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Strict Foreclosure Unavailable Once Foreclosing Mortgagee Transfers Property To Third Party

Last year, in the wake of the Indiana Court of Appeals’ opinions in Deutsche Bank v. Mark Dill Plumbing, I described in four separate posts on April 17, April 24, May 4 and July 20, 2009 what happens if your title company or your foreclosure lawyer misses a junior lien in the lawsuit to enforce your mortgage.  Deutsche Bank did not definitively answer the question raised in my April 24th post, namely what happens if the foreclosing lender conveys the property before clearing title.  The federal court decision in Brightwell v. United States of America, 805 F.Supp. 1464 (S.D. Ind. 1992) dealt with that very issue, but not until the 2010 decision in Citizens State Bank of New Castle v. Countrywide Home Loans, 922 N.E.2d 655 (Ind. Ct. App. 2010) (.pdf) did Indiana formally adopted the Brightwell analysis. 

Order of events.  Here’s what happened in Citizens State Bank:

04/27/05: Lender obtained mortgage.
06/09/06: Money judgment entered against owners; Judgment Creditor perfected judgment lien on property.
08/28/06: Lender filed complaint to foreclose mortgage but did not name Judgment Creditor in action.
10/30/06: Lender obtained foreclosure judgment without terminating Judgment Creditor’s lien.
02/22/07: Lender obtained title to property at sheriff’s sale.
03/15/07: Lender recorded sheriff’s deed.
05/03/07: Lender transferred title to property to Federal National Mortgage Association (FNMA).
10/02/07: Upon learning of prior judgment lien, Lender filed complaint against Judgment Creditor for strict foreclosure.

Initially, no merger.  Citing to and following Deutsche Bank, the Court in Citizens State Bank concluded that Lender’s mortgage lien and title to the property did not merge when Lender acquired the property through the sheriff’s sale.  At that point, Lender’s mortgage lien had been preserved.  Unlike Deutsche Bank, however, Lender took the additional step, before clearing title, of transferring the property to FNMA, a third party. 

Applying Brightwell.  Indiana’s anti-merger rule benefits only the foreclosing mortgagee:   

By transferring the property to FNMA, [Lender] has already had “first crack” at a full recovery ahead of any junior lien holders . . . and the purpose of the anti-merger rule has been satisfied.  After the transfer to FNMA, [Lender] no longer had any interest in the property to protect, and there was no basis for its mortgage-assertion right to pass to FNMA.

The Court declared that Lender’s right to assert the mortgage against the Judgment Creditor was extinguished upon subsequent transfer of the property to FNMA.  As such, the third party, FNMA, took the property subject to the valid judgment lien. 

Message.  The Court, in footnote 4, echoed a theme from all of my 2009 posts on Deutsche Bank regarding the importance of obtaining appropriate title work before, during and after the foreclosure process:

We feel compelled to state the obvious.  All of this could have been avoided had [Lender] conducted a thorough title search of the property prior to the original foreclosure or had FNMA done the same prior to purchasing the property from [Lender], as such searches surely would have revealed [Judgment Creditor’s] properly recorded judgment lien.  While [Lender] and FNMA fancy these mistakes as “technicalities,” they are significant when applying principles of equity.

NOTE:  On June 29, 2011, the Indiana Supreme Court issued its opinion on transfer in  Citizens State Bank.  Accordingly, please refer to my October 7, 2011 post