The North Carolina General Statutes prohibit a creditor in a seller-financed purchase money real estate transaction (where the seller of the land and the creditor providing financing for the sale are the same person) from obtaining a judgment against the buyer for any unpaid debt. The theory behind this anti-deficiency statute is that the foreclosure of the real estate by the seller of the land puts the seller back in exactly the position they were in prior to the sale, making any monetary recovery against the buyer after the foreclosure an unfair windfall to the seller. While easy to understand in theory, the cumbersome wording of the statute makes understanding the application and scope of the statute difficult to interperet. N.C.G.S. § 45-21.38 reads as follows:
In all sales of real property by mortgagees and/or trustees under powers of sale contained in any mortgage or deed of trust . . . to secure to the seller the payment of the balance of the purchase price of real property, the mortgagee or trustee or holder of the notes secured by such mortgage or deed of trust shall not be entitled to a deficiency judgment on account of such mortgage, deed of trust or obligation secured by the same: Provided, said evidence of indebtedness shows upon the face that it is for balance of purchase money for real estate: Provided, further, that when said note or notes are prepared under the direction and supervision of the seller or sellers, he, it, or they shall cause a provision to be inserted in said note disclosing that it is for purchase money of real estate; in default of which the seller or sellers shall be liable to purchaser for any loss which he might sustain by reason of the failure to insert said provisions as herein set out.
Summarized below in question and answer format are some common questions regarding the anti-deficiency statute and its application of interest to creditors.
Question 1. Is this anti-deficiency statute limited to a transaction involving a person’s primary residence? Answer: No. While many states will limit application of their anti-deficiency statutes to cover only real estate which consists of a buyer/borrower’s primary residence, this particular statute is not so limited. It applies to any type of seller financed real estate sale including commercial property, primary residences, second homes, or farmland. See Barnaby v. Boardman, 313 N.C. 565 (1985).
Question 2. Does this anti-deficiency statute also prohibit claims against guarantors? Answer: Yes. In Adams v. Cooper, 340 N.C. 242 (1995), the North Carolina Supreme Court held that the statute should be read broadly to effectuate the intent of the legislature, namely, to prohibit suits on the debt. The Court held that overriding principle to be followed is that when the purchase money debtor defaults, the purchase money creditor is limited strictly to the property conveyed and nothing else.
Question 3. Does this anti-deficiency statute apply to second liens or junior financing? Answer: Yes. If any part of the seller/creditor’s loan is used to purchase the property then that loan is a purchase money transaction subject to this anti-deficiency statute. In Sink v. Edgerton, 76 N.C. App. 526 (1985), the North Carolina Court of Appeals held that the anti-deficiency statute applied to subordinate notes and deeds of trust and prevented suit on the note after the senior lien had been foreclosed. See also, Childers v. Parker’s, Inc., 274 N.C. 256 (1968).
Question 4. Does this anti-deficiency statute also prohibit recovery of attorney’s fees and costs of collection? Answer: Yes. In Merritt v. Ridge, 323 N.C. 330 (1988), the North Carolina Supreme Court held that the specific limitations regarding recovery in this anti-deficiency statute prevailed over general statutes allowing recovery of attorney’s fees in promissory notes. As a result, attorney’s fees and collections costs can only be recovered from the equity in the property.
Question 5. Does this anti-deficiency statute also apply to sales of the property by a third party? Answer: No. The North Carolina Supreme Court has held that this statute was meant to apply to deeds of trust and mortgages from the buyer of the property in favor of the seller. Childers v. Parker’s, Inc., 274 N.C. 256 (1968)
Question 6. Can a creditor/seller avoid application of the anti-deficiency statue by not inserting a provision in the note and deed of trust disclosing that they are for the purchase money of real-estate? Answer, perhaps, but it could lead to a lawsuit against the creditor. While North Carolina courts have held that the anti-deficiency statute does not apply if the note, deed of trust or other evidence of indebtedness does not contain a statement that the obligation is a purchase money obligation, see, Bigley v. Lombardo, 90 N.C. App. 79 (1988), courts have also said that if the seller/creditor prepares the loan documents, and these documents do not state that the transaction is a seller financed sale, then the seller/creditor is liable for all damages that result from the seller failing to include the language. See Childers v. Parker’s, Inc., 274 N.C. 256 (1968). As a result, a seller/creditor omits the purchase money language from the loan documents it prepares at its peril.
Based on the foregoing, if a seller/creditor wishes to finance the sale of its property (such as a bank financing the sale of its own OREO property) and would like to avoid application of the statute, then there are two options:
(1) Don’t finance the sale. If the seller requires the buyer to obtain financing from a source other than the seller, then the anti-deficiency statue does not apply.
(2) Don’t have the party financing the sale also take title to the property. If the person holding title to the property at the time of sale is a person other than the person providing the financing (such as a bank subsidiary or affiliate), then the anti-deficiency statute does not apply.
Additionally, it is likely that the anti-deficiency statute would not apply to a seller-financed purchase money real estate transaction if the buyer prepares the loan documents and the documents do not include any reference to the sale being a purchase money transaction. This exception, however, may raise other risks for the creditor because it would mean that the borrower is preparing their own loan documents for the transaction.