Mortgage Financing

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					                               Chapter 3


               Mortgage Financing


§ 3:1    Basic Mortgage Principles
§ 3:2    New Mortgage from Third Party
   § 3:2.1    Buyer’s Affirmative Obligation to Seek the Mortgage
              [A] Down Payment
              [B] “Reasonable Efforts”
              [C] Conditions
              [D] Mortgage Terms
              [E] Lenders
   § 3:2.2    Single or Multiple Loan Applications
   § 3:2.3    Waiver of Mortgage Condition
   § 3:2.4    Seller Financing as Substitute for Institutional Loan
   § 3:2.5    Commitment Fees
   § 3:2.6    Lender’s Revocation of Commitment
§ 3:3    Continuation of Existing Mortgage
   § 3:3.1    Ambiguity
   § 3:3.2    Due-on-Sale Clauses
   § 3:3.3    Exoneration of Debt After Mortgagor’s Death
§ 3:4    Purchase Money Mortgages
   § 3:4.1    Seller’s Purchase Money Mortgage
§ 3:5    Property Covered by the Mortgage
   § 3:5.1    Fixtures and Personal Property
   § 3:5.2    After-Acquired Fixtures and Personal Property
§ 3:6    The New York Statutory Form Mortgage
§ 3:7    Clauses of the New York Statutory Form Mortgage
   § 3:7.1    Payment of Indebtedness
   § 3:7.2    Insurance
              [A] Purchase of Insurance by Mortgagee
              [B] Restoration of Premises
              [C] Application of Insurance Proceeds to Debt
              [D] Claims of Co-owners and Holders of Other Interests
              [E] Transfers of Mortgaged Premises or Mortgage Loan
              [F] Mortgagee Endorsements
              [G] Mortgagee’s Acquisition of Title Before Insured Loss



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§ 3:1                       FRIEDMAN   ON   CONTRACTS

                 [H] Mortgagee’s Acquisition of Title After Insured Loss
                 [I] Loss Payable Endorsement
                 [J] Liability of Mortgagee for Insurance Premiums
                 [K] Installment Land Contracts
     § 3:7.3     Building Removal
     § 3:7.4     Acceleration of Debt
     § 3:7.5     Appointment of Receiver
     § 3:7.6     Payment of Taxes and Charges
     § 3:7.7     Estoppel Certificate
     § 3:7.8     Notices
     § 3:7.9     Warranty of Title
§   3:8    Other Mortgage Clauses
     § 3:8.1     Waste
     § 3:8.2     Non-Recourse
     § 3:8.3     Maintenance of Premises in Good Condition
     § 3:8.4     Prepayment
     § 3:8.5     “Brundage” Clause
     § 3:8.6     Sale in One Parcel
     § 3:8.7     Lien Clause
     § 3:8.8     Condemnation
     § 3:8.9     Attorneys’ Fees
     § 3:8.10 Corporate Execution
     § 3:8.11 Lease Modification
     § 3:8.12 Survival of Mortgagor’s Liability
     § 3:8.13 Escrow Deposits
     § 3:8.14 Transferable Development Rights
§   3:9    Junior Mortgages
§   3:10 Discharge of Mortgage
     § 3:10.1 Merger
     § 3:10.2 Deed in Lieu of Foreclosure
§   3:11 Mortgage Bond or Note
§   3:12 Expenses of Mortgage
§   3:13 Release of Part of Mortgaged Premises
     § 3:13.1 Sample Forms of Release



§ 3:1        Basic Mortgage Principles
   Mortgage financing is an integral part of most sales and purchases
of real property. This section discusses basic principles of mortgage
law, and subsequent sections in this chapter analyze how buyers and
sellers may handle financing issues in their contract—as they prepare
for closing and at the closing itself.
   Two types of mortgages may be involved in title closings: (1) existing
mortgages that affect the premises prior to the closing, and (2) purchase
money mortgages, that is, those placed on the premises at the closing
in part payment of the purchase price. Existing mortgages may be paid



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off at closing, or they may continue in existence, thus helping the
buyer to finance the purchase. The buyer may obtain a new purchase
money mortgage from a third party, usually, but not always, an
institutional lender. Alternatively, the seller may provide financing
in the form of a purchase-money mortgage or in another form.
    In a title theory state, mortgagors only hold an equitable interest in
the mortgaged property. The mortgagor is left with an equity of
redemption, but legal title revests in the mortgagor on payment of
the debt. The mortgagee has title, the right to possession, and absolute
ownership rights in the mortgaged property. However, the mortgagor
remains in possession, even though the mortgagee has all the inci-
dents of ownership.1
    Deeds of trust are used in some areas instead of mortgages. There is
little difference between the two. A deed of trust is substantially a
mortgage with a power of sale. It transfers legal title from a borrower to
one or more trustees for the benefit of the lender, who is called the
beneficiary.2 Similar rules are applied to both mortgages and deeds of
trust.3 One difference is that enforcement of the deed of trust proceeds
with the trustee selling the property without the protection of a
judgment of foreclosure and sale,4 with the result that a wrongful
sale may make the deed-of-trust beneficiary liable for damages. 5

  1.      In re Turtle Creek Ltd., 194 B.R. 267 (Bankr. N.D. Ala. 1996). Some of this
          is not true in the bankruptcy of the mortgagor. In re Guardian Realty
          Group, 205 B.R. 1 (Bankr. D.C. 1997); In re Lyons, 193 B.R. 637 (Bankr.
          D. Mass. 1996).
  2.      Springhill Laske Invs. Ltd. P’ship v. Prince George’s County, 690 A.2d 535,
          539 (Md. 1997).
  3.      Cornelison v. Kornbluth, 116 Cal. Rptr. 902, 904–05 n.1 (Ct. App. 2d Dist.
          1974), vacated on other grounds, 542 P.2d 981 (Cal. 1975); Rustad Heating
          & Plumbing Co. v. Waldt, 588 P.2d 1153 (Wash. 1979).
             A deed of trust is a security device. It transfers legal title from a
             property owner to one or more trustees to be held for the benefit of a
             beneficiary. . . . [T]he deed of trust secures repayment of the loan. If
             the loan is not repaid, it is through the deed of trust that the
             beneficiary has recourse against the property—e.g., by selling
             the borrower ’s property and applying the funds received against
             the borrower ’s indebtedness.
          Springhill Laske Invs. Ltd. P’ship v. Prince George’s County, 690 A.2d 535,
          539 (Md. 1997).
            While enforcement of a mortgage requires a civil action, a deed of trust
          may be enforced by a sale out of court. Patton v. First Fed. Sav. & Loan
          Ass’n, 578 P.2d 152 (Ariz. 1978).
  4.      Patton v. First Fed. Sav. & Loan Ass’n, 578 P.2d 152 (Ariz. 1978) (enforce-
          ment of a mortgage requires a civil action, a deed of trust may be enforced
          by a sale out of court).
  5.      In re Slover, 71 B.R. 9, 12 (Bankr. E.D. Mo. 1986); Owens v. Grimes, 539
          S.W.2d 387 (Tex. Civ. App. – Tyler 1976); 2 G. GILMORE, SECURITY INTER-
          ESTS IN PERSONAL PROPERTY § 38.4 at 1017 (1965).




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   A mortgage given to a related entity, to whom the mortgagor owes
no debt and for which no consideration was given, is a sham and
without effect on third parties.6
   An agreement by an owner not to encumber or transfer his property,
even when accompanied by an assignment of rents, is not a lien or
mortgage and may not be foreclosed.7 A sale of real property, subject to
an option in the grantor to repurchase the premises, may in some
circumstances be held to be a disguised mortgage. 8 It creates no lien
and is not paramount to subsequent liens.9 A repurchase option, with
no specific time for its exercise, raises a question of the rule against
perpetuities. In some states, such an option violates the rule, 10 but in
others the option is valid because the court infers that the option
must be exercised within a reasonable time.11 If the documents are
ambiguous, the court may conclude that the option must be exercised
within the lifetime of the optionee,12 which is consistent with the
general exclusion of the rule against perpetuities from commercial
transactions,13 and is also consistent with cases involving a lease for
a term to commence after completion of a structure housing the


  6.    United States v. Klimeek, 952 F. Supp. 1100, 1114 (E.D. Pa. 1997) (given to
        avoid federal taxes).
  7.    In re Rotehnberg, 173 B.R. 4, 19 (Bankr. D.D.C. 1994); Weaver v. Tri City
        Credit Bureau, 557 P.2d 1072 (Ariz. Ct. App. 1976); Tahoe Nat’l Bank v.
        Phillips, 480 P.2d 320 (Cal. 1971).
  8.    Swallow Ranches, Inc. v. Bidart, 525 F.2d 995 (9th Cir. 1975). Cf. In re
        Kassuba, 562 F.2d 511 (7th Cir. 1977). In stressing the intent of the
        parties, the transaction was held an outright sale. In re Corey, 892 F.2d
        829, 837–38 (9th Cir. 1989).
  9.    Equitable Trust Co. v. Imbesi, 412 A.2d 96 (Md. 1980) (contains form for
        agreement in note 1).
 10.    Coxe v. Wyatt, 349 S.E.2d 75 (N.C. Ct. App. 1986) (right vested in
        corporation, which may have excluded possible saving limit of natural
        person’s lifetime). Cf. Certified Corp. v. GTE Prods. Corp., 467 N.E.2d
        1336 (Mass. 1984). A New York statute codifies the common-law rule,
        striking down any interest where the duration or vesting might take place
        later than lives in being plus twenty-one years. N.Y. EST. POWERS &
        TRUSTS LAW § 9-1.1; Symphony Space, Inc. v. Pergola Props., 631
        N.Y.S.2d 136, 143 (App. Div. 1st Dep’t 1995) (statute precludes operation
        of the wait-and-see rule in New York).
 11.    Byke Constr. Co. v. Miller, 680 P.2d 193 (Ariz. Ct. App. 1984) (seller ’s
        option to repurchase if purchaser did not begin construction of house by
        May 1, 1979); Coulter & Smith, Ltd. v. Russell, 966 P.2d 852 (Utah 1998)
        (option to buy lots must be exercised within reasonable time and thus does
        not violate rule against perpetuities).
 12.                                  .2d
        Barnhart v. McKinney, 682 P 112 (Kan. 1984) (buyer’s right of refusal to buy
        seller’s retained parcel when seller should decide to sell or vacate); Thomas v.
        Kiendzior, 538 N.E.2d 66 (Mass. App. Ct. 1989) (provision for alternate per-
        formances is free of the rule if either is performable during its period). RESTATE-
        MENT (SECOND) OF PROPERTY (Donative Transfers) § 1.4 comment o (1983).
 13.    Hinson v. Roberts, 349 S.E.2d 454 (Ga. 1986).



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                              Mortgage Financing                                    § 3:1

leased premises.14 In many states, the “wait-and-see” rule protects an
option from violating the rule against perpetuities. 15 The repurchase
price must also be reasonable.16 A repurchase option is not a covenant
running with the land, and when there is no provision for its applica-
tion to heirs and assigns it ends with the life of the optionee.17
   Any provision whereby a mortgagor waives his equity of redemption,
in advance of default, is void.18 This is said to “clog” the equity of redemp-
tion. The forbidden provision may be a covenant by the mortgagor, inc-
luded in the mortgage or in a collateral agreement, undertaking to convey
the property to the mortgagee promptly after a default in the mortgage. Or
it may be by the mortgagor’s deposit of a deed under an agreement
permitting its recordation promptly after default by the mortgagor. Such
devices deprive the mortgagor of the right to time or a defense ordinarily
available in a foreclosure action. For the borrower ’s protection, the
mortgagee’s remedy is to foreclose, not to utilize the alternative it
extracted. Courts are vigilant in striking down such techniques, 19
although there are occasional decisions that seem to go the other way.20


 14.      Wong v. DiGrazia, 386 P.2d 817 (Cal. 1963); 1 MILTON R. FRIEDMAN,
          FRIEDMAN ON LEASES § 4:1.2 (Patrick A. Randolph, Jr., ed., 5th ed. PLI 2006).
 15.      See 2 MILTON R. FRIEDMAN, FRIEDMAN ON LEASES § 15:1, at 15-13 to
          15-15 (Patrick A. Randolph, Jr., ed., 5th ed. PLI 2006).
 16.      The option must be reasonable as to duration, price and purpose. DeWolf v.
          Usher Cove Corp., 721 F. Supp. 1518, 1535–36 (D.R.I. 1989). Seller ’s option
          to repurchase when convenient, at a price to be determined at the current
          value at the time of the repurchase was not lost by laches after thirteen years.
          Wall v. Huguenin, 406 S.E.2d 347 (S.C. 1991) (distinguishing case where
          repurchase price was original sales price and delay over nine years).
 17.      In re Fleishman, 138 B.R. 641 (Bankr. D. Mass. 1992). Clarke v. Caldwell,
          521 N.Y.S.2d 851 (App. Div. 3d Dep’t 1987). Provision can be made for the
          covenant to run. See 2 MILTON R. FRIEDMAN, FRIEDMAN ON LEASES
          § 15:6.2, at 15-91 (Patrick A. Randolph, Jr., ed., 5th ed. PLI 2006).
 18.      The equity of redemption applies before foreclosure, and is to be distin-
          guished from a statutory right of redemption, which is a debtor ’s right to
          regain property lost through foreclosure. The waiver of the latter is
          supported by some authority. E.g., John Hancock Mut. Life Ins. Co. v.
          Breuning Farms Corp., 537 F. Supp. 936 (N.D. Iowa 1982).
 19.      Hamud v. Hawthorne, 338 P.2d 387 (Cal. 1959) (plaintiff barred by laches);
          Cohn v. Bridgeport Plumbing Supply Co., 115 A. 328 (Conn. 1921);
          Oakland Hills Dev. Corp. v. Luederc Drainage Dist., 537 N.W.2d 258
          (Mich. Ct. App. 1995); Russo v. Wolbers, 323 N.W.2d 385, 390 (Mich. Ct.
          App. 1982); Humble Oil & Ref. Co. v. Doerr, 303 A.2d 898 (N.J. Super. Ct.
          1973); Basile v. Erhal Holding Co., 538 N.Y.S.2d 831 (App. Div. 2d Dep’t
          1989) (waiver in open court unenforceable); Sannerud v. Brantz, 928 P.2d
          477 (Wyo. 1996). Cf. Verity v. Metropolis Land Co., 288 N.Y.S. 625 (App.
          Div. 1936), aff ’d, 10 N.E.2d 582 (N.Y. 1937). Some states codify the rule.
          CAL. CIV. CODE § 2953; OKLA. STAT. tit. 42, § 11.
 20.      In Allen v. Storie, 579 So. 2d 1316 (Ala. 1991), a mortgagee with an option
          to purchase was given specific performance of this option. Waiver of equity
          of redemption was not discussed.



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§ 3:1                        FRIEDMAN    ON   CONTRACTS

   A claim that there has been an impermissible waiver of the equity of
redemption has been made, and sometimes upheld, in situations more
complex than those mentioned in the preceding paragraph. One such
example is Humble Oil & Refining Co. v. Doerr.21 Humble arranged
for Doerr to obtain a mortgage loan, to expand her gasoline station,
larger in amount and on better terms than Doerr could. This was
accomplished by a “two party lease,” under which Doerr leased her
property to Humble for fifteen years and Humble subleased the
property back to Doerr for one year, with the understanding, but not
the obligation, to continue the sublease from year to year. The amount
of rent from Humble to Doerr and the subrent from Doerr to Humble
was the same, and in an amount that would pay the mortgage. The
lease to Humble gave it an option to buy the property at a price equal
to the fair value of the property when the lease was made. Because the
rents offset each other, Humble received the option without cost.
When the value of the property increased substantially, Humble
sought to exercise the option. The court deemed Humble the virtual
guarantor of the mortgage because the lease to Humble effected the
mortgage. That was enough for the court to determine that Humble
was close enough to the mortgage to make its option a clog on, that is,
a waiver of, Doerr ’s equity and therefore unenforceable. Inasmuch as
actual possession of the property by Humble was never contemplated,
it was in fact a loan transaction.
   Humble distinguishes cases where the landlord is a joint
venturer or where the transaction was a sale with an option to
repurchase.22 Humble is to be distinguished in cases where the
intention of the parties is other than to create a mortgage, or where
the relinquishment of the mortgagor ’s equity is subsequent to




             Ringling Joint Venture II v. Huntington Nat’l Bank, 595 So. 2d 180
        (Fla. Dist. Ct. App. 1992), recognized the rule against clogging, but found
        an exception in unusual circumstances that involved delivery of a deed in
        escrow to nonresidential property under an agreement made subsequent to
        the mortgage and on further consideration.
 21.    Humble Oil & Ref. Co. v. Doerr, 303 A.2d 898 (N.J. Super. Ct. 1973).
 22.    Id.
             In Cunningham v. Esso Standard Oil Co., 118 A.2d 611 (Del. 1955),
        aff ’g 114 A.2d 380 (Del. Ch. 1955), the facts were quite similar to Humble,
        but the result was contra. Among the differences was the fact that clogging
        or waiver of redemption was not considered by the court. Humble, 303
        A.2d at 914–15.
             In Hopping v. Baldridge, 266 P. 469 (Okla. 1928), the mortgagor gave
        the mortgagee, simultaneously with delivery of the mortgage, a ten-year
        option to buy oil and gas rights. In Coursey v. Fairchild, 436 P.2d 35 (Okla.
        1967), the mortgagor delivered a mineral deed as consideration for a renewal
        of a mortgage obligation. In these cases when the mortgage was paid, the



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                              Mortgage Financing                                 § 3:1

the creation of the mortgage.23 Some American statutes validate
secured parties’ options to purchase, provided their exercise is not
conditioned on a default in the security instrument.24
    California and Guam have statutes that invalidate contracts in
restraint of redemption. Cases under these statutes tend to view
mortgagor-mortgagee transactions more with regard to business fair-
ness than to the technicalities of waiver of redemption. 25
    Inasmuch as the rule against waiver of redemption applies to
mortgages, it is necessary to determine if the nature of a transac-
tion is that of a mortgage. It has been held that in a matter of doubt
a security arrangement should be deemed a mortgage to protect
all parties by denying forfeiture and denying waiver of redemption. 26
Courts have established factors to determine whether a mortgage or
a security transaction is involved. When a deed is made for
the payment of money and is held as security, it is an equitable




          option and deed were canceled. The mortgagor was held entitled to
          return of his property in the form in which he mortgaged it.
              The cases cited in this note, and other English and American cases are
          analyzed and discussed extensively in Kane, The Mortgagee’s Option to
          Purchase Mortgaged Property, in FINANCING REAL ESTATE DURING THE
          INFLATIONARY 80s, at 123 (Strum ed. ABA 1981) [hereinafter Kane], and
          also in Licht, The Clog on the Equity of Redemption and Its Effect on
          Modern Real Estate Finance, 60 ST. JOHN’S L. REV. 452 (1986) [hereinafter
          Licht].
 23.      In MacArthur v. N. Palm Beach Utils., Inc., 202 So. 2d 181 (Fla. 1967),
          plaintiff sold property to defendant-mortgagor and took back a purchase
          money mortgage, together with an option to buy a utility system mortgagor
          was to build. Plaintiff-mortgagee loaned defendant-mortgagor money for
          this purpose. A divided court held the purchase option enforceable. It deemed
          the transaction a sale with an option to repurchase and the mortgage merely
          incidental. The dissent viewed the utility agreement as essentially a mort-
          gage transaction. Cf. Smith v. Smith, 135 A. 25 (N.H. 1926).
              See generally, Kane, note 22 supra, at 128 et seq.
 24.      CAL. CIV. CODE § 2906 (inapplicable to residential property with four
          or less units); N.Y. GEN. OBLIG. LAW § 5-334 (applicable to loans of
          $2.5 million or more); UNIFORM LAND SECURITY INTEREST ACT § 211,
          7A U.L.A. (1986). These are discussed in Licht, note 22 supra, at 492–97.
 25.      CAL. CIV. CODE § 2889; 18 GUAM CODE § 35302 (borrowed verbatim from
          California Code).
              See Guam Hakubotan, Inc. v. Furusawa Inv. Corp., 947 F.2d 398 (9th
          Cir. 1991), for a discussion of decisions in California. In Guam Hakubotan,
          a mortgagor delivered a deed to the mortgaged premises to the mortgagee
          on execution of an extension agreement with authority to record the
          deed on a mortgage default. The mortgagee’s recording of this deed in
          accordance with this provision was held proper. It is doubtful if states
          following the common-law rule would reach this result.
 26.      Sannerud v. Brantz, 928 P.2d 477, 480 (Wyo. 1996).



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§ 3:1                        FRIEDMAN     ON   CONTRACTS

mortgage. The intention of the parties is determinative of this rather
than the form or name of the instrument.27 In determining this
intention courts have looked to various factors, which include the
following:
   •    the existence of a debt prior to the transaction or created as part
        of the transaction,
   •    documents entitling the grantor to redeem the property by
        performing specified acts within a specified time,
   •    the grantee gave inadequate consideration for the property and
        the grantor paid interest to the grantee,
   •    the grantor retained possession, control, and use of the property,
        particularly while paying no rent,
   •    the grantor made improvements that a tenant was unlikely to
        make,
   •    the grantee did not exercise control or ownership of the prop-
        erty, and
   •    the parties did not intend to extinguish a debt.28
   Humble Oil & Refining Co. v. Doerr29 was distinguished in a case
with complicated facts where although a mortgage was involved, there
was no loan.30
   A mortgage obtained by duress is usually unenforceable. When
his parents mortgaged their property to a bank that threatened to
send their son to jail for check kiting, the mortgage was held




 27.     Patterson v. Grace, 661 N.E.2d 580 (Ind. Ct. App. 1996).
 28.     In re UNI-RT Corp., 191 B.R. 595 (Bankr. S.D.N.Y. 1996) (extended
         discussion and cases in New York law of parol evidence); N.Y. REAL
         PROP. LAW § 320; Patterson v. Grace, 661 N.E.2d 580, 584 (Ind. Ct.
         App. 1996).
 29.     Humble Oil & Ref. Co. v. Doerr, 303 A.2d 898 (N.J. Super. Ct. 1973).
 30.     In Blackwell Ford v. Calhoun, 555 N.W.2d 856 (Mich. Ct. App. 1996), a
         tenant had a first option to buy the property. Subtenant sought an option
         to buy the property, making the proposal prior to the expiration of the head
         or subleases, but to become effective after the expirations. This was to
         avoid the main tenant’s right of refusal. See 2 MILTON R. FRIEDMAN,
         FRIEDMAN ON LEASES § 15:6 (Patrick A. Randolph, Jr., ed., 5th ed. PLI
         2006). Subtenant paid the head landlord $175 for the option, which was to
         be returned only if (1) the option was exercised and marketable title could
         not be conveyed, or (2) the head tenant exercised its right of refusal.
         Subtenant obtained specific performance, the court noting that after the
         option was exercised there was no equity of redemption to clog. The court
         also noted that substance, not title of papers, prevailed and that it still
         adhered to the rule of Humble.



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                              Mortgage Financing                                § 3:1

unenforceable.31 The nature of duress has changed over the years
from the threat of an unlawful act, for example, a tort or a crime, to
include business compulsion that leaves the victim no reasonable
alternative.32 In a Florida case in which a mortgage was given by a
husband and wife to the defendant, to avoid prosecution of the wife
for admitted embezzlement, the mortgage was held enforceable. The
court noted the fine distinctions in other Florida cases in which the
result would be otherwise.33
   Assignment of a mortgage by a mortgagee, as collateral security,
creates a pledge not a sale of the mortgage, vesting a defeasible title to
the mortgage in the assignee, which ends on payment of the debt. 34
   Generally there is no fiduciary relation between mortgagor and
mortgagee, although one may occur where one party to the relation
relies heavily on the judgment of the other. A slightly dominant
business position is not enough for this.35
   When property is held in a tenancy by the entirety, a mortgage
granted by one spouse is problematic. In some states, the mortgage is
invalid, but in New York the mortgage passes the interest of the
signing spouse. On foreclosure by the mortgagee, the purchaser
becomes a tenant in common with the non-signing spouse, with
the right of survivorship. After the divorce of the spouses, following
the making of the mortgage, a foreclosing mortgagee becomes a




 31.      Osage Corp. v. Simon, 613 N.E.2d 770 (Ill. App. Ct. 1993); Triad Distribs.,
          Inc. v. Conde, 391 N.Y.S.2d 897 (App. Div. 2d Dep’t 1977).
              In In re Rochkind, 128 B.R. 520 (Bankr. E.D. Mich. 1991), a co-owner,
          a wife, signed a mortgage because of a threat that her husband would be
          driven from his law practice if the husband’s debt was not paid. The
          mortgage was held unenforceable to her.
              A dictum in Rochkind is to the effect that where husband and wife
          execute a mortgage, a separate consideration to the wife is unnecessary.
 32.      See In re Rochkind, 128 B.R. 520 (Bankr. E.D. Mich. 1991); RESTATEMENT
          (SECOND) OF CONTRACTS § 175(1) (1981); 13 S. WILLISTON, CONTRACTS
          ch. 47, particularly § 1606 (1981).
 33.      Franklin v. Wallack, 576 So. 2d 1371 (Fla. Dist. Ct. App. 1991).
          A dissenting opinion in Franklin discusses the “modern law,” with author-
          ities that are against the use of criminal law to collect private debts.
 34.      Desser v. Schatz, 581 N.Y.S.2d 796 (App. Div. 1st Dep’t 1992), relying on
          In re Gilbert, 10 N.E. 148, 151 (N.Y. 1887).
              A mortgage given as security for tenant’s liability under a lease is not
          modified by modification of the lease or other changes so long as
          rent remains unpaid under the original lease. Trans Ohio Sav. Bank v.
          Patterson, 590 N.E.2d 1338 (Ohio Ct. App. 1990).
 35.      Stern v. Great W. Bank, 959 F. Supp. 478 (N.D. Ill. 1997). In Stern, a bank
          mortgagee was held under no liability for supplying financial information
          of the mortgagor to the lawyer for the mortgagor ’s ex-wife under a
          subpoena.



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§ 3:2                       FRIEDMAN   ON   CONTRACTS

tenant in common of the non-signing spouse, with no right of
survivorship.36 A mortgage purportedly signed by tenants by the
entirety, but with the wife’s signature forged, was treated as if signed
by the husband alone.37
   A mortgage must be supported by consideration to be enforceable,
but the consideration need not move from the mortgagee to the
mortgagor; it may consist of a loan to a third person.38

§ 3:2      New Mortgage from Third Party
    In most transactions, the buyer requires some form of financing in
order to close her purchase. In the absence of any express term in the
contract dealing with financing, the baseline rule is that the buyer
must pay “all cash.” This means that the buyer promises to arrive
at closing with the entire purchase price. The buyer takes on the risk
that she will not be able to produce the cash at closing. An all-cash
contract does not preclude the buyer from seeking and obtaining
financing from a lender. It’s just that she undertakes the risk that
she cannot get financing on affordable terms, or even at all.
    To reduce the risk stemming from an all-cash contract, the buyer
includes a mortgage condition. The seller and buyer have different
perspectives with respect to the mortgage condition. The seller prefers
broad language that obligates the buyer to accept almost any offer of a
mortgage loan made by a lending institution to the buyer. The buyer,
on the other hand, prefers a narrow condition that allows the buyer to
withdraw from the transaction, with a full refund of earnest money,
if the buyer cannot get a mortgage loan with a specifically defined
set of parameters. This is the only way the buyer can control both
the amount of money required to close the loan and the monthly
payments on the loan.
    A clause for a fixed-rate mortgage typically is reasonably specific
and relieves the buyer who cannot find acceptable financing. A sample
of such a clause is provided below.




 36.    V.R.W., Inc. v. Klein, 503 N.E.2d 496 (N.Y. 1986). Accord Sanderson v.
        Heffington, 757 P.2d 866 (Or. Ct. App. 1988).
 37.    First Am. Title Ins. Co. v. Kevlin, 610 N.Y.S.2d 361 (App. Div. 3d Dep’t
        1994).
 38.    Auburn Cordage, Inc. v. Revocable Trust Agreement of Treadwell, 848
        N.E.2d 738 (Ind. Ct. App. 2006) (landlord mortgaged its property to
        secure loan to tenant to finance tenant’s improvements); First Nat’l Bank
        & Trust Co. v. Brakken, 468 N.W.2d 633 (N.D. 1991) (mortgage given to
        secure loans made to mortgagor ’s sons, which were past due and
        renegotiated).



                                    3–10
                              Mortgage Financing                            § 3:2

                                     CLAUSE 3-1

                       Clause for Fixed-Income Mortgage

    Buyer’s obligation to close this purchase is conditioned on Buyer
    obtaining from a lending institution a commitment for a conven-
    tional first mortgage loan for $_____, at a fixed-interest rate not to
    exceed ___% per annum, payable in equal monthly installments
    over a term of ___ years, for which Buyer shall not be required to
    pay in excess of ___ points for discount, origination, or similar fees.
    Buyer shall apply for such a loan within ___ business days from the
    date hereof and shall use best efforts to obtain a loan within these
    guidelines, but shall not be required to apply to more than one
    lender. If Buyer is unable to obtain such a commitment within ___
    days from the date hereof, this agreement shall terminate and the
    earnest money shall be returned to Buyer; provided, Buyer may,
    within the time above specified, choose to waive all or any of the
    foregoing conditions.

   This “best efforts” clause is short and flexible. A more detailed
explanation of the buyer ’s duty to seek the loan is provided below.

                                     CLAUSE 3-2

                               “Best Efforts” Clause

    Buyer will endeavor in good faith to obtain a mortgage loan on said
    terms, shall supply any prospective mortgagee with such informa-
    tion as the latter shall request, shall pay the usual charges therefor,
    and shall execute and deliver the mortgage instruments and other
    papers customarily used by such institution.

   Standard contract law principles govern the interpretation and en-
forcement of financing provisions. Reformation of an improperly drafted
provision is one example. Problems with the parties’ selection of numbers
comes up regularly. When a mistake is made in drafting the seller
financing clause, a party may seek reformation. In one case, a court
granted this relief when parties made a mathematical mistake with respect
to payments required to amortize a purchase-money mortgage loan.39




 39.      Mathis v. Wendling, 962 P.2d 160 (Wyo. 1998) (mutual mistake in contract
          for deed for purchase of ranch; contract clearly specified note amount,
          interest rate, and term; buyer required to make further payments to
          amortize debt).



(Friedman on Contracts, Rel. #7, 5/09)   3–11
§ 3:2.1                        FRIEDMAN    ON   CONTRACTS

   § 3:2.1          Buyer’s Affirmative Obligation to Seek
                    the Mortgage
   Lack of mutuality does not render a contract unenforceable if the
buyer is under an affirmative obligation to seek the mortgage. 40
Inasmuch as mortgages are usually obtained only by application of
the borrower, a condition that a mortgage be obtained appears distinct
from an obligation that the buyer make an effort to obtain the
mortgage.41 This would make all these agreements enforceable. How-
ever, it is good practice, and one probably followed by careful practi-
tioners everywhere, to include an express obligation by the buyer to
make bona fide efforts to obtain the mortgage, or to comply with
whatever other conditions may be involved, and to prosecute such
efforts to completion with diligence and continuity.42 A distinction
might be made between a provision entitling the purchaser to a refund
of his down payment if he “shall be unable to obtain approval” and a
provision “subject to” granting of approval. The former directly implies



 40.      The purchaser ’s promise to endeavor to obtain financing was held suffi-
          cient consideration in White & Bollard, Inc. v. Goodenow, 361 P.2d 571
          (Wash. 1961).
 41.      Wooten v. DeMean, 788 S.W.2d 522 (Mo. Ct. App. 1990); Rhodessa Dev.
          Co. v. Simpson, 658 S.W.2d 218 (Tex. Ct. App. – El Paso 1983). Purchaser
          is under an implied duty to apply for the mortgage, Schottland v. Lucas,
          396 So. 2d 72 (Ala. 1981). Billman v. Hensel, 391 N.E.2d 671, 673 (Ind.
          Ct. App. 1979); Wiggins v. Shewmake, 374 N.W.2d 111, 116 (S.D. 1985);
          Covington v. Robinson, 723 S.W.2d 643 (Tenn. Ct. App. 1986); Carroll v.
          Wied, 572 S.W.2d 93 (Tex. Civ. App. 1978); Manning v. Bleifus, 272 S.E.2d
          821 (W. Va. 1980); see also Dodson v. Nink, 390 N.E.2d 546 (Ill. App. Ct.
          1979).
              “The parties quite clearly intended a binding contract to purchase, not
          a mere option . . . in the plaintiff to purchase without any obligation of
          affirmative action on his part.” Stabile v. McCarthy, 145 N.E.2d 821, 823
          (Mass. 1957); accord Abrams v. Motter, 83 Cal. Rptr. 855, 861 (2d Dist.
          Ct. App. 1970); Aubert v. Bourg, 259 So. 2d 103, 106 (La. Ct. App. 1972);
          Williams v. Cormier, 100 So. 2d 307 (La. Ct. App. 1958); Szelik v.
          Bonsignore, 145 N.Y.S.2d 659 (Sup. Ct. Nassau County 1955), aff ’d, 164
          N.Y.S.2d 1003 (App. Div. 2d Dep’t 1957); Mezzanotte v. Freeland, 200
          S.E.2d 410 (N.C. Ct. App. 1973); Aldrich v. Forbes, 391 P.2d 748, 750 n.5
          (Or. 1964) (quoting this treatise); Anaheim Co. v. Holcombe, 426 P.2d 743
          (Or. 1967); Jamison v. Concepts Plus, Inc., 552 A.2d 265 (Pa. Super. Ct.
          1988) (application for subdivision).
              Where the application is to be made on purchaser ’s behalf by another,
          purchaser is under an implied obligation to cooperate. Alois v. Waldman,
          149 A.2d 406 (Md. 1959) (failure barred purchaser ’s recovery of down
          payment).
 42.      A purchaser who had agreed to apply for a mortgage was held to default the
          down payment on changing her mind and abandoning the mortgage
          application. Bushmiller v. Schiller, 368 A.2d 1044 (Md. Ct. Spec. App.
          1977).



                                       3–12
                             Mortgage Financing                                § 3:2.1

an affirmative covenant on the purchaser ’s part to obtain the specified
approval,43 for failure of which he is liable in damages.44 Arguably the
latter imposes no obligation to act, thus depriving the contract of
mutuality, but the better reasoning is that a “subject to financing”
clause also impliedly obligates the buyer to seek financing.45

              [A] Down Payment
   The dollar amount specified in the financing condition is highly
important. The buyer is responsible for coming up with cash equal
to the difference between the price and the specified loan amount.
Institutional lenders will refuse to issue a commitment unless the
buyer can demonstrate the source of the down payment. A buyer
who cannot obtain a commitment for this reason is in default.46
A mortgage condition that fails to specify the principal amount of the
buyer ’s loan is badly flawed. A Louisiana court had held that a
condition calling for the amount “to be determined” does not allow
a buyer to terminate the contract.47




 43.      Stabile v. McCarthy, 145 N.E.2d 821 (Mass. 1957); Sorota v. Baskin, 134
          N.E.2d 428 (Mass. 1956); Burst v. R.W. Beal & Co., 771 S.W.2d 87 (Mo.
          Ct. App. 1989) (based on “availability” of financing); accord Glassie v.
          King, 360 F.2d 503 (D.C. Cir. 1965) (purchaser denied recovery of down
          payment); Lach v. Cahill, 85 A.2d 481 (Conn. 1951) (contract “contin-
          gent” on purchaser ’s ability to obtain loan); Rand v. B.G. Pride Realty, 350
          A.2d 565 (Me. 1976); Norgate Homes, Inc. v. Cent. State Bank, 440
          N.Y.S.2d 51 (App. Div. 2d Dep’t 1981) (application to subdivide); Renovest
          Co. v. Hodges Dev. Corp., 600 A.2d 448 (N.H. 1991) (discusses reasonable
          efforts); W. Hills, Or., Ltd. v. Pfau, 508 P.2d 201 (Or. 1973).
              Where the contingency is based on purchaser ’s ability to obtain a loan,
          purchaser must allege his inability in order to recover his down payment.
          Sheldon Simms Co. v. Wilder, 131 S.E.2d 854 (Ga. Ct. App. 1963)
          (complaint held subject to demurrer).
 44.      See Widebeck v. Sullivan, 99 N.E.2d 165 (Mass. 1951).
 45.      Inv. Syndicates, Inc. v. Clark, 478 P.2d 752 (Wash. Ct. App. 1970) (contract
          made “subject to formation of group for this purchase” is not illusory;
          parties understood this meant subject to financing; buyer entitled to
          specific performance).
 46.      Billman v. Hensel, 391 N.E.2d 671 (Ind. Ct. App. 1979) (buyer could not
          persuade his parents to supply additional funds); Lynch v. Andrew, App.
          623, 481 N.E.2d 1383 (Mass. App. Ct. 1985) (buyers were short of funds
          because they had not sold existing residence; lender was willing to make
          bridge loan, which buyers refused to accept).
 47.      La. Real Estate Comm’n v. Butler, 899 So. 2d 151 (La. Ct. App. 2005).
          Buyers contracted to purchase a home for $770,000, giving a deposit of
          $12,500. A mortgage contingency specified an interest rate of 8.5% with
          the loan amount “to be determined.” The buyers applied for a loan of 90%
          of the price, but were rejected. The sellers refused to return their deposit.
          The court held for the sellers because there was no evidence that the buyers



(Friedman on Contracts, Rel. #7, 5/09)   3–13
§ 3:2.1                         FRIEDMAN    ON   CONTRACTS

   A contract to close when the purchaser has arranged financing
agreeable to him has been held conditional. 48 It has been suggested
that a reference to uncertain purchase money financing must neces-
sarily be intended to create a condition.49 Any doubt in these cases can
be avoided by specifying whether the parties contemplate a condition
or a mere postponement of the time for performance.
   Even performance of the condition was held not to bar rescission of
a conveyance in a case where the contract of sale was subject to the
purchaser ’s obtaining a G.I. mortgage. Approval of such a mortgage
required a termite certificate, which proved to be incorrect. 50
   An FHA mortgage may present a problem in requiring “points,” the
common term for a mortgage premium. A mortgagor is legally
forbidden to make this payment; but this puts the seller under no
obligation to pay this charge, although the contract of sale is subject to
a mortgage “on F.H.A. terms.”51 But when a seller agreed, after
execution of a contract of sale, to pay a mortgage company discount,
to enable the purchaser to obtain the specified mortgage and convert




          could not obtain 8.5% financing for a smaller loan amount. It observed
          that the buyers inserted the words “to be determined” in the broker’s form
          contract, stating that any ambiguity must be construed against the party
          who “furnished the text in question.” The court also rejected the buyers’
          arguments that the contract was indefinite and was subject to a mutual
          mistake. A realtor testified that 40% of the purchase agreements in the
          community used the “to be determined” language, a practice that ob-
          viously ought to change in the decision’s wake.
 48.      Locke v. Bort, 103 N.W.2d 555 (Wis. 1960). Annot., Vendor and Purchaser:
          Contract Provision Referring to Purchaser’s Uncompleted Arrangement for
          Financing the Balance of Purchase Price as Creating a Condition Prece-
          dent, 81 A.L.R.2d 1338 (1962); see Gerruth Realty Co. v. Pire, 115 N.W.2d
          557 (Wis. 1962).
 49.      Aiken, “Subject to Financing.” Clauses in Interim Contracts for Sale of
          Realty, 43 MARQ. L. REV. 265, 271 (1960).
              But a contract requiring purchaser to pay $2,250 cash and obtain the
          balance by a thirty-year conventional loan was held unconditional. Hawk
          v. Daugherty, 251 S.E.2d 390 (Ga. Ct. App. 1978) (purchaser not entitled
          to refund; collects Georgia cases).
 50.      In re Wilson v. Romeos, 199 N.W.2d 208 (Mich. 1972); In re N. Broadway
          Funding Corp., 6 B.R. 133 (Bankr. E.D.N.Y. 1980).
              Seller is likewise under no duty to make repairs necessary to conform
          the premises to F.H.A. specifications. Warriner v. Superior Court of
          Maricopa County, 519 P.2d 81 (Ariz. Ct. App. 1974). Accord Dodson v.
          Nink, 390 N.E.2d 546 (Ill. App. Ct. 1979).
              Contra Walsh v. Kelly, 406 N.E.2d 741 (N.Y. 1980), ruling that seller ’s
          implied agreement not to interfere with or prevent performance by
          purchaser of the condition specified required seller to pay the “points” to
          the extent that the FHA forbade payment by the purchaser.
 51.      Rocker v. Murphy, 322 N.E.2d 541 (Ill. App. Ct. 1975).



                                       3–14
                             Mortgage Financing                              § 3:2.1

the purchaser ’s liability from contingent to unconditional, the seller ’s
agreement was held supported by adequate consideration.

              [B] “Reasonable Efforts”
   If the contract requires the buyer, whether expressly or by implica-
tion, to make reasonable efforts to obtain a mortgage loan, there will
necessarily be uncertainty about what efforts should be made. 52 What
will constitute reasonable efforts is largely a question of fact and
entails a showing by the party under the duty to act of activity
reasonably calculated to obtain the object in question or expenditure
not disproportionate in the circumstances.53 The purchaser ’s personal
contacts with several financial institutions were deemed “reasonable
efforts”, although no formal loan application was made. 54 A distinc-
tion has been drawn between reasonable efforts and good-faith efforts,
the former involving an objective determination and usually greater
efforts, the latter involving a subjective determination. On this basis a
requirement that the purchaser proceed immediately and with dili-
gence was not satisfied with good-faith efforts.55 Absent specifics, a
mortgage contingency clause requires only good faith.56 “Best efforts”
require more than good-faith efforts.57
   “Best efforts” have been defined in various ways, as more demand-
ing than due diligence, as an “unprovable standard,” and as “clatter-
some shambles,” depending on its mechanism.58
   It would make for clarification and, from the purchaser ’s point of
view, safety, for a contract of sale to require him to make one or a
specified number of mortgage applications to lending institutions and
supply them with the information they require. This would still leave
open the nature of the mortgage—Will it require the mortgagee to
apply insurance proceeds to repair damage? Will it contain a due-on-
sale clause?, etc., or some requirement, such as that the purchaser sell




 52.      WYDA Assocs. v. Merner, 50 Cal. Rptr. 2d 323, 330 (Dist. Ct. App. 1996).
          This does not consider purchaser ’s possible waiver of the condition before
          seller cancels.
 53.      In re J.B. Van Sciver Co., 73 B.R. 838, 844–47 (Bankr. E.D. Pa. 1987);
          Allview Acres, Inc. v. Howard Inv. Corp., 182 A.2d 793 (Md. 1962); Smith
          v. Currie, 253 S.E.2d 645 (N.C. Ct. App. 1979) (obtaining mortgage).
          Annot., Sufficiency of Real-Estate Buyer’s Efforts to Secure Financing upon
          Which Sale Is Contingent, 78 A.L.R.3d 880 (1977).
 54.      Case v. Forloine, 639 N.E.2d 576 (Ill. App. Ct. 1993).
 55.      Phillipe v. Thomas, 489 A.2d 1056 (Conn. App. Ct. 1985).
 56.      Blass v. Miller, 588 N.Y.S.2d 940, 942 (App. Div. 3d Dep’t 1992).
 57.      Grossman v. Lowell, 703 F. Supp. 282 (S.D.N.Y. 1989) (application to one
          bank and phone calls to three others insufficient).
 58.      In re Heard, 6 B.R. 876, 883–84 (Bankr. W.D. Ky. 1980).



