Strict Foreclosure. Strict Foreclosure in Equity 10/14/2014

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Vanessa Douglas
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1 Strict Foreclosure Historical foreclosure method Mortgagee held fee simple title subject to condition subsequent; once mortgagor defaulted, mortgagor forfeited its title (i.e., its future interest) Problem: Chancellor (Equity) sometimes allowed the mortgagor to have a reasonable time after Law Day to repay the loan, redeem the land, and recover title This created uncertainty for mortgagees: When can I be sure, after mortgagor defaults, that I have clear title to the mortgaged land? Strict Foreclosure in Equity After Law Day (date for payment in the mortgage), ME could petition the Chancellor to set a new last day, in Equity, for MR to repay If MR failed to pay by that date, MR s right of redemption was foreclosed forever (MR s title was forfeited) It was irrelevant whether value of mortgaged land >> balance of the mortgage debt Hans Holbein, Portrait of Henry VIII Concern with strict foreclosure: mortgagee is unjustly enriched if FMV of mortgaged premises >>> balance of debt (results in forfeiture of mortgagor s equity in land) As a result, in American law, nearly all states today require foreclosure by sale (public auction) Lender can apply proceeds to 1) costs of sale, 2) satisfaction of debt owed to foreclosing lender, and 3) satisfaction of any extinguished junior liens But, any surplus proceeds belong to mortgagor Strict Foreclosure Still exists and still used in VT, CT (is in fact the primary method of foreclosure in Connecticut) However, if MR introduces evidence that land s FMV >>> balance of debt, court must determine the property s FMV [p. 613] If court concludes land is worth >>> debt (i.e., sale would likely produce surplus), court must order sale of the mortgaged land 1

2 Modern Foreclosure Choices Judicial foreclosure (all states) Any mortgage can be foreclosed judicially Required (only method) in: AR, CT, DE, FL, IL, IN, IA, KS, KY, LA, NY, NJ, ND, OH, PA, SC, VT (homes), WI Power of sale foreclosure (30 states) Only if state statute allows, and only if mortgage/deed of trust contains a power of sale Mortgage: sale conducted by mortgagee Deed of trust: sale conducted by named trustee, on behalf of lender/beneficiary Judicial Foreclosure After default, mortgagee brings a judicial action to foreclose mortgage debt. Issues: Is the debt valid? Is Mortgagor in default? What is the unpaid balance due? Does mortgagee have the right to foreclose (e.g., has the debt been properly accelerated)? After court enters judgment (often a default), court orders execution sale (sheriff s sale) Judicial foreclosure sale is typically a sheriff s sale Public auction, minimal advertising (typically legal notices in local newspaper) Cash sale, as is (although the foreclosing creditor may credit bid against the judgment amount) Land goes to high bidder, but only after the court confirms the sale Until sale occurs, MR has right to redeem by paying off the full balance of debt (and costs) If applicable, MR can also prevent the sale by reinstating the mortgage (if state law or loan documents permit) Effect of a Foreclosure Sale At a foreclosure sale, the buyer gets title as it existed on the day that the foreclosing creditor acquired its lien Thus, a foreclosure sale: Extinguishes the lien of the foreclosing lienor Extinguishes any liens or interests that are subordinate (junior) to the lien of the foreclosing lienor Transfers the mortgagor s interest to the high bidder, free of the extinguished liens Extinguished liens are transferred to the proceeds of the sale (in the same order of priority) 2

Mortgagor owns land subject to First priority mortgage held by Bank One (debt = $100,000) Second priority mortgage held by Bank Two (debt = $50,000) Third priority judgment lien held by Creditor

