The Demise of Indiana’s Strict Foreclosure Remedy, Part II: Trying To Peel The Onion That Is Deutsche Bank

This follows-up my April 17 post discussing how the recent Deutsche Bank (.pdf) case calls into question whether Indiana recognizes the remedy of strict foreclosure.  Despite the remedy’s potential demise, there appears to be an argument that, under certain circumstances, a senior lender/purchaser at a mortgage foreclosure sale, which didn’t include junior lienors, may not lose the property after all - - it’ll just lose time and money. 

Devil’s in the details - Brightwell.  I shared my prior post with a handful of creditor’s rights lawyers, some of whom pointed out the significance of footnote 5, buried at the end of the Deutsche Bank opinion, which provided:

Because issues regarding division of proceeds may arise during further proceedings in the trial court, we note that, in Brightwell, the Federal District Court, applying Indiana law, explained the procedure for determining the relative rights of the parties in a case like that before us.

That’s all Deutsche Bank really told us about the priority issue – arguably the most important issue in the case.  It’s only after studying the 1992 Brightwell v. United States of America, 805 F. Supp. 1464 (S.D. Ind. 1992) (.pdf) opinion that we can piece together the upshot of Deutsche Bank.  In Brightwell, Judge McKinney more directly tackled the issue of priority and, unlike the Court in Deutsche Bank, discussed Indiana’s “anti-merger” rule.  According to Brightwell, the subsequent execution sale contemplated in Deutsche Bank should be subject to the senior mortgagee’s lien, and the underlying mortgage foreclosure judgment should permit the mortgagee to make a first-priority credit bid at the second sale.  (Beware:  if the foreclosing lender sells the property before clearing title, Brightwell suggests that the mortgagee’s right to assert the mortgage lien against junior lien holders does not pass to subsequent purchasers – a post for another day.)     

Anti-merger.  To fully understand the implications of Deutsche Bank and Brightwell, lenders and their foreclosure counsel need to be aware of Indiana’s “anti-merger” rule: 

• The general rule is that a mortgagee’s acquisition of title to mortgaged property will result “in a merger of the mortgage with the title, thus extinguishing the mortgage lien.”
• The exception to this rule where merger would harm the interests of the mortgagee, thus permitting the lien to be preserved.
• The “key factor” in deciding whether a merger has occurred “is determining what the parties to the sale – primarily the mortgagee – intended.”
• If intent is not express, Indiana courts will presume that no merger was intended if the circumstances indicate that preservation of the lien would “benefit” the mortgagee.
• The exception/presumption allows mortgagees to prevent junior lien holders from stepping-up in priority, foreclosing and reducing the mortgagee’s “already diminished recovery . . . guarantees the mortgagee’s priority in any proceeds.” 

In a nutshell, “anti-merger” is a priority-protection rule:

Put simply, the anti-merger rule gives a mortgagee first crack at any money generated by foreclosures on the property, ahead of any junior lien holders, until it has been paid what it is owed in full. 

Judge McKinney held that there was no evidence in the Brightwell case to overcome the presumption that the mortgagee intended to preserve its lien, so the mortgage was preserved after the mortgagee bought the property at foreclosure.

All may not be lost.  Admittedly, it would appear that I jumped the gun when I stated that the Deutsche Bank “opinion’s implication is that the subsequent sale is not subject to the prior mortgage lien/interest.”  Assuming courts read Deutsche Bank and Brightwell in tandem, the plaintiff/senior lender-mortgagee, who purchases property at a foreclosure sale, ultimately should not lose the property, unless the missed junior lienor or a third party first pays the mortgage debt as established in the underlying foreclosure action.  Having said that, with the elimination of the strict foreclosure remedy by Deutsche Bank, lenders still face substantial headaches, delays and expenses to clear title. 

How senior lenders should proceed under circumstances involving missed junior liens, as well as other practical considerations arising out of the Deutsche Bank case, will be addressed next week in yet another strict foreclosure-related post.  For now, lenders and their counsel should remain mindful of the importance of ordering date downs of title work before proceeding to judgment, and any title insurance representatives reading this should be very sensitive to the consequences of missing perfected junior liens.  More next week…. 

Does Indiana’s Strict Foreclosure Remedy Still Exist?

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.

CMBS Defaults In The News

Today, The Wall Street Journal reports on General Growth Properties Inc.'s Chapter 11 filing and how default rates on commercial mortgage-backed securities may be rising substantially over the next two to three years:  Small Creditors Hurt Mall Owner.

Indy Star: Subdivision Foreclosures

The Indianapolis Star has a couple stories today that touch upon commercial foreclosure issues arising out of the demise of residential builders and developers.  These cases do not involve loan defaults by homeowners.  Rather, they deal with loans to the subdivision developers and the builders secured by the real estate they develop.  Here are the links:

Vacant lots fill subdivisions as builders go bust

Subdivision is stopped short

As noted, these cases are challenging for all involved and affect many parties and entities.  The second link deals with a Gunstra condo development.  I know from experience - serving as counsel for a receiver in a similar case - that the developer's default triggers a variety of problems for, not only the developers and the lenders, but the homeowners and even the municipalities.

One of the many difficulties in getting these cases worked out is the considerable lack of demand for new houses or condos, as well as the inability to determine the value (if any) of the ground - the loan collateral.  From what I'm hearing, nobody really knows what these subdivisions are worth in today's market, and nobody really knows when the market will turn around.  Traditional lenders can't wait indefinitely, and they ultimately must foreclose in order to collect something on their loans.