(Friedman on Contracts, Rel. #7, 5/09)   3–15
§ 3:2.1                         FRIEDMAN    ON   CONTRACTS

an existing house or apartment that he may want available for
his family.
   Recovery of a down payment was denied where a bank revoked its
commitment to a husband and wife after the wife filed for divorce. 59
The result was otherwise when a purchaser lost his eligibility for a
mortgage when his employer relocated him to another state. 60
A purchaser whose application was rejected for insufficient income,
because he executed a second contract of sale for an in-law, recovered
his down payment.61
   A contract contingent on a buyer’s obtaining a $12,000 mortgage was
held in the circumstances to imply his promise to make reasonable
efforts to obtain a mortgage, but only on reasonable terms as to the
amount and time of installment payments. A commitment subject to
matters of substance beyond the scope of the contingent clause is no
commitment.62 A commitment conditioned on a purchaser ’s selling his




 59.      Bruyere v. Jade Realty Corp., 375 A.2d 600 (N.H. 1977). The bank relied
          on two wage earners for its security. Contra Stevens v. Cliffs at Princeville
          Assocs., 684 P.2d 965 (Haw. 1984) (wife not a co-purchaser).
 60.      Carmichael v. Lambert Constr. Co., 487 So. 2d 1367 (Ala. Ct. App. 1986).
 61.      Maynard v. Bazazzdegan, 732 S.W.2d 950 (Mo. Ct. App. 1987).
 62.      Sala v. Hay, 415 P.2d 330 (Colo. 1966); Lach v. Cahill, 85 A.2d 481 (Conn.
          1951) (purchase of home by young veteran in modest circumstances);
          Antonini v. Thrifty-Nifty Homes, 76 So. 2d 564 (La. Ct. App. 1955); Tieri
          v. Orbell, 162 A.2d 248 (Pa. Super. 1960).
              A contract subject to purchaser obtaining a mortgage implies an
          obligation on purchaser to reasonable efforts for this. Warstler v. Cibrian,
          859 S.W.2d 162 (Mo. Ct. App. 1993).
              A condition that purchaser obtain a twenty-year mortgage was held not
          complied with by an offer of a twenty-five-year mortgage with right of
          prepayment. Donato v. Baltrusaitis, 290 N.Y.S.2d 659 (Sup. Ct. Queens
          County 1958).
              A condition that seller have an existing mortgage extended requires
          only reasonable efforts to obtain the extension. Sorota v. Baskin, 134
          N.E.2d 428 (Mass. 1956).
              Annot., Sufficiency of Real Estate Buyer’s Efforts to Secure Financing
          upon Which Sale Is Contingent, 78 A.L.R.3d 880 (1977).
              The ordinary conditional contract of sale does not require purchaser or
          seller to satisfy extraordinary conditions imposed by a lender. Kimbrough v.
          Belk & Co., 256 S.E.2d 119 (Ga. Ct. App. 1979) (sale of purchaser ’s
          property); Dodson v. Nink, 390 N.E.2d 546 (Ill. App. Ct. 1979) (repairs by
          seller); Crane v. Mulliken, 408 N.E.2d 778 (Ill. App. Ct. 1980) (delivery of
          leases and financial records on sale of shopping center); McKenna v. Rosen,
          570 A.2d 1277 (N.J. Super. Ct. 1990); Farrell v. Janik, 542 A.2d 59 (N.J.
          Super. Ct. 1988) (same); Kressel, Rothlein & Roth v. Gallagher, 547
          N.Y.S.2d 653 (App. Div. 2d Dep’t 1989) (sale of purchaser ’s house; citing
          New York cases); Clarke v. Hartley, 454 N.E.2d 1322 (Ohio Ct. App. 1982)
          (sale of purchaser ’s property); Tighe v. Wilson, 427 N.E.2d 531 (Ohio Ct.
          App. 1980) (FHA requirement of appraisal).



                                       3–16
                             Mortgage Financing                              § 3:2.1

property is not a firm commitment.63 A long-term loan is implied.64
A buyer is not required to accept two mortgages;65 or to accept a single
mortgage for a lesser amount and obtain the balance elsewhere;66 or to
guaranty a corporate mortgage;67 or to agree to a due-on-sale clause.68
He need not accept terms more onerous than those specified in the
contract;69 or use a corporate applicant, instead of himself, to avoid
usury laws.70 Neither does the purchaser need to mortgage any
property other than that involved in the sale.71 A purchaser may
refuse to sign and deliver to a seller a purchase money mortgage that
was made, inter alia, additional security for the seller ’s debt to a third
party.72 A condition that a purchaser obtain a lending institution
mortgage permits him to reject a loan from an unincorporated group
with no evidence of financial responsibility.73 A buyer ’s failure to make



              Requirements that purchaser sell his house and also verify his monthly
          income were held not unreasonable. Welkind v. Hall, 503 A.2d 779 (N.H.
          1985). The problem presented by this case is to trap a purchaser into a
          forfeiture for guessing wrong. Purchaser may have valid reasons for keeping
          his present house—for other members of the family or for speculation.
              A contract specifying that purchaser apply for a loan at 10% interest
          was not broken by applying for 10.5% loan on terms otherwise the same.
          Clearly a lender refusing 10.5% would have refused 10%. Herbage v.
          Smoddy, 864 S.W.2d 695 (Tex. Civ. App. 1993).
 63.      Finkelman v. Wood, 609 N.Y.S.2d 655 (App. Div. 2d Dep’t 1994) (citing
          New York cases).
 64.      Rand v. B.G. Pride Realty, 350 A.2d 565 (Me. 1976), 78 A.L.R.3d 873
          (1977).
 65.      Merritt v. Davis, 265 So. 2d 69 (Fla. Dist. Ct. App. 1972); Slack v.
          Munson, 61 So. 2d 618 (La. Ct. App. 1952). Cf. Di Benedetto v. Di Rocco,
          93 A.2d 474 (Pa. 1953). But see Burris v. Craven, 477 A.2d 627 (Vt. 1984).
 66.      Finke v. Lemle, 252 P.2d 869 (Kan. 1953). See also Makris v. Nolan, 335
          A.2d 655 (N.H. 1975).
 67.      Educ. Placement Serv., Inc. v. Watts, 789 S.W.2d 902 (Tenn. Ct. App. 1990).
 68.      Maccaro v. Andrick Dev. Corp., 311 S.E.2d 91 (S.C. 1984).
 69.      Williams v. Enmon, 380 So. 2d 144 (La. Ct. App. 1979). An obligation to
          apply for a fixed rate mortgage, with a right to apply for any other kind,
          permitted purchaser to cancel the contract on rejection of the fixed rate.
          Carrol v. Harry, 402 S.E.2d 357 (Ga. Ct. App. 1991).
 70.      Young v. Koehl, 417 So. 2d 24 (La. Ct. App. 1982) (alternate decision).
 71.      Kinmonth v. Griffith, 304 P.2d 494 (Kan. 1956). But see Lynch v. Andrew,
          481 N.E.2d 1383 (Mass. App. Ct. 1985).
 72.      W. Bay Realty Corp. v. Gad-Sal Realty Corp., 392 N.Y.S.2d 83 (App. Div. 2d
          Dep’t 1977).
 73.      Asplund v. Marjohn Corp., 168 A.2d 844 (N.J. Super. Ct. 1961). Accord
          Dawson v. Malloy, 428 So. 2d 297 (Fla. Dist. Ct. App. 1983) (conditioned
          on institutional mortgagee’s permitting purchaser to assume existing
          mortgage); Woods v. Austin, 347 So. 2d 897 (La. Ct. App. 1977); Berman
          v. Rife, 644 S.W.2d 574 (Tex. Civ. App. 1982).
              In Glassman v. Gerstein, 200 N.Y.S.2d 690 (App. Div. 2d Dep’t 1960),
          a purchaser, whose contract was conditioned on his getting money from a



(Friedman on Contracts, Rel. #7, 5/09)   3–17
§ 3:2.1                         FRIEDMAN     ON   CONTRACTS

written application for a mortgage, as required by his contract, was
deemed immaterial and insufficient to prevent recovery of his down
payment, where he had made a bona fide oral application that failed
because of inadequate income.74
   A purchaser ’s failure to notify a seller of failure to obtain a mortgage
within the time specified therefore is the subject of contrary results.
Some courts overlook a purchaser ’s delay on the ground that time is
not of the essence. Others note the harm to a seller of keeping his
property off the market while the purchaser gambles with the property.75




          lending institution, was held entitled to reject seller ’s offer of a mortgage
          on even better terms where he claimed an unwillingness to accept private
          financing. Perhaps seller should expressly reserve a right to accept a
          mortgage in this situation if consummation of the transaction is suffi-
          ciently important to him.
              The same court, in a 3-2 decision, permitted a seller to give a mortgage
          on terms similar to those specified in the contract. The contract was
          subject to purchaser ’s securing a mortgage, no reference to “institution”
          being made. But purchaser agreed to apply to lending institutions. On his
          failure, seller had the option to secure the mortgage. The dissent argued
          that seller could not “secure” a mortgage from himself, and that references
          in the contract to processing costs and escrow deposits, and provision for
          closing title at the office of an institution, all reflected the parties’
          intentions. Marino v. Nolan, 266 N.Y.S.2d 65 (App. Div. 2d Dep’t
          1965), aff ’d, 219 N.E.2d 291 (N.Y. 1966).
              A purchaser who agreed to apply to an institution was held under no
          duty to accept a mortgage from seller on conditions customarily different
          from those given by institutions. Katz v. Chatelain, 321 So. 2d 802 (La. Ct.
          App. 1975).
 74.      Bellina v. Graybar, 532 So. 2d 847 (La. Ct. App. 1988); accord Elghanyan v.
          Mundy, 639 N.Y.S.2d 175 (App. Div. 2d Dep’t 1996) (purchaser rejected
          because of business losses); Gast v. Miller, 541 N.E.2d 497 (Ohio Mun. Ct.
          Hamilton County 1988); see Saltzman v. McCombs, 281 P.2d 394 (Nev.
          1955). Compare Giba v. Bastian, 229 A.2d 93 (Md. 1967), note 129, infra.
 75.      That is, purchaser ’s time to give notice of failure was not of the essence.
          Foelsch v. Eaton, 180 N.Y.S.2d 757 (App. Div. 2d Dep’t 1958), modifying
          and aff ’g 172 N.Y.S.2d 243 (Sup. Ct. Nassau County 1958). Cf. Zuk v.
          Irion, 171 N.Y.S.2d 465 (Sup. Ct. Nassau County 1958). A requirement
          that purchaser give written notice was waived by acceptance of parol
          notice. Dellicarri v. Hirschfeld, 619 N.Y.S.2d 816 (App. Div. 3d Dep’t
          1994). Contra Thakral v. Mattran, 509 N.E.2d 772 (Ill. App. Ct. 1987).
              Purchaser ’s application within twenty-two days, instead of a required
          six days, was held immaterial when purchaser ’s income would have
          justified rejection of a mortgage. Nicholls v. Pitoukkas, 491 N.E.2d 574
          (Ind. Ct. App. 1986). Such delay may keep property off the market longer
          than seller intends.
              Purchaser was under no implied obligation to notify seller of the
          rejection, resulting in substantial loss to seller. Meaux v. Adams, 456
          So.2d 670 (La. Ct. App. 1984). Contra Perrino v. Hogan, 572 N.Y.S.2d 523
          (App. Div. 3d Dep’t 1991).



                                        3–18
                             Mortgage Financing                                § 3:2.1

A purchaser’s notice within the required time ends the contract.76
A purchaser’s suggested changes in the contract thereafter is a counter-
offer without effect by itself.77 The cases do not agree if time is of the
essence in giving notice in this situation.78 Recent cases have required
purchasers to comply with some reasonable requirements not men-
tioned in the contract of sale.79 A purchaser’s arbitrary failure to apply
for a mortgage80 or an application on terms different from those
specified in the contract81 makes the contract unconditional.




              Foelsch, 180 N.Y.S.2d 757, modifying and aff ’g, 172 N.Y.S.2d 243,
          holds time is not of the essence but must be deemed overruled by Cortesi,
          534 N.E.2d 313, modifying 524 N.Y.S.2d 874, which remanded the case to
          determine if notice to seller was given within the required time. Cf. Zuk v.
          Irion, 171 N.Y.S.2d 465 (Sup. Ct. Nassau County 1958).
              See also Merrill Lynch Realty/Carll Burr, Inc. v. Skinner, 63 N.Y.2d 590
          (1984).
              Churgin v. Hobbie, 635 N.E.2d 1280 (Mass. App. Ct. 1995), reviewing
          Massachusetts cases, holds an extension of time to close title is no
          extension of time to give notice of failure to obtain a mortgage commit-
          ment. Purchaser ’s deposit was forfeited.
 76.      In re Stafford’s In The Field, Inc., 162 B.R. 29 (Bankr. D.N.H. 1996).
 77.      Id.
 78.      Faulkner v. Millar, 460 S.E.2d 378 (N.C. 1995) (time not of essence in
          reporting feasibility study, partly dictum).
 79.      Lynch v. Andrew, 481 N.E.2d 1383 (Mass. App. Ct. 1985) (requires
          purchaser to accept bridge loan on existing house, that is, a temporary
          loan, to have enough money to complete transaction); Fry v. George Elkins
          Co., 327 P.2d 905 (Cal. Dist. Ct. App. 1958) (2% prepayment premium
          during first three years); Farrell v. Janik, 542 A.2d 59, 62 (N.J. Super. Ct.
          1988) (dictum re termite inspection and certificate of employment); see
          also cases in Lynch, 481 N.E.2d at 1386; cases in 78 A.L.R.2d 880 (1977).
 80.      Cobbs v. Fred Burgos Constr. Co., 477 So. 2d 335 (Ala. 1985); Schottland v.
          Lucas, 396 So. 2d 72 (Ala. 1981); Smith v. Tiblier, 374 So. 2d 685 (La. Ct.
          App. 1979); Hendel v. Scheuer, 541 N.Y.S.2d 40 (App. Div. 2d Dep’t 1989)
          (purchaser loses down payment); Gasparino v. Rigatti, 554 N.Y.S.2d 696
          (App. Div. 2d Dep’t 1990); Hamilton v. Harborview Dev. Partners, 359
          S.E.2d 516 (S.C. Ct. App. 1987).
 81.      Price v. Bartkowiak, 715 F. Supp. 76 (S.D.N.Y. 1989) (larger mortgage and
          longer term); Goldberg v. Charlie’s Chevrolet, Inc., 672 S.W.2d 177 (Mo.
          Ct. App. 1984) (application for larger financing than specified); Post v.
          Mengoni, 604 N.Y.S.2d 186 (App. Div. 2d Dep’t 1993) (application for
          larger mortgage than specified); Silva v. Celella, 545 N.Y.S.2d 367 (App.
          Div. 2d Dep’t 1989); Smith v. Evans, 620 S.W.2d 627 (Tex. Civ. App. 1981).
              But a contract conditioned on purchasers obtaining a mortgage “not
          less than ____” permitted application for a larger mortgage and recapture of
          a down payment for failure. Slamow v. Delcol, 594 N.E.2d 918 (N.Y.
          1992). This language is virtually an open invitation to purchaser ’s break-
          ing the contract at will.



(Friedman on Contracts, Rel. #7, 5/09)   3–19
§ 3:2.1                         FRIEDMAN    ON   CONTRACTS

   A purchaser is not to be penalized for making a truthful applica-
tion, although his candor makes rejection virtually certain, 82 and
where rejection is certain, a purchaser was not required to await
formal rejection.83 A buyer was held to have broken the contract by
stopping his check for the down payment within three days, after one
bank had rejected his application for a mortgage. Subsequent efforts to
obtain a loan after the breach were deemed immaterial. 84

             [C]    Conditions
    If a contract is subject to a purchaser ’s obtaining a mortgage, the
existence of other adequate assets of the purchaser is irrelevant. 85
    A purchaser may well provide that his obligation to seek a loan will
be satisfied if he retains a specified broker—a party qualified in this specialized
field—to obtain the loan, whether or not the broker succeeds.86 Generally,
whether the purchaser acted in good faith is a jury question.87 A seller
may terminate the contract after the specified time has run,88 but


 82.      M.F.&G. Trading Co. v. Jensen, 107 S.E.2d 441 (Va. 1959); Holst v. Guynn,
          696 P.2d 632 (Wyo. 1985) (purchaser informed V.A. of loss of
          employment).
 83.      Levine v. Robin, 277 N.Y.S.2d 474 (App. Div. 2d Dep’t 1967) (house lacked
          certificate of occupancy).
 84.      Bayon v. Pettingill, 77 So. 2d 202 (La. Ct. App. 1955). Purchaser ’s
          cancellation of a check for a down payment after one day entitled seller
          to a judgment for the amount of the check. Korabel v. Natoli, 619 N.Y.S.2d
          833 (App. Div. 3d Dep’t 1994).
 85.      Kelly v. Terrill, 268 N.E.2d 885 (Ill. App. Ct. 1971) (purchaser recovered
          down payment).
 86.      The contract may name a mortgage broker who is qualified to arrange the
          type of loan needed, or the listing or selling broker. Frequently, the broker
          who effects the sale of a home obtains the mortgage as a matter of course
          and without compensation other than his sales commission.
              A New Jersey statute has been construed to deny a broker a right to a
          commission for obtaining a home loan if he represents either party to the
          transaction for compensation. N.J. REV. STAT. § 45:15-17(i) (1990); Mort-
          gage Banker ’s Ass’n v. N.J. Real Estate Comm’n, 491 A.2d 1317 (N.J.
          Super. Ct. 1985) (extended discussion of mortgage practice). Similar
          statutes elsewhere may lead to similar results.
 87.      Murphy v. Morse, 100 S.E.2d 623 (Ga. Ct. App. 1957); Osten v. Shah, 433
          N.E.2d 294 (Ill. 1982); Honkomp v. Dixon, 422 N.E.2d 949 (Ill. App. Ct.
          1981) (application to one institution); Falk v. Goodman, 163 N.E.2d 871
          (N.Y. 1959).
              Under a contract that was subject to purchaser ’s obtaining a $35,000
          mortgage, purchaser ’s application to one bank for a $40,000 loan and his
          inquiry at a second bank was held no bona fide effort. Beekay Realty Corp.
          v. Cayre, 256 So. 2d 539 (Fla. Dist. Ct. App. 1972).
 88.      Hanson v. Moeller, 376 N.W.2d 220 (Minn. Ct. App. 1985); Opton
          Handler Gottlieb Feller Landau & Hirsch v. Patel, 610 N.Y.S.2d 26 (App.
          Div. 1st Dep’t 1994) (same; down payment of $100,000 forfeited); Ferlita v.
          Guarneri, 524 N.Y.S.2d 94 (App. Div. 2d Dep’t 1988) (purchaser ’s time to



                                       3–20
                             Mortgage Financing                                § 3:2.1

may not obstruct or delay a purchaser ’s efforts and then cancel
the contract on the basis of the purchaser ’s failure to timely per-
form.89 A contract conditional on a purchaser ’s receiving an FHA
mortgage within fifteen days was held to permit the purchaser to
rescind after fifteen days, despite subsequent FHA approval.90 One
purchaser recovered his down payment in a case involving a contract
conditioned on his obtaining a mortgage in six weeks, where he
obtained a timely commitment, but the lender changed his mind
during a delay caused by the seller ’s defective title.91 If a purchaser
fails to obtain a mortgage commitment within a specified period, he
may cancel the contract, and the fact that a commitment is subse-
quently available is immaterial.92 In this situation, a seller has also
been held authorized to cancel despite the purchaser ’s suit for specific
performance.93 A purchaser ’s right to a refund of the down payment if
he did not succeed in getting a mortgage within fifteen days was not
waived by continuing his efforts thereafter.94 But where a purchaser
accepted a later commitment, and scheduled a closing, he could no
longer withdraw without being in breach of contract.95 A purchaser



          obtain mortgage). Accord Levine v. Trattner, 516 N.Y.S.2d 43 (App. Div. 2d
          Dep’t 1987) (two-and-a-half month delay). But cf. Lang v. Blumenthal, 609
          N.Y.S.2d 336 (App. Div. 2d Dep’t 1994) (delayed application immaterial;
          time not of essence).
              A clause permitting either purchaser or seller to cancel after forty-five
          days was deemed for the benefit of both and could be waived by purchaser,
          who elected to cancel. Foster v. Lall, 516 N.Y.S.2d 570 (Sup. Ct. Queens
          County 1987).
              But time to obtain a mortgage commitment has been held not of the
          essence, Kakalik v. Bernardo, 439 A.2d 1016, 1019–20 (Conn. 1981), same
          as in delivery and acceptance of a deed.
 89.      Merrill Lynch Realty/Carll Burr, Inc. v. Skinner, 63 N.Y.2d 590 (1984);
          Schwartz v. Donnenberg, 168 N.Y.S.2d 31 (Sup. Ct. Nassau County 1957)
          (seller delayed inspection by mortgage appraiser); Meyer v. Custom Manor
          Homes, 167 N.Y.S.2d 112 (App. Div. 4th Dep’t 1957) (seller failed to
          comply with agreement to apply for mortgage); RESTATEMENT (SECOND) OF
          CONTRACTS § 245 (1981); 3A A. CORBIN, CONTRACTS § 767 (1960).
 90.      Soudelier v. Whitney, 141 So. 2d 91 (La. Ct. App. 1962). Accord Gardner v.
          Padro, 517 N.E.2d 1131 (Ill. App. Ct. 1987).
 91.      Patterson v. Marchese, 173 N.Y.S.2d 759 (Sup. Ct. Westchester County
          1958), aff ’d, 196 N.Y.S.2d 903 (App. Div. 2d Dep’t 1960).
 92.      Sainato v. Hormozdi, 448 N.Y.S.2d 240 (App. Div. 2d Dep’t 1982); Zigman
          v. McMackin, 177 N.Y.S.2d 723 (App. Div. 2d Dep’t 1958); Weschler v.
          Winter, 190 N.Y.S.2d 828 (N.Y. Sup. Ct. Nassau County 1959).
 93.      McDonald v. Cullen, 559 P.2d 506 (Or. 1977).
 94.      Abramson v. Briardale Builders, Inc., 156 N.E.2d 607 (Ill. App. Ct. 1959);
          Baumann v. Brittingham, 759 S.W.2d 880 (Mo. Ct. App. 1988).
 95.      Loper v. O’Rourke, 382 N.Y.S.2d 663 (Dist. Ct. Suffolk County 1976)
          (purchaser sought withdrawal by reason of matrimonial problem). Accord
          Keliher v. Cure, 534 N.E.2d 1133 (Ind. Ct. App. 1989).



(Friedman on Contracts, Rel. #7, 5/09)   3–21
§ 3:2.1                          FRIEDMAN     ON   CONTRACTS

entitled to a refund of his down payment in this situation was held
entitled to interest thereon.96

             [D]     Mortgage Terms
    A contract “subject to necessary financing,” or with similar lan-
guage, is unsatisfactory because of the uncertainty it may generate.
It has been held to make a contract void for indefiniteness unless the
surrounding circumstances show what the parties had in mind.97
It has also been held to permit the purchaser alone to determine what
is “necessary” for him, subject to good faith on his part.98 The same is




 96.      Holst v. Guynn, 696 P.2d 632 (Wyo. 1985).
 97.      Garner v. Brown, 171 S.E.2d 391 (Ga. Ct. App. 1969); Perkins v.
          Gosewehr, 295 N.W.2d 789 (Wis. 1980) (subject to commitment for
          $52,000 void for indefiniteness); Gerruth Realty Co. v. Pire, 115 N.W.2d
          557 (Wis. 1962), noted in 46 MARQ. L. REV. 388 (1963). Accord Miracle
          Revival Ctr. Move of God Church v. Kindred, 615 S.W.2d 257 (Tex. Civ.
          App. 1981). Contra In re Flannery, 11 B.R. 974 (Bankr. E.D. Pa. 1981).
               See also Locke v. Bort, 103 N.W.2d 555 (Wis. 1960).
               Under a contract “contingent on the Buyer obtaining a mortgage at his
          terms,” buyer unsuccessfully sought a $21,000 mortgage and then, at
          seller ’s suggestion, unsuccessfully tried another bank. Buyer recovered his
          down payment. The contract was held conditional, despite the failure to
          fill in the blank, largely on the basis of practical construction by the parties.
          Grayson v. LaBranche, 225 A.2d 922 (N.H. 1967) (citing text). Failure to
          fill in these blanks does not make the contract unenforceable. Allen v.
          Smith, 508 N.Y.S.2d 331 (App. Div. 3d Dep’t 1986).
               A contract subject to “favorable financing” was held enforceable. Hunt
          v. Shamblin, 371 S.E.2d 591 (W. Va. 1988).
               A contract contingent on an FHA mortgage, and providing for payment
          of $20,350 from the FHA loan, contemplates a mortgage in that amount.
          Parker v. Averett, 151 S.E.2d 475 (Ga. Ct. App. 1966).
               Requiring purchaser to give notice, by a specified time, of failure to
          obtain a mortgage makes this time of the essence, so seller can promptly
          seek another purchaser. Tator v. Salem, 439 N.Y.S.2d 497 (App. Div. 3d
          Dep’t 1981). Accord R&R Insurers & Builders, Inc. v. Fink, 205 S.E.2d 297
          (Ga. 1974) (though closing scheduled for later date); Mouhelis v. Thomas,
          419 N.E.2d 956 (Il. App. Ct. 1981) (purchaser lost job). Contra Kakalik v.
          Bernardo, 439 A.2d 1016 (Conn. 1981) (seller, with informal actual
          knowledge, sought subterfuge to renege). See also Kelly v. Doran, 458
          A.2d 962 (Pa. Super. Ct. 1983) (issue whether seller waived notice).
               “Subject to adequate financing” is satisfied if financing is available in a
          nearby community. Moore v. Moore, 603 S.W.2d 736 (Tenn. Ct. App.
          1980).
 98.      Mezzanotte v. Freeland, 200 S.E.2d 410 (N.C. Ct. App. 1973) (“satisfactory
          financing”); Reese v. Walker, 151 N.E.2d 605 (Ohio Mun. Ct. Cincinnati
          1958); Kovarik v. Vesely, 89 N.W.2d 279 (Wis. 1958).
               Any indefiniteness in this situation is cured, sufficiently for purchaser
          to have specific performance against seller, when purchaser obtains



                                         3–22
                             Mortgage Financing                               § 3:2.1

true of “suitable financing.”99 But once the purchaser has made a
determination he is bound thereby, as where he files an application for
a loan and sets forth therein the specific terms that will be acceptable
to him.100 In one case, a purchaser determined a mortgage of $3,000,
plus the sale of certain shares, would be sufficient. The mortgage
proved available, but the shares failed to produce the expected sum.
The purchaser ’s inability to complete the sale was held to be his
fault.101 A contract subject to obtaining financing “reasonable” to the
borrower is construed objectively and governed by what others simi-
larly situated would consider reasonable.102 But a contract subject to a




          financing. Highlands Plaza, Inc. v. Viking Inv. Corp., 467 P.2d 378 (Wash.
          Ct. App. 1970). See generally Aiken, “Subject to Financing” Clauses in
          Interim Contracts for Sale of Realty, 43 MARQ. L. REV. 265 (1960). Contra
          Nodolf v. Nelson, 309 N.W.2d 397 (Wis. 1981).
              A contract subject to purchaser ’s obtaining a mortgage of “not more
          than $10,000” was deemed intended to permit the purchaser to determine
          the amount he needed, but not in excess of $10,000. Zigman v.
          McMackin, 177 N.Y.S.2d 723 (App. Div. 2d Dep’t 1958).
              Compare Mobil Oil Corp. v. Wroten, 303 A.2d 698 (Del. Ch. 1973)
          (and authorities collected); 1 A. CORBIN, CONTRACTS § 149 (1963); 3A Id.
          § 644 (1960).
              Every contract imposes on each party a duty of good faith and fair
          dealing in its performance and enforcement. RESTATEMENT (SECOND) OF
          CONTRACTS § 205 (1981) (and authorities cited).
              A contract of sale conditioned on purchaser obtaining a mortgage of “at
          least $ ____” permitted him to apply for a larger mortgage and recover his
          down payment for failure. Slamow v. Delcol, 571 N.Y.S.2d 335 (App. Div.
          2d Dep’t 1991). This clause gave purchaser a virtual revocable purchase
          option.
 99.      Gildea v. Kapenis, 402 N.W.2d 457 (Iowa Ct. App. 1987) (and cases
          discussed).
100.      Kovarik v. Vesely, 89 N.W.2d 279 (Wis. 1958).
101.      Barber v. Crickett [1958] N.Z.L.R. 1057, noted in 34 N.Z.L.J. 16, at 241
          (1958).
102.      Connell v. Avon Garage Co., 137 A.2d 765 (Pa. 1958); Kleiman v. White,
          476 S.W.2d 375 (Tex. Civ. App. 1972) (not reasonable to require loan of
          100% of value of land and improvement). But see Stone Mountain Props.
          v. Helmer, 229 S.E.2d 779 (Ga. Ct. App. 1976), where a contract subject
          to obtaining railroad’s approval for a spur line, satisfactory to purchaser,
          was held lacking in mutuality on the ground that “satisfaction” was
          wholly in purchaser ’s control; Hansen v. Circle Lake Dev. Corp., 260
          N.W.2d 609 (Neb. 1977) (contra conditional on “financing” held ambig-
          uous; purchaser recovered down payment despite commitment for 70%
          mortgage). The “satisfaction cases” generally take two lines. (1) Those
          allowing a subjective determination, usually involving feelings or taste,
          with the decision completely reserved to the party given the right of
          determination. It is said that a court may not inquire into the reason for
          the determination. But a court may find that a waiver has occurred,



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§ 3:2.1                        FRIEDMAN     ON   CONTRACTS

purchaser ’s obtaining “satisfactory” financing was held to be sub-
jective. The court distinguished between a condition existing before
any performance and “satisfaction” after a thing has been constructed
or repaired.103 A purchaser ’s “ability” to obtain financing for $16,000
has been held to involve not only the amount to be borrowed but the
rate of interest and length of time for amortization to fit his
circumstances, as well as a responsible lender. Parol evidence of this
was deemed competent.104 Parol evidence was also held competent to
determine the intention of the parties in inserting into a contract the
phrase “obtain maximum loan.”105
    On the other hand, a contract of sale subject to a purchaser ’s ability
to secure a mortgage for $10,500 for ten years was held invalid for
failure to specify the interest rate or terms of payment. 106 A contract
subject to the “best obtainable” first mortgage was held not to
authorize the purchaser to obtain a mortgage large enough to permit
him to pocket part of its proceeds and diminish the value of a junior
purchase mortgage to be delivered to the seller.107 A contract “subject
to bank financing” was held in the circumstances to mean for 65% of
the purchase price.108 A condition for a mortgage at a fixed rate of
interest is not fulfilled by one with an adjustable rate.109




          possibly when a flagrant abuse is found. (2) Those allowing an objective
          determination, easily judged by a reasonable man standard, e.g., operative
          fitness or mechanical utility. This line is preferred by courts when
          appropriate. Matters of financial concern fit into either line, more
          frequently in the second. These are apt to require consideration of the
          circumstances. It is possible to give one party complete discretion despite
          an objective situation. See the cases discussed in Forman v. Benson, 446
          N.E.2d 535 (Ill. App. Ct. 1983).
103.      Watkins v. Williamson, 869 S.W.2d 383 (Tex. Civ. App. 1993).
104.      Tieri v. Orbell, 162 A.2d 248 (Pa. Super. Ct. 1960). The court noted that a
          twenty-year mortgage on a $20,000 house is usual. Accord Reese v. Walker,
          151 N.E.2d 605 (Ohio Mun. Ct. Cincinnati 1958).
105.      Marlatt v. La Grange, 357 P.2d 927 (Colo. 1960). The court found $14,000
          or $14,475 as the maximum loan. Unable to obtain this, purchaser
          recovered his down payment.
106.      Scott v. Lewis, 112 Ga. App. 195, 144 S.E.2d 460 (1965); Neiss v. Franze,
          101 Misc. 2d 871, 422 N.Y.S.2d 345 (Sup. Ct. 1979) (provision for
          conventional mortgage).
107.      Antonelli v. Senate Realty Corp., 230 F. Supp. 776 (D.D.C. 1963).
108.      Makris v. Nolan, 335 A.2d 655 (N.H. 1975) (purchaser applied for
          $416,000, bank granted $340,000 loan, purchaser not obliged to accept
          second mortgage loan from seller for difference). The court called this kind
          of drafting a “plague.”
109.      Zepfler v. Neandross, 497 So. 2d 901 (Fla. Dist. Ct. App. 1986) (interest at
          no more than 13.5% not satisfied by one at 13% subject to increase with
          2.5% “cap”).



                                       3–24
                             Mortgage Financing                          § 3:2.1

              [E]    Lenders
    A seller has no claim against a prospective lender who revokes its
commitment to the purchaser. Any incidental benefit that would
otherwise accrue to the seller does not make him a creditor or donee
contract beneficiary.110
    An applicant for a mortgage must usually make a deposit with the
lender, which is often referred to as a standby or commitment fee. This
is generally not returnable if the loan fails to close, unless the failure is
the lender ’s fault. The deposit may be regarded as consideration for an
option agreement, consideration for the expenses of the loan, or an
enforceable provision for liquidated damages. A liquidated damage
provision is enforceable if reasonable in amount, because of the
difficulty of fixing precise damages—.5% to 3% is in this category. 111
In one case there was no operational language indicating the nature of
the fee and that the commitment was conditioned on 93% occupation
of the property. Occupancy was not that high. It was held that failure
of performance of a condition was no breach of contract, and return of
the deposit was ordered.112
    The possibility of an applicant’s forfeiture of a commitment or
standby fee makes it advisable for the applicant to know what
the prospective mortgage and related instruments will provide.
If the contract of sale requires a purchaser to accept a mortgage
with the mortgagee’s “usual provisions,” the applicant has little
leeway. Do the usual terms provide for a fixed or sliding rate of
interest or a due-on-sale clause? Must the mortgagee apply the
proceeds of insurance or an award in partial condemnation to
restoration of the property or may he use them to reduce the amount
of the mortgage? Does the mortgagor have a right of partial or full
prepayment of the mortgage and on what terms? Where a substantial
loan on commercial property is involved, the majority of the terms of
the prospective mortgage and related instruments should be settled at
an early stage.
    A lending institutional mortgagee has also been held liable to a
purchaser for misrepresentation or failure to disclose information. 113
A lending institution has been held not liable to a purchaser-mortgagor




110.      Khabbaz v. Swartz, 319 N.W.2d 279 (Iowa 1982).
111.      See Woodridge Place Apartments v. Wash. Square Capital, 965 F.2d 1429
          (7th Cir. 1992) (discussing cases); Annot., Enforcement of Provision in
          Loan Commitment Authorizing Lender to Charge Standby, Commitment
          Fee or Similar Deposit, 93 A.L.R.3d 1156 (1979).
112.      Woodbridge Place Apartments, 965 F.2d 1429.
113.      Miles v. Perpetual Sav. & Loan Co., 388 N.E.2d 1364 (Ohio 1979)
          (collecting authorities on agency and fiduciary relations).



(Friedman on Contracts, Rel. #7, 5/09)   3–25
§ 3:2.2                        FRIEDMAN    ON   CONTRACTS

for allegedly negligent review of commercial leases. The review was
deemed for the institution’s benefit not the purchaser ’s.114
   Purchasers often obtain residential purchase-money mortgages
through mortgage brokers. When a borrower gets a loan through a
mortgage broker, the borrower often pays an interest rate in excess of
the lender ’s “par” or market rate. The lender pays the value of the
excess—the yield spread premium—to the broker. Such payments
arguably constitute illegal referral fees under the Real Estate Settle-
ment Procedures Act (RESPA). In 1999 and 2001, the Department of
Housing and Urban Development (HUD) issued policy statements,
supportive of the lending industry, allowing the practice if: (i) the total
compensation of the broker was for services performed, and (ii) that
compensation was reasonably related to the services provided. The
Ninth Circuit has validated the HUD policy statements. 115

   § 3:2.2         Single or Multiple Loan Applications
   The sample clause set forth above in section 3:2 (Clause 3-1, Clause
for Fixed Mortgage) states that “Buyer shall not be required to apply to
more than one lender.” If the parties agree that the buyer should make
more than a single application, the language in Clause 3-2 below can be
substituted.

                                  CLAUSE 3-2

       Clause Allowing Buyer to Apply to More Than One Lender

   If Buyer’s bona fide application to two lending institutions for such
   mortgage shall be rejected, Buyer shall be deemed unable to obtain
   such commitment.

   If the buyer knows where he will apply for a loan when the contract
is signed, it is appropriate to name the lender in the contract. This
limits the buyer ’s obligation to make only one application. Similarly, if



114.      Yousef v. Trustbank Sav., 568 A.2d 1134 (Md. Ct. Spec. App. 1990).
115.      In Schuetz v. Banc One Mortgage Corp., 292 F.3d 1004 (9th Cir. 2002),
          cert. denied, 537 U.S. 1171 (2003), a mortgage borrower brought a class
          action challenging yield spread premiums. In enacting the policy, HUD did
          not follow formal rulemaking procedures, including notice to the public
          and the invitation of comments. The Ninth Circuit refused to certify the
          class action, reasoning the HUD policy statement was entitled to deference
          under Chevron U.S.A., Inc. v. Natural Res. Defense Council, 467 U.S. 837
          (1984). The court focused on Congress’s explicit grant to HUD of
          authority to interpret RESPA and HUD’s expertise in the home lending
          industry.



                                      3–26
                             Mortgage Financing                               § 3:2.2

the buyer is willing to use a particular broker to shop for the loan, the
contract may limit the buyer ’s obligation to deal with only that
broker.116
   Many contracts employ financing clauses that do not specify
whether the buyer is obligated to make more than one loan applica-
tion. This prejudices both parties because their rights are not clearly
defined. This drafting weakness is especially bad for the buyer, who
may prefer a refund of the earnest money after a single rejection, but
finds a recalcitrant seller who refuses to release the money.
   Judicial results are uncertain when the clause does not say whether
the buyer has to apply to more than one lender. A buyer cannot be
expected to apply to every available lending institution, but courts
interpreting clauses that fail to specify the number of applications have
often required more than one application. 117 Sometimes when a
buyer ’s first application is rejected, the seller or broker recommends
another lender. The buyer ’s failure to try the recommended source
may support a finding that the buyer has not diligently sought
financing.118
   On the other hand, a single unsuccessful loan application some-
times suffices to allow the buyer to terminate and recover the earnest
money. Usually the buyer prevails by introducing evidence that further
applications would have been futile.119 Particular language of the
financing condition may support this conclusion. For example, a


116.      The contract may name a mortgage broker who is qualified to arrange the
          type of loan needed, or the listing or selling broker. Frequently the broker
          who effects the sale of a home obtains the mortgage as a matter of course
          and without compensation other than his sales commission.
              A New Jersey statute has been construed to deny a broker a right to a
          commission for obtaining a home loan if he represents either party to the
          transaction for compensation. N.J. REV. STAT. § 45:15–17(i) (1990); Mort-
          gage Banker’s Ass’n v. N.J. Real Estate Comm’n, 200 N.J. Super. 584, 491
          A.2d 1317 (1985) (extended discussion of mortgage practice). Similar
          statutes elsewhere may lead to similar results.
117.      E.g., Brewster v. Yockey, 153 So. 2d 489 (La. Ct. App. 1963) (single
          application insufficient under condition that buyer obtain “a Homestead
          or conventional loan of $11,500 over a period of twenty or twenty-five
          years”).
118.      Fry v. George Elkins Co., 327 P.2d 905 (Cal. Ct. App. 1958) (two
          unsuccessful applications not sufficient when broker told buyer that lender
          who had existing mortgage on home was willing to refinance for buyer on
          terms specified in contract); Smith v. Vernon, 286 N.E.2d 99 (Ill. App. Ct.
          1972) (three banks rejected buyer; one other bank offered to lend a lower
          amount than buyer wanted; seller ’s attorney arranged for buyer to apply
          from another lender, but buyer refused to follow through).
119.      Luttinger v. Rosen, 316 A.2d 757 (Conn. 1972) (buyer applied to only
          institution in community that would make the large loan specified in the
          contract); Woods v. Austin, 347 So. 2d 897 (La. Ct. App. 1977) (bank
          rejected buyer ’s application due to her deceased husband’s bad credit);



(Friedman on Contracts, Rel. #7, 5/09)   3–27
§ 3:2.2                        FRIEDMAN   ON   CONTRACTS

sloppily drafted contract mixed the plural and singular, requiring the
buyer to make “truthful and proper applications to a lending institu-
tion designated by the Seller.”120
   Usually the issue of whether the buyer must apply to more than one
lender is a question of fact, rather than a matter of law to be resolved
by summary judgment.121 Only rarely have courts discussed which
party has the burden of proving that the buyer could or could not
obtain the requisite mortgage loan, and the courts have split. 122
The better rule is to place the burden on the buyer, who has peculiar
knowledge of his income, credit history, and the steps he has taken
with respect to contacting lenders.
   An illustrative case is Myers v. Kayhoe,123 wherein a home purchase
contract had a mortgage contingency calling for a $245,000 loan upon
specified terms. The buyers agreed to “make written application for
the financing herein described” within five days of the making of the
contract. The buyers timely applied to an institutional lender, who
rejected the application, giving as a reason its conclusion that the
original appraisal of the property overstated its value. The lender was
willing to lend only $225,000. The buyers did not make another loan
application and declined an offer made by the seller ’s broker to arrange
financing for the full amount on the terms specified in the contract.
The court held that the buyers were entitled to a refund of their deposit.
The court interpreted the contract to require that the buyers make only
one loan application for the described financing. The court recognized
that, in the absence of an express contract provision, a buyer may have
had an implied obligation to make more than one application, but any
such obligation was displaced by the parties’ contract.



          Rand v. B.G. Pride Realty, 350 A.2d 565 (Me. 1976) (buyer dealt with the
          bank that was most likely to finance land to be developed as summer boys’
          camp); D’Ambrogio v. Morgenstern, 516 N.Y.S.2d 447 (Sup. Ct. 1987)
          (single application sufficient when buyers were turned down for insuffi-
          cient income, even though twelve days remained in forty-five-day contract
          period for buyers to obtain financing); Gast v. Miller, 541 N.E.2d 497
          (Ohio Mun. Ct. 1988) (bank rejected application because buyer ’s income
          was not sufficient).
120.      Cohen v. Turnpike Dev. Corp., 213 N.Y.S.2d 245 (Sup. Ct. 1961) (first
          lender designated by seller issued a commitment for amount less than
          specified in contract).
121.      Honkomp v. Dixon, 422 N.E.2d 949 (Ill. App. Ct. 1981) (question of fact
          as to whether “reasonable efforts” required buyer to make more than one
          application); Johnson v. Werner, 407 N.Y.S.2d 28 (App. Div., 1st Dep’t
          1978) (question of fact whether buyer, whose application for VA mortgage
          was denied, should have then applied for conventional mortgage).
122.      Tipton v. Harden, 197 S.E.2d 746 (Ga. Ct. App. 1973) (buyer has burden);
          Gast v. Miller, 541 N.E.2d 497 (Ohio Mun. Ct. 1988) (seller has burden).
123.      Myers v. Kayhoe, 892 A.2d 520 (Md. 2006).



