By now almost everyone is aware that Nevada was one of the worst hit states in the foreclosure crisis, both in residential and commercial real estate. Thanks to some recent statutory changes, debtors and guarantors are receiving a break from their financing gamble.
Nevada action is instructive on what other state legislatures may do to appease underwriters, debtors and unhappy guarantors. Such populist measures may gain short term support from their proponents, but will likely roil the secondary market in real estate secured promissory notes. This article discusses the Nevada experience, which may be predictive of future action by other states.
Nevada allows creditors to pursue deficiency judgments against debtors and guarantors following foreclosure.1 Two years ago, the Nevada legislature made minor changes to make it more difficult to obtain deficiencies on residential mortgages. In 2011, the Nevada legislature brought the hammer. Assembly Bill 273 (AB 273) made significant changes to how deficiency judgments are calculated and provided new protections to guarantors. AB 273 passed both houses of the Nevada legislature unanimously.
Nevada Revised Statutes (NRS) 40.451-40.463 set forth the procedure for holding a foreclosure sale and obtaining a deficiency judgment. Under prior law, following a foreclosure sale, the creditor could obtain a deficiency judgment for the lesser of the amount by which the indebtedness exceeds:
1) The fair market value of the property at the time of foreclosure; or
2) The price obtained at the foreclosure sale.
See prior NRS 40.459. The statutory definition of "indebtedness" was vague and included a restriction that it was limited to the "amount of the consideration paid by the lienholder." See NRS 40.451. Most courts accepted that "indebtedness" means the face value of the note.
During the recent financial crisis a secondary market for non-performing loans developed where companies would purchase loans from banks, or often the Federal Deposit Insurance Corporation, at huge discounts. These companies would foreclose and then seek deficiencies against debtors and guarantors.
This practice led to AB 273. The legislative history of AB 273 shows that many legislators questioned why banks were so willing to discount the notes to third parties, but unwilling to make similar concessions to the debtors themselves. Enter the hammer. AB 273 took a major swing at restricting this practice.
Nevada now greatly restricts the amount which can be recovered by an assignee of a note secured by real property. AB 273 does not offer much new protection for debtors where the original lender seeks a deficiency. However, if the note has been sold at a discount to another party, AB 273 could operate to severely restrict or eliminate the ability to obtain a deficiency judgment. Deficiency judgments are now limited to the lesser amount of (1) or (2) described above or "the amount by which the amount of the consideration paid for that right exceeds the fair market value of the property sold at the time of sale or the amount for which the property was actually sold whichever is greater, with interest from the date of sale and reasonable costs.2
In essence, if the creditor pays less than full market value for the note, the creditor cannot recover the full value in a deficiency action. A party buying a note at a substantial discount risks forfeiting its right to obtain a deficiency judgment. The law went into effect upon the Governor's signature and applies to all cases (including pending cases) where a deficiency judgment has not been entered.
The other major change made by AB 273 relates to suits against guarantors. Under prior Nevada law, the holder of a debt could sue the guarantor directly without first foreclosing on the property. The amount of the judgment was based only on the contractual obligations and the fair market value of the property was not considered.3 That type of lawsuit could be filed independently from any other action on the debt.
AB 273 addresses this situation and amends NRS 40.495. It provides that if an action is commenced by a holder of a note secured by real property against a guarantor before a foreclosure sale, "the court must hold a hearing and take evidence presented by either party concerning the fair market value of the property as of the date of the commencement of the action." If a money judgment is to be awarded against the guarantor the court must not award a judgment for more than the lesser of: (1) "the amount by which the amount of the indebtedness exceeds the fair market value of the property as of the date of the commencement of the action"; or (2) "if a foreclosure sale is concluded before a judgment is entered, the amount that is the difference between the amount for which the property was actually sold and the amount of the indebtedness which was secured." See Section 5.5 to AB 273 which amends NRS 40.495.
In other words, now a direct action against a guarantor will be reduced by either the fair market value of the property or the amount the property is sold for at foreclosure. This portion of AB 273 became effective for all actions commenced after July 1, 2011 (the effective date of the act).
The larger effects of AB 273 are not known at this time. One side effect may be a decline in the secondary market for real estate secured loans in Nevada. A decline in the secondary market may actually harm borrowers who may find it more difficult to obtain loans in Nevada.
3 For actions against guarantors, the statutory definition of "indebtedness" is different than for foreclosure or deficiency actions. NRS 40.465 defines "indebtedness" as "the principal balance of the obligation, together with all accrued and unpaid interest, and those costs, fees, advances and other amounts secured by the mortgage or lien upon real property." This is a broader definition that does not include limiting language that "such amount constituting a lien is limited to the amount of the consideration paid by the lienholder."