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To Terminate Post-Mortgage Leases, Tenants Generally Must Be Named In Foreclosure Actions

Secured lenders struggling with the question of whether tenants must be parties to Indiana commercial mortgage foreclosure suits have been given a fairly definitive answer by the Indiana Supreme Court in Myers v. Leedy, 2009 Ind. LEXIS 1370 (Ind. 2009) (.pdf).  Myers actually involved the enforcement of a land contract, not a mortgage, but to the chagrin of Chief Justice Shephard, who concurred in the result, the Myers opinion applies with equal vigor to mortgage foreclosures.  In most instances, if a business decision is made to end a post-mortgage leasing relationship, the tenant in possession should be included in the litigation.

Myers particulars.  In August of 2002, two individuals entered into a land contract for the purchase of farmland and had a memorandum of that contract recorded.  In 2004, the land contract vendee (“buyer”) entered into a written lease with a third party to rent the tillable soil.  That third party (“tenant”) farmed the land in 2004, and the owner/land contract vendor (“seller”) had actual knowledge of this.  Leases between the same parties for the same purpose were entered into in 2005 and in 2006, again with the actual knowledge of the seller.  (The leases were not recorded, however.)

Proceedings.  In December of 2004, the seller sued the buyer for breach of the land contract but did not name the tenant as a defendant.  On May 17, 2006, the trial court ruled that the buyer had defaulted under the land contract and ordered the forfeiture of the buyer’s interest in the real estate.  On May 20, 2006, pursuant to the previously-existing lease, the tenant began farming the property.  The next day, the seller ordered the tenant off the property, and the tenant never returned.  Later, the tenant sued the seller because the seller prohibited the tenant from farming the property in 2006. 

The question.  The Myers case presented a matter of first impression: 

Whether a tenant’s leasehold interest in property survives a land contract vendee’s forfeiture when the tenant was not made a party to the forfeiture action and where the vendor had actual knowledge that the tenant was in possession of the property.

To answer that question, the Court examined whether a tenancy survives a foreclosure action.  The Court explained that, for purposes of its holding, there was no reason for treating forfeiture and foreclosure cases differently. 

Test for inclusion.  The Court in Myers set out the following test for inclusion of a tenant in a foreclosure action:

Where at the time a mortgagee files suit for foreclosure it knows, or upon reasonable diligence should have known, that a tenant is in possession of the property, the tenant’s leasehold interest survives the foreclosure action unless the tenant is made a party to that action.

The Court noted that the “weight of authority” provides that “a lease is terminated by the foreclosure of a prior mortgage if, and only if, the tenants are made parties to the foreclosure proceedings.” 

An aside.  Please note that the subject lease came into existence after the subject land contract.  Thus the Myers case speaks to post-mortgage leases, not leases executed before the recordation of the mortgage.  It is my understanding that, in Indiana, a foreclosing mortgagee generally will acquire the real estate collateral subject to any preexisting, recorded leases, regardless of whether the tenants are defendants in the action.  Whether a foreclosing mortgagee would acquire the property subject to any preexisting unrecorded leases is a post topic for another day . . ..)

Read all docs.  Footnote 2 on pp. 5-6 of the Court’s opinion acknowledges that the rights of the parties may otherwise be defined or governed by contract or subordinated without the need for joinder of the tenant.

Actual knowledge.  In Myers, the evidence was not in dispute that the seller had actual knowledge that the tenant was farming the subject property at the time he filed the breach of contract action against the buyer.  Because the seller failed to join the tenant in the action, the subsequent forfeiture of the buyer’s interest in the property did not extinguish the tenant’s leasehold interest.

I’m not finished with Myers … and will be posting one or two more articles based upon this significant opinion rendered by the Indiana Supreme Court….