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Tax Sale Set Aside: Inadequate Notices To Property Owner

The Indiana Court of Appeals opinion in City of Elkhart v. SFS, LLC, 968 N.E.2d 812 (Ind. Ct. App. 2012) is a nice contrast to the Sawmill Creek case discussed in my prior post Tax Sale Bullet Strikes Property Owner.  In Sawmill Creek, the Indiana Supreme Court denied a property owner’s motion to set aside a tax sale.  In SFS, the Court of Appeals reached the opposite conclusion.  At issue is the nature and extent of the notice that must be given to a property owner before the owner loses title.  (For rules on notices to mortgagees, please click here for my prior post on that subject.)

Background.  SFS involved two tax sales regarding the same property.  The dispute was between the first tax sale purchaser and the second tax sale purchaser.  The first purchaser alleged that it did not receive notice of the second tax sale, which occurred before the first purchaser recorded its tax deed.  For the facts and circumstances surrounding the nature of the notice and its alleged deficiencies, please read the opinion. 

Fundamentals.  Importantly, Indiana law provides that title conveyed by a tax deed may be defeated if the three required notices were not issued in “substantial compliance” with the statutes.  One element that the Court really sliced and diced related to Ind. Code § 6-1.1-25-4.5 and the “ordinary means” requirement for notice.  SFS discussed the application of the notice requirements when there are alleged defects in the means used to provide notice. 

3 notices.  The SFS opinion succinctly outlined the three notices that must be given to property owners in connection with an Indiana tax sale:

1. First, the county auditor must provide notice of the tax sale per I.C. § 6-1.1-24-4.

2. Second, the party that purchases the property at the tax sale must send the notice of the right of redemption pursuant to I.C. § 6-1.1-25-4.5.

3. Third, the party that purchases the property at the tax sale must send the notice of filing of a petition for tax deed per I.C. § 6-1.1-25-4.6(a).

The first tax sale purchaser in SFS did not receive notice #2 from the second purchaser even though the first purchaser had recorded its tax deed from the first sale before the redemption period expired. 

Defective notice.  In SFS, an employee of the second tax sale purchaser had actual knowledge of the recorded tax deed for the first sale.  Accordingly, the second purchaser was on “inquiry notice” of the first purchaser’s correct address more than two months before the redemption period had expired and well before the issuance of the third notice.  The second purchaser disregarded such information and resorted to alternative measures to satisfy the statutory notice, which measures were deemed by the Court to be improper and ultimately unconstitutional:

It would not be ordinary but, rather, extraordinary to permit the [second purchaser] to obtain a tax deed after it had failed to send notice to the [first purchaser’s/the owner’s] address as it appears on the public records when it had the means of knowledge at hand two months before the redemption had expired.

As mentioned here before, I periodically write about tax sales for the simple reason that such sales terminate any mortgage liens on the property.  Best practices for secured lenders are to monitor tax payments and ensure tax sales do not occur without your knowledge.

How Can A Subsequent Mortgage Have Priority Over A Prior Mortgage?

In Indiana, a mortgage lien generally takes priority in title “according to the time of its filing.”  I.C. § 32-21-4-1(b).  In other words, the mortgage that gets recorded first is senior.  But sometimes prior mortgages are not paid off at closings as intended.  In such cases, the doctrine of equitable subrogation can trump the lien priority rule in I.C. § 32-21-4-1(b).  Finance Center Federal Credit Union v Brand, 967 N.E.2d 1080 (Ind. Ct. App. 2012) illustrates this. 

Scenario.  Funds received from GMAC at a refi closing fully satisfied the borrower’s obligations to both Meridian Group, the senior lender, and Finance Center, the HELOC lender.  Finance Center failed to release its mortgage, which contained a provision requiring the borrower to send notice requesting the release of the lien.  Finance Center received no such notice, left the line of credit open, and later advanced additional funds to the borrower.  The borrower later defaulted on the GMAC mortgage, and in the foreclosure action the issue became whether GMAC or Finance Center was first in priority.

Argument.  Generally, as long as the refinancing lender is not culpably negligent, it is entitled to stand in the shoes of the senior lien and retain its priority status. For more on the doctrine, please click on my February 9, 2008 post, which discussed a similar case.  However, culpable negligence, if established, is an exception to the doctrine of equitable subrogation.  Finance Center contended that GMAC was not entitled to a first lien because GMAC was culpably negligent for not ensuring the notice letter got to Finance Center. 

No culpable negligence.  The Brand opinion noted that the “culpable negligence” exception “contemplates action or inaction which is more than mere inadvertence, mistake or ignorance and focuses on the activity of the party asserting subrogation [the subsequent lender].”  Finance Center asserted that GMAC was culpably negligent by failing to obtain a release of the HELOC mortgage.  The Court disagreed and concluded that GMAC’s mere failure to ensure that it had properly paid off Finance Center was not enough to pass the culpable negligence test:

[a]ny negligence in GMAC’s failure to ensure that the [borrower’s] second mortgage with Finance Center was released did not prejudice Finance Center because the Finance Center mortgage was always junior to the senior Meridian Group mortgage, which was fully satisfied with the loan proceeds from the GMAC refinancing.  Allowing GMAC to step into the shoes of the Meridian Group mortgage will leave Finance Center in the very same junior position.  This is a clearly equitable result.  See Nally, 820 N.E.2d at 655 (“The mere fact that a person seeking subrogation was negligent does not bar him or her from relief where such negligence is as to his or her own interests and does not affect prejudicially the interest of the person to whose rights subrogation is sought.”) 

