Suits for Deficiency
In the event that the foreclosure sale proceeds are insufficient to pay the secured obligation, the mortgagee must evaluate whether to proceed with a deficiency suit against the obligors on the debt. This chapter discusses how one calculates the deficiency, the parties who may be liable for payment of the deficiency, the statutes governing (and in some cases, limiting) the recovery of a deficiency, the bringing of the deficiency suit, and the recovery of the costs and expenses of the deficiency suit.
In the event that the nonjudicial foreclosure sale of the deed of trust collateral does not generate sufficient proceeds to pay off the entirety of the secured debt, one of the options that the holder of a recourse debt has is to bring suit against the obligors on the debt for the remaining unpaid balance—the deficiency. A deficiency is the amount of the secured debt remaining unpaid after payment of the allowable expenses and fees of foreclosure from the proceeds received at foreclosure. An important point to remember in evaluating action to collect the deficiency, however, is that the amount of the deficiency is not necessarily the amount that the lender may actually enforce against individual obligors of the debt. First, Texas statutes provide that under appropriate circumstances the deficiency is calculated by crediting payment of the secured debt with the fair market value of the collateral rather than merely with the net sales proceeds. (See section 17.5 below.) Second, a deficiency action is limited to the portion of the deficiency for which recourse lies against a potential obligor. (See section 17.7 below.) Finally, the practicality of bringing a deficiency action may be limited in whole or in part by the expense, time, and likelihood of success associated with pursuing and collecting a deficiency judgment against the obligor. Accordingly, the person holding a deficiency and desiring to sue on the debt must carefully evaluate (1) the amount of the deficiency for which each potential defendant (whether as maker, assumptor, or guarantor) remains personally liable under law following the foreclosure; (2) whether such defendant owns sufficient nonexempt, unpledged assets to justify the collection effort against the defendant; and (3) whether it is commercially feasible to pursue collection in light of the time, expense, and likelihood of obtaining and enforcing collection of a judgment.
Texas Property Code section 51.003 provides that the creditor must bring suit to recover a deficiency within two years following the date of the foreclosure sale. Tex. Prop. Code § 51.003(a). The two-year limitations period in Texas Property Code section 51.003(a) applies and controls over any limitations period which would otherwise apply to a suit to collect the indebtedness from the maker or guarantor in the absence of a foreclosure. Sowell v. International Interests, L.P., 416 S.W.3d 593, 600 (Tex. App.—Houston [14th Dist.] 2013, pet. denied). The claim for the deficiency must be filed within two years of the foreclosure even if the two-year anniversary of the foreclosure is beyond the end of the four-year limitations period otherwise applicable to the lender’s suit against the maker to collect the note or to sue the guarantor to enforce the guaranty. Sowell, 416 S.W.3d at 600. Likewise, if the foreclosure takes place within the first two years of the four-year limitations period for a foreclosure in Texas Civil Practice and Remedies Code section 16.035, Texas Property Code section 51.003(a) effectively shortens the time which would otherwise be available to the lender to sue the borrower and any guarantor for the debt. Sowell, 416 S.W.3d at 600. Accordingly, the determination as to whether a deficiency exists, whether the potential defendants have both liability for the deficiency and assets worth pursuing, and the cost and likelihood of success in pursuing the deficiency must be made and action initiated during this two-year period.
§ 17.4Waiver of Two-Year Limitations Period
The Texas Supreme Court has held that the two-year limitations period in Texas Property Code section 51.003(a) can be waived provided that the waiver is both specific and for a reasonable time. Godoy v. Wells Fargo Bank, N.A., 575 S.W.3d 531, 537–40 (Tex. 2019). In Godoy, a guarantor’s waiver of “any ‘one action’ or ‘anti-deficiency’ law or any other law which may prevent Lender from bringing any action, including a claim for deficiency, against Guarantor before or after Lender’s commencement or completion of any foreclosure action either judicially or by exercise of power of sale,” was held to be sufficient to waive the two-year limitations period for a suit for deficiency in Tex. Prop. Code § 51.003. Godoy, 575 S.W.3d at 538–40. The supreme court recognized its long-standing principle that an agreement to waive and not plead a statute of limitations for future claims violates Texas public policy and is void. Godoy, 575 S.W.3d at 537–38. The court, however, also recognized that a waiver of a statute of limitations that is both specific and for a reasonable time is not void. Godoy, 575 S.W.3d at 537–38. Although the waiver language in Godoy did not specifically mention limitations, the supreme court determined that the references to “any ‘one action’ or ‘anti-deficiency’ law or any other law which may prevent Lender from bringing any action, including a claim for a deficiency against Guarantor” were sufficiently specific. Godoy, 575 S.W.3d at 539. Even though Tex. Prop. Code § 51.003(a) is not identified by citation, the court noted that Texas Property Code section 51.003 is often referred to as Texas’s “anti-deficiency law.” Godoy, 575 S.W.3d at 539. The court concluded that the waiver provision also satisfied the “for a reasonable time” requirement even though the waiver provision did not state an alternative time period or mention a specific end date. Godoy, 575 S.W.3d at 539–40. The court found that Texas Civil Practice and Remedies Code section 16.004(a)(3) applies to a suit to collect a debt and provides a reasonable “backstop” for a suit on a debt. Godoy, 575 S.W.3d at 539–40. The court determined that the waiver provision was sufficient to waive the two-year limitations period in Texas Property Code section 51.003, that a four-year limitations period applied to the lender’s deficiency claim, and that because the deficiency claim was filed within four years of the foreclosure, limitations did not bar the deficiency claim. Godoy, 575 S.W.3d at 540.
