Sheriff’s Sales Of Separate Tracts: Principal’s Real Estate First, Surety’s Second

The Keesling v. T.E.K. Partners case has produced a second appellate court opinion.  I wrote about Keesling I on March 23, 2007.  That post dealt with the liability of sureties (or accommodation parties) when an original obligation is materially altered.  The latest opinion, decided March 6 (2008 Ind. App. LEXIS 431) (KeeslingII.pdf), discusses among other things the order (sequence) of the sheriff’s sales when there are multiple tracts to be sold.  So, Keesling I discusses liability issues, and Keesling II addresses judgment enforcement-related matters.  Commercial lenders may want to note Keesling II in the event they need guidance where there is more than one parcel of real estate subject to a foreclosure sale. 

Overview.  The Keeslings and Heritage Land were the defendants in the case and were deemed to be accommodation parties/sureties on the original note.  The collateral in question consisted of two separate tracts, a thirty-six-acre tract and a ten-acre tract.  The Court stated that the thirty-six-acre tract was the “property of the surety,” while the ten-acre tract was determined to be the principal collateral for the original note.  The specific issue in Keesling II was whether the thirty-six-acre tract or the ten-acre tract should be sold at a sheriff’s sale first.  The defendants clearly wanted to protect their interests in the thirty-six-acre tract.  The primary contention of the Keeslings/Heritage Land in the appeal was that, if the thirty-six-acre “surety collateral” was to be sold at all, then it should only be sold to satisfy any deficiency that remained on the original note after the ten-acre “primary collateral” posted by them had first been sold.

Legal principles.  An Indiana statute and an Indiana trial rule controlled the appellate court’s decision.  Ind. Code § 34-22-1 et seq. deals with the remedies of sureties against their principals.  Specifically, I.C. § 34-22-1-4 entitled “Order on levy upon property of principal and surety,” section (a), provides that where a court finds in favor of a surety on the question of a suretyship, the court shall make an order directing the sheriff to levy first upon the property of the principal and to exhaust the property of the principal before levying upon the property of the surety.  And, Ind. Trial Rule 69 generally governs sheriff’s sales.  The rule states “unless otherwise ordered by the court, the sheriff or person conducting the sale upon execution shall not be required to offer it for sale in any particular order.”  T.R. 69(A).  The Court stated that this rule applies to the foreclosure of mortgage liens “and in commercial transactions, it is not uncommon for the loan documents to provide that in the event of default the creditor shall have recourse to the collateral in any order, without priority.”  The Court focused on the “unless otherwise ordered by the court” language for its conclusion that, based upon the facts of this case, the order of sale and the allocation of proceeds must correlate with the liabilities of the parties and their collateral.

36 acres saved, perhaps.  A separate entity, Heritage/M.G., was the principal debtor on the original note, and the ten-acre tract was the principal collateral for that debt.  Heritage Land (a connected entity) and the Keeslings merely were accommodation parties, or sureties, on the original note, and the thirty-six-acre tract was the property of the sureties.  Thus the case apparently involved a fairly uncommon scenario where the accommodation parties/sureties pledged real estate collateral to secure the borrower’s note.  Given I.C. § 34-22-1-4(a), the Court concluded that the ten-acre tract must be sold first, and the thirty-six-acre tract was to be sold “only if the sale of the ten acres does not satisfy the debt on the original note.”  This result is consistent with the basic notion that an accommodation party’s liability is secondary to the liability of the principal. 

Indiana Tax Sale And Related Proceedings Violate Bankruptcy Stay

From time to time, rights arising out of property tax liens collide with rights arising out of mortgage liens.  Priority determinations and related issues sometimes can be complicated.  The Indiana Court of Appeals case ATFH Real Property v. Stewart, 879 N.E.2d 1184 (Ind. Ct. App. 2008) (ATFHOpinion.pdf) provides some clarity regarding whether and when formal property tax lien proceedings impact a mortgagor and, in turn, a mortgagee when the mortgagor has filed for bankruptcy protection.

Procedural history.  Mortgagor petitioned for Chapter 13 bankruptcy protection.  Among mortgagor’s assets was mortgaged real estate.  Post-petition, a tax lien on the property was sold to a party in a Marion County, Indiana tax sale.  The County, however, had not applied for relief from the bankruptcy automatic stay.  The purchaser of the tax lien then assigned its lien to another party (assignee).  Months later, mortgagee had the bankruptcy automatic stay lifted so it could foreclose on its mortgage on the property.  After the bankruptcy case concluded, and the mortgagor/debtor was discharged, the Marion County Tax Auditor issued a deed to the property to the assignee of the tax sale lien.  The assignee then conveyed its interests in the property to ATFH, the plaintiff in the current case.  ATFH filed an action to quiet title, essentially claiming that its interest in the property, which arose from the tax lien, was superior to the interests of the mortgage lender that foreclosed on the property. 