In Brand, the doctrine of equitable subrogation applied, and the Court determined that the refinancing lender’s mortgage (the GMAC mortgage) was a first and senior lien on the subject real estate.

If, as a secured lender, you close a real estate loan thinking that all prior mortgages had been paid off, but you later learn that a mortgage was not released as it should have been, then you and your counsel’s first thought should be to explore the relief afforded by Indiana’s doctrine of equitable subrogation.  The second thought should be to make a claim on your title insurance policy - if you purchased one.

Full Credit (Judgment) Bid in Michigan Extinguishes Debt and Mortgage in Indiana

Sometimes multiple mortgages on multiple properties secure a single promissory note.  Lenders/mortgagees may pursue separate foreclosure actions against separate properties, but there cannot be a double recovery.  Neu v. Gibson, 968 N.E.2d 262 (Ind. Ct. App. 2012) illustrates this and applies the so-called “full credit bid rule” that was the subject of my post Full Judgment Bid = Zero Deficiency

The transaction.  In exchange for the sale of stock, Nowak gave Gibson a promissory note and granted Gibson a mortgage against real estate in both Indiana and Michigan.  Nowak sold the Indiana real estate to Neu but did not inform Gibson of the sale.  Nowak ultimately defaulted on the promissory note to Gibson. 

Suits.  Legal proceedings ensued in Indiana between Gibson and Neu that led to an Indiana Supreme Court decision concerning the doctrine of equitable subrogation, which was the subject of my March 1, 2011 post.  Unbeknownst to Neu, Gibson also pursued a legal proceeding in Michigan with respect to the Michigan real estate.  Gibson obtained a foreclosure judgment in Michigan and made a credit bid at the sale for the full amount of the judgment.  Gibson ultimately acquired title to the Michigan real estate.  The collection proceedings then turned back to Indiana where the issue was whether the Indiana judgment had been satisfied by virtue of the Michigan sale. 

Full credit bid rule.  Neu’s primary argument in the Indiana case focused on Gibson’s entry of a full credit bid in the foreclosure sale of the Michigan real estate.  The question was whether Gibson’s claim against the Indiana real estate, which claim rested on the same debt secured by the Michigan real estate, was barred by the “full credit bid rule.”  (Michigan also recognizes and applies this rule.)  Essentially, the rule provides that the payment of a bid at a sheriff’s sale sufficient to satisfy the judgment extinguishes that judgment.  It follows that, where a judgment creditor has been paid the full amount of the judgment, there is a complete satisfaction of that judgment. 

Rule applied.  In Neu, Gibson obtained a foreclosure judgment on Nowak’s promissory note with regard to the Michigan real estate in the amount of $305,722.48.  A few months later, the Michigan real estate was the subject of a foreclosure sale where Gibson submitted the highest bid of $305,722.48.  The Court said:  “as Gibson purchased the Michigan Real Estate for a price equal to the amount of the foreclosure judgment, the debt became satisfied and the underlying promissory note was extinguished.”  Consequently, the mortgage on the Indiana real estate was terminated. 

Fair market value immaterial.  In an effort to avoid the consequences of the Michigan proceedings, Gibson contended that the Court should use the fair market value of the Michigan real estate – not the full credit bid – in determining the amount still owed in the Indiana action.  Gibson submitted an appraisal of the Michigan real estate stating the property was only worth $72,000.  As discussed in the Titan opinion and my 8/1/08 post, however, the full credit bid rule “precludes a lender for purposes of collecting its debt from making a full credit bid and subsequently claiming that the property was actually worth less than the bid.”  The Court summed up its opinion as follows:

As Gibson purchased the Michigan real estate for a price equal to the amount of the foreclosure judgment, the debt became satisfied and the underlying promissory note was extinguished. . . . With the satisfaction of the underlying promissory note, there is no longer any debt to support the foreclosure on the Indiana real estate.  If, in fact, we were to allow Gibson to foreclose on the Indiana real estate after foreclosing on the Michigan real estate, we would grant him a windfall, which we are not prepared to do.

Takeaway.  One of the lessons of Neu is that judgment creditors probably should not make full judgment (credit) bids at foreclosure sales unless the real estate is worth the amount of the judgment.  On the other hand, if judgment creditors absolutely want the property, and if there are no other assets to pursue, then a full credit bid at a sheriff’s sale makes sense.  But do so knowing that there is no residual debt to collect.  A full credit (judgment) bid resolves the debt and extinguishes any other liens securing such debt.