                                      3–28
                             Mortgage Financing                                § 3:2.3

    § 3:2.3          Waiver of Mortgage Condition
    The buyer may waive a mortgage condition by accepting a loan for a
shorter term than the one specified in the contract. 124 The buyer may
negotiate with the lender over issues not addressed in the financing
condition, but a buyer breaches if he withdraws the application
because those negotiations fail. Buyer may also waive, and put himself
in default under the contract, if he relies unsuccessfully on obtaining
other financing.125 Likewise, if he applies for a larger mortgage than
specified in the contract of sale.126 A buyer may be estopped to set up
the condition, as by accepting a mortgage of $16,000 where the
contract is conditioned upon his obtaining a larger mortgage. 127
If the condition is the obtaining of a mortgage from a third person,
the buyer may waive the condition by offering cash. 128



124.      Lipscomb v. Chadbourne, 378 So. 2d 147 (La. Ct. App. 1979) (ten years
          rather than specified twenty-year term).
125.      Williams v. Ubaldo, 670 A.2d 913 (Me. 1996); Connell v. Parlavecco, 604
          A.2d 625 (N.J. Super. 1992). Rice v. Buie, 687 N.Y.S.2d 52 (App. Div. 1st
          Dep’t 1999) (contract provided for standard $600,000 mortgage loan;
          buyers defaulted by applying for larger loan that included amounts for
          renovation).
126.      Post v. Mengoni, 604 N.Y.S.2d 186 (App. Div. 2d Dep’t 1993). But see Katz
          v. Simon, 627 N.Y.S.2d 763 (App. Div. 2d Dep’t 1995), where the result
          was contra. There purchaser applied for a larger loan but the bank decided
          to give only a smaller loan than that specified.
127.      Loda v. H.K. Sargeant & Assocs., Inc., 448 A.2d 812 (Conn. 1982); Appel v.
          Cusumano, 142 N.Y.S.2d 443 (Sup. Ct. 1955).
128.      Blanton v. Williams, 70 S.E.2d 461 (Ga. 1952); De Freitas v. Cote, 174
          N.E.2d 371 (Mass. 1961); Fleischer v. McCarver, 691 S.W.2d 930, 934
          (Mo. Ct. App. 1985); Ross v. Eichman, 529 A.2d 941 (N.H. 1987);
          Cwiakala v. Giunta, 92 A.2d 849 (N.J. Super. 1952); Huntington Mining
          Holdings, Inc. v. Cottontail Plaza, Inc., 433 N.Y.S.2d 824 (App. Div. 2d
          Dep’t 1980); see also Kenney v. Wedderin, 56 So. 2d 550 (La. 1951).
              The fact that purchaser received financing from a source other than
          that contemplated by the contract of sale is no defense to seller. Mezza-
          notte v. Freeland, 200 S.E.2d 410 (N.C. Ct. App. 1973); Renouf v. Martini,
          577 S.W.2d 803 (Tex. Civ. App. 1979). A contract contingent on purcha-
          ser’s ability to get a mortgage from a specified institution was held no bar
          to purchaser ’s getting a loan elsewhere, where the specified institution was
          seller’s mortgagee and insisted on a $1,192.50 prepayment premium.
          Rowan v. Ell-Dav Corp., 364 N.Y.S.2d 393 (Sup. Ct. Suffolk County
          Dist. 1975).
              Purchaser may elect to take a third-party mortgage in an amount less
          than that specified in the contract of sale. Doryon v. Salant, 142 Cal. Rptr.
          378 (2d Dist. Ct. App. 1977); Friedman v. Chopra, 533 A.2d 48 (N.J.
          Super. Ct. App. Div. 1987).
              In Nikora v. Mayer, 257 F.2d 246 (2d Cir. 1958), a contract was to
          “cease and terminate” if purchaser failed to obtain a mortgage within a
          specified time. This was held to make the contract self-terminating despite



(Friedman on Contracts, Rel. #7, 5/09)   3–29
§ 3:2.3                          FRIEDMAN     ON   CONTRACTS

   The right to waive may be qualified by a court if its exercise would
lead to unintended prejudice. A Massachusetts case (1) made a
contract conditional on purchaser ’s obtaining a theatre license, and
(2) provided for a purchase money mortgage, with amortizations
payable only after the theatre opened. The court held (2) inapplicable
after purchaser waived the condition and thereby made it uncertain if a
theatre would ever open.129 In one case the contract was conditioned
upon the buyer ’s obtaining an FHA commitment for development of
the premises. Upon failing to obtain the commitment the buyer
offered to pay for the property in cash. In view of the fact that the
seller owned other property in the neighborhood that would benefit
from the consequences of FHA development, it was held that the
condition was for the benefit of both parties and that it could not be
waived by one party alone.130




          purchaser ’s offer of cash. This literal interpretation disregards the fact that
          the condition was for purchaser ’s benefit. See 3A A. CORBIN, CONTRACTS
          § 761 (1960) and other authorities in this section. Nikora was also based
          on another ground. The Nikora result can be avoided by giving the
          purchaser an express option to offer cash in this situation. In accord
          with Nikora is Dale Mortgage Bankers Corp. v. 877 Stewart Ave. Assocs.,
          518 N.Y.S.2d 411 (App. Div. 2d Dep’t 1987). Contra Friedman v. Chopra,
          533 A.2d 48 (N.J. Super. Ct. App. Div. 1987).
               The Wisconsin practice and authorities are discussed at length in
          Raushenbush, Problems and Practices with Financing Conditions in Real
          Estate Purchase Contracts, 1963 WIS. L. REV. 566.
129.      E.M. Loews, Inc. v. Deutschmann, 147 N.E.2d 832 (Mass. 1958). Under a
          contract to purchase, subject to (1) acquiring adjoining properties and
          (2) rezoning for an apartment house, which required purchaser to apply for
          rezoning, purchaser was held excused from making such application in the
          face of professional advice that the application would fail and give the
          properties a “black mark,” a conclusion in which the adjoining owners
          concurred. Giba v. Bastian, 229 A.2d 93 (Md. 1967). Cf. Hing Bo Gum v.
          Nakamura, 549 P.2d 471 (Haw. 1976).
130.      Woodlark Constr. Corp. v. Callahan, N.Y.L.J., Jan. 8, 1948, at 113, col. 5,
          aff ’d, 89 N.Y.S.2d 67 (App. Div. 2d Dep’t 1949). A similar contract was
          involved in Miller v. Moylan, 72 So. 2d 380 (Fla. 1954), where a broker
          sued a seller for a commission. It was held that the purchaser properly
          waived a condition that he obtain an FHA mortgage. There was no
          evidence that the seller owned neighboring property or would be benefited
          otherwise by the mortgage. Seller was not permitted to take a purchase
          money mortgage where the contract contemplated a V.A. mortgage.
          Weschler v. Winter, 190 N.Y.S.2d 828 (N.Y. Sup. Ct. Nassau County
          1959). Compare Lamb v. Staples, 72 S.E.2d 219 (N.C. 1952), where a
          contract of sale was conditioned on the buyer ’s obtaining, within thirty
          days, a release of a federal tax lien affecting the premises. A failure to
          obtain the release until after thirty days was held to excuse the seller and to
          permit him to accept a better offer from a third person.



                                         3–30
                             Mortgage Financing                                 § 3:2.3

   When seller takes back security for part of the purchase price, any
condition that may impair his security is deemed for his benefit as
well as the purchaser ’s. This may, among other matters, bar purcha-
ser’s right to waive provisions in a proposed paramount mortgage. 131
Some New York cases hold that despite a statement that the con-
tingency is for the benefit of both parties, the purchaser may alone
cancel the contract.132 Some other New York cases hold that a
mortgage contingency clause is for the benefit of seller as well as
purchaser, and that seller alone may cancel for purchaser ’s failure to
obtain a mortgage.133
   Making the contract of sale subject to purchaser ’s obtaining a
mortgage is for the purchaser ’s benefit. Giving the purchaser a
specified time for this is for the seller ’s benefit. A seller need not
keep the property off the market indefinitely. If the seller deems the
condition for his benefit as well as for purchaser, the seller should
include in the contract a provision forbidding waiver of the condition
without consent of both.



              A purchaser has been denied the right to waive where performance of
          the condition would improve seller ’s purchase money security. It was so
          held where a contract was to be void if purchaser did not have the property
          rezoned by a specified date. Metz v. Heflin, 201 A.2d 802 (Md. 1964); Jones
          v. Saah, 275 A.2d 165 (Md. 1971); where the condition was purchaser
          obtaining a water easement on adjoining property, Lehman v. Williamson,
          533 P.2d 63 (Colo. Ct. App. 1975); and likewise with respect to a contract
          subject to a condition that part of the property be exchanged for property of
          a third person. The exchange would be of some slight advantage to seller ’s
          purchase money deed of trust, Scheffres v. Columbia Realty Co., 223 A.2d
          619 (Md. 1966); accord Isaacson v. G.D. Robertson & Co., 192 P.2d 486
          (Cal. Dist. Ct. App. 1948); Annot., 39 A.L.R.3d 362, 391 (1971).
              Purchaser was not permitted to waive a condition that seller obtain
          approval of a subdivision of that part of his property contracted to be sold
          to purchaser, because of its effect on seller ’s remaining property. Uscian v.
          Blacconeri, 340 N.E.2d 618 (Ill. App. Ct. 1975). Same: Poquott Dev. Corp.
          v. Johnson, 478 N.Y.S.2d 960 (App. Div. 2d Dep’t 1984); Lynlil Land Dev.
          Corp. v. Deluca, 553 N.Y.S.2d 185 (App. Div. 2d Dep’t 1990) (permit for
          “cluster housing”); Dan Bunn, Inc. v. Brown, 590 P.2d 209 (Or. 1979).
              A contract of sale provided for closing on a specified date but with
          monthly adjournments, for no more than six months, until purchaser ’s
          property would be taken under a prospective condemnation. This arrange-
          ment would permit use of the condemnation award to replace the property
          to be taken. Purchaser ’s election to waive this condition was held to make
          the contract unconditional and with no lack of mutuality. Safeway Sys. v.
          Manuel Bros., Inc., 228 A.2d 851 (R.I. 1967).
131.      Fleischer v. McCarver, 691 S.W.2d 930, 934 (Mo. Ct. App. 1985) (citing
          other examples of forbidden waiver).
132.      W.W.W. Assocs., Inc. v. Giancontieri, 548 N.Y.S.2d 580 (App. Div. 2d Dep’t
          1989).
133.      See id. at 584 et seq.



(Friedman on Contracts, Rel. #7, 5/09)   3–31
§ 3:2.4                         FRIEDMAN    ON   CONTRACTS

   § 3:2.4          Seller Financing as Substitute for
                    Institutional Loan
   A contract of sale may be subject to a buyer ’s obtaining a mortgage
from a third party, on specified terms, with an express proviso that if
the purchaser fails to obtain such mortgage within a specified time, the
seller will be privileged to take back a purchase money mortgage on the
same terms.134 If the seller ’s financing is acceptable to the buyer in
case a third-party loan is unavailable, the optional clause shown below
is appropriate.

                                   CLAUSE 3-3

                          Clause for Seller Financing

   Notwithstanding the foregoing provisions of this paragraph,
   if Buyer shall give notice of an inability to procure a mortgage
   from a lending institution on the aforementioned terms, Seller may,
   within five days after notice from Buyer thereof, give Buyer notice
   of an election, which is hereby conferred on Seller, to accept a
   purchase money mortgage, and a mortgage note [bond] to be
   secured thereby, in said amount and on said terms. In this event the
   form of the mortgage instruments shall conform to __________
   [insert reference to forms to be used].

   When the contract fails to authorize or exclude the possibility of the
seller stepping in to provide the described financing, judicial results
have varied. Some courts allow the seller to avoid the condition and
bind the buyer by offering to take back a purchase money mortgage on
terms no more onerous than those contemplated in the contract. 135
But this is not invariably true. A purchaser may prefer to borrow from
a bank or other lending institution, with its established practices, than




134.      Sillur Realty Corp. v. Lirco Realty Corp., 128 N.Y.S.2d 800 (Sup. Ct.
          Queens County 1954). Accord Kimbrough v. Belk & Co., 256 S.E.2d 119
          (Ga. Ct. App. 1979); Dodson v. Nink, 390 N.E.2d 546 (Ill. App. Ct. 1979).
135.      Duncan v. Rossuck, 621 So. 2d 1313 (Ala. 1993); Berlinger v. Moffitt, 82
          N.Y.S.2d 833 (N.Y. Sup. Ct. Queens County 1948); Kovarik v. Vesely, 89
          N.W.2d 279 (Wis. 1958). See Raushenbush, Problems and Practices With
          Financing Conditions in Real Estate Purchase Contracts, 1963 W IS. L. REV.
          566, 576 (describing why some Wisconsin brokers were critical of Kovarik
          decision).
              A purchaser who had sought a twenty-year mortgage was not required
          to accept a seller ’s offer to take an eleven-year and seven-month mortgage,
          which would entail substantially larger payments. Tieri v. Orbell, 162 A.2d
          248 (Pa. Super. Ct. 1960).



                                       3–32
                             Mortgage Financing                                § 3:2.5

from a private lender. The latter, a court might note, may be a rougher
creditor.136

    § 3:2.5          Commitment Fees
   Applicants for large commercial mortgage loans often must pay the
lender a substantial commitment fee, which may be refundable if the
applicant closes the loan in accordance with its terms. This practice
may have resulted from an inclination of some applicants with a
commitment from one institution to go shopping around thereafter for
a better deal and, if successful, to abandon the first institution. In the
majority of cases the institution may retain the payment if the
applicant fails to close in accordance with the commitment terms. 137
But there is a substantial amount of relevant litigation partly because
of ambiguous language in some commitments, and also a fee of .5% to
3% offers a tempting quest. If the fee is characterized as damages or
liquidated damages this may give the applicant a chance to dispute the




              A purchaser who failed to obtain a contemplated mortgage was not
          required to accept in lieu thereof an installment contract under which the
          deed would be withheld until full payment. Seller ’s proposal was not the
          equivalent of ownership in fee, subject to a mortgage. Christmas v. Cooley,
          406 P.2d 333 (Colo. 1965).
136.      See Dawson v. Malloy, 428 So. 2d 297 (Fla. Dist. Ct. App. 1983); Gardner
          v. Padro, 517 N.E.2d 1131, 1134 (Ill. App. Ct. 1987); Berwick v. Daniel W.
          Keuler Realtors, Inc., 595 A.2d 1272, 1276 (Pa. Super. Ct. 1991). In
          Kovarik v. Vesely, 89 N.W.2d 279 (Wis. 1958), the court noted that the
          source of the financing was not a material part of the transaction. See also
          W. Bay Realty Corp. v. Gad-Sal Realty Corp., 392 N.Y.S.2d 83 (App. Div. 2d
          Dep’t 1977), and Makris v. Nolan, 335 A.2d 655 (N.H. 1975).
              Purchaser need not give mortgage to seller. Gardner v. Padro, 517
          N.E.2d 1131 (Ill. App. Ct. 1987); Macho Assets, Inc. v. Spring Corp., 513
          N.Y.S.2d 180 (App. Div. 2d Dep’t 1987); Senese v. Litz, 471 N.Y.S.2d 401
          (App. Div. 3d Dep’t 1984). Nor need purchaser agree to seller ’s guarantee-
          ing purchaser ’s mortgage to a third party. Seller ’s threat to forfeit down
          payment for purchaser ’s refusal was held coercion, making seller liable for
          treble damages. Wilder v. Squires, 315 S.E.2d 63 (N.C. Ct. App. 1984).
              A lending institution has been defined as an enterprise organized for
          the purpose of making loans. See Gardner, 517 N.E.2d at 1134–35.
137.      Woodridge Place Apartments v. Wash. Square Capital, 965 F.2d 1429, 1435
          (7th Cir. 1992).
              Many commitment letters require leases to meet with lender ’s satisfac-
          tion, and cases on this tend to give the lender broad discretion. See Draper,
          Tight Money and Possible Substantive Defenses to Enforcement of Future
          Mortgage Commitments, 50 NOTRE DAME L. REV. 603 (1975). In other
          situations satisfaction clauses have been given disparate meanings. In this
          situation the borrower might well endeavor to specify some standards, that
          is, term, market rent, and financial status of tenant, to avoid giving the
          lender unlimited discretion.



(Friedman on Contracts, Rel. #7, 5/09)   3–33
§ 3:2.5                       FRIEDMAN    ON   CONTRACTS

amount of the damages or the enforceability of a liquidated damage
clause. If the clause states that it is consideration for mortgagee
making the obligation, retention of the payment is clearly enforceable.
The clause may also be enforced as a “standby fee,” although the actual
segregation of the proceeds of the loan, except possibly in construction
loans, has been said to be “a common misconception among borrowers
and lawyers.”138 As stated by Wolf:

           Each year an investment company reviews its cash-flow, its
       investment portfolio, its policy borrowings and decisions are
       reached as to how much money is to be lent and from where the
       funds are to come. The usual technique is to meet commitment
       requirements out of the cash-flow from prior investments and
       maturing obligations. If necessary, short-term paper can be sold or,
       if further necessary, money can actually be borrowed by the lender
       at a prime rate for a brief period until the lender has the funds to
                       139
       repay the loan.

   If the payment is for an option, it is clearly nonrefundable unless
the mortgagee commits a breach. But if it is an option, the mortgagee
is bound, but not the borrower, who may walk away from the deal if
he is willing to lose his payment. In Woodridge Place Apartments,140
the applicant received a commitment for a mortgage loan, subject to
the property having an occupancy of at least 93%. The mortgagee
refused to make the loan because the occupancy was less. The
applicant then sued for return of the advance payment of $139,500.
The court noted it was not clear whether the commitment was an
option, permitting retention of the fee, or a bilateral contract, which
was subject to a condition precedent, that is, occupancy. The court
cited cases going both ways on this issue.141 Here it found no bad faith
in seeking occupancy, construed the ambiguity against the draftsman,
and gave the applicant a refund with accrued interest. It has been
suggested that this can be avoided by a simple commitment clause
such as the one below.

                                  CLAUSE 3-4

                             Commitment Clause

   Borrower is to deliver to lender the sum of $___, as part of the
   consideration for the issuance of this commitment and for the

138.      Wolf, The Refundable Commitment Fee, 23 BUS. LAW. 1065, 1069 (1968).
139.      Id.
140.      Woodridge Place Apartments v. Wash. Square Capital, 965 F.2d 1429, 1435
          (7th Cir. 1992).
141.      Id. at 1437.



                                     3–34
                             Mortgage Financing                        § 3:2.6

    lender’s obligation to loan the money in question, but this sum
    shall be returned if the loan is consummated in accordance with
    the terms of this commitment.142

   The possibility of an applicant’s forfeiture of a commitment
or standby fee in case of a substantial mortgage on commercial
property is far more serious than in case of a prospective loan on a
house. A failure of the loan to close will probably make impossible an
acquisition of the property or prevent other contemplated payments.
In this connection there are provisions of the proposed mortgage that
could presumably be negotiated when the application and commit-
ment payments are made. The borrower will want grace periods after
notice before acceleration of the debt for monetary defaults (nonpay-
ment of principal or interest, failure to pay taxes, or supply insurance)
as well as non-monetary defaults (failure to repair, cure violations, or
other matters where time necessary for completion is uncertain). 143
The borrower will also want provisions dealing with fire and casualty
insurance144 and partial condemnation145 to provide that their pro-
ceeds may be used for restoration of the property. Other matters
cannot be negotiated that soon and may leave the applicant at a risk
that should be mitigated. Insofar as the mortgage commitment
reserves the right to pass on appraisals of the property, leases,
mortgagor ’s title, and other items, the mortgagee should be required
to make its determination as early as possible and, if possible, before
the mortgagor pays any loan charges or becomes subject to any risk of
forfeiture of any of these charges.

    § 3:2.6          Lender’s Revocation of Commitment
   There is a split of authority as to whether a standard financ-
ing condition, such as the sample clause set forth above in section 3:2
(Clause 3-1, Clause for Fixed Mortgage), protects the buyer from a
revocation of the commitment by the lender. When the contract has a
mortgage condition, usually the contract language does not expressly
address the effect of revocation of the loan commitment. Nor does the
typical contract state whether buyer ’s obligation to purchase is condi-
tioned on closing of the loan. In the absence of such language, courts
generally allow the buyer to rescind and recover her earnest money if she




142.      Wolf, The Refundable Commitment Fee, 23 BUS. LAW. 1065, 1074 (1968).
143.      See infra section 3:7.4.
144.      See infra section 3:7.2[B].
145.      See infra section 3:8.8.



(Friedman on Contracts, Rel. #7, 5/09)   3–35
§ 3:2.6                         FRIEDMAN    ON   CONTRACTS

was not at fault,146 but there are contrary decisions.147 States that
generally protect the buyer from the lender ’s revocation come out
differently if revocation is due to the buyer ’s fault. Then the seller
may retain the earnest money.148
   A pro-buyer “loan funding” clause, which can be added to the clause
set forth in section 3:2 above (Clause 3-1, Clause for Fixed Mortgage)
is shown below.

                                   CLAUSE 3-5

                        Pro-Buyer Loan Funding Clause

   If Buyer obtains a commitment for a mortgage loan from a lending
   institution (whether or not the loan described in the commitment
   meets the specifications stated above), Buyer’s obligation to
   close this purchase is conditioned on the lender disbursing the
   loan proceeds at closing. If for any reason the lender fails or refuses
   to disburse the loan proceeds at closing, Buyer shall have the
   right to terminate this agreement, with the earnest money returned
   to Buyer.




146.      Ne. Custom Homes, Inc. v. Howell, 553 A.2d 387 (N.J. Super. Ct. Mon-
          mouth County 1988); Kapur v. Stiefel, 695 N.Y.S.2d 330 (App. Div. 1st
          Dep’t 1999) (summary judgment not appropriate for either party when
          lender revoked mortgage commitment due to buyer ’s loss of job; buyer ’s
          fault or bad faith is issue of fact); Lane v. Elwood Estates, Inc., 298
          N.Y.S.2d 751 (App. Div. 2d Dep’t 1969), aff ’d, 268 N.E.2d 805
          (N.Y. 1971) (purchaser lost job); Patterson v. Marchese, 173 N.Y.S.2d
          759 (Sup. Ct. Westchester County 1958), aff ’d, 196 N.Y.S.2d 903 (App.
          Div. 2d Dep’t 1960) (seller ’s bad title); Rosen v. Empire Valve & Fitting,
          Inc., 553 A.2d 1004 (Pa. Super. Ct. 1989).
              Northeast distinguishes between interpretation and construction. It
          notes that the contract at issue made no express reference to the possibility
          of obtaining a commitment and its subsequent rejection. It concluded that
          its holding could not be based on interpretation, which refers to the words
          used. Following Corbin, it rules that construction, which refers to the
          contract as distinguished from its words, fills in the gaps in the contract
          with respect to which the parties had no contemplation or intent. 3 A.
          CORBIN, CONTRACTS § 534, at 11 (1960); 2 MILTON R. FRIEDMAN, FRIED-
          MAN ON LEASES § 26:3 (Patrick A. Randolph, Jr., ed., 5th ed. PLI 2006).
147.      Malus v. Hager, 712 A.2d 238 (N.J. Super. Ct. App. Div.) (lender revoked
          commitment because borrower was terminated from employment; court
          held seller did not have to refund buyer ’s deposit), cert. denied, 719 A.2d
          642 (N.J. 1998).
148.      Keliher v. Cure, 534 N.E.2d 1133 (Ind. Ct. App. 1989); Bruyere v. Jade
          Realty Corp., 375 A.2d 600 (N.H. 1977) (purchaser ’s divorce eliminated
          one income).



                                       3–36
                             Mortgage Financing                                § 3:3.1

§ 3:3         Continuation of Existing Mortgage
    § 3:3.1          Ambiguity
   Great care must be taken when the price clause refers to the buyer
assuming or taking subject to an existing mortgage. A purchase price
of $12,000 “subject to a mortgage of $5,000” has resulted in at least
two lawsuits on whether the recited price was over and above the
existing mortgage, that is, whether the cost to the purchaser was
$12,000 or $17,000. In one case the buyer was held entitled to credit
for this amount against the sum payable to the seller.149 But another
case concluded that the phrase might mean the contrary and, for this
reason, held the contract too indefinite for specific performance.150
   This ambiguity may be avoided by reciting the purchase price
substantially as follows:
   The purchase price is $250,000, payable as follows:
   •    $20,000 on the signing of this contract, by check subject to
        collection.
   •    $150,000 by taking subject to an existing first mortgage in that
        amount.
   •    $50,000 by Purchaser ’s purchase money note and mortgage.



149.      Didriksen v. Havens, 68 A.2d 163 (Conn. 1949). A mortgage is ordinarily
          part of the purchase price unless the contract provides otherwise. Vickers v.
          Horster, 451 P.2d 7 (Okla. 1969) (mortgage taken subject to is ordinarily
          part of price unless contract provides otherwise).
              An installment sale, subject to specified mortgages, required purchaser
          to pay a purchase price of $35,000 in installments, after which a deed was
          to be delivered. Seller was held to have no claim against purchaser for the
          amount of mortgage payments made by seller between the date of the
          contract and the delivery of the deed. Fye v. Cox, 263 N.W.2d 725 (Iowa
          1978). See also Garner v. Metro. Life Ins. Co., 262 S.E.2d 544 (Ga. Ct.
          App. 1979).
              In a more complicated version of this situation a divided court gave
          seller recovery for unjust enrichment. Wolford v. Tankersley, 695 P.2d 1201
          (Idaho 1985).
150.      Williams v. Manchester Bldg. Supply Co., 97 S.E.2d 129 (Ga. 1957). Terms
          of sale that included “subject to mortgage” were held to indicate the
          purchase price was the amount paid to the seller, plus the amount of the
          mortgage. Del Rio Land, Inc. v. Haumont, 514 P.2d 1003 (Ariz. 1973).
              A contract was held unenforceable where the recited purchase price was
          subject to an “existing loan.” Morgan v. Hemphill, 110 S.E.2d 780 (Ga. Ct.
          App. 1959). McDonald v. Moore, 790 P.2d 213 (Wash. Ct. App. 1990), held
          the same with respect to an option included in a will to buy for $40,000
          subject to a mortgage.
              For a similar reason a contract requiring purchaser to “assume” existing
          assessments was held ambiguous. Wright v. Lowe, 296 P.2d 34 (Cal. Dist.
          Ct. App. 1956).



(Friedman on Contracts, Rel. #7, 5/09)   3–37
§ 3:3.1                          FRIEDMAN    ON   CONTRACTS

   •      $30,000 on the delivery of the deed, in cash or by Purchaser ’s
          certified check to the order of Seller, drawn on a bank which is a
          member of the Clearing House.
   •      In no event shall Seller be required to accept an endorsed check.
    This recital provides for a purchaser ’s credit for the amount of a
first mortgage, and also for a payment at the closing of cash and a
purchase money junior mortgage, each in a specified sum. It may leave
uncertain whether the cash or the purchase money mortgage is to be
reduced if the closing adjustments give the purchaser a net credit, 151 or
if the purchaser is to be credited with insurance moneys paid to a seller
for fire damage,152 or, on the other hand, that one is to be increased if
the first mortgage is reduced by amortization between the date of the
contract and of the closing.153 This uncertainty may be avoided by
specifying the effect of these. If the purchase money mortgage is to be
made to a third person, rather than to the seller, and in a specified
sum, there would appear to be no doubt that any variation should
apply to the cash payment.
    Where an existing mortgage requires amortization, the contract
should provide that if, in the interim between contract and closing, the
mortgage is reduced by one or more payments, the amount of cash
payable by the purchaser at the closing shall be increased by an
amount equal to such principal payments.154 The purchaser should
see that this provision is limited to payments required under the
mortgage and does not permit the seller to prepay otherwise.



151.       Mann v. Wolff, 226 N.E.2d 263 (Mass. 1967), upheld seller ’s right to
           receive the cash payment in full and apply the credit in reduction of the
           purchase money mortgage. This was based on a preliminary agreement
           that provided: (a) for a purchase money mortgage of “approximately
           $5,000,” whereas the other sums were specific; and (b) for execution of a
           mutually satisfactory definitive agreement.
152.       Larstan Indus., Inc. v. Res-Alia Holding Co., 232 A.2d 440 (N.J. Super. Ct.
           App. Div. 1967) (proceeds of insurance applied to reduced mortgage).
153.       A contract of sale was held unenforceable for indefiniteness in this
           situation. Moog v. Palmour, 155 S.E.2d 692 (Ga. Ct. App. 1967). An
           additional factor in the Moog contract was the absence of a closing date,
           which made it uncertain what amortizations would accrue under the first
           mortgage in the interim. Georgia is apparently more ready than other
           states to nullify a contract for uncertainty.
154.       A contract of sale contained the unusual provision that the purchase price
           should be reduced by the amount of amortizations made by the seller
           between the date of the contract and “the date affixed herein for the
           closing.” Several adjournments were agreed to by stipulations under which
           the adjustments would be “as of the date of consummation.” During the
           adjourned periods seller made amortizations of almost $14,000. Purchaser
           was held entitled to no credit for these. Ditmars-31 St. Dev. Corp. v. Punia,
           235 N.Y.S.2d 796 (App. Div. 2d Dep’t 1962).



                                        3–38
                             Mortgage Financing                                § 3:3.1

    The buyer may, and should, ascertain the terms and verify the
amount owing on an existing mortgage, unless the mortgage is to
be satisfied by the seller on or before the closing. If the form of
mortgage is unsatisfactory, there is ordinarily nothing the buyer and
seller can do about it. In a rare case the mortgagee may be induced to
modify the mortgage in connection with a conveyance. The form of
the purchase money mortgage will be governed by the contract of sale.
    Sometimes a buyer finances the purchase in part by taking over the
seller ’s existing mortgage or mortgages. If an existing mortgage is to
continue after a sale, the contract should indicate whether the sale is
to be merely subject to the mortgage or whether the purchaser is to
assume personal liability for payment of the mortgage debt, as well as
liability on the mortgage covenants.
    In view of the fact that some mortgages, particularly those affect-
ing residential properties, permit the mortgagee to accelerate payment
of the mortgage debt upon a sale of the property, it is in order for a
purchaser to ask a seller to represent in the contract whether the
mortgage or any related instrument authorizes acceleration of pay-
ment or a modification of its terms by reason of a change of ownership
of the mortgaged property.155
    Under most mortgages, the mortgagee may require an owner to
make necessary repairs. A buyer taking subject to or assuming a
mortgage sometimes asks the seller to certify whether any such
requirement has been made.
    If the sale is to be subject to an existing mortgage, the contract
should so state and should identify the mortgage by at least the book
and page of its recordation. This is sufficient to charge the buyer
with knowledge of its terms.156 These terms must be examined.
The mortgage may cover more property than the property to be sold.
If this should be true, the mortgage may become in default by matters
over which the purchaser will have no control, such as nonpayment of
taxes or waste in connection with the other premises. Occasionally, a



155.      A form for this purpose reads:
             Seller represents that no mortgage affecting the premises hereby
             agreed to be sold is required to be paid, in whole or in part or to be
             modified in any way, by reason of this contract or the conveyance
             hereby provided for.
            A fraudulent misrepresentation respecting a due-on-sale clause rendered
          seller liable for damages. Home Sav. & Loan Ass’n v. Schneider, 469 N.E.2d
          585 (Ill. App. Ct. 1984).
156.      Baucher v. Stewart, 122 N.Y.S. 202 (App. Div. 2d Dep’t 1910); Blanck v.
          Sadlier, 47 N.E. 920 (N.Y. 1897); G. DAVIS, MARKETABILITY OF TITLE IN
          NEW YORK 377–78 (1916); see generally Annot., 57 A.L.R. 1253, 1394–99
          (1928). Cf. Baker v. Leight, 370 P.2d 268 (Ariz. 1962).



(Friedman on Contracts, Rel. #7, 5/09)   3–39
§ 3:3.1                        FRIEDMAN     ON   CONTRACTS

bizarre provision will be found in the mortgage, such as payment in
gold.157
   In some states, a “dragnet” clause mortgage presents special pro-
blems. A Georgia open end or “dragnet” clause mortgage, which
secures “any other present or future indebtedness,” may be increased,
after purchaser ’s acquisition of title, by loans made to the original
mortgagor.158 By statute, tort claims are excluded from the dragnet. 159
In many states, the application of a dragnet clause is limited to the
same or a series of similar transactions unless otherwise specified.160
The clause in a mortgage with several debtors does not apply a
subsequent mortgage to all the previous debtors.161 Possible complica-
tions are raised with a mortgage by a husband and wife who thereafter
split up.162 Dragnet clauses do not generally extend to unmentioned
prior obligations.163 Dragnet clauses are construed against the mort-
gagee and have been denominated “anaconda mortgages” for their
tendency to enwrap a mortgagor in debts he did not contemplate. 164
The clause is enforced in Arizona.165
   The dragnet mortgage is a relative minor example of the broader
and much more used mortgage for future advances. If a mortgage
provides for obligatory advances, they have priority over subsequent
liens. But if the advances are optional, and the mortgagee
had knowledge of subsequent liens at the time the advances are
made, these lose priority over the subsequent liens. If, however,
the mortgagee does not have such knowledge, the optional advances
take priority whether made before or after the subsequent liens, and in


157.      Blanck v. Sadlier, 47 N.E. 920 (N.Y. 1897).
158.      Commercial Bank v. Readd, 242 S.E.2d 25 (Ga. 1978); Courson v.
          Atkinson & Griffin, Inc., 198 S.E.2d 675 (Ga. 1973).
159.      GA. CODE § 44-14-1.
160.      In re Ballarino, 180 B.R. 343 (Bankr. D. Mass. 1995); In re Mullan, 196
          B.R. 818, 827–29 (Bankr. W.D. Ark. 1996) (with broad dragnet clause,
          citing Union Nat’l Bank v. First State Bank & Trust Co., 697 S.W.2d 940
          (Ark. Ct. App. 1985), and other cases with similar clauses). Sowers v. Fed.
          Deposit Ins. Corp., 96 B.R. 897 (Bankr. S.D. Iowa 1989).
161.      In re Lemka, 201 B.R. 765 (Bankr. E.D. Tenn. 1996).
162.      See Schmidt v. Wantresh State Bank, 555 N.W.2d 655 (Wis. 1996).
163.      United Nat’l Bank v. Tellan, 644 So. 2d 97 (Fla. Dist. Ct. App. 1994) (sets
          forth dragnet clause).
164.      Berger v. Fuller, 21 S.W.2d 419, 421 (Ark. 1929).
165.      La Cholla Group, Inc. v. Timm, 844 P.2d 657 (Ariz. Ct. App. 1992); see
          also Merchs. Nat’l Bank v. Stewart, 608 So. 2d 1120, 1125–27 (Miss.
          1992) (narrow construction against mortgagee). For a detailed discussion
          and authorities of the debts included by dragnet clauses and the differences
          among states in interpreting the clauses, see Lundgren v. Nat’l Bank, 756
          P.2d 270, 277–80 (Alaska 1987). Restrictions on the scope of dragnet
          clauses are discussed in Decorah State Bank v. Zidlicky, 426 N.W.2d 388
          (Iowa 1988).



                                       3–40
                             Mortgage Financing                               § 3:3.1

this connection the mortgagee must have actual knowledge of the
subsequent liens, not the constructive knowledge imparted by their
recordation.166 In other words, the mortgagee need not check the
records before making subsequent advances. 167
   But even routine provisions may have significance. In one case, a
contract of sale provided for a purchase money mortgage to be in the
form printed by a specified title company. This form permitted
acceleration for failure to maintain buildings in repair. Because
the buildings were dilapidated, the mortgage was virtually callable
at-will.168 Generally speaking, however, a default in existence at the
time a mortgage is given may not be relied on to accelerate maturity
unless the mortgage expressly so provides.169
   Among the clauses to be noted are the maturity of the mortgage,
interest rate, mortgagee’s right to accelerate for breach, a due-on-sale
clause,170 the owner ’s right to prepay the mortgage in whole or in part,
and any other provision that may be unusual generally or of special
interest to the buyer. Any prospective financing for new construction
or otherwise may be prevented by lack of a right to prepay an existing
mortgage.171
   An agreement to take subject to or to assume a mortgage charges
the buyer with knowledge of all the terms of the mortgage, but not
where these are incorrectly described in the contract of sale. 172
A material misdescription of the mortgage excuses the buyer from
performance.173 It is, therefore, risky for a seller to attempt to



166.      La Cholla Group, Inc. v. Timm, 844 P.2d 657 (Ariz. Ct. App. 1992).
167.      See Dyches, Priority Disputes in Future Advance Mortgages: Picking the
          Winner in Arizona, 1985 ARIZ. ST. L.J. 537 (problems of notice, difference
          between optional and obligatory advances is not always clear; at times
          mortgagee makes advances that are legally optional but “economically
          obligatory,” as where more money is necessary to complete a building, pay
          taxes, insurance, etc.).
168.      Sanka Classics, Inc. v. Atlanta Terra Cotta Co., 79 N.Y.S.2d 748 (App. Div.
          1st Dep’t), aff ’d, 83 N.E.2d 150 (N.Y. 1948).
169.      Houser v. Heider, 350 P.2d 422 (Or. 1960); 59 C.J.S. Mortgages § 495(4)(a)
          (1949).
170.      For a discussion of due-on-sale clauses, see infra section 3:3.1. See also
          Home Sav. & Loan Ass’n v. Schneider, 469 N.E.2d 585 (Ill. App. Ct. 1984).
171.      For a discussion of prepayment, see infra section 3:8.4.
172.      See Annot., 26 A.L.R. 528, 532 (1923).
173.      An agreement to sell subject to a mortgage is not broken by the existence of
          two mortgages aggregating the sum specified. Greenfield v. Mills, 107
          N.Y.S. 705 (App. Div. 2d Dep’t 1907); see Thackaberry v. Kibbe, 119 N.E.
          897 (Ill. 1918); Haberer v. Kunstman, 194 Ill. App. 306 (1915). But see
          Park v. Johnson, 7 Allen 378 (Mass. 1863). Mortgages differing in amount
          or maturity, or with higher interest rates than those described excuse the
          buyer. Crooke v. Nelson, 191 N.W. 122 (Iowa 1922) (dictum that later
          maturity immaterial); Weiner v. Simons, 166 N.E. 765 (Mass. 1929);



(Friedman on Contracts, Rel. #7, 5/09)   3–41
§ 3:3.1                         FRIEDMAN    ON   CONTRACTS



          Maxey v. Quintana, 499 P.2d 356 (N.M. 1972) (upholds complaint for
          fraud where FHA mortgage represented as V.A. mortgage; FHA cost ½%
          more for insurance); Schmidt v. Reed, 30 N.E. 373 (N.Y. 1892) (three-year
          mortgage described in contract of sale as five-year mortgage; purchaser
          need not accept security in lieu of extension of mortgage); Rabinowitz v.
          Marcus, 123 A. 21 (Conn. 1923). Cf. Goldblatt v. Rosenwasser, 86
          N.Y.S.2d 684 (App. Div. 2d Dep’t 1949), aff ’d, 93 N.E.2d 490 (N.Y.
          1950); Keitel v. Zimmermann, 43 N.Y.S. 676 (Sup. Ct. N.Y. County 1897).
              But Miller v. Milwaukee Odd Fellows Temple, 240 N.W. 193 (Wis.
          1932), refused to abrogate a contract of sale that understated somewhat the
          amount owing on a mortgage, on the ground that the difference could be
          credited to the buyer in the closing adjustments. A reference to a 4½%
          mortgage, due in six months, as 4% was held immaterial in face of seller ’s
          offer to credit buyer with the difference, which amounted to $8.75. Kauflin
          v. Turek, 277 S.W.2d 540 (Mo. 1955). Keitel v. Zimmermann, 43 N.Y.S.
          676, refused to abrogate a contract to sell subject to a 5% mortgage, where
          the mortgage called for 6%. The record showed that no more than 5% had
          been exacted for a considerable period. It did not appear that the mortgage
          was not due, nor did the contract of sale require the mortgage to remain on
          the property. The court ruled that the sum to be paid, rather than the rate
          originally fixed, was the only practical matter to be considered.
              A buyer was excused by a reference in the contract to mortgage
          payments, which omitted a requirement of monthly tax deposits, and by
          a reference to a right of prepayment, which failed to mention a limit of
          prepayment of 20% in any one year. Star Apartment, Inc. v. Martin, 204
          F.2d 829 (5th Cir. 1953).
              An incorrect reference in the contract to the subordination clause in a
          junior mortgage excuses the buyer. Tiffany Realty Co. v. Estey Constr.
          Corp., 166 N.E. 319 (N.Y. 1929); Ruckstuhl v. Healy, 225 N.Y.S. 570 (App.
          Div. 1st Dep’t 1927). Likewise, an agreement to take subject to a mortgage
          “with the usual clauses” when the mortgage provides for assignment of
          rents to the mortgagee on breach, right to accelerate on actual or threa-
          tened demolition of buildings, and an obligation by the mortgagor to give
          an “estoppel certificate.” Elterman v. Hyman, 84 N.E. 937 (N.Y. 1908).
          And, a seller ’s agreement to obtain an extension of an existing mortgage,
          effected by an agreement with similar provisions. Schiff v. Tamor, 93 N.Y.S.
          853 (App. Div. 2d Dep’t 1905). A purchaser was also excused by the
          presence of a “Brundage clause” in a mortgage. Groden v. Jacobson, 114
          N.Y.S. 183 (App. Div. 2d Dep’t 1908).
              In view of the present form statutory mortgage in New York and some
          other states, most of these provisions would undoubtedly be held “usual”
          today. Compare, in this respect, Frank v. Frank, 108 N.Y.S. 549 (App. Div.
          2d Dep’t 1908). A similar question arises with respect to the form of
          purchase money mortgage to which the seller is entitled where the contract
          of sale is not specific in this regard.
              A contract of sale referred to a mortgage, which purchaser was to
          assume, of approximately $52,000, “payable at approximately $518.39”
          per month, but did not mention an option in the mortgage to accelerate
          full payment if the property was sold. In an action by purchaser for
          recovery of his down payment, a judgment for defendant was reversed
          and the case remanded for a new trial. Baker v. Leight, 370 P.2d 268 (Ariz.
          1962). The court wrote: “Had the agreement merely said, ‘The buyer buys
          subject to the mortgage,’ or ‘The buyer assumes and agrees to pay the