§ 17.5Calculation of Deficiency
As noted above, the deficiency is the unpaid balance that remains owing on the secured debt once the net foreclosure proceeds remaining after payment of the allowable fees and expenses of sale have been applied to the secured debt. If the collateral has been damaged by casualty, see also section 13.4 in this manual concerning how the application of the insurance proceeds can affect the lender’s bid, and thus indirectly the amount of the potential deficiency.
In PlainsCapital Bank v. Martin, 459 S.W.3d 550 (Tex. 2015), the lender attempted to argue that because Property Code section 51.003(a) uses the phrase “the deficiency” rather than “a deficiency,” the statutory requirement that the borrower, following proper request, be given credit for at least the fair market value of the collateral at the time of sale when calculating a deficiency applied to only a deficiency calculated using the exact foreclosure sale price and did not apply when the deficiency was calculated using a different method. PlainsCapital Bank, 459 S.W.3d at 555. In this case, the lender sought to calculate the deficiency using the price recovered from the lender’s resale of the property following foreclosure, which was lower than the actual sales price. The court refused to accept this argument.
§ 17.5:1Force-Placed Insurance Premiums and Escrow Funds
In determining whether a deficiency or a surplus bid exists, credit is to be given by the mortgagee to premiums on force-placed insurance refunded to the mortgagee after the foreclosure sale that were included as part of the secured debt. Likewise, interest that would have been earned on the mortgagor’s escrow accounts had the mortgagee followed the deed-of-trust requirements for interest-bearing escrow accounts is to be credited against the balance of the secured debt. See Myrad Properties, Inc. v. LaSalle Bank N.A., 252 S.W.3d 605 (Tex. App.—Austin 2008), rev’d on other grounds, 300 S.W.3d 746 (Tex. 2010); see also Tex. Ins. Code ch. 549.
§ 17.5:2Private Mortgage Insurance Payments
Section 51.003(d) of the Texas Property Code provides the following:
Any money received by a lender from a private mortgage guaranty insurer shall be credited to the account of the borrower prior to the lender bringing an action at law for any deficiency owed by the borrower. Notwithstanding the foregoing, the credit required by this subsection shall not apply to the exercise by a private mortgage guaranty insurer of its subrogation rights against a borrower or other person liable for any deficiency.
The failure of the mortgagee to apply payments received from the mortgagor to private mortgage insurance premiums will not prevent the mortgagee from collecting on the resulting deficiency. See Shields v. Atlantic Financial Mortgage Corp., 799 S.W.2d 441 (Tex. App.—El Paso 1990, no writ) (mortgagee applied payments to loan balance, resulting in cancellation of private mortgage insurance). However, the lender cannot unilaterally change private mortgage insurance coverage to the detriment of the debtor. See Fort Worth Mortgage Corp. v. Abercrombie, 835 S.W.2d 262 (Tex. App.—Houston [14th Dist.] 1992, no writ).
If the deed of trust contractually limits the manner of collecting the trustee’s fees to a deduction from sales proceeds, a trustee’s fee may not be recovered in the deficiency action. Richardson v. Raby, 376 S.W.2d 422, 427 (Tex. App.—Tyler 1964, no writ).
§ 17.6Credit for Fair Market Value in Deficiency Action
Texas Property Code section 51.003 allows any person against whom an action is brought to recover a deficiency to request that the court determine the fair market value of the real property as of the date of the sale. See Tex. Prop. Code § 51.003.
§ 17.6:1Request for Determination of Fair Market Value
If the court determines that the fair market value of the collateral sold at foreclosure exceeds the amount of the successful bid at the foreclosure sale, the obligors are entitled to an offset in the amount of the excess against the remaining indebtedness. See Tex. Prop. Code § 51.003(b), (c). Section 51.003 thus regulates the calculation of the deficiency remaining after a foreclosure sale, although it does not affect the mechanics of the foreclosure process itself. However, the obligors are not entitled under section 51.005 to offset the mortgaged property’s unrealized fair market value in a suit by a second lienholder, whose lien was cut off by the first lienholder’s foreclosure. Mays v. Bank One, N.A., 150 S.W.3d 897, 898–900 (Tex. App.—Dallas 2005, no pet.). “The language of section 51.005(c) makes it clear that the calculation of a ‘deficiency’ includes only a lien or encumbrance on mortgaged property ‘that was not extinguished by the foreclosure.’ ” Mays, 150 S.W.3d at 900. Texas Property Code section 51.003 applies to both borrowers and guarantors and provides an affirmative defense to offset any deficiency sought following a real estate foreclosure. Marhaba Partners v. Kindron Holdings, LLC, 457 S.W.3d 208, 214–15 (Tex. App.—Houston [14th Dist.] 2015, pet. denied).
