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Surplus Funds 101: What Happens to the Proceeds following the Sale?

by Patti Army
Routh Crabtree Olsen — USFN Member (OR, WA)

As more and more third-party investors purchase property at nonjudicial trustee’s sales, trustees must contend with the distribution of any excess proceeds following the sale. State statutes generally provide that the proceeds from a trustee’s sale must be distributed first according to the costs and expenses of the sale and then to the obligation secured by the deed of trust. If these expenses and obligations are paid in full and there is surplus remaining, the junior liens extinguished by the sale attach to the surplus in the same order of priority that they attached to the foreclosed property. If there are no junior liens, or if the surplus is beyond what is owed on all the junior liens, the remainder is distributed to the property’s owner of record at the time of the trustee’s sale.

Competitors for Surplus Funds

Identifying the parties entitled to receive the surplus funds is usually a simple process. The trustee first compiles a list of interested parties from the dated-down foreclosure title report. Next, the trustee’s attorney notifies all parties on the list that there are surplus funds the attorney intends to distribute according to the priority established in the foreclosure title report. If no one objects, the trustee’s attorney then requests that the junior lienholder receiving the funds sign an agreement containing estoppels that the lienholder is legally entitled to receive the funds and that the lienholder will indemnify the trustee for damages and any legal costs or fees that arise if the distribution of the surplus funds is later disputed.

The process can become problematic, however, when there are numerous judgment creditors vying for the excess, when the borrowers file bankruptcy, or when there is a pending dissolution action. It can also become extremely frustrating for the trustee’s attorney when there are no junior liens of record, but the borrower cannot be located or is not in a cooperative mood. Commonly, borrowers leave the property following the trustee’s sale without a forwarding address. Borrowers who refuse to leave the property after foreclosure and must be sued in an eviction action are no less common and are usually in no mood to cooperate with the lender or its agents even when it may mean they have money coming to them. In either case, the trustee’s attorney is generally the last person from whom the borrower wants to receive a telephone call or letter.

Depositing Surplus into Court

When problems such as these arise, the trustee can usually elect to deposit the excess proceeds with the court registry in the county where the property is located. (See for example: Arizona Rev. Statutes § 33-812; Montana Code § 71-1-316; Nevada Rev. Statutes § 40.462; Utah Code § 57-1-29.) 

The state of Washington, however, has a mandatory requirement that the trustee deposit all surplus funds into the court registry (RCW 61.24.080). While the Washington statute makes handling the surplus uncomplicated for the trustee, it forces junior lienholders to incur additional legal costs in order to retrieve the surplus from the court registry. Upon depositing the funds, the trustee must mail notice of the deposit to all interested parties and file an affidavit of mailing with the court. Any party seeking disbursement must then file a motion, set a hearing date, and provide the same parties with at least 20 days’ notice of the hearing date.  

This process can be frustrating for lenders who hold the first- and second-position liens on the property. The lender may elect to foreclose on its first lien position and then bid and purchase at the sale to protect its second lien position. Instead of distributing any of the surplus funds to cover the second lien position directly to the lender, the trustee is statutorily required to deposit the entire surplus with the court. The lender must then hire an attorney to file a motion seeking disbursement of the funds and to appear for the lender at the hearing.

The Danger of Unrecorded Assignments

The process can also cause problems for lenders who hold junior liens but have unrecorded assignments. For example, the trustee sends the deposit to court and provides notice of the surplus to all parties of record. The lender’s predecessor-in-interest receives notice of the deposit where it can languish on someone’s desk for a few weeks before being forwarded to the true holder of the junior lien or can get thrown away. Meanwhile, the borrower files a motion seeking disbursement of the funds and provides proof to the court that he has notified all parties of record. The judge then signs an order disbursing the funds. Once the current junior lienholder discovers that there were surplus funds available, the borrower has already received and likely spent the money. 

Conclusion

The responsibilities of a trustee do not conclude with the issuance of a trustee’s deed. Rather, the last important duty of the trustee is handling surplus funds after a sale. It is a duty fraught with exposure to liability in states where the deposit of funds into the court is not required. In those states, a trustee must choose wisely. When distributing funds directly to junior lienholders, there is always the potential to distribute to the wrong party, possibly requiring a second disbursement from the trustee’s own pockets. In Washington state, where the deposit of the surplus into the court is required, the trustee is protected from this risk by eliminating the need to decide the relative rights of junior lienholders and borrowers. By protecting the trustee, however, the Washington procedure imposes additional financial burdens (attorneys’ fees and costs) on junior lienholders seeking to claim the surplus funds.

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