                                       3–42
                             Mortgage Financing                                § 3:3.1

recapitulate the terms of a mortgage. It is preferable to identify the
mortgage in the contract of sale by its recordation date and either
attach a copy to the contract or exhibit a copy to and have the same
initialed by the buyer. An agreement to take subject to a mortgage “due
and payable August 1, 1952” does not include an installment payment
mortgage.174 And an agreement to take subject to a past due mortgage
does not require the buyer to take subject to a foreclosure action. 175 A
failure to mention the existence of an assignment of rents to the
mortgagee was held to excuse performance by the buyer.176
    The buyer should have a copy of an existing mortgage for present
examination and future reference. In absence of a copy the terms may
be examined on the public records. This may be insufficient, however,
because there may be other terms included in the note or bond secured
by the mortgage. Sometimes the maturity of the mortgage will appear
only in the note or bond.177 Furthermore, as a result of clerical error,
there may be a repugnance between the mortgage and the accompany-
ing note or bond. Inasmuch as in legal theory the latter is the debt and
the mortgage merely the security thereof, any repugnance is resolved in
favor of the bond or note, despite the fact that the mortgage alone will
be found in the public records.178 It is, therefore, insufficient to rely on
the mortgage alone.


          mortgage,’ then the buyer would be charged with full knowledge of the
          terms and conditions of the mortgage. However, when the seller expressly
          contracts that the buyer will be privileged to pay the mortgage at approxi-
          mately $518.39 per month, then the buyer is entitled to rely on the
          contract so far as the seller is concerned.” Baker, 370 P.2d at 270. In a
          similar situation, a purchaser, who agreed to assume a 6% mortgage,
          recovered his down payment when the mortgagee would waive his right
          of acceleration only if the interest rate were raised. Lane v. Bisceglia, 488
          P.2d 474 (Ariz. 1971).
174.      J.O. Constr. & Dev. Corp. v. Cuendet, 108 N.Y.S.2d 782 (App. Div. 1st
          Dep’t 1951) (alternate ground of decision).
175.      Wacht v. Hart, 105 N.Y.S. 78 (App. Div. Sup. Ct. 1907), aff ’d, 92 N.E. 1105
          (N.Y. 1910); Dorf v. Bossert Terminal, Inc., 59 N.Y.S.2d 732 (Mun. Ct.
          Manhattan 1946) (tax foreclosure). But see Lynch v. Volckening, 171
          N.Y.S. 991 (County Ct. Kings County 1918).
              Compare Heidi Assocs. v. Lawyers Title Ins. Co., 495 N.E.2d 350 (NY.
          1986).
176.      Star Apartment, Inc. v. Martin, 204 F.2d 829 (5th Cir. 1953).
177.      The mortgage may state it is security for the payment of a specified sum
          “in accordance with the terms of a certain mortgage bond. . . .” One reason
          for withholding the due date from the record is to prevent raiding by
          competing mortgagees seeking investments. Some lending institutions do
          not record extension agreements for this reason.
178.      In re Sweatte, 76 B.R. 822 (Bankr. W.D. Okla. 1987); Brown v. First Nat’l
          Bank, 75 So. 2d 141 (Ala. 1954); Blalock v. Blalock, 288 S.W.2d 327 (Ark.
          1956); Griswold State Bank v. Milne, 416 N.W.2d 109 (Iowa 1987); Frenzel
          v. Frenzel, 152 N.W.2d 157 (Iowa 1967); Comer v. Hargrave, 598 P.2d 213



(Friedman on Contracts, Rel. #7, 5/09)   3–43
§ 3:3.1                         FRIEDMAN    ON   CONTRACTS

   A purchaser was charged with knowledge of a due-on-sale clause in
a mortgage note that was incorporated by reference in a recorded
mortgage.179 The same was held with respect to a requirement for a
prepayment premium incorporated only in the note.180
   If the mortgage and other instruments were executed at the same
time and as part of the same transaction, these instruments are
construed together to give effect to the intentions of the parties.181
Nevertheless, a failure to incorporate expressly the provisions of one
instrument in another has resulted in a provision that is enforceable,
for example, acceleration, in one instrument and not in another. 182
   The purchase price payable by the buyer at the closing will be
credited with the amount of an existing mortgage. If this has been
reduced by part payment to a sum less than that appearing on record
(and the record will probably not show such payment), this credit of
the buyer will be less and the cash payable by him will be greater. The
purchaser should have reasonable proof of any such payments. 183



          (N.M. 1979); Samples v. Robinson, 275 P.2d 185 (N.M. 1954); Adler v.
          Berkowitz, 173 N.E. 574 (N.Y. 1930), noted in 31 COLUM. L. REV. 328
          (1931); First Interstate Bank v. Rebarchek, 511 N.W.2d 235, 241 (N.D.
          1994).
             This rule was held limited to the parties to the mortgage. A purchaser
          from the mortgagor was held bound by a prepayment privilege in the
          mortgage that was conditioned on payment of a premium, rather than on a
          comparable clause in the mortgage bond that contained no such condition.
          This was on the ground that the mortgage had met the purchaser ’s eye.
          Manhattan Coll. v. Staten Island Sav. Bank, 265 N.Y.S.2d 251 (Civ. Ct.
          Bronx County 1965).
             The acceleration provision in a mortgage was held controlling in view
          of a provision reading “anything in said note or herein to the contrary
          notwithstanding.” Grier v. M.H.C. Realty Corp., 274 So. 2d 21 (Fla. Dist.
          Ct. App. 1973).
179.      Provident Fed. Sav. & Loan Ass’n v. Realty Ctr., Ltd., 428 N.E.2d 170 (Ill.
          App. Ct. 1981); Wood v. LaFleur, 408 So. 2d 37 (La. Ct. App. 1981).
180.      Leisure Villa Investors v. Life & Cas. Ins. Co., 527 So. 2d 520 (La. Ct. App.
          1988).
181.      Metro. Life Ins. Co. v. Monroe Park, 442 A.2d 503, 509 (Del. Super. Ct.
          1982); Boyette v. Carden, 347 So. 2d 759 (Fla. Dist. Ct. App. 1977);
          Gonzales v. Tama, 749 P.2d 1116 (N.M. 1988); Comer v. Hargrave, 598
          P.2d 213 (N.M. 1979); 55 AM. JUR. 2D Mortgages § 176 (1971); 59 C.J.S.
          Mortgages § 156 (1949).
182.      Abdul-Karim v. First Fed. Sav. & Loan Ass’n, 451 N.E.2d 618 (Ill. App. Ct.
          1983) (due-on-sale clause in mortgage permitted acceleration and fore-
          closure of mortgage, but ineffective to enforce personal liability on note).
          Accord White v. Miller, 54 N.W. 736 (Minn. 1893).
183.      “The plaintiff was, of course, entitled to conclusive evidence of this
          reduction [in the rate of interest]. He was not bound to accept the
          defendant’s assurance that it had been done.” Campbell v. Prague, 39
          N.Y.S. 558, 560 (App. Div. 1st Dep’t 1896).



                                       3–44
                             Mortgage Financing                                   § 3:3.1

On the other hand, the mortgage may secure more than its recorded
principal by reason of interest arrears or advances made by the
mortgagee for taxes, insurance, discharge of prior liens, 184 or by a
“dragnet” clause. A mortgage whose principal has been reduced may
have been increased, pursuant to an “open end” statute, which permits
further advances by the mortgagee for repairs or improvements, or to
discharge taxes.185 If the premises are subject to a mortgage, therefore,
the contract of sale should require the seller to obtain a certificate from
the mortgagee, in recordable form, stating the amount of unpaid
principal and accrued interest, the maturity, and the existence of any
prepayment right.186 Banks, insurance companies, and other institu-
tional lenders will often refuse to give more than a letter to such effect.
This should be sufficient from a responsible party except where the
mortgagee includes in the letter a statement that it is not to be bound
thereby or that the letter is not to operate as an estoppel. 187 An owner
is not entitled to a statement of the sum owing on a mortgage either by
implication188 or by any provision usually found in a mortgage. It may
be noted, by way of analogy, that a lease that the tenant intends to
mortgage generally anticipates a customary requirement of a leasehold
mortgagee by requiring the landlord to give an assurance of the status
of the lease. A New York statute entitles an owner of real property who
has signed a contract to sell or has received a written mortgage


184.      Plaintiff-grantee, who paid the full purchase price, after credit for
          (1) $35,425, the sum apparently owing on a mortgage, and (2) $5,000 by
          way of a purchase money mortgage, discovered after receipt of the deed
          that an informal arrangement for partial accumulation of interest resulted
          in $14,000 of interest arrears. Plaintiff ’s remedy consisted of cancellation
          of the purchase money mortgage and a judgment for the remainder.
          Blaylock v. McMillan Farms, Inc., 214 So. 2d 456 (Miss. 1968). The
          situation would have been avoided if an estoppel letter had been obtained
          from the mortgagee before the closing.
185.      Wellfleet Sav. Bank v. Swift, 162 N.E.2d 799 (Mass. 1959).
186.      A form of contract formerly in use in the City of New York contained the
          following clause for this purpose:
             If there be a mortgage on the premises the seller agrees to deliver to
             the purchaser at the time of delivery of the deed a proper certificate
             executed and acknowledged by the holder of such mortgage and in a
             form for recording, certifying as to the amount of the unpaid principal
             and interest thereon, date of maturity thereof and rate of interest
             thereon, and the seller shall pay the fees for recording such certificate.
          The clause made no reference to a right of prepayment.
            Seller ’s failure to comply with this requirement, or at least tender an
          acceptable substitute, permitted purchaser to rescind. Grace v. Nappa, 389
          N.E.2d 107 (N.Y. 1979).
187.      For a mortgagee’s statement of amount due as an estoppel, see Annot., 90
          A.L.R. 1432 (1934).
188.      Pavanello v. Adikas, 139 N.Y.L.J. 11, Feb. 4, 1958 (Sup. Ct. 1958).



(Friedman on Contracts, Rel. #7, 5/09)   3–45
§ 3:3.1                         FRIEDMAN    ON   CONTRACTS

commitment, to a statement from the holder of a mortgage on the
property of the amount of the mortgage debt.189 A mortgagee that
submitted a “pay-off letter” that understated the amount due was entitled
to recover the difference on the ground of a mistake of fact and unjust
enrichment, as distinguished from a mistake of law.190 One that over-
stated the amount and refused a refund was held liable in damages.191
   There are two ways of treating an existing mortgage at the closing.
The conveyance may be subject to the mortgage, in which event it
remains as a lien upon the premises without imposing any personal
liability on the grantee, 192 or it may be assumed by the buyer.



189.      The statement must include the amount of unpaid principal, the date to
          which interest has been paid, and the itemized amounts claimed to be
          unpaid for principal and interest. The statement may be in letter form if
          the mortgagee is a lending institution, the State of New York, or a
          subdivision or agency thereof. Otherwise, it must be in recordable form.
          N.Y. REAL PROP. LAW § 274-a.
190.      First Wis. Trust Co. v. Schroud, 916 F.2d 394 (7th Cir. 1990). The letter
          omitted deferred interest of over $105,000, a matter known to the
          mortgagor.
191.      Griffith v. Porter, 817 S.W.2d 131 (Tex. Civ. App. 1991). This was under
          the Texas Deceptive Trade Practices Act.
192.      Bayou Land Co. v. Talley, 924 P.2d 136, 152 (Colo. 1996); Walther v.
          Comm’r, 316 F.2d 708 (7th Cir. 1963); In re Emerald Oil Co., 807 F.2d
          1234 (5th Cir. 1987) (Louisiana law); Bernhardt v. Hemphill, 878 P.2d 107,
          110 (Colo. Ct. App. 1994); Cassidy v. Bonitatibus, 497 A.2d 1018 (Conn.
          App. Ct. 1985) (parol evidence of assumption must be clear); Adams v.
          George, 812 P.2d 280 (Idaho 1991); Dorothy Edwards Realtors, Inc. v.
          McAdams, 525 N.E.2d 1248 (Ind. Ct. App. 1988); First State Bank & Trust
          Co. v. Seven Gables Inn, 501 So. 2d 280, 290 (La. Ct. App. 1986); Meco
          Realty Co. v. Burns, 200 A.2d 869 (Pa. 1964); Hussey v. Ragsdale, 831
          S.W.2d 279 (Tenn. 1993).
              Neither is the grantee liable, under the majority rule, to indemnify the
          mortgagor against the mortgagee. People ex rel. Banner Land Co. v. State Tax
          Comm’n, 155 N.E. 84, 85 (N.Y. 1926); Smith v. Truslow, 84 N.Y. 660 (1881);
          2 S. WILLISTON, CONTRACTS §§ 382, 383 (3d ed. 1959); 1 C. WILTSIE,
          MORTGAGE FORECLOSURES §§ 218, 220 (5th ed. 1939); 2 L. JONES, MORT-
          GAGES § 942 (8th ed. 1928); 5 H. TIFFANY, REAL PROPERTY § 1435 (3d ed.
          1939); Annot., 111 A.L.R. 1114, 1124 (1937); 1917C L.R.A. 592, 594–95.
              The majority rule, that a grantee “subject” to a mortgage is not
          impliedly liable thereon, was adopted by statute in New Jersey. N.J. S TAT.
          ANN. § 46:9-7.1 (1990) (overruling Max v. Beckelman, 169 A. 640 (N.J.
          Ch. 1934)). In Pennsylvania, a conveyance by a mortgagor subject to a
          mortgage makes the grantee an indemnitor of the grantor, but this liability
          does not extend to any third person. Naffah v. City Deposit Bank, 23 A.2d
          340 (Pa. 1941).
              In Maryland an assumption is implied when a grantee is credited,
          against the purchase price, with the amount of the mortgage debt. This
          implication is negated in a wrap-around mortgage situation when the
          wrap-around mortgagee agrees to make payments on the preexisting
          mortgage. Daugharthy v. Monritt Assocs., 444 A.2d 1030 (Md. 1982).



                                       3–46
                             Mortgage Financing                                § 3:3.1

The contract of sale determines which is to occur.193 A grantee of
property with knowledge of a mortgage who assumes or takes subject
to the mortgage is estopped to assert a lack of consideration or
usury.194 Assumption of a mortgage creates an obligation to pay the
interest as well as the principal, even without express reference to
interest.195 The difference should be noted between an assumption of
payment, which renders the grantee personally liable only for payment
of principal and interest, and an assumption generally of the mortgage,
which makes the grantee personally liable as well on all the mortga-
gor ’s covenants, such as covenants of title.196
   A grantee’s assumption of an existing mortgage inures to the
benefit of and may be enforced by the mortgagee, without releasing
the mortgagor or prior obligor.197 In New York and some other states
the mortgagee may enforce such assumption only if the grantor is
liable on the mortgage, whereas many states enforce this assumption
regardless of the grantor ’s liability.198 A grantee’s assumption may be


              “Subject to” a mortgage was held to impose liability thereon in unusual
          circumstances. Rogers v. Niforatos, 394 N.Y.S.2d 473 (App. Div. 3d Dep’t
          1977) (transferees were attorney and accountants of transferor).
              A reference to the “property subject to a mortgage” may merely refer to
          certain property as a form of description. Regan v. ITT Indus. Credit Co.,
          469 So. 2d 1387 (Fla. Dist. Ct. App. 1984).
193.      A buyer’s agreement, included in the contract, to assume mortgage, may
          be merged by a deed that makes no provision for assumption. Bayou Land
          Co. v. Talley, 924 P.2d 136, 152 (Colo. 1996). The cases are split.
194.      Eurovest, Ltd. v. Segall, 528 So. 2d 482 (Fla. 3d Dist. Ct. App. 1988).
          Normally, a grantee who assumes or takes subject to a mortgage cannot
          raise the defense of usury. However, the court in Seidel v. 18 E. 17th St.
          Owners, Inc., 598 N.E.2d 7 (N.Y. 1992), recognized an exception when the
          grantee is closely related to the original borrower. In Seidel, the borrower
          obtained a loan to purchase a loft building, which it planned to convert to
          cooperative housing. Pursuant to this plan, it formed a cooperative
          housing corporation and conveyed the property to that corporation. The
          corporate grantee was allowed to assert usury.
195.      Kendrick v. Garrene, 96 So. 2d 58 (La. 1957).
196.      Silverstein v. Brown, 138 N.Y.S. 848 (App. Div. 1st Dep’t 1912).
197.      Bayou Land Co. v. Talley, 924 P.2d 136, 152 (Colo. 1996); W. Point Corp. v.
          New N. Miss. Fed. Sav. & Loan Ass’n, 506 So. 2d 241 (Miss. 1988); First
          Ind. Fed. Sav. Bank v. Hartle, 567 N.E.2d 834 (Ind. Ct. App. 1991); Beaver
          v. Ledbetter, 152 S.E.2d 165 (N.C. 1967); 4 A. CORBIN, CONTRACTS § 796
          (1951); 59 C.J.S. Mortgages § 418 (1949); 55 AM. JUR. 2D Mortgages
          § 1050 (1971); Annot., 21 A.L.R. 439 (1922).
198.      Vrooman v. Turner, 69 N.Y. 280 (1877); accord Dail v. Campbell, 12 Cal.
          Rptr. 739 (4th Dist. Ct. App. 1961); Milton R. Friedman, Creation and
          Effect of Personal Liability on Mortgage Debts in New York, 50 YALE L.J.
          224, 234 (1940).
              In Connecticut, by statute, an assuming grantee is liable irrespective of
          his grantor ’s liability. CONN. GEN. STAT. ANN. § 52-75; Schneider v.
          Ferrigno, 147 A. 303 (Conn. 1929). Accord Bankers Mortgage Corp. v.



(Friedman on Contracts, Rel. #7, 5/09)   3–47
§ 3:3.1                         FRIEDMAN    ON   CONTRACTS

effected by the deed conveying the premises. In the absence of statute
the grantee’s mere acceptance of a deed with a clause reading,
substantially

       Subject to a certain mortgage . . . which the grantee hereby assumes
       and agrees to pay.

is an effective assumption by the grantee, although the deed is
executed only by the grantor. The statute of frauds is inapplicable
because this is an original undertaking by the grantee and not an
agreement to answer for the debt, default, or miscarriage of another.199
And for the same reason, a parol assumption of a mortgage is valid and
enforceable.200 But in New York the assumption must, by statute, be
in writing. In Maryland a grantee who is credited against the purchase
price with the amount of an existing mortgage is held, as against his
grantor, to have assumed the mortgage by implication. 201



          Jacobs, 613 F. Supp. 1579 (E.D. Va. 1985) (VA. CODE ANN. § 55-22);
          Somers v. Avant, 261 S.E.2d 334 (Ga. 1979).
              The rule that denies a mortgagee’s right to enforce a grantee’s assump-
          tion, absent liability on his grantor ’s part, may be predicated on two
          different theories. Under the modern theory of third-party contracts, New
          York and other states enforce the rights of a creditor-beneficiary, but not
          those of a donee-beneficiary. The same result follows under the older
          theory of equitable subrogation. Under this theory an assuming grantee
          becomes, as to his grantor, the principal debtor and the latter takes the
          position of a surety. Milton R. Friedman, Creation and Effect of Personal
          Liability on Mortgage Debts in New York, 50 YALE L.J. 224, 230 et seq.
          (1940).
              If the conveyance to an assuming grantee is not an absolute convey-
          ance, e.g., a conveyance for security only, and with no intent that the debt
          become the debt of the grantee, the mortgagee has no right of enforcement
          against the grantee. See Friedman, supra, preceding paragraph.
199.      Moss v. Minor Props., Inc., 69 Cal. Rptr. 341 (2d Dist. Ct. App. 1968);
          Hafford v. Smith, 369 S.W.2d 290 (Mo. Ct. App. 1963); Fed. Nat’l
          Mortgage Ass’n v. Carrington, 374 P.2d 153 (Wash. 1962); Beacon Fed.
          Sav. & Loan Ass’n v. Panoramic Enters., Inc., 99 N.W.2d 696 (Wis. 1959);
          RESTATEMENT (SECOND) OF CONTRACTS § 123 (1981); see Milton R.
          Friedman, Creation and Effect of Personal Liability on Mortgage Debts in
          New York, 50 YALE L.J. 224, 226 et seq. (1940).
              This is part of a general rule that binds a grantee, by acceptance of a
          deed and possession, to perform a covenant on grantee’s part included in
          the deed. Mearida v. Murphy, 435 N.E.2d 1352 (Ill. App. Ct. 1982).
200.      Dieckman v. Walser, 168 A. 582 (N.J. Ch. 1933) (overruled by N.J. REV.
          STAT. § 46:9-7.1 (enacted 1947)). But see Weiner v. Hroch, 196 N.W.2d
          907, 908 (Neb. 1972); CAL. CIV. CODE § 1624(a)(6). Accord Kam, Inc. v.
          White, 675 S.W.2d 459 (Mo. Ct. App. 1984).
201.      Brice v. Griffin, 307 A.2d 660 (Md. 1973) (grantor-mortgagor recovered
          against grantee amount of mortgage installment payment made by
          grantor).



                                       3–48
                             Mortgage Financing                                § 3:3.1

   Successive assuming grantees form a chain of liability, the last
grantee being the principal debtor and the others assureties. 202
The assumption is in the nature of an indemnity for the grantor,
and the creditor (mortgagee) becomes entitled to the benefit of
the security received by the surety. Similarly, any such surety is
subrogated to the rights of the mortgagee against subsequently assum-
ing grantees.203 As heretofore mentioned, there is a split of authority
with respect to a mortgagee’s right to enforce the mortgage debt



202.      In re Quinco Corp., 389 F.2d 900 (6th Cir. 1968); In re Jordan, 199 B.R.
          68, 70 (Bankr. S.D. Fla. 1996) (citing Florida cases); Swanson v. Krenik,
          868 P.2d 297 (Alaska 1994); Sw. Sav. & Loan Ass’n v. Ludi, 594 P.2d 92
          (Ariz. 1979); Everts v. Matteson, 132 P.2d 476 (Cal. 1942); Moss v.
          McDonald, 772 P.2d 626 (Colo. Ct. App. 1988); Wagoner v. Brady, 223
          N.Y.S. 99 (App. Div. 3d Dep’t 1927); Langman v. Alumni Ass’n, 442 S.E.2d
          669 (Va. 1994).
              Grantee’s assumption is no release of the mortgagor from personal
          liability on the mortgage. Berg v. Liberty Fed. Sav. & Loan Ass’n, 428 A.2d
          347 (Del. 1981); Glenn v. Maddox, 253 S.E.2d 835 (Ga. Ct. App. 1979);
          State ex rel. LeFevre v. Stubbs, 642 S.W.2d 103 (Mo. 1982); Blackman v.
          Pael, 396 S.E.2d 128 (S.C. Ct. App. 1990).
              A mortgagor who redeemed the mortgaged premises from foreclosure
          recovered against an assuming grantee a sum equal to the excess of his
          proper payment for redemption above the value of the property he obtained
          thereby. Konoff v. Lantini, 306 A.2d 176 (R.I. 1973), following Jacobs v.
          Kupperstein, 153 A. 656 (Conn. 1931), and citing G. OSBORNE, MORT-
          GAGES § 259, at 516–19 (2d ed. 1970). See Foremost Life Ins. Co. v. Dep’t
          of Ins., 395 N.E.2d 418, 424 (Ind. Ct. App. 1979).
              Query: How would this claim of mortgagor be affected by statutes
          limiting or barring recovery on the mortgage debt after foreclosure?
              A mortgagee’s application of proceeds of credit insurance, on the life of
          the mortgagor, to satisfy the mortgage, was held to revive the mortgage and
          subrogate the estate of the mortgagor, as a surety, against an assuming
          grantee of the property. Betts v. Brown, 136 S.E.2d 365 (Ga. 1964), noted in
          43 TEX. L. REV. 580 (1965).
203.      State ex rel. LeFevre v. Stubbs, 642 S.W.2d 103 (Mo. 1982). See also the
          Washington cases discussed in First Interstate Bank, N.A. v. Nelco Enters.,
          Inc., 822 P.2d 1260, 1262 (Wash. Ct. App. 1992).
              A mortgagor, who had not paid the mortgagee, recovered a judgment
          against an assuming grantee, but the proceeds were to be in trust for the
          mortgagee. Riedle v. Peterson, 560 N.E.2d 725 (Mass. App. Ct. 1990).
              “[T]he liability for the mortgage debt is cast upon the grantees in the
          inverse order of assumption.” Swanson v. Krenik, 868 P.2d 297, 300
          (Alaska 1994), quoting Milton R. Friedman, Discharge of Personal Liability
          on Mortgage Debts in New York, 52 Yale L.J. 771, 774 n.13 (1943). In
          Swanson the first grantee claimed that a second assuming-grantee made
          both the mortgagor and the first grantee co-sureties because they were both
          liable to the mortgagee and, therefore, their liability was split. The court
          held the mortgagor was a subsurety with a right over against the first
          grantee. RESTATEMENT OF SURETY § 145, comment a (1941). Accord
          Langman v. Alumni Ass’n, 442 S.E.2d 669 (Va. 1994).



(Friedman on Contracts, Rel. #7, 5/09)   3–49
§ 3:3.1                         FRIEDMAN    ON   CONTRACTS

against an assuming grantee if some intermediate owner of the
mortgage property is not liable. Where this is true, some courts
note, there is no liability that can be the subject of indemnification.
    An assumption of an entire mortgage by a grantee of a portion of
the mortgaged premises makes the portion so conveyed a primary
security for the mortgage and the unsold portion a secondary secu-
rity.204 The assuming grantee is under a duty to protect the unsold
premises and is liable for a breach.205 If in this situation the mortgagor
is compelled to pay the mortgage debt, he is subrogated to the rights of
the mortgagee as against the grantee of the part of the mortgaged
premises206 and may recover judgment against the grantee for the
money so paid.207 If the portion not so conveyed is applied under
compulsion of law toward payment of the mortgage debt, the mortga-
gor or his successor may recover against the grantee for the value of the
land so taken.208 If the grantee of part of the mortgaged premises
assumes the entire mortgage by parol, his successors may not be
subjected to these consequences. Subsequent owners and lienors of the
premises acquired by the assuming grantee are not bound by a
mortgage assumption that is unknown to them. In this situation, all
the parcels covered by the mortgage are required to contribute to the
mortgage debt in proportion to their relative values.209 An agreement
extending the mortgage made between the mortgagee and a grantee of
part of the mortgaged property, who has assumed the entire mortgage,
may release the mortgagor from liability on the mortgage debt but does
not generally release the unsold property from the lien of the mort-
gage.210 A variation of this occurred when part of the mortgaged



204.      Annot., 21 A.L.R. 504, 530 (1922); 59 C.J.S. Mortgages § 433 (1949).
205.      Sanders v. Lackey, 439 S.W.2d 610 (Tenn. Ct. App. 1968).
206.      Markarian v. Morazines, 144 A. 265 (N.H. 1929). Compare Betts v. Brown,
          136 S.E.2d 365 (Ga. 1964).
207.      McRae v. Pope, 42 N.E.2d 261 (Mass. 1942).
208.      Russell v. Pistor, 7 N.Y. 171 (1852); see Milton R. Friedman, Creation and
          Effect of Personal Liability on Mortgage Debts in New York, 50 YALE L.J.
          224, 248–49 (1940).
              The mortgagor or subsequent “surety” who is forced to pay the
          mortgage debt is subrogated to the rights of the mortgagee. Toler v. Baldwin
          County Sav. & Loan Ass’n, 239 So. 2d 751 (Ala. 1970).
              Proceeds of credit life insurance, maintained on the life of the mort-
          gagor, were awarded to the mortgagor ’s children rather than to the
          assuming grantee. Toler, 239 So. 2d 751. The case is odd in that the
          mortgagee waived a right to apply the money in reduction of the mortgage
          and, further, the grantee had inadvertently paid premiums on the credit
          life insurance.
209.      Mo. Home Sav. & Loan Ass’n v. Allen, 452 S.W.2d 109 (Mo. 1970).
210.      Seale v. Berryman, 49 P.2d 997 (Ariz. 1935); Pearson v. Smith, 273 N.E.2d
          179 (Ill. App. Ct. 1971). But see Annot., 101 A.L.R. 618 (1936).



                                       3–50
                             Mortgage Financing                                § 3:3.1

property was sold to X by a warranty deed and thereafter the mortgagee
released the mortgagor and its guarantor from personal liability on the
mortgage debt. The releases were held to discharge the property of X
from the lien of the mortgage. The basis for this was the court’s
reasoning that the releases prevented X from paying off the blanket
mortgage and thereby becoming subrogated to the mortgagee’s rights
against the mortgagor, who is the primary debtor.211 The converse of
this occurs when an owner gives a blanket mortgage on one or more
parcels of land and subsequently conveys portions of the property
subject to the lien of the mortgage. This makes the respective parcels
liable for the payment of the blanket mortgage in the inverse order of
their alienation. The last parcel sold or encumbered by the mortgagor
is subject first to satisfaction of the blanket mortgage. 212 This does not
apply in the face of evidence of a contrary intention. 213 Some jurisdic-
tions follow a rule of apportionment, under which each parcel con-
veyed subsequent to the mortgage is prorated between the parcels




              For release of mortgagor by agreements between mortgagee and sub-
          sequent owner of mortgaged property, see Milton R. Friedman, Discharge
          of Personal Liability on Mortgage Debts in New York, 52 YALE L.J. 771
          (1943).
211.      MGIC Fin. Corp. v. H.A. Briggs Co., 600 P.2d 573 (Wash. Ct. App. 1979).
          In MGIC the blanket mortgage secured $1.42 million and covered land in
          two counties. The property conveyed to X was one lot, for a price of about
          $8,000, with no credit thereon by reason of the mortgage (facts amplified
          by counsel). The releases of the mortgagor and guarantor were given in
          connection with conveyance of most of the mortgaged property to the
          mortgagee in lieu of foreclosure. If the deed to X had been expressly subject
          to the mortgage, or if X had assumed the mortgage or received some credit
          therefor against the purchase price, the result would presumably have been
          contra. See also 5 H. TIFFANY, REAL PROPERTY § 1495 (3d ed. 1939); id.
          § 1435 n.26.
212.      See the detailed discussion and authorities in In re Dan Hixson Chevrolet
          Co., 20 B.R. 108, 111–13 (Bankr. N.D. Tex. 1982); Hill v. Lane, 848 P.2d
          43 (Okla. Ct. App. 1933).
              Inverse order of alienation is a form of marshalling assets. But Hill
          rejected marshalling of assets in favor of sale in inverse alienation.
213.      Maurer v. Arab Petroleum Corp., 135 S.W.2d 87 (Tex. 1940) (opinion
          adopted). This intent is demonstrated when a subsequent grantee or
          mortgagee assumes the paramount mortgage. 53 AM. JUR. 2D Marshalling
          Assets § 64 (1970). The amount of consideration paid by a grantee is also
          evidence of intent. Payment of full consideration, for instance, would
          indicate the inverse sale rule should not apply. See the discussion and
          authorities in In re Boswell Land & Livestock, Inc., 86 B.R. 665 (Bankr. D.
          Utah 1988). There is authority that when a grantee takes subject to a
          mortgage, as part of the consideration, the doctrine of inverse order of
          alienation does not apply. In re Oxford Dev. Ltd., 67 F.3d 683 (8th Cir.
          1995); 4 J. POMEROY, EQUITY JURISPRUDENCE §§ 1224–25 (4th ed. 1941).



(Friedman on Contracts, Rel. #7, 5/09)   3–51
§ 3:3.1                         FRIEDMAN     ON   CONTRACTS

according to their respective values.214 If a mortgagor conveys part and
retains part of the mortgaged property, the retained part is almost
always the first to be subjected to payment of the mortgage debt. 215
   The chain of liability that is created by successive assuming
grantees of the property may be reversed by a reconveyance of the
property to a former owner. Reconveyance by an assuming grantee to
his grantor, for a consideration that reflects a deduction for the amount
of the mortgage, makes the grantee-former-owner again primarily
liable.216 In the cases cited for this, the grantees receiving back the
property did not expressly reassume the mortgage. This has no
significance under the “primary fund” or “primary security” doctrine,
which means merely that a mortgagor (or successive obligor) who pays
the mortgage debt, may resort to the mortgaged property for reimbur-
sement. Any other rule would give unjust enrichment to a grantee who
acquired property subject to a mortgage and with credit therefore
against the purchase price. In this situation, the grantee is regarded
as having assumed payment of the mortgage to the extent of the value
of the land.217
   The existence of an assumption in the deed, or the recordation of
such deed, is not conclusive evidence of an assumption of a mortgage
by a grantee. If the covenant was unknown to the grantee, it may not




214.      See authorities in In re Dan Hixson Chevrolet Co., 20 B.R. 108, 111 n.7
          (Bankr. N.D. Tex. 1982). The parties may agree on the proportion of the
          mortgage the grantor and grantee are to bear. See Wiggins v. Leinenweber,
          404 So. 2d 778 (Fla. Dist. Ct. App. 1981).
215.      Seasons, Inc. v. Atwell, 527 P.2d 792, 797–78 (N.M. 1974) (“one man’s
          property should not be subjected to the payment of another man’s debt”);
          Annot., 131 A.L.R. 4, 11 (1941).
216.      Ruther v. Thomas, 604 P.2d 703 (Colo. Ct. App. 1979); Sanderson v.
          Turner, 174 P. 763 (Okla. 1918).
217.      Howard v. Robbins, 63 N.E. 530, 531 (N.Y. 1902) (and authorities
          discussed in this and following case); see Rochester Sav. Bank v. Stoeltzen
          & Tapper, Inc., 26 N.Y.S.2d 718, 721 (Sup. Ct. Monroe County 1941);
          Milton R. Friedman, Discharge of Personal Liability on Mortgage Debts in
          New York, 52 YALE L.J. 771, 773–74 (1943).
              The minority rule is that acquisition subject to a mortgage and with
          credit therefor is an assumption of the mortgage or if they rely on the
          presumed assumption arising out of the primary fund doctrine. The
          importance of this is that the primary fund doctrine operates between a
          mortgagor and successive owners, without affecting the right of the
          mortgagee to proceed in the first instance against one or more obligors
          or sureties. See the authorities in the preceding paragraph.
              The primary fund doctrine does affect the mortgagee in another
          connection. If the mortgagee acquires title to the property, this constitutes
          a release of the mortgage debt, either in full or to the extent of the value of
          the mortgaged premises. See Friedman, supra, at 786–87.



                                        3–52
                             Mortgage Financing                               § 3:3.1

be enforced by the mortgagee, and the grantee may obtain reformation
in a foreclosure or separate action.218 The presumption that a pur-
chaser has notice of everything in the deed under which he buys is not
applied to a mortgage assumption clause. This is deemed a collateral
undertaking and no part of the grant.219 A grantee’s assumption, as
has been said, inures to the benefit of the mortgagee. Cases have arisen
with respect to the right of a mortgagor-grantor (or a subsequent
obligee who conveys) to release the liability of a grantee who has
assumed. Insofar as the grantor thereby releases a right that is personal
to him, there is no problem. The question is whether the rights of the
mortgagee, a third-party beneficiary, may be so released. The cases are
in conflict.220 A grantee who assumed a mortgage by agreement with
the mortgagor-grantor was held released from his assumption per se,
when he succeeded in rescinding his purchase for fraud. The holder of
the mortgage was held to have no rights that survived the termination
of those of the mortgagor.221 The liability of an assuming grantee is
also unenforceable for lack of consideration if this grantee is evicted for
failure of title.222
    The possibilities of mistake, misunderstanding, and fraud in con-
nection with grantee assumptions of mortgages, which are not
evidenced by the grantees’ signatures, led to a statute enacted in
New York in 1938. This statute requires a grantee’s assumption of a
mortgage to be by written instrument, stating the amount of the debt,
signed and acknowledged by the grantee.223 This is usually carried out



218.      Consol. Realty Corp. v. Dunlop, 114 F.2d 16 (D.C. Cir. 1940); Fishback v.
          J.C. Forkner Fig. Gardens, Inc., 30 P.2d 586 (Cal. 4th Dist. Ct. App. 1934);
          Ludlum v. Pinckard, 136 N.E. 725 (Ill. 1922); Blass v. Terry, 50 N.E. 953
          (N.Y. 1898); Beaver v. Ledbetter, 152 S.E.2d 165 (N.C. 1967); Marrow v.
          Marrow, 454 S.E.2d 853 (N.C. Ct. App. 1995); Milton R. Friedman,
          Creation and Effect of Personal Liability on Mortgage Debts in New York,
          50 YALE L.J. 224, 227 (1940).
              Pioneer Sav. & Trust, F.A. v. Ben-Shosen, 826 P.2d 421 (Colo. Ct. App.
          1992), held it was an issue of fact whether a grantee intended to assume
          the mortgage and that the mortgagee, a third party, could not assert the
          parol evidence rule. Contra Muhlig v. Fiske, 131 Mass. 110 (1881).
219.      59 C.J.S. Mortgages § 403 (1949).
220.      Milton R. Friedman, Creation and Effect of Personal Liability on Mortgage
          Debts in New York, 50 YALE L.J. 224, 236–40 (1940); Annot., 21 A.L.R.
          439, 462 (1922); 55 AM. JUR. 2D Mortgages § 1081 (1971); 59 C.J.S.
          Mortgages § 420 (1949).
221.      Capac State Sav. Bank v. McKnight, 191 N.W.2d 55 (Mich. Ct. 1971);
          Meyer v. Ludvik, 680 P.2d 459 (Wyo. 1984).
222.      In re Cunningham, 48 B.R. 509, 513 (Bankr. M.D. Tenn. 1985); Dunning
          v. Leavitt, 85 N.Y. 30 (1881).
223.      N.Y. GEN. OBLIG. LAW § 5-705. See 13 ST. JOHN’S L. REV. 215 (1938);
          Milton R. Friedman, Creation and Effect of Personal Liability on Mortgage
          Debts in New York, 50 YALE L.J. 224, 226 et seq. (1940).



(Friedman on Contracts, Rel. #7, 5/09)   3–53
§ 3:3.1                         FRIEDMAN    ON   CONTRACTS

by having the grantee, as well as the grantor, execute and acknowledge
a deed that includes this recital.
   A mortgage clause that requires any transferee to assume the
mortgage does not make a grantee of the premises liable per se.224
   There is a current tendency to include in mortgages provisions for
variable interest, which permit the mortgagee to increase the rate of
interest in specified situations. These clauses have been enforced, 225
although there is dictum to the effect that they may be subject to some
equitable limitations.226
   A provision for increase in the interest rate has been held to permit
multiple increases.227 It implies no right to increase the amount of
the periodic payments or to extend the maturity of the mortgage. 228




              The statute as enacted in 1938, was limited to assumptions of mort-
          gages thereafter executed. A 1953 amendment makes it applicable to any
          mortgage executed prior to the time of the conveyance. The amendment
          does not apply to assumption by deed between 1938 and 1953.
224.      Brakhausen v. Cont’l Ill. Nat’l Bank & Trust Co., 120 N.E.2d 649 (Ill.),
          cert. denied, 348 U.S. 897 (1954).
              A mortgage provision that purports to make the mortgagor ’s liability
          run with the land does not bind a grantee who has not expressly assumed
          the mortgage. Weaver v. King County, 437 P.2d 698 (Wash. 1968).
225.      Miller v. Pac. First Fed. Sav. & Loan Ass’n, 545 P.2d 546 (Wash. 1976); Sec.
          Sav. & Loan Ass’n v. Wauwatosa Colony, Inc., 237 N.W.2d 729 (Wis.
          1976). Cf. Roach, The Variable Interest Rate Clause and Its Use in
          California Real Estate Transactions, 19 UCLA L. REV. 468 (1972); 60
          A.L.R.3d 473 (1974).
              For variations in the form of variable rate mortgages and a suggestion of
          their advantages, see 61 MARQ. L. REV. 140 (1977).
              For a general discussion, see Baher, Adjustable Interest Rate in Home
          Mortgages: A Reconsideration, 1975 WIS. L. REV. 742.
              Provision for repayment in an amount reflecting the difference between
          the Consumer Price Index between the time of the execution of the
          mortgage and its repayment has been held usurious. Olwine v. Torrens,
          236 Pa. Super. 51, 344 A.2d 665, 90 A.L.R.3d 757 (annot. at 763) (1975).
              For a brief discussion of alternative mortgage instruments, see
          Kratovil, A New Dilemma for Thrift Institutions: Judicial Emasculation of
          Due-On-Sale Clauses, 12 JOHN MARSHALL J. PRAC. & PROC. 299, 312–14
          (1979).
226.      Miller v. Pac. First Fed. Sav. & Loan Ass’n, 545 P.2d 546 (Wash. 1976).
          Same, where no provision therefor in mortgage other than due-on-sale
          clause. Rayford v. La. Sav. Ass’n, 380 So. 2d 1232 (La. Ct. App. 1980).
227.      Sec. Sav. & Loan Ass’n v. Wauwatosa Colony, Inc., 237 N.W.2d 729 (Wis.
          1976).
228.      Goebel v. First Fed. Sav. & Loan Ass’n, 266 N.W.2d 352 (Wis. 1978). The
          court noted that the mortgage specified increase of installments in other
          situations. The result is to create a “balloon” payment at the original
          mortgage expiration.



                                       3–54
                             Mortgage Financing                                § 3:3.2

The effect of usury laws on this clause is not clear when the variable
rate of interest exceeds the legal maximum for part of the time. 229
   The right of a mortgagee to make a transfer charge on a conveyance
of the property has been upheld.230 But a charge of 1% of the mortgage
principle was held unreasonable and inequitable where the charge was
unrelated to the mortgagee’s actual cost.231

    § 3:3.2          Due-on-Sale Clauses
   Prior to the 1970s, the sale of mortgaged property subject to the
continuance of the mortgage required a consideration of little more than
whether the purchaser is to take the property subject to the mortgage or
subject to the mortgage plus an assumption by the purchaser of the
mortgagor’s obligations under the mortgage. Since the 1960s, due-on-
sale clauses have come into widespread use, injecting considerable
complications. The clause purports to authorize the mortgagee to
accelerate the mortgage debt if the mortgagor sells or encumbers the
property. The language of the clause may vary and its scope may be
broader than mentioned above.232 The due-on-sale clause set forth in



229.      It has been held that the rate charged cannot exceed the maximum rate at
          any point during the term unless the agreement was consummated in good
          faith and without intent to avoid the usury laws. McConnell v. Merrill
          Lynch, Pierce, Fenner & Smith, Inc., 578 P.2d 1375 (Cal. 1978), criticized
          in 67 CALIF. L. REV. 621 (1979).
230.      Tucker v. Pulaski Fed. Sav. & Loan Ass’n, 481 S.W.2d 725 (Ark. 1972). The
          charge was $100. The mortgage showed that numerous records relating to
          payment and to insurance had to be amended. O’Connell v. Dockendorff,
          415 So. 2d 35 (Fla. Dist. Ct. App. 1982); First Fed. Sav. & Loan Ass’n v.
          Lockwood, 385 So. 2d 156 (Fla. Dist. Ct. App. 1980); Conner v. First Nat’l
          Bank & Trust Co., 439 N.E.2d 122 (Ill. App. Ct. 1982).
231.      The charge was unbargained for and was made as a condition of mort-
          gagee’s waiver of a due-on-sale clause. Cont’l Fed. Sav. & Loan Ass’n v.
          Fetter, 564, P.2d 1013 (Okla. 1977). Contra Pleasants v. Home Fed. Sav. &
          Loan Ass’n, 569 P.2d 261 (Ariz. 1977) (1% and .5% in interest).
232.      The clause in Patton v. First Fed. Sav. & Loan Ass’n, 578 P.2d 152, 156
          (Ariz. 1978), noted in 1979 ARIZ. ST. L.J. 367, authorized acceleration on
          mortgagor ’s giving a lease for over five years, a lease with an option to
          purchase, involuntary divestiture of ownership, further encumbrance of
          the property, change of its character or use, digging for gas, oil, or other
          minerals, and, in case of partnership or corporate ownership, a transfer of
          the interest of a general partner or of more than 25% of the stock. All
          transfers other than leases for less than two years was the test in Siegel v.
          Empire Sav. Bank, 304 N.W.2d 335 (Minn. 1981). The clause in Lake v.
          Equitable Sav. & Loan Ass’n, 674 P.2d 419 (Idaho 1983), included a lease.
              The clause was made applicable to “a transfer of . . . the stock of the
          Borrower . . . excepting only by the laws of descent and distribution.” Barry
          M. Dechtman, Inc. v. Sidpaul Corp., 429 A.2d 411, 413 (N.J. Super. Ct.
          App. Div. 1981), rev’d, 446 A.2d 518 (N.J. 1982). Query: Would this



(Friedman on Contracts, Rel. #7, 5/09)   3–55
§ 3:3.2                        FRIEDMAN    ON   CONTRACTS

the forms jointly promulgated by two federal entities, the Federal
National Mortgage Association (Fannie Mae) and the Federal Home
Loan Mortgage Association (Freddie Mac) have been used in millions of
home mortgage loans.
   The most recent version of the Fannie Mae/Freddie Mac clause
provides as below.