Although not defined by statute, “fair market value” is determined as of the date of the sale by the finder of fact after the introduction by the parties of competent evidence of the value. See Tex. Prop. Code § 51.003(b). Competent evidence of value may include, but is not limited to, expert opinion testimony, comparable sales, anticipated marketing time and holding costs, and the necessity and amount of any discount to be applied to the future sale price or the cash flow generated by the property to arrive at a current fair market value. Tex. Prop. Code § 51.003(b). In determining the fair market value, the court may consider a postforeclosure sales price as competent evidence of the fair market value, as well as the actual holding costs incurred by the lender in reselling the property following the foreclosure sale. PlainsCapital Bank v. Martin, 459 S.W.3d 550, 555–58 (Tex. 2015). However, evidence of the foreclosure sales price is not competent evidence of fair market value because the transaction is not one between a willing buyer and a willing seller. Silberstein v. Trustmark National Bank, 533 S.W.3d 403, 412 (Tex. App.—Houston [14th Dist.] 2016, pet. denied); Preston Reserve, LLC v. Compass Bank, 373 S.W.3d 652, 663 (Tex. App.—Houston [14th Dist.] 2012, no pet.).
Although section 51.003 refers to both the court and the finder of fact in discussing the determination of fair market value, it states, “The fair market value shall be determined by the finder of fact after the introduction by the parties of competent evidence of the value.” Tex. Prop. Code § 51.003(b). In spite of the statute’s inconsistency, this provision apparently gives the debtor the opportunity to have fair market value determined by a jury. See form 17-1 in this chapter for a petition for fair market value after nonjudicial foreclosure.
§ 17.6:2No Request for Determination of Fair Market Value
The foreclosure sale price will be used to compute the deficiency if “no party requests the determination of fair market value or if such a request is made and no competent evidence of fair market value is introduced.” Tex. Prop. Code § 51.003(c). See section 17.5 above for a discussion of the application of private mortgage insurance to the deficiency.
§ 17.6:3No Affirmative Right of Recovery
Texas Property Code section 51.003 does not provide that the debtor is entitled to an affirmative recovery if the fair market value exceeds the amount of the debt. The statute provides for an offset only. See Tex. Prop. Code § 51.003. Under case law, however, the debtor may be entitled to such a recovery if there were technical defects in the foreclosure proceedings that led to an inadequate price. See chapters 10 and 16 in this manual concerning typical borrower challenges to foreclosure and the consequences of wrongful foreclosure.
§ 17.6:4Use of Fair Market Value after Judicial Foreclosure
Texas Property Code section 51.004, a more or less parallel statute to section 51.003, similarly regulates the calculation of any deficiency resulting after a judicially ordered foreclosure sale. See Tex. Prop. Code § 51.004. See chapter 20 in this manual concerning judicial foreclosures.
§ 17.6:5Third-Party Purchasers
In calculating a deficiency, Texas Property Code section 51.003 does not distinguish between foreclosure sales at which the lender is the purchaser and sales at which a third party is the purchaser. If a third party buys the property, the person against whom a deficiency judgment is sought is entitled to prove and receive an offset equal to the excess of the fair market value over the bid price and the lender will be required to reduce the amount of the deficiency without the benefit of receiving the full value of the property. The lender, however, may be in a better position to argue that the sale price equaled the fair market value if an unrelated party bought the property.
§ 17.7Continued Liability of Obligors under Recourse and Nonrecourse Loans
An important question to resolve in evaluating whether to pursue a deficiency action is whether the maker and any other obligors (such as a guarantor) are personally liable for the deficiency. A recourse loan “allows the lender, if the borrower defaults, not only to attach the collateral but also to seek judgment against the borrower’s (or guarantor’s) personal assets.” Black’s Law Dictionary 1021 (9th ed. 2009). Conversely, the maker of a nonrecourse loan “does not personally guarantee repayment of the note and will, thus, have no personal liability.” Fein v. R.P.H., Inc., 68 S.W.3d 260, 266 (Tex. App.—Houston [14th Dist.] 2002, pet. denied). “A nonrecourse note has the effect of making a note payable out of a particular fund or source, namely, the proceeds of the sale of the collateral securing the note.” Fein, 68 S.W.3d at 266. In other words, under a fully nonrecourse loan, the borrower has no personal liability beyond the loss of the collateral securing the note. However, the nonrecourse nature of the note does of itself destroy the negotiability of the note. See Tex. Bus. & Com. Code § 3.106(b)(ii), cmt. 1.
