Outline

Dylan Holland Real Estate Financing (2011)
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Introduction to mortgage financing a. Modes of financing i. All cash sale 1. Buyer pays all cash to Seller ii. Assumption or taking subject to existing mortgage 1. Buyer takes over the Seller s existing mortgage financing and pays cash equal to the difference between the sales price of the property and the balance on the existing loan a. May take over through Assumption Agreement b. May merely take subject to the loan without an express promise to pay it i. Not personally liable, but will still have powerful economic incentive to pay the mortgage loan iii. Seller financing 1. Buyer enters into mortgage loan or installment K with Seller iv. Combination of assumption/subject to and seller financing 1. Buyer takes over the Seller s existing mortgage but must take out a loan to pay the difference between the price and loan balance a. Buyer gives Seller a note secured by a second mortgage for part of this difference v. Wrap-around financing 1. Structured like Seller financing, but the Seller has preexisting mortgage financing on the property, and does not pay it off at the time of the transfer a. Instead, the Seller is required to continue making payments on the underlying loan at the same time the Buyer makes payments on the new (wrap-around) loan b. Mortgage foreclosures i. Forecloses the borrower s ability to assert an equitable right of redemption 1. Development of the statutory right of redemption ii. Deed of trust 1. Involves the conveyance of the realty to a third person in trust to hold as security for the payment of the debt to the lender-noteholder (ME) a. Is essentially similar to a mortgage with a power of sale iii. Mortgage substitutes and clogging the equity of redemption 1. Courts do not allow clogging by the mortgage language a. So ME tries to resort to other documents with the same effect i. Installment land K is most common device 1. Vendee goes into possession and agrees to make monthly payments of principal and interest until the principal balance is paid off 2. Vendor retains legal title until the final payment is made, at which time he has a duty to execute a deed to the land The use of mortgage substitutes a. The absolute deed and conditional sale i. Humble Oil & Refining Co. v. Doerr 1. Anti-clogging rule a. MR s equity of redemption cannot be clogged and that he cannot, as part of the original mortgage transaction, cut off or surrender his right to redeem b. The debtor/MR cannot, in the inception of the instrument, as a part of or collateral to its execution, in any manner deprive himself of his equitable right to come in after a default in paying the money at the stipulated time, and thereby to redeem the land from the lien and encumbrance of the mortgage ii. American Law of Property 16.59 1. The ME is not allowed, at the time of the loan, to enter into an option or K for the purchase of the mortgaged property iii. The policy is so strong against clogging that it is applied to hold such options absolutely void and unenforceable regardless of whether there is actual oppression 1
iv. Subsequent conveyances as clogs 1. The anti-clogging doctrine is generally inapplicable to transactions that are subsequent to the execution of the mortgage a. i.e. deed in lieu of foreclosure v. Disguised real estate security transactions as mortgages in substance 1. Court look beyond the document to see if there is actually a loan transaction a. Factors i. Relationship of the parties ii. Intent of using the deed to stand as security for a debt iii. Access to legal counsel iv. Sophistication and circumstances of parties v. Adequacy of consideration 1. Where consideration received by grantor is much less than the value of his property, there is an inference that a security device, as opposed to outright sale, was intended vi. Whether Grantor retained possession of the property 1. Where a grantor continues to occupy the premises, there is an inference that a security device was intended vi. Perry v. Queen 1. is a low income homeowner with a high school education. had two defaulted properties. approached to help cure default. required the deed to s property but would allow to buy it back. a. argued that it was a mortgage loan transaction with the property acting as security for the loan from . By determining that it is a mortgage, it would require the lender to adhere to the Truth In Lending Act. 2. Proof that a conveyance was intended as a security must establish a. The GR was indebted to the GE b. The GR intended his conveyance to serve as a security device 3. Parol evidence a. Is permitted to use extrinsic evidence to prove that a transaction is a mortgage 4. Statute of frauds a. If SoF applied, it would be very difficult for a GR to admit a written document to prove that the transaction should be a mortgage i. Therefore, does not stand in the way of establishing that an absolute deed or conditional sale was a security transaction 5. NOTES a. Restatement 3.2 Absolute Deed Intended As Security i. Parol evidence is admissible to establish that deed purporting to be an absolute conveyance was intended to serve as security for an obligation ii. Intent may be inferred from the totality of the circumstances, including 1. Statements of the parties 2. Substantial disparity between the value received by GR and FMV 3. GR retained possession of the real estate 4. GR continued to pay real estate taxes 5. GR made improvements post-conveyance 6. Nature of the parties b. Restatement 3.3 Conditional Sale Intended As Security i. Parol evidence is admissible to establish that a deed purporting to be an absolute conveyance accompanied by a written agreement conferring on the GR a right to purchase was intended to serve as a security 1. Same factors as 3.2 vii. Downs v. Ziegler 2
1. As security for repayment of debt, transferred deed to Doctors, and brought current the money due to Downs. was given the right to repurchase the property. If Doctors were not a ME, then they would have liability to . Therefore, it is the Doctors that are trying to prove that they were ME. 2. Parol evidence is admissible to show that a conveyance absolute on its face was intended as a mortgage a. Of primary importance in determining whether a transaction was intended as a security device is the presence of a subsisting obligation 3. NOTES a. Dangers in using the absolute deed as security i. A BFP is not subject to an equitable mortgage 1. If the GR remains in possession, there cannot normally be a BFP because purchase has a duty to know who is in possession ii. GE will not be able to use power of sale 1. Will likely require judicial foreclosure if treated as a mortgage b. The negative covenant as a mortgage i. Equitable Trust Co. v. Imbesi 1. Lender s loan contained a negative covenant not to convey, but the son borrowed more money and gave the Bank a mortgage. This was a breach of the covenant. When the Bank foreclosed the mortgage, the Lender sought to invalidate the mortgage as being a breach of the covenant. 2. Rule intent that the transaction be a mortgage is the predominating factor 3. Holding the covenant was a covenant. The covenant was not a mortgage because it was not intended to be a mortgage ii. There is near unanimous agreement that covenants not to convey or encumber do not create a security interest 1. The covenant not to convey does not create a security interest in exchange for the land c. Installment Land K i. Carries out the same economic function as a purchase money mortgage 1. Financing by the seller of the unpaid portion of the purchase price of the real estate ii. The land K governs the parties throughout the life of the debt 1. Different than the binder type of K a. The debt relationship after the closing date is governed by the security device and the binder K no longer has a function iii. Traditional remedies for land K default 1. Sue for installments which are due with interest thereon 2. Sue for specific performance of the K 3. Sue for damages for the breach 4. Sue to foreclose his vendee s rights 5. Sue to quiet title 6. Rescind the K iv. Russell v. Richards 1. Russell was the purchaser; Richards was the seller. Russell paid $11,188 and assumed $37,938 under a land K. Russell reduced the principal by $10,782 at her default, and the value of the property had risen by 100%. a. Trial court said there was a forfeiture, but that the forfeiture shocked the court s conscience 2. Rule a forfeiture provision under a land K is enforceable absent unfairness which shocks the conscience a. Factors: i. Amount of money already paid by Vendee ii. Period of possession by Vendee 3
iii. Market value at default iv. Rental potential and value 3. NOTES a. Burgess v. Shiplet i. Buyers under a land K cannot look to the mortgage law for alternative remedies, but must accept the remedies set forth in their K with Sellers b. Relaxing strict enforcement i. Many states refused to enforce against a defaulting vendee forfeiture clauses 1. Some have conferred on the vendee a MR s equity of redemption 2. Judicial foreclosure 3. Right to restitution to the defaulting vendee v. Petersen v Hartell 1. FACTS Decedent entered into land K with grandchildren, which grandchildren were delinquent in making payments on. Decedent attempted to cancel the K, and grandchildren sued for specific performance. 2. RULE the prohibition of punitive damages for breach of K, the strict limitations on the right to provide liquidated damages, and the provision that neither specific nor preventive relief can be granted to enforce a penalty or forfeiture in any case together establish a policy that precludes forfeiture. 3. HOLDING A vendee who has made substantial payments on a land K or substantial improvements on the property, and whose defaults, albeit willful, consist solely of failure to pay, has an unconditional right to a reasonable opportunity to complete the purchase. a. Requires paying the entire remaining balance plus damages 4. NOTES a. It is important to note what the defaulting party is asking for i. Courts may be more sympathetic for a defaulting party seeking specific performance versus asking for damages 1. Court wants to try to restore the parties to where they would otherwise be without a resulting windfall to the seller b. Restitution as an alternate form of relief for vendee i. Forfeitures may not be free, and a vendor may have to return payments received minus what the vendor has actually been damaged 1. Clampitt v AMR Corp a. One question that arises when looking to market value of property is determining when to prescribe the value b. Court concluded that the use of the forfeiture clause was not unconscionable b/c Seller got reasonable compensation for the losses it incurred i. Did not award any restitution to vendee ii. Damages to vendor in forfeiture 1. Market Value a. Where there is a liquidated damages clause, a determination of the difference between K price and FMV should be made to determine whether or not what the seller is acquiring back as a result of the forfeiture is more valuable than what he contracted to sell 2. Rental Value a. Consider the loss of rental value during the time the defaulting purchaser was in possession 3. Costs of repossession, refinancing and resale 4. Miscellaneous damages 4
vi. Sebastian v Floyd 1. FACTS Sebastian defaulted on land K with Floyd. K had a forfeiture clase that was enforced by the circuit court and appeals court. 2. RULE A rule treating the seller s interest as a lien will protect the interest of both buyer and seller a. Ordinarily the seller will receive the balance due on the K plus expenses b. In addition, the buyer s equity in the property will be protected i. Legal title remains with the seller in land K until the entire K price has been fulfilled. Equitable title passes to the buyer when the K is entered into. 3. NOTES a. Treating land K as a mortgage i. Restatement 3.4(b) 1. An installment land K creates a mortgage and will be governed procedurally and substantively by the law of mortgages ii. Determining whether more than minimal payments have been made looks at BOTH principal and interest 1. Also considers the length of time and number of payments made in determining whether a vendee had made minimal payment iii. Even if only a minimal amount has been paid on the K price, forfeiture is not appropriate unless the vendor s security is jeopardized by the vendee s acts or omissions 1. EXCEPTIONS THAT ALLOW FORFEITURE a. Vendee has abandoned the premises b. Vendee has paid minimal amount AND the security has been jeopardized b. Waiver or estoppel as a defense against forfeiture i. If a vendor accepts late payments w/o declaring default, many court say that it is the vendor s waiver of the forfeiture 1. Creates in the vendee a right analogous to an equity of redemption ii. Danelson v Robinson 1. Defaulting vendee asserted that the vendor said he was not worried about the payment, but later initiated forfeiture a. Vendor was estopped to assert forfeiture 4. The Case for the Restatement Approach a. Other Vendor remedies i. Where forfeiture is available, it may be undesirable for the vendor 1. Vendor could opt to foreclose and if the foreclosure sale yields less than what was owing, a deficiency judgment would be available 2. Vendor could sue on K obligation, obtain a judgment for that amount and collect out of vendee s assets ii. Allows a vendor to achieve indirectly what is usually available as a matter of course in mortgage law 1. Is able to have his cake and eat it too a. Specific performance b. Action for damages i. Where forfeiture is necessary to regain property, an action for damages could be barred by election of remedies doctrine c. Foreclosure of purchaser s right i. Vendor is able to seek a mortgage remedy under a device that is governed by K law 5
ii. A judgment for the remaining balance is usually unavailable unless the K contains an acceleration clause b. NOTES i. ME remedies when K is recharacterized as a mortgage 1. The mortgage remedy not only affords the vendor a practical substitute for a K action for damages, but also gives the vendor the advantage of not having to prove the FMV of the real estate, as would be required in an action for damages ii. Premises liability of vendors 1. ME will not be liable for unsafe conditions on the mortgages real estate unless she is in possession or otherwise exercises dominion or control a. Treats vendors on both sides (liable and not liable) 5. Summit House v Gershman a. FACTS Gershman entered into land K with Summit. Summit sued to terminate the K when the market took a downturn. Gershmans counterclaimed for specific performance and were awarded SJ. Once Summit paid the judgment amount, Gershman was required to convey title to the property i. Summit never paid the judgment, and the property was sold to Gershman at a sheriff s sale for less than the judgment amount. Summit said that this was all Gershman was entitled to under the K b. RULE Election of remedies doctrine i. Vendor may either seek specific performance on the K or may cancel the K. 1. Is designed to prevent double recovery for a single wrong, and therefore the vendor cannot seek both specific performance and K cancellation c. HOLDING Allowing Gershman s judgment for specific performance to be satisfied b/c they had to buy the property at sheriff s sale would in effect eliminate specific performance as a viable remedy for a K and eviscerate the election of remedies doctrine i. Choice of remedies would be effectively eliminated if vendor knew that the vendee could simply refuse to pay a money judgment and force the seller to accept the return of the property as full satisfaction of the judgment d. NOTES i. Election of remedies doctrine 1. Once forfeiture has been accomplished, the vendor is barred from seeking to recover the equivalent of a mortgage deficiency judgment 2. Gruskin v Fisher a. The election of remedies has been made when the vendor attempts to take possession i. Not when the notice has been sent out 3. Mazur v Young a. Guarantor s obligations to vendor do not survive the forfeiture i. So if there are guarantors of the interest, sue the guarantors first b/c the guaranty is wiped out when there is a forfeiture ii. Does the election of remedies bar vendor s recovery of waste? 1. Michigan Nat l Bank v Cote 6
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a. Vendor cannot collect delinquent real estate taxes that vendee was obligated to pay under the K When must the vendor perfect title? a. Usual view is that the vendor has no duty to perfect the title until the vendee makes the final payment Clearing the vendor s title after a forfeiture a. Vendors attempt to avoid predicaments by making sure that the K is not recordable i. Vendees attempt to overcome this by recording an affidavit or notice that incorporates the essential terms of the K Vendee s possession as notice a. Possession by the vendee normally will prevent a lien from attaching to the vendee s interest b. Henteges v PH Feely & Son i. Possession by a vendee under a K for deed operates as full notice of his rights to creditors of the vendor Use of deeds in escrow a. Vendee, at the time of execution, will deliver an executed quitclaim deed to an escrow agent i. If the vendee defaults, the vendor notifies the escrow agent of the termination of the K and is able to record the deed A vendee s equity interest is mortgageable a. ME cannot take any greater interest in the land than his MR i. If MR is a vendee, the vendee s interest is equitable title that may be subject to forfeiture 1. Means that the ME needs adequate assurances that the land K will be paid off so that the ME will have security in the land a. ME will want a provision that allows the ME to cure any default by the vendee b. Protecting the vendee s ME from forfeiture or foreclosure i. ME has the burden to notify the vendor of its mortgage interest 1. Vendor is otherwise not under an obligation to notify the ME if it seeks forfeiture c. Rights of the vendee s ME i. When a forfeiture occurs under circumstances where prior notice to the ME is required, court find that the rights of the ME remain unimpaired 1. If the vendor and vendee s ME agree, the ME can acquire title by paying vendor the balance due under the land K a. Means that an equity of redemption was no eliminated and vendee may be able to exercise that right d. Documents used in mortgaging vendee s interest i. Prudent lenders use standard financing forms to effectuate security interest in the vendee s interest 1. Mortgage or deed of trust 2. If permitted, will require the form to include a power of sale to obviate the need for judicial foreclosure e. Prohibition on assignment by the vendee i. A land K may purport to deny the vendee the power to assign or mortgage his interest w/o the vendor s consent 1. May be struck down as an unreasonable restraint on alienation Cascade Security Bank v Butler a. FACTS obtained a judgment against the vendees. The vendees then assigned their interest to the who held then held the land K 7
