What happens if your title company or your foreclosure lawyer missed a junior lien in the lawsuit to enforce your mortgage? Past practice has been to file a strict foreclosure case to extinguish the overlooked interests from title, as mentioned in my March 3, 2008 post. The validity of that remedy is now in doubt because, on March 25, 2009, in Deutsche Bank National Trust Co. v. Mark Dill Plumbing Co., 2009 Ind. App. LEXIS 524 (.pdf), the Indiana Court of Appeals issued a decision that appears to stand for the proposition that a senior lender/mortgagee, which acquired property at a sheriff’s sale, takes the real estate subject to any junior liens that existed pre-suit, without recourse. Although I’m still digesting the opinion, which is significant on many levels, my interpretation is that Deutsche Bank basically kills the strict foreclosure remedy in Indiana.
The litigation. In the underlying lawsuit, the lender/mortgagee filed suit against the borrower/mortgagor and ultimately took title to the property at a sheriff’s sale. However, the lender failed to name three judgment lien holders as parties to the foreclosure action, even though the “junior liens were properly recorded.” Lender thus brought a strict foreclosure action against the judgment lien holders to cut off the rights of the junior lienors to the subject property. The judgment lien holders countered that the lender’s equity of redemption should be foreclosed and that another sheriff’s sale should be held in order to satisfy the amounts owed to them.
English law-forfeiture. At English common law, “strict foreclosure” basically constituted a forfeiture:
A rare procedure that gives the mortgagee title to the mortgaged property –
without first conducting a sale – after a defaulting mortgagor fails to pay the
mortgage debt within a court-specified period.
The Court reasoned that Deutsche Bank could not be deemed a “strict foreclosure” case because the lender already had title to the mortgagor’s property by virtue of Indiana’s statutory foreclosure proceeding. (But, as noted in the next section, an Indiana strict foreclosure isn’t really a forfeiture because the lien isn’t really being voided outright – the lienor maintains the equity of redemption.)
Indiana law-remedy. Interestingly, the Court’s opinion also addressed the definition of strict foreclosure recognized previously by Indiana courts (and me):
A strict foreclosure proceeds upon the theory that the mortgagee or purchaser
has acquired the legal title, and obtained possession of the mortgaged estate,
but that the right and equity of redemption, of some judgment creditor, junior
mortgagee, or other person similarly situated, has not been cut off or barred.
In such a case, the legal title of the mortgagor having been acquired, the
remedy by strict foreclosure is appropriate to cut off the equity and right of
junior encumbrances to redeem.
Such persons have a mere lien upon, or an equity in, the land which is
subordinate to the right of the owner of the legal title. A statutory foreclosure,
in such a case, would be manifestly inappropriate. The owner of the legal title
may, with propriety, maintain a proceeding in the nature of a strict foreclosure,
to bar the interest of persons who have a mere lien upon or right of redemption
in the land.
This is what I understood the strict foreclosure remedy to mean in Indiana - a lender could file a quiet title (strict foreclosure) suit to give the junior lien holder the opportunity (right) to redeem (to payoff the judgment/buyer). Absent a payoff, the junior lienor’s equity of redemption is foreclosed, causing the lien on the property to be terminated.
Applying the law: fairness? The Court, however, steered away from prior Indiana law and instead focused on the forfeiture concept, stating: “courts must always approach forfeitures with great caution, being forever aware of the possibility of inequitable dispossession of property and exorbitant monetary loss.” The Court felt there was nothing fair or just about ordering forfeited the judgment liens “when their junior liens were properly recorded and when the failure to join them as parties in the forfeiture action resulted from the negligence of Deutsche Bank or its agent.” (But, what about the windfall associated with allowing a subordinate lien to leapfrog a senior mortgage lien?)
No strict foreclosure. In Indiana, foreclosure by a senior mortgagee does not affect the rights of a junior lien holder who was not made a party to the foreclosure action. (See my 12-21-06 post.) In its analysis, the Court in Deutsche Bank relied upon the following rule applicable to foreclosures and sales:
Junior lien holders who are not made parties to the foreclosure action were
not bound by such foreclosure, and their situation “after the foreclosure
remained the same as it had been before.” The purchaser at the foreclosure
sale “simply stepped into the shoes of the original holder of the real estate and
took such owners’ interest subject to all existing liens and claims against it.”
The Court ultimately agreed with the judgment lien holders’ argument that it would be erroneous to allow their interests to be eliminated without notice and due process. (But, doesn’t the subsequent strict foreclosure suit present junior interest holders with notice and due process?)
The upshot - stunning. According to Deutsche Bank, Indiana junior lien holders, who are not named in a foreclosure suit, have valid liens against the title held by the purchaser at a sheriff’s sale and can have the real estate sold to satisfy their liens. The opinion’s implication is that the subsequent sale is not subject to the prior mortgage lien/interest. So, unless the foreclosure sale purchaser (usually, the mortgagee) buys off the junior liens, the purchaser, like the borrower/mortgagor before it, will lose the property. Deutsche Bank seems to signal a dramatic change in Indiana foreclosure law and practice, but the party’s not over because I’m told the lender is appealing the Court of Appeals’ decision. Stay tuned and, because I can’t tackle all issues in one post, I intend to write a follow-up article addressing some of the more practical implications of this case next week. Please call, email or post a comment with your thoughts.