A question that all creditors wish they faced: what happens if a foreclosed property sells for more than the foreclosure purchase price?  Does the extra amount received need to be credited against the deficiency balance or does the creditor get to keep the “profit”?  The short answer is that Colorado law does not require a creditor to apply the profit realized from the subsequent sale against the deficiency balance — all so-called profits are the creditor’s to keep.  However, that does not mean creditors should simply bid low, sell high, and then pursue the debtor or guarantor for a large deficiency.

Any person sued on a deficiency can raise the defense that the creditor failed to bid its good faith estimate of the fair market value of the property (less amounts withheld for taxes, prior liens and holding costs).  For instance, lets say the 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. 

Another factor that needs consideration is the ability of junior creditors to redeem.  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 (taking into account any prior liens and applicable holding costs).  With an appraisal in hand, a creditor has the proof necessary to overcome most any claim that the bid was not a good faith estimate of the property’s fair market value.

Photo by respres (Flickr).