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b. RULE A real estate K vendee s interest is real estate within the meaning of the judgment lien statute i. A judgment lien arises as soon as the judgment is docketed or recorded c. NOTES i. Is the vendee s interest real estate? 1. A lien arises as soon as the judgment is docketed or recorded a. Some case law holds that a judgment lien does not attach to equitable interests in real estate ii. Bank of Santa Fe v Garcia 1. A judgment lien creditor s interest attaches to the full interest of the vendee iii. Perfection of security interests in vendor s rights under land K 1. UCC 9-308(e) a. Perfection of a security interest in a right to payment or performance also perfects a security interest in a security interest, mortgage, or other lien on real property securing the right, notwithstanding other law to the contrary i. The prudent lender who wants a valid security in a vendor s interest will ALWAYS file a financing statement ii. A vendor s interest in a land K is now an account rather than a general intangible iv. Is the vendor s interest real estate for purposes of judgment liens? 1. Majority rule is that a judgment lien against a vendor after the making of the K, but prior to making and delivery of the deed, extends to all of the vendor's interest remaining in the land and binds the land to the extent of the unpaid purchase price v. Vendee vs. holder of judgment lien against vendor 1. Vendee should: a. Cease making payments to the seller/judgment debtor b. Initiate a separate action to resolve questions related to the right to the unpaid balance of the purchase amount c. Arrange to pay the balance due under the K to the court and so notify the court Rights and Duties of the Parties Prior to Foreclosure a. Theories of Title i. Title theory 1. Legal title to the mortgaged real estate remains in ME until the mortgage is satisfied or foreclosed a. As legal titleholder, in the absence of agreement to the contrary, ME has a right to immediate possession against MR ii. Lien theory 1. ME is regarded as owning a security interest only and both legal and equitable title remain in the MR until foreclosure a. Is an inchoate interest to becoming the owner, but is not being the owner 2. Majority of American jurisdictions iii. Intermediate theory 1. Legal and equitable title remain in MR until a default, at which time legal title passes to the ME iv. ME in possession in lien states 1. ME can get MR to agree to give ME possession 8
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2. ME may purchase at an invalid foreclosure sale, and remain in possession until a valid foreclosure sale takes place 3. If MR abandons, ME can usually retake possession until foreclosure ME taking possession without judicial process 1. Wheeler v Community Fed Sav & Loan Ass n a. received $100,000 in punitive damages for an intentional unlawful entry by the bank into their home Liability of ME in possession 1. ME must operate the property no only to protect its own interest, but also for the benefit of the MR to pay off the debt a. ME who goes into possession is under a duty to maintain and preserve the property i. Standard by which the discharge of that duty should be judged is that of a provident owner 1. There are limitations a. ME is not bound to dig into his own pocket and so need not expend more than the rents and profits he receives b. Standards is willful default, recklessness and improvidence 2. ME in possession status makes ME liable in tort for injuries resulting either through its actionable fault in utilizing the property or by reason of its failure to perform duties imposed by law upon the owner of land Avoiding ME in possession status 1. ME frequently use receivership to avoid ME in possession status a. Allows access to the rents and profits and control over the mortgage real estate pending foreclosure Dover Mobile Estates v Fiber Form Products Inc 1. FACTS Dover purchased property at a trustee sale, and knew of a preexisting lease by Fiber Form with the defaulting landlord. Dover wanted to keep the Fiber Form lease in place. Fiber Form continued to pay rent to Dover, but left the lease before its expiration 2. ISSUE Did the lease survive the foreclosure a. Fiber Form argues that the sale extinguished the lease b. Dover argues that the lease was ratified by Fiber Form continuing to pay rent 3. RULE a. A lease which is subordinate to the deed of trust is extinguished by the foreclosure sale i. If the sale of the landlord s interest is forced by one having a paramount title to that of the tenant, such as a ME whose interest existed at the time the lease was made, the tenant s interest will be defeated by the sale 4. HOLDING the lease did not survive the sale a. The lease was subordinate to the deed in trust, so title was taken without the lease encumbering it. 5. NOTES a. Senior vs subordinate leases i. A lease that antedates a mortgage, if duly recorded, is prior and SUPERIOR to the mortgage 1. Cannot be extinguished by foreclosure of the mortgage 2. If such a lease contains an option to purchase the property, THE OPTION MUST BE SUBORDINATED TO THEMORTGAGE 3. Complete subordination of a prior lease to a subsequent mortgage is legally possible 4. In lien theory state, ME is not entitled to make demand on the tenant to pay rent to to ME because has no privity of estate ii. Leases junior to the mortgage 9
1. Such a lease can be extinguished by foreclosure of the mortgage 2. In title and intermediate theory states, ME has the right to evict junior leases as soon as default occurs in the mortgage payments a. Also true in lien states where a clause is inserted in mortgage giving ME right to possession on default 3. If ME enters under his mortgage and tenant chooses to remain and pay rent, creates a month-to-month tenancy b. Varying priorities by agreement i. Subordination agreement 1. Is an act by which one having an interest in particular real estate consents to a reduction in priority as against another holding an interest in the same real estate a. Usually executed in a separate document executed by the tenant and ME b. Lessee specifically subordinates the lease to the mortgage ii. Nondisturbance agreement 1. ME holding a senior lien agrees that in the event of foreclosure, the foreclosure purchaser will permit the lease to continue and allow the tenant to remain on the leased premises so long as the tenant continues to comply with the terms of the lease and is not in default a. ME grants the lessee the protection of a nondisturbance clause so that any foreclosure purchaser agrees to recognize lessee s rights under the lease iii. Attornment agreement 1. Tenant agrees with ME that if the interest of the Landlord under the lease shall be transferred by reason of foreclosure/deed in lieu, Tenant shall be bound to the Purchaser under all of the terms, covenants and conditions of the lease for the balance of the term thereof with the same force and effect as if the Purchaser were the original landlord under the lease a. Lessee, by attorning, agrees to be bound under the terms of the lease to any foreclosure purchaser even though, as a junior party, a foreclosure would otherwise terminate his leasehold obligation i. Puts the tenant and lender in direct privity of K ii. Provides the lender with specific covenant from tenant that, after foreclosure, the tenant will perform for the benefit of the lender upon demand to do so iv. Tenant estoppel certificate 1. ME needs to be able to justifiably get a valid copy of a lease during the underwriting process a. ME sends the tenant a tenant estoppel certificate. Lender directly asks the tenant to confirm certain aspects of the lease. ix. Security interests in rents 1. Assignment of rents agreement is enforceable in every jurisdiction, whether it follows lien or title theory x. In the Matter of Millette 1. FACTS there was a judgment against Millette. The creditor was O Neal Steel. O Neal found out about the building, and attempted to garnish the rents. However, Millette had assigned to Bank in a deed of trust. Bank began foreclosure proceedings. 10
2. ISSUE Whether ME, which has obtained assignment of rents, is perfected in the rents when the assignment is recorded, or whether it must take additional steps to perfect its interest in the rents 3. RULE The recording of a mortgage document containing an assignment of rents gives the ME rights superior to any subsequent third party who would seek to take a security interest in the leases and rentals pertaining thereto as a type of collateral a. ME does not have to take additional steps to perfect its interest. The assignment is perfected when it is recorded. 4. NOTES a. Three crucial focal points in the creation and enforcement of a rents assignment i. When does the assignment become effective between MR and ME? ii. When has the lien been perfected? 1. Is perfected when recorded iii. When does ME have the right to collect/enforce the assignment? 1. Is enforced when additional steps have been taken b. Restatement approach i. Page 382 xi. Coleman v Hoffman 1. FACTS Six month old daughter fell off balcony in July 1997. In April 1997 the owner defaulted on its loan. OCI took an assignment of the rents, A&H began paying the utility and repair costs, and Hoffman was the expected purchaser. 2. RULE ME who properly acquires ME in possession status is held accountable for that possession to third parties. a. Held to the standard of a provident owner to use reasonable diligence to keep the property in a good state of repair 3. HOLDING Hoffman performed two acts that show possession/control: made repairs and managerial decisions. A&H performed acts indicating possession/control: paid utility bills, collected rents, and hired Hoffman. OCI only collected rents: does not establish possession or control b. Receiverships i. Action taken by court, using its equitable powers, to appoint a third party to act on behalf of the court at the request of one of the parties in the transaction (normally the lender) 1. Why appoint a receiver? a. Avoids termination of leases i. Buys lender time to try to get the existing tenants to sign an attornment agreement ii. Dart v Western Savings & Loan Ass n 1. FACTS Dart owned a trailer park and Western Sought to foreclose its first mortgage. Inland crossclaimed to foreclose its second mortgage and to foreclose the first mortgage on Dart s home. At the time, the value of the property was well in excess of both the first and second mortgage and tax lien. 2. RULE ME s equitable right to have a receiver arises only when he shows something more than a default a. No K should force a court to exercise its discretion in favor of a party who stands in no need of aid i. If the security is plainly adequate, a receiver will not be appointed, despite the presence, in the mortgage, of a rent pledge or receivership clause 3. NOTES a. Standards for receivership i. Insolvency of MR and inadequacy of security are not enough to justify receivership 11
1. Must be some additional ground such as danger of loss, waste, destruction or serious impairment of the property ii. Restatement 1. ME is entitled to appointment of receiver if: a. MR is in default b. Value of real estate is inadequate to satisfy mortage c. MR is committing waste b. Impact of receivership and rent assignment clauses i. Just b/c there is an assignment of rent clause does not mean that the lender should be entitled to receivership ii. Restatement 1. ME is entitled to receivership if the MR is in default and the mortgage contains either a mortgage on the rents or a provision authorizing appointment of a receiver to take possession and collect rents upon the MR default c. Ex parte receivership i. Entails the appointment of a receiver, usually pending judicial foreclosure, without providing notice or a hearing for MR and other interested parties 1. No violation of due process where the appointment of the receiver is based upon sworn ex-parte documents under judicial supervision and followed by an early opportunity by debtor to put the creditor to his test d. Ability of receiver to terminate leases i. Receiver of rents and profits in mortgage is bound by the agreement between the tenant and MR-landlord, even if the lease is less than the FMV 1. Presupposes the existence of a bona fide lease a. Court has power to prevent frustration by a collusive or fraudulent lease for an inadequate rental or advance payment of rent in anticipation of foreclosure action iii. Trustco Bank v Eakin 1. FACTS Eakin executed a mortage with Bank for an apartment complex, and defaulted. Receiver was appointed, but took several months for the receiver to be qualified. Property became vacant, and Eakin drained the water pipes. Bank did not provide funds to board up the property, and Eakins said it would not take steps to maintain. Bank sued for deficiency judgment 2. RULE A court appointed receiver in a foreclosure action is an officer of the court and not an agent of the party who procured the appointment a. A receiver should not be put in jeopardy personally as to his own financial status merely b/c the property is one which cannot readily be administered b. ME has not duty (except ME in possession) has no duty to expend funds to preserve the mortgaged premises 3. HOLDING MR had most to lose and therefore the greatest incentive to act based on potential of deficiency judgment a. MR has a duty to maintain the premises even after a receiver is appointed c. Waste i. Prudential Insurance v Spencer s Kenosha Bowl 1. FACTS Kenosha had not assumed a prior owner s mortgage when it acquired property. Prior owner defaulted, and Prudential foreclosed. Prudential could have sought a deficiency judgment from MR, but it was advised to seek waste damages from Kenosha 2. RULE Waste is a species of tort
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a. Is the unreasonable conduct by the owner of a possessory estate that results in physical damage to the real estate and substantial diminution in value of the states in which others have an interest 3. HOLDING Waste Doctrine permits a ME to maintain an action for waste against a nonassuming grantee of MR a. Damages is the conduct that created the loss plus the diminution in value. Cannot exceed the deficiency judgment 4. NOTES a. What constitutes waste? i. Restatement approach 1. Waste occurs when, w/o ME s consent, the MR a. Physically changes the real estate, whether negligently or intentionally, in a manner that reduces its value b. Fails to maintain and repair in a reasonable manner c. Fails to pay property taxes before delinquency d. Materially fails to comply with covenants in the mortgage e. Retains possession of rents to which ME has the right of possession b. Waste liability of nonassuming grantee i. When foreclosure sale yield less than debt, ME may recover a judgment for the deficiency against anyone who is personally liable on the mortgage obligation 1. Grantee of mortgaged real estate who merely takes subject to the existing mortgage does not assume, is not personally liable c. Waste liability when a deficiency judgment is barred by mortgage clause or by statute i. Carefully drafted non-recourse clauses often carve out liability for waste 1. Make the MR liable for waste even if there would be no general liability on the mortgage debt d. Waste committed by non-owners i. Liability for waste generally does not extend to non-owners ii. If the waste was committed by MR s consent, liability exists only if the person committing it had actual knowledge of the existence of the mortgage e. Limitations on recovery of damages for waste i. Three limitations on ME s recovery of waste 1. May not exceed the least of: a. Actual harm caused by the waste b. Amount of the mortgage debt or the unpaid deficiency c. Amount by which ME s security has been impaired f. Measuring impairment of security i. Loan to Value ratio 1. As the loan is paid down, the L/V improves ii. Restatement approach 1. Impairment of security exists if the ratio of mortgage obligation to FMV is above its scheduled level a. Lender will recover amount to put L/V ratio where scheduled to be d. ME Liability for Environmental Problems i. CERCLA 1. Significantly increased potential for ME liability 2. ME has two reasons for concern 13
a. Preforeclosure period i. ME may be considered a participant in management and would have CERCLA liability b. Acquires ownership through foreclosure or deed in lieu i. Makes ME the owner 1. May still be protected from liability if ME can establish that even post-foreclosure ownership is held primarily to protect his security interest in the facility 3. United States v Mirabile a. ME was only liable if it participated in operational, production, or waste disposal activities 4. United States v Fleet Factors a. ME is liable if it had the capacity to influence borrower s treatment of hazardous waste even if it did not actually involve itself in the operations 5. Resulted in legislation to provide better guidance a. No liability so long as not participating in management i. See 415-16 ii. RCRA applies to underground petroleum storage tanks 1. Owner is responsible if the if the contamination exposes adjacent property and is responsible for cleaning up the adjacent property and groundwater iii. CERCLA lien 1. Lien is given SUPERPRIORITY iv. Edwards v First Nat l Bank of North East 1. FACTS Bank held a mortgage on a gas station, and foreclosed. The Bank purchased the station at a foreclosure sale. Hired ESSE to test the storage tanks. Edwards were neighbors to station, and their water supply was contaminated 2. HOLDING the RCRA statute does not eliminate a cause of action in tort e. Insurance and Real Estate Taxes i. MR and ME have insurable interests with respect to loss suffered by the mortgaged premises 1. ME only to the extent of its loan 2. Loss payable policy a. Loss would be payable to MR and ME as their interests appear i. If MR did something wrong, precluded ME from collecting 3. Standard mortgage/Union mortgage a. Payable to MR and ME as interests may appear, but does not allow ME s interest to be terminated by wrongful act of MR i. ME will be able to recover on insurance policy even though MR has engaged in acts such as arson, fraud, etc. ii. If MR neglects to pay premiums, ME can pay the premiums on demand b. If insurer pays mortgage debt in full, becomes subrogated to the debt and can attempt to collect from MR c. IF MR promised ME to purchase insurance, ME has a right to the insurance proceeds to the extent the casualty has impaired the ME s interest i. ME has an equitable lien on the proceeds even if it is a nonrecourse loan ii. Starkman v Sigmond 1. FACTS MR made purchase money mortgage to ME. There was a fire loss. ME wanted the insurance proceeds applied to payments due under the mortgage. MR wanted the proceeds available to rebuild. 2. RULE standard mortgage clause creates an independent K of insurance, for the separate benefit of ME, engrafted upon the main K of insurance contained in the policy itself a. Where mortgage is not in default, MR should be able, where rebuilding is practical, to insist upon the application of the insurance proceeds to rebuild the premises 14
IV.
