Over the last few years, the Arizona Court of Appeals wrestled with the question of who should receive the excess proceeds from a foreclosure sale. We’ve blogged about some these past unreported decisions here and here. Those decisions, somewhat inexplicably, required excess sale proceeds to be paid to senior creditors. As we noted at the time, these unreported (and non-precedential) decisions did not seem to make much sense in the context of debtor/creditor rights. Thankfully, a reported opinion finally sets the record straight. Excess sale proceeds should be paid downstream.

In Tortosa Homeowners Assoc. v. Garcia, et al., No. 2 CA-CV 2021-0114 (Ct. App. Aug. 1, 2022), the Court of Appeals held that after the foreclosing lienholder is paid in full, then the excess sale proceeds should be paid to claimants in the order of their priority after the foreclosing lienholder. In other words, if a junior lienholder forecloses, then any creditors behind (i.e., junior to) the foreclosing creditor should be paid, and if all such creditors are paid, then the rest should be given to the owner. Creditors senior to the foreclosing creditor should not be paid anything from the foreclosure sale. This makes sense from a policy perspective, because the senior creditor retains its lien against the property and the bidder presumably took the presence of the senior lien into account when it made its bid for the foreclosed property.

For the uninitiated, a good definition of a senior creditor is found here:

A good definition of junior debt is found here:

The Tortosa decision is well-reasoned and supported by well-recognized authorities. Although this holding ostensibly contradicts the two unreported decisions discussed above, Tortosa controls not only because it is published, but also because it addresses the issues correctly. In short, all excess sale proceeds from foreclosure sales should be paid according to the priority of creditors after and behind the foreclosing creditor. Creditors senior to the foreclosing creditor (who happened to retain their interest in the property) don’t receive excess sale proceeds, but retain their lien against the property. This result (which we think is correct) follows what the law requires regarding foreclosure sales.