Legal Q & A

Question:
Despite negotiations by seller's lawyer with seller's short sale lender, short sale lender still insisted that seller carry back a personal obligation for released debt. Short sale lender was non-negotiable on this issue. Is there a new trend in this direction? Seller chose not to proceed with the short sale and is letting the property go to foreclosure.


Answer:
Yes. A new trend is developing in which short sale lenders are establishing policy statements that short sale sellers will not be forgiven of personal liability for any debt released during the short sale. In other words, some major institutional lenders appear to be adopting across-the-board policies refusing to discharge sellers of personal liability. What this means is that these sellers will necessarily continue to be liable for the amount of debt released by the lender to allow the short sale transaction to close. While it cannot be said that every short sale lender has adopted this policy, it appears that several of the major, institutional lenders have adopted this policy.

The end result for sellers in this position is that their lender could sue them (or otherwise attempt to collect the funds) for six years following closing of the short sale. There is a six year statute of limitations on a written contract. The lender could also sell its rights to collect the debt to a third party who could pursue seller. If a judgment is ultimately taken against seller, the judgment will attach to any real property owned by seller (conceivably any real estate owned by seller in any state). A judgment is valid for up to 20 years.

As this seller chose to do, many sellers will refuse to sell the property under these terms. The alternative choice is that the property will be foreclosed which, depending on other facts at issue, will be preferable to many sellers. REALTORS should be aware of this developing trend and make even more of an effort to get sellers to legal counsel for assistance in negotiating and understanding the short sale agreement. Under no circumstances should REALTORS take responsibility for advising sellers as to the merits of signing or declining a short sale agreement.

The way in which many lenders are effectuating this ongoing personal liability is more subtle than stating specifically that seller will remain liable. Some lenders are simply choosing to remain silent, in the short sale agreement, with respect to ongoing liability for the released debt. The effect of that silence is that seller remains liable. Here is how that works. Recall that seller signed a promissory note and a deed of trust when the loan was taken. In the short sale transaction, the deed of trust is released from title to the property but the promissory note remains as evidence of an obligation from seller to lender. The amount owing under the promissory note is reduced by the proceeds of the short sale, but the remaining amount remains an obligation of seller to lender. Unless seller is specifically discharged of all obligation to repay the promissory note, seller remains liable for the unpaid balance.

Aside from the obvious risk to sellers, the real world difficulty presented by this scenario is that there is almost no way for REALTORS to manage this issue without incurring significant lost time and expense for everyone involved. If lender does not clearly indicate its intention in this regard to seller prior to seller marketing the property as a short sale, then what will happen is that seller and listing agent will market the property, buyer(s) through their agent(s) will offer to purchase the property, an offer will be accepted, buyer will pay for and conduct inspections, appraisals, credit reports, etc., escrow will set up an account, title will issue a commitment, etc. and when the short sale agreement is finally produced and the personal liability issue is made clear to seller, seller is likely to refuse to close the transaction making a waste of everyone's time and expense.

This is a dangerous trend for everyone involved. Sellers are taking significant risk in selling their property short without a complete discharge of their obligations under the note. Buyers are taking a risk in spending time and money moving toward closing of a short sale purchase. REALTORS risk losing the value of their time participating in these transactions. And the short sale lenders themselves risk a whole lot of sellers choosing to allow their properties to go to foreclosure, where the lender still will not recover the deficiency, many of the properties will be substantially damaged in the process of foreclosure and the lenders will then have to find their own buyers for the properties at whatever value remains in the property. Hopefully, the negative effects of this trend will reveal themselves to the lending industry immediately and short sale lenders will reverse this policy. Until then, REALTORS must be certain to advise their short sale sellers, in writing, to seek legal counsel for assistance in understanding and determining whether to sign a short sale agreement.

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