3. HOLDING by allowing ME to take the premiums, it is cutting short the terms of the loan a. Absent an impairment, ME has no right to insist on payment from insurer i. MR will lose the benefit of a long-term loan which was bargained for iii. NOTES 1. When should rebuilding be permitted with insurance proceeds? a. Unless Lender and Borrower otherwise agree in writing, insurance proceeds shall be applied to restoration or repair of the Property damaged, if the restoration or repair is economically feasible and Lender s security is not lessened 2. How much of the proceeds may ME capture? a. Restatement approach i. Entitled to recover insurance proceeds only to the extent that ME s security has been impaired by the loss or damage b. Majority approach i. Entitled to all the insurance proceeds up to the amount of the mortgage debt 3. Disposition in eminent domain awards a. ME is entitled to the entire condemnation award, or so much of it as is needed to satisfy the mortgage debt b. Partial taking i. ME only recover enough to compensate for impairment of the security c. Fannie/Freddie approach i. Allows ME to capture the full award when a total taking occurs (up to the amount of the debt) ii. Partial taking allows ME to recover the amount of the proceeds multiplied by the following fraction 1. Total amount of the sums secured immediately before the partial taking divided by FMV of property immediately before partial taking 4. Effect of full credit bid on insurance recovery a. Suppose ME purchases mortgaged premises at a foreclosure sale by bidding the full amount of the debt i. If mortgage debt is satisfied by the proceeds of sale, the ME is entitled to no further payment on account thereof 1. Proceeds go to MR 5. Insurance recovery for losses occurring after foreclosure a. ME is entitled to all proceeds where the casualty loss occurs after a foreclosure purchase by the ME i. Is the owner of the real estate now rather than the holder of the security interest iv. Escrow Account for Taxes and Insurance 1. Real estate taxes are a SUPERPRIORITY lien a. ME utilize mortgage clauses specifically imposing the duty to pay taxes and insurance premiums on MR i. Make failure to pay a cause for acceleration of the mortgage debt b. ME may demand that MR set up accounts with the ME into which MR will pay 1/12 of the annual taxes and insurance premiums each month 2. Escrow accounting under RESPA a. RESPA limits the cushion that a lender may collect i. Cannot exceed 1/6 of the estimated annual taxes and other escrowed items ii. Requires aggregate computation 1. Requires escrow of association fees, taxes, etc. Transfer and Discharge a. Transfer of MR s Interests 15
i. Two concepts of taking over an existing mortgage 1. Assuming it a. Under an assumption, the Lender can pursue default payments from the Grantor and the Grantee of the assignment 2. Taking subject to it a. Lender can only pursue the Grantor of the assignment ii. Middleton v Hancock 1. RULE assumption is a promise by purchaser to make the payments and perform the other covenants in the note and mortgage a. Must be an EXPRESS PROMISE i. Assumptions are not implied b. If the grantee assumed, MR who pays the debt has three avenues to proceed against the grantee i. Subrogation 1. MR must pay mortgage debt in full, and receives ME s note and mortgage. MR can sue grantee on the note OR foreclose the mortgage 2. Major disadvantage of subrogation is that it is available only upon the surety-MR s payment in full ii. Reimbursement 1. MR pays the mortgage in whole or in part is entitled to indemnity provided there was an assumption iii. Exoneration 1. MR may obtain a court order compelling grantee to pay c. Impact of the absence of an assumption agreement i. Reimbursement and Exoneration are not available ii. Subrogation right is only to the mortgage 1. Not to the note 2. NOTES a. Assuming grantee s assertion of defenses i. Assuming grantee does not have the right/ability to assert defenses that would have been available to the MR against the ME b. Subject-to grantee s assertion of defenses i. Grantee cannot assert defenses for the same reason as assuming grantee c. Nature of ME s rights against grantee i. Two theories 1. ME is a third-party beneficiary of the assumption agreement a. Majority view 2. Suretyship subrogation theory d. Rescission of the assumption agreement i. Under the third-party beneficiary theory, if the ME has sufficiently relied on the assignment, ME may be able to subject grantee to liability even after the MR has rescinded the assignment e. Suretyship defenses i. Surety ought not be held liable under a different deal tan he originally made, unless the surety consents to the change in the terms of the deal 1. Discharge is granted on the grounds the actions of ME a. Have made it less likely that the grantee or the land will satisfy the debt b. Have made it more difficult for the MR to assert recourse 2. Extent of discharge? 16
a. Recognized only to the extent that the surety would suffer loss as a result of the impairment i. Although historically it was a complete discharge iii. First Federal Savings & Loan v Arena 1. FACTS grantee increased the term of the loan and increased the interest rate upon assuming the assignment of grantor-MR. 2. HOLDING - Express clause that ME and MR agreed upon allowed for many things, but same manner as MR did not allow ME to increase the interest rate. a. MR acts as a surety, and surety law provides that a surety is entitled to stand on the strict letter of the law 3. NOTES a. How can ME avoid suretyship defenses? i. Include a clause in the mortgage preserving ME s claim against MR 1. Must be broadly written because it is strictly construed ii. Obtain MR s consent to the modification after the mortgage is entered into, but before the modification itself is made iii. Obtain MR s consent after the modification is made b. Restrictions on Transfer by MR i. Due-on sale clauses 1. Affords ME the right to accelerate the mortgage debt and to foreclose if the mortgaged real estate is transferred w/o ME s consent a. Used to protect ME against transfers that endanger mortgage security or increase the risk of default i. This is false b/c transfer creates the surety relationship so that the interest is still protected against the MR-grantor b. Enable ME to recall lower than market interest rate loans during periods of rising interest rates ii. Events triggering acceleration 1. Fannie/Freddie approach a. If all or any part of the property or any interest in it is sold or transferred, , the lender may accelerate i. Under this language, even a short-term lease or easement would suffice to trigger the lender s right to accelerate iii. Garn St. Germain Act 1. (d) states the specific exemptions to what would otherwise trigger due on sale clauses (page 475) a. Creation of lien subordinate to lender s security b. Purchase money security interest for household appliances c. Transfer by devise, descent or at death d. Leasehold interest of three years or less e. Transfer to relative resulting from the death of borrower f. Transfer by divorce g. Transfer into trust 2. Lenders covered a. Is broadly applied, but DOES NOT COVER PRIVATE BANKS 3. Loans covered a. Is not limited to residential loans 4. Application to Land K a. Land K vendor retains a vendor s lien for the unpaid purchase price 5. NOTES a. Transfer of stock or p ship interests 17
i. Not a trigger b/c General Partner stayed the same and the p ship was a separate legal entity ii. But it all depends on the language of the K b. Successive transfers i. Generally due on sale clause applies to every transfer, no matter how many times a property is conveyed 1. So if A is the MR, and sells to B (takes subject to), and B sells to C, the due on sale clause applies to A, B, and C c. Waivers by lenders i. Lenders can and do waive the right to accelerate 1. Commonly given in return for the payment to lender of an assumption fee, an increase in interest rate, or both d. Concealment of transfers i. Most due on sale clauses have no express covenant that the MR must disclose to the ME that a transfer is taking place 1. Some cases have said that there is no duty to disclose ii. If there is a concealed transfer, what damages can ME assert? 1. Can accelerate the loan 2. May also get damages for the difference in the old interest rate from the new interest rate e. Concealment by lawyers i. Lawyers are required to keep the confidence of client as long as not illegal or fraudulent ii. How should one advise client? 1. Put in writing what obligations the client has and let the client know of the possible implications c. Transfer of ME s Interest i. Outright sale to an investor who will hold the mortgage in its portfolio 1. MR (note and mortgage) => ME (endorsement of note, assignment of mortgage) => Investor a. Assignment of the mortgage was recorded, but not necessary to transfer ME s right i. Transfer of the note is adequate to transfer ME s right ii. Partial assignments (participations) sold to multiple investors 1. MR (note and mortgage) => ME (endorsement of note, assignment of mortgage) => Investor (sales participations) => multiple investors a. Is the typical scenario in large commercial real estate transactions. ME makes a huge loan that ME does not want to be exclusively at risk for i. Participation interests are tenancy in common interests ii. Where Fannie/Freddie is the initial Investor, it will issue hundreds of participation certificates to other investors in capital markets 1. Fannie/Freddie issues the participation certificates back to ME, and ME then sells the participation certificates on the capital markets. Allows ME to determine what percentage of participation ME wants to have in the loan a. Having the certificates also gives ME greater liquidity iii. Sale of mortgage-backed pass-through securities 1. MR (note and mortgage) => ME (endorsement/assignment) => Issuer (sales of bonds/securities) => Multiple investors: GNMA guaranties the bonds/securities a. GNMA guaranties the securities at face value even if some of the payments due on the underlying mortgages experience default i. Bonds/securities are collateralized by the mortgages in groups ii. GNMA essentially only had to guaranty 2% of the loan b/c FHA or VA guaranteed 98% of the loan at the time MR gave ME the mortgage 18
iv. Sale of multiclass mortgage-backed securities 1. Terms a. Commercial mortgage back securities (CMBS) b. Conduits are the loans themselves c. Tranches class of securities 2. Housing collapse (486) BOOK S VERSION a. The problems arose b/c of confluence of two factors i. Prolonged period of exceptionally low interest rates 1. Would have corrected itself, leading to a price stagnation or deflation, but correction proved more severe because of another factor: ii. Fundamental structural realignment in the mortgage lending industry 1. Broke down in two ways a. More and more loans were made by independent mortgage brokers i. Broker would qualify borrower, and receive a commission from the yield spread ii. Brokers were unscrupulous b. Advent of residential mortgage securitizations i. Should have been concerned about the quality of the underlying mortgages, but it was impractical for them to investigate thousands of individual loans ii. As a fallback, investors relied on rating given to the securities by the three rating agencies (Moody s, Standard & Poor, and Fitch s) 2. Residential mortgage industry had restructured itself into three components a. Mortgage brokers b. Wholesale lender/securities issuers c. Securities investors b. The issuers wanted the securities to be investment-grade, and had the ratings agencies supply a rating i. Most were rated AAA 1. In the 1990s they deserved a AAA rating b/c the default rate was excellent 2. But as the underwriting standards were creatively applied, the rating agencies failed to look at the underlying collateral a. ME had incentive to pass-through as many loans as possible b/c ME had no responsibility after the issue divided the loan amongst all of the investors c. Loosened underwriting standards i. Loosened b/c executives stood to gain substantial compensation by increasing the number of loans that they could underwrite 1. Much of the public didn t know that the gov t was no longer guaranteeing the loans, and that Fannie was privatized ii. Wall Street saw the success of Fannie/Freddie because they were public 1. Started soliciting lenders to sell their mortgages to them. The iBanks had no risk b/c sold them as quickly as they bought them. Only problem was there was not enough volume a. Increased volume through decreasing the down payments and using credit default swaps d. Perfect storm 19
i. Prices began to stagnate and borrowers could not sell their houses for enough to cover their indebtedness 1. Many adjustable interest rates were also beginning to reset and resulted in higher payments ii. Large upswing in foreclosures was caused by a combination of housing price deflation and an industry characterized by a huge moral hazard 1. No one had a sufficient stake in ensuring that the mortgages being originated could and would be paid back 2. Houses that were dumped back on the market further increased supply and drove prices downward iii. Institutional investors had attempted to hedge their default risk by entering into credit default swaps 1. In essence were selling insurance against mortgage default to the securities holders a. So long as housing prices were rising, defaults were low and selling such insurance was highly profitable i. But when housing market declined and defaults increased, the institutions that had sold the credit default swaps were force to begin paying off in amounts far beyond their expectations and capacities iv. Bank auditors took the view that mortgage backed securities had ZERO MARKET VALUE even though they were in fact returning a cash flow and producing income 1. Marking the securities down to zero had the effect of reducing the bank s lending capacity by roughly 12 times the amount of the markdown a. This contributed to the illiquidity of the credit markets 3. The biggest problem was the competitive nature of the market in underwriting loans a. The banks were making so much money that they relaxed underwriting standards, down payments, etc to maximize on instant profits v. Collateral or security transfer of notes and mortgages 1. MR (note/mortgage) => ME (endorsement/assignment) => Lender (Loan $ back to ME) a. Known as loan warehousing i. Note and mortgage serve as collateral subject to the terms of a Purchase and Repurchase Agreement 1. Considered to be short period escrows 2. Mechanics of mortgage transfer a. Two transfers are made i. Transfer of the promissory note 1. May be accomplished either by endorsement and delivery of the note itself, or (if the note is not negotiable) by a separate document of assignment ii. Assignment of the mortgage 1. Assignment is technically unnecessary a. The note, which represents the debt, is the principal thing being sold, and since the mortgage is merely security for the not, any transfer of the note will automatically serve to transfer the mortgage as well b. Kluge v Fugazy i. Where mortgage was assigned but note was excluded from assignment, assignee of mortgage could not foreclose it 20
c. Restatement approach i. A mortgage may be enforced only by, or in behalf of, a person who is entitled to enforce the obligation the mortgage secure d. Virtually all secondary market sales by competent professional lenders involve both a delivery of a promissory note and a (recorded) assignment of its accompanying mortgage vi. In re AppOnline.com, Inc 1. FACTS Two MEs sold mortgages and related notes to Apponline.com and its subsidiary company, Island Mortgage. Island s checks were dishonored. Broward, serving as disbursing agent, argued that the MEs were not holders in due course of the mortgages and notes involved 2. RULE the negotiability of a promissory note is not destroyed by the mere reference to a related security instrument, such as a mortgage a. A holder in due course takes the instrument free from i. All claims to it on the part of any person ii. All defenses of any party to the instrument with whom the holder has not dealt b. A holder in due course takes the instrument i. For value ii. In good faith iii. Without notice that it is overdue or has been dishonored or of any defense against or claim to it on the part of any person c. For the instrument to be negotiable, it must i. Be assigned by the marker or drawer ii. Contain an unconditional promise or order to pay a sum certain in money and no other promise 1. If the note requires one to look outside the note to determine the terms of repayment, then the promise is NOT unconditional and the note is NOT negotiable iii. Be payable on demand or at a definite time iv. Be payable to the payee s order or to the instrument s bearer 3. HOLDING Broward only took issue with the contain an unconditional promise to pay a sum certain. a. The existence of a separate agreement does not affect the note s negotiability 4. NOTES a. Real and personal defenses i. HDCs are free only from personal defenses, and remain subject to real defenses 1. Real defenses include a. Infancy of obligor b. Duress, lack of legal capacity, or illegality of transaction c. Fraud that induced obligor to sign the instrument d. Discharge of the obligor in insolvency proceedings b. Requirement for HDC status: NEGOTIABLE NOTE i. Three requirements 1. Note itself must be negotiable, that is, be in proper form 2. Process by which the note is transferred must constitute proper negotiation 3. Holder must personally satisfy the necessary behavioral requirements ii. It is risky to include to include in the note a clause generally incorporating the terms of the mortgage by reference 21
