Debtor May Be Entitled to Credit for “Reasonable Value” of Property Purchased by Lender at Mortgage Foreclosure Sale

In Idaho, it has long been understood that a secured creditor that has foreclosed a mortgage may be able to also get a judgment against the debtor for the remainder of the debt, if the proceeds of the foreclosure sale are not enough to satisfy the debt. The amount of the judgment, sometimes called a deficiency judgment, is limited. The secured creditor cannot get a deficiency judgment for more than the amount of the debt minus the reasonable value of the property sold. That result is clearly mandated by Idaho Code Section 6-108. That statute protects the debtor in the event that the mortgaged property is sold for less than its reasonable value.

Until recently, however, Idaho’s appellate courts had not addressed whether the debt is also considered to be reduced by the reasonable value of the property sold, if that amount is more than the sale proceeds. In the recent case of Agstar Financial Services v. Northwest Sand & Gravel, Inc., Docket No. 42932 (Idaho 2017), a sharply divided Idaho Supreme Court ruled that, in certain common circumstances, the debt will be considered reduced by the reasonable value of the property, even if the price paid at the foreclosure sale is much less. This has important implications if the secured creditor has other sources of security for the debt.

In Agstar, the debt was secured by three main sources of security: mortgages on real estate, security interests in equipment, and personal guaranties. The lender first foreclosed on the mortgages, then purchased the land at the foreclosure sale for a sales price that was several million dollars less than the amount of the debt, and then sought a deficiency judgment against the debtor for the balance of the debt. The trial court denied the lender’s request for a deficiency judgment, ruling that the reasonable value of the mortgaged land was actually several million dollars more than the amount of the debt. The lender did not appeal the trial court’s determination of the reasonable value of the mortgaged property, but instead sought to sell some of the equipment it had previously repossessed.

On appeal, the Idaho Supreme Court looked at the situation and essentially ruled that, although no Idaho statute demands the result, it would simply be unfair to let the lender continue to pursue its other sources of security when the trial court had already determined that the lender received mortgaged property worth millions of dollars more than the amount of the debt.

The Court appears to have limited its holding to situations where (1) the lender was the buyer at the foreclosure sale; and (2) the trial court determined the reasonable value of the mortgaged property. Both of those situations are fairly common. It is quite typical for lenders to purchase at the foreclosure sale through a credit bid (i.e., a reduction in the debt) and then to ask the trial court for a deficiency judgment, necessitating that the trial court determine the reasonable value of the mortgaged property. A creditor will now have to think twice about pursuing a deficiency judgment before pursuing its other sources of security because, if the trial court determines that the property is worth more than the debt, the creditor will no longer be able to pursue its other security.

The Agstar case leaves us with a lot of questions:

1. Could the creditor have avoided this result, and added to what the Court considered to be a multimillion-dollar windfall, simply by pursuing the personal property collateral and the personal guarantors before, or instead of, pursuing a deficiency judgment against the debtor?
2. To protect against such expanded windfalls, will courts now let debtors present evidence of the reasonable value of mortgaged property even when the creditor has not sought a deficiency judgment?
3. What happens if the property is redeemed? Idaho permits foreclosed debtors and foreclosed junior lienholders to buy the property from the initial purchaser at a mortgage foreclosure sale for a period of time after the sale. The redemption price is based on the foreclosure sale price (not on a higher reasonable value of the mortgaged property). Hopefully, in that scenario, where the creditor must give up the mortgaged property in return for the sale price, the court will not require the creditor to still give the debtor credit for a higher reasonable value of the mortgaged property. Unfortunately, the creditor may now have to wait until the end of the redemption period to find out if it can and should go after its other sources of security. Worse yet, the lender’s other sources of security may diminish in value before the redemption.
4. What if the secured creditor has already recovered on some of its other sources of security before foreclosing the mortgage? For example, what if the creditor already sold some of its personal property security? Will the creditor be forced to disgorge its other recoveries?
5. Will this same equitable theory apply to foreclosures under deeds of trust, if the creditor buys at the trustee’s sale and then pursues a deficiency judgment?

Interestingly, two of Idaho’s five justices dissented from the majority opinion in Agstar, noting, among other things, that:

The mortgagor has a statutory remedy if the mortgaged property is sold for significantly less than its fair market value. Pursuant to Idaho Code section 11-401, the mortgagor has a right of redemption. If the mortgagor could find a purchaser who was willing to pay what the mortgagor claims the property is worth, the mortgagor could sell its right of redemption to that purchaser.

If just one more justice agreed with the two dissenters, creditors would not be left with so many unanswered questions.