What Happens to Excess Proceeds After a Foreclosure Sale in Arizona?

In Arizona, there are two primary ways to secure payment for a lien on real property: a trustee’s sale and a judicial foreclosure. The two procedures have some technical differences but the same end result: the property that is the security for the lien is sold to generate proceeds to pay the lien. There is no theoretical limit on the amount of liens with which one can encumber a piece of real estate, but the first lien created is senior to the second lien created. The second lien is senior to the third lien created but junior to the first lien, and so on down the line.

What happens, then, when a junior lienholder wants to foreclose on its lien? This occurs frequently with homeowners associations that want to foreclose their lien for HOA dues or other assessments, and those HOA liens are typically junior to the lien for the property owner’s mortgage loan.

So, for example, say that Celeste has a home with a mortgage balance of $200,000 owed to Union Bank. Celeste also has failed to pay her HOA dues for some time, and she now owes her HOA $5,000. The HOA forecloses its junior lien and holds a judicial foreclosure sale where Omar buys Celeste’s property for $40,000. The HOA gets paid its $5,000, but what happens to the other $35,000? What about the $200,000 that is owed to Union Bank? Did Omar get a great deal and purchase a home worth at least $200,000 for only $40,000?

No, Omar is not that lucky (and, if Omar is bidding on property at a judicial foreclosure sale, he should already know this. If he does not, he should think about different investment opportunities). The senior lienholder, Union Bank, has an intact lien on Omar’s property; the judicial foreclosure sale did not affect Union Bank’s lien. Omar has to make the mortgage payments to Union now, or he will face foreclosure from Union Bank.

But what about the $35,000? Does Union Bank get to take that money, too? That is the question the Arizona Court of Appeals, Division Two, answered in August of this year in Tortosa Homeowners Association v. Garcia (2 CA-CV 2021-0114). The court said no, Union Bank does not get that money. There is a statute that directs how the excess proceeds are to be paid, A.R.S. Section 33-727(B), and the senior lienholder argued in Tortosa that the statute directed payment to “other liens” in order of seniority, not just “junior liens.” The Court of Appeals went through numerous other authorities to show that interpretation is contrary to established law regarding the disposition of excess proceeds and reasoned, correctly, that the recourse of the senior lienholder is the intact senior lien that remains on the foreclosed property, not the excess proceeds. The excess proceeds flow down to the junior lienholders and then, finally, to the owner of the property.

So, in our example above, Celeste actually would receive the $35,000 in excess proceeds, given that there are no other junior liens in my example.

The senior lienholder in Tortosa deserves credit for making a unique argument, but ultimately the right decision seems to have attained. A senior lienholder is protected in a foreclosure sale and gets to keep its lien. That should be recourse enough.