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The Supreme Court of Appeals of West Virginia recently created significant new law regarding foreclosures and deficiency actions in West Virginia.

Background

On November 12, 2014, the Supreme Court of Appeals of West Virginia released its opinion in Sostaric v. Marshall, No. 14-013. The salient facts in Sostaric are as follows: In 2006, the Sostarics bought a piece of property from Sally Marshall for $200,000. The purchase was an owner-financed transaction in which the Sostarics made a promissory note payable to Marshall in the original principal amount of $200,000, and executed a deed of trust for the benefit of Marshall to secure repayment of the note. The Sostarics defaulted on their obligations in 2010. In 2012, Marshall foreclosed under her deed of trust. At the foreclosure sale, Marshall bid the property in at $60,000, and credited the Sostarics with approximately $58,000 after payment of expenses. Marshall then instituted a deficiency action against the Sostarics, seeking to recover judgment for the balance remaining under the note. The circuit court awarded Marshall the entire amount outstanding under the note (accounting for the $58,000 credit).

On appeal, the Supreme Court of Appeals of West Virginia held that, if the fair market value of the property is greater than the foreclosure sale price, then a defendant in a deficiency action is entitled to an "offset" that equals the difference between the fair market value and the foreclosure sale price. This offset must be raised by the deficiency defendant as an affirmative defense in the deficiency action.

Implications

Under Sostaric, a deficiency defendant may only be entitled to the offset if both (1) the defendant affirmatively asserts the defense in the deficiency action and (2) the court determines that the fair market value was greater than the foreclosure sale price (less any liens not extinguished at the sale). This is a significant change in the law in West Virginia with far-reaching implications. What about the line of cases that uses the "shock the conscience" standard in foreclosures? Will courts extend this currently-narrow holding to cases involving only the upset of foreclosure sales? If a lender files a deficiency action for the full amount, and the defendant raises the defense entitling the defendant to an offset, has the lender violated the West Virginia Consumer Credit and Protection Act by representing it is owed more than it actually is? For several reasons, this case is likely to change the way secured lenders conduct foreclosures and pursue deficiencies in West Virginia.

Continued Viability of the "Shock the Conscience" Standard

Before the court's decision in Sostaric, the court handed down several decisions that indicated that the standard for determining whether to set aside a foreclosure sale is to determine if the lender's credit bid was so low and so unfair that it "shocked the conscience" of the court.

On its face, Sostaric does not change these cases, but there is a concern that borrowers will seek to expand its holding to the actual foreclosure sale process. Although based on current case law, we believe a lender may still enter a bid at 70 to 80 percent of market value at foreclosure, doing so will affect how the lender proceeds in a deficiency action against the borrower.

Recommendation

Because each bank conducts its foreclosures and accounts for its OREO property differently, we believe there is no one-size-fits-all way that a bank should respond to the Sostaric decision. Please give us a call to analyze how best to implement this new case law taking into account your current business practices.