1. Will usually make the note nonnegotiable 2. However, there is no objection to merely reciting in the note that it is secure by a mortgage c. Requirements for HDC status: NEGOTIATION i. Focuses on the process by which the note is transferred 1. Possession of the instrument must be transferred to the holder a. Transferring a photocopy will not do 2. If the instrument is payable to an identified person, must be endorsed a. in blank i. Means that it is merely a signature b. special i. Endorsement that identifies the person to whom it makes the instrument payable c. If there is not enough room to endorse, can attach an allonge i. The along must be affixed to the note d. Non-HDC and patent equities i. Assignee of a note who believes that HDC protection may be lacking often wisely demands that the maker provide an estoppel certificate at the time of transfer 1. Avers that the note is valid and not subject to defenses by the maker e. Close-connectedness doctrine i. HDC status is lost if the purchaser of a negotiable note is too closely connected with the transferor 1. Purchaser is regarded as lacking good faith vii. Transfers of mortgage servicing 1. Servicing can be separated from the note/mortgage a. The servicer is the agent of the owner/investor and represents it in dealing with the borrower b. Transfer of servicing can be transferred separate from the transfer of a note/mortgage i. Is very frustrating for MR who has to constantly send mortgage payments to a separate servicer 1. Cranston-Gonzalez Affordable Housing Act corrected the frustration a. Requires lender to inform borrower of servicing practices and likelihood of the servicing being transferred viii. Payment problem 1. Payment to the assignor of your note/mortgage is ineffective against the assignee even though a payor had no idea that there was an assignment a. Makes servicing very important b. Nonnegotiable notes i. Restatement approach 1. Performance of the obligation to the transferor is effective against the transferee if rendered before the obligor receives notice of the transfer c. Negotiable notes i. UCC approach 1. An instrument is paid to the extent payment is made by or on behalf of a party obliged to pay the instrument, and to a person entitled to enforce the instrument 22
ix. Collateral assignments of mortgages 1. Two types of assignments of notes/mortgages a. Outright i. A sale of the loan, usually for cash, to an investor who plans to hold it for the long term or securitize it b. Collateral assignment i. Loan is pledged by ME as collateral for another loan, one made by the assignee to the ME 2. How does the pledgee of a mortgage foreclose? a. May put the underlying note and mortgage on the secondary mortgage market and sell them b. Pledgee may simply notify MR on the underlying debt to begin making payments on that debt directly to pledgee x. Recordation of mortgage assignments 1. The way to transfer ownership is to transfer possession of the note a. No assignment of the mortgage is necessary; a transfer of the note will automatically transfer the mortgage rights as well i. Nonetheless, use of a separate assignment of the mortgage is customary b. Assignee s failure to record does not protect MR s default c. Recording of an assignment of a mortgage is not in itself a notice of such assignment to MR where assignment is recorded subsequent to the recording of the conveyances of such premises d. Recording as notice to a grantee taking title from MR i. Without notice, grantee is entitled to assume that ME still hold the note and mortgage, and a payoff by grantee to ME is binding against the assignee e. Failure to record as facilitating a wrongful release by the original ME i. There are situations of collusion between ME and MR 1. Is the most important reason that assignees of mortgages should record a. Assignee may otherwise be bound because a subsequent grantee may be a BFP xi. In re Kan Jin Hwang 1. FACTS Hwang filed for bankruptcy protection. Mortgageit transferred the note to IndyMac, which was taken over by the FDIC. IndyMac had sold the note to MERS, and does not know who owns the note today. There is no evidence IndyMac ever transferred the note. 2. RULE If a loan has been securitized, the real party in interest regarding the loan is the trustee of the securitization trust, not the servicing agent for the loan a. An instrument may only be enforced by the holder of the note i. Two requirements to qualify as a holder 1. Must be in possession of the instrument 2. Instrument must be payable to that person b. The holder of a note is entitled to enforce it, notwithstanding sale of the note to another party, until the note is delivered to the purchaser 3. NOTES a. Foreclosures in the name of MERS i. MERS was set up to avoid the necessity of repeated recordation of the mortgage assignments as mortgages are traded on the secondary market 1. Note is made payable to lender, but the mortgage is made to MERS mas ME b. Lost note problem i. UCC approach 23
1. A person not in possession of an instrument is entitled to enforce the instrument if a. The person seeking to enforce the instrument i. Was entitled to enforce the instrument when loss of possession occurred ii. Has directly or indirectly acquired ownership of the instrument from a person who was entitled to enforce the instrument when loss of possession occurred xii. Perfection of security interests in notes and mortgages 1. Perfection gives the secured party (pledgee) priority over competing secured parties who perfect later, subsequent lien creditors, and subsequent purchasers of the security property 2. Why does Article 9 apply? a. In collateral assignments of notes/mortgages, the property which is the subject of the security is not the underlying real estate i. It is the set of intangible rights created by the note and mortgage 1. Article 9 does apply to a security interest in the promissory note even though the note is secured by a real estate mortgage 3. Perfection of a security interest in a right to payment or performance also perfects a security interest in a lien on property securing the right a. Assignee can perfect by filing a financing statement i. Filing is second rate perfection because it can be trumped by debtor giving actual possession of the note to a different creditor who pays value and lacks knowledge of the earlier transfer 1. POSSESSION OF THE NOTE ALWAYS OBTAINS A GREATER PRIORITY 4. Perfection of HDC status a. Transfer of possession of the instrument kills two birds with one stone i. Essential element of HDC status ii. Accomplishes perfection xiii. Mortgage participations 1. Most common method is to use a single note and mortgage for each loan a. Originating ME is the lead lender i. Will generally retain the original note/mortgage and sell participation certificates 2. Participations as securities a. All cases refuse to treat a participation sold to a financial institution as a security i. On the other hand, if the participation interest is sold to an unsophisticated private individual, it is relatively easy to convince a court that it is a security b. Participants want it to be security to hold the lead lender liable d. Discharge of the debt and mortgage i. A mortgage may be paid off by two classes of persons 1. Primarily responsible a. MR if he still owns the real estate b. Payoff extinguishes the mortgage i. ME has a duty to provide a suitable document, recordable in form, showing that the mortgage has been released 2. Not primarily responsible a. Have the right to pay the mortgage in full (if it is due by its terms or has been accelerated by the ME) i. Payment is known as a redemption 1. It DOES NOT EXTINGUISH the mortgage 24
a. Instead, it assigns both the obligation (note) and the mortgage to the payor ii. Tender 1. Present offer to pay off the mortgage debt in full is a tender a. It is as good as actual payment i. Immediately stops the running of interest on the mortgage debt ii. Entitles payor to a release or an assignment of the mortgage iii. ME disclosures 1. How do I know if I am tendering an adequate amount as a MR? a. Custom is to provide a pay-off letter that may entail a fee i. Discloses whether or not the loan is in default among other information b. Restatement approach i. Takes the view that lenders have a common law obligation to provide a statement of the amount owing, current interest rate and the basis if it is adjustable, any additional fees/charges, and whether the loan is in default iv. Prepayment 1. ME has a common law right to refuse an early tender or prepayment of principal or interest a. Lenders count on the interest payments i. May have borrowed the money themselves and need to rely on the stream of income to make payments to depositors 2. Lock-out provision a. ME tries to specifically prohibit prepayment for a fixed period of time i. Is not necessary b/c there is no common law duty to accept a prepayment unless the mortgage or note expressly authorize borrower to prepay v. Westmark Commercial Mtg Fund v Teenform Assoc 1. FACTS defaulted on their loan and obtained a foreclosure judgment, including late fees, default interest, prepayment fees, and attorneys fees. All of the fees were provided for in the promissory note. argued that the amounts for each were unreasonable and unwarranted 2. RULE ME may charge a prepayment penalty, even if prepayment is the result of the ME accelerating the debt, if the MR freely signed a promissory note entitling the ME to do so a. Right to prepayment premium is not unlimited i. Cannot be charged if it is the result of being taken by eminent domain, or if results from casualty insurance proceeds 3. NOTES a. Language permitting prepayment i. Following language permits prepayment 1. X dollars per month or more 2. Entire balance must be paid by X date if not sooner paid b. Attacking prepayment fees i. Borrowers are very unsuccessful 1. Best chance is unconscionable 2. Some argue that the prepayment is interest and therefore violates usury laws c. Prepayment caused by ME s acceleration i. Four causes for acceleration 1. On account of borrower s default a. Enforcement of the prepayment clause depends on whether the mortgage clause specifies that it will 2. Under a due-on-sale clause when borrower transfers w/o approval 25
a. If it is covered by Garn-St. Germain Act (1 to 4 family home) then a lender cannot impose a prepayment penalty 3. Payment of insurance proceeds due to casualty a. Split. Some court allow prepayment premium, others don t 4. Payment of eminent domain award a. Usually will not enforce the prepayment premium d. Prepayment fees in bankruptcy i. Question is whether the fee is collectible as a secured claim in b ruptcy 1. 506(b) of the B ruptcy Code requires that the fee be reasonable vi. Westmark Commercial Mtg v Tennform Assoc 1. RULE liquidated damages clauses in commercial context between sophisticated parties are presumptively reasonable a. Must be fraud duress or unconscionability to defeat the presumption i. Burden is on MR b. Default interest rates should be measured for reasonableness i. If found unreasonable, will be struck down as a penalty 2. NOTES a. Unconscionability as a standard i. May be substantive, procedural or both b. What default interest rate is excessive? i. Increase by Three to four percent will be upheld ii. Larger increases will have to be analyzed for context 1. Increase from 18-36% has been upheld a. Was excessive in the first place, so there was a reason for the vast increase c. What amount of late charge is excessive? i. If the fee is based on the outstanding principal balance rather than on the missed installment, it will be struck down vii. Devlin v Wiener 1. FACTS agreed to sell to , and in return agreed to give cash and provide a home/land/condo on the land. Mortgage stated that the debt was $84,000 and gave $86,000. conveyed to his company, the company conveyed to and wife, and conveyed the interest to wife. defaults, and claims that the mortgage failed to define any other obligation or debt in sufficient detail 2. RULE the dispositive question in examining the validity of a mortgage is whether it provides reasonable notice to third parties of the obligation that is secured a. Recorded mortgage does not need to recite with particularity all of the details of the underlying transaction i. Must be clearly enough specified in the mortgage so that the person who becomes the owner of the property can figure out what is necessary to satisfy the obligation 3. NOTES a. Definiteness of obligation i. ME need not describe the obligation whose performance it secures, provided the parties have otherwise reach agreement identifying that obligation b. Non-monetary obligations i. If the non-monetary obligation is not capable of being reduced to a money equivalent, it cannot be secured by a mortgage 1. Mortgage enforcement would break down if mortgages were permitted to secure performance of obligations that could not be measured in terms of money 26
a. Would be no means of determining whether a foreclosure sale produced a surplus or deficiency b. If a junior lienholder desired to redeem, would be no means of determining the amount necessary to accomplish redemption c. Support mortgages i. A promise of emotional support cannot be reduced to a monetary equivalent 1. Is therefore not valid to secure the mortgage e. Merger, Deed in Lieu of Foreclosure i. Merger 1. Theory is that when a ME s interest and a fee title coincide and meet in the same person, the lesser estate, the mortgage, mergers into the greater, the fee, and is extinguished a. Doctrine can be utilized either as a defense to the mortgage debt or as an argument that the mortgage no longer exists 2. Mid Kansas Federal v Dynamic Development a. FACTS loaned to to finance construction. The loan was secured by first and second deeds of trust. The loan fell into arrears, and exercised its sale powers under the second deed of trust. then sued for the difference between sale amount and the amount of the note. b. RULE when a party holds a first and second mortgage and forecloses on the second, he cannot sue for the balance of the loan i. If one holding both junior and senior mortgages forecloses the junior and purchases the property at foreclosure sale, rule is that MR s personal liability for the debt secured by the first mortgage is extinguished 1. Merger rights doctrine states that the purchaser at a foreclosure sale of a junior lien takes subject to all senior liens a. Purchaser is presumed to have deducted the amount of the senior liens from the amount bid at foreclosure sale ii. Deeds in lieu of foreclosure 1. Attractive for several reasons a. Avoid the delay and expense of foreclosure b. ME may be perfectly willing to forego seeking a deficiency judgment c. Advantageous where statutory redemption legislation mandate long postforeclosure redemption periods 2. Not a clog on the equitable right of redemption a. Clogs are applicable only to agreements given at the time of execution of the original mortgage i. Not to transaction to wind up and terminate the mortgage relationship b. May still be treated as a mortgage if a lender requires a borrower to escrow a deed in lieu during a workout agreement i. As a lender, must look to whether it is the type of deed that extinguishes the mortgage relationship 3. Merger problems a. A deed in lieu of foreclosure IS NOT a foreclosure and will not operate to cut off intervening lienors i. ME who is about to accept a deed in lieu is very wise to have the title examined, and to ascertain that no junior interests exist ii. Conveyance of the equity of redemption by MR to ME will not terminate the latter s mortgage as against liens or other interests that prior to the conveyance were junior to it 4. Is a deficiency judgment available? 27