3 Mortgagor owns land subject to First priority mortgage held by Bank One (debt = $100,000) Second priority mortgage held by Bank Two (debt = $50,000) Third priority judgment lien held by Creditor (judgment amount = $50,000) Mortgagor defaults to Bank One, which forecloses (land sold to Buyer for $175,000) Buyer gets title free and clear of all three liens, which attach to sale proceeds in same order of priority Judicial Foreclosure: Problem 1 Wells owns Blueacre, subject to: First mortgage held by BankOne (debt = $150,000) Second mortgage held by BankTwo (debt = $100,000) Wells defaults to BankTwo Q: Can BankTwo foreclose as a junior lienor? Q: If BankTwo brings a judicial foreclosure, does it have to join BankOne as a party to that action? BankTwo can foreclose its junior mortgage lien, but its foreclosure sale will NOT affect the lien of the senior lienholder (BankOne) Buyer at sale will get title free and clear of BankTwo s lien, and any junior liens, but would take it subject to BankOne s senior mortgage lien Thus, while BankTwo can join BankOne as a party to its judicial foreclosure action: BankTwo does not have to join BankOne (which is a proper party but not a necessary one), and Even if BankTwo does join BankOne as a party, BankTwo can t force BankOne to foreclose its senior lien Foreclosure by Junior Lienholder Foreclosure sale by junior lienholder cannot affect the lien of a senior lienholder without the senior s consent E.g., If BankTwo forecloses and joins BankOne as a party, BankOne could agree to have the foreclosure extinguish its lien If so, Buyer at sale would get title free and clear of both liens (and liens would attach to sale proceeds in the same order of priority) 3

g., tenants, easement holders) Thus, BankTwo must conduct a title search prior to foreclosure, to identify all such necessary parties Wells owns Blueacre First mortgage: BankOne ($150K) Second

4 Necessary Parties In a judicial foreclosure, BankTwo MUST join (1) the mortgagor and (2) any party that holds an interest that could be extinguished by the sale, e.g., Wells (mortgagor) Any persons holding liens junior to BankTwo Any other persons holding subordinate interests in the land (e.g., tenants, easement holders) Thus, BankTwo must conduct a title search prior to foreclosure, to identify all such necessary parties Wells owns Blueacre First mortgage: BankOne ($150K) Second mortgage: BankTwo ($100K) BankTwo brings a judicial foreclosure Trump buys the land at the foreclosure sale for $200K Distribution of proceeds? Problem 1(b) B/c Trump takes title subject to BankOne s senior mortgage lien, that lien is still valid against the land and thus that lien does not attach to the sale proceeds Distribution of proceeds: First: costs of sale Second: BankTwo would get the next $100K of sale proceeds (in satisfaction of its debt) Third: Any subordinate lienholder(s), in order of their priority Fourth: Wells (mortgagor) Should Trump have bid $200K to buy the land at the sale? It depends on value of the land If its unrestricted value (value in fee simple absolute) is only $200K, then no He should ve bid <= $50K, b/c he still has to pay off BankOne s debt ($150K) to get clear title 4

Buyer at judicial foreclosure sale takes as is, w/out warranty or representation as to quality of title being conveyed B/c BankOne s senior mortgage was recorded, Trump had constructive notice of it,

5 Buyer at judicial foreclosure sale takes as is, w/out warranty or representation as to quality of title being conveyed B/c BankOne s senior mortgage was recorded, Trump had constructive notice of it, and thus takes title subject to it Sheriff and foreclosing mortgage lender have no duty to disclose any senior lien (bidders are expected to investigate title, like any other potential buyer) The Omitted Party: Problem 2 Wells owns land, subject to: First mortgage held by Bank1 ($150K) 2nd mortgage held by Bank2 ($100K) Wells defaults to Bank1, which starts foreclosure Wells is named as party, but Bank2 is not (assume that Bank1 missed Bank2 s lien in its title search) After judgment, Trump buys the land at the sheriff s sale for high bid = $150,000 Bank2 makes three arguments: 1) Our lien was not extinguished by Bank1 s foreclosure sale 2) Since we weren t joined as a party, the sale to Trump was entirely invalid/void 3) If we pay off the $150K that was owed by Wells to Bank1, we get fee simple title to the land Which (if any) are correct? Bank2 s first argument is correct! B/c Bank2 was not joined as a party, it isn t bound by the result (no due process of law) Thus, the foreclosure sale did not extinguish Bank2 s lien (which remains valid) 5