§ 17.7:1Springing Recourse Provisions in Nonrecourse Loans
Most nonrecourse loans include a set of “nonrecourse carveout” covenants, referred to as “bad-boy” covenants, the violation of which results in the loan, either in whole or in part, becoming (“springing into”) recourse, to the borrower and guarantor. These covenants focus on preventing or inhibiting the borrower or its principals from taking actions that constitute fraud, gross negligence, willful misconduct, waste, or misapplication or conversion of operating funds or insurance or condemnation proceeds, or that interfere with the mortgagee’s pursuit of its rights and remedies under the loan documents. See Sanford A Weiner, Springing Guarantees: No, It Can’t Mean What It Actually Says, Can It?, in Advanced Real Estate Law Course, State Bar of Texas (2012); James A. Wallenstein, Negotiating Loan Documents to Avoid Inadvertent Recourse, in Advanced Real Estate Drafting Course, State Bar of Texas (2013). However, see also Rampart Capital Corp. v. Egmont Corp., 18 S.W.3d 318 (Tex. App.— Beaumont 2000, no pet.), where a broadly worded nonrecourse provision was held to bar an action against the mortgagor for breach of the warranty of good title.
§ 17.7:2Types of Nonrecourse Carveouts
There are generally two types of carveouts: (1) limited recourse carveouts, which limit the borrower’s and guarantor’s recourse liability to damages resulting from the triggering event (for example, misappropriation of insurance proceeds, security deposits, or prepaid rents), and (2) springing full recourse carveouts. Many times nonrecourse loans require the mortgagor to be a single purpose entity (SPE) and to comply with bankruptcy-remote requirements designed to isolate and protect the mortgaged property from unrelated obligations of affiliates of the borrower. Especially in secured transactions in which the borrower is an SPE, the springing recourse liability is guaranteed by a separate guaranty. As to SPEs and commercial mortgage-backed security transactions, see generally Jonathan Thalheimer, Commercial Mortgage-Backed Securities 2013, in Advanced Real Estate Law Course, State Bar of Texas (2013); Patrick C. Sargent, CMBS 3.0: An Updated Overview, in Advanced Real Estate Law Course, State Bar of Texas (2012); and Thomas A. Hauser, CMBS 2.0: Things to Consider from a Borrower’s Perspective, in Advanced Real Estate Strategies Course, State Bar of Texas (2011).
§ 17.7:3Examples of Nonrecourse Loan Carveouts
Violation of Covenant against Loans; Expansions of Entity Purpose: In LaSalle Bank N.A. v. Mobile Hotel Properties, LLC, 367 F. Supp. 2d 1022 (E.D. La. 2004), a borrower’s and guarantor’s conduct intended to aid a distressed project resulted in springing recourse for the borrower and guarantor. The guarantor made multiple interest-free loans to the borrower in violation of loan covenants restricting against additional debt. Additionally, the borrower modified its articles of incorporation to expand its stated purpose. The court held that these actions triggered full recourse liability for the borrower and guarantor despite the fact that the guarantor acted to preserve the property and the borrower never engaged in any business activity other than ownership and operation of the property. LaSalle Bank, 367 F. Supp. 2d at 1029–31; see also Blue Hills Office Park LLC v. J.P. Morgan Chase Bank, 477 F. Supp. 2d 366, 382 (D. Mass. 2007). However, some courts have entertained an argument that a springing recourse liability is an unenforceable penalty in circumstances in which the mortgagee has not suffered damage or loss. See ING Real Estate Finance (USA) LLC v. Park Avenue Hotel Acquisition LLC, No. 601860-2009, 2010 WL 653972 (N.Y. Sup. Ct. Feb. 24, 2010) (recourse liability not triggered as tax lien discharged during cure period).
Permitting Prohibited Mechanic’s Liens: In Pineridge Associates, L.P. v. Ridgepine, LLC, 337 S.W.3d 461 (Tex. App.—Fort Worth 2011, no pet.), the court held that even though mechanic’s liens were cut off by the mortgagee’s foreclosure, the mortgagor’s failure to obtain a “release of record” triggered full recourse liability for the loan deficiency, which included liability for the prepayment premium and for accrued but unadvanced property taxes that had accrued to the date of foreclosure sale. “Appellants argue that the mechanic’s liens were released of record when they were extinguished by the June 2007 foreclosure sale. . . . Rather, they assume that ‘extinguished’ and ‘released of record’ are synonymous. We disagree . . . .” Pineridge Associates, 337 S.W.3d at 466. Similarly, in Heller Financial, Inc. v. Lee, No. 01 C 6798, 2002 WL 1888591 (N.D. Ill. Aug. 16, 2002), the court found that the borrower’s failure to have mechanic’s liens removed from the property in violation of the covenant prohibiting subordinate liens triggered full recourse liability. The fact that management had been delegated to a lender-approved management company, which failed to resolve the lien filing, was irrelevant. Also, in CSFB 2001-CP-4 Princeton Park Corporate Center, LLC v. SB Rental I, LLC, 980 A.2d 1 (N.J. Super. Ct. App. Div. 2009), the court held that full recourse liability was triggered by violation of a covenant against second-lien financing even though at time of foreclosure of the first-lien mortgage the second lien had been paid and released.