a. MR should obtain a formal cancellation of the promissory note or other evidence of the debt i. Deficiency liability continues to exist unless the parties specifically agree to cancel it V. Foreclosure a. Acceleration and Marshaling i. Graf v Hope Bldg Corp 1. FACTS Graf was the holder of two notes of hope. Hope s secretary miscalculated the interest payment, Hope signed the check, and left for Europe. Hope was unable to make up the deficiency until he returned From Europe. Graf foreclosed in the meantime. 2. RULE If from the mere negligence of the MR in performing his K, he suffers the whole debt to become due and payable, according to the terms of the mortgage, no court will interfere to relieve him from the payment thereof according to the conditions of his own agreement. a. Generosity is a voluntary attribute b. Must show fraud, bad faith or an unconscionable act on the part of the lender ii. Federal Home Loan Mtg Corp v Taylor 1. FACTS made a loan to . was in the Air Force and stationed in the Philippines and regularly made payments. One payment was returned, stating it was insufficient. continued to attempt to make payments, and eventually began to escrow all payments. 2. RULE Court in equity may refuse to foreclose a mortgage when an acceleration of the due date of a debt would be inequitable or unjust and the circumstances would render the acceleration unconscionable 3. NOTES a. Tender before acceleration i. Acceleration is options as opposed to automatic 1. If MR tenders arrearages prior to acceleration, the mortgage is reinstated 2. ME s post-acceleration acceptance of arrearages only serves to reduce the mortgage obligation and will not defeat acceleration ii. ME must perform some overt act evidencing intention to accelerate the loan b. Note and mortgage inconsistency i. Suppose the mortgage contains an acceleration clause, but the note does not 1. Restatement approach a. Permits acceleration in the event of a default and allow foreclosure for the full amount of the mortgage debt 2. UCC approach a. Permits inclusion in the mortgage note, w/o loss of negotiability, of a provision providing for acceleration whenever a mortgage covenant is breached c. Judicial discretion to permit reinstatement i. Restatement approach 1. Discretion to defeat acceleration exists only if ME has waived right to accelerate, or has engaged in fraud, bad faith or conduct making the acceleration unconscionable d. Waiver and estoppel i. All courts recognize that acceleration may be defeated by ME waiver 1. i.e. accepting late payments for a substantial period of time 2. On the other hand, courts will rarely find abandonment ii. Even if there is not inconsistent prior pattern of forbearance, ME may be estopped to accelerate based on a single transaction 28
1. i.e. ME tries to accelerate after giving oral assurance that acceleration will be postponed while MR tries to sell e. HOPE for Homeowners Act of 2008 i. Encouraged lenders to accept write-down in the loan balance on a defaulted home loan 1. The new loan would be at a fixed interest rate and would be payable over 30 years a. In return for lender s participation, the Gov t would insure the loan ii. The Act did not work well 1. Millions of people were eligible, but very few actually had their loans adjusted a. It was too complicated of a federal program, and as with most federal programs, it takes significant time to get up and running b. Lenders didn t like the program. Thought they could get more money by foreclosing quickly and reselling the property i. Lenders did not use the TARP funds to cushion the blow that would have occurred had it participated in the Act, which was what TARP was intended to do c. No one knew who would get the up-side if the land appreciated in value d. If the loan was rewritten, junior liens had to be extinguished f. FNMA-FHLMC form language i. Fannie/Freddie contained important acceleration limitations 1. Required detailed mailed notice and thirty-day grace period 2. Afforded MR the right to defeat acceleration until five days prior to foreclosure by payment of the arrearages and ME s reasonable cost g. Absence of acceleration clause i. Court may still allow acceleration by using the concept of anticipatory repudiation iii. Marshaling 1. Is an equitable doctrine that may dictate the order in which ME must foreclose when the mortgage covers more than one parcel of land a. Two funds rule i. Is an attempt, where possible, to avoid the unnecessary wiping out of junior interests 2. Matter of Estate of Hansen a. FACTS Hansen borrowed from BND which had a mortgage covering the surface and mineral rights. Hansen settled a lawsuit with SBT and gave SBT a mortgage on the surface rights only. Hansen defaulted on SBT loan, and later on the BND loan. i. BND began to foreclose surface and mineral rights. SBT requested that BND marshal its security by selling mineral rights first. b. HOLDING Court ruled that the mineral rights could be sold separate of the surface rights. There is an equitable right that the senior lienholder treat the junior lienholder fairly in the foreclosure of assets i. Purpose is to give the debtor an opportunity to redeem from any, or all parcels or lots, to sell only so much of the property as is necessary to pay the debt, and to get the highest possible price for the land sold 3. Inverse Order of Alienation Rule 29
a. Where a portion of land subject to a lien has been alienated, the grantees may insist that the land retained by grantor or original owner be sold first to satisfy the lien i. Where original owner has alienated all of the land subject to the lien in separate parcels successively, the parcels alienated or encumbered be sold in reverse order of alienation b. Miscellaneous Foreclosure Methods i. Strict foreclosure 1. Foreclosure is in court, but there is no judicial sale a. Instead, defaulting MR is given a period of time by court to pay the mortgage debt. Failure to do so w/in that time period will result in the mortgaged property vesting in the ME w/o sale i. Only used in VT and CT 1. Used in certain circumstances by other states such as where there has been an abandonment of the property ii. Entry w/o process & Action at law for writ of entry 1. ME after a default may take possession of the premises w/o legal help a. Then after expiration of a time period, MR s equity of redemption is forever barred 2. Results in strict foreclosure; there is no sale of the premises iii. Scire Facias 1. Used only in DE 2. ME obtains a writ of scire facias which is an order to show cause to MR why the land should not be taken in execution to satisfy the defaulted mortgage obligation a. Court will issue a judgment for amount owing and will direct by writ of levari facias that the judgment be satisfied out of the proceeds of public execution sale c. Judicial Foreclosure i. Is the majority method of foreclosure ii. Necessary-proper party distinction 1. Foreclosure should, if successful, terminate the rights of all interested parties who are subject to the mortgage being foreclosed a. Party is necessary if failure to join him will not accomplish the purposes for foreclosure b. Where holder of a junior interest is not made a party that interest is neither terminated nor otherwise prejudiced by the foreclosure iii. Impact of foreclosure on senior interests 1. Senior lienor is not necessary b/c he is not subject to or subordinate to the mortgage being foreclosed a. Senior lienor s interest will not be terminated or prejudiced by the junior foreclosure iv. Junior lessee as a necessary party 1. Where a lease is senior to a mortgage, the lessee and lease are unaffected by foreclosure a. Where the mortgage is senior to the lease, the general rule is that the foreclosure of the leased premises nullifies and extinguishes the lease v. Murphy v Farwell 1. FACTS and were the first and second mortgage holders. foreclose its mortgage w/o naming as a party. Then foreclosed on his interest w/o making a party. sued to redeem the property. 2. RULE the holder of a second mortgage cannot diminish the rights of the holder of the first mortgage by failing to make the first mortgage holder a party to a foreclosure sale on the second mortgage 3. HOLDING had stepped into the shoes of the MR and ME by purchasing the fee at the first foreclosure, and was able to pay the second mortgage 4. NOTES 30
a. Method of analysis i. Was the purchaser at the foreclosure a BFP 1. If yes, was the second mortgage recorded? a. If no, then the junior lien is eliminated ii. Lack of knowledge or notice of the subordinate interest of another does not excuse a foreclosing ME from making such a person a party to the suit 1. Purchaser who is a BFP will take free of a junior interest if it is equitable only b. Lis Pendens doctrine i. Recording the lis pendens makes a subsequent ME take subject to the result of the outcome of the existing foreclosure action vi. Omitted Party Problem 1. When any party having the right to redeem is omitted from a foreclosure action, his interest is NOT terminated by that action a. Purchaser succeeds to the rights of the ME even though the sale is void as to an omitted party 2. Rights of omitted owner a. If the omitted party is owner of the entire redemption interest, the foreclosure sale is entirely void as to his interest i. But the foreclosure purchaser stands as assignee of the mortgage and may re-foreclose against the omitted owner 3. Rights of omitted lienor a. The lien stays outstanding, and the right to redeem the loan stays outstanding i. Two remedies (maybe three) 1. Foreclosure a. Foreclosure by junior of his own lien, with resulting judicial sale i. Sale is subject to the first mortgage, which is revived or recognized as still subsisting for this purpose 2. Redemption a. Junior may tender to the buyer at the senior foreclosure sale the balance which was owed on the senior lien at the time of foreclosure, and compel an assignment of a revived senior lien to the junior lienor 3. Third remedy? a. If the foreclosure sale of the senior lien produced a surplus, the junior can assert a lien on the surplus funds 4. Rights of foreclosure purchaser a. Three remedies when the junior exercises one of the above remedies i. Redemption 1. If the omitted junior has not taken any action, the purchaser may simply pay off the junior lien and thereby clear title a. Purchaser succeeds not only to the rights of the ME, but to the rights of the foreclosed MR as well ii. Re-foreclose the first mortgage 1. This time, make sure to include the junior lienor iii. Strict foreclosure 1. Not always available 2. Amount to a judicial decree that the junior lien be canceled unless the junior pays off the senior debt w/in certain time period vii. Citicorp Mtg v Pessin 31
1. FACTS Holcom gave mortgage to Citi. On the same day, Holcom gave a second mortgage to Grillo. Grillo assigned its mortgage to Pessin. The assignment was recorded on 10/16. A complaint was prepared on 10/13 and filed on 10/19 to foreclose by Citi. Citi also recorded a notice of lis pendens. 2. RULE strict foreclosure is available when a foreclosing ME fails to discover an outstanding junior ME 3. NOTES a. Availability of strict foreclosure i. Restatement approach 1. Should be available only where the senior purchaser can establish that the omission was the result of inadvertence or mistake and that the FMV of the mortgaged real estate does not exceed the amount of encumbrances senior to the junior lien b. Equitable redemption vs Statutory redemption i. Equitable right continues until it has been eliminated by foreclosure ii. Statutory right has a finite application according to the statute 1. Sometimes cannot be exercised until the equitable right has been eliminated viii. Portland Mrtg v Creditors Protective Ass n 1. FACTS CPA obtained a judgment against MR. PMC then foreclosed the mortgage and purchased at the foreclosure sale. PMC filed suit against CPA to require CPA to redeem or be barred from claim. PMC paid the amount of the judgment at 9:30AM and CPA tried to redeem at 10:30AM. 2. RULE one who purchases property at a foreclosure sale may extinguish a junior lienor s right to redeem it by simply paying the debt for which the junior lien is security a. If there has never been a foreclosure of the junior lien, then there is no statutory right of redemption, only the equitable right of redemption i. Junior lienor who was omitted in the foreclosure of the senior mortgage, still has the valuable right of redemption available to him, but, when such a right is exercised, junior is not entitled to a conveyance of the property 1. Is merely entitled to an assignment of the security interest of the senior mortgage ix. Land Assoc v Becker 1. FACTS was a land K vendor. sought to foreclose by judicial sale. After the complaint was filed, two trust deeds and a judgment went on the record. The parties that held the trust deeds were not joined in the foreclosure a. was given a sheriff s deed, and assigned the deed to E&B. The three lien holder assigned their interests to Bautista. 2. RULE statutory redemption starts after the foreclosure and sale itself and is one last chance for the previous owner and any lien creditors to regain the property a. Equitable redemption only exists until the interest is foreclosed, while statutory redemption only begins after the interest is foreclosed 3. HOLDING doctrine of lis pendens controls a. Bautista s predecessors were not lienholders of record when the initial complaint was filed d. Power of Sale Foreclosure i. General considerations 1. Deed of trust is the most commonly used mortgage instrument a. MR-trustor conveys the real estate to a trustee who holds the property in trust for the ME-beneficiary until full payment of the debt i. In event of foreclosure, power of sale is exercised by trustee 1. Holds public sale of the mortgaged 32
a. Sale is usually not judicially supervised 2. Notice requirements under power of sale foreclosure vary a. Usually less rigorous than those associated with judicial foreclosure i. After notice is provided, a sale is held and the proceeds are used to pay off the debt of the party that initiated the foreclosure by advertisement b. Federal legislation makes power of sale foreclosure ineffective against a junior federal tax lien unless written notice is provided to the United States at least 25 days prior to the sale 3. Advantages of power of sale foreclosure a. Cost in time and money is substantially lower than judicial foreclosure 4. Disadvantages of power of sale vs judicial foreclosure a. Judicial foreclosure prevents any defects from arising b. Judicial finality provides substantial insulation against subsequent collateral attack even on technically defective judicial foreclosure proceedings ii. Defects in the exercise of the power 1. Baskurt v Beal a. FACTS bought two parcels of land, one from Mortimer Moore and other from Marion Moore. Deed to the property was held in trust by . When all of the debt was paid except for 80% of the second note, defaulted. Foreclosure sale was set, and wanted to buy the property. made a bid for $1 over the remaining debt. sought to have the sale set aside b. RULE a foreclosure sale must be set aside if the price was grossly inadequate when compared to the FMV of the property on the date of foreclosure and the proceedings of the sale were defective i. Foreclosure sale prices of 50% or more of FMV are routinely upheld 1. 10-40% should not be confirmed absent good reasons why it should be ii. Restatement approach 1. Court is warranted to invalidate a sale where the price is less than 20% of the FMV 2. Absent foreclosure procedural defects, court is not warranted to invalidate a sale in excess of 20% of FMV iii. Trustee in a deed of trust is a fiduciary 1. Has obligations to both the lender and the borrower a. Has an obligation to conduct a fair sale c. NOTES i. Attack power of sale foreclosure 1. Three remedies a. Injunction suit against a pending foreclosure b. Suit in equity to set aside a sale c. Action for damages against the foreclosing ME or trustee ii. Tender requirement 1. Courts may require MR seeking injunction to tender the amount due under the mortgage into the court iii. Common foreclosure defects 1. Right of ME to foreclose a. May assert that there was not default or no right to accelerate 2. Foreclosure process a. Chilled bidding, improper place/time of sale, defective notice, selling too much/little of the mortgage security iv. Void-voidable distinction 33
v.