Property tax lien primer.  The Indiana Court of Appeals in ATFH Real Property set out the following general rules applicable to property tax liens in Indiana:

 When the owner of real property fails to pay property taxes, the property may be sold to satisfy the delinquent taxes. 

 The process by which property is sold to satisfy delinquent taxes is governed by statute, and a valid sale requires material compliance with those statutes.

 At such a “tax sale,” when a bid from a member of the public equals at least the amount of the delinquent taxes (plus some miscellaneous expenses), the buyer receives a certificate of sale and a lien against the property in the amount paid.  I.C. § 6-1.1-24-5 and 9.

 This lien is superior to all other liens that exist against the property.  I.C. § 6-1.1-24-5.

 Any person, however, may redeem (buy back) the real property in question by paying to the county treasurer an amount specified by I.C. § 6-1.1-25-2.  See, I.C. § 6-1.1-25-1.

 If no redemption is made within the specified period, the purchaser of the tax lien (or his assignee) may then petition the court in which the judgment of sale was entered to order the auditor to issue a tax deed, which, when issued, vests in the grantee an estate in fee simple absolute.  I.C. § 6-1.1-25-4.6.

Bankruptcy automatic stay.  The issue in ATFH Real Property was whether the purchase of the tax lien on the property at the tax sale violated the bankruptcy stay.  More specifically, did the purchase constitute an “act to obtain possession of property” under 11 U.S.C. § 362(a)(3)?  The Court concluded that it did, “even if the immediate result was not actual possession.”  The rationale was that one cannot obtain possession of property from a tax sale without first purchasing the tax lien.  The Court held that the tax sale and all proceedings flowing therefrom were therefore void as violative of the automatic stay.   

Bout Over An Indiana Warehouseman’s Lien

Although the Miller’s Turnkey v. Cybertek case from the Indiana Court of Appeals may not directly affect most commercial lenders, the case does speak to the enforcement of an Indiana lien under the Uniform Commercial Code.  If you happen to be involved in, or want to learn about, the foreclosure of a warehouseman’s lien in Indiana, you or your counsel should review Miller’s Turnkey, 878 N.E.2d 280 (Ind. Ct. App. 2007) (Miller'sOpinion.pdf). 

Punch.  Plaintiff Miller owned a warehouse and stored defendant Cybertek’s equipment for a fee.  Cybertek delivered the equipment to Miller but never paid rent.  Miller sued Cybertek and obtained a judgment for $23,600, presumably the amount owed for storage fees, and a decree authorizing the foreclosure of the possessory lien held by Miller.  To satisfy the judgment, Miller sold Cybertek’s equipment for $45,000 to a third party in a private sale.  (Miller put the proceeds in escrow.) 

Counterpunch.  Thereafter, Cybertek pursued a counterclaim against Miller for damages due to alleged non-compliance with Indiana’s Uniform Commercial Code in the sale of the equipment.  Cybertek’s action sought damages for what it claimed to be the fair market value of the goods - $93,500.  At issue was Indiana Code § 26-1-7-210, which deals with the enforcement of a warehouseman’s lien in Indiana. 

Knockdown.  The Indiana Court of Appeals concluded that defendant Cybertek was correct in that plaintiff Miller didn’t follow the rules when it disposed of the equipment.  First, the Court found Miller did not provide the appropriate notice to Cybertek with regard to the sale.  Second, the Court found that the sale was not “commercially reasonable” as required by statute.  Finally, the Court found that there was sufficient evidence to support the contention that the fair market value of the goods was $93,500, not the $45,000 received in the Miller’s private sale.  The opinion provides a road map for parties and their counsel who need to enforce a warehouseman’s lien, including how to establish a proper sale and sale price.  Please read the opinion for more details.

Split decision.  Although plaintiff/creditor Miller, the warehouse owner, ultimately was defeated by defendant Cybertek, the debtor who did not pay rent, all was not lost.  At the end of the day, Miller will forfeit about $25,000, not $93,500.  This is because Miller will get a credit for the initial $23,600 judgment it obtained against Cybertek.  Furthermore, Miller’s private sale of the equipment, albeit defective, netted $45,000, which will be used to pay Cybertek.  $93,500 – ($23,600 + $45,000) = $24,900, the net amount Miller will be out of pocket to Cybertek. 

Lest we forget the attorneys’ fees and litigation costs both parties incurred in fighting one another.  Neither the trial court nor the Court of Appeals awarded Cybertek attorney’s fees as a part of the judgment against Miller.  Cybertek, in the end, probably lost money because it likely spent more than $25,000 in defending Miller’s lien foreclosure claim and in prosecuting its counterclaim.  The same can be said for Miller –not only did it lose net $25,000, but it surely lost more when attorney’s fees and litigation costs were considered.  The result of this case brings to mind a quote from our sixteenth president, Abraham Lincoln:  “Discourage litigation.  Persuade your neighbors to compromise whenever you can.  As a peacemaker the lawyer has superior opportunity of being a good man.  There will still be business enough.”  Perhaps the lawyers followed Lincoln’s advice in Miller’s Turnkey.  Maybe the parties – the litigants themselves – just didn’t heed it. 

