Lien Priority Dispute: 2005 Mortgage v. 2000 Land Contract

The Indiana Court of Appeals, in Lunsford v. Deutsche Bank, 966 N.E.2d 815 (Ind. Ct. App. 2013), begins its opinion with this legal principle:  “. . . first in time is first in right . . . .”  In Indiana property and debt collection law, this means “a prior lien gives a prior claim, which is entitled to prior satisfaction, out of the subject it binds . . . .”  This rule doomed a land contract buyer (vendee) in his priority dispute with a lender (mortgagee).

The operative dates.  In Lunsford, the owner of the real estate entered into a land contract to sell on August 28, 2000, but the buyer failed to record the land contract until March 8, 2006.  On August 25, 2005, the owner obtained a mortgage loan, and the lender recorded the mortgage approximately six months before the recordation of the land contract.  The owner subsequently defaulted on the mortgage loan, resulting in the lender’s foreclosure suit. 

Priority dispute.  The issue in Lunsford was whether the land contract should have been foreclosed as a junior and subordinate interest to the lender’s mortgage.  In other words, was the land contract buyer’s claim to the real estate subject to the lender’s mortgage, even though the land contract predated the mortgage by five years?

Mortgage superior.  The Court in Lunsford swiftly dispensed with the land contract buyer’s priority contention.  Since the lender recorded its mortgage six months before the buyer recorded its land contract, the mortgage was senior in priority.  Further, since the lender made the buyer a party to the foreclosure action, thereby giving him the opportunity to assert his junior interest in the real estate, the trial court’s foreclosure decree was conclusive as to the buyer.  The Court affirmed the trial court’s summary judgment in favor of the lender accordingly.  Moral:  Don’t Forget To Record.

Different outcome.  While Lunsford appears to be a straight forward case, the Court of Appeals actually reached the opposite result in the 2007 Pramco opinion I discussed here.  The Pramco Court leaned on principles of equity and focused on, among other things, the amount of payments that the land contract buyer had made before the lender’s foreclosure suit.  The Pramco opinion was much more factually involved, while the land contract facts in Lunsford really were not addressed.  Note that the prevailing land contract buyer in Pramco was represented by counsel, whereas the losing buyer in Lunsford was pro se


Despite Lis Pendens, Onus Generally On Plaintiffs (Mortgagees), Not Tenants, To Deal With Leasehold Interests In Mortgage Foreclosure Actions

This follows-up my June 28th post about Myers v. Leedy, “To Terminate Post-Mortgage Leases, Tenants Generally Must Be Named In Foreclosure Actions.”  What actions must the tenant take if it knows or should know about a pending foreclosure action? 

Seller’s contention.  One of the arguments of the land contract seller on appeal of the Myers case was that the tenant had both constructive and actual knowledge of the pending breach of contract action at the time the tenant entered into the lease for the 2006 crop season.  The seller claimed it should not have been forced to name the tenant as a defendant in the action; rather, the tenant should himself have intervened in that action in order to protect his interests. 

Lis pendens, generally.  The seller’s argument triggered the Court’s analysis of Indiana lis pendens law.  See, Ind. Code §§ 32-30-11-1 to 10 and Indiana T. R. 63.1.  “Lis pendens” is Latin for “pending suit.”  The Court outlined that, historically, lis pendens provided that one who acquires an interest in real estate during the pendency of a lawsuit concerning the title to that real estate takes notice of such lawsuit and has to take its interest in the real estate subject to any subsequent judgment.  Ind. Code § 32-30-11-2 modified the common law and requires that the plaintiff file a separate, written notice with the county clerk’s office to perfect the lis pendens protections.  (I also wrote about lis pendens on 12-27-07 and 9-20-07.) 

Lis pendens, exception.  Statutory written notice is not required if the suit is founded upon a written instrument executed by the party having title to the real estate (like a mortgage) as appears from the properly-filed county records.  Thus the filing of the mortgage foreclosure complaint itself will provide the requisite constructive notice to post-suit claimants.  From the Court: 

We have no quarrel with the general proposition that the commencement of a foreclosure action standing alone provides third parties with constructive notice of a pending lawsuit. 

Constructive notice, but . . ..  In Myers, the seller retained legal title to the subject real estate, which interest was reflected by the memorandum of contract recorded in the county recorder’s office.  Under Indiana lis pendens law, therefore, the tenant was deemed to have constructive notice of the suit on the land contract against the buyer commenced two years before the subject lease.  But the Court did not adopt the seller’s lis pendens-related argument, reasoning that it “makes no sense” to say that a lis pendens notice of a foreclosure proceeding should bind a tenant already in possession.  To hold otherwise, a tenant in possession “must regularly check the records of the County Recorder’s office to determine whether a foreclosure action has been filed.” 

