Arizona Court of Appeals Division One Holds That An HOA’s Assessment Lien Is Subordinate To A First Deed of Trust And That Counsel For An HOA Committed A Fraud On The Court By Concealing The Existence of a Superior First Deed of Trust.

This appeal concerns the conduct of counsel for an HOA in two consolidated actions, a lien foreclosure action and a later action to quiet title.  Cypress, the HOA for the property, filed a lien foreclosure action for unpaid HOA fees.  The owner took out loans when he purchased the property and the original lender recorded deeds of trust.  Like with many deeds of trust, the original lender assigned the first deed of trust to another bank and then again to a third bank (the “Bank”). 

In its action to foreclose an assessment lien for the unpaid HOA fees, Cypress served only the original lender, not the assignee Bank.  Its complaint failed to allege that there was a first deed of trust, and failed to cite a statute providing that an assessment lien was not superior to a first deed of trust.  The original lender did not answer and, after an ex parte hearing, a commissioner entered a default judgment in favor of the HOA.  The judgment was drafted by Cypress’s attorneys.  Among other things, it declared the Cypress’s assessment lien a “valid first lien” and ordered a sale of the property to pay the debt.

In July 2007, the property was sold to Draper at a sheriff’s sale for much less than its appraised value.  Some months later, the trustee for the Bank noticed a trustee’s sale.  After learning of Cypress’s judgment in early 2008, the Bank asked Cypress’s attorneys to acknowledge the priority of the Bank’s deed of trust over Cypress’s lien and to confirm that the judgment’s language suggesting otherwise was wrong.  Cypress’s attorney responded, agreeing that the earlier foreclosure action did not assert priority and that the bidder at the sheriff’s sale would have understood that he was purchasing the property subject to the first deed of trust. 

Meanwhile, Draper sold the property to Jacoby, who knew about the pending trustee’s sale.  In September 2008, the Bank sold the property sale to Orlandini.  Jacoby filed a quiet title action against the Bank, arguing that the default judgment foreclosed the Bank’s first deed.  The judge subsequently granted Orlandini’s and First American Title Co.’s (the insurer of the deed of trust) motion to intervene.  They counterclaimed to set aside the default judgment and resulting sheriff’s sale.  Jacoby moved to dismiss the intervenors’ counterclaim and the intervenors cross-moved for summary judgment.

The judge ruled for the intervenors and set aside the default judgment and sheriff’s sale, finding that the first deed of trust had priority and that Cypress’s attorneys’ statements made in the foreclosure action to the contrary were false, made in bad faith, and constituted a fraud on the court. 

Cypress, not a party to the quiet title suit, asked the court to consolidate the foreclosure and quiet title actions so that it may be heard.  Before consolidation, Cypress asked the commissioner in the foreclosure action to reconsider the superior court’s order and to reinstate the default judgment.  The commissioner granted the consolidation motion and later granted the motion for reinstatement, finding that Cypress’s attorneys had a legitimate basis to propose the default judgment they drafted and had therefore not committed a fraud on the court.  The commissioner also awarded Cypress its fees, finding, among other things, that the intervenors and their counsel’s conduct violated Rule 11. The intervenors appealed.

In a unanimous opinion, the Court of Appeals affirmed the consolidation but reversed the commissioner’s reinstatement of the default judgment and the attorneys’ fees award.  With respect to consolidation, the Court rejected the intervenors’ argument that the actions should not have been consolidated because the foreclosure action was not pending.  To the contrary, after the judge set aside the default judgment, the foreclosure action was no longer final. 

Turning to the merits, the Court reversed, holding that the first deed of trust had priority over the HOA’s assessment lien.  Under A.R.S. § 33-1807(B), a “lien for assessments” has priority to all other interests except, among other things, “a recorded first deed of trust.”  Consistent with this statutory provision, the CC&Rs creating the assessment lien stated that “the lien of the Assessment(s) provided for herein shall be subordinate to the lien of any first mortgage.”  Furthermore, the statute’s use of the term “first deed of trust” did not mean that the deed of trust had to be recorded first in time before all liens and other encumbrances; rather, the term refers to “the order in which deeds of trust” are recorded.  Thus, because the Bank’s deed of trust was the “first” deed of trust, it had priority over Cypress’s assessment lien. 

The Court agreed that Cypress’s attorneys “committed a fraud upon the court” and held that the default judgment should be set aside.  Reversing the commissioner’s conclusion that Cypress’s arguments were “legitimate,” the Court described Cypress’s arguments as “specious, legally and logically unsound, and . . . so contrived as to be little more than sophistry.”  Furthermore, the Court held that during the foreclosure action the attorneys for Cypress improperly concealed the existence of a first deed of trust and falsely stated that the assessment lien had priority over all other liens when clear statutory language and provisions in the CC&Rs stated the opposite. The fact that Cypress’s attorneys also told the Bank that the assessment lien was subordinate provided additional evidence that the attorneys’ concealment was intentional.  Finally, the Court reversed the commissioner’s award of fees to Cypress and denied all other requests for fees.

Judge Weisberg authored the opinion; Judges Kessler and Johnsen concurred.