vi.
vii.
viii.
ix.
x.
xi.
1. Void a. No title is passed to the sale purchaser or subsequent grantees, except, perhaps by adverse possession 2. Voidable a. Bare legal title passes to the sale purchaser, subject to the rights of redemption of those injured by the defective exercise of the power of sale i. Rights are cut off if conveyed to BFP Who is a BFP? 1. Three criteria a. Had no actual notice of the defects b. Purchaser is not on reasonable notice from recorded documents c. Defects are not such that a person attending the sale exercising reasonable care would have been aware of the defect Trustee as a fiduciary 1. Is a fiduciary for both the MR and ME and must act impartially 2. Trustee is not obligated to contact MR or otherwise examine if there actually has been a default a. Can rely on the request of ME to pursue power of sale foreclosure i. UNLESS the deed of trust says otherwise Trustee as a foreclosure purchaser 1. Trustee may not purchase the premises at a sale she conducts a. UNLESS has express consent of the MR-trustor Inadequate foreclosure price 1. HUD a. Presumes that the foreclosure sale price is reasonable 2. Restatement approach a. grossly inadequate standard i. Court is warranted to invalidate where the price is less than 20% of FMV ii. Not warranted in in invalidating in excess of 20% unless procedural defects Sales by parcel or in bulk 1. Where a mortgage obligation is secured by more than one parcel, trustee or foreclosing ME is confronted by choice of whether to sell one parcel at a time or to sell the parcels in bulk a. Required to pursue the method that will be the most beneficial to MR Chilled bidding 1. Irregular conduct by ME that suppresses bidding is characterized as chilled bidding a. Is the basis to set aside sale b. Two types of chilled bidding i. Collusion between ME and other can void the sale ii. Innocent mistakes Junior federal tax liens 1. Power of sale foreclosure is ineffective against a junior federal tax lien unless written notice provided to United States at least 25 days prior to the sale 34
2. In re Edry a. FACTS held mortgage by assignment on s home. gave 30 days to pay the full balance after default. then commenced foreclosure and hired auctioneer to sell the property. instructed auctioneer not to promote the sale. did the bare minimum in advertising the sale. Winning bid was for $1,000 over the debt, which was less than half of FMV. b. RULE foreclosing ME seeking to exercise power of sale must use reasonable diligence to protect the MR s interests, in addition to the minimum requirements prescribed by statute c. NOTES i. Power of sale in ME 1. Many state hold that where ME exercises power of sale and purchases the property, the sale is VOIDABLE a. Makes things difficult b/c 80% of the time the ME is the only bidder ii. Damages for wrongful foreclosure 1. If a BFP takes the property at sale, then the MR s recourse is damages a. Difference between the market value of the real estate and the aggregate amount of liens thereon as of the date of sale iii. Trustee or ME liability to foreclosure purchaser 1. General rule is that foreclosure purchaser takes a property subject to prior liens and interests accruing prior to consummation of the sale a. Purchaser is presumed to have adequately investigated existing liens b. Trustee makes no warranty of title and is generally subject to no duty to investigate or describe outstanding liens 2. Unless trying to deliberately perpetrate a fraud, trustee or ME cannot be held liable even if he knew there was an existing lien 3. Glidden v Municipal Authority of Tacoma a. FACTS Mount Bay borrowed from Glidden, OSB and Municipal. Mount Bay defaulted on the loan to Glidden. Trustee did not make the other lienholders aware of the sale. Municipal Authority learned of the sale through a posted notice. OSB started its own foreclosure. Trustee learned of OSB s foreclosure sale. At trustee s sale, Glidden bid amount of debt and Municipal bid $200 more. Trustee tried to undo the sale after realizing OSB had not been notified. Glidden brought this action to declare the sale void. b. NOTES i. Presumption of statutes 1. Several states have presumption statutes that are aimed at enhancing the finality of power of sale foreclosure and the marketability of titles they produce a. Rebuttable presumptions b. Conclusive presumption for BFP notice only i. Only protects BFP from notice defects c. Conclusive presumption for BFP all aspects of foreclosure i. Affords greatest protection for BFP ii. Procedural defects, notice defects, and may protect when ME had not substantive right to foreclose iii. Constitutional Problems with Power of Sale 1. Power of sale almost never provides for a hearing, judicial or otherwise prior to foreclosure 35
2. Ricker v United States a. FACTS Rickers purchased a potato farm. Rickers lived on the property, and executed 5 promissory notes to FmHA. Executed a sixth loan for the harvest of potatoes in one season, and had to give a mortgage. FmHA foreclosed. FmHA mailed a notice of acceleration and published a notice of foreclosure. Rickers sought declaratory judgment that the sale was void b. HOLDING sale was void b/c it violated their due process rights under Fifth Amendment i. Deprived of property w/o due process of law 1. At a minimum, lender must provide notice and an opportunity to be heard a. Notice by publication is not enough with respect to a person whose address is known, and if they are known to be an interested party ii. To be effective, waiver of a constitutional right must be voluntary, knowing, and intelligently made c. NOTES i. Notice requirement 1. Turner v Blackburn a. Court invalidated a North Carolina power of sale statute that required only notice by newspaper 2. Mennonite Bd of Missions v Adams a. Emphasized that when the ME is identified in a mortgage that is publicly recorded, constructive notice by publication must be supplemented by notice mailed to ME s last known address, or by personal service i. But unless ME is not reasonably identifiable, constructive notice alone does not satisfy the mandate of Mullane ii. Request for notice statutes 1. Some states have enacted statutes that allow parties that want notice to record a request to receive notice a. There are also decisions that hold such statutes to be unconstitutional i. Have to provide notice to certain parties even if the request was not recorded iii. Hearing requirement 1. The best way to win a constitutional challenge would be to bring a suit to enjoin foreclosure for failure to have a hearing 2. It does not have to be a judicial hearing a. May be an administrative hearing as long as it is done impartially i. If the hearing officer is not a neutral party, there is a question of whether it is an adequate hearing iv. Waiver of due process rights 1. In Ricker the court held that MR s attempted waiver was invalid a. Not VOLUNTARY, KNOWING, and INTELLIGENTLY MADE 2. In Fuentes waivers were ineffective for different reasons a. K did not provide specifically for a waiver of constitutional rights b. Lack of awareness by the parties of the significance of waiver 36
c. There was no bargaining power over the K terms v. Federal power of sale legislation 1. Two statutes authorize power of sale foreclosure of all residential mortgages held by HUD 2. Lisbon v United States a. By offering MR a chance to explain the failure to make mortgage payments, HUD provides all the due process required of the Fifth Amendment b. MR who fails to respond to notices of delinquency waives the right to be heard 3. Fourteenth Amendment requires State action before the amendment is applicable a. Unless sufficient state action is found in connection with power of sale foreclosure, a court will not reach the notice or hearing issues b. Power of sale statutes continue to provide an effective foreclosure method for nongovernmental ME even where the statutes are noticeably deficient in the notice and hearing arena 4. Warren v Gov t Nat l Mrtg Assoc a. FACTS Borrower challenged the foreclosure having been denied Fifth Amendment due process and hearing b. RULE standard is that the must exist a sufficiently close nexus between the government and the challenged action of the regulated entity so that the action of the latter may be fairly treated as that of the government itself c. HOLDING GNMA is not wholly owned by federal government although it operates under federal authority i. Court said that GNMA was simply acting under the K to the mortgage. Therefore, GNMA was acting like a private party enforcing a K. d. NOTES i. Impact of the Lebron v National RR Passenger Corp decision 1. Amtrak should be treated as the federal government for First Amendment purposes a. Amtrak clearly acting in a proprietary function, and yet SCOTUS found the corp to be part of the government 2. Two prong test a. Extent to which the corporation was formed for the furtherance of government objectives b. Extent to which the federal government retains control over the corporation s efforts to achieve its objectives 3. There has not been a challenge as to whether Warren is still good law iv. Uniform Nonjudicial Foreclosure Act 1. Methods of foreclosure a. Three methods i. Conventional foreclosure (auction sale) 1. Conducting by representative of the foreclosing creditor ii. Foreclosure by negotiated sale 1. Same thing as a short sale a. Creditor notifies debtor and junior lienors of the foreclosure amount that it is willing to offer i. Can disapprove the sale if they are dissatisfied with the amount ii. If disapproves, foreclosing creditor has three choices: discontinue negotiated sale; exclude the 37
objecting party from the effect of foreclosure; or pay off the objecting party, if that party holds a lien iii. Foreclosure by appraisal 1. Accomplishes only the first function of foreclosure: evaluation of the collateral a. Does not liquidate the property, but leaves it in the hands of the secured creditor v. U.S. Bank Nat l Ass n v Ibanez (CLASS HANDOUT) 1. This case had wide ranging impact b/c it came down when there was a sense that as a result of the vast pools of mortgages, that there were problems in foreclosing a. ME treated the problems as minor defects when there was a clear sense that the MR was in default i. Growing bar of attorneys took the stance that power of sale foreclosures should be challenged for failure of the ME to meet the statutory requirements 2. FACTS - US Bank foreclosed n Ibanez on the same day that Wells Fargo foreclosed on the LaRace mortgage. The judge ruled that the foreclosure sales were invalid because neither bank had been assigned the mortgage. Both banks were assigned the mortgage only after the foreclosure, and therefore did not have the ability to foreclose the mortgage in the first place. The banks moved to have the judgment set aside, and contended that the documents might exist that could demonstrate an assignment of the mortgage preforeclosure. The court gave leave to produce such documents. The newly submitted documents did not provide adequate showing that the banks were the assignees prior to the foreclosure 3. RULE One who sells under a power of sale must FOLLOW STRICTLY ITS TERMS. If he fails to do so there is no valid execution of the power, and the sale is WHOLLY VOID a. Who is entitled to foreclose b. Notice requirements e. Disbursement of Foreclosure Sale Proceeds i. Generally 1. The surplus from a foreclosure sale represents the remnant of equity of redemption and security wiped out by the foreclosure a. Surplus stands in the place of the foreclosed real estate and the liens and interests that previously attached to that real estate now attach to the surplus i. Entitled to be paid out of that surplus in the order of priority they enjoyed prior to foreclosure ii. Bank of America v BA Mrtg 1. ISSUE whether junior ME or debtor s assignee of rights of redemption is entitled to surplus 2. RULE Restatement approach a. The surplus is applied to liens and other interests terminated by foreclosure in order of their priority and the remaining balance, if any, is distributed to the holder of the equity of 3. HOLDING Junior ME had recorded its lien before the assignee obtained the equity of redemption from MR. Therefore Junior ME had a higher priority to the surplus 4. NOTES a. Procedural requirement on a junior lienor to preserve a claim to surplus in a judicial foreclosure i. Have to be aware if representing a junior lienor that there may be certain requirements that you have to follow b. Senior lien claim on junior surplus i. Only those whose interests were cut off by the foreclosure have a valid claim on surplus 38
f.