                                   CLAUSE 3-6

                              Due-on-Sale Clause

                       (From Fannie Mae/Freddie Mac)

   If all or any part of the Property or any Interest in the Property is
   sold or transferred (or if Borrower is not a natural person and a
   beneficial interest in Borrower is sold or transferred) without
   Lender’s prior written consent, Lender may require immediate
   payment in full of all sums secured by this Security Instrument.
   However, this option shall not be exercised by Lender if such
   exercise is prohibited by Applicable Law.
   If Lender exercises this option, Lender shall give Borrower notice
   of acceleration. The notice shall provide a period of not less than
   30 days from the date the notice is given in accordance with
   section 15 within which Borrower must pay all sums secured by
   this Security Instrument. If Borrower fails to pay these sums prior to
   the expiration of this period, Lender may invoke any remedies
   permitted by this Security Instrument without further notice or
   demand on Borrower.233

  A strict due-on-sale clause used by a financial institution for
business property, after substantial changes made by the author
(Milton Friedman) is shown below.




          language apply to one or more transfers of part of the stock of a corporate
          owner?
              A clause has been enforced permitting acceleration if the mortgaged
          premises are not owner-occupied as the primary residence of the mort-
          gagor. Investors Sav. & Loan Ass’n v. Ganz, 416 A.2d 918 (N.J. Super. Ct.
          Ch. Div. 1980). The mortgagee in Investors contended that nonoccupying
          owners tend to restrict and minimize maintenance and upkeep to enhance
          financial return.
233.      Multistate Fixed Rate Note—Single Family—Fannie Mae/Freddie Mac
          Uniform Instrument, Form 3200 (Jan. 2001).



                                       3–56
                             Mortgage Financing                                 § 3:3.2

                                     CLAUSE 3-7

                                Due-on-Sale Clause

                  Financial Institutions for Business Property

    The Mortgagee may declare the sum secured by this mortgage
    immediately due and payable in case of
    (a)   any transfer of title to the mortgaged property or any part
          thereof;
    (b)   any issuance or transfer of stock of the Mortgagor, if the
          Mortgagor is a corporation, or of any interest in the Mortgagor
          if the Mortgagor is a partnership or joint venture, whether by
          sale, exchange, conveyance, merger, consolidation, or other-
          wise; or
    (c)   a conveyance of an interest in the mortgaged property to a
          trustee of a land trust or a transfer in whole or part of a
          beneficiary’s interest in a land trust.
    The matters mentioned in (a), (b), and (c), above, shall apply to any
    transaction that is voluntary or occurs by operation of law, other
    than by death.234 Any consent to, or waiver by, the Mortgagee of,
    or any estoppel of the Mortgagee to object to, any matter men-
    tioned in (a), (b), or (c), above, shall apply only to that matter and
    not to anything thereafter occurring.235




234.      But a sale by an administrator or executor is subject to the clause. Howell
          v. Murray Mtg. Co., 890 S.W.2d 78 (Tex. Civ. App. 1994).
235.      A mortgagor will note that if it is a corporation listed on a stock exchange,
          it cannot control transfers of its stock, and that if it is not on an exchange
          but has a sizeable number of shareholders, the clause should permit
          transfers and issuance of shares in an amount of, perhaps, a maximum
          of 25% of the stock existing after completion of all such transfers and
          issuance. If the number of partners or joint venturers is substantial a
          comparable provision should be applicable.
              Subdivision (b) of the clause inhibits issuance of stock dividends, which
          could be changed by revising (b) to read:
             (b) any issuance of transfer of stock in the Tenant, if the Tenant is a
             corporation (unless such issuance is to an existing holder of such
             stock and in the same proportion as such holder owned in the
             corporation immediately prior to such issuance), or of any interest
             of the Tenant if the Tenant is a partnership or joint venture, whether
             by sale, exchange, merger, consolidation, or otherwise.
           The clause was held no restriction on alienation. Howell v. Murray Mtg.
          Co., 890 S.W.2d 78 (Tex. Civ. App. 1994).



(Friedman on Contracts, Rel. #7, 5/09)   3–57
§ 3:3.2                      FRIEDMAN   ON   CONTRACTS

   A sizeable body of cases among the states resulted in a general
enforcement of due-on-sale clauses, with some qualifications, excep-
tions, and conflict. Traditionally, lenders justified this based on risk of
default and impairment of mortgage security. This was the original
purpose of the clause, but beginning in the 1960s, lenders used it as
protection from the risks of inflation.236 The question is whether a
lending institution that makes a twenty- to thirty-year mortgage at a
fixed current interest rate must commit itself inflexibly to this bargain
in the face of increasing interest rates and inflation, with its conse-
quent reduced ability to pay or attract depositors. Many courts decided
that lenders’ use of due-on-sale clauses to retire unprofitable loans
when the buyer sold the property was legitimate. But other courts
disagreed, reasoning that the clause was an unreasonable restraint on
alienation.237
   In 1982, Congress enacted the Garn-St. Germain Depository Institu-
tions Act,238 which swept away most of the case law that had denied
enforcement to the clause. The act preempts inconsistent state statutory
and case law, making the clause generally enforceable, but barring
enforcement for the creation of junior liens and various personal
transfers, sometimes called “nonsubstantive transfers.” They are:
   (1)    the creation of a lien or other encumbrance subordinate to the
          lender ’s security instrument that does not relate to a transfer
          of rights of occupancy in the property;
   (2)    the creation of a purchase money security interest for house-
          hold appliances;
   (3)    a transfer by devise, descent, or operation of law on the death
          of a joint tenant or tenant by the entirety;
   (4)    the granting of a leasehold interest of three years or less not
          containing an option to purchase;
   (5)    a transfer to a relative resulting from the death of a borrower;
   (6)    a transfer where the spouse or children of the borrower become
          an owner of the property;
   (7)    a transfer resulting from a decree of a dissolution of marriage,
          legal separation agreement, or from an incidental property
          settlement agreement, by which the spouse of the borrower
          becomes an owner of the property;



236.      Dunham v. Ware Sav. Bank, 423 N.E.2d 998, 1001 (Mass. 1981).
237.      The best-known decision was Wellenkamp v. Bank of Am., 582 P.2d 970
          (Cal. 1978).
238.      Garn-St. Germain Depository Institutions Act, 12 U.S.C. § 1701j-3.



                                    3–58
                             Mortgage Financing                                 § 3:3.2

   (8)    a transfer into an inter vivos trust in that the borrower is and
          remains a beneficiary and which does not relate to a transfer of
          rights of occupancy in the property; or
   (9)    any other transfer or disposition described in regulations
          prescribed by the Office of Thrift Supervision.239
   The regulations take a broad view of federal preemption of due-on-
sale clauses. The act does not indicate whether it applies to due-on-
sale clauses in leasehold mortgages and in installment land contracts,
but the regulations of the Office of Thrift Supervision assert that it
does.240
   Since Garn-St. Germain, courts have routinely enforced due-on-
sale clauses when the lender employed standard language, and no
exception for a “nonsubstantive transfer” applies.241 A due-on-sale



239.      12 U.S.C. § 1701j-3(d).
240.      12 C.F.R. § 591.2(h):
             Loan secured by a lien on real property means a loan on the security
             of any instrument (whether a mortgage, deed or trust, or land
             contract) which makes the interest in real property (whether in
             fee, or in a leasehold or subleasehold) specific security for the
             payment of the obligation secured by the instrument.
241.      First Fed. Sav. & Loan Ass’n v. Quigley, 445 So. 2d 1052 (Fla. Dist. Ct.
          App. 1984); Home Fed. Sav. & Loan Ass’n v. Campney, 357 N.W.2d 613
          (Iowa 1984); Stenger v. Great S. Sav. & Loan Ass’n, 677 S.W.2d 376 (Mo.
          Ct. App. 1984); United Sav. Bank Mut. v. Barnette, 695 P.2d 73 (Or. Ct.
          App. 1985); Sec. Fed. Sav. & Loan Ass’n v. Coleman, 325 S.E.2d 546 (S.C.
          1985).
              The clause in a contract of sale between private individuals was
          enforced. W. Life Ins. Co. v. McPherson K.M.P., 702 F. Supp. 836
          (D. Kan. 1988); Lyons v. Skunda, 514 N.E.2d 944 (Ohio Ct. App. 1986);
          Morris v. Woodside, 682 P.2d 905 (Wash. 1984).
              A conveyance to a trustee of a land trust triggered the clause. N. Cmty.
          Bank v. Nw. Nat’l Bank, 467 N.E.2d 1094 (Ill. App. Ct. 1984). Same as to
          transfer of a beneficiary’s interest in a land trust. Barnes v. VNB Mortgage
          Corp., 334 S.E.2d 531 (Va. 1985).
              After a conveyance that would permit the mortgagee to accelerate, a
          reconveyance to the mortgagor made no difference. Stenger, 677 S.W.2d
          376. The same was true of the forfeiture of the purchaser ’s interest. Home
          Fed. Sav. & Loan Ass’n v. Campney, 357 N.W.2d 613 (Iowa 1984).
              A corporate mortgagor ’s conveyance to its principal individual, for tax
          purposes, and a reconveyance did not trigger the clause. Fid. Land Dev.
          Corp. v. Rieder & Sons Bldg. & Dev. Co., 377 A.2d 691 (N.J. Super. Ct.
          App. Div. 1977).
              Inclusion of the clause in the mortgage but not the note was immaterial
          to its enforcement. Abdul-Karim v. First Fed. Sav. & Loan Ass’n, 462
          N.E.2d 488 (Ill. 1984).
              Under Louisiana law an ordinary contract of sale did not trigger the
          clause. First Fed. Sav. & Loan Ass’n v. Botello, 725 F.2d 350 (5th Cir. 1984).



(Friedman on Contracts, Rel. #7, 5/09)   3–59
§ 3:3.2                        FRIEDMAN    ON   CONTRACTS

clause is enforced in bankruptcy of the mortgagor.242 A clause invoc-
able on a change of ownership of the property, or any part thereof, was
held enforceable after the mortgagor transferred a half interest therein
to her husband.243 The same was held to the delivery of a purchase
option.244 An installment sale,245 as well as a land contract sale246
have been held to trigger the clause. The clause was not activated by
the introduction of a new general partner followed by withdrawal and
substitution of partners247 A clause providing for acceleration after a
taking in condemnation of any part of the premises was denied effect
after a small part was taken with no showing of an impairment of
security.248 A provision that a sale would accelerate the mortgage was
not given effect; an election by the mortgage was necessary. 249
   A loan made by a federal savings and loan institution is enforceable
under federal law despite the conversion of the lender into a state
institution.250 A federal bankruptcy court has ruled that a national



              A provision forbidding mortgagor to sell without mortgagee’s consent
          was held to permit refusal of consent for any reason, and a breach
          permitted acceleration. Quintana v. First Interstate Bank, 737 P.2d 896
          (N.M. 1987).
242.      In re Martin, 176 B.R. 675 (Bankr. D. Conn. 1995).
243.      Lyons v. Skunda, 514 N.E.2d 944 (Ohio Ct. App. 1986). Contra 12 C.F.R.
          § 591.5(b)(2), (3), (4) (1987).
244.      Auernheimer v. Metzen, 780 P.2d 796 (Or. Ct. App. 1989).
245.      Income Realty & Mortgage, Inc. v. Columbia Sav. & Loan Ass’n, 661 P.2d
          257 (Colo. 1983); Capitol Fed. Sav. & Loan Ass’n v. Glenwood Manor, 686
          P.2d 853 (Kan. 1984) (no restraint on alienation); Greater Louisville First
          Fed. Sav. & Loan Ass’n v. Etzler, 659 S.W.2d 209 (Ky. Ct. App. 1983)
          (though transaction labeled an option); Darr v. First Fed. Sav. & Loan
          Ass’n, 393 N.W.2d (Mich. 1986); Blue Ash Bldg. & Loan Co. v. Hahn, 484
          N.E.2d 186 (Ohio Ct. App. 1984); New Home Fed. Sav. & Loan Ass’n v.
          Trunk, 482 A.2d 625 (Pa. Super. Ct. 1984), see also cases in Cent. Nat’l
          Bank v. Shoup, 501 N.E.2d 1090, 1095 (Ind. Ct. App. 1986).
              Contra Boyes v. Valley Bank, 701 P.2d 1008 (Nev. 1985).
              Darr held that excepting subordinate liens from a due-on-sale clause
          does not permit an installment sale.
246.      First Fed. Sav. & Loan Ass’n v. Perry’s Landing, Inc., 463 N.E.2d 636 (Ohio
          Ct. App. 1983).
247.      Fid. Trust Co. v. BVD Assocs., 492 A.2d 180 (Conn. 1985). This has long
          been the law with respect to nonassignment clauses in leases. 1 M ILTON R.
          FRIEDMAN, FRIEDMAN ON LEASES § 7:3.3[B] (Patrick A. Randolph, Jr., ed.,
          5th ed. PLI 2006).
248.      Sessler v. Arshak Corp., 464 So. 2d 612 (Fla. Dist. Ct. App. 1985).
249.      Roosevelt Sav. Bank v. A.V.R. Realty Corp., 544 N.Y.S.2d 650 (App. Div. 2d
          Dep’t 1989). This accords with the general rule of acceleration.
250.      Freedom Sav. & Loan Ass’n v. LaMonte, 448 So. 2d 51 (Fla. Dist. Ct. App.
          1984); Aetna Cas. & Sur. Co. v. Valdosta Fed. Sav. & Loan Ass’n, 333
          S.E.2d 849 (Ga. Ct. App. 1985). The converse of this appears in New
          Mexico v. N.M. Fed. Sav. & Loan Ass’n, 699 P.2d 604 (N.M. 1985).



                                       3–60
                             Mortgage Financing                               § 3:3.2

bank that makes a mortgage loan is not subject to the Garn-St.
Germain Act.251 The federal bankcruptcy court misread the statutory
definition of the term “lender.”252
   A clause reading, “To protect the security of this Deed of
Trust, Grantor agrees . . .” indicates that its purpose was merely to
protect the security of the mortgage and is unenforceable unless
the mortgagee shows an impairment of security.253 A clause that
limits transfers to those made with the mortgagee’s consent, such
consent not unreasonably to be withheld, has been construed both
ways, one holding that the consent may not be conditioned on
an increase of interest rate,254 and another holding that it is not
unreasonable for a mortgagee to demand an increase in interest. 255
A clause that permits acceleration in limited circumstances does not
permit acceleration generally.256 A clause that permits the making of
a junior mortgage is not activated by the foreclosure of that junior
mortgage.257




251.      In re Black, 221 B.R. 38 (Bankr. S.D. Fla. 1998) (lender not subject to
          statutory prohibition due to transfer resulting from marriage property
          settlement).
252.      The Act defines lender as “a person or government agency making a real
          property loan.” 12 U.S.C. § 1701j-3(a)(2). The court incorrectly reasoned
          that a private bank is not a person.
253.      O’Boskey v. First Fed. Sav. & Loan Ass’n, 678 P.2d 1112 (Idaho 1984), later
          opinion, 739 P.2d 301 (Idaho 1987) (upholds injunction and class action).
254.      Fogel v. S.S.R. Realty Assocs., 461 A.2d 1190 (N.J. Super. Ct. 1983).
255.      W. Life Ins. Co. v. McPherson K.M.P., 702 F. Supp. 836 (D. Kan. 1988);
          Rubin v. Centerbanc Fed. Sav. & Loan Ass’n, 487 So. 2d 1193 (Fla. Dist.
          Ct. App. 1986); Torgerson-Forstrom H.I. v. Olmsted Fed. Sav. & Loan
          Ass’n, 339 N.W.2d 901 (Minn. 1983).
              Western and Torgerson hold the purpose of the clause is to protect the
          mortgagee’s interest in the money market as well as to protect his security.
256.      A clause permitting acceleration with neither mortgagee’s consent nor
          assumption of the mortgage did not permit acceleration when grantee
          assumed. Morse v. City Fed. Sav. & Loan Ass’n, 567 F. Supp. 699 (S.D. Fla.
          1983); Sec. First Fed. Sav. & Loan Ass’n v. Jarchin, 479 So. 2d 767 (Fla.
          Dist. Ct. App. 1985).
              A clause providing that a transfer purchaser shall not assume the
          mortgage unless the mortgage shall immediately become due did not apply
          to a three-year lease providing for a conveyance thereafter. First Sav. &
          Loan Ass’n v. Treaster, 490 N.E.2d 1149 (Ind. Ct. App. 1986).
257.      Blitz v. Marino, 786 P.2d 490 (Colo. Ct. App. 1989) (conveyance in lieu of
          foreclosure; citing cases); Yelen v. Bankers Trust Co., 476 So. 2d 767 (Fla.
          Dist. Ct. App. 1985). Accord In re Ruepp, 321 S.E.2d 517 (N.C. Ct. App.
          1984) (permitting a junior mortgage is an anticipation that it may be
          foreclosed). Contra Unifirst Fed. Sav. & Loan Ass’n v. Tower Loan, Inc.,
          524 So. 2d 290 (Miss. 1986).



(Friedman on Contracts, Rel. #7, 5/09)   3–61
§ 3:3.2                         FRIEDMAN     ON   CONTRACTS

   A due-on-sale clause is not self executing.258 The clause may be
waived.259 The mortgagee has a reasonable time to enforce it,260 but
taking an excessive time is a waiver.261
   A mortgagee who exercises his rights under the clause is not
entitled to a prepayment premium.262 The premium is collectable
on a voluntary prepayment,263 which is not applicable to mortgagee’s
enforcement of the clause.
   Transfers completed before Garn-St. Germain are not affected by
that statute if they would not have triggered the clause before its
enactment.264 Transactions in a “window period state” during a
“window period” are not affected by Garn-St. Germain.265 If the
mortgage was made after the effective date of Garn-St. Germain the



258.      McJenkin v. Cent. Bank, 417 So. 2d 153 (Ala. 1982).
259.      Powell v. Phoenix Fed. Sav. & Loan Ass’n, 434 So. 2d 247 (Ala. 1983);
          Cooper v. Deseret Fed. Sav. & Loan Ass’n, 757 P.2d 483 (Utah Ct. App.
          1988) (four years too long; collecting cases); 12 C.F.R. § 591.5(b)(4) (1987).
              Contra Auernheimer v. Metzen, 780 P.2d 796 (Or. Ct. App. 1989). The
          fact that the statute of limitations to collect the debt has not run is
          immaterial. Cooper, 757 P.2d 483.
260.      Capitol Fed. Sav. & Loan Ass’n v. Glenwood Manor, 686 P.2d 853 (Kan.
          1984) (no restraint on alienation); First Fed. Sav. & Loan Ass’n v. Perry’s
          Landing, Inc., 463 N.E.2d 636 (Ohio Ct. App. 1983); Rakestraw v. Dozier
          Assocs., Inc., 329 S.E.2d 437 (S.C. 1985); Longview Sav. & Loan Ass’n v.
          Nabours, 673 S.W.2d 357 (Tex. Civ. App. 1984). But see Columbia Sav. &
          Loan v. Easterlin, 466 A.2d 968 (N.J. Super. Ct. Ch. Div. 1983) (mort-
          gagee’s acceptance of grantee’s checks for two years, accompanied by
          payment coupons in name of original grantee no waiver).
261.      McJenkin v. Cent. Bank of Tuscaloosa, N.A., 417 So. 2d 153.
262.      Abramoff v. Life Ins. Co., 92 B.R. 698 (Bankr. W.D. Tex. 1988); Tan v. Cal.
          Fed. Sav. & Loan Ass’n, 189 Cal. Rptr. 775 (Ct. App. 1983); Los Quatros,
          Inc. v. State Farm Life Ins. Co., 800 P.2d 184 (N.M. 1990) (discusses
          window period; extended discussion); Wide Scope, Inc. v. Freedom Fed.
          Sav. & Loan Ass’n, 520 N.E.2d 35 (Ohio Mun. Ct. Franklin County 1987);
          12 C.F.R. § 591.5(b)(2), (3) (1987).
              Abramoff, 92 B.R. 698, deemed a combination of due-on-sale clause
          and a prepayment premium a restraint on alienation.
              Prepayment penalties are generally limited to mortgagor ’s voluntary
          payments.
263.      Garn-St. Germain is not retroactive. Boyes v. Valley Bank, 701 P.2d 1008
          (Nev. 1985).
264.      Kiefer v. Fortune Fed. Sav. & Loan Ass’n, 453 So. 2d 430 (Fla. 1984); Home
          Sav. Bank v. Baer Prop., Ltd., 460 N.Y.S.2d 833 (App. Div. 3d Dep’t 1983);
          Perry v. Island Sav. & Loan Ass’n, 684 P.2d 1281 (Wash. 1984).
265.      A “window period state” is one in which enforcement of a due-on-sale
          clause was denied or qualified before Garn-St. Germain. The “window
          period” is that beginning with such state’s limitation of enforcement, and
          ending on the enactment of Garn-St. Germain (Oct. 15, 1982). Loans
          made during this period are governed by the prior law of the state for a
          period of three years following Garn-St. Germain (Oct. 15, 1985). The



                                        3–62
                             Mortgage Financing                               § 3:3.2

due-on-sale clause is enforceable,266 but only if they are nonfederal
loans.267
   A mortgagee who agreed to permit grantee to assume a mortgage at
9.5% interest but increased this to 13.5% after execution of a contract
of sale was held liable for breach of contract and of promissory
estoppel, though not for intentional interference with an advantageous
relationship.268
   Several cases permit the use of the due-on-sale clause to protect the
mortgagee’s security but not to exact changes in business condi-
tions.269 Other cases, apparently the majority, hold that a mortgagee’s
right to accelerate the debt is absolute, with no standard of reason-
ableness.270 A threat to use the clause for unpermitted purposes was


          window period is considered at length in Geier, Due-On-Sale Clauses
          Under the Garn-St. Germain Depository Institution Act of 1982, 17 S.F. L.
          REV. 355 (1983); Note, Garn-St. Germain. Congress Preempts Due-On-
          Sale—Fills Void Left by De La Cuesta, 12 STETSON L. REV. 461 (1983).
          Window period cases are discussed in Annot., 61 A.L.R.4TH 1070, 1087–
          96 (1988).
              Phillips v. Superior Court, 143 Ariz. 189, 692 P.2d 1038 (Ariz. Ct. App.
          1984), is an example of denial of enforcement of a loan made during the
          window period (a period beginning on July 8, 1971 in Arizona). Accord
          New Mexico v. N.M. Fed. Sav. & Loan Ass’n, 699 P.2d 604 (N.M. 1985).
              A clause included in a window-period mortgage was enforceable
          because of mortgagor ’s refusal to supply information as to whether the
          security was impaired. Santa Clara Sav. & Loan Ass’n v. Pereira, 211 Cal.
          Rptr. 54 (Ct. App. 1985). Florida, a window period state enforced the clause
          where security would have been impaired because it would have enforced
          the clause for this reason before Garn-St. Germain. Weiman v. McHaffie,
          470 So. 2d 682 (Fla. 1985).
              Nevada is not a window period state. Boyes v. Valley Bank, 701 P.2d
          1008 (Nev. 1985).
266.      First Fed. Sav. & Loan Ass’n v. Siegel, 456 So. 2d 579 (Fla. Dist. Ct. App.
          1984).
267.      First Fed. Sav. & Loan Ass’n v. Stacha, 688 S.W.2d 269 (Ark. 1985).
268.      Rosa v. Fla. Coast Bank, 484 So. 2d 57 (Fla. Dist. Ct. App. 1986).
269.      Snow v. W. Sav. & Loan Ass’n, 730 P.2d 204 (Ariz. 1986); Cent. Nat’l Bank
          v. Shoup, 501 N.E.2d 1090 (Ind. Ct. App. 1986).
              In Snow, the mortgagee was deemed unreasonable in demanding a 3%
          increase in the interest rate and a “balloon payment” after five years. This
          applies to commercial as well as residential property. Snow, 730 P.2d 204.
              Central Nat’l Bank held that a mortgagee must prove the transfer
          prejudiced the mortgagee’s security and that the purpose was not solely to
          increase the interest rate, but cites many cases to the contrary. Central
          Nat’l Bank, 501 N.E.2d 1090, deemed this a restraint on alienation.
270.      Destin Sav. Bank v. Summer House of FWB, Inc., 579 So. 2d 232 (Fla.
          Dist. Ct. App. 1991). See also Cent. Nat’l Bank v. Shoup, 501 N.E.2d 1090
          (Ind. Ct. App. 1986). Cases prior to Garn-St. Germain hold the same.
              In Destin Sav. Bank, 579 So. 2d 232, there was no legal objection to the
          mortgagee’s demand of a second mortgage on the mortgagor ’s house or the
          pledge to the mortgagee of a $100,000 certificate of deposit.



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§ 3:3.3                         FRIEDMAN    ON   CONTRACTS

held an anticipatory breach of contract for which damages were
recoverable.271

   § 3:3.3          Exoneration of Debt After Mortgagor’s Death
   The common law rule entitles the heir or devisee of real property
that was mortgaged by the testator to call upon the representa-
tive of the decedent to pay off the mortgage debt, so that the real
property may pass unencumbered. This is currently the law in many
jurisdictions.272 It is often referred to as “exoneration” of the debt.
The rule is subject to some qualifications that should be considered.
   The operation of the rule is barred by a contrary intention of the
testator, but this intention must be clearly expressed. The traditional
direction to “pay all my just debts,”273 to give “all my right, title and
interest,”274 or to give “subject to a mortgage”275 are not generally suffi-
cient for this purpose, though on each of these are cases to the contrary.276



271.      Snow v. W. Sav. & Loan Ass’n, 730 P.2d 204 (Ariz. 1986). Snow contains an
          extended discussion of good faith, generally, and privilege.
272.      In re Estate of Dolley, 71 Cal. Rptr. 56 (Ct. App. 1968) (dictum); Higginbo-
          tham v. Manchester, 154 A. 242 (Conn. 1931); Tunis v. Dole, 89 A.2d 760
          (N.H. 1952); Bethel v. Magness, 296 P.2d 792 (Okla. 1956), see also Caruthers
          v. Buscher, 382 A.2d 608 (Md. Ct. Spec. App. 1978); Norris v. Pellinger, 31
          A.2d 398 (N.J. Ch. 1943); Wright v. Holbrook, 32 N.Y 587 (1865).
              The rule is reviewed in 3 AMERICAN LAW OF PROPERTY § 14.25 (1952);
          UNIFORM PROB. CODE PRAC. MANUAL 38, 44 (1972); Paulus, Exoneration
          of Specific Devises: Legislation vs. The Common Law, 6 WILLAMETTE L.J.
          53 (1970) (comprehensive); Ryan, Exoneration of the Specific Devise at the
          Expense of the Residue, 44 MARV. L. REV. 290 (1960–61) [hereinafter Ryan];
          Milton R. Friedman, The Enforcement of Personal Liability on Mortgage
          Debts in New York, 51 YALE L.J. 382, 390–93 (1942); Johnson, Executor or
          Heir Who Pays the Mortgage?, 113 TR. & EST. 244 (1974), Notes, 40 CALIF.
          L. REV. 457 (1952); 40 HARV. L. REV. 630 (1927); 19 MD. L. REV. 247 (1959):
          Annot., Right of Heir or Devisee to Have Realty Exonerated From Lien
          Thereon at Expense of Personal Estate, 4 A.L.R.3d 1023 (1965).
273.      Tunis v. Dole, 89 A.2d 760 (N.H. 1952), see also Ryan, supra note 272 at
          295; Annot., Right of Heir or Devisee to Have Realty Exonerated From Lien
          Thereon at Expense of Personal Estate, 4 A.L.R.3d 1023, 1057 et seq.
          (1965).
274.      Tobiason v. Machen, 142 A.2d 145, 146–47 (Md. 1958), noted in 19 MD.
          L. REV. 247; Kent v. McCaslin, 117 So. 2d 804 (Miss. 1960); 3 AMERICAN
          LAW OF PROPERTY § 14.25, at 669 (1952). Contra Taylor’s Ex’r v. Broadway
          Methodist Church, 106 S.W.2d 69 (Ky. 1937) (alternate holding); Sav.
          Trust Co. v. Beck, 73 S.W.2d 282 (Mo. Ct. App. 1934).
275.      Caruthers v. Buscher, 382 A.2d 608 (Md. Ct. Spec. App. 1978); 4 A.L.R.3d
          1023, 1037–39 (1965). Tobiason, 142 A.2d 145, regarded these items as
          merely descriptive of the property demised.
276.      Bridgeport Trust Co. v. Fowler, 128 A. 719 (Conn. 1925); 1 CLEAVELAND,
          HEWITT & CLARK, PROBATE LAW & PRACTICE IN CONNECTICUT § 460, at
          676 (1915) [hereinafter CLEAVELAND]; see also 4 A.L.R.3d at 1057 et seq.



                                       3–64
                             Mortgage Financing                                 § 3:3.3

   Several reasons have been advanced for the rule. One is that
the testator ’s property was increased by his placing a mortgage on
the property,277 a reason that does not apply to a purchase money
mortgage (or its equivalent for this purpose, a testator ’s assumption of
a preexisting mortgage), an improvement loan, or security pledged for
another ’s debt. Another is a presumption that it represents the
testator ’s intent, that is, an intent to leave an asset, not debts,
especially where there is a specific legacy or devise.278 Exoneration is
to be out of undisposed personalty or realty charged with payment
of debts. This reason is doubtful, especially where intestacy is
involved. A third reason is to deprive a third person, the mortgagee,
of a right to choose, in the enforcement of the debt, between foreclos-
ing the mortgage, or maintaining an action at law for the debt. 279
Foreclosure would deprive the heir or devisee of the realty, in favor of
the residuary estate. It is noteworthy that the common law presump-
tion of testator ’s desire to have the mortgage paid out of other assets is
reversed by the statutes, hereafter mentioned, that presume the
opposite.
   Some cases limit exoneration as to mortgages to those made by the
testator and where the debt is his.280 Some apply exoneration to mortg-
ages assumed by the testator and others do not.281 Exoneration is appli-
cable to the extent of the residuary estate, including undisposed realty.282




277.      In re Estate of Dolley, 71 Cal. Rptr. 56, 61 (Ct. App. 1968); CLEAVELAND
          supra note 276, at 677–78; Ryan, supra note 272
278.      See Ryan, supra note 272 at 304–05, 4 A.L.R.3d at 1034–36.
279.      Ryan, supra note 272, at note 290–91; Note, 40 HARV. L. REV. 630, 631
          (1927). The New York statute effects this result.
280.      In re Estate of Dolley, 71 Cal. Rptr. 56 (Ct. App. 1968); Higginbotham v.
          Manchester, 154 A. 242 (Conn. 1931); 3 AMERICAN LAW OF PROPERTY
          § 14.25, at 669 (1952); CLEAVELAND, supra note 276, at 677; Ryan, supra
          note 272, at 292; 4 A.L.R.3d at 1039–43 (1965).
281.      Applying exoneration. Tracy v. Atwell, 32 F.2d 392 (D.C. Cir. 1929); In re
          Lienhart’s Estate, 21 N.W.2d 749 (Neb. 1946); Owen v. Lee, 37 S.E.2d 848
          (Va. 1946). Contra In re Hunt, 32 A. 204 (R.I. 1895).
              Cases giving exoneration to purchase money mortgages, and denying it
          to others but not purchase money mortgages, and those drawing no
          distinction are listed in Paulus, Exoneration of Specific Devises: Legislation
          vs. the Common Law, 6 WILLAMETTE L.J. 53, 61 (1970).
              In denying exoneration of a purchase money mortgage, one court
          explained that purchasers buy property on small down payments, in
          mushrooming credit, with little intention of paying off the mortgage,
          and that it is ridiculous to believe the testator intended his executors to
          make payment for benefit of a third person. In re Estate of Brown, 50 Cal.
          Rptr. 78 (Ct. App. 1966).
282.      Tunis v. Dole, 89 A.2d 760 (N.H. 1952); Note, 40 HARV. L. REV. 630,
          631–32 (1927).



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§ 3:3.3                         FRIEDMAN     ON   CONTRACTS

The common law rule has been applied to encumbrances other than
mortgages.283
    Failure of a mortgagee to file a claim against the estate of a testator
has been held to have no effect on the operation of the common law
rule,284 but here too there are cases contra.285 The contra cases are not
in accord with one of the reasons advanced for the common law rule,
that is, that a third-party mortgagee should not affect the distribution
of a decedent’s estate.
    Several cases involve the effects of conflicts of laws on the common
law rule, as where a decedent was domiciled in a state following one
rule and owned mortgaged real estate in a state following another rule.
In a Connecticut case the testator was domiciled in Connecticut and
the real estate was in Massachusetts. Connecticut follows the com-
mon law rule, which was abrogated by statute in Massachusetts. The
Connecticut court presumed an intention by the testator that Con-
necticut’s common law rule should govern.286 On the other hand,
New Hampshire and New York have applied the rule in effect at the
location of the real estate. The New Hampshire court applied its
common law rule to property located in New Hampshire and the
contra statutory rule to Massachusetts property.287
    The common law rule is limited to acquisition of real estate by will
or intestacy. Accordingly, it does not apply to a joint tenant or tenant
by the entirety who acquired realty by survivorship. These people take
title by their deed, not as heir or devisee.288 Because a surviving joint
tenant does not have a common law right of exoneration, a modern
statute that eliminates or restricts exoneration does not improve the
joint tenant’s position.289 Denial of exoneration in this situation is
distinguishable from contribution between joint debtors, as tenants-
by-the-entirety are apt to be when both execute a mortgage and the

283.      Bethel v. Magness, 296 P.2d 792 (Okla. 1956); In re Riegelman’s Estate, 34
          A. 120 (Pa. 1896); Ryan, supra note 272, at 304–05; 40 HARV. L. REV.
          630–31; Note, 19 MD. L. REV. 247, 248–49 (1959).
284.      In re Estate of Dolley, 71 Cal. Rptr. 56 (Ct. App. 1968).
285.      See generally 4 A.L.R.3d 1023, 1045–49 (1965).
286.      Higginbotham v. Manchester, 154 A. 242 (Conn. 1931).
287.      Tunis v. Dole, 89 A.2d 760 (N.H. 1952); In re Blackinton’s Estate, 275
          N.Y.S. 544 (Sur. Ct. N.Y. County 1934).
288.      In re Estate of Dolley, 71 Cal. Rptr. 56 (Ct. App. 1968); In re Estate of Keil,
          145 A.2d 563 (Del. 1958), noted in 73 HARV. L. REV. 425; 8 KAN. L. REV.
          143; 42 MARQ. L. REV. 555; 58 MICH. L. REV. 137; 11 STAN. L. REV. 778;
          Lopez v. Lopez, 90 So. 2d 456 (Fla. 1956), noted in 11 MIAMI L.Q. 526
          (1957); Cunningham v. Cunningham, 148 A. 444 (Md. 1930); In re
          Staiger’s Estate, 144 A. 619 (N.J. Ch. 1929).
              Staiger noted that exoneration would not benefit the estate of the
          deceased husband.
289.      In re Estate of Zahn, 702 A.2d 482 (N.J. Super. Ct. App. Div. 1997)
          (rejecting argument of joint tenant, testator ’s girlfriend, that because



                                        3–66
                             Mortgage Financing                                  § 3:3.3

mortgage obligation. Some cases that deny exoneration have given the
survivor pro rata contribution.290
   Colorado is apparently the only state that has rejected the common
law rule by judicial decision.291
   It is doubtful that application of the rule of exoneration carried out
the testator ’s intent most of the time.292 It was abrogated by statute in
England.293 It has been nullified by statutes in California, Maryland,
Massachusetts, New Jersey, New York, Oklahoma, Pennsylvania,
South Dakota, and Washington.294 Furthermore, the Uniform Probate
Code section 2-609 provides that a specific devise passes subject to any
security interest existing at the date of death, without right of
exoneration, regardless of a general directive in the will to pay debts.
   The New York statute has a long background and is the only
one that has been thoroughly litigated. “As originally enacted, it
included no charges other than mortgages, and the general estate,
therefore, remained liable for all other debts affecting the mortgaged



          New Jersey statute, N.J. REV. STAT. § 3B:25-1, only refers to heirs and
          devisees, she is entitled to exoneration on testator ’s purchase-money
          mortgage on house). The Zahn court also cast aside two other arguments
          raised by the joint tenant: that language in the will directing the executors
          “to pay all of my just debts” applied to the mortgage; and that the testator ’s
          alleged oral statements that she would get the house “free and clear”
          entitled her to exoneration.
290.      Keil, 145 A.2d 563; Cunningham, 148 A. 444. See also 32 B.U. L. REV. 253
          (1952). Contribution was denied in Lopez, 90 So. 2d 456; Magenheimer v.
          Councilman, 125 N.E. 77 (Ind. Ct. App. 1919); Ratte v. Ratte, 156 N.E.
          870 (Mass. 1927). Ratte stated by way of dictum that the result might be
          different in case of tenants in common.
291.      Ambrose v. Singleton, 356 P.2d 253 (Colo. 1960).
292.      An extreme but hypothetical example would be: Testator leaves a house to
          his daughter, worth $100,000, but subject to a mortgage of $50,000, that
          is, the daughter receives an equity of $50,000. The residuary estate,
          amounting to $50,000 is left to the son. Testator believes he has treated
          his children equally. But when the daughter has the residuary estate
          applied to pay the mortgage, she ends with a $100,000 house free and
          clear and the son has nothing. For purposes of simplicity this example
          disregards death taxes.
293.      Locke King’s Act, 17 & 18 Vict., § 113 (1854), amended by 30 & 31 Vict.,
          ch 69 (1867): Admin. Estate Act of 1925, 15 Geo. 5 ch. 23, § 35. These are
          discussed in 1 COOTE, MORTGAGES 792–800 (8th ed. 1912).
294.      CAL. PROB. CODE § 21131 (“A specific gift passes the property transferred
          subject to any mortgage, deed of trust, or other lien existing at the date of
          death, without right of exoneration, regardless of a general directive to pay
          debts contained in the instrument”); MD. CODE, EST. & TRUSTS § 4-406;
          MASS. GEN. LAWS ch. 191, § 23; N.J. REV. STAT. § 3B:25-1; N.Y. EST.
          POWERS & TRUSTS LAW § 3-3.6; OKLA. STAT. ANN. tit. 46, § 5; 20 PA. CONS.
          STAT. ANN. § 2514(12.1); S.D. CODIFIED LAWS § 29A-2-607; WASH. REV.
          CODE § 11.12.070.



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§ 3:3.3                         FRIEDMAN     ON   CONTRACTS

premises.”295 By a 1937 amendment it referred to real property
“subject to a mortgage executed by any ancestor, or subject to any
other charge.” It provided that when such property passes, the
distributee must satisfy the mortgage out of his own property. 296
The Massachusetts, New Jersey, and South Dakota statutes are
substantially the same as this.297 The New York statute was con-
strued to have a substantial effect on the remedies of the mort-
gagee.298 The current version of the statute is broader and refers to
“any property, subject, at the time of the decedent’s death, to any lien,
security interest or other charge, including a lien for unpaid purchase
price.”299
   The Maryland statute makes a legacy of specific property pass
subject to a security interest, existing at the time of execution of the
will, or a renewal, extension, or refinancing, all unless otherwise



295.      Milton R. Friedman, The Enforcement of Personal Liability on Mortgage
          Debts in New York, 51 YALE L.J. 382, 391 n.59 (1942) (discussing cases).
296.      Former N.Y. REAL PROP. LAW § 250 (Laws 1937, ch. 75), now N.Y. EST.
          POWERS & TRUSTS LAW § 3-3.6.
297.      MASS. GEN. LAWS ch. 191, § 23; N.J. REV. STAT. § 3B:25-1; S.D. CODIFIED
          LAWS § 29A-2-607.
298.      Section 250 was limited in its terms to the relations between heir or
          devisee and the general estate, but it was nevertheless extended by
          construction to the mortgagee. Though not intended to deprive the
          mortgagee of any part of his debt, it was held to make the mortgaged
          premises primarily liable for the mortgage debt and to limit the liability of
          the representative and distributees of the estate to a deficiency judgment.
          By judicial legislation, therefore, the mortgagee was required first to
          foreclose and then to claim against the general estate only for the
          deficiency. The mortgagee could not waive his lien on the property and
          claim for the full amount of the debt against the representative; section
          250, on the other hand, created no personal liability in the heir or devisee
          for the debt. Thus the mortgagee could recover a judgment against neither
          for principal or interest. For interest accruing before the obligor ’s death,
          the mortgagee could recover directly against the representative, but for
          interest accruing subsequently it was necessary first to resort to foreclosure
          and only charge the representative with any resulting deficiency. Enacted
          for the purpose of preventing an heir or devisee from taking property, as
          against the representative, free and clear of the mortgage, section 250 thus
          construed had the further effect of marshalling the assets by postponing
          and qualifying the mortgagee’s rights on the bond. The mortgagee, how-
          ever, was afforded some protection against the dissemination of assets
          properly applicable to payment of his deficiency by a statute empowering
          the surrogate, on the mortgagee’s application as a contingent creditor, to
          direct reservation of assets deemed sufficient to pay a deficiency judgment
          when finally determined.
              Milton R. Friedman, The Enforcement of Personal Liability on Mort-
          gage Debts in New York, 51 YALE L.J. 382, 391–93 (1942) (footnotes
          omitted). See also Jemzura v. Jemzura, 330 N.E.2d 414, 418 (N.Y. 1975).
299.      N.Y. EST. POWERS & TRUSTS LAW § 3-3.6.



