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When a borrower defaults on his or her commercial real estate loan in Washington, the bank has a number of options for collecting the debt.  Lenders usually secure their real estate loans with deeds of trust, which gives the lender the option to foreclose on the collateral either non-judicially through a Trustee’s Sale, or non-judicially through a judicial foreclosure and subsequent Sheriff’s Sale.  In each of those situations the rules governing the borrower’s and guarantor’s continuing liability on the loan after the sale differ.

As a real estate finance lawyer, I often review bank loan documents and shake my head over the extreme measures taken to protect the rights, prerogatives and leverage of banks. Lenders are given every conceivable remedy as against the borrowers, and borrowers and loan guarantors are required to waive all statutory, equitable and common law defenses and rights. Once in a while this approach backfires.

Standard loan documents used by many commercial banks have included a provision which said the deed of trust not only secures the obligation to repay the indebtedness, but also secures performance of “any and all obligations under the note, the related documents and the deed of trust.” “Related documents” is defined as including any “guaranties”.

At the same time, there is a general rule in Washington State and in most states that prevents lenders from obtaining deficiency judgments against borrowers and guarantors after non-judicial foreclosure of a deed of trust securing a loan. RCW 61.24.100. There are exceptions to that rule, including the provision of RCW 61.24.100(10) which allows a lender to sue a commercial loan guarantor for a deficiency if the guaranty was not secured by the foreclosed deed of trust. It is the interaction of the “related documents” language common to bank loan documents and the limited exception to the general rule prohibiting deficiency judgments which was examined by Division II of the Washington Court of Appeals in First-Citizens Bank & Trust Company v. Cornerstone Homes & Development, LLC, No. 43619-1 (Wash. Ct. App. 2013).

In First-Citizens Bank, the lender non-judicially foreclosed on a number of borrower’s properties after a series of commercial construction loans went into default. Because the amounts bid at the trustee’s sales did not fully repay the amounts owed under the loans, the bank then brought a lawsuit seeking a deficiency judgment against the loan guarantors. However the guarantors argued that because the guaranties were “related documents” which were secured by the deed of trust foreclosed, the general anti-deficiency rule of RCW 61.24.100 barred the lawsuit against them.

The bank and the amici (Washington Bankers Association) argued that the bank did not intend to secure the specific Commercial Guaranty signed by the guarantors, not withstanding the language that the “related documents” secured included “guaranties”. They also argued that the guarantors waived their right to raise the “anti-deficiency” defense in their guaranty, among the laundry list of rights and remedies which a guarantor ostensibly waives in the bank’s form guaranties.

In the first decision by an appellate court which I could find in the United States, Division II of the Court of Appeals agreed with the guarantors, that the bank was barred from seeking a deficiency judgment against them in this context. The Court ruled that the deeds of trust in question secured performance of the guaranties. While the bank may not have intended the effect of its explicit language, it drafted the instruments and is bound by the express language. To the extent the language may not have been clear, ambiguities are construed against the drafter and in favor of the guarantors. Because the guaranties were secured by the deed of trust non-judicially foreclosed, RCW 61.24.100 barred a deficiency judgment against the guarantors thereafter. It also cited recent Supreme Court precedent strongly disfavoring waivers of statutory requirements governing non-judicial foreclosures in rejecting the bank argument that the guarantors waived the anti-deficiency defense.

In a fashion which is typical in bank loan documents, the lender tried to overreach in providing protection for its prerogatives and expansive rights and remedies. This case confirmed that in this context, banks’ over-zealous efforts to provide maximum security for loan documents can backfire. Usually us lawyers representing lenders are more effective in enlarging a lender’s hammer in a way which does not harm its position. The “related documents” dragnet went too far.

As the Court noted, the bank had other approaches which would have preserved its right to sue the guarantors. But the bank chose to first conduct a Trustee’s Sale. There are at least ten cases pending in the Superior Courts of Washington or on appeal with a similar fact pattern. For commercial loan guarantors swept up in the real estate downturn of the last five years, this drafting and procedural misstep by many banks makes Christmas a little cheerier!

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