1. Thus, if a Junior ME forecloses, the senior mortgage remains intact and only other junior liens would have a right to the surplus c. Payment of surplus to holder of non-possessory junior interests i. What if an easement is eliminated? Is there a right to the surplus? 1. Yes. Restatement approach a. Such persons are entitled to receive, in order of their preforeclosure priority, the FMV of their interests as of the date of foreclosure d. Acceptance of surplus as ratifying foreclosure i. Acceptance of a surplus derived from a foreclosure sale waives the MR s right to attack the foreclosure e. Junior lienor s right to surplus where MR claims homestead rights i. Generally, a property owner s homestead interest in property takes priority over the interests of other creditors 1. EXCEPTION a. An owner s homestead interest is subordinate to the interest of a deed of trust beneficiary Reacquisition of Title by MR i. Old Republic Ins v Currie 1. RULE If the MR is the purchaser at a foreclosure sale or subsequently reacquires the property, the junior mortgages revive as liens on the property a. Three theories i. Payment theory 1. When MR purchases the property at the sale, MR is in effect paying the first mortgage and the second mortgage moves into first position ii. Covenant to defend title 1. Second mortgage that is revived usually contains a warranty that the MR agrees that he will defend the title against all lawful claims. Permitting foreclosure of the first mortgage is a breach of the warranty iii. Warranty of title 1. MR has warranted that the mortgaged premises shall be security for the debt and that the MR will produce the property if the debt is not paid b. Junior lienor s claim may be barred by laches if it does not bring an action to revive the lien when it has notice 2. NOTES a. Reacquisition by non-recourse MR or subsequent grantee i. Even where the mortgage obligation is completely non-recourse, the MR agrees to the satisfaction of that obligation out of the mortgaged real estate 1. Thus, actions by MR that undermine ability of ME to realize on the benefits of that agreement are discouraged b. MR reacquisition from a BFP i. There are good reasons to allow MR to reacquire title from BFP free and clear of previously foreclosed interests c. Acquisition of title by junior interest holders i. Restatement approach 1. A purchase by junior lienor or other junior interest at a validly conducted foreclosure of senior lien cuts off the right of both the holder of the equity of redemption and other junior interests as well a. There is no revival of other junior interests 39
g. Statutory redemption i. When a valid foreclosure has taken place, the equitable right of redemption ends 1. About half of the states provide for a statutory right of redemption a. In equity of redemption you have to pay the amount due on the loan b. In statutory redemption, you have to pay the amount paid at the foreclosure sale i. May be available after judicial foreclosure or power of sale foreclosure ii. Two categories for redemption statutes 1. Strict Priority a. If the MR does not redeem, then the junior interests may redeem according to their priority 2. Scramble Method a. There is no priority order in which redemptions may be made from the purchaser iii. United States v Stadium Apartments Inc 1. FACTS Prudential assigned the mortgage to FHA after a developer defaulted. FHA obtained a default judgment. FHA appealed the redemption period. 2. RULE Statutory period of redemption is not applicable to the FHA a. FHA has a policy of bidding FMV at foreclosure sale, and it has the property carefully appraised before bidding i. The statutory redemption period is contrary to its interest as ME iv. Farmers Production Credit Assoc v McFarland 1. HOLDING although we hold a junior lienor cannot redeem in this case, the reason for our decision is different than argued by MR and assignee. Since the assignee redeemed within the exclusive statutory period granted to a debtor, the junior lienor has no right to redeem a. If the debtor or assignee redeems, the junior lien is revived 2. NOTES a. Assignee of MR as redeeming party i. In most jurisdictions, the MR s statutory redemption right is assignable b. Redemption by junior lienor i. Redemption by a junior lienor gives it the same title the foreclosure sale purchaser would have obtained had there been no redemption 1. Therefore, junior liens do not revive h. Anti-Deficiency Legislation i. Once mortgage goes into default and the obligation is accelerated, ME has two options 1. Obtain a judgment on the personal obligation and enforce it by levying upon any of the MR s property, and, if a deficiency remains, foreclose on the mortgaged real estate for the balance 2. Foreclose on the real estate first and if the proceeds are insufficient to satisfy the mortgage obligation, obtain a deficiency judgment a. Election of remedies requirement i. Some states require ME to choose one of the two options 1. If you are suing on the note, cannot start foreclosure proceedings 2. If you are foreclosing, cannot sue on the note 3. Calculating the deficiency a. Most statutes use the Sale Price Amount of Debt i. Amount of debt = principal balance, interest, legal fees, costs to preserve assets, etc. 4. Majority of states place limit on deficiency judgments a. Procedural limitations i. Notice requirements before getting judgment, and before sale ii. Time limits within which you can obtain a judgment iii. One action rule iv. Security First 40
ii.
iii.
iv.
v.
b. Substantive limitations i. Fair value legislation 1. Takes the basic concept of how to derive a deficiency and change it a. Deficiency is the FMV at the time of the sale less the debt i. Rather than the amount received at the sale less the debt ii. Forced appraisal legislation 1. Appraiser is appointed by the court or the trustee in a deed of trust a. Different from fair value legislation? i. In fair value, court is saying that it is going to determine the value to present evidence of the value ii. In appraisal, the appointed appraiser determines the value California has a prohibition on deficiency judgments from 1. Purchase money mortgages 2. Power of sale proceedings Deberard Properties v Lim 1. FACTS Lim agreed to buy a shopping center from Deberard. Lim assumed a first deed of trust and a second deed of trust was given back to sellers. Lim defaulted. Deberard agreed to reduce the interest rate on the note and to reduce the monthly payments. Agreed to subordinate its deed trust, in return for Lim s waiver of 580(b) rights. Lim defaulted again and the first deed of trust was foreclosed, eliminating Deberard s interest. Deberard sued on the note. 2. ISSUE whether or not waiver of the prohibition on collecting a deficiency on the deed of trust was effective 3. HOLDING waiver of the deficiency judgment rights was not justified because the same property secured its note. Deberard began with a risky subordinated interest and ended up in the same position 4. NOTES a. Waivers of 580b i. Virtually all post-default waivers of 580b are UNENFORCEABLE ii. Virtually all California homeowners are protected against deficiency judgments on institutional purchase-money mortgages 1. Refinanced mortgages are not purchase money Talbot v Hustwit 1. FACTS Hustwits were guarantors of a loan that Talbott made to a trust 2. RULE 580a does not apply to guarantors. K of guaranty gives rise to a separate and independent obligation from that which binds the principal debtor a. Deficiencies may be sought against the guarantors Bowen v Yniguez 1. FACTS Bowen sold Yniguez a motel. Made a down payment and obtained a purchase money mortgage. Bowen recorded a notice of default, and Yniguez filed for bankruptcy. After Bankruptcy Court lifted the stay, Bowen initiated foreclosure. Bowen was the only bidder at the nonjudicial foreclosure sale. Bowen sued for bad faith waste. 2. HOLDING This was a purchase money mortgage, so there is no deficiency judgment. However, Bowen was allowed damages for bad faith waste a. Has to be due to malicious destruction or neglect beyond the inability to pay for things b. Waste is still limited to the amount that could have been available in a deficiency judgment if the bid was less than the debt 41
i. Had there been a full credit bid, there would have been no ability to collect on bad faith waste 3. NOTES a. Anti-deficiency statutes and the full credit bid problem i. Bowen tells us that anti-deficiency legislation does not bar most actions against MR for fraud or bad faith waste vi. California s One Action Rule 1. In the event of default, ME s sole remedy is foreclosure action and that any deficiency claim must be sought in that proceeding a. Two fold purpose i. Protect MR against multiplicity of actions ii. Compel a creditor who has taken a mortgage on land to exhaust the security before attempting to reach any unmortgaged property to satisfy the claim b. MR may use the rule both defensively and as a sanction 2. A draw against a letter of credit does not violate the one action rule 3. Obtaining the appointment of a receiver OR assignment of rent a. Is not an action for the purposes of the rule i. There is no violation of the rule in including a receivership request in a judicial foreclosure action 4. CERCLA a. ME is permitted to waive its security interest in environmentally impaired real estate and proceed against the MR as an unsecured creditor 5. Nevada approach a. Has a list of actions that are not actions under the rule i. See page 760 vii. Mid Kansas Fed S&L v Dynamic Development Corp 1. ISSUE whether the anti-deficiency statutes apply to a residential developer and whether a lender may recover the balance owing on the first notes after it has acquired title to the property at the foreclosure sale of it second deed of trust? 2. RULE So long as the subject PROPERTIES fit within the statutory definition, the identity of the MR as either homeowner or developer is irrelevant a. Had to be two acres or less; had to be utilized as a dwelling 3. HOLDING Commercial residential properties for eventual resale as dwellings are not utilized as a dwelling. Therefore, the deficiency judgment statute did not apply 4. NOTES a. Restatement approach i. ME, after acceleration, may either 1. Obtain a judgment on the personal obligation and enforce it by levying upon any of the MR s property, and, if a deficiency remains, foreclose on the mortgaged real estate for the balance 2. Foreclose on the real estate first and if the proceeds are insufficient to satisfy the mortgage obligation, obtain a deficiency judgment ii. Rejects the one action rule iii. Permits deficiency judgments even though the mortgage is purchase money or is being foreclosed by power of sale 1. Adopts the fair value approach by giving MR the right to insist that the greater of the FMV or sale price be used in calculating the deficiency Servicemembers Civil Relief Act i. Statutes of Limitation 1. Automatically tolls all statutes of limitation during the period of service that would otherwise run against a serviceperson 42
i.
j.
a. Extends the time for redemption under state statutory redemption by a period equal to MR s period of service 2. SCOTUS said there is not requirement to show that being in the service made it difficult or impossible to redeem a. If the person is in the service, then the period to redeem is extended ii. Maximum Rate of Interest 1. Limits interest to six percent during military service on obligations incurred before entering service even though a higher rate was originally agreed upon iii. Installment Land K 1. Default under an installment land K entered into prior to military service a. Vendor may not terminate or rescind the K or repossess the land except by judicial action i. Court may condition its order on repayment of all or part of the deposit and prior installments iv. Mortgages and Deeds of Trust 1. After a default in payment of obligation consummated prior to service, the ME may not sell, foreclose, or seize the mortgaged real estate during the term of service or for nine months thereafter a. Except by judicial order v. Waiver by Servicemember 1. Rights can be waived after the servicemember is engaged in service a. Cannot get a waiver before the person is in active duty Bankruptcy i. Introductory concepts 1. Four types of bankruptcy a. Chapter 7 i. Straight bankruptcy b. Chapter 11 i. Reorganization of corporate debtors. Rehabilitation, not liquidation is the purpose c. Chapter 12 d. Chapter 13 i. Is the equivalent of Chapter 11 for individuals 2. Automatic stay a. All foreclosure proceedings, whether judicial or power of sale, are automatically stayed by the filing of petition for bankruptcy i. EXCEPTION 1. Action brought by HUD b. Foreclosure consummated in violation of a stay is void i. ME risks liability for damages and being punished for contempt ii. Creditors may occasionally be given retroactive relief to avoid the stay and be allowed to foreclose 1. Not easy to get a. Creditor violated stay w/o actual/constructive knowledge of stay b. No equity in property of the estate c. Property was not necessary for effective reorganization d. Ground for relief from stay existed and would have been granted if filed e. Failure to grant retroactive relief would cause unnecessary expense to creditor ii. Straight Bankruptcy (Ch. 7) 43
1. Trustee has a legitimate interest in the mortgaged real estate only if MR has equity in that real estate a. If ME seeks relief from stay and equity does exist, trustee should abandon the real estate to ME who then can proceed to foreclose i. If equity is found to exist, real estate will be sold to the court either 1. Subject to the existing mortgages/liens 2. Free and clear of them a. Those liens will be transferred to the sale proceeds and satisfied in order of their priority iii. Trustee s avoidance powers 1. Section 558 a. Gives the trustee the benefit of any defense available to the debtor against the ME i. Even if the debtor waives it after the commencement of bankruptcy 2. Section 544 a. Afford trustee, irrespective of knowledge, the status of a BFP of real property from the debtor who has perfected under state law i. Trustee will always be able to defeat any mortgage of the debtor that is unrecorded as of the commencement of bankruptcy 3. Section 548 a. Transfers made by debtor w/in two years of the bankruptcy may be set aside by trustee if made with intent to hinder, delay or defraud any creditor i. Constructive fraud is increasingly used for real estate that yield less than its reasonably equivalent value ii. Deed in lieu given to ME by insolvent debtor w/in two years of bankruptcy may be set aside if the debtor receives less than reasonably equivalent value for the transfer 4. Section 547 a. Mortgages given w/in 90 days of MR s bankruptcy will be voidable by trustee iv. NOTES 1. Stay no longer applies uniformly to all debtors a. Bankruptcy Abuse and Consumer Protection Act i. Limits the stay for debtors who have had a case pending within the past year 2. Bifurcation of the under-water mortgage a. A lien is void to the extent that it secures a claim against the debtor that is not an allowed secured claim b. Dewsnu v Timm i. Debtor-MR and trustees will not be permitted to bifurcate a mortgage debt into secured and unsecured claims so as to deprive ME of any postvaluation increase in the value of the real estate v. Chapter 11 Reorganization 1. Is the rehabilitation of the debtor, rather than liquidation a. Debtor is able to continue to operate the estate as a debtor in possession i. Trustee is normally not appointed 1. Is considered an extraordinary remedy ii. Debtor in possession is entitled to exercise the avoidance powers of a Ch. 7 Trustee 2. When adequate protection is lacking, Section 361 sets out three ways to provide it a. Trustee may be required to make periodic cash payment to ME in an amount sufficient to compensate for decrease in value of ME s interest b. ME may be provided with an alternative or additional lien equal in value to the decrease in value of ME s interest 44
VI.