                                        3–68
                             Mortgage Financing                             § 3:3.3

indicated in the will. Any such interest created or attaching after the
will is subject to exoneration.300
   The Pennsylvania statute bars exoneration with respect to any
mortgage affecting the property and notwithstanding any general
direction by the testator to pay debts.301
   An Illinois court reached a decision comparable to a denial of
exoneration but on other grounds. In essence, a husband, who had
mortgaged realty to his wife, left the realty to her by will. When she left
the properties to charities her executors claimed the property was still
subject to the mortgage. The court held the wife’s equity in the
property merged and cancelled the mortgage. 302
   Where a demand mortgage is used—and it is or has been usual in
some places—many special clauses hereinafter mentioned are unne-
cessary for the mortgagee’s security. It is unimportant, for instance,
whether a demand mortgage expressly requires a mortgagor to main-
tain fire insurance for the benefit of the mortgagee if the latter may
demand such insurance and call the mortgagor if he does not get it.
But where the mortgage principal is payable otherwise, some special
clauses are essential and these will be discussed. Whether an instru-
ment is a demand instrument or one payable in installments may be
doubtful. This is true when an instrument is payable “on demand” and
also provides for payment of interest and installments of principal
periodically. A New Hampshire court had no difficulty in holding
a mortgage in this form callable on the mortgagee’s demand. 303
A dissenting judge cited four cases involving promissory notes in
this form that were held installment obligations.304 If the instrument
is held an installment obligation and includes no right to accelerate,
the holder may recover only for past due installments. 305 Furthermore,
the statute of limitations, which runs on a demand obligation from its



300.      MD. CODE, EST. & TRUSTS § 4-406.
301.      20 PA. CONS. STAT. ANN. § 2514(12.1).
302.      In re Estate of Grozier, 587 N.E.2d 77 (Ill. App. Ct. 1992).
303.      Simon v. N.H. Sav. Bank, 296 A.2d 913 (N.H. 1972). At a time when
          demand mortgages were customary, they were rarely called. “It is a matter
          of common knowledge that a savings bank rarely, if ever, collects a loan
          when secured and the interest is paid.” Shelly v. Bristol Sav. Bank, 26 A.
          474, 475 (Conn. 1893).
              A note payable “on demand and if no demand be made . . . in monthly
          installments of ____” was held an installment note but the court cited
          cases showing the law is split. Reese v. First Mo. Bank & Trust Co., 664
          S.W.2d 530 (Mo. Ct. App. 1983). In Reese, the accompanying mortgage
          referred to installments.
304.      See cases in notes 17 & 18, infra. Accord Bank of Nova Scotia v. St. Croix
          Drive-In Theatre, Inc., 552 F. Supp. 1244 (D. St. Croix 1982).
305.      Maffett v. Emmons, 192 P.2d 557 (N.M. 1948).



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§ 3:4                       FRIEDMAN    ON   CONTRACTS

inception, runs on an installment obligation only from maturity of the
installments.306
   If the mortgage and its accompanying note, bond, or otherwise does
not specify the payment date, then it is payable instantly and the
statute of limitations begins to accrue instantly, unless there is some
event that tolls the statute.307

§ 3:4      Purchase Money Mortgages
   It is customary, and good practice, to include in a mortgage given
to secure part of the purchase of real estate a recital that the mortgage
is a purchase money mortgage. This recital generally follows the
description of the mortgaged premises and may read substantially as
below.

                                 CLAUSE 3-8

          Recital: Mortgage As a Purchase Money Mortgage

   Being the same premises conveyed to the mortgagor by the
   mortgagee by deed dated and intended to be recorded simulta-
   neously herewith in the Office of ____________, this being
   a purchase money mortgage given to secure a portion of the
   purchase price.

   There are advantages in a purchase money mortgage over other
mortgages and this recital is of evidentiary value to the mortgagee or
subsequent holder of such mortgage. In fact, some statutes afford the
benefits of a purchase money mortgage only to those mortgages that
expressly recite they secure the purchase price of the property, in whole
or in part.308
   A deed and a purchase money mortgage are presumably a single
transaction309 and the two are construed together.310 The lien of
the purchase money mortgage is presumably coextensive with the




306.    Trigg v. Arnott, 71 P.2d 330 (Cal. Dist. Ct. App. 1937); Barron v. Boynton,
        15 A.2d 191 (Me. 1940); Collateral Liquidation, Inc. v. Renshaw, 3 N.W.2d
        834 (Mich. 1942).
307.    Vanica v. Oehm, 526 N.W.2d 648 (Neb. 1995).
308.    MD. CODE ANN., REAL PROP. § 7-104; N.C. GEN. STAT. § 45-21.38.
309.    Stephenson v. Naumann, 195 N.Y.S. 768 (Sup. Ct. Kings County), aff ’d,
        197 N.Y.S. 951 (App. Div. 2d Dep’t 1922).
310.    DeGarmo v. Phelps, 68 N.E. 873 (N.Y. 1903); McDuffie v. Clark, 9 N.Y.S.
        826 (Sup. Ct. 1890) (corrects wrong initials of grantee).



                                     3–70
                              Mortgage Financing                              § 3:4

estate passing by the accompanying deed, and this presumption may
be sufficient to correct an inadvertent error in drafting the
mortgage.311
   A mortgage may be a purchase money mortgage although not
executed the same day as the deed, provided it is part of one
continuous transaction.312 A purchase money mortgage may be validly
given to a third party, provided the money was loaned for use in
payment of the purchase price,313 and in this event it is a purchase
money mortgage only to the extent that the consideration therefore
was used for the purchase.314 It is a purchase mortgage only with




311.      A recital that the mortgage is given to secure purchase money may,
          therefore, help establish a lien broader than a limited reading of the
          mortgage might indicate. In re City of New York (Lawrence Ave.), 169
          N.Y.S. 1018 (App. Div. 2d Dep’t 1918) (street rights included in deed but
          omitted from mortgage); see Annot., 134 A.L.R. 1041 (1941).
312.      G. GLENN, MORTGAGES § 345.2 (1943); 55 AM. JUR. 2D Mortgages § 13
          (1971); 59 C.J.S. Mortgages § 231(b) (1949). A mortgage executed eight
          months after a conveyance by purchaser ’s corporation and covering only
          part of the land conveyed was held a purchase money mortgage for the
          purpose of an anti-deficiency statute. Swenson v. Rampage, 762 P.2d 851
          (Mont. 1988). See also Sunshine Bank v. Smith, 631 So. 2d 965 (Ala. 1994)
          (mortgage described the wrong land; corrected mortgage recorded
          eleven months later qualifies as purchase money mortgage).
313.      Martin v. First Nat’l Bank, 184 So. 2d 815 (Ala. 1966); Garrett Tire Ctr.,
          Inc. v. Herbaugh, 740 S.W.2d 612 (Ark. 1987); Mercantile Collection
          Bureau v. Roach, 15 Cal. Rptr. 710 (3d Dist. Ct. App. 1961); Banc Fla. v.
          Hayward, 689 So. 2d 1052 (Fla. 1997); Sarmiento v. Stockton, Whatley,
          Davin & Co., 399 So. 2d 1057 (Fla. Dist. Ct. App. 1981); Hand Trading
          Co. v. Daniels, 190 S.E.2d 560 (Ga. Ct. App. 1972); Pulse v. N. Am. Land
          Title Co., 707 P.2d 1105 (Mont. 1985); Boies v. Benham, 28 N.E. 657 (N.Y.
          1891).
314.      Carteret Sav. Bank v. Citibank Mortgage Corp., 632 So. 2d 598 (Fla. 1944)
          (part used for construction no purchase money mortgage), aff ’g Citibank
          Mtg. Corp. v. Ceret Sav. Bank, 612 So. 2d 539 (Fla. Dist. Ct. App. 1992);
          Syracuse Sav. & Loan Ass’n v. Hass, 234 N.Y.S. 514 (Sup. Ct. Onondaga
          County 1929) (part used for construction no purchase money mortgage).
          Contra Barone v. Frie, 472 N.Y.S.2d 119 (App. Div. 2d Dep’t 1984) (may be
          purchase money though given on other property).
              It is not a purchase money mortgage with respect to property that was
          not acquired by the mortgagor as part of the transaction in which the
          mortgage was given. Loretz v. Cal-Coast Dev. Corp., 57 Cal. Rptr. 188 (1st
          Dist. Ct. App. 1967); Bank Fla. v. Hayward, 689 So. 2d 1052 (Fla. 1997);
          Dobias v. White, 80 S.E.2d 23 (N.C. 1954).
              Contra to Syracuse Savings & Loan Ass’n, 234 N.Y.S. 514, the priority
          of a purchase money mortgage was held to cover not only the part thereof
          used to purchase the property but also the amount intended for construc-
          tion. Hand Trading Co. v. Daniels, 190 S.E.2d 560 (Ga. Ct. App. 1972);
          Resolution Trust Corp. v. Bopp, 850 P.2d 939 (Kan. Ct. App. 1993).



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respect to the property conveyed to the mortgagor.315 A mortgage, the
proceeds of which are not used for the acquisition of the realty, is not a
purchase money mortgage.316
   A purchase money mortgage is a limitation on the title conveyed,
not an encumbrance.317 It takes precedence over prior judgments
recovered against the mortgagor318 and over an after-acquired property




315.    Armel Mgmt. Corp. v. Stanhagen, 241 S.E.2d 713 (N.C. Ct. App. 1978).
        A mortgage given on one house to buy another was held not a purchase
        money mortgage, at least within an antideficiency statute. Cely v. De
        Concini, McDonald, Brammer, Yetwin & Lacy, 803 P.2d 911 (Ariz. Ct.
        App. 1990) (following California law).
316.    Union Bank v. Anderson, 283 Cal. Rptr. 823 (5th Dist. Ct. App. 1991)
        (mortgage on corporate owned realty given to secure payment of shares of
        stock of that corporation); Slate v. Marion, 408 S.E.2d 189 (N.C. Ct. App. 1991)
        (mortgage subordinate to judgment lien against mortgagor). See also C&L
                                                                  .2d
        Lumber & Supply, Inc. v. Tex. Am. Bank/Galeria, 795 P 502 (N.M. 1990).
            Earlier cases are discussed in Brock v. First Sav. Ass’n, 10 Cal. Rptr. 2d
        700 (3d Dist. Ct. App. 1992), and 55 A.L.R.2d, supra. Brock relies largely
        on Fisk v. Potter, 2 Keyes (N.Y.) 64, 2 Abb. Ct. App. Dec. 138 (1865), which
        ruled in favor of a purchase money mortgagee on the ground that an
        unrecorded vendor ’s lien was tantamount to a secret lien that would not be
        found in the public records. This would not apply to Brock because the
        mortgagee knew of the lien when the deed and mortgage were delivered.
        Brock also cites cases based on a preference for legal over equitable liens.
        Fisk was one of the cases “that were omitted from the official reports
        between 1863 and 1869. They were published without official sanction
        and from lack of authentic information or the necessary materials for
        preparing reports. There are some opinions that the court did not adopt
        and others without the statements necessary to show what was actually
        decided. They are regarded as of questionable authority and only cited with
        caution.” 2 Abbot, N.Y. DIG., Consol. Ed. at xxiii.
317.    Troyer v. Mundy, 60 F.2d 818, 821 (8th Cir. 1932) (citing many cases).
318.    In re Register, 37 B.R. 708 (Bankr. N.D. Ga. 1983); United States
        v. Miller, 400 F. Supp. 1080 (S.D.N.Y. 1975); Transamerica Fin. Serv.,
        Inc. v. Lafferty, 856 P.2d 1188, 1194 (Ariz. 1993); Garrett Tire Ctr., Inc.
        v. Herbaugh, 740 S.W.2d 612 (Ark. 1987); Baron v. Aiello, 319 So. 2d
        198 (Fla. Dist. Ct. App. 1975); County of Pinellas v. Clearwater Fed. Sav.
        & Loan Ass’n, 214 So. 2d 525 (Fla. Dist. Ct. App. 1968); Murray v.
        Chulak, 300 S.E.2d 493 (Ga. 1983); Bank of Homewood v. Gembella,
        199 N.E.2d 293 (Ill. App. Ct. 1964); Boggs v. O.S. Kelly Mfg. Co., 90
        P. 765 (Kan. 1907); DeGarmo v. Phelps, 68 N.E. 873 (N.Y. 1903);
        Shilowitz v. Wadler, 261 N.Y.S. 351 (App. Div. 3d Dep’t 1932); Nelson
        v. Stoker, 669 P.2d 390 (Utah 1983) (deed of trust); N. State Bank v. Toal,
        230 N.W.2d 153 (Wis. 1975). This is codified by D EL. CODE ANN. tit. 25,
        § 2108 (provided mortgage recorded within five days after deed to
        mortgagor); D.C. C ODE ANN. § 15-104; MD. CODE ANN., REAL PROP.
        § 7-104; N.J. STAT. ANN. § 46:9-8; N.Y. C.P.L.R. § 5203(a)(2); see CAL.
        CIV. CODE ANN. § 2898.



                                       3–72
                              Mortgage Financing                                § 3:4

clause in a prior mortgage,319 is paramount to any dower interest in
the mortgagor’s wife despite her failure to join in the execution of the
mortgage,320 and homestead rights,321 and, when made by a corpora-
tion, is valid without any stockholder consent that may be required by
statute in connection with corporate mortgages generally.322 A purchase
money mortgage made to a third party is superior to a vendor ’s lien.323
All this because the parties so subordinated “are no worse off than
they were before.” Without the proceeds from the purchase-money
mortgage the property would not have been acquired.”324 But if a
purchase money mortgagee fails to record his mortgage, he will be
postponed to subsequent innocent purchasers for value.325 A purchase




              The rule applies to a mortgage that is a substitute for a purchase money
          mortgage. Commerce Sav. Lincoln, Inc. v. Robinson, 331 N.W.2d 495
          (Neb. 1983).
              The rule was applied despite the mortgagor ’s earlier interest in the
          property as purchaser under an installment sale. Liberty Parts Warehouse,
          Inc. v. Marshall County Bank & Trust, 459 N.E.2d 738 (Ind. Ct. App.
          1984). Contra to Liberty Parts is C&L Lumber & Supply, Inc. v. Tex. Am.
          Bank/Galeria, 795 P.2d 502 (N.M. 1990), which holds that a mortgage
          given by a purchaser in possession to pay off a land sales contract is not a
          purchase money mortgage.
              The rule was applied where the deed and purchase mortgage referred to
          the wrong property and were corrected by instruments eleven months later.
          Sunshine Bank v. Smith, 631 So. 2d 965 (Ala. 1994).
319.      Chase Nat’l Bank v. Sweezy, 281 N.Y.S. 487, 492 (Sup. Ct. N.Y. County
          1931), aff ’d, 259 N.Y.S. 1010 (App. Div. 1st Dep’t 1932), aff ’d, 185 N.E.
          803 (N.Y. 1933); 2 G. GLENN, MORTGAGES § 348 (1943); G. OSBORNE,
          MORTGAGES § 556 (1943).
              An intending purchaser gave a mortgage on property he did not yet
          own. Later a purchase-money mortgage was given on a sale of this property.
          The purchase-money mortgage was held prior despite an argument that an
          after-acquired provision in the earlier mortgage gave it priority. Libby v.
          Brooks, 663 A.2d 422 (Me. 1995). Cf. Ala. Home Mortgage Co. v. Harris,
          582 So. 2d 1080 (Ala. 1991).
320.      Boggs v. O.S. Kelly Mfg. Co., 90 P. 765 (Kan. 1907); DeGarmo v. Phelps, 68
          N.E. 873 (N.Y. 1903); 2 G. GLENN, MORTGAGES § 345 (1943); 28 C.J.S.
          Dower § 36(c) (1941).
321.      Harlem Sav. Ass’n v. Lesniak, 257 N.E.2d 230 (Ill. App. Ct. 1970).
322.      N.Y. STOCK CORP. LAW § 16 (repealed Sept. 1, 1963); 7 W. FLETCHER,
          CYCLOPEDIA OF CORPORATIONS § 3117 (rev. 1988). But see Peerson v. Gray,
          184 Ala. 312, 63 So. 467 (1913).
323.      Brock v. First Sav. Ass’n, 10 Cal. Rptr. 2d 700 (3d Dist. Ct. App. 1992);
          Fisk v. Potter, 2 Keyes (N.Y.) 64, 2 Abb. Ct. App. Dec. 138 (1865); Johnson
          v. Fugate, 293 P.2d 559 (Okla. 1956). Contra Rader v. Dawes, 651 S.W.2d
          629 (Mo. Ct. App. 1983).
324.      Banc Fla. v. Hayward, 689 So. 2d 1052, 1054 (Fla. 1997).
325.      Id.; Kemp v. Zions First Nat’l Bank, 470 P.2d 390 (Utah 1970); G.
          OSBORNE, MORTGAGES § 213 (2d ed. 1970).



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money mortgage has been held paramount, under the New Jersey
statute, to a mechanic’s lien predicated on work done on the property
on behalf of a purchaser.326 But this is not invariably true.327
   A purchase money mortgage is not a loan or forbearance and
involves no usury merely because a seller obtains a higher price than
if the consideration were paid wholly in cash.328 It has been held
consistent with this that the interest rate on a purchase money
mortgage may validly be higher than the maximum fixed by usury
laws.329 This assumes that the transaction is not a cloak for a loan at
excessive interest rates. This rationale applies only to purchase money
mortgages running to a seller. It would not apply to a third party who
loans money for the purchase of real property. A purchase money
mortgage was held not secondary financing within the contemplation
of a first mortgage that forbade any payments with respect to second-
ary financing unless the first mortgage was current.330
   A purchase money mortgage given by one without authority, there-
fore, as in the case of an infant, is valid unless and until the
accompanying conveyance is repudiated.331 The mortgagor cannot
repudiate one without repudiating the other. A claim of the grantee-
mortgagor arising out of the sale of the property is assertable by the
mortgagor in an action to foreclose the mortgage.332


326.    Dev. Design, Inc. v. Rainbow Dev., Inc., 444 F. Supp. 155 (E.D. Tex. 1978); Am.
        Lumber & Bldg. Supply v. D&M, Inc., 210 A.2d 119 (N.J. Super. Ct. 1965).
327.    A mechanic’s lien, based on work visibly done before delivery of the deed,
        was held paramount to a purchase money mortgage. Summer & Co. v.
        DCR Corp., 351 N.E.2d 485 (Ohio 1976). The court stated the Ohio
        mechanic’s lien displaced the doctrine of simultaneous seizin. It said the
        seller’s remedy is either to record the purchase money mortgage before the
        construction (an awkward procedure if before the conveyance) or expressly
        reserve a vendor ’s lien (a remedy with some disadvantages).
             Cf. Sontag v. Abbott, 344 P.2d 961 (Colo. 1959), where an optionee of
        real property ordered materials for an improvement. After he acquired title,
        a mechanic’s lien based on this material was given precedence over a
        purchase money mortgage given by the optionee.
328.    S. WILLISTON, CONTRACTS § 1685, at 4766 (rev. ed. 1938); Annot.,
        Advance in Price for Credit Sale as Compared with Cash Sale as Usury, 14
        A.L.R.3d 1065 (1967).
329.    Mandelino v. Fribourg, 242 N.E.2d 823 (N.Y. 1968), noted in 15 N.Y.L.F.
        405 (1969); followed in Barone v. Frie, 472 N.Y.S.2d 119 (App. Div. 2d
        Dep’t 1984).
330.    DHNH Realty Corp. v. Marino P. Jeantet Residence for Seniors, Inc., 432
        N.Y.S.2d 829 (Sup. Ct. Queens County 1980).
331.    Stephenson v. Naumann, 195 N.Y.S. 768 (Sup. Ct. Kings County), aff ’d,
        197 N.Y.S. 951 (App. Div. 2d Dep’t 1922); Content v. Servoss, 3 Barb. 128,
        141–42 (N.Y. 1848); 2 G. GLENN, MORTGAGES § 344 (1943). But see
        Fulton Sav. Bank v. Downs, 148 N.Y.S.2d 556 (Sup. Ct. Suffolk County),
        aff ’d, 153 N.Y.S.2d 578 (App. Div. 2d Dep’t 1956).
332.    Snyder v. Potter, 521 N.Y.S.2d 175 (App. Div. 3d Dep’t 1987).



                                      3–74
                             Mortgage Financing                            § 3:4.1

   When a purchase money mortgage is given to several persons, it is
advisable to have written evidence as to their form of ownership of the
mortgage. In the absence of evidence, a Massachusetts court applied a
presumption that their ownership should correspond with their for-
mer ownership of the property that they sold.333 In this situation, joint
tenants of the property took the mortgage as joint tenants with the
right of survivorship, not as tenants in common.

    § 3:4.1          Seller’s Purchase Money Mortgage
   The contract may flounder if it fails adequately to describe the
terms of the seller ’s mortgage. In preparing a purchase money mort-
gage, its amount, interest rate, and terms of payment should be free
from dispute. These will be set forth in the contract or memorandum
of sale, if the contract or memorandum complies with the statute of
frauds.
   There is more, however, to a well-drawn mortgage than terms of
payment. If the seller is financing the purchase, the contract should
indicate the form of purchase money mortgage the seller will hold; that
is, the specific covenants to be included, the intention that the
purchaser also execute a note or bond to evidence his personal liability
and his liability for the expense of the mortgage, or if the mortgage
debt (that is, the mortgage and its mortgage note or bond) be non-
recourse. If a purchase money mortgage is contemplated, it is advis-
able, for reasons hereinafter mentioned, that the deed to be delivered
by the seller makes express reference to the purchase money mortgage
and that the contract of sale permits the seller, rather than the
purchaser, to arrange for recordation of the deed.
   There are many provisions that mortgagees deem essential for their
protection, some of which a well-advised mortgagor will regard as
objectionable. How will the dispute be resolved? There will be no
dispute if the contract of sale is sufficiently explicit, by identifying the
form of mortgage to be used or annexing it as an exhibit. There will
also be little ground for dispute if the contract provides for a purchase
money mortgage with “such covenants for the seller ’s protection as
the seller ’s attorneys may specify,” but the results then may not be
happy for the mortgagor. Absent a clear directive, there will be plenty
of ground for dispute.
   In the first place, a provision in the contract of sale for a purchase
money mortgage, specifying only the mortgage principal and terms
of payment, will probably not entitle the mortgagee to a mortgage



333.      Bertolami v. Corsi, 537 N.E.2d 1271 (Mass. App. Ct. 1989) (statutory rule
          that conveyance creates tenancy in common unless otherwise expressly
          stated is not applicable to mortgages).



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bond, note, or covenant for payment of the principal and interest.334
Personal liability is not a prerequisite of a mortgage, although con-
sideration is necessary.335
    The fact that the contract does not provide for the usual terms of a
mortgage in local use—such as a covenant to pay taxes or to supply
insurance—is insufficient to make it unenforceable. 336 A contract to
give a mortgage in “usual” form, with “statutory . . . covenants,
conditions and powers of sale” was held sufficiently definite for
enforcement.337 Under the majority rule, a memorandum of sale
that provides for a purchase money mortgage, without specification
of its maturity or rate of interest, is unenforceable.338 The same would,

334.      Cochran v. Taylor, 7 N.E.2d 89, 93 (N.Y. 1937). But see Weidenbaum v.
          Raphael, 90 A. 683, 684 (N.J. Ch. 1914).
              In this event the mortgage will be a valid lien on the property entitling
          the mortgage to foreclose for its breach but without right to a money
          judgment. N.Y. REAL PROP. LAW § 249; WIS. STAT. § 706.10(6); Vreeland v.
          Dawson, 151 A.2d 62 (N.J. Super. Ct. 1959).
              The execution of a mortgage does not imply a personal obligation to
          pay the debt. Flover v. Lavington, 1 P. Wms. (1714); I ND. CODE § 3-1813
          (1968); Alexander v. Hergenroeder, 138 A.2d 366 (Md. 1958); Matthews v.
          Sheehan, 69 N.Y 585 (1877). The rule that no covenants are implied in
          conveyances, 7 S. WILLISTON, CONTRACTS § 926 (3d ed. 1963); N.Y. REAL
          PROP. LAW § 251; OR. REV. STAT. § 93.140; WIS. STAT. ANN. § 706.10(6), has
          been applied to mortgages. Stoddard v. Weston, 53 Hun. 634, 6 N.Y.S. 34
          (Sup. Ct. 1889).
              See generally Milton R. Friedman, Creation and Effect of Personal
          Liability on Mortgage Debts in New York, 50 YALE L.J. 224 (1940).
              An agreement to enter into a mortgage extension agreement does not
          entitle the mortgagee to the owner ’s covenant to pay where this was not
          one of the terms agreed on. In re Home Title Ins. Co., 32 N.E.2d 548 (N.Y.
          1940).
335.      See cases collected in Kawauchi v. Tabata, 413 P.2d 221, 229–30 (Haw.
          1966); M. De Matteo Constr. Co. v. Daggett, 168 N.E.2d 276 (Mass.
          1960); Derry v. Babcock, 438 P.2d 1008 (Or. 1968); Seattle-First Nat’l Bank
          v. Hart, 573 P.2d 827 (Wash. Ct. App. 1978).
336.      Baker v. Dawson, 141 A.2d 157, 165 (Md. 1958).
337.      M. De Matteo Constr. Co. v. Daggett, 168 N.E.2d 276 (Mass. 1960).
338.      Kearns v. Andree, 131 A. 695 (Conn. 1928); Bambico v. Perez, 631 P.2d
          592 (Haw. Ct. App. 1981); Sweeting v. Campbell, 132 N.E.2d 523 (Ill.
          1956); Balboa Constr. Co. v. Golden, 639 P.2d 586 (N.M. 1981); Pollak v.
          Dapper, 220 N.Y.S. 104 (App. Div. 1st Dep’t), aff ’d per curiam, 157 N.E.
          886 (N.Y. 1927); RESTATEMENT (SECOND) OF CONTRACTS § 33 illustration
          2 (1981).
              A contract for a “$48,500 second mortgage” was held too ambiguous for
          enforcement. Ide Farm & Stable, Inc. v. Cardi, 297 A.2d 643 (R.I. 1972).
              A contract specifying that purchaser is to secure a first loan on the
          property for at least $12,500, no other details being specified, is void. See
          Kenimer v. Thompson, 196 S.E.2d 363 (Ga. Ct. App. 1973).
              A broker’s claim for commission, based on the theory that a sale had
          been consummated, was dismissed where the amount, interest and
          amortization rate, and term of purchase money mortgage, had been left



                                       3–76
                             Mortgage Financing                                § 3:4.1

of course, apply where the principal of the mortgage has been left
indefinite.339 If the purchase money mortgage is prepayable, the
purchaser may treat the transaction as a cash sale by offering
full payment and avoiding the problems of uncertainty.340 New York
and New Jersey are in the minority in holding that if no reference is
made to maturity or rate of interest then the mortgage is impliedly
payable on demand and at the legal rate of interest. 341 But even in
these states this presumption is not applied where the papers negate
any intention of creating a demand obligation. 342 There is some
authority to the effect that a failure to specify interest and maturity
is immaterial where a mortgage loan from a third person is contem-
plated.343 Other cases refuse to recognize a contract as complete where




          for future determination at the time of defendant’s repudiation. Oliver
          Williams, Inc. v. Nielsen, 131 N.Y.S.2d 773 (Sup. Ct. App. Term 1st Dep’t
          1954).
              The Georgia cases are collected in Hicks v. Stucki, 137 S.E.2d 399 (Ga.
          Ct. App. 1964); the Maryland cases in Gilbert v. Banis, 257 A.2d 206 (Md.
          1969); see also Cook v. Barfield, 162 S.E.2d 417 (Ga. 1968).
              An agreement that contemplates further negotiations respecting the
          terms of a purchase money mortgage is unenforceable. Read v. Henzel, 415
          N.Y.S.2d 520 (App. Div. 4th Dep’t 1979). Same as to terms of a wrap-
          around mortgage. Fromberg, Fromberg & Roth Props., Inc. v. Springtree I,
          Ltd., 408 So. 2d 1070 (Fla. Dist. Ct. App. 1982).
339.      Annot., 60 A.L.R.2d 251, 276–78 (1958). Specifying a mortgage of a
          minimum amount without indicating the maximum is insufficient.
          Grooms v. Williams, 175 A.2d 575 (Md. 1961).
340.      A mortgage payable in specified installments “or more” permits prepay-
          ment and permits the purchaser to treat the matter as a cash transaction.
          Darneille v. Geraci, 205 A.2d 55 (Md. 1964) (and authorities collected);
          Haire v. Patterson, 386 P.2d 953 (Wash. 1963).
              A contract providing for payment of specific installments, with the
          balance payable when specified “if not sooner paid,” does not permit
          prepayment. Kruse v. Planer, 288 N.W.2d 12 (Minn. 1979).
341.      Ansorge v. Kane, 155 N.E. 683, 685 (N.Y. 1927) (dictum); Berlinger v.
          Moffitt, 82 N.Y.S.2d 833 (N.Y. Sup. Ct. Queens County 1948); see Cauco
          v. Galante, 77 A.2d 793 (N.J. 1951).
              A failure to designate a time for payment has been held to imply an
          obligation to pay within a reasonable time in the circumstances. Ferris v.
          Jennings, 595 P.2d 857 (Utah 1979).
342.      Heim v. Shore, 151 A.2d 556 (N.J. Super. Ct. 1959); Monaco v. Levy, 209
          N.Y.S.2d 555 (App. Div. 2d Dep’t 1961) (mortgage payable in installments,
          with no indication of their amount and duration); Israelson v. Bradley, 139
          N.Y.S.2d 107 (Sup. Ct. Rockland County 1954), aff ’d, 139 N.Y.S.2d 913
          (App. Div. 2d Dep’t 1955) (provision for release of individual lots from lien
          of mortgage on specified payments).
343.      Chambers v. Jordan, 262 A.2d 505 (Md. 1970); see Johnson v. Watson, 272
          P.2d 580 (Nev. 1954); Heim v. Shore, 151 A.2d 556, 562 (N.J. Super. Ct.
          1959); Kenner v. Edwards Realty & Fin. Co., 236 N.W. 597 (Wis. 1931).



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§ 3:4.1                         FRIEDMAN    ON   CONTRACTS

details of third-party financing remained open.344 A contract to sell for
$9,500, payable $3,000 in cash with the balance payable in annual
installments of $1,500, with interest at 5%, was held to infer an
intention to follow “ordinary practice” by securing the deferred pay-
ments by a mortgage with terms in accordance with those specified in
the contract.345 Other contracts that provided for deferred payments
without security have caused difficulty.346
   It may well be that a provision for a purchase money mortgage will
entitle the seller to a mortgage in the form and containing conditions
usually found in mortgages affecting similar properties in the com-
munity. It has been so held with respect to a farm mortgage. 347 But
generally speaking it is not clear what provisions may properly be
included in “a mortgage.”
   When the seller has agreed to subordinate the seller ’s purchase-
money mortgage to a new mortgage to be obtained by the buyer, the
contract should describe the buyer ’s new mortgage in detail. Some
courts, but not all, are quite forgiving when the provision is sketchy.
An Alabama court enforced a contract in which the provision did not
specify the amount of the buyer ’s new mortgage.348 However, a


344.      Cole v. Cutler, 102 S.E.2d 82 (Ga. Ct. App. 1958); Smith v. Biddle, 52 A.2d
          473 (Md. 1947); see Harris v. Kirshner, 70 A.2d 47 (Md. 1949); Annot., 23
          A.L.R.2d 164, 213 et seq. (1952).
               A contract fixing a purchase price of $14,000 payable by the buyer ’s
          obtaining a $10,000 mortgage, with the balance payable in cash, was held
          too indefinite to be enforceable. Williams v. Gottlieb, 83 S.E.2d 245 (Ga.
          Ct. App. 1954).
               Failure to specify the interest rate on a mortgage to be obtained by
          plaintiff or his assigns made the agreement incomplete. If the assignee
          were a corporation there would be no legal limit on the interest rate in New
          York. The case involved a contract to lease under which the prospective
          lessor agreed to “subordinate the fee” to a mortgage to be made by the
          lessee. Kusky v. Berger, 225 N.Y.S.2d 797 (Sup. Ct. Nassau County 1962),
          aff ’d, 249 N.Y.S.2d 858 (App. Div. 2d Dep’t 1964).
345.      Durepo v. May, 54 A.2d 15 (R.I. 1947).
346.      Rhyne v. Garfield, 225 S.E.2d 43 (Ga. 1976), states that a purchase money
          note need not be secured or include an acceleration clause. But it held that
          a provision for release of the land “at rate of 120% per acre” implied an
          intention for security. Other cases hold that omission of security makes
          the contract fatal. Bonk v. Boyajian, 274 P.2d 948 (Ct. App. 1954);
          Reynolds v. Sullivan, 383 A.2d 609 (Vt. 1978). Contra Wilson v. Holyfield,
          313 S.E.2d 396 (Va. 1984).
347.      Gibson v. Brown, 73 N.E. 578 (Ill. 1905). Provision for a “usual deed of
          trust lien” was held not so ambiguous as to vitiate a contract of sale.
          Phillips v. Campbell, 480 S.W.2d 250 (Tex. Civ. App. 1972).
348.      McCarty v. Harris, 216 Ala. 265, 113 So. 233 (1927) (clause authorized
          purchaser to place first mortgage on property with $2,900 cash due at
          closing “to be paid out of the proceeds of the first mortgage”); accord
          Atwood v. Cobb, 33 Mass. 227 (1834); Milner Hotels v. Ehrman, 11
          N.W.2d 914 (Mich. 1943); Ray v. Wooster, 270 S.W.2d 743 (Mo. 1954).



                                       3–78
                             Mortgage Financing                               § 3:4.1

contract requiring subordination of a purchase money mortgage to a
future mortgage was held too uncertain for enforcement where the
amount of the future mortgage was to be not over 60% of the cost of a
prospective building to cost between $75,000 and $300,000. The
decision was based on a failure to state the amount of interest and
the terms and conditions of the obligation to be secured by the future
mortgage.349 This would appear to be the better rule.
   If the contract provides for a purchase money mortgage, and the
purchaser or an assignee of the purchaser is a corporation an entity
other than one or more individuals, the seller should have satisfactory
evidence that the purchase money mortgagor is a properly organized
legal entity and authorized to execute the mortgage. A clause for this
purpose appears below.

                                     CLAUSE 3-9

                 Purchase Money Mortgagor As Legal Entity
    If a purchase money mortgagor shall be a party other than one or
    more individuals, Seller shall be entitled to proof reasonably

              Uncertain provision for subordination of a purchase money mortgage
          to a construction loan may entitle purchaser to damages or specific
          performance, without the subordination but subject to equities. Stenehjem
          v. Kyn Jin Cho, 631 P.2d 482 (Alaska 1981).
349.      Gould v. Callan, 273 P.2d 93 (Cal. Dist. Ct. App. 1954); accord Kusky v.
          Berger, 225 N.Y.S.2d 797 (Sup. Ct. Nassau County 1962), aff ’d, 249
          N.Y.S.2d 858 (App. Div. 2d Dep’t 1964); see generally Comment, Sub-
          ordination of Purchase-Money Security, 52 CALIF. L. REV. 157 (1964).
              Contracts were held too uncertain for enforcement where the purchase
          money mortgage was to be subordinate to a building construction mort-
          gage in an amount to be computed at a maximum rate per square foot of
          new construction, but where the interest rate, monthly payments, and
          period of the debt were left to future agreement, Kessler v. Sapp, 338 P.2d
          34 (Cal. Dist. Ct. App. 1959); and also where not even the amounts of the
          construction loan were specified, Lahaina-Maui Corp. v. Tau Tet Hew, 362
          F.2d 419 (9th Cir. 1966) (distinguished in Malani v. Clapp, 542 P.2d 1265
          (Haw. 1975)); Roven v. Miller, 335 P.2d 1035 (Cal. Dist. Ct. App. 1959);
          Magna Dev. Co. v. Reed, 39 Cal. Rptr. 284 (1st Dist. Ct. App. 1964). A
          similar contract was upheld where the construction loan was not to exceed
          $80,000 with interest at no more than 7.5%, payable at such terms and
          upon such conditions as might be required by the lender. Stockwell v.
          Lindeman, 40 Cal. Rptr. 555 (2d Dist. Ct. App. 1964). This situation,
          involving perhaps a minimum of uncertainty respecting the terms of
          superior encumbrances, has been contrasted with an uncertainty of terms
          between purchaser and seller. See Handy v. Gordon, 52 Cal. Rptr. 385 (2d
          Dist. Ct. App. 1966), aff ’d, 422 P.2d 329 (Cal. 1967).
              A contract requiring seller to subordinate to a construction mortgage
          for a specified sum did not obligate the seller to subordinate to a larger
          mortgage, part of which was to be used to pay the purchase price. Pollock v.
          Tiano, 61 Cal. Rptr. 235 (2d Dist. Ct. App. 1967).



(Friedman on Contracts, Rel. #7, 5/09)   3–79
§ 3:5                        FRIEDMAN     ON   CONTRACTS

   satisfactory to Seller’s attorney, that such mortgagor is a properly
   organized legal entity and authorized to execute such mortgage.

§ 3:5        Property Covered by the Mortgage
   A mortgage must contain a description of the property that is
adequate or a reference to another writing, thereby incorporating an
adequate description.350 In general, courts apply the same standards to
mortgages as they do to deeds of conveyance. 351 If the mortgage
properly describes a parcel of real estate, the mortgage automatically
conveys appurtenances to that parcel. In a Georgia case, a mortgage
included airspace rights over a neighboring parcel, as an appurtenance,
when the airspace was improved with part of a parking garage that was
chiefly built on the parcel described in the mortgage. 352
   It occasionally happens that a description is on an exhibit to be
attached to a preprinted mortgage form and the exhibit is not attached
or is lost before recordation.
   In the case of a purchase money mortgage, there would appear to be
no reason for question with respect to the scope of the mortgage lien.
The mortgagee is selling specified real estate and the mortgage should
cover this realty.353

   § 3:5.1         Fixtures and Personal Property
   The sale may include not only land and permanent improvements
to the land, but also fixtures as well as personal property. If all such
property is to be security for the purchase price, it is necessary not only
that the contract of sale should so indicate but that proper steps be
taken to comply with statutory prerequisites for effecting a lien
thereon. Without special provisions a mortgage on real property will,
per se, cover fixtures, that is, existing as well as after-acquired fixtures
(unless the latter are subject to a purchase money mortgage given to
their installer),354 but not personal property.355




350.     In re Poteat, 176 B.R. 734 (Bankr. D. Del. 1995) (grossly inadequate
         description, no metes and bounds description, street address, road names,
         or reference to any other instrument).
351.     See generally section 10:7.2.
352.     In re Huckabee Auto Co., 58 B.R. 826 (Bankr. M.D. Ga. 1986).
353.     “There is a necessary intent to mortgage back the identical lands conveyed
         to the mortgagor.” In re City of New York (Lawrence Ave.), 169 N.Y.S.
         1018 (App. Div. 2d Dep’t 1918).
354.     See K&L Distribs., Inc. v. Kelly Elec. Co., 908 P.2d 429, 433 (Alaska 1996);
         ALASKA STAT. § 45.09.313(d)(11) (1962), codifying U.C.C. § 9-313(4)a.
355.     White v. Murtha, 343 F.2d 831 (5th Cir. 1965); In re Shore Haven Motor
         Inn, Inc., 124 B.R. 617 (Bankr. S.D. Fla. 1991) (ski chair lift); In re



                                      3–80
                             Mortgage Financing                                 § 3:5.1

   The difference between fixtures and personal property is technical
and may not be self-revealing. For instance, in a few states, gas ranges
and refrigerators are personal property and are not automatically
included in a mortgage of real property.356 In other states, gas ranges
and refrigerators are treated as fixtures, and thereby included, without
express provision therefore, in a mortgage or conveyance. 357 In a


          Huckabee Auto Co., 58 B.R. 826 (Bankr. M.D. Ga. 1986); K&L Distribs.,
          Inc. v. Kelly Elec. Co., 908 P.2d 429 (Alaska 1996) (citing large number of
          authorities); McFadden v. Allen, 32 N.E. 21 (N.Y. 1892); McKeage v.
          Hanover Fire Ins. Co., 81 N.Y. 38 (1880); 59 C.J.S. Mortgages §§ 181,
          192 (1949); Annot., 175 A.L.R. 404 (1948).
              The rule with respect to after-acquired fixtures was unaffected by the
          mortgagor ’s voluntary return of them to the installer for nonpayment.
          K&L Distributors, 908 P.2d 429.
              For an extended clause covering existing and future fixtures and
          personal property in a hotel but appropriate for any high rise building,
          see In re Johnson, 139 B.R. 208, 210 (Bankr. D. Minn. 1992). The clause
          was held to cover framed wall paintings.
              For a catalogue of articles covered by mortgages as fixtures, see 1
          L. JONES, MORTGAGES § 530 et seq. (8th ed. 1928); 36A C.J.S. Fixtures
          § 45 (1961). Mobile homes attached to the ground are held fixtures and are
          usually subject to the lien of a real property mortgage. They are also real
          property for the purpose of state and local taxation. See In re Cliff ’s Ridge
          Skiing Corp., 123 B.R. 753, 760 (Bankr. W.D. Mich. 1991); C.I.T. Fin.
          Servs. v. Premier Corp., 747 P.2d 934 (Okla. 1987). A rented telephone
          system was held personal property. Hoffman Mgmt. Corp. v. S.C.L., Inc.,
          800 S.W.2d 755 (Mo. Ct. App. 1990).
              For annotations on specific articles as fixtures coming under lien of a
          mortgage, see Annot., 48 A.L.R. 1146, 1147 (1927) (water heater); Annot.,
          126 A.L.R. 599, 600 (1951) (heating plant); Annot., 19 A.L.R.2d 1300,
          1311 et seq. (1940) (sprinkler); Annot., 43 A.L.R.2d 1378, 1382 (1955) (air
          conditioning equipment); Annot., 52 A.L.R.2d 222, 234 et seq. (1957)
          (plumbing and plumbing accessories); Annot., 55 A.L.R.2d 1044 (1957)
          (carpets, linoleum, and other floor coverings).
              An easement acquired by a mortgagor after the date of the mortgage
          comes under the lien of the mortgage automatically. In re Bende, 152 B.R.
          677 (Bankr. S.D. Fla. 1993); Gurevich v. Goldman, 105 A.2d 466 (Conn.
          1954); Crawford v. Lesco, 136 N.YS.2d 771 (Sup. Ct. Eq. Term Monro
          County 1955).
356.      Madfes v. Beverly Dev. Co., 166 N.E. 787 (N.Y. 1929); accord State v.
          Feves, 365 P.2d 97 (Or. 1961).
357.      Tifton Corp. v. Decatur Fed. Sav. & Loan Ass’n, 222 S.E.2d 115 (Ga. Ct.
          App. 1975); Guardian Life Ins. Co. v. Swanson, 3 N.E.2d 324 (Ill. App. Ct.
          1936); First Mortgage Bond Co. v. London, 244 N.W. 203 (Mich. 1932);
          Glueck & Co. v. Powell, 61 S.W.2d 406 (Mo. Ct. App. 1933); Mortgage
          Bond Co. v. Stephens, 74 P.2d 361 (Okla. 1937); Tudor Arms, Inc. v.
          McKendall Land Co., 6 A.2d 735 (R.I. 1939); Knoxville Gas Co. v. W.I.
          Kirby & Sons, 32 S.W.2d 1054 (Tenn. 1930); Leisle v. Welfare Bldg. & Loan
          Ass’n, 287 N.W. 739 (Wis. 1939) (gas ranges fixtures when in apartment
          house; dictum that result contra when ranges in private residence);
          Kratovil, Fixtures and the Real Estate Mortgagee, 97 U. PA. L. REV. 180,
          184 (1948).



