Lenders often cross state boundaries when
making real estate loans. For example, a California lender
may make a loan secured by New Hampshire real estate or a
New Hampshire lender may make a loan secured by New York real
estate. Institutional lenders nearly always have a set of
standard forms. These forms usually provide that the law of
the lender's home state governs the transaction. For example,
a New York lender loaning money in New Hampshire will normally
provide that New York law governs the transaction. In most
cases, no one pays much attention to these provisions. However,
a recent case has shown how important they can be.
The laws governing any given transaction can be divided into
two categories: (1) procedural law, and (2) substantive law.
If the particular issue of law is procedural, the law of the
state where the case is heard (the forum state) will always
apply. On the other hand, if the issue is substantive, the
parties are free to choose the state whose law will govern
so long as (a) that the state has some relationship to the
transaction, and (b) the chosen law does not violate the public
policy of the forum state.
Now that we know the ground rules, we need to see how they
can actually affect a transaction.
In a recent case, an Arizona resident borrowed money from
a California lender. The loan documents provided that California
law would govern the transaction. When the loan went into
default, the lender conducted a trustee's sale in Arizona
and then sued for a deficiency judgment in an Arizona
court. A suit for a deficiency is permissible under
Arizona law, but is not permissible under
California law following a trustee's sale (although it is
acceptable following a judicial foreclosure). The Arizona
court held that because the right to a deficiency judgment
was substantive, rather than procedural, the parties' agreement
that California law governed the transaction would be enforced.
This meant that California law would apply to the Arizona
lawsuit, and the lender had no right to a deficiency judgment!
This is a case where a sophisticated lender, by insisting
on the law of its home state, actually cost itself a deficiency
judgment of millions of dollars.
The lesson of this case is clear. If you are a borrower or
a lender engaged in an interstate loan transaction, pay close
attention to the choice of law provision. The law governing
enforcement of real estate loans varies greatly from state
to state. This disparity in the laws means that a borrower
or lender may be waiving valuable rights when he agrees to
a choice of law provision without even knowing that he is
Therefore, when borrowing or lending money across state lines,
it is always a good policy to check with counsel in the other
state before agreeing on the choice of law provision so you
know exactly what you are getting or giving up by doing so.
If you do not, you may be in for a very expensive surprise.
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