Case SummaryJune 2010 – Newsletters In the Zone
This case explores the question of whether the borrower or the lender bears the burden of proceeding to establish the fair market value (FMV) of a business or commercial property. The facts of this case, in brief, are as follows.
In 1986, the lender made a loan to the borrower that was guarantied by, among others, the two guarantors seeking relief in this case. By 1992, the lender had prevailed against the borrower and the guarantors in a vigorously defended foreclosure action. The court in 1992 rendered final judgment in foreclosure and also a money judgment against the borrower and the guarantors. Negotiations between the lender and the borrower continued through 1995. Those negotiations broke down and, in 1995, the foreclosure sale finally took place, at which time the property was sold to a third party for approximately $640,000, although the debt owed by the borrower and the guarantors exceeded $4,330,000. The borrower and the guarantors did not object to the sale pursuant to Rule 4:65-5 by serving a notice of motion within 10 days after the sale contending that the sale price was below the FMV. Thereafter, the lender took no action to collect the roughly $3.6 million deficiency on the judgment.
Then, in 2007, after the passage of 12 years, a successor to the lender attempted to enforce the deficiency against the guarantors. The guarantors argued that the lender was estopped from bringing the action by its failure in 1995 to have brought an action in the foreclosure matter establishing the FMV of the property.
The court began its analysis by stating the fundamental principle that a mortgagee is not entitled to recover more than the full amount of its mortgage debt. The court noted that although the New Jersey statute requiring that a lender establish the FMV of a property sold at foreclosure does not apply to business or commercial properties, New Jersey case law provides that, in the case of business and commercial properties, a court will afford the borrower (and the guarantors) the right to bring an action in equity to establish the FMV. Upon establishing the FMV, the borrower (and the guarantors) will receive a credit against any personal judgment under the note and the guaranty in the amount of the FMV. The question in this case is who has the burden of bringing the action to establish FMV, and when does that action need to be brought?
The court held that although a borrower (and its guarantors) have an equitable, although not a statutory, right to an FMV hearing, the time to demand such a hearing is at the time of the foreclosure sale. The burden is on the borrower to bring an action within 10 days after the foreclosure sale to demand an FMV hearing to establish the property's FMV. In this case, the guarantors wanted to establish the FMV 12 years after the original foreclosure sale, in the deficiency action brought by the lender. The court held that the deficiency action was not the proper forum to establish FMV but, instead, the action must be brought within the 10 days required by Rule 4:65-5 following the sheriff's sale in the foreclosure action.The court thus permitted the judgment to be pursued against the guarantors with no FMV credit.
It should be noted that the court stated that since the guarantors were named in the original mortgage foreclosure action, they had ample notice of the foreclosure action and had an opportunity to demand an FMV hearing in the foreclosure action. The court left open the question of what the result would have been if the guarantors had not been named in the foreclosure action.
There are two lessons to be drawn from this case. First, lenders, if they intend to pursue guarantors under the guaranty, should name those guarantors in the foreclosure action, to avoid giving the guarantors the opportunity to claim prejudice by not having had the opportunity to establish the FMV credit in the foreclosure action. Second, borrowers and guarantors should seek an FMV hearing in the foreclosure action; failing to do so could result in the unpleasant surprise of having a money judgment enforced against them years later.