Deed of Trust vs. Personal Liability: An Important Distinction
Lawyers and non-lawyers alike often get confused between legal documents which constitute personal liability and legal documents which secure the debt. When you get a mortgage on your house or other property, the most common set of documentation included in the loan will include a promissory note and a deed of trust. The promissory note (sometimes shortened as just “note”) constitutes the contract between a borrower and a lender that obligates the borrower to repay the loan. The deed of trust is a separate document which does not establish personal liability, but rather establishes real estate as collateral for the loan. If a borrower fails to make payments under the note as required, the lender has the remedy under the deed of trust of foreclosing on the property. Foreclosure involves a forced auction of the property, so that the proceeds of the sale can be used to fully or partially pay off the outstanding loan. (This blog post does not address all of the complexities of foreclosure, such as lien priorities, homestead exemptions, foreclosure procedures, disposition of excess proceeds, foreclosure prevention, etc. Rather, this is a post about appreciating the distinction between deeds of trust and personal liability.)
The distinction between personal liability and deeds of trust tends to be most pronounced when a borrower files for bankruptcy. Obtaining a discharge from the bankruptcy court only means that the borrower is no longer personally liable for repaying the loan. That does not mean that the lender’s collateral gets erased. Following the borrower’s discharge from personal liability under the note, the lender still has the right to foreclose under the deed of trust if the loan remains in default. What the lender cannot do following a discharge is sue the borrower to recoup money from other sources, such as a bank account, personal property, or employment income; the lender is confined to the remedy of foreclosure. While people may view the lender’s foreclosure action as suing the borrower for damages, that perception is technically incorrect, because the lender is merely pursuing their collateral, not the borrower personally.
Because of these important distinctions, questions can arise concerning the statute of limitations for the lender to take action to foreclose following a bankruptcy discharge. The Washington Supreme Court recently settled this question in a pair of cases issued on the same day (Copper Creek Homeowners Association v. Kurtz et al., and Merritt v. USAA Federal Savings Bank). Borrowers obtained several home equity lines of credit, secured by deeds of trust. The loan terms required monthly installment payments, with balloon payments due when the loans would eventually mature starting in the year 2025. Borrowers defaulted and stopped making payments, and then filed for bankruptcy. Borrowers claimed that once they obtained discharges of their personal liability, the 6-year statute of limitations began to run for their lenders to foreclose on the deeds of trust. Borrowers sought to quiet title free and clear of the lender’s deeds of trust based upon the underlying note supposedly no longer being unenforceable. The Supreme Court disagreed, holding that the statute of limitations had not yet run on the deeds of trust, even though the bankruptcy discharges occurred more than 6 years earlier. The court explained that while a bankruptcy discharges personal liability for the debt, it does not extinguish the underlying debt itself. Because a secured creditor’s lien passes through bankruptcy unaffected, and is avoided only by order of the court, if the court takes no action with respect to a secured claim, the secured creditor’s entitlement to receive regular payments continues. The Court’s decision rested heavily on the recognition that the loans still had not matured with the balloon payments becoming due. In light of that, the Court stated, “The final statute of limitations to enforce the deeds of trust will begin to run at each loan’s maturity date. None of the loans have yet matured, so none of the statutes of limitations have begun to run.”
Whether you are a lender or borrower in a loan or lien dispute, the lawyers at Beresford Booth have a wealth of experience in real estate matters and litigation. We would be happy to assist you with your needs.