Actual notice side-stepped.  The Court also addressed the issue of the tenant’s alleged actual notice of the underlying lawsuit.  Should the tenant have intervened in the pending litigation of which he was aware?  In the final analysis, it appears that the Court may have simply concluded that the evidence was not altogether clear on whether, or to what extent, the tenant knew of the suit as it may have related to the real estate and his rights.  The Court ultimately affirmed the trial court’s finding that, among other things, the tenant should have been allowed to finish planting and harvesting his crop in 2006.  The Court had to choose a side, and it did.

“Should have known.”  As noted in my June 28th post, one of the critical factors in the Court’s decision was that the seller had actual knowledge that the tenant was farming the property at the time seller filed suit.  Thus the Court did not expand on the “upon reasonable diligence should have known” part of the test.  The Court appears to be deliberate in its requirement of notice of a tenant’s “possession” of the property.  The Court’s charge seems to be that lenders must undertake reasonable measures to determine whether there is a tenant in possession of the property.  To me, this implies observing the real estate.  Perhaps a site visit or property inspection may need to occur.  Having said that, we must remember that Myers was not a mortgage foreclosure case and dealt with the unique situation of a single tenant (farmer) on the property.  Ultimately, a secured lender’s “reasonable diligence” will need to be evaluated on a case-by-case basis. 

Business decision.  As a practical matter, in most commercial mortgage foreclosure actions the lender/mortgagee will not want to terminate any of the existing leases.  The leases generate income and thus increase the value of the property.  There are, however, instances where one or more tenants of a subject property may be undesirable and thus the target of termination.  If a business decision is made to terminate such post-mortgage leasehold interests, I recommend that you and your counsel ensure that those tenants are named as defendants in the foreclosure action. 

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….

Indiana Land Contracts and Forfeiture

I understand that commercial lending institutions typically do not get involved in land contracts.  As such, today’s post addressing the Indiana Court of Appeals’ opinion in Hooker v. Norbu, 2008 Ind. App. LEXIS 2566 (Ind. Ct. App. 2008) (Hooker.pdf) is slightly off topic.  Nevertheless, land contracts are a form of real estate financing, and enforcing such contracts could trigger the remedy of foreclosure.  In Hooker, the default under the land contract resulted in a forfeiture.

Land contract, defined.  My trusty Black’s Law Dictionary defines “land contract” as follows:

Contract for the purchase and sale of land upon execution of which title is transferred.  Term commonly refers to an installment contract for the sale of land whereby purchaser (vendee) receives the deed from the owner (vendor) upon payment of final installment.  The vendor retains legal title to the property as security for payment of contract price, while the vendee is said to have equitable title during the term of the agreement.

Unlike the promissory note/mortgage scenario, in which a mortgage creates a lien on property but not title to it, vendors (sellers) in the land contract transaction are the property owners.  See, Indiana Follows The Lien Theory Of Mortgages.

Circumstances.  In Hooker, plaintiff (property owner) and defendants entered into an installment real estate contract for the purchase of restaurant property.  The sale price was $338,000 plus 11.5% interest, which translated to payments of about $3,600 per month.  The defendants had difficulty making payments and, after two years, abandoned the property and returned the keys to the plaintiff.  The plaintiff, in turn, filed a breach of contract claim.  The issue on appeal surrounded how to calculate the plaintiff’s damages.  The specific question was whether the plaintiff could keep the real estate and collect unpaid contract payments for the period that the defendants possessed the premises.

Forfeiture.  The Court in Hooker noted that forfeiture is “the divesture of property without compensation.”  In other words, “forfeiture terminates an existing contract without restitution, while rescission of such contract terminates it with restitution [compensation] and restores the parties to their original status.”  Indiana disfavors forfeitures “because a significant injustice can result.”  See, Land Contract Vendee Defeats Mortgagee’s Foreclosure Case.

The choice.  The Court held that the plaintiff had two options in light of the defendants’ contractual default.  First, he could have proceeded “as though he had a mortgage” by accelerating the land contract and foreclosing (if the defendants were unable to pay the full amount due).  The second option was to pursue the remedy of forfeiture, thereby cancelling the land contract and retaining the payments made by the defendants and the real estate (in addition to recouping any actual damages sustained as a result of the transaction).  Indeed it was undisputed in Hooker that the defendants themselves forfeited by abandoning the property and returning the keys to the plaintiff about two years after the execution of the contract.  By then, the defendants had paid less than one percent of the purchase price.  “Under these circumstances, the Contract and [Indiana Supreme Court] guidelines render forfeiture an appropriate remedy.”

