Anti-deficiency protection and the unfinished home

In 2005, Mr. & Mrs. Mueller bought a plot of vacant land in Arizona. In July 2006, the Muellers borrowed $444,000 from M&I Marshall & Ilsley Bank so that they could build a single-family home on that property. To secure the loan, the Muellers gave M&I a deed of trust on the property.

Several months into construction, the Muellers discovered that the contractor’s work was defective and behind schedule. M&I refused the Muellers’ requests for advances to remedy the defects, so the Muellers abandoned the property and defaulted on the note. M&I foreclosed on the property (by means of a trustee’s sale) and thereafter sued the Muellers for a deficiency of $68,200 (the difference between the pre-sale appraised value of the property and the loan balance).

The trial court dismissed M&I’s deficiency claim, finding that the Muellers were entitled to the protection of Arizona’s anti-deficiency statute, A.R.S. § 33-814(G). M&I appealed, but the Arizona Court of Appeals affirmed the dismissal.

The Court of Appeals examined the anti-deficiency statute, which states (with the emphasis by the Court), "If trust property of two and one-half acres or less which is limited to and utilized for either a single one-family or a single two-family dwelling is sold pursuant to the trustee's power of sale, no action may be maintained to recover any difference between the amount obtained by sale and the amount of the indebtedness and any interest, costs and expenses.

M&I argued on appeal that this statute did not apply to the Muellers because their home was not completed, and, therefore, according to M&I, the property was not – in the words of the statute – “utilized for” a single-family home. M&I relied on the Arizona Supreme Court’s decision in Mid Kansas, 167 Ariz. 122, 804 P.2d 1310 (1991), which also involved the question of whether the anti-deficiency statute applied when the homes in question were not fully constructed and had not yet been occupied. In that case, the Supreme Court held that the owner of the homes, a developer, was not entitled to anti-deficiency protection.

The Court of Appeals distinguished Mid Kansas by noting that the Muellers intended to occupy their home once it was complete, whereas the builder in Mid Kansas was a corporation that never intended to occupy the homes it was constructing. The Court of Appeals noted that the primary purpose of the anti-deficiency statutes is to protect homeowners from deficiency judgments, not to protect commercial homebuilders. The Court stated that the result in Mid Kansas would have been the same even if the homes there had been completed, because the homes still would hot have been “utilized” as single-family homes, and ultimately decided that the Mid Kansas decision was limited to its specific facts.

The Court of Appeals held that because the Muellers intended to live in the single-family home upon its completion, they were entitled to anti-deficiency protection. The Court went on to explain why M&I’s insistence on actual occupancy of the home was not the appropriate legal test:

"M&I’s argument that a person has to physically inhabit the dwelling would create a blurry and artificial line. An individual facing the possibility of foreclosure may camp out in the unfinished home, claiming to be ‘utilizing’ the dwelling. Additionally, a person who lived in a new home for a day would be entitled to anti-deficiency protection, whereas someone who had not yet moved into a newly constructed home would not be entitled to such protection."