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….