c. Any other relief that will give ME realization of indubitable equivalent of its interest 3. Stay relief for ME a. Two requirements i. MR must lack equity in the mortgaged real estate ii. Real estate must not be necessary to an effective reorganization vi. Chapter 13 Wage Earner Plan 1. Purpose is to enable an individual, under court supervision/protection, to develop and perform under a plan for the repayment of his debts over an extended period a. Designed to catch-up debt within three years i. Is also set up so that the party can use some of the avoidance powers of the trustee 1. Trustee is passive a. Debtor remains in possession during proceedings i. If the debtor presents a plan that exceeds three years, but less than five years, the court may approve the plan if it improves the amount paid to creditors 2. Benefit of Ch. 13 to debtor is that it permits the debtor to protect its assets a. Benefit to creditors is that their losses will be significantly less than if their debtors opt for straight bankruptcy 3. At the end of the program the debts are paid off or discharged a. Except alimony and child support b. Unsecured creditors must be paid no less than they would receive in Ch. 7 liquidation c. Secured claims may be modified, except when it is secured by a mortgage on the debtor s principal residence i. So what if the lender has to accelerate the debt? 1. The stay provisions apply 2. Special stay provisions protect third parties who have guaranteed the debtor s debt or put up property to secure it a. Section 1301 stays ME who holds consumer debt from foreclosing against the real estate of third parties that has been used as security for MR s non-business related debt 4. De-acceleration of Home Mortgage The Taddeo Case a. In re Taddeo i. The concept of cure in section 1322(b)(5) contains the power to deaccelerate ii. The ban on modification in section 1322(b)(2) does not limit the debtors exercise of their curative powers under the section 1. Consequently debtors can cure their default and thereafter maintain their payments b. Conditioning a debtor s right to cure on its having filed a Ch. 13 petition to acceleration would prompt unseemly and wasteful races to the courthouse 5. Bifurcation and the Undersecured Home Mortgage a. Majority of courts upheld debtor s ability to bifurcate the unsecured portion of the loan from the secured portion of the loan i. Suppose that a $100,000 obligation is secured by a mortgage, but the home is only worth $65,000. The $35,000 unsecured portion can, thus, be modified Priority problems a. Purchase Money Mortgages i. Is a mortgage that MR grants to enable the MR to acquire ownership of the mortgaged land 45
1. Vendor purchase money mortgage a. Arises when seller of land agrees to extend credit to the buyer for some portion of the land s purchase price and the buyer grants mortgage on the land to secure the buyer s obligation to pay the remaining purchase price 2. Third party purchase money mortgage a. Arises when buyer obtains a loan from a third party (bank), uses the proceeds to pay the purchase price of the land, and grants the third party a mortgage to secure the buyer s repayment of the loan ii. Kentucky Legal Systems v Dunn 1. FACTS Bank made a loan to Dunn notwithstanding that there was judgment lien in place against the property. Bank sought foreclosure and declaration that its mortgage held priority over the lien 2. RULE third parties who lend money used to purchase real estate in exchange for a mortgage hold special priority over all other recorded liens and judgments a. Unless agreed otherwise by the parties or specified by statute b. Restatement approach i. Purchase money lender has priority 1. Does not need to search for judgment liens, as they should be given first priority regardless of whether they had notice of any kind of interest/lien 3. NOTES a. Construction loan as purchase money mortgage i. Restatement approach 1. Proceeds of a mortgage loan used not only to acquire title, but also to construct a building on the land is treated entirely as a purchase money mortgage 2. Even where proceeds of the loan are used exclusively for improving the mortgaged real estate, the mortgage will receive purchase money treatment a. So long as it is given as part of the same transaction in which the real estate was acquired ii. Impact of recording acts 1. PMM need NEVER be recorded to protect ME against judgment liens or other claims that arise against MR prior to MR s acquisition of title 2. Subsequent interests that arise through MR are another matter a. PMM may be junior to a subsequent mortgage if not recorded iii. Vendor PMM vs Third Party PMM 1. Generally, when there is a dispute between a vendor PMM and a third party PMM, the vendor s mortgage has priority unless it can be resolve by the recording acts 2. Suppose that both the vendor and the third party lender are aware of each other a. Vendor s mortgage should be senior; third party cannot gain priority simply by recording first 3. Suppose that neither party has notice of the other s mortgage a. Vendor will prevail; recording acts will not change the result b/c they grant priority only to a subsequent purchaser w/o notice 4. Suppose that only one of the parties has notice of the other a. Recording acts, rather than vendor preference will govern 46
i. The party lacking notice should prevail b. After Acquired Property Clause and Dragnet Clause i. Article 9 of UCC authorizes a debtor to grant a security interest in both present and after acquired property 1. Nemo dat principle a. A cannot grant B any rights in an object of property that A does not have in the first place 2. UCC permits the seller and creditor to enter into one security agreement that is sufficient to cover both the seller s existing on-hand inventory and all inventory subsequently acquired by the seller a. It is less common for a real estate mortgage to contain an after acquired property clause ii. Hickson Lumber v Gay Lumber 1. FACTS Mortgages were given Gay to Pou and to Hickson. The Pou mortgage had an after acquired property clause 2. ISSUE whether the mortgage to Pou covers the property specifically described in the mortgage to Hickson by virtue of the after acquired property clause 3. RULE when the mortgage is intended to cover subsequently acquired property, either express terms should be used to that end, or else the language must clearly manifest the intention of the parties a. Courts will not enforce the after acquired property clause in a mortgage against anyone who can set up an equity of equal dignity in his own behalf 4. NOTES a. Is an after acquired property provision in a mortgage effective to cover personal property? i. Yes, if it bears a functional relation to the property originally mortgaged ii. Most prudent lenders would have the borrower execute both a real estate mortgage covering the land and an Article 9 security agreement covering the personal property b. Relationship to accession and the law of fixtures i. An after acquired property clause is not necessary for a mortgage to attach to subsequent improvements made on the real estate 1. Is because of law of accessions or law of fixtures c. Recording act and chain of title problems i. Restatement approach 1. Treats a recorded mortgage with an after acquired property provision as unrecorded as against those who later purchase interests in the after acquired real estate iii. Dragnet clause 1. States that the real estate covered by the mortgage will stand as security not only for the loan now being made, but also for any other debt for which the borrower is already liable to the lender or for which the borrower may become liable to the lender in the future a. Until the mortgage is satisfied 2. First Sec Bank of Utah v Shiew a. FACTS Shiew purchased a home with loan from Bank. Shiews obtained a subsequent loan from a different branch of the same Bank for cattle. The subsequent loan did not make mention of the dragnet clause in the home loan. Bank filed an action against the cattle loan. b. RULE in the absence of clear evidence of a contrary intention, a mortgage containing a dragnet clause will not be extended to cover future advances unless: i. the advances are of the same kind and quality or relate to the same transaction or series of transactions as the principal obligation, 47
ii. or unless the document evidencing the subsequent advance refers to the mortgage as providing security therefor c. NOTES i. Future advances under Restatement 1. To be secured under a dragnet clause: a. The advances must be made in a transaction similar in character to the mortgage transaction, unless i. The mortgage describes with reasonable specificity the additional type of transaction in which advances will be secured ii. The parties specifically agree, at the time of making the advances, that the mortgage will secure them c. Replacement and Modification of Senior Mortgages i. Houston Lumber v Skaggs 1. FACTS Skaggs gave Bank a mortgage for money to construct a home. Skaggs hired Houston as a contractor. Houston was not paid amount due. Bank released the construction loan mortgage and simultaneously filed a permanent loan mortgage 2. RULE where the holder of a senior mortgage discharges it of record, and contemporaneously takes a new mortgage, he will not, in the absence of paramount inequities, be held to have subordinated his security to an intervening lien a. Unless the circumstances of the transaction indicate this to have been his intention 3. NOTES a. Replacement of senior mortgages: impact on junior interests i. Pervasive rule is that a senior ME who discharges it mortgage of record and takes and records a replacement mortgage nevertheless retains the priority of the original mortgage unless paramount equities exist or ME intended a subordination of the mortgage b. Modification of senior mortgages: impact on junior interests i. Senior ME can enter into agreement with MR modifying the terms w/o first having to notify any junior lienors 1. But if the modification prejudices the rights of the junior lienors or impairs the security, their consent is required ii. Restatement approach 1. If senior mortgage is modified by the parties, the mortgage as modified retains priority as against the junior interest in the real estate, except to the extent that the modification is materially prejudicial c. Extension of time i. Where there is an extension of time, there is no loss of priority ii. Houston v Bank of America 1. FACTS Houston paid David Boone. Boone converted the payment to his own use, and quitclaimed the property to his wife in a divorce. Norwest, Bank of America s predecessor, held the deed. Houston filed a complaint against Boone and obtained a judgment. Bank of America then refinanced the property. BoA argued that it had a priority over the judgment lien because it succeeded to Norwest. 2. RULE equitable subrogation a. Permits a person who pays off an encumbrance to assume the same priority position as the holder of the previous encumbrance i. Three approaches 1. Actual knowledge of an existing lien precludes application of equitable subrogation, but constructive knowledge does not a. IS MAJORITY VIEW 48
2. Bars the application of equitable subrogation when a lien holder possesses either actual or constructive notice of an existing lien 3. Restatement approach: disregards actual or constructive notice if the junior lienholder is not prejudiced 3. HOLDING Court adopts Restatement approach a. The only question is whether the payor reasonably expected to get security with a priority equal to the mortgage being paid i. However, the BoA loan was $5,000 more than the previous loan. BoA was not subrogated as to the amount that exceeded the previous loan iii. Countrywide Home Loans v First Nat l Bank of Steamboat 1. FACTS Ketcham had a mortgage with BNY. Ketchams granted another mortgage to FNB to secure a business loan. Obtained refinancing from Countrywide. FNB claimed first priority under the recording statutes and Countrywide claimed priority by equitable subrogation 2. RULE Opposite of Houston a. Each and every deed made and recorded shall be notice to and take precedence of any subsequent purchaser d. Fixtures i. UCC concept of fixtures 1. Tri-partite concept consists of three classes a. Incorporated building materials i. No security interest exists in ordinary building materials incorporated into an improvement on the land irrespective of whether local law classifies such materials as fixtures b. Fixtures i. Are the only items of concern under the UCC priority system c. Purely personal property i. Goods that are purely personal property do not become part of real estate mortgage, even though a chattel security interest is never perfected 2. Subsequent real estate mortgages a. As between subsequent ME and prior chattel security interest in fixtures, the first party to make a fixture filing or record his real estate mortgage attains priority 3. Prior real estate ME a. Even though a real estate mortgage precedes a chattel ME s interest, the code nevertheless awards priority to the chattel claim if i. It is a purchase money security interest ii. A fixture filing was made before or within 20 days after the goods were affixed to the premises so as to become fixtures 4. Construction mortgages a. Special protection for construction ME so long as the mortgage is recorded before the goods are affixed i. Any goods that become fixtures during course of construction, the construction ME enjoys priority to the extent of all advances made under the mortgage to finance the construction 1. Such advances prevail over purchase money security interests in goods 5. Exceptions favoring fixture financers a. Real estate ME with priority may consent to subordinate his claim to the security interest of the fixture financer i. Before doing it, the ME would want to know the economic reason for requiring ME to subordinate
49
VII.
b. If fixtures are installed by MR s tenant, UCC gives priority to the tenant/debtor s fixture claimant as against the realty ME if the tenant has the right as against the MR to remove the fixtures from the mortgaged property i. Unless the lease gets wiped out by foreclosure 6. Fixture secured party s rights in a real estate foreclosure sale a. Maplewood Bank v Sears i. Court held that a secured party s right to priority in a fixture was limited to its removal and that a secured party had no claim against the land itself 1. Thus, no claim to the proceeds of the foreclosure sale b. UCC overruled Maplewood i. Allows a fixture secured party to choose to enforce its interest either under Article 9 or under applicable state real estate law e. Rights in Crops i. Question is, if a borrower has a farm and has a first mortgage loan and grows crops, when the foreclosure takes place, who gets the crops? 1. What if the borrower leases the land to a farmer, and foreclosure occurs? ii. Fletcher v Stillman 1. RULE if the crops is mature and no longer drawing any nutrients or sustenance from the real estate, it is personalty and does not pass with the land a. Once a crop matures and is no longer being supported by the soil a constructive severance occurs so that the crop thereafter bears the same relation to the land on which it stood as it would if stored in a warehouse or barn 2. NOTES a. Foreclosure purchaser vs MR s lessee i. If the lease was senior to the foreclosed mortgage, the tenant is entitled to the crops b/c his lease rights were unaffected by the foreclosure ii. If the lease is subordinate and destroyed by foreclosure the results vary 1. Some courts reject lessee s post-foreclosure claim to the crop a. Severance analysis from Fletcher 2. Many courts use emblements to defeat the foreclosure puracher a. Unsevered annual crops produced primarily through the labor and industry of the land s possessor are treated for this purpose as personalty b. Foreclosure purchaser vs holder of Article 9 security interest in crop i. A perfected security interest in crops has priority over the conflicting interest of the holder of the mortgage on the real property on which the crops are growing f. Wrap-Around Mortgages i. Economics of the wraparound mortgage 1. See the example on 893-894 ii. Foreclosing wraparound mortgages 1. The wraparound portion of the mortgage is second in priority a. So the question is which mortgage are you foreclosing when you foreclose the wraparound mortgage Subdivisions a. Lien priority i. Subordination of the Purchase Money Mortgage 1.
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Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

Dylan Holland Real Estate Financing (2011)

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