Recovery limited.  The plaintiff sought an additional award of outstanding interest for the time in which the defendants occupied the real estate but neglected to make sufficient payments.  The problem was that the plaintiff “elected to have the Contract forfeited - - cancelled.”  Once he made that decision, he was no longer permitted to enforce the contract.  He was only entitled to receive the defendants’ payments made before their abandonment.  As an aside, the Court suggested that the plaintiff essentially sat on his rights for several months by allowing the defendants to remain in possession of the real estate while in default. The Court did, however, approve of plaintiff’s recovery for actual losses associated with tax payments he was forced to make, personal property taken by the defendants and his attorney’s fees and costs. 

Under the circumstances of Hooker, the Indiana Court of Appeals determined that the owner/vendor elected the remedy of forfeiture rather than foreclosure and therefore was prohibited from recovering the missed contract payments that he conceivably could have recovered had he elected the alternative remedy.  One other lesson from Hooker:  normally the contract language will control the outcome, so you or your lawyer must review the written agreement for additional insight into your remedies. 

Land Contract Vendee Defeats Mortgagee’s Foreclosure Case

In the event you ever deal with priority disputes involving an Indiana mortgage and a land sale contract, or related issues, the October 15, 2007 opinion of the Indiana Court of Appeals in Pramco v. Yoder, et al., 2007 Ind. App. LEXIS 2320 (PramcoOpinion.pdf) will be instructive.  The Court denied mortgage holder Pramco’s request to foreclose on property occupied by Jose Arellano through a land sale contract. 

The loan and contract.  Steven Yoder entered into a promissory note with Bank in the amount of $33,000, which note was secured by a mortgage on residential real estate Yoder owned.  The Bank recorded the mortgage on July 31, 2001.  Subsequently, Yoder entered into a land sale contract with Arellano in the amount of $54,000 that got recorded on January 16, 2002, after the recordation of Bank’s mortgage. 

Subsequent loans and defaults.  Yoder and Bank later entered into other loan transactions worth several hundred thousand dollars secured by mortgages on thirteen different properties, including the property in question.  Yoder ultimately defaulted on his loan obligations, and Bank sold/assigned the notes and mortgages to Pramco.  Before this particular case, Pramco had foreclosed on and liquidated all the properties except for the property occupied by Arellano.  The residual debt totaled about $415,000. 

Status of land contract.  Plaintiff Pramco sought to foreclose on the property Arellano occupied pursuant to the land contract.  Arellano already had made, in addition to a $15,000 down payment, thirty-nine other payments for a total amount paid under the contract of about $45,000.  Remember, the original mortgage between Yoder and Bank was for only $33,000. 

The equitable result.  The trial court held that its equitable powers could prevent the injustice that would result from the foreclosure of the mortgage, including specifically Arellano’s forfeiture of the $45,000 he paid pursuant to the land sale contract.  Yoder had used Arellano’s payments to make mortgage payments to Bank. With a foreclosure, all that money would be lost.  And to add insult to injury, Arellano would lose possession of the property.  The Indiana Court of Appeals reasoned that to grant foreclosure would be to grant Pramco a double recovery.

If forfeiture were allowed, Pramco would have received the benefit of Arellano’s down payment, and subsequent monthly payments, which were taken by Yoder to the Bank, which in turn sold the mortgage to Pramco.  Pramco would then be allowed to sell the Property at sheriff’s sale, as Pramco did with the twelve other parcels of real estate, and retain the proceeds from the sale.

Id. at 14.  The Court of Appeals relied, in part, on the landmark Indiana Supreme Court decision in Skendzel v. Marshall, 301 N.E.2d 641 (Ind. 1973) concerning forfeiture/land sale contracts. 

Fair to the lender?  The mortgage Pramco sought to foreclose had been recorded before the land contract, had never been released and had remained unpaid.  Had the competing lien been another mortgage, Pramco would have prevailed.  Land contracts, however, are treated differently in Indiana, and one must remember that foreclosure actions “are essentially equitable.”  Id. at 11.  When trial courts make decisions with regard to equitable remedies (generally, remedies other than money damages), they are not compelled to strictly follow particular rules of law but rather have great latitude to promote fairness and justice.  (Mortgage foreclosure actions seek an equitable court order to sell real estate to satisfy a debt.)  Lenders thus may not always get what they want or perhaps even deserve.  This is particularly true in Indiana when there is a collision of interests between a mortgage holder and a land contract vendee.