Allison Transmission Owner Receives Default Notices

Click for stories released today:  inside indiana and IBJ.

Click for March 10 AP story concerning Carlyle Capital's response.

March 13 press release from Allison owner:  click here. 

An Indiana Federal Court Discusses Strict Foreclosure

If you’re wondering what “strict foreclosure” means in Indiana, look no further than Judge Barker’s opinion in the CIT Group v. United States of America, 2007 U.S.Dist. LEXIS 96180 (S.D. Ind. 2007) (CITOpinion.pdf) case. The opinion provides a straightforward discussion of strict foreclosure, with a federal tax lien twist.

What happened. Lender entered into a purchase money mortgage transaction with borrower. Borrower defaulted, and lender foreclosed. The real estate was sold at a sheriff’s sale, and the lender was the successful bidder. Unbeknownst to the lender, a federal tax lien had been filed against the borrower and had been recorded before the filing of the foreclosure action, albeit after the recording of the lender’s mortgage. Presumably due to inadvertence, the lender failed to name the United States in its foreclosure action, so the tax lien survived the foreclosure case. The lender brought an action for strict foreclosure against the federal government with the goal of cutting off the federal tax lien.

Strict foreclosure, generally. In Indiana, strict foreclosure is defined as “the means by which a party, who acquires title through or after a foreclosure sale (or by deed in lieu of foreclosure), may cut off the interests of any junior lienholders who, for some reason, were not parties to the foreclosure action.” Strict foreclosure is a remedy that operates to cut off the right of junior lienholders to redeem. In CIT, seemingly the lender (senior lien holder) should have been entitled to strict foreclosure because it purchased the property at the sheriff’s sale after foreclosure of the borrower’s/owner’s/mortgagor’s interests.

The rub. Only later did the lender discover that the United States had recorded a tax lien on the property. Even though the lien undoubtedly was junior to the lender’s mortgage lien, the United States argued that its lien should not be extinguished in the strict foreclosure action given its unique, statutorily-protected nature. The statue at issue was 26 U.S.C. § 7425(a) entitled “Discharge of Liens.” The United States argued, based on the statute, that because the government was not joined as a party to the action, the judicial sale should be subject to the federal tax lien. Judge Barker adopted this “defense” and concluded that the federal tax lien should survive and continue to encumber title to the property, no matter who holds title, until it is satisfied. Judge Barker stated “but for the fact that, by federal statute, primacy is given to the federal tax lien, we believe strict foreclosure likely would be available to a mortgagee so as to extinguish any other junior lienholders’ interests.”

Survival. As explained in CIT, strict foreclosure normally provides a remedy to senior lienholders, after the sale of the property at a foreclosure sale, to bring an action for the purposes of clearing title and extinguishing any subordinate liens or interests. But the CIT case illustrates a unique scenario involving the treatment of a federal tax lien. Here is Judge Barker’s explanation of, in essence, the upshot of her decision:

Provided [lender] continues to hold title to the real estate it acquired by Sheriff’s Deed at the foreclosure sale, equity allows it to assert its mortgage lien position as against the United States even though the United States was not named in the foreclosure action. If title to the property is thereafter conveyed to a third-party purchaser, however, that purchaser would no longer be able to assert [lender’s] mortgage lien priority so as to extinguish the federal tax lien. So long as [lender] continues to hold legal title to the real estate, the United States’s lien remains in effect, but inchoate – dormant, as it were – because it is uncollectible against [lender]. Should the property be sold by [lender] to a third party, the government is entitled to execute on its lien and be paid, presumably from the proceeds of the sale.

Do due diligence. This was a bad result for the lender because it acquired the property at the sheriff’s sale subject to a $10,200 lien, which will have to be satisfied when the lender liquidates the property. It is my understanding the result could have been avoided had the United States been made a party to the foreclosure action, although rules and exceptions surrounding federal tax liens could be (and someday will be) the subject of their own blog post. The failure to name the United States in CIT probably stemmed from a defective title insurance policy commitment (title search) or possibly the lender’s failure to order a title search to begin with. Lenders and Indiana counsel should remain mindful to purchase a title insurance policy commitment before filing a complaint, with a “date down” thereafter, which commitment will help identify all parties, with interests in the property, that should be named in the suit. If that was in fact done by the lender in CIT, and if the title company missed the federal tax lien, then the lender may have been indemnified by the title insurance company for the loss associated with the $10,200 tax lien.

NOTE: Legislation in 2012 impacted strict foreclosures in Indiana.