2013, the Fairbrook Trust sold the home to the Castleton Trust for $535,000 and the PWB judgment remained unpaid.

More than three years after the sale, PWB sued the Castleton Trust, seeking declaratory relief and to quiet title to the home, contending that the PWB judgment remained an enforceable lien against the home. PWB obtained a writ of general execution and the Maricopa County Sheriff noticed a sale of the home. The Castleton Trust then obtained a preliminary injunction against the sale from the Superior Court.

The Court of Appeals framed the issues for decision as (i) whether the Sepics’ homestead exemption prevented the PWB judgment from attaching as a lien against the home, and (ii) if so, whether the Sepics abandoned their homestead exemption before they transferred title to the home.

Under Arizona law, a recorded judgment becomes a lien on all real property owned by the judgment debtor unless the property is exempt from execution, including homestead property. The homestead statute allows an individual or married couple to claim a homestead exemption in a personal residence of up to $150,000 in equity, which is “exempt from attachment, execution and forced sale”.

Arizona’s homestead statute establishes a general rule that a recorded judgment does not become a lien on homestead property, and that any person entitled to a homestead exemption holds the homestead property free and clear of the judgment lien, even when the value of the property exceeds the amount of the homestead.

The Court held that both the homestead statute and the judgment lien statute conceive of the “homestead” as being the real property, not the equity value of the real property, but that a judgment creditor who believes there is excess property in a debtor’s homestead can still force an execution sale under A.R.S. § 33-1105 if the judgment debtor’s interest in the property exceeds the sum of the homestead exemption plus the amount of any consensual liens on the property having priority over the judgment.

Therefore, PWB could have tried to satisfy its judgment by conducting a forced judicial sale under A.R.S. § 33-1105, but only if it could sell the home for more than the sum of the homestead plus the amount of any consensual liens on the property having priority over the judgment. However, PWB chose not to pursue its remedy under A.R.S. § 33-1105 because the home was not worth enough. The senior lien on the home secured $937,500, which, when combined with the $150,000 homestead exemption, meant that PWB could sell the home under A.R.S. § 33-1105 only at a price exceeding $1,087,500 (recall that the Sepics ultimately negotiated a short sale of the home for only $535,000).

PWB then argued that, even if the homestead exemption prevented the judgment lien from attaching to the home, the Sepics abandoned the protection of the homestead by transferring their home to the Fairbrook Trust prior to the short sale (a conveyance may constitute an abandonment of a homestead). However, the Court of Appeals held that when a homestead exemption is abandoned by a conveyance of the property, a judgment lien does not revive and re-attach to the property upon sale. Further, the Court held that the Sepics’ departure from the home shortly prior to its sale did not constitute an abandonment. Therefore, the PWB judgment never attached as a lien on the home, and the Sepics conveyed the home free and clear of PWB’s judgment.

Lender takeaway. This case illustrates that a judgment lien in Arizona is properly viewed as a potential claim on excess sale proceeds (above the sum of the $150,000 homestead exemption and the amount of any prior consensual liens on the property), rather than a lien on the property itself. Lenders will often record and renew judgments in the hope that their judgment liens will eventually be addressed when the judgment debtors’ homes are sold or refinanced. However, given the difficulty a judgment creditor will have in forcing an execution sale of a mortgaged residence and the need to be patient for perhaps years before any proceeds come its direction, a lender underwriting a commercial real estate loan ought to place little, if any, weight on a guarantor’s apparent equity in his or her primary residence.