The Fair Market Value Credit in NJ Commercial Foreclosures:
Practical Considerations and Strategies
Dateline: May, 2005
Overview:
By statute, holders of defaulted residential mortgages are required to first foreclose the mortgage and may only sue the borrower personally on his or her note if, at the Sheriff’s foreclosure sale “the mortgaged premises do not bring an amount sufficient to satisfy the debt, interest and costs.” N.J.S.A. 2A:50-2.
Regardless of the price obtained at the Sheriff’s sale, the borrower in such a deficiency action has the express, statutory right to dispute the deficiency by demonstrating, and in effect, claiming a “credit” for, the “fair market value” of the foreclosed property. N.J.S.A. 2A:50-3.
However, the Legislature exempted commercial mortgages from the foregoing statutory requirements. This has led to a judicially created right to a “fair market value credit” for commercial borrowers and guarantors that is often misunderstood and misapplied by litigants, counsel and trial courts alike.
This article will examine the fair market value credit in the commercial context and address some of the practical issues related to its application at the trial level.
What Errico wrought—the court-created fair market value credit in the commercial context.
N.J.S.A. 2A: 50-2.3(a) renders the fair market value credit inapplicable to debts secured for commercial or business purposes. This well-founded exemption recognizes that commercial loan transactions do not involve ordinary homeowners and mortgage lenders that are motivated in substantial part by the value of the property offered as the exclusive security for the loan.
In CitiBank, N.A. v. Errico, 251 N.J. Super. 236 (App. Div. 1991) the court dismissed the statutory exemption and, using its equitable powers to prevent a “windfall”, afforded a commercial obligor the right to a “fair market value credit” in a deficiency action following a judicial sale of mortgaged premises which served as collateral for a commercial loan. However, the court in Errico made no effort to define “fair market value” in this context and provided no practical guidance as to exactly how the credit was to be determined at the trial level.
In RTC v. Berman Industries, 271 N.J. Super. 56 (Law Div. 1993), the court extended the equitable right created by the Appellate Division in Errico to guarantors of commercial loans to prevent the mortgagee which took title to the mortgaged premises at sheriff’s sale for the minimum bid of $100 from scoring a “windfall”.
Obviously encouraged by the Errico decision, the commercial guarantors in Summit Trust v. Willow Business Park, 269 N.J. Super. 439 (App. Div. 1994) claimed an equitable right to compel their lender to foreclose first on the valuable mortgaged premises, or in the alternative, that they be given a credit for the fair market value of the mortgaged premises “up front” in the suit on the guaranties. They lost. The court rejected both arguments and ultimately noted in a cursory fashion that, in the event of a subsequent foreclosure, the maker and guarantors “at that time may assert a right to a fair market value credit”. See, Summit Trust, supra, at 449.
Clearly, Errico and Summit Trust offer very little in practical guidance as to how the credit is to be implemented at the trial level. Ironically, while it may appear to be a totally pro-borrower decision, the Law Division case of RTC v. Berman offers the most practical assistance to lenders litigating a fair market value credit case against a commercial note maker or guarantor.
Practical considerations regarding the fair market value credit at the trial level.
In the residential context, the application of the fair market value credit by the court in a deficiency action is spelled out to some degree in N.J.S.A. 2A:50-3. Of course, this statute does not apply in the commercial context. RTC v. Berman offers some guidance in this regard.
The court in Berman granted the lender summary judgment on liability. The court then ruled that, before entry of judgment on damages, the guarantor would be given a fair market value hearing at which time he “shall be permitted an opportunity to introduce evidence as to the fair market value of the mortgaged premises at the time of the sheriff’s sale.” See, 271 N.J. Super. at 68.
The foregoing ruling sets forth the relevant date for determining the fair market value—the date of the sheriff’s sale. It also strongly suggests, if not outright determines, that the guarantor or note maker has the burden of proof of establishing the fair market value credit to be applied by the court against the outstanding amount due the lender.
This means that the appraisal obtained at the loan’s inception is irrelevant and that the lender need not prove the borrower’s fair market value credit for him/her in an action on the note and/or guaranty. The FMV credit is, after all, in this commercial context, a judicially created, affirmative defense that carries with it the burden of persuasion. See, Rendine v. Pantzer, 276 N.J. Super. 398, 435 (App. Div 1994), aff’d 141 N.J. 292 (1995).
Nonetheless, when a lender, in addition to foreclosing on mortgaged commercial premises, at the same time sues a commercial borrower and/or guarantor personally on a note and guaranty, it should obtain an appraisal of the mortgaged premises at or about the time of any sheriff’s sale. What value the lender’s REO department “books” or assigns to the mortgaged premises is not the fair market value credit that a court will apply against the outstanding obligation. There is no reported case in New Jersey that equates such an internally assigned and calculated subjective value with fair market value. The New Jersey Supreme Court has declared the traditional, “objective” definition to apply “regardless of the purpose for which market value is sought.” In re Estate of Romnes, 79 N.J. 139, 144 (1978).
The appraiser must be made aware of the fact that his/her appraisal is not “just for the file”, but rather may at some point be subjected to judicial scrutiny. Further, he or she must be made aware that the appraisal is not being requisitioned in connection with a new loan application but rather in connection with a judicial hearing on the issue of a fair market value credit to be afforded by a court to a defaulted borrower. This is not improper “coaching”; it is simply accurately defining the circumstances of the professional’s retention so that the appraisal will be admissible and relevant.
Conclusion
The concept of the fair market value credit seems simple enough, but in the commercial context its application is often misunderstood and/or misapplied. Borrowers’ counsel love to make a big issue of lofty, optimistic appraisals related to their clients’ initial loan application and press for across-the-board, haphazard applications of Errico and its anti-windfall sentiment. Lenders love the convenience and, understandably, the “reality” of their internal valuation of a mortgaged property taken back in foreclosure that must then be carried and marketed and resold by the lender at considerable expense. Trial courts may simply assume that the lender just by being the plaintiff has the burden of proof as to the fair market value of the mortgaged property.
Lenders and their counsel must be prepared in such cases to push the burden of proof on the borrower, where it belongs, and to obtain and present a relevant, defensible appraisal of the property’s fair market value as of the sheriff’s sale date.
This Article is a service of the Creditors’ Rights Department of Fein, Such, Kahn & Shepard, P.C., 7 Century Drive, Suite 201, Parsippany, NJ 07960. Phone: 973-538-4700. Website: www.feinsuch.com. It does not constitute legal advice nor create an attorney-client relationship. For more information contact Shareholder Alan F. Such, Esq. and afs@feinsuch.com.
© 2005, Fein, Such, Kahn & Shepard, P.C., all rights reserved. Permission is granted to reproduce and redistribute this article so long as (i) the entire article, including all headings and the copyright notice are included in the reproduction, and (ii) no fee or other charge is imposed.