6 Argument 2 is incorrect! Wells (mortgagor) was properly joined, so foreclosure sale is valid against her (she is bound by res judicata, can t relitigate) Wells s title thus passed to Trump (buyer) But, Trump took title subject to Bank2 s not yetextinguished mortgage lien! Problem 2: Buyer s Two Hats Trump got Wells s title ( buyer s hat ), subject to Bank2 s mortgage (not affected by sale) Trump also got Bank1 s rights as senior mortgage lender, by way of subrogation ( lender s hat ) Defective sale assignment of Bank1 s interest as senior mortgagee Sale extinguished Bank1 s mortgage vs. Wells, but not vs. Bank2 (which was an omitted necessary party)! 1 st mortgage lien still exists and has priority vs. Bank2 (whose mortgage lien was junior) Problem 2: Trump s Options Now? Trump can redeem his title from Bank2 s lien by paying it off ($100K) Trump would then have title free and clear Trump could reforeclose the senior mortgage (joining Bank2 to extinguish its junior lien) Which of these two options would Trump take, and why? Trump s decision will depend upon the FMV of the land If FMV is => $250,000, Trump will probably just redeem (wearing its buyer hat) by paying $100,000 to Bank2 to satisfy its lien (and thus prevent Bank2 from foreclosing) If FMV is < $250,000, Trump will re foreclose the first mortgage (wearing its lender hat) This will put the burden on Bank2 to bid at the sale if it wants to protect its lien 6

7 Problem 2: Options for BankTwo? Bank2 can foreclose its junior lien Buyer would get Trump s title, but subject to Trump s rights as first mortgagee ( lender hat ) Buyer would then have to pay off Trump s senior mortgage lien ($150K) to gain clear title Bank2 could redeem its junior lien by paying Trump the balance due on first mortgage ($150K) Trump would then hold fee title, but subject to both the $150K senior lien and the $100K junior lien, both of which would then held by Bank2 To redeem his title, Trump would have to pay off both liens Note: Trump and Bank2 both have rights of redemption, but they aren t the right to redeem the same interest Trump has right to redeem the fee title, b/c he purchased that right at the first (defective) foreclosure sale By contrast, Bank2 only has the right to redeem its lien (its interest as the junior lienholder) If Trump redeems his interest (by paying off Bank2 s lien), then Bank2 s lien is extinguished! Strict Foreclosure/Omitted Juniors Therefore, in Problem 2, Bank2 s third argument is incorrect Bank2 s lien was not extinguished, so Bank2 can still act to redeem its lien But, Bank2 would be redeeming its subordinate lien, not the mortgagor s title The mortgagor s title (Wells s title) actually passed to Trump (buyer) at the foreclosure sale, so only Trump can redeem full title Some states would allow Trump to use strict foreclosure to clean up the mess caused by omission of junior lienor (e.g., Pessin, p. 627) If granted, court would order Bank2 s junior lien to be extinguished, unless Bank2 paid off the senior mortgage within the time period set by court Note: if Bank2 redeemed w/in time period set by court, Bank2 wouldn t get fee title; Bank2 would only get Trump s right as first mortgagee (by subrogation) Thus, Trump could still redeem fee title by paying off both liens 7

Assignment 4 Judicial Foreclosure and Sale (Mortgage Law) Credit Bidding. Problem 4.1. Judicial (Traditional) Foreclosure

Assignment 4 Judicial Foreclosure and Sale (Mortgage Law) Judicial (Traditional) Foreclosure Public auction, conducted by sheriff (or other official) Sale as is, for cash, following publication of legal