Interference with Creditor’s Realization on the Collateral: In FDIC v. Prince George Corp., 58 F.3d 1041 (4th Cir. 1995), defensive actions taken by the borrower against the lender (injunction and involuntary bankruptcy petition filed by general partner, which delayed foreclosure) were found to violate the no-interference covenants and triggered springing recourse liability. See also First Nationwide Bank v. Brookhaven Realty Associates, 223 A.D.2d 618 (N.Y. App. Div. 1996) (borrower’s filing voluntary bankruptcy petition triggered springing recourse liability on guarantor); 111 Debt Acquisition LLC v. Six Ventures, Ltd., No. C2-08-768, 2009 WL 414181 (S.D. Ohio Feb. 18, 2009). Some courts have been faced with the argument that in this circumstance triggering recourse liability should be deemed a penalty or against public policy. The following courts have upheld springing recourse liability over such arguments: UBS Commercial Mortgage Trust 2007-FL1 v. Garrison Special Opportunities Fund L.P., 33 Misc.3d 1204(A), 2011 N.Y. Slip Op. 51774(U) (N.Y. Sup. Ct. 2011); and Bank of America, N.A. v. Lightstone Holdings, LLC, No. 601853/2009 (N.Y. Sup. Ct. 2009).
A deficiency note executed by a maker pursuant to a plan of reorganization in Chapter 11 proceedings is neither an accord and satisfaction nor a payment in full of the maker’s prior debt such that a guarantor will be discharged on its guaranty. See NCNB Texas National Bank v. Johnson, 11 F.3d 1260, 1266 (5th Cir. 1994).
§ 17.8Deficiency Liability of Guarantors
As a general rule a guarantor will be liable for the deficiency established by a foreclosure sale, even if the borrower has been discharged in bankruptcy proceedings or if the borrower’s liability has been reduced in accordance with an approved Chapter 11 plan. As provided in 11 U.S.C. § 524(e), the “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” See NCNB Texas National Bank v. Johnson, 11 F.3d 1260, 1266 (5th Cir. 1994); United States v. Stribling Flying Service, Inc., 734 F.2d 221, 223 (5th Cir. 1984); R.I.D.C. Industrial Development Fund v. Snyder, 539 F.2d 487, 494 (5th Cir. 1976). For additional discussion, see Charles A. Guerin, A Nonrecourse Lending Carveout Checklist, in Advanced Real Estate Drafting Course, State Bar of Texas, Austin (2003); and Lorin Williams Combs et al., Annotated Guaranty, in Mortgage Lending Institute, University of Texas, Austin (2011).
§ 17.8:1Allocation of Bid Proceeds to Preserve Guaranty of Deficiency
The Texas Supreme Court addressed the propriety of entering a single bid on a foreclosure sale held as a single sale on a multiple-parcel shopping center in Provident National Assurance Co. v. Stephens, 910 S.W.2d 926 (Tex. 1995). The court upheld the mortgagee’s allocation four months after the foreclosure sale of $8,000,000 between portions of the center that were encumbered by separate deeds of trust, respectively securing separate notes of $5,025,000 (supported by a $1,256,250 guaranty) and $6,000,000 (supported by a $1,500,000 guaranty). The allocation of the bid by the mortgagee between the separate parcels resulted in a deficiency of $1,526,000 on one note and deed of trust on the first parcel (triggering in full the guarantor’s liability on its $1,256,250 guaranty) and a deficiency of $1,473,900 on the other note and deed of trust as to the other parcel (triggering in full the guarantor’s liability on its $1,500,000 guaranty). The court agreed that the single sales price may be reasonably allocated between the two properties by using a ratio derived from a comparison of the individual fair market values of the separately secured parcels. See Stephens, 910 S.W.2d at 929.
Where a loan is secured by multiple sources of collateral such as multiple properties, the lender may be able to collect the indebtedness through a series of nonjudicial foreclosures, and Texas Property Code section 51.003 cannot be asserted until all collateral has been sold or when the lender seeks to impose personal liability against the obligors through judicial action. Marhaba Partners v. Kindron Holdings, LLC, 457 S.W.3d 208, 215 (Tex. App.—Houston [14th Dist.] 2015, pet. denied); Branch Banking & Trust Co. v. TCI Luna Ventures, LLC, No. 05-12-00653-CV, 2013 WL 1456651, at *4–5 (Tex. App.—Dallas Apr. 9, 2013, no pet.).
One way to meet these obligations is to routinely provide the client with copies of all pertinent correspondence, documents, and file memoranda; to advise the client in writing of risks involved with the transaction; and to document the business decisions made by the client.
