Hi Underwater- reading thru the answers you have received the past several months, there is some conflicting information. Truth is that each bank operates by a unique play book on short sales. I currently am steps away from closing the listing side of a short sale in Bergen County and the Lender did make reference to "Arms Length Transaction" in their documentation. They defined it as follows:
"The purchase and sale transaction reflected in the agreement is an Arms Length Transaction, meaning the transaction has been negotiated by unrelated parties, each of whom is acting on his or her own self-interest, and that the sale price is based on fair market value of the property. With respect to those persons signing this affidavit as an agent for the Seller (s), Buyer (s), or both, those agents are acting in the best interest of their respective principle (s)."
Now the true question is how the individual lender defines "Unrelated Parties." How I have seen this interpreted is that the sellers and buyers can not be of blood relation, or familial relation. Friends and neighbors, as long as they are not blood related or related thru marriage or other familial relations, do constitute an example of Unrelated.
This would be best asked when first entering a Short Sale transaction directly with your lender thru your Realtor or Attorney.