(Friedman on Contracts, Rel. #7, 5/09)   3–81
§ 3:5.2                      FRIEDMAN    ON   CONTRACTS

number of states, the “assembled industrial plant doctrine” makes
machinery that is indispensable to an industry a fixture covered by the
lien of a real property mortgage.358 In this situation, physical annexa-
tion is unnecessary.359
   In some cases it may be desirable to obtain a separate security
agreement pursuant to Article 9 of the Uniform Commercial Code to
cover personal property, but it is possible to include the grant of a
security interest on personal property in the real property mortgage. 360
The New York statutory form mortgage361 is construed to include “all
fixtures and articles of personal property attached to, or used in
connection with, the premises.”362 The usual mortgage forms broaden
this language to “all fixtures and articles of personal property now or
hereafter attached to or used in connection with the premises,” thus
purporting to cover after-acquired property as well. Forms prepared for
banks and other institutions or prepared especially for a particular
transaction contain more elaborate personal property clauses.
   It is current practice in connection with mortgages on apartment,
office, and industrial buildings to obtain from a mortgagor and file a
financing statement under the Uniform Commercial Code, which
brings fixtures and personal property under the lien of the real property
mortgage. This practice is not applied to one- and two-family houses.
   A mortgagor ’s claim against the engineer and architect of an office
building, based on defective design and construction, was held a
personal right under Louisiana law and not included in the lien of a
mortgage.363

   § 3:5.2         After-Acquired Fixtures and Personal Property
   The after-acquired personal property clause mentioned above364
may be expanded by a more specific list of articles to be covered
and also by a requirement that any owner of the premises deliver
further instruments from time to time on the mortgagee’s request to
confirm the lien of the mortgage on the articles specified. This makes
evidence available in the event of foreclosure to prove the full extent of
the lien.




358.      Com. v. Haveg Indus., 192 A.2d 376, 378 (Pa. 1963).
359.      Metro. Life Ins. Co. v. Kimball, 94 P.2d 1101 (Or. 1939).
360.      For discussion of the law prior to adoption of the Uniform Commercial
          Code, see Milton R. Friedman, The Scope of Mortgage Liens on Fixtures
          and Personal Property in New York, 7 FORDHAM L. REV. 331 (1938).
361.      N.Y. REAL PROP. LAW § 258, Schedule M.
362.      N.Y. REAL PROP. LAW § 254.
363.      In re Schrewe, 108 B.R. 116 (Bankr. E.D. La. 1989).
364.      See section supra 3:5.1.



                                    3–82
                             Mortgage Financing                               § 3:5.2

    It also helps to hurdle a difficulty that has historically troubled
after-acquired property clauses. A mortgage on after-acquired property
is, in legal theory, not a lien in praesenti, but merely a covenant to give
a mortgage in the future. This covenant is self-effecting as to the
mortgagor but, being an affirmative covenant, does not run with the
land to bind a subsequent owner who has not assumed the mort-
gage.365 Therefore, articles of personal property may not come under
the mortgage lien, though within the scope of the after-acquired
personal property clause, when installed by a subsequent owner.
Inasmuch as the articles in question, such as refrigerators and ranges,
are replaced comparatively frequently, the problem is practical in a
jurisdiction like New York where these articles are personal property.
The problem under modern law is confined to real property. The
Uniform Commercial Code explicitly authorizes an after-acquired
property clause in a security agreement, with no necessity for the
debtor to authenticate any additional record in the future when the
debtor acquires the after-acquired property.366
    If the mortgagee is relying on the law of mortgages to gain a security
interest in after-acquired fixtures, rather than an Article 9 security
agreement, then the mortgage clause requiring that the mortgagor
execute further instruments permits a solution. The same result may
be achieved by a provision permitting foreclosure if any subsequent
owner fails on request of the mortgagee to assume the mortgage or at
least the obligations under the after-acquired property clause. There is
authority that disregards an after-acquired property clause as a covenant
for future performance. It rules that a specification in a mortgage of
equipment that is part of the realty brings after-acquired property of the
specified nature under the lien of the mortgage, regardless of whether the
installer of such equipment assumed the mortgage.367 A purchase
money security interest in personal property, other than inventory, has
priority under the Uniform Commercial Code over a fee mortgagee’s
after-acquired personal property clause, but only if it is perfected within
twenty days after delivery of the personal property. Otherwise, title to
the personal property is subordinated to that of the fee mortgagee.368



365.      Guar. Trust Co. v. N.Y. & Queens County Ry., 170 N.E. 887, 890 (N.Y.
          1930); see Milton R. Friedman, Creation and Effect of Personal Liability on
          Mortgage Debts in New York, 50 YALE L.J. 224 at 241 (1940). The rule was
          apparently overlooked in Gen. Synod of Reformed Church v. Bonac Realty
          Corp., 75 N.E.2d 841 (N.Y. 1947).
366.      U.C.C. § 9-204(a).
367.      In re Dover’s Landing, 19 B.R. 139 (Bankr. N.D. Fla. 1981).
368.      U.C.C. § 9-334); see also Regan v. ITT Indus. Credit Co., 469 So. 2d 1387,
          1391 n.5 (Fla. Dist. Ct. App. 1984), and cases collected in 3 FLA. ST. U. L.
          REV. 150, 156 n.26 (1975).



(Friedman on Contracts, Rel. #7, 5/09)   3–83
§ 3:6                        FRIEDMAN     ON   CONTRACTS

§ 3:6       The New York Statutory Form Mortgage
   There is no form that may be called customary in New York. There
is a statutory short form of mortgage in New York, and comparable
forms in other states,369 but the New York statutory form mortgage is
not complete. For example, it does not contain the “lien clause,” which
is necessary to maintain priority of the mortgage lien over some
mechanics’ liens,370 and the statutory acceleration clause contains
blanks for “grace periods” and presupposes an agreement as to how
these blanks are to be filled in.371 The New York statutory form is of
substantial advantage because its brief clauses are given an expanded
statutory construction.372 The statutory construction governs when
the mortgage is in statutory or substantially similar form,373 but is not
lost by inclusion of additional provisions.374 The statutory rules also
apply to the extension and modification of mortgages and other
mortgage agreements.375
   The statutory form is not in general use as such in New York. Its
use is permissive, and other forms are not thereby invalidated. 376




369.    For statutory forms in other states, see MD. CODE, REAL PROP. § 4-202
        (1990); MASS. GEN. LAWS ANN. ch. 183, Appendix (5) (1977); MINN. STAT.
        ANN. § 507.15 (1990); NEV. REV. STAT. §§ 106.025, 106.040 (1986); N.H.
        REV. STAT. ANN. § 477-29 (repl. 1983); N.J. STAT. ANN. §§ 46:9-1, 46:9-6
        (1989); N.M. STAT. ANN. 47-1-44 (1978); S.D. CODIFIED LAWS ANN.
        § 44-8-3 (1983); WYO. STAT. ANN. § 34-2-47 (1977); MANITOBA REV.
        STAT., 1940, ch. 193, Second Schedule, Item 15.
            For permissible forms in all jurisdictions, see MARTINDALE-HUBBELL
        LAW DIRECTORY, volumes on Law Digest, under the various states.
370.    The “lien clause” provided for by N.Y. LIEN LAW § 13(3). See section infra
        3:8.7.
371.    See section infra 3:7.4.
372.    The statutory form in N.Y. REAL PROP. LAW § 258, Schedule M, is
        construed in N.Y. REAL PROP. LAW § 254.
            The advent of short form instruments in England was greeted with a
        fear of mischief “if an unnatural and secondary meaning is given by”
        statute to words that are prima facie clear and intelligible, for the effect is
        to increase the difficulty of legal documents to the unprofessional reader.
        See W. RAWLE, COVENANTS § 20 (5th ed. 1887). This fear was realized in
        Albertina Realty Co. v. Rosbro Realty Corp., 180 N.E. 176 (N.Y. 1932). As
        a result of Rosbro, the acceleration provision of the statutory form mort-
        gage was changed. N.Y. LEGIS. DOC. No. 65(H)35 (1945). Compare Engel v.
        Thompson, 146 N.E.2d 657 (Mass. 1957), overruled on other grounds,
        Silverblatt v. Livadas, 164 N.E.2d 875, 878 (Mass. 1960).
373.    Seligman v. Burg, 251 N.Y.S. 689 (App. Div. 2d Dep’t 1931) (but see
        Leakey v. Schwing, 270 N.Y.S. 69 (County Ct. Jefferson County 1934)).
374.    Prudential Ins. Co. v. Sanford Real Estate Corp., 284 N.Y.S. 73 (County Ct.
        Monroe County), aff ’d, 282 N.Y.S. 840 (App. Div. 4th Dep’t 1935).
375.    Bankers Trust Co. v. Fuller, 37 N.Y.S.2d 536 (Sup. Ct. 1942).
376.    Goldberg v. Norek, 166 N.Y.S. 1023 (Sup. Ct. Kings County 1917).



                                      3–84
                              Mortgage Financing                             § 3:7

A statute allows the recording office to charge a penalty of $5 for the
recordation of a mortgage with long forms of covenants, 377 but this is
rarely invoked. Perhaps the most frequently used forms are those
printed by various title companies for the use of their clients and
forms prepared for legal stationers. Lending institutions for the most
part have their own forms that are apt to be longer, more detailed, and
more favorable to the mortgagee. These are, basically, the statutory
form with some clauses added and others modified. The mortgagee is
not entitled, per se, to these additional or expanded provisions. For
example, if a clause is included that permits the mortgagee to accel-
erate maturity of the debt for failure of the owner to maintain the
premises in a reasonably good state of repair, after notice, the buyer
may properly refuse to execute the mortgage.378 The same is appar-
ently true if the mortgage permits acceleration upon a sale of the
property.379

§ 3:7         Clauses of the New York Statutory Form Mortgage
    Mortgage forms vary from state to state and within each state.
There is considerable variation in the material added to basic forms,
the most elaborate being those prepared for banks and other lending
institutions. The forms used in New York have been developed to a
greater degree than those in some other states. Their clauses should
illustrate most of the questions that are apt to arise in all states. For
this reason, this section uses as a basis for discussion the New York
statutory form mortgage clauses. This section also considers modifi-
cations to the statutory form clauses that are often added to amplify
the coverage, as well some variations outside New York. Section 3:8
then considers additional clauses that are often added to mortgages in
New York and other states. Cases cited to support this discussion are
not only from New York, but include other states with the thought of
giving a general picture of U.S. mortgages.




377.      N.Y. REAL PROP. LAW § 327.
378.      Compare Ansorge v. Belfer, 161 N.Y. 450 (N.Y. 1928). But see Goldberg v.
          Norek, 166 N.Y.S. 1023, 1024 (Sup. Ct. Kings County 1917) (whether a
          clause is “usual” depends on its general use and not upon its conformance
          to any statutory provision). Jackson v. Domschot, 239 P.2d 1058 (Wash.
          1952), excused the buyer from joining in a mortgage containing provisions
          not found in the executory contract; accord Johnson v. Goldberg, 279 P.2d
          131 (1st Dist. Ct. App. 1955).
379.      Merriam v. Leeper, 185 N.W. 134 (Iowa 1921). For due-on-sale clauses, see
          supra section 3:3.1.



(Friedman on Contracts, Rel. #7, 5/09)   3–85
§ 3:7.1                        FRIEDMAN    ON   CONTRACTS

   § 3:7.1         Payment of Indebtedness
   The New York statutory form mortgage provides:
   1.     That the mortgagor will pay the indebtedness as hereinbefore
          provided.380
   This clause makes the mortgage serve as a bond as well as a
mortgage.381 It overrides a statutory rule that a “mortgage of real
property does not imply a covenant for the payment of the sum
intended to be secured . . . .”382 This means that the failure of the
mortgagor to sign a bond or promissory note, or the inability of
the mortgagee to find and produce a bond or note, does not prevent
the mortgagee from suing the mortgagor for the debt or seeking a
deficiency judgment upon foreclosure.
   When there are multiple owners of the property, normally all
owners sign both the promissory note and the mortgage. Liability
issues can become complicated when less than all of the owners-
mortgagors sign the note. A mortgagor who does not sign the promis-
sory note can become liable on the note by virtue of a promise to pay in
the mortgage.383

   § 3:7.2         Insurance
   The New York statutory form mortgage provides:
   2.     That the mortgagor will keep the buildings on the premises
          insured against loss by fire for the benefit of the mortgagee;
          that he will assign and deliver the policies to the mortgagee;
          and that he will reimburse the mortgagee for any premiums
          paid for insurance made by the mortgagee on the mortgagor ’s
          default in so insuring the buildings or in so assigning and
          delivering the policies.384
   In a case of first impression, a court held that a mortgagor complied
with the New York insurance covenant by delivery of a “Home Owners



380.      N.Y. REAL PROP. LAW § 258, Sch. M.
381.      Pioneer Sav. & Loan Co. v. City of Cleveland, 479 F.2d 595 (6th Cir. 1973);
          Mateyka v. Schroeder, 504 N.E.2d 1289 (Ill. App. Ct. 1987); Warner v.
          Webber Apartments, Inc., 400 N.E.2d 1180 (Ind. Ct. App. 1980); Neidich
          v. Petilli, 420 N.Y.S.2d 301 (App. Div. 2d Dep’t 1979); Sullivan v. Corn
          Exch. Bank, 139 N.Y.S. 97 (App. Div. 2d Dep’t 1912).
382.      N.Y. REAL PROP. LAW § 249.
383.      Ehrlich v. Mangicapra, 626 So. 2d 702 (Fla. Dist. Ct. App. 1993)
          (mortgage covenant “to pay promptly when due the principal and interest
          and other sums of money provided for in said note” creates personal
          liablity on note).
384.      N.Y. REAL PROP. LAW § 258.



                                       3–86
                             Mortgage Financing                            § 3:7.2

Policy,” that is, a multiple risk policy insuring against liability and
other risks in addition to fire.385
   Delivery of a fire insurance policy with a standard mortgagee clause
is not sufficient in itself to stop the running of the statute of limita-
tions with respect to the mortgage.386
   Covenant 4 of the New York covenants387 was amended in 1945 to
permit acceleration of the mortgage debt for breach of the insurance
covenant. Otherwise, the mortgagee would not be empowered to call
the mortgage for the mortgagor ’s failure to supply the mortgagee with
required insurance.388
   The insurance clause may be expanded to entitle the mortgagee to
extended coverage and war damage insurance when available and to
insurance on personal property covered by the mortgage, and to clarify
the mortgagee’s right to retain insurance policies that may be un-
expired after completion of a foreclosure.
   In commercial transactions, the mortgagor often promises to
provide “comprehensive all risk insurance.” An “all risk” policy is
property insurance that covers damage resulting from all risks, other
than those specifically excluded from coverage. The term “all risk” is a
misnomer, because “all risk” policies invariably have some exclusions.
Policies typically exclude coverage for war, pollution, earthquake, and
flood.
   Prior to the events of September 11, 2001, “all risk” policies covered
property damage caused by acts of terrorism. After 9/11, insurance
companies began excluding damage from terrorist attacks from their
“all risk” policies. This change in the “all risk” policy has triggered
disputes between lenders and borrowers as to whether the borrower
must insure against terrorism. Omni Berkshire Corp. v. Wells Fargo
Bank, N.A., 389 is illustrative. In 1998, Omni Hotels borrowed
$250 million, secured by five hotels located in New York City,
Chicago, and Texas. Omni agreed to provide “comprehensive all risk
insurance” on the hotels as well as “such other reasonable insurance”
as the lender might request. In 2002, when it renewed its “all risk”
policy, Omni was unable to find a policy that covered terrorism due


385.      Century Fed. Sav. & Loan Ass’n v. Mers, 231 N.Y.S.2d 66 (Sup. Ct. N.Y.
          County 1962), aff ’d, 236 N.Y.S.2d 939 (App. Div. 1st Dep’t 1963).
386.      Greenfield v. Kaplan, 179 N.Y.S.2d 381 (Sup. Ct. Kings County 1958).
387.      See infra section 3:7.4.
388.      Johnson v. N. Minn. Land & Inv. Co., 150 N.W. 596, 598–99 (Iowa 1915);
          Spires v. Lawless, 493 S.W.2d 65 (Mo. Ct. App. 1973). There is authority
          for denying acceleration for failure to supply insurance where the mort-
          gagee’s security is not impaired. See Freeman v. Lind, 226 Cal. Rptr. 515
          (3d Dist. Ct. App. 1986).
389.      Omni Berkshire Corp. v. Wells Fargo Bank, N.A., 307 F. Supp. 2d 534
          (S.D.N.Y. 2004).



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to the reform made by insurance companies. Instead of offering “all
risk” policies that insured against terrorism, insurance companies
offered separate, stand-alone terrorism policies. The quoted annual
premium for Omni’s five hotels was over $1 million. Omni negotiated
with Wells Fargo, the servicing agent for the loan, over whether Omni
would obtain terrorism coverage. Wells Fargo agreed to accept a
$60 million policy at a time when the loan balance was $230 million,
but negotiations broke down. Omni brought an action seeking a
declaratory judgment that it was not required to obtain terrorism
insurance. The court agreed with Omni’s position that its obligation
to maintain “all risk” insurance did not require it to purchase terror-
ism insurance. In the loan agreement, the parties did not define “all
risk.” In the insurance industry, “all risk” policies have evolved over
time, with companies previously adding exclusions for mold problems
and Y2K problems. Thus, Omni’s duty to provide “all risk” insurance
was measured not by the policy as it existed in 1998, when the loan
was made, but by an evolving standard. The court, however, held that
Wells Fargo acted reasonably in requiring $60 million worth of
terrorism coverage under the “other reasonable insurance” clause.
Omni had a quote for such a policy for an annual premium of
$316,000, and evidence indicates that many hotels presently carry
terrorism insurance.

             [A] Purchase of Insurance by Mortgagee
   The mortgagee is under no implied obligation to obtain insurance
when the mortgagor fails to insure.390 The fact that the mortgagee has
a right to insure is immaterial. But he may make himself liable if he
agrees to insure and does not, or if he undertakes to insure and fails to
obtain proper coverage,391 as where he omits a garage392 or insures the

390.      Providence Wash. Ins. Co. v. Smith, 253 S.W.2d 226, 229 (Ark. 1952);
          Purcell v. Williams, 511 So. 2d 1080 (Fla. 1st Dist. Ct. App. 1987);
          Beckford v. Empire Mut. Ins. Group, 525 N.Y.S.2d 260 (App. Div. 2d
          Dep’t 1988).
391.      Warrener v. Fed. Land Bank, 99 S.W.2d 817 (Ky. 1936); Crouse v. Vernon,
          59 S.E.2d 185 (N.C. 1950); 62 HARV. L. REV. 1069 (1949).
              Hudson v. Ellsworth, 105 P. 463 (Wash. 1909), holds that a mortgagee’s
          agreement to procure insurance, made after execution of the mortgage, was
          a gratuitous undertaking and without consideration though the mortgagor
          had paid the mortgagee the amount of the premiums. The mortgagee was
          held liable only for the return of the money paid. In a somewhat similar
          situation the mortgagee was held liable for fraud. First Nat’l Bank v.
          Dowdell, 157 So. 2d 221 (Ala. 1963) (overruling defense of ultra vires).
              For the comparable rules as between landlord and tenant, see 3 MILTON
          R. FRIEDMAN, FRIEDMAN ON LEASES § 38:1, at 38-6 to 38-7 (Patrick A.
          Randolph, Jr., ed., 5th ed. PLI 2006).
392.      Wellens v. Perpetual Bldg. Ass’n, 184 A.2d 36 (D.C. 1962). Colonial Sav.
          Ass’n v. Taylor, 544 S.W.2d 116 (Tex. 1976), where one of two buildings



                                      3–88
                             Mortgage Financing                             § 3:7.2

wrong property.393 The measure of damages for breach of duty to place
fire insurance is the amount that would have been due under the
policy if it had been obtained.394 Consequential damages have been
recovered.395 The mortgagee is not responsible for the insolvency of
the insurer at the time the claim is filed.396
    Many mortgages require that the mortgagor make monthly escrow
payments to the mortgagee, which the mortgagee customarily uses to
pay for real property taxes and insurance premiums. Occasionally, an
insurance policy is cancelled when neither mortgagor nor mortgagee
timely pays the premium. There is a split of authority as to the
mortgagee’s liability to the mortgagor for policy cancellation when
the mortgagee holds escrowed funds. Some cases hold that a mort-
gagee who receives escrow deposits from the mortgagor for payment of
taxes and insurance is not liable for failure to pay insurance pre-
miums,397 but an almost equal number of cases have recognized a
mortgagee’s duty to renew the policy or notify the mortgagor of its
imminent lapse.398


          was omitted, reversed a judgment for the owner against the mortgagee and
          remanded the case to determine if the owner had relied on the mortgagee’s
          gratuitous undertaking to obtain insurance. The court relied on RESTATE-
          MENT (SECOND) OF TORTS § 323 (1965).
393.      Boyce v. Union Dime Permanent Loan Ass’n, 67 A. 766 (Pa. 1907).
394.      Cromartie v. Carterette Sav. & Loan Ass’n, 649 A.2d 76 (N.J. Super. Ct.
          App. Div. 1994); Hardcastle v. Greenwood Sav. & Loan Ass’n, 516 P.2d 228
          (Wash. Ct. App. 1973).
395.      See Cromartie v. Carterette Sav. & Loan Ass’n, 649 A.2d 76 (N.J. Super.
          Ct. App. Div. 1994).
396.      Gulfco Fin. Co. v. King, 552 So. 2d 1199 (La. 1989).
397.      Home Fed. Sav. & Loan Ass’n v. Dooley’s, 716 P.2d 1042 (Ariz. Ct. App.
          1985); Agee v. First Nat’l Bank, 386 N.E.2d 899 (Ill. App. Ct. 1979);
          Hassell v. Sterling Fed. Sav. & Loan Ass’n, 271 N.E.2d 7 (Ill. App. Ct.
          1971); Rayborn v. Fort Thomas Bldg. & Loan Ass’n, 453 S.W.2d 558 (Ky.
          1970) (court noted that mortgagor was an insurance agent who would be
          expected to give notice of a policy’s expiration; Beckford v. Empire Mut.
          Ins. Group, 525 N.Y.S.2d 260 (App. Div. 2d Dep’t 1988); Brown v. C&S
          Real Estate Servs., 445 S.E.2d 463 (S.C. Ct. App. 1994) (mortgagee holding
          escrow funds not obligated to procure flood insurance). In Boyce v. Nat’l
          Commercial Bank & Trust Co., 247 N.Y.S.2d 521 (Sup. Ct. Eq. Term
          Albany County), aff ’d per curiam, 254 N.Y.S.2d 127 (App. Div. 3d Dep’t
          1964), the opinion states, obiter, that a mortgagee with sufficient escrow
          funds would be liable for failure to pay the insurance premium after
          demand by the mortgagor or insurer. The sting of the holding of no duty
          absent demand was removed by the court’s other holding that the insurer,
          also a defendant, had not effectively exercised a cancellation right.
398.      First Fed. Sav. & Loan Ass’n v. Savage, 435 S.W.2d 67 (Ky. 1968);
          Cromartie v. Carterette Sav. & Loan Ass’n, 649 A.2d 76 (N.J. Super. Ct.
          App. Div. 1994); Pacheco v. Heussler, 390 N.Y.S.2d 761 (App. Div. 4th
          Dep’t 1977) (jury question as to whether mortgagee breached duty by
          failing to pay); Hardcastle v. Greenwood Sav. & Loan Ass’n, 516 P.2d 228



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§ 3:7.2                        FRIEDMAN     ON   CONTRACTS

   Similar issues arise when the mortgagee is involved with or knows
of the cancellation of the insurance policy. As a general matter, the
mortgagee is under no implied duty to notify the mortgagor of a
cancellation of the policy, even though the mortgagee is in receipt of a
notice of cancellation of the policy sent by the insurer.399 The mort-
gagee may justifiably assume that the insurer also gave notice of
cancellation to the mortgagor when the policy is of a type that cannot
legally be cancelled without such notice to the mortgagor. In one case,
a mortgagee’s return of a policy for cancellation, in the mistaken belief
that the policy had been replaced, was held to have no effect on the
mortgagor ’s rights to enforce the policy.400 But another court has held
a mortgagee liable for canceling a policy in the mistaken belief that the
policy had been superseded by another.401
   Credit life insurance has been treated somewhat similarly.
A mortgagee who was held under the circumstances to be a broker
for the credit insurer was held liable for failure to notify the mortga-
gor ’s widow that the insurer was placed in governmental rehabilita-
tion.402 A mortgagee’s breach of an agreement, made simultaneously
with the mortgage, to obtain credit life insurance for the mortgagor,
was a defense to foreclosure.403
   When a mortgagee purchases insurance solely for his protection
and with his own funds, the insurer, after paying the mortgagee
his loss, is subrogated to the right of the mortgagee against the
mortgagor.404 But when the policy solely in the mortgagee’s name is
procured by the mortgagee pursuant to the authority of the mortgage
and at the expense of the mortgagor, the insurer has no right of




          (Wash. Ct. App. 1973). In Tincher v. Greencastle Fed. Sav. Bank, 580
          N.E.2d 268 (Ind. Ct. App. 1991), a judgment for the mortgagee was
          remanded to determine if there was a separate agreement by the mortgagee
          to maintain insurance or a promissory estoppel.
399.      Beckford v. Empire Mut. Ins. Group, 525 N.Y.S.2d 260 (App. Div. 2d Dep’t
          1988); see Rocque v. Co-Operative Fire Ins. Ass’n, 438 A.2d 383 (Vt. 1981)
          (in dispute concerning whether mortgagor had received notice of cancella-
          tion from insurer, court rejected insurer ’s argument that mortgagee who
          had received notice had duty to inform mortgagor).
400.      Falchook Mkts., Inc. v. Warner Reciprocal Insurers, 388 N.Y.S.2d 100
          (App. Div. 1st Dep’t 1976) (“replacement” policy was on other property).
401.      Hatfield v. Minden Bank & Trust Co., 361 So. 2d 901 (La. Ct. App. 1978).
402.      Kinder Mortgage Co. v. Celestine, 635 So. 2d 527 (La. Ct. App. 1994).
          Kinder discusses cases in comparable situations.
403.      Bonner v. Bank of Coushatta, 445 So. 2d 84 (La. Ct. App. 1984) (mortgage
          was cancelled).
404.      Pantano v. Md. Plaza P’ship, 507 N.W.2d 484 (Neb. 1993); see Mann v.
          Glens Falls Ins. Co., 541 F.2d 819 (9th Cir. 1976); Employers’ Fire Ins. Co.
          v. British Am. Assurance Co., 131 S.E.2d 36, 38 (N.C. 1963).



                                       3–90
                             Mortgage Financing                                § 3:7.2

subrogation and the proceeds of insurance are applied to the mortgage
debt.405

              [B] Restoration of Premises
   Prior to 1966, the New York statutory covenant to insure gave the
mortgagee the choice of applying insurance moneys either to reduction
of the mortgage debt (despite repairs or restoration by the mortgagor)
or to restoration of the premises.406 Most other states, then and now,
follow this rule—it being generally held that a provision making
insurance proceeds payable to a mortgagee entitles him to these
proceeds to the extent of the mortgage debt, and to hold any surplus
after extinguishment of the mortgage debt for the benefit of
the mortgagor.407 A mortgagee’s reasonable delay in asserting its
rights to the proceeds will not bar its claim, even if the mortgagee
notifies the mortgagor of its election after the mortgagor has com-
pleted restoration.408 An owner who repairs without getting his mort-
gagee’s commitment to apply funds to the restoration acts at his peril.
But if, after an insured loss, the mortgagee agrees to allow proceeds for




405.      Employers’ Fire Ins. Co. v. British Am. Assurance Co., 131 S.E.2d 36
          (N.C. 1963). In Employer’s Fire, the mortgagor purchased one policy
          insuring herself with a standard mortgagee endorsement and the mort-
          gagee purchased a policy naming only himself as insured, but he added
          the premium to the mortgage debt. Charging the premium to the
          mortgagor was sufficient to bring the case within the rule mentioned.
          Each insurer was held liable for that part of the loss its policy bore to the
          total insurance.
406.      Savarese v. Ohio Farmers’ Ins. Co., 182 N.E. 665 (N.Y. 1932), noted in 42
          YALE L.J. 788 (1933).
407.      Walter v. Marine Office, 537 F.2d 89, 97 (5th Cir. 1976) (Louisiana law);
          Price v. Harris, 475 S.W.2d 162 (Ark. 1972) (seller retained vendor ’s lien,
          with buyer promising to insure building; parties treated this agreement as
          mortgagee clause, entitling vendor to retain proceeds despite buyer ’s
          restoration); Pearson v. First Nat’l Bank, 408 N.E.2d 166, 169–70 (Ind.
          Ct. App. 1980); Pink v. Smith, 274 N.W. 727 (Mich. 1937); Gen. G.M.C.
          Sales, Inc. v. Passarella, 481 A.2d 307 (N.J. Super. Ct. App. Div. 1984);
          English v. Fischer, 660 S.W.2d 521 (Tex. 1983) (rejects application of
          implied covenant of good faith and fair dealing; parol promise lacks
          consideration).
408.      First Fed. Sav. & Loan Ass’n v. Stone, 467 N.E.2d 1226, 1234 (Ind. Ct.
          App. 1984) (when owners “authorized the repair of the home without an
          assurance from [mortgagee] that the insurance proceeds would be applied
          to repair the home, they gambled that [mortgagee] would not elect to apply
          the insurance proceeds to the mortgage debt and lost”).



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§ 3:7.2                        FRIEDMAN    ON   CONTRACTS

restoration, such an agreement is enforceable in accordance with
general principles of contract law.409
    A few cases entitle the mortgagor to the insurance moneys when
the mortgage is in good standing and the security is not impaired. 410
This approach has been criticized for requiring a lawsuit to determine
the value of the remaining security,411 but a mortgagor might prefer
litigation to an inability to rebuild.
    The operation of the majority rule can be rough on a mortgagor who
paid premiums for years for fire insurance and then learned, after the
event, that by application of the insurance moneys to reduction of the
mortgage, he had half a building and half a mortgage, but no money for
restoration. Some mortgagees have used this situation as a lever to
depart from their bargain by increasing the interest rate or calling a
mortgage they regretted making. A mortgagee’s use of fire damage to
call a mortgage might be justified in the occasional case of a large
mortgage made in reliance on the security of high credit tenants,
where destruction terminated these leases.
    Parties to a mortgage are free to enter into an agreement that will
govern application of the insurance proceeds in event of a loss, and
such agreements sometimes allow the mortgagor to use the insurance
money to restore the property rather than to pay the mortgage debt.412
In substantial mortgages, involving a borrower with bargaining power,
the mortgage may expressly require the mortgagee to apply the
insurance moneys to restoration. This may be by payment to the
mortgagor immediately, or not until restoration. Or it may provide for
payment in stages as restoration progresses, with a specified percen-
tage held back until completion. The mortgage may provide for
remission of the moneys to a trustee, usually a bank, to make these
payments.



409.      See United Bilt Home, Inc. v. Sampson, 832 S.W.2d 502 (Ark. 1992)
          (mortgagee and mortgagor agreed, after fire, that mortgagee would reim-
          burse mortgagor for cost of repairs; mortgagee’s failure resulted in action
          by contractor against mortgagor; mortgagee was liable for compensatory
          and punitive damages).
410.      Schoolcraft v. Ross, 146 Cal. Rptr. 57 (Ct. App. 1978) (but cf. Lee v.
          Murphy, 61 Cal. Rptr. 174 (1st Dist. Ct. App. 1967)); Cottman Co. v.
          Cont’l Trust Co., 182 A. 551 (Md. 1936); Starkman v. Sigmond, 446 A.2d
          1249 (N.J. Super. Ct. Ch. Div. 1982). See also English v. Fischer, 660
          S.W.2d 521, 526–27 (Tex. 1983). Starkman v. Sigmond was disapproved in
          Gen. G.M.C. Sales, Inc. v. Passarella, 481 A.2d 307 (N.J. Super. Ct. App.
          Div. 1984), aff ’d per curiam, 499 A.2d 1017 (N.J. 1985).
411.      Knapp v. Victory Corp., 302 S.E.2d 330, 331 (S.C. 1983).
412.      Hoosier Plastics v. Westfield Sav. & Loan Ass’n, 433 N.E.2d 24, 27 (Ind.
          Ct. App. 1982); Pearson v. First Nat’l Bank, 408 N.E.2d 166, 169–70 (Ind.
          Ct. App. 1980).



                                       3–92
                             Mortgage Financing                             § 3:7.2

   When the mortgagee makes the payments to a contractor who
performs restoration work, a written contract should specify the
criteria the mortgagee will follow in deciding when and how much
to pay. If such a contract agreed to the mortgagor does not require
inspections of the work, a court has held that a mortgagee who paid
insurance moneys to a contractor, whose work was deficient, was not
liable for negligent conduct or as an implied trustee.413
   When the mortgagee releases insurance moneys to the mortgagor
for the purpose of restoration, the mortgagor ’s use for other purposes
may be an actionable wrong.414
   In 1966 New York departed from the majority rule, which gives the
mortgagor no right to use insurance proceeds to restore unless
the mortgage expressly allows such restoration. A statute revised the
construction of the insurance covenant in statutory form mortgages,
providing that the mortgagee hold the insurance proceeds “as trust
funds until paid over or applied.”415 If the mortgagor notifies the
mortgagee of the fire within thirty days thereafter and makes “good
the damage by means of such repairs, restoration or rebuilding as may
be necessary to restore the buildings to their condition prior to the
damage,” then upon presentation of proof the mortgagor becomes
entitled to reimbursement from the insurance moneys.416 The mort-
gagor’s right to the insurance proceeds is conditioned on there being
no “default by the mortgagor in the performance of any of the terms or
provisions of the mortgage on his part to be performed.”417 The statute
gives the mortgagor a maximum of three years to restore, but he is
under pressure to restore promptly because he gets no benefit from the
insurance and must pay for restoration, plus taxes and all mortgage
charges, with little or no income from the property, until restoration is
complete. In essence the mortgagor ’s rights depend on restoring the
mortgagee to his original security position.418
   Inasmuch as the use of the statutory form mortgage is merely
permissive, the statutory construction conferring restoration rights
on the mortgagor may be avoided by stipulating otherwise in the
mortgage. Most mortgage forms prepared for lending institutions


413.      McWaters v. Frederick W. Berens, Inc., 238 S.E.2d 717 (Ga. Ct. App. 1977)
          (mortgagee complied with contract requirement that contractor should be
          paid in “25% increments”).
414.      Law v. Dewoskin, 447 S.W.2d 361 (Tenn. 1969) (mortgagee allowed to
          pursue claim after purchasing at foreclosure for full amount of debt due
          under non-recourse mortgage).
415.      N.Y. REAL PROP. LAW § 254(4).
416.      Id.
417.      Id.
418.      The statute does not apply to a purchaser under an installment contract of
          sale. See infra section 3:7.2[K] infra.



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§ 3:7.2                         FRIEDMAN    ON   CONTRACTS

stipulate otherwise by giving the mortgagees the rights they held
before the 1966 amendment, though in large transactions this may
be changed, as mentioned above. If a mortgage loan was made in
reliance on the existence of a lease to a high credit tenant, a mort-
gagee’s agreement to apply insurance proceeds to restoration may be
conditioned on the continuance of the lease after restoration. If a
group of such leases is involved, the condition may be that the
aggregate annual rents do not drop, by reason of the damage, below
a specified sum or percentage.

             [C]    Application of Insurance Proceeds to Debt
   The standard mortgage clause has been called “a pre-appropriation
of insurance proceeds to payment of the mortgage debt.” 419 Making
the insurance moneys payable to a mortgagee does not, per se, give the
mortgagee a free hand in their application. When the proceeds of
insurance are payable to a mortgagee, with no obligation to apply them
otherwise than to the mortgage debt, the mortgagee is usually required
to apply them to installments of interest and principal as they fall due.
This bars him from foreclosing for current defaults, at a time when an
owner may be hard pressed, in order to hold the insurance moneys as
security for final installments of the mortgage debt.420 It may also
require him to hold the insurance money, if the mortgage has not
matured, until the debt or part of it becomes due.421
   However, the disposition of insurance moneys may be controlled by
agreement between mortgagor and mortgagee, usually found in the
mortgage itself. And a mortgage provision permitting a mortgagee to
apply the insurance money against the mortgage debt or for other
purposes has been held to permit application to the balance of the debt
payable at maturity instead of to installments next accruing. 422


419.      Sureck v. United States Fid. & Guar. Co., 353 F. Supp. 807, 810 (W.D. Ark.
          1973) (mortgagee’s right to insurance proceeds paramount to claim of
          mortgagor’s attorney for legal work done to collect on policies); Leiden v.
          Gen. Motors Acceptance Corp., 220 S.E.2d 716 (Ga. Ct. App. 1975). See
          also Giberson v. First Fed. Sav. & Loan Ass’n, 329 N.W.2d 9 (Iowa 1983).
420.      Crone v. Johnson, 403 S.W.2d 738 (Ark. 1966) (but see Price v. Harris, 475
          S.W.2d 162 (Ark. 1972)); Hadjis v. Anderson, 271 A.2d 350 (Md. 1970);
          Zeigler v. Fed. Land Bank, 86 S.W.2d 864 (Tex. Civ. App. 1935); Thorp v.
          Croto, 65 A. 562 (Vt. 1907); see Lee v. Murphy, 61 Cal. Rptr. 174, 176 n.1
          (1st Dist. Ct. App. 1967).
              But note Ziello v. Superior Court, 42 Cal. Rptr. 2d 251 (Ct. App. 1995),
          where the mortgage provided that absent a contrary agreement the
          proceeds of insurance should not postpone the date of the periodic
          payments or change their amount.
421.      Thorp v. Croto, 65 A. 562 (Vt. 1907).
422.      Lee v. Murphy, 61 Cal. Rptr. 174 (1st Dist. Ct. App. 1967); Atl. & Gulf
          Props., Inc. v. Palmer, 109 So. 2d 768 (Fla. Dist. Ct. App. 1959).



                                       3–94
                             Mortgage Financing                               § 3:7.2

Application to the balance payable at maturity is permitted under the
New York statute.423

              [D] Claims of Co-owners and Holders of Other
                  Interests
    A mortgagee who plans to pay the proceeds of insurance to
an owner should consider the possible rights of a junior lienor or a
co-owner in these proceeds. Any such rights would be based on
the terms of the mortgage or the insurance policy or both.
A mortgagee who might have applied the proceeds, as of right, to
the mortgage debt was held liable for the diversion made possible by
paying the proceeds to one of several co-owners. 424 If the insurance is
for the benefit of first and second mortgagees, the first mortgagee is
liable to the second for the proceeds in excess of the first mortgage
debt425 and may not, as against the second mortgagee, remit the
proceeds to the mortgagor for purposes of repair.426 If the first mort-
gage requires insurance for a stated amount, the first mortgagee is
estopped from claiming a greater amount, with the junior mortgagee
entitled to apply the excess proceeds to its debt.427
    When senior and junior mortgagees are named in the same policy,
their rights inter se may be governed by the terms of the senior
mortgage. In this situation, a clause in the first mortgage that gives
its holder the choice of applying the proceeds either to reduction of the
debt or to repair of the damage has been upheld against a junior
mortgagee.428 A mortgage that permitted its holder to apply the
proceeds of insurance to the mortgage debt, to restoration, or for any


423.      Terraqua Corp. v. Emigrant Indus. Sav. Bank, 75 N.Y.S.2d 453 (Sup. Ct
          N.Y County 1947), aff ’d, 76 N.Y.S.2d 610 (App. Div. 1st Dep’t 1948).
424.      Conn. Mut. Life Ins. Co. v. Scarnmon, 117 U.S. 634 (1886). Cf. McWaters
          v. Frederick W. Berens, Inc., 238 S.E.2d 717 (Ga. Ct. App. 1977) (mort-
          gagee who paid contractor for restoration work did not breach duty of care
          in failing to ascertain completeness of work).
425.      Parker v. Ross, 11 S.W. 865 (Tex. 1889).
426.      Carlin v. Frey, 141 N.Y.S. 580 (App. Div. 3d Dep’t 1913).
427.      Knapp v. Victory Corp., 302 S.E.2d 330 (S.C. 1983) (fire insurance
          procceds were $225,000, but mortgage only required mortgagor to main-
          tain insurance of $160,000).
428.      Application to the first mortgage debt was upheld in Woody v. Lytton Sav.
          & Loan Ass’n, 40 Cal. Rptr. 560 (2d Dist. Ct. App. 1964).
              An agreement between mortgagor and mortgagee controls disposition
          of insurance moneys and binds other lienors. Lee v. Murphy, 61 Cal. Rptr.
          174 (1st Dist. Ct. App. 1967).
              A first mortgagee was held justified in paying the proceeds to the owner
          in reliance on an affidavit that restoration had been made. The first
          mortgagee was held not negligent as a matter of law in relying on the
          affidavit. Walton v. Gen. Am. Life Ins. Co., 383 S.W.2d 854 (Tex. Civ. App.
          1964).