§ 17.8:2Guarantor’s Right to Fair Market Value Determination
Entitlement to an offset under section 51.003 of the Property Code is not limited to the mortgagor or the original debtor. Subsection (b) states, “Any person against whom such a recovery is sought by motion may request that the court in which the action is pending determine the fair market value of the real property as of the date of the foreclosure sale.” Tex. Prop. Code § 51.003(b). The phrase such a recovery refers to the language in subsection (a): “If the price at which real property is sold . . . is less than the unpaid balance of the indebtedness secured by the real property . . . any action brought to recover the deficiency . . . is governed by this section.” Tex. Prop. Code § 51.003(a). Subsection (c) refers to “the persons against whom recovery of the deficiency is sought,” and subsection (d) preserves the subrogation rights of the private mortgage guaranty insurer against “a borrower or other person liable for any deficiency.” Tex. Prop. Code § 51.003(c), (d). Moreover, the guarantor may bring an independent action for determination of the fair market value not later than the ninetieth day after the date of the foreclosure sale or the date the guarantor receives actual notice of the sale, whichever is later. Tex. Prop. Code § 51.005(b). Accordingly, a mortgagee should always give a guarantor notice of any foreclosure sale.
§ 17.8:3Guarantor’s Request for Determination of Fair Market Value
Section 51.005 of the Texas Property Code permits a guarantor against whom a prior judgment on its guaranty has been obtained to bring an action not later than the ninetieth day after the date of a foreclosure sale or the date the guarantor receives actual notice of the foreclosure, whichever is later, for a determination of the fair market value of the foreclosed real property. If the finder of fact finds that the fair market value exceeds the foreclosure bid price, the guarantor is entitled to an offset against the debt equal to the fair market value of the property rather than the foreclosure bid price. See Tex. Prop. Code § 51.005(a)–(c).
§ 17.8:4Waiver of Texas Property Code Protections
The Texas Supreme Court in Moayedi v. Interstate 35/Chisam Road, L.P., 438 S.W.3d 1, 6 (Tex. 2014), held that a guarantor who had waived “all rights and remedies of surety” waived the protections of section 51.003 of the Texas Property Code. The court held that “all” was clear and specific, meaning “all of them.” Moayedi, 438 S.W.3d at 8. Previously, the Fifth Circuit and a Texas court of appeals have upheld contractual waiver in advance by a guarantor of the protections of section 51.003 of the Texas Property Code. See LaSalle Bank N.A. v. Sleutel, 289 F.3d 837, 839–41 (5th Cir. 2002); Segal v. Emmes Capital, LLC, 155 S.W.3d 267 (Tex. App.—Houston [1st Dist.] 2004, pet. abated). The waiver in Segal stated, “To the maximum extent permitted by applicable law, the [Guarantor] waives all rights, remedies, claims and defenses based upon or related to Sections 51.003, 51.004 and 51.005 of the Texas Property Code, to the extent the same pertain or may pertain to any enforcement of this Guaranty.” Segal, 155 S.W.3d at 278. The courts found that the policy behind these sections was not so fundamental that they could not be waived. See Sleutel, 289 F.3d at 841–42; Segal, 155 S.W.3d at 278–79. Thus the courts found that the guarantors had waived their right to challenge the foreclosure sale price in a deficiency suit. The Segal court further found that if the fair-notice test applied to the waiver, the waiver was conspicuous because it appeared immediately above the signature lines and the Property Code sections that were being waived were underlined. See Segal, 155 S.W.3d at 283–84. The right to a fair market value determination in Texas Property Code sections 51.003, 51.004, and 51.005 can be waived. The same rationale for upholding a waiver by a guarantor applies to a waiver by a borrower, and Texas courts have enforced waivers by borrowers. LSREF2 Cobalt (TX), LLC v. 410 Centre, LLC, 501 S.W.3d 626, 633–34 (Tex. App.—San Antonio 2016, pet. denied); Compass Bank v. Manchester Platinum Management, Inc., No. 05-11-00912-CV, 2013 WL 4081420 at *2–3 (Tex. App.—Dallas Aug. 13, 2013, pet. denied).
§ 17.9Impact of Conflict-of-Law and Choice-of-Law Provisions
Conflict-of-law rules and contractual choice of a particular state’s law as being applicable to the loan transaction can significantly impact a lender’s ability to collect on a deficiency after foreclosure on mortgaged property in Texas.
§ 17.9:1General Conflict-of-Law Principles Absent Contractual Choice of Laws
In the absence of an express choice-of-law provision in the loan documents, courts in Texas will generally follow the Restatement (Second) of Conflict of Laws “most significant relationship” test to determine which state’s laws are to apply to the determination of whether the lender is entitled to collect a deficiency after a foreclosure on Texas mortgaged property. Maxus Exploration Co. v. Moran Bros., 817 S.W.2d 50, 53 (Tex. 1991); DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 679 (Tex. 1990); Duncan v. Cessna Aircraft Co., 665 S.W.2d 414, 420 (Tex. 1984); Restatement (Second) of Conflict of Laws § 188 (1971).
