Strict Foreclosure in Equity. Strict Foreclosure 3/5/2013

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1 Strict Foreclosure Foreclosure developed out of dual Law/Equity systems At law, mortgagee held fee simple title (subject to condition subsequent); once mortgagor defaulted, mortgagor forfeited its title (i.e., its future interest) But, Chancellor (Equity) could let mortgagor have reasonable time after Law Day to redeem land by repaying debt This created uncertainty (when can mortgagee be sure of having clear title to mortgaged land?) Strict Foreclosure in Equity After Law Day, ME could ask Chancellor to set last day in Equity for payment MR had until that new date to redeem; if MR failed to redeem, 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: mortgagee is unjustly enriched if FMV of mortgaged premises >>> balance of mortgage debt (capture of mortgagor s equity in land) In American law, all states today require foreclosure by sale (public auction) Lender can apply proceeds to 1) costs of sale, 2) satisfaction of debt, and 3) satisfaction of extinguished junior liens But, any surplus proceeds belong to mortgagor Strict Foreclosure Still allowed in a few states (common in VT, CT) Judicial process is required Court sets a redemption date; if MR doesn t redeem by that date, title vests in ME (no need for sale) However, if MR produces evidence that land s FMV >> balance of debt, court must determine FMV [p. 613] If court concludes land is worth >> debt (i.e., sale would likely produce surplus), court must order sale If land is worth << debt, no sale; if debt is recourse debt, court can still award ME a judgment for deficiency! 1

2 Modern Foreclosure Choices Judicial foreclosure (all states) Any mortgage can be foreclosed judicially Required in AR, DE, FL, IL, IN, IA, KS, KY, LA, MT, NM, NY, NJ, ND, OH, PA, SC, WI, CT, VT Power of sale foreclosure (30 states) Only if state allows, and only if mortgage/deed of trust has 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 judicial action to foreclose mortgage debt. Issues: Is the debt valid? Is Mortgagor in default? What is the unpaid balance due? Does mortgagee have right to foreclose (e.g., has the debt been properly accelerated)? Court enters judgment (often a default), orders judicial sale (sheriff s sale), w/proceeds applied to judgment Judicial foreclosure sale is typically a sheriff s sale Public auction, minimal advertising (typically legal notices in local newspaper) Cash only, as is (foreclosing creditor may credit bid ) Land goes to high bidder, but only after the court confirms the sale Until sale occurs, MR has right to redeem by paying off full balance of debt (if applicable, MR can also prevent the sale by reinstating the mortgage) Judicial Foreclosure: Problem 1 Wells owns Blueacre, subject to: First mortgage held by BankOne ($150,000) Second mortgage held by BankTwo ($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? 2

3 Necessary and Proper Parties Buyer at foreclosure sale gets title as it existed on date MR granted the mortgage being foreclosed Any subordinate interests (interest that arose after that date) are extinguished by the sale Buyer takes subject to any prior interests Anyone that must be joined to accomplish this result (e.g., any holder of a junior interest whose interest needs to be extinguished) is a necessary party Any party with a junior lien on the mortgaged land or a junior interest (e.g., easement) is necessary party Thus, foreclosing mortgagee must conduct title search prior to foreclosure to identify all junior interest holders Foreclosing mortgagee must join as a party to the foreclosure action each person holding a subordinate interest in the mortgaged land Necessary and Proper Parties Other parties might be joined for other reasons, and might be called proper parties, although not necessary E.g., a guarantor of the mortgage debt (to establish/preserve their liability on the debt) E.g., BankOne (senior lender), to establish the balance due on the senior debt BankOne is not a necessary party (foreclosure can t affect its senior mortgage), but it is a proper party BankTwo may want court to make a determination of the balance due to BankOne on the senior mortgage debt This information would be useful to bidders (any buyer at the foreclosure sale will have to pay off BankOne s senior debt in order to get clear fee simple absolute title! 3

4 Wells owns Blueacre First mortgage: BankOne ($150K) Second mortgage: BankTwo ($100K) BankTwo brings judicial foreclosure, joins BankOne 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 does not attach to the sale proceeds After costs of sale, BankTwo gets the next $100K of sale proceeds (in satisfaction of junior debt) Remaining surplus goes to Wells Should Trump have bid $200K to buy the land at the sale? It depends on value of the land If its value (FSA) = $200K, then no He should ve bid <= $50K, b/c he ll have to pay off BankOne s debt ($150K) to get clear title Buyer at judicial sale takes as is, w/out warranty or representation as to quality of title conveyed at execution sale As long as BankOne s senior mortgage was recorded, Trump had constructive notice of it, and thus takes subject to it No duty on sheriff or foreclosing mortgage lender to disclose junior liens (bidders expected to investigate title, like any other potential buyer) 4

5 Bank is foreclosing mortgage on mall owned by Landlord Anchor tenant lease (Target) is junior (later in time) to Bank s mortgage, and there s no SNDA agreement Target wants lower rent; Bank wants to be able to enforce Target s lease Can Bank preserve Target s lease by not joining Target as a defendant to the foreclosure? Strategic Non Joinder Bank can try strategically omitting Target, but it probably won t work Courts in many states hold that junior leases are terminated automatically by foreclosure, absent SNDA agreement [Fiber Form v. Dover] Also, Target could join itself as a defendant (and seek a declaration that its lease is junior) 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 not Bank2 (Bank1 missed Bank2 s lien in its title search) After judgment, Trump buys land at the sale for high bid = $150,000 Bank2 argues: 1) Our lien was not extinguished by Bank1 s foreclosure sale 2) We weren t joined as party, so sale to Trump was void 3) If we (Bank2) pay off the $150K first mortgage owed to Bank1, we get fee simple title to the land by redemption Which (if any) are correct? 5