Credit Bidding at Foreclosure Sales

Otten Johnson Alert September 2010

With foreclosure sales up by 30% from August 2009 to August 2010, creditors foreclosing on real property in Colorado increasingly face the important challenge of determining how much to bid at the foreclosure sale. If the bid is for less than the total amount owing under the evidence of debt, then the debtor and any guarantors will most likely remain liable to repay the deficiency. Also, if a foreclosed property later sells for more than the amount bid by the creditor at the foreclosure sale, the creditor does not need to apply the profit realized from the subsequent sale against the deficiency balance – all such profits are the creditor's to keep. However, there are important rules in place that should prevent creditors from submitting low bids simply for the purpose of inflating the deficiency amount.

Specifically, C.R.S. § 38-38-106(6) requires creditors to bid their good faith estimate of the fair market value of the property, less the amount of any unpaid real estate taxes, prior liens as well as estimated holding, marketing and selling costs. Failure to bid the good faith estimate of the property's fair market value does not affect the validity of the sale. However, it does allow the debtor or a guarantor to raise the failure as a defense in any suit brought to collect on the deficiency. For instance, if a creditor bids $500,000.00 of a $1,000,000.00 debt at the foreclosure sale, then, one month later, sells the property for $750,000.00, a debtor sued on the resulting $500,000.00 deficiency will undoubtedly raise failure to bid fair market value as a defense and ask that the deficiency be reduced accordingly. The result will be costly litigation and a possible reduction to the deficiency amount. However, it should be noted, that a creditor never has to bid more than the total amount owing under the evidence of debt, even if that amount is lower than the property's fair market value.

Another factor meriting consideration is the ability of junior creditors to redeem the property after the foreclosure sale. Under Colorado law, a junior creditor can redeem the foreclosed property from the senior creditor by paying the senior creditor the amount of the senior creditor's bid, in cash. If the senior creditor bids less than the property's fair market value, then a junior creditor, with available funds, has an incentive to redeem and realize the latent profit. That leaves the senior creditor in the position of receiving less than fair market value for the property while also facing the prospect of a possible reduction to the deficiency.

The best practice is to bid close to the property's most recently appraised value (less any unpaid taxes, prior liens and applicable holding costs). With an appraisal in hand, a creditor usually has the proof necessary to overcome a claim that the bid was not a good faith estimate of the property's fair market value.

Navigating the rules surrounding foreclosure sales can be complicated. The Troubled Credits practice group has substantial experience in helping clients to avoid the potential pitfalls associated with foreclosures of real property. For more information on this Client Alert or for help evaluating your current situation, contact any of the attorneys in the Troubled Credits practice group  (for a listing, click here.)

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