The Restatement sets forth the following general rules if the parties have not themselves chosen what law governs their agreement: “The rights and duties of the parties with respect to an issue in contract are determined by the local law of the state which, with respect to that issue, has the most significant relationship to the transaction and the parties.” Restatement (Second) of Conflict of Laws § 188(1) (1971).
Section 188(2) lists the contacts comprising the relationship between transactions and locale ordinarily to be taken into account in applying this test, including—
(a)the place of contracting,
(b)the place of negotiation,
(c)the place of performance,
(d)the location of the subject matter of the contract, and
(e)the domicile, residence, nationality, place of incorporation and place of business of the parties.
Restatement (Second) of Conflict of Laws § 188(2) (1971).
Section 6 of the Restatement provides that absent a statutory directive concerning the law to be applied in a case, the following seven factors are relevant:
The factors relevant to the choice of the applicable rule of law include
(a)the needs of the interstate and international systems,
(b)the relevant policies of the forum,
(c)the relevant policies of other interested states and the relative interests of those states in the determination of the particular issue,
(d)the protection of justified expectations,
(e)the basic policies underlying the particular field of law,
(f)certainty, predictability and uniformity of result, and
(g)ease in the determination and application of the law to be applied.
Restatement (Second) of Conflict of Laws § 6 (1971).
§ 17.9:2Express Choice-of-Law Provisions
The Texas Supreme Court has adopted the principles set forth in section 187 of the Restatement (Second) of Conflict of Laws (1971) to determine if a choice-of-law provision is to be enforced by a Texas court. See DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 680–81 (Tex. 1990); Sanford A. Weiner & John C. Ale, Making Choice of Law a Contact Sport: Contractual Choices of Law in Texas, 54 Tex. B.J. 262 (1991).
Under the Restatement rule, the choice-of-law provision will be upheld unless all the factors in Restatement section 187(2)(b) are met; namely, (1) some other state’s law would apply had the parties not made a choice, (2) that other state has a materially greater interest than does the chosen state in the enforceability of the contractual provisions at issue, and (3) the contractual provisions at issue violate a fundamental policy of that other state. See Restatement (Second) of Conflict of Laws § 187(2) (1971).
In Chase Manhattan Bank, N.A. v. Greenbriar North Section II, 835 S.W.2d 720 (Tex. App.—Houston [1st Dist.] 1992, no writ), the court required compliance with New York foreclosure procedures as a condition to collecting a deficiency following a Texas foreclosure sale. The note and the guaranty provided that they would “be construed and enforced in accordance with the laws of the State of New York.” The lender foreclosed on the Texas mortgaged property in accordance with section 51.002 of the Texas Property Code. However, the court denied the lender the right to collect on the resulting deficiency because the lender failed to comply with the New York Real Property Actions and Proceedings Law, which requires obtaining an order within ninety days after the foreclosure and a judicial determination of appraised value as a condition to collecting a deficiency. The court held that the New York law should be applied to bar the deficiency for the following reasons: (1) the court decided that New York had a substantial relationship to the parties and the transaction, (2) Texas did not have a more significant relationship with the parties and the transaction than New York, (3) Texas did not have a materially greater interest than New York in determining whether the holder could recover a deficiency judgment because the mortgaged property had already been foreclosed on and there was not an issue whether the foreclosure was proper, and (4) the application of New York law to the recovery of the deficiency did not violate a fundamental public policy of the state of Texas. Chase Manhattan, 835 S.W.2d at 726–27.
See also SBKC Service Corp. v. 1111 Prospect Partners, No. 97-3193, 1998 WL 436579 (10th Cir. July 30, 1998), analyzing whether California or Kansas law applied to a post-nonjudicial foreclosure deficiency collection action.
§ 17.10Costs and Attorney’s Fees in Collecting Deficiency
Attorney’s fees are recoverable if provided for by the contract between the parties or by statute. See Tex. Civ. Prac. & Rem. Code § 38.001. In a deficiency suit following foreclosure, the provisions of the real estate lien note usually govern the collection of attorney’s fees.
If the deed of trust so provides, the beneficiary may deduct from the proceeds of the foreclosure sale all attorney’s fees that are (1) reasonable, (2) necessary to enable the trustee to properly execute the power of sale, and (3) actually rendered to and incurred by the beneficiary. Airline Commerce Bank v. Commercial Credit Corp., 531 S.W.2d 171, 175–76 (Tex. App.—Houston [14th Dist.] 1975, writ ref’d n.r.e.). It is a potential violation of the Texas Deceptive Trade Practices–Consumer Protection Act for the mortgagee to charge its attorney’s fees incurred in a foreclosure against the borrower’s escrow account if the loan documents do not provide for such offset. Wieler v. United Savings Ass’n of Texas, FSB, 887 S.W.2d 155, 160 (Tex. App.—Texarkana 1994), writ denied per curiam, 907 S.W.2d 454 (1995).
