Arizona Court of Appeals Division One Holds That (1) Refinancing a Loan Does Not Destroy Anti-Deficiency Protection to The Extent Proceeds Satisfy the Underlying Purchase Money Obligation, (2) Loans Used to Construct a Residence Sometimes Merit Anti-Deficiency Protection, and (3) Loans Used for Non-Purchase Money Purposes May be Traced, Segregated, and Recovered in a Deficiency Action.

In 2003, the Pasquans purchased a home in Paradise Valley.  The Pasquans had obtained a loan, secured by a deed of trust, to purchase the home.  They later obtained a second loan from a new lender.  This second loan was used (1) to pay off the first loan and (2) to demolish the home on the property and build a new residence.  The Pasquans then obtained another loan from a third lender — Helvetica Service, Inc.  This loan was used, in part, to pay off the second lender’s loans. 

The Pasquans defaulted on the Helvetica Loan, and Helvetica Servicing filed a judicial foreclosure action.  The superior court granted partial summary judgment to Helvetica regarding its right to foreclose, and the property was sold at a sheriff’s sale.  The superior court subsequently ruled that Helvetica could obtain a deficiency judgment against the Pasquans.  Pasquan appealed this ruling. 

A.R.S. § 33-729(A) provides anti-deficiency protection “if a mortgage is given to secure the payment of the balance of the purchase price, or to secure to pay all or part of the purchase price[.]”  Pasquan argued that the construction loans obtained from the second lender were purchase money in nature and therefore protected under the anti-deficiency statute. The Helvetica Loan, he then argued, refinanced an existing purchase money loan and should also be protected under the anti-deficiency statute.  Helvetica argued that Pasquan’s refinancing of the first loan destroyed the “purchase money status,” forfeiting anti-deficiency protection.

The Court of Appeals held that “refinancing a purchase money loan does not destroy purchase money status and forfeit anti-deficiency protection to the extent proceeds from the refinancing transaction are disbursed in satisfaction of the underlying purchase money obligation.”  Discussing the legislative intent to protect consumers by placing the risk of inadequate security on lenders rather than borrowers, the Court found that it would contravene the legislative intent and policy to hold that refinancing destroys anti-deficiency protection. 

The Court of Appeals further held that construction loans used to build a residence qualify as a purchase money obligation if: “(1) the deed of trust securing the loan covers the land and the dwelling constructed thereon; and (2) the loan proceeds were in fact used to construct a residence that meets the size and use requirements set forth in A.R.S. § 33-729(A).”  Whether a construction loan qualified as a purchase money obligation was previously an open question under Arizona law.  The Court of Appeals reasoned — with guidance from Prunty v. Bank of America, 112 Cal. Rptr. 370 (Cal. Ct. App. 1974) — that it furthered the legislative intent and policy to construe anti-deficiency protection to apply to some construction loans.

Finally, the Court of Appeals held that non-purchase money loan funds may be traced, segregated, and recovered in a deficiency action. 

The Court vacated the deficiency judgment and remanded for further proceedings. 

Judge Downie authored the opinion; Judges Barker and Brown concurred.