When A Lender Issues Tax Form 1099-C, Is It Barred From Collecting The Debt Under Arizona Law?

The Arizona Court of Appeals, in the case of Amtrust Bank v. Fosset, recently addressed the question of whether a lender who has issued federal tax Form 1099-C indicating a debt was cancelled may thenn sue the borrowers on the obligation. This is an issue of significant importance in Arizona due to the economic conditions that have resulted in a flood of foreclosures, following which many borrowers will receive Form 1099-C.

As addressed in other posts, Arizona law precludes lenders from seeking to collect following foreclosures in many, but not every case. For those instances where a lender is not barred from collecting - such as in the foreclosure of vacant land - it is important to understand the legal effect of the bank's issuance of Form 1099-C. Of course, Form 1099-C is not just issued in the case of cancellation of mortgage debt, and the Amtrust Bank case itself involved collection of a deficiency after an automobile repossession.

Issuance of 1099-C Does Not Necessarily Mean That the Lender Has Cancelled the Debt

The Amtrust Bank Court's holding is summarized by the Court as follows:

We hold that while issuance of a Form 1099-C may be prima facie evidence of cancellation of a debt, the lender may rebut that evidence by showing that when it issued the form it did not intend to forgive the obligation.

In other words, issuance of Form 1099-C establishes that the lender forgave the debt, but the lender can produce evidence to show that was not its intent.

1099-C Must Be Issued Under Certain Circumstances

The bank in the Amtrust Bank case was able to successfully argue that the Plaintiff could not prevail as a matter of law because the federal regulations requires lenders to issue a Form 1099-C in certain circumstances regardless of whether the lender intends to cancel or forgive the debt. These circumstances include the occurrence of an "identifiable event." These are summarized by the I.R.S. in the Instructions for Form 1099-C.

Burden on Lender to Show Lack of Intent to Discharge

Although the Amtrust Bank Court declined to affirm the summary judgment in favor of the Plaintiff borrower, it did pronounce the principle that under Arizona law the "issuance of the Form 1099-C is prima facie evidence" of a lender's intent to discharge the debt. This means that the lender carries the burden of showing there was some other reason, such as being compelled by federal law, to issue the 1099-C.