§ 17.10:1Stipulated Percentages
Stipulated-percentage attorney’s fee clauses are not regarded as absolute promises to pay the contractual amount but as contracts to indemnify the noteholder for attorney’s fees actually incurred in collection. F.R. Hernandez Construction & Supply Co. v. National Bank of Commerce, 578 S.W.2d 675, 676 (Tex. 1979); Kuper v. Schmidt, 338 S.W.2d 948, 950 (Tex. 1960); Gardner v. Associates Investment Co., 171 S.W.2d 381, 384 (Tex. App.—Amarillo 1943, writ ref’d w.o.m.). Therefore the unreasonableness of contractual attorney’s fees, including stipulated percentages, may be challenged, and the holder of the note is not entitled to recover the full contractual amount that is unreasonable under the circumstances. F.R. Hernandez Construction & Supply Co., 578 S.W.2d at 676–77; Keenan v. Gibraltar Savings Ass’n, 754 S.W.2d 392, 395 (Tex. App.— Houston [14th Dist.] 1988, no writ); Spring Branch Bank v. Mengden, 628 S.W.2d 130, 134 (Tex. App.—Houston [14th Dist.] 1981, writ ref’d n.r.e.). Attorney’s fees will be limited to the contractually fixed percentage even if a greater amount is found to be a reasonable fee. Beltran v. Groos Bank, N.A., 755 S.W.2d 944, 951 (Tex. App.—San Antonio 1988, no writ).
The Texas Real Estate Forms Manual’s form for promissory note provides: “Borrower also promises to pay reasonable attorney’s fees and court and other costs if an attorney is retained to collect or enforce the note.” 1 State Bar of Texas, Texas Real Estate Forms Manual ch. 6, form 6-1 (2022 ed.).
The legal owner and holder of the note is prima facie entitled to recover the attorney’s fees stipulated in the note, which if unchallenged shall be awarded. F.R. Hernandez Construction & Supply Co. v. National Bank of Commerce, 578 S.W.2d 675, 677 (Tex. 1979).
One challenging the reasonableness of the attorney’s fees contractually stipulated in a note must affirmatively plead and prove that (1) the contractual fee is unreasonable and (2) a lesser fee is reasonable under the circumstances. F.R. Hernandez Construction & Supply Co. v. National Bank of Commerce, 578 S.W.2d 675, 677 (Tex. 1979).
A noteholder may be denied any recovery of expenses if it appears that no expense has been incurred as a result of the maker’s default. F.R. Hernandez Construction & Supply Co. v. National Bank of Commerce, 578 S.W.2d 675, 677 (Tex. 1979) (citing Kuper v. Schmidt, 338 S.W.2d 948 (Tex. 1960)).
§ 17.10:5Fees to Collect Attorney’s Fees
Attorney’s fees expended to collect attorney’s fees provided for under a promissory note are not recoverable unless the contract between the parties so states. F.R. Hernandez Construction & Supply Co. v. National Bank of Commerce, 578 S.W.2d 675, 677 (Tex. 1979) (citing Southwest National Bank v. Employers’ Indemnity Corp., 12 S.W.2d 189 (Tex. Comm’n App. 1929, judgm’t adopted)); Miller v. Bush, 42 S.W.2d 156, 159 (Tex. App.—Waco 1931, writ ref’d).
§ 17.11Reimbursement between Jointly Liable Parties
The rights and obligations between joint obligors on a secured debt subject of a deficiency action are implied by common law; however, it is a better practice for joint obligors to enter into a reimbursement agreement. Form 17-2 in this manual is a sample reimbursement agreement regarding guarantors that are jointly and severally liable to a creditor for a secured debt and providing for security supporting the reimbursement obligation.
Combs, Lorin Williams, et al. “Annotated Guaranty.” In Mortgage Lending Institute, 2011. Austin: University of Texas School of Law and Texas Mortgage Bankers Association, 2011.
Guerin, Charles A. “A Nonrecourse Lending Carveout Checklist.” In Advanced Real Estate Drafting Course, 2003. Austin: State Bar of Texas, 2003.
Hauser, Thomas A. “CMBS 2.0: Things to Consider from a Borrower’s Perspective.” In Advanced Real Estate Strategies Course, 2011. Austin: State Bar of Texas, 2011.
Sargent, Patrick C. “CMBS 3.0: An Updated Overview.” In Advanced Real Estate Law Course, 2012. Austin: State Bar of Texas, 2012.
Thalheimer, Jonathan. “Commercial Mortgage-Backed Securities 2013.” In Advanced Real Estate Law Course, 2013. Austin: State Bar of Texas, 2013.
Wallenstein, James H. “Negotiating Loan Documents to Avoid Inadvertent Recourse.” In Advanced Real Estate Drafting Course, 2013. Austin: State Bar of Texas, 2013.
Weiner, Sanford A. “Springing Guarantees: No, It Can’t Mean What It Actually Says, Can It?” In Advanced Real Estate Law Course, 2013. Austin: State Bar of Texas, 2013.