(Friedman on Contracts, Rel. #7, 5/09)   3–95
§ 3:7.2                         FRIEDMAN    ON   CONTRACTS

other purpose, without impairment of the lien of the mortgage, was
held to justify payment to the owner without regard to restoration. 429
   A junior mortgagee, who is not named in a policy insuring the
owner and first mortgagee, has been held to have no valid objection to
use of the proceeds for restoration430 or even, possibly, for their
diversion.431 But query whether a junior mortgagee who is not named
in the policy may not on timely application prevent the use of the
proceeds for a purpose other than that of repair or reduction of a
paramount mortgage. The doctrine of marshalling assets is applicable
when two or more creditors of the same debtor have successive claims
on the same property, and the creditor prior in right holds additional
security. In this situation, equity will compel one creditor to collect
from the funds unavailable to the other, where this can be done with
justice to all concerned.432 The doctrine of marshalling assets, how-
ever, does not apply between a mortgagee and a subsequent purchaser
of the property. In Peoples State Bank v. Marlette Coach Co.,433 a first
mortgagee and the owner agreed, after their collection, to apply the
insurance proceeds to an unsecured debt. This agreement was held
binding on a junior mortgagee who, though known to the first
mortgagee, was not a party to the policy. At the time of the action
the junior mortgagee acquired title to the property through foreclosure.
This ended its lien and its claim as a creditor. For this reason the court
refused to apply the doctrine.434


429.      Meltzer v. Blumberg, 231 N.Y.S. 513 (Sup. Ct. Kings County 1928) (junior
          mortgagee not named in policy).
430.      Gordon v. Ware Sav. Bank, 115 Mass. 588 (1874).
431.      See Meltzer v. Blumberg, 231 N.Y.S. 513 (Sup. Ct. Kings County 1928).
432.      See Peoples State Bank v. Marlette Coach Co., 336 F.2d 3 (10th Cir. 1964);
          Bartley v. Pikeville Nat’l Bank & Trust Co., 532 S.W.2d 446 (Ky. 1975). See
          also Ranier v. Mount Sterling Nat’l Bank, 812 S.W.2d 154 (Ky. 1991).
433.      Peoples State Bank v. Marlette Coach Co., 336 F.2d 3 (10th Cir. 1964).
434.      Marshalling assets cannot be availed of by an unsecured creditor. Eisenhart
          v. Schreimann, 889 S.W.2d 887, 892 (Mo. Ct. App. 1994). The doctrine
          does not apply where it would not be equitable to do so. In re Oxford Dev.
          Ltd., 67 F. 3d 683 (8th Cir. 1995) (purchase of part of land subject to a
          mortgage).
              Sale of mortgaged property in foreclosure in separate parcels in the
          inverse order in which the parcels were sold by the mortgagor (the “inverse
          order of alienation”) is a form of marshaling assets. See In re Boswell Land
          and Livestock, Inc., 86 B.R. 665 (D. Utah 1988). But see Hill v. Lane, 848
          P.2d 43 (Okla. Ct. App. 1933). Comparable to this is the rule that
          foreclosure of a mortgage covering homestead and non-homestead property
          requires sale of the non-homestead property first. Lee v. Mercantile First
          Nat’l Bank, 765 S.W.2d 17 (Ark. Ct. App. 1989).
              Where a second mortgage is paramount to subsequent mortgages, the
          second mortgagee may have a sale under the first mortgage and seek
          satisfaction first from properties in which the subsequent mortgagees have
          an interest. In re Shull, 72 B.R. 193 (Bankr. D.S.C. 1986).



                                       3–96
                             Mortgage Financing                               § 3:7.2

   The existence of a tenant and a paramount mortgage may create a
three corner priority. In one case a lease required the tenant to restore
after a fire, at the tenant’s expense and with no liability therefor on
the landlord, but entitled the tenant to reimbursement to the extent of
the insurance.435 The tenant was required to supply replacement
value insurance for the benefit of both landlord and tenant and any
paramount mortgagee. After a fire the paramount mortgagee elected to
take enough of the insurance proceeds to satisfy its mortgage. The
tenant restored at its expense and received the balance of the insurance
money, a sum insufficient for full reimbursement. If there were no
mortgage the insurance proceeds would have paid for restoration and
any balance would have gone to the landlord. To avoid giving the
landlord a windfall (satisfaction of its mortgage debt) at the tenant’s
expense, the tenant was given a right against the landlord by subroga-
tion to be made whole by deferred payments for the cost of restoration.
   The requirement in a first mortgage that the owner insure for the
mortgagee was held to give a junior wraparound mortgagee a right to
insurance because of the owner ’s obligation in the wraparound to
comply with the first mortgage.436
   Suppose an owner of the premises fails to supply the mortgagee
with fire insurance, but obtains such insurance for his own benefit. If
the owner was under no obligation to insure for the mortgagee’s
benefit, the proceeds of such insurance are the sole property of the
owner.437 This is an application of the general rule that one who is not
a party to an insurance contract has no claim to its proceeds. 438
   If the owner is liable on the covenant to insure, as in the case of
either the mortgagor or a subsequent owner who has effectively
assumed the mortgage, this covenant is sufficient in most states to
predicate a lien in the mortgagee’s favor on the proceeds of
such insurance439 that is paramount to rights of the mortgagor ’s




435.      Loving v. Ponderosa Sys., 479 N.E.2d 531 (Ind. 1985).
436.      Ark. Teacher Ret. Sys. v. Commando Props. Ltd., 801 S.W.2d 50 (Ark. Ct.
          App. 1990).
437.      Bodwitch v. Allen, 459 N.Y.S.2d 148 (App. Div. 4th Dep’t 1983). This was
          applied to earthquake insurance not required by the mortgage. For this
          reason Alexander v. Sec.-First Nat’l Bank, 62 P.2d 735 (Cal. 1936), was
          distinguished. Ziello v. Superior Court, 42 Cal. Rptr. 2d 251 (Ct. App.
          1995). In Ziello, the mortgagee’s reference to the provision in the mortgage
          assigning to the mortgagee all sums due and payable for injury to the
          property was rebuffed by the holding that insurance is a personal contract
          and its proceeds are payment on a contract, not a judgment.
438.      See Peoples State Bank v. Marlette Coach Co., 336 F.2d 3 (10th Cir. 1964).
439.      Alexander v. Sec.-First Nat’l Bank, 62 P.2d 735, 737–38 (Cal. 1936);
          Lakeshore Bank & Trust Co. v. United Farm Bureau Mut. Ins. Co., 474



(Friedman on Contracts, Rel. #7, 5/09)   3–97
§ 3:7.2                         FRIEDMAN     ON   CONTRACTS

creditors.440 But this lien is subordinate to a junior mortgagee who has
the benefit of insurance bearing a mortgagee endorsement in his
favor.441 Furthermore, a covenant to insure does not run with the
land, and if in this situation an owner has not assumed the mortgage,
he is entitled to receive the proceeds of insurance free of any claim
of the mortgagee.442 Accordingly, it is essential that a mortgagee
always have proper insurance policies from the owner. If the mortgage
contains the provisions herein discussed, the mortgagee has two
remedies: (1) an owner ’s failure to supply the mortgagee with insur-
ance is a breach that permits the mortgagee to accelerate the mortgage;
or (2) the mortgagee may obtain the insurance himself and add this
cost to the mortgage debt.443 If in this situation the mortgagee insures
for himself, the policy is held dual interest insurance, covering the
mortgagor and the mortgagee, requiring the mortgagee to apply




          N.E.2d 1024 (Ind. Ct. App. 1985); Cromwell v. Brooklyn Fire Ins. Co., 44
          N.Y. 42 (1870); see Oregon Mut. Ins. Co. v. Cornelison, 330 P.2d 161, 165
          (Or. 1958). But there is authority to the effect that the mortgagee has no
          lien in this situation unless the owner has obtained insurance with an
          intention of complying with the covenant to insure. Stearns v. Quincy
          Mut. Fire Ins. Co., 124 Mass. 61 (1878); see Papamechail v. Holyoke Mut.
          Ins. Co., 397 N.E.2d 1153 (Mass. App. Ct. 1979); First Nat’l Bank v.
          Cappellini, 26 A.2d 119, 120 (Pa. Super. Ct. 1942).
              In this situation the insurer is not liable to the mortgagee for paying the
          insurance moneys to the mortgagor if without actual or constructive
          knowledge of the mortgagee’s rights. Paskow v. Calvert Fire Ins. Co., 579
          F.2d 949, 952 (5th Cir. 1978).
              A mortgagor’s parol agreement to insure for the mortgagee’s benefit
          was held binding. Butson v. Misz, 160 P. 530 (Or. 1916).
              A mortgage requirement that the mortgagor insure against fire and
          deliver the policies to the mortgagee was held a covenant to insure for the
          mortgagee’s benefit, on the ground there was no other reason for delivering
          the policies to the mortgagee. Winneshiek Mut. Ins. Ass’n v. Roach, 132
          N.W.2d 436 (Iowa 1965).
440.      Gulf Nat’l Bank v. Hartford Fire Ins. Co., 264 So. 2d 401 (Miss. 1972).
441.      Hartford Fire Ins. Co. v. Landreneau, 140 So. 52 (La. Ct. App. 1932);
          Dunlop v. Avery, 89 N.Y. 592 (1852).
442.      Kaplan v. Wilderman, 123 A. 165 (N.J. Ch. 1924); Sheenan v. Spring Valley
          Wood Prods. Corp., 185 N.Y.S. 641 (App. Div. 2d Dep’t 1920), aff ’d, 135
          N.E. 918 (N.Y. 1922); Rollman Corp. v. Goode, 400 A.2d 968 (Vt. 1979).
443.      The New York statutory mortgage is so construed. N.Y. REAL PROP. LAW
          § 254(4). Where not so implied, a comparable provision should be
          expressed. The two remedies are not mutually exclusive. Upon the
          mortgagor’s default, the mortgagee may elect to pay the insurance pre-
          mium and proceed to foreclose. Farmers & Merchs. Bank v. Copple, 373
          P.2d 219 (Kan. 1962) (mortgagee paid premium on last day of grace period
          before cancellation of policy).



                                        3–98
                             Mortgage Financing                                 § 3:7.2

the insurance proceeds to reduction of the mortgage and depriving the
insurer of any subrogation against the mortgagor.444
   A mortgagee with insurance in its name is entitled to its proceeds to
the exclusion of a prior mortgage445 or lien.446
   The lien of a mortgagor ’s lawyer on the insurance moneys, for
effecting their collection, is usually subordinate to the right of the
mortgagee thereto.447

              [E]    Transfers of Mortgaged Premises or
                     Mortgage Loan
   The fact that an owner who has not assumed the mortgage is not
personally liable for the premiums, or for any other part of the
mortgage debt, does not preclude the mortgagee from enforcement of
the rights given him by the mortgage.
   A purchaser of mortgaged property who neglected to have his name
substituted on a fire policy for that of his mortgagor-vendor was denied
recovery on the policy after a disastrous fire.448 The mortgagee recovered
enough to satisfy its mortgage, but this sum was less than half the
amount of the damage. This result seems unduly technical because the
purchaser had assumed the mortgage and paid the insurance premiums,
which were included in his payments to the mortgagee.
   A mortgagor who sells the property retains an insurable interest if
he remains liable for the mortgage debt, despite an assumption of the
mortgage by the grantee.449

444.      In re SPG, Inc., 833 F.2d 413 (2d Cir. 1987). This is not true with respect
          to subrogation where a mortgagor ’s breach of the policy makes it un-
          enforceable by the mortgagor.
445.      Butler v. Ringrose, 16 P.2d 202 (Wash. 1932).
446.      Midland Lumber & Supply, Inc. v. J.B. Builders, 626 A.2d 89 (N.J. Super.
          Ct. 1993).
447.      Sureck v. United States Fid. & Guar. Co., 353 F. Supp. 807 (W.D. Ark.
          1973); Howard, Singer & Meehan v. Clayton Fed. Sav. & Loan Ass’n, 578
          S.W.2d 56 (Mo. Ct. App. 1978).
448.      Am. Family Mut. Ins. Co. v. Walton, 926 F. Supp. 811 (S.D. Ind. 1996).
          This case compares with those that involve the right of an insurance
          company that pays a loss, say, to a landlord, to be subrogated to the
          amount of its payment against the wrongdoer who caused the damage.
          This usually involves recovery against a tenant who negligently caused a
          fire. If the tenant is included in the landlord’s policy, making the tenant an
          insured, the insurer has no such right of subrogation because the insurer
          has no right to recover against its insured. But some cases hold that if
          tenant’s rent expressly includes a charge for insurance or if this is included
          in rent escalation, then the result is the same and tenant is absolved. Some
          cases hold that a tenant’s mere payment of rent, with no more, presumably
          goes in part to pay for insurance and here too tenant is absolved. See 1
          MILTON R. FRIEDMAN, FRIEDMAN ON LEASES § 9:10 (Patrick A. Randolph,
          Jr., ed., 5th ed. PLI 2006).
449.      Reid v. Hardware Mut. Ins. Co., 166 S.E.2d 317 (S.C. 1969).



(Friedman on Contracts, Rel. #7, 5/09)   3–99
§ 3:7.2                        FRIEDMAN    ON   CONTRACTS

   When a mortgagee assigns a promissory note and mortgage, the
assignee may become the named mortgagee on the insurance policy if
the parties contact the insurer to request a change. This step, however,
is often not taken. Failure to do so may jeopardize insurance coverage
in the event of casualty, but usually is not fatal. The assignment of the
mortgage loan by the initial mortgagee carries with it the assignor ’s
rights in the insurance unless the insurance policy contains express
language voiding the mortgage clause if the current mortgagee’s name
does not appear therein.450 Moreover, an action for reformation may
be available to correct the name of the mortgagee. 451
   A policy requirement that the mortgagee give the insurer notice of a
change of ownership that comes to his attention is not applied to a
transfer to the mortgagee. The latter is already an insured and his
increased interest in the property subjects the insurer to no increased
risk.452 The rule applies when the policy has a standard mortgagee
clause. The rule is contra where the mortgagee’s interest is reflected in
a loss payment clause.453
   The policy requirement that the mortgagee notify the insurer of a
change in ownership is necessary for the mortgagee’s protection, not
the mortgagor ’s. When a mortgagor sold a house to his brother and
the insurer denied coverage after a fire, a court held that the mort-
gagee was not liable to the mortgagor or his brother for failing to
notify the insurer of the ownership change. 454




450.      Sprouse v. N. River Ins. Co., 344 S.E.2d 555 (N.C. Ct. App. 1986).
451.      Cheperuk v. Liberty Mut. Fire Ins. Co., 693 N.Y.S.2d 304 (App. Div. 3d
          Dep’t 1999) (fire occurred eleven months after mortgage assignment;
          granting reformation when failure to change name of mortgagee on policy
          was inadvertent and company did not claim it would have discontinued
          coverage had it received notice of change of mortgagee).
452.      S. States Fire & Cas. Ins. Co. v. Napier, 96 S.E. 15 (Ga. Ct. App. 1918);
          Union Cent. Life Ins. Co. v. Franklin County Farmers Mut. Ins. Ass’n, 270
          N.W. 398 (Iowa 1936); Pioneer Sav. & Loan Co. v. St. Paul Fire & Marine
          Ins. Co., 70 N.W. 979 (Minn. 1897); Binghamton Sav. Bank v. Mount
          Vernon Fire Ins. Co., 162 N.Y.L.J. 2, 14 (Sup. Ct. 1969); Union Cent. Life
          Ins. Co. v. Clinton Mut. Ins. Ass’n, 199 N.E. 223 (Ohio Ct. App. 1935).
          But see Royal Ins. Co. v. Drury, 132 A. 635 (Md. 1926) (sale to note
          holders a change of ownership).
453.      Boston Co-op Bank v. Am. Cent. Ins. Co., 87 N.E. 594 (Mass. 1909); see
          Royal Ins. Co. v. Drury, 132 A. 635, 641 (Md. 1926).
454.      Nassar v. Utah Mortgage & Loan Corp., 671 P.2d 667 (N.M. Ct. App.
          1983). Cf. Rocque v. Co-Operative Fire Ins. Ass’n, 438 A.2d 383 (Vt. 1981)
          (mortgagee has no duty to notify mortgagor of receipt of notice of
          cancellation of insurance policy).



                                     3–100
                             Mortgage Financing                             § 3:7.2

              [F] Mortgagee Endorsements
   Insurance policies name the mortgagor-owner as the insured, but a
mortgagee endorsement is invariably added. There are two different
types of mortgagee endorsements: (1) the standard or “union” endor-
sement, and (2) the “open” mortgage or loss payable clause. They vary
substantially in their effect.455
   The standard or union mortgage endorsement is more than a mere
assignment to the mortgagee of a right to the proceeds of insurance. It
is deemed to create a separate contract between the mortgagee and the
insurer. The mortgagee is entitled to its own notice of cancellation. 456
   The primary effect of the mortgagee endorsement is to insulate the
mortgagee from any act or omission of the mortgagor. This benefit is
highly significant. If the mortgagor should violate some provision of
the policy, such as by maintaining inflammables or explosives on the
premises, this, too, would not prejudice the mortgagee’s rights under
the standard mortgage endorsement. Nor does arson committed by the
mortgagor deprive the mortgagee of insurance coverage. 457
   An owner’s failure to file proof of loss does not prevent recovery by a
mortgagee under the standard mortgagee clause.458 In Hartford Fire
Insurance Co. v. Moore,459 an owner ’s failure to file proof of loss did
not prevent recovery by a mortgagee under the standard mortgagee
clause. The owner ’s failure to file proof of loss or to begin an action
within their respective time limits was waived by the insurer ’s full
payment to the mortgagee. The mortgagee made proof of loss, and the
insurer had taken an assignment of the mortgage. The owner ’s action
was not for money, but to have the mortgage lien canceled of record.
The court noted that the insurer made payment to the mortgagee
without disclaiming liability to the owner.
   A clause in a policy, typical of Lloyd’s underwriters, terminating the
policy in case of reduction in the amount of similar insurance
maintained on the premises with other insurers, was held without
effect on the mortgagee. 460 A provision voiding the policy for



455.      Louisiana cases discussing extensively the different forms of endorsements
          appear in Bohn v. La. Farm Bureau Mut. Ins. Co., 482 So. 2d 843 (La. Ct.
          App. 1986).
456.      Firstbank Shinnston v. W. Va. Ins. Co., 408 S.E.2d 777 (W. Va. 1991)
          (insurer ’s failure to notify mortgagee of policy cancellation resulted in
          survival of insurer ’s liability to mortgagee).
457.      Aetna Life & Cas. Co. v. Charles S. Martin Distrib. Co., 169 S.E.2d 695
          (Ga. Ct. App. 1969).
458.      McDowell v. St. Paul Fire & Marine Ins. Co., 101 N.E. 457 (N.Y. 1913).
459.      Hartford Fire Insurance Co. v. Moore, 412 S.W.2d 860 (Ky. 1967).
460.      Nat’l Factors, Inc. v. Waters, 249 N.Y.S.2d 121 (Sup. Ct. N.Y. County
          1964).



(Friedman on Contracts, Rel. #7, 5/09)   3–101
§ 3:7.2                        FRIEDMAN     ON   CONTRACTS

vacancy of the property for sixty days was held inapplicable to a
mortgagee.461
   Furthermore, if the insurer claims the policy never had a valid
inception, because of misrepresentation by the mortgagor in his
application, this too is without effect on the mortgagee’s rights. 462
   Despite the foregoing, there is a slight suggestion that a mortgagee
is protected by the standard mortgage endorsement only so long as he
had no knowledge of the mortgagor ’s default or other act.463
   If the policy is void as to the mortgagor, payment by the insurer to
the mortgagee may subrogate the insurer to the mortgagee’s rights
against the mortgagor. Many policies expressly entitle the insurer to
subrogation in this situation.464 These clauses are enforceable. In the
absence of a subrogation clause, some courts deny the insurer sub-
rogation,465 but others allow it.466
   Suppose the mortgagor should obtain a second policy, which
insures him alone and results in over-insurance. Whatever effect this
may have on the mortgagor ’s rights, it does not affect the mortgagee’s.
   Proceeds of insurance paid to a mortgagee under a standard mort-
gagee endorsement are for the benefit of both the mortgagor and the
mortgagee, and operate to reduce the mortgage debt.467 The standard
endorsement provides that whenever the insurer pays the mortgagee
and claims it is under no liability to the mortgagor, the insurer will be
subrogated to the rights of the mortgagee under the mortgage. This
provision is valid and the right of subrogation is enforceable against
the mortgagor.468 The insurer ’s right of subrogation against the owner




461.      Roosevelt Sav. Bank v. State Farm Fire & Cas. Co., 556 P.2d 823 (Ariz. Ct.
          App. 1976).
462.      See generally Iowa Nat’l Mut. Ins. Co. v. Cent. Mortgage & Inv. Co., 708
          P.2d 480 (Colo. Ct. App. 1985); Syracuse Sav. Bank v. Yorkshire Ins. Co.,
          94 N.E.2d 73, 76–77 (N.Y. 1950); Firstbank Shinnston v. W. Va. Ins. Co.,
          408 S.E.2d 777, 783 (W. Va. 1991).
463.      See Nassar v. Utah Mortgage & Loan Corp., 671 P.2d 667, 671 (N.M. Ct.
          App. 1983); 10A G. COUCH, INSURANCE § 42:735 (2d ed. 1982).
464.      See, e.g., the New York statutory form policy, N.Y. INS. LAW § 168.
465.      See Fields v. W. Millers Mut. Fire Ins. Co., 48 N.E.2d 489, 491 (N.Y. 1943),
          criticized in 12 FORDHAM L. REV. 289 (1943).
466.      E.g., Twin City Fire Ins. Co. v. Walter B. Hannah, Inc., 444 S.W.2d 131
          (Ky. 1969). See Campbell, Non-Consensual Suretyship, 45 YALE L.J. 69,
          101–02 (1935).
467.      Liverpool & London & Globe Ins. Co. v. Orrell, 190 So. 552 (Fla. 1939);
          see O’Neil v. Franklin Fire Ins. Co., 145 N.Y.S. 432, 438 (App. Div. 4th
          Dep’t 1913), aff ’d, 110 N.E. 1045 (N.Y. 1915).
468.      Surratt v. Fire Ass’n, 43 F.2d 467 (4th Cir. 1930); Auto-Owners Mut. Ins.
          Co. v. Newman, 851 S.W.2d 22 (Mo. Ct. App. 1993;) Larchmont Fed. Sav.
          & Loan Ass’n v. Ebner, 454 N.Y.S.2d 450 (App. Div. 2d Dep’t 1982).



                                      3–102
                             Mortgage Financing                               § 3:7.2

is not dependent upon an express provision to this effect in the
mortgage clause.469
   A literal reading of the mortgagee endorsement indicates that a mere
claim of non-liability is sufficient to establish the insurer ’s rights against
the mortgagor. As it is construed, however, the right of subrogation
depends on proof that the policy is void as against the mortgagor.470
Cases have arisen in which one of several co-owners was guilty of arson
or other intentional injury to the property. Some decisions give full
recovery to the innocent owner.471 Others have denied recovery.472 Still
others depend on “a reasonable expectation by the innocent party that
his or her individual interest would be protected without reference to the
acts committed by the coinsured.”473 If the insured is a corporation,
then recovery is barred by willful acts of its agents.474
   The insurer is not entitled to subrogation unless it satisfied the
mortgage in full.475 This is an application of the general rule under
which a party is not entitled to be subrogated to the rights or security
of a creditor until the creditor ’s claim has been fully paid.476
   When the insurer has paid the mortgagee and has subrogation
rights due to its nonliability to the mortgagor, the proceeds of
insurance are not applied to reduction of the mortgage debt. 477

469.      First Nat’l Bank v. Springfield Fire & Marine Ins. Co., 178 P. 413 (Kan.
          1919).
470.      Cronenwett v. Dubuque Fire & Marine Ins. Co., 186 P. 826 (Cal. 1st Dist.
          Ct. App. 1919); Sun Ins. Office v. Heiderer, 99 P. 39 (Colo. 1909); Ins. Co.
          of St. Louis v. Lounsbury, 199 So. 2d 730 (Fla. Dist. Ct. App. 1967);
          Frontier Mortgage Corp. v. Heft, 125 A. 772 (Md. 1924); Loewenstein v.
          Queen Ins. Co., 127 A. 772 (Mo. 1909); Reed v. Fed. Ins. Co., 510 N.Y.S.2d
          618 (App. Div. 2d Dep’t 1987); O’Neil v. Franklin Fire Ins. Co., 145 N.Y.S.
          432 (App. Div. 4th Dep’t 1913), aff ’d, 110 N.E. 1045 (N.Y. 1915).
471.      Reed v. Fed. Ins. Co., 510 N.Y.S.2d 618 (App. Div. 2d Dep’t 1987).
472.      See id. at 621.
473.      Id.
474.      See id. at 622.
475.      Nat’l Union Fire Ins. Co. v. Price, 99 So. 848 (Ala. 1924).
476.      But see Garrison v. Great S. Ins. Co., 809 F.2d 500 (8th Cir. 1987), which
          held that an insurer that paid a mortgagee for its fire loss became
          subrogated to the rights of the mortgagee against the mortgagor to the
          extent that the insured paid the mortgage debt. The mortgagor had
          permitted its interest in the policy to lapse.
477.      Auto-Owners Mut. Ins. Co. v. Newman, 851 S.W.2d 22 (Mo. Ct. App.
          1993); Dollar Fed. Sav. & Loan Ass’n v. Herbert Kallen, Inc., 410 N.Y.S.2d
          1004 (App. Div. 2d Dep’t 1978).
              The insurer’s right against the first assuming grantee may be ques-
          tioned because the latter ’s liability is sufficient to create an insurable
          interest. See Palisano v. Bankers & Shippers Ins. Co., 84 N.Y.S.2d 637
          (Sup. Ct. Erie County 1948), noted in 49 COLUM. L. REV. 866 (1949), aff ’d,
          95 N.Y.S.2d 543 (App. Div. 4th Dep’t 1950).
              Where the insurer paid off mortgagor ’s mortgage it was subrogated
          to mortgagee’s right to enforce payment of the mortgage and



(Friedman on Contracts, Rel. #7, 5/09)   3–103
§ 3:7.2                        FRIEDMAN    ON   CONTRACTS

   With a standard mortgagee endorsement, analysis can become
more complicated when the property is rented and the tenant obtains
the insurance policy. In one case, a net lease obligated a department
store tenant to purchase insurance, which was issued with a mort-
gagee endorsement naming the lessor ’s mortgagee.478 The court
concluded that the policy was procured for the benefit of the lessor-
mortgagor, although not named in the policy, as well as the mortgagee.
The mortgagee’s acceptance of the proceeds of insurance was held to
require their application in reduction of the mortgage.
   The “open” mortgage or loss payable clause is, in substance, an
assignment by a mortgagor to a mortgagee. It makes the mortgagee an
appointee for collection and gives the mortgagee no greater rights than
that of the mortgagor, so that a breach of conditions of the policy by
the mortgagor that would bar recovery by the mortgagor acts to bar
recovery by the mortgagee.479 But, under the prevailing authority, the
mortgagee under a loss payable clause is not bound by an arbitration or
settlement between the insurer and the mortgagor made without his
consent.480

             [G]    Mortgagee’s Acquisition of Title Before
                    Insured Loss
   A mortgagee’s right to receive the proceeds of insurance, to the
exclusion of the owner-mortgagor, was considered above. 481 That
consideration was predicated on two separate interests then vested


          accompanying note. Silman Custom Painting, Inc. v. Aetna Life & Cas.
          Co., 990 F.2d 1063 (8th Cir. 1993).
              When an insurer paid the mortgage debt and took an assignment of the
          mortgage and debt on the ground of arson by a second grantee-assumer of
          the mortgage, the insurer ’s claim for reimbursement was upheld against
          the second and the previous grantee against whom there was no claim of
          arson. Fireman’s Fund Ins. Co. v. Rogers, 712 S.W.2d 311 (Ark. Ct. App.
          1986).
478.      United Stores of Am., Inc. v. Fireman’s Fund Ins. Co., 420 F.2d 337 (8th
          Cir. 1970). The insurer unsuccessfully claimed a right of subrogation
          against the lessor-mortgagor.
479.      Ins. Co. of N. Am. v. Gulf Oil Corp., 127 S.E.2d 43 (Ga. Ct. App. 1962);
          First Nat’l Bank v. Newark Fire Ins. Co., 180 A. 163 (Pa. Super. Ct. 1935)
          (arson); Note, The Standard Mortgage Clause in Fire Insurance Policies, 33
          COLUM. L. REV. 305 n.3 (1933); see Fields v. W. Millers Mut. Fire Ins. Co.,
          48 N.E.2d 489, 490 (N.Y. 1943).
              In holding that the stockholders of a corporate mortgagor have an
          insurable interest, a defense on this ground against a loss-payee mortgagee
          was overruled. Booker T. Wash. Ins. Co. v. Transcon. Ins. Co., 263 F. Supp.
          1005 (N.D. Ala. 1966).
480.      Woody v. Lytton Sav. & Loan Ass’n, 40 Cal. Rptr. 560 (2d Dist. Ct. App.
          1964).
481.      See supra section 3:7.2[B].



                                      3–104
                             Mortgage Financing                                 § 3:7.2

in the mortgaged property: (1) the fee interest, in the owner-mortgagor,
and (2) the mortgage lien, in the mortgagee. If the mortgage interest is
converted into a fee by foreclosure or otherwise, the mortgagor ’s
interest is extinguished and the entire ownership is now in the former
mortgagee. If he is still named in a fire insurance policy only by way of
a mortgage endorsement, his right to receive the entire proceeds of
insurance, to the exclusion of the former mortgagor, depends on
several factors.
   Under the “union” or standard mortgagee endorsement the pro-
ceeds of insurance are payable “as interest may appear.” A preliminary
question is is whether “interest” means interest in the mortgage debt,
or in the mortgaged realty, or both? The prevailing view is that
“interest” means both.482 Based on this perspective, when the mort-
gagee acquires title to the realty before a loss, his interest is then in the
fee and he is entitled to the full proceeds of insurance regardless of
what is left of the debt, that is, the protection of the policy does not
end with foreclosure, although the debt is satisfied thereby. 483 The
extent of the coverage depends on the extent of the mortgagee’s
interest at the time of the loss, not on the continued existence of
the mortgage.484
   After foreclosure, in many states the mortgagor has a statutory right
of redemption. A mortgagee has been held entitled to insurance
proceeds during the mortgagor ’s period of redemption485 and after



482.      For another view, see Hartford Fire Ins. Co. v. Bleedorn, 132 S.W.2d 1066,
          1072 (Mo. Ct. App. 1939): “‘As its interest may appear ’ does not refer to
          appellant’s interest in the property, but refers to the amount of the debt
          owed to it secured by the deed of trust” (citations omitted).
483.      495 Corp. v. N.J. Ins. Underwriting Ass’n, 430 A.2d 203 (N.J. 1981).
484.      Nationwide Mut. Fire Ins. Co. v. Wilborn, 279 So. 2d 460 (Ala. 1973); 495
          Corp. v. N.J. Ins. Underwriting Ass’n, 430 A.2d 203 (N.J. 1981). In 495
          Corp., the mortgagee recovered the full amount of the loss, to the policy
          limits, subject to the rights of a superior mortgage. The court ruled that the
          mortgage endorsement protects the interest of the mortgagee in the
          insured property. It overcame a difficulty in construing the clause by
          centering on the words “a mortgagee’s interest in the insurance is not
          invalidated by foreclosure.” The insurer had argued that the mortgagee’s
          interest was limited to the debt, and that at the time of the fire there was
          no debt and therefore no insurable interest in the former mortgagee. The
          court reasoned that the insurer would reap a windfall if premiums were
          paid covering a full loss with nobody eligible for payment of the loss for the
          reason that the former owner lacked an insurable interest. The court
          distinguished the mortgagee’s post-loss acquisition, where recovery is
          limited to the deficiency in the mortgage debt and where, if the property
          is acquired in its full satisfaction, the former mortgagee is not entitled to
          any proceeds of insurance.
485.      City of Chicago v. Maynur, 329 N.E.2d 312 (Ill. App. Ct. 1975). Contra
          Wharen v. Markle Banking & Trust Co., 20 A.2d 885 (Pa. Super. Ct. 1941).



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§ 3:7.2                         FRIEDMAN    ON   CONTRACTS

expiration of the redemption period.486 A mortgagor redeeming during
the redemption was held entitled to the insurance.487
   The requirement in the standard mortgage endorsement that the
mortgagee give the insurance company notice of any change of owner-
ship is held inapplicable to the mortgagee’s acquisition of title unless
an increase of hazard is involved. It is said that this is no change of
ownership, merely an enhancement of the mortgagee’s interest. 488
   A fire occurring after the mortgagee bid the full amount of the debt,
but before the mortgagee obtained a deed was treated as a bid made
after acquisition of title, and the mortgage moneys were paid to the
mortgagee.489
   A few cases differ from the foregoing and limit a mortgagee’s
recovery to the preforeclosure debt for damage accruing after his
acquisition of title.490

             [H]    Mortgagee’s Acquisition of Title After Insured
                    Loss
   If the mortgagee acquires title to the mortgaged property after the
loss, the property in its damaged state is deemed a payment of the
mortgage debt to the extent of its then-value. Any recovery of insur-
ance proceeds by the mortgagee without deduction for this value of the
property is deemed an impermissible double recovery.491 This is a


486.      Citizens Mortgage Corp. v. Mich. Basic Prop. Ins. Ass’n, 314 N.W.2d 635
          (Mich. Ct. App. 1981); Pioneer Sav. & Loan Co. v. St. Paul Fire & Marine
          Ins. Co., 70 N.W. 979 (Minn. 1897).
487.      Malvaney v. Yager, 54 P.2d 135 (Mont. 1936).
488.      Esch v. Home Ins. Co., 43 N.W. 229, 232 (Iowa 1889); Citizens Mortgage
          Corp. v. Mich. Basic Prop. Ins. Ass’n, 314 N.W.2d 635 (Mich. Ct. App.
          1981); 495 Corp. v. N.J. Ins. Underwriting Ass’n, 430 A.2d 203, 208 (N.J.
          1981); Equitable Life Assurance Soc’y v. Great Atl. Ins. Co., 330 N.Y.S.2d
          840, 842–43 (Sup. Ct. N.Y. County 1972), aff ’d, N.Y.S.2d 983 (App. Div.
          1st Dep’t 1972); Laurel Nat’l Bank v. Mut. Benefit Ins. Co., 444 A.2d 130,
          132 (Pa. Super. Ct. 1982).
489.      Estate of Brindisi v. State Farm Ins. Co., 564 N.Y.S.2d 985 (Sup. Ct. Erie
          County 1991).
490.      Fed. Nat’l Mortgage Ass’n v. Great Am. Ins. Co., 300 N.E.2d 117 (Ind. Ct.
          App. 1973); Equitable Life Assurance Soc’y v. Great Atl. Ins. Co., 330
          N.Y.S.2d 840, 842–43 (Sup. Ct. N.Y. County 1972), aff ’d, N.Y.S.2d 983
          (App. Div. 1st Dep’t 1972).
              Equitable Life follows Rosenbaum v. Funcannon, 308 F.2d 680, 684
          (9th Cir. 1962), and Whitestone Sav. & Loan Ass’n v. Allstate Ins. Co., 311
          N.Y.S.2d 75 (App. Div. 2d Dep’t 1970), aff ’d, 270 N.E.2d 694 (N.Y. 1971),
          and assumes the time of mortgagee’s acquisition of title does not affect his
          right to insurance money. See also Burner v. Mut. Protective Ass’n, 185
          S.E. 222 (W. Va. 1936).
491.      Rosenbaum v. Funcannon, 308 F.2d 680, 684 (9th Cir. 1962); Nationwide
          Mut. Fire Ins. Co. v. Wilborn, 279 So. 2d 460, 464 (Ala. 1973); 495 Corp.
          v. N.J. Ins. Underwriting Ass’n, 430 A.2d 203, 208 (N.J. 1981).



                                      3–106
                             Mortgage Financing                                 § 3:7.2

corrolary of a more general rule that after payment of a mortgage debt
in full, the mortgagee has no right to the proceeds of insurance. 492
   A mortgagee’s acquisition of title after an insured loss is often
accomplished by foreclosure. Not surprisingly, the casualty often
makes it difficult for the mortgagor to continue making timely pay-
ments. If the mortgagee bids the full amount of the debt at the
foreclosure sale the debt is extinguished493 and his recovery of insur-
ance proceeds barred.494 A lesser bid reduces the debt, and his right to
insurance proceeds, pro tanto.495 This makes it advisable for a mort-
gagee to bid at foreclosure no more than the value of the property in its
damaged condition.496
   A Florida case illustrates the importance of preserving the right to
insurance proceeds by bidding less than the debt at foreclosure. In Sea
Island Operating Corp. v. Hochberg,497 after hurricane damage, the
mortgagee bought the property for $1 million when the mortgage debt


492.      Meyers v. Norwich Union Fire Ins. Soc’y Ltd., 262 N.Y.S.2d 579 (Sup. Ct.
          Ulster County 1965) (mortgagee claimed right to insurance because of his
          surviving liability under another mortgage after sale of property). See also
          Chrysler Capital Realty, Inc. v. Grella, 942 F.2d 160 (2d Cir. 1991).
493.      On this rationale there is a series of California cases precluding a mort-
          gagee who purchases the property by a full credit bid, that is, the amount of
          the debt, from recovering from a third party for waste and other claims;
          though the cases differ where the claim is for fraud. See Pac. Inland Bank v.
          Ainsworth, 48 Cal. Rptr. 2d 489 (Ct. App. 1995).
494.      In re Vota, 165 B.R. 92 (Bankr. D.R.I. 1994).
495.      Rosenbaum v. Funcannon, 308 F.2d 680, 684 (9th Cir. 1962); In re Cayer,
          150 B.R. 829 (Bankr. M.D. Fla. 1993) (mortgagee, whose rights were fixed
          at time of loss, recovered entire proceeds because foreclosure sale insuffi-
          cient to satisfy mortgage debt); Nationwide Mut. Fire Ins. Co. v. Wilborn,
          279 So. 2d 460, 464 (Ala. 1973); Ark. Teacher Ret. Sys. v. Commando
          Props. Ltd., 801 S.W.2d 50 (Ark. Ct. App. 1990); Rollins v. Bravos, 565
          A.2d 382 (Md. Ct. Spec. App. 1989) (despite assignment in mortgage of
          insurance to mortgagee); Nw. Nat’l Ins. Co. v. Mildenberger, 359 S.W.2d
          380 (Mo. Ct. App. 1962); Power Bldg. & Loan Ass’n v. Ajax Fire Ins. Co.,
          164 A. 410 (N.J. 1933); Whitestone Sav. & Loan Ass’n v. Allstate Ins. Co.,
          311 N.Y.S.2d 75 (App. Div. 2d Dep’t 1970), aff ’d, 270 N.E.2d 694 (N.Y.
          1971), followed in Kessler v. Gov’t Employees Ins. Co., 579 N.Y.S.2d 13
          (App. Div. 1st Dep’t 1992). Contra Laurel Nat’l Bank v. Mut. Benefit Ins.
          Co., 297 Pa. Super. 473 (1982).
              In this connection it may be said, “‘As its interest may appear ’ does not
          refer to appellant’s interest in the property, but refers to the amount of the
          debt owed to it secured by the deed of trust. . . .” Hartford Fire Ins. Co. v.
          Bleedorn, 132 S.W.2d 1066, 1072 (Mo. Ct. App. 1939) (citations omitted).
496.      Some cases cited in this subsection resulted from mortgagees’ unaware-
          ness of the rule. In Nw. Nat’l Ins. Co. v. Mildenberger, 359 S.W.2d 380
          (Mo. Ct. App. 1962), mortgagee believed, and informed prospective bidders
          that, there would be full recovery of insurance moneys. Whitestone, 311
          N.Y.S.2d 75, surprised New York practitioners.
497.      Sea Island Operating Corp. v. Hochberg, 198 So. 2d 336 (Fla. Dist. Ct.
          App. 1967).



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§ 3:7.2                        FRIEDMAN     ON   CONTRACTS

was $1,302,635, seeking no deficiency judgment. In an interpleader
action, the court awarded the insurance proceeds to the mortgagee as
against the mortgagor. The endorsement was apparently standard and,
in addition, gave the mortgagee the option to apply the insurance to
the debt or to the mortgagor.498
   Even if there is a deficit at the foreclosure sale any claim of the
mortgagee may be barred if the mortgage debt is deemed satisfied by
the mortgagee’s failure to apply for or obtain a deficiency judg-
ment.499 The New York statute makes failure to apply for a deficiency
judgment a presumption that the proceeds of sale in the foreclosure
action are in full satisfaction of the mortgage debt.500 The Nevada
statute is even stronger; it renders failure to apply for a deficiency
judgment equivalent to a finding that the mortgage debt is extin-
guished.501 This defeats a claim by the mortgagee to the insurance
proceeds.502 The California statute bars deficiency judgments, but
does not prevent a mortgagee from realizing on other security; and a
mortgagee who acquired title on a bid of less than the mortgage debt
was held entitled to the proceeds of insurance to the extent of the
deficit.503



498.      See also Lutheran B’hood v. Hooten, 237 So. 2d 23 (Fla. Dist. Ct. App.
          1970) (mortgagee entitled to proceeds; foreclosing and obtaining deficiency
          judgment not inconsistent with claim to proceeds); Meyers v. Norwich
          Union Fire Ins. Soc’y Ltd., 262 N.Y.S.2d 579 (Sup. Ct. Ulster County
          1965) (mortgagee acquired property at foreclosure by $250 bid, resold it for
          $7,000, and also recovered insurance proceeds); Nat’l Union Fire Ins. Co.
          v. Davis, 389 S.W.2d 941 (Tenn. Ct. App. 1965).
499.      Coppotelli v. Ins. Co., 631 F.2d 146 (2d Cir. 1980); Bohn v. La. Farm
          Bureau Mut. Ins. Co., 482 So. 2d 843 (La. Ct. App. 1986); Moke Realty
          Corp. v. Whitestone Sav. & Loan Ass’n, 370 N.Y.S.2d 377 (Sup. Ct. Nassau
          County 1975), aff ’d, 382 N.Y.S.2d 289 (App. Div. 2d Dep’t 1976), aff ’d,
          363 N.E.2d 587 (N.Y. 1977).
500.      N.Y. REAL PROP. ACTS. LAW § 1371. See Moke Realty Corp. v. Whitestone
          Sav. & Loan Ass’n, 370 N.Y.S.2d 377 (Sup. Ct. Nassau County 1975),
          aff ’d, 382 N.Y.S.2d 289 (App. Div. 2d Dep’t 1976), aff ’d, 363 N.E.2d 587
          (N.Y. 1977).
501.      NEV. REV. STAT. § 40.455 (1986).
502.      Hellman v. Capurro, 549 P.2d 750 (Nev. 1976). In Mann v. Glens Falls Ins.
          Co., 541 F.2d 819 (9th Cir. 1976), a mortgagee accepted a deed in lieu of
          foreclosure and released the mortgagor from liability. Applying Nevada law,
          the court denied the mortgagee a recovery from the insurer. Denial,
          however, was based on the mortgagee’s refusal to permit subrogation
          against the mortgagor, to whom the insurance had not been assigned.
          Accord Indus. Indem. Co. v. Great Am. Ins. Co., 686 P.2d 1216 (Alaska
          1984).
503.      CAL. CIV. PROC. CODE § 580b. See Redingler v. Imperial Sav. & Loan Ass’n,
          120 Cal. Rptr. 575 (1st Dist. Ct. App. 1975). The same was applied to a
          claim for waste. Hickman v. Mulder, 130 Cal. Rptr. 304 (4th Dist. Ct. App.
          1976).



                                      3–108
                             Mortgage Financing                         § 3:7.2

   A mortgagee’s insurance is on the mortgagee’s interest in or lien
upon the realty, not upon the realty itself. In a Nebraska case, the
mortgagee obtained a fire policy after the mortgagor defaulted, with the
policy insuring only the mortgagee.504 After a fire occurred, the insurer
paid proceeds to the mortgagee. Six months after the fire, the mort-
gagee purchased the property at foreclosure for a price substantially
less than the outstanding debt. The mortgagee was denied a deficiency
judgment under the Nebraska anti-deficiency statute, which denies a
deficiency judgment if either the value of the property or the price bid
at foreclosure is at least as much as the mortgage debt. 505 This action
terminated the mortgagee’s interest in the debt as well as its insurable
interest, thereby triggering an obligation on the mortgagee’s part to
return all insurance proceeds to the insurer. The court distinguished
California and Oregon cases holding that denial of a deficiency
judgment under comparable statutes does not bar the mortgagee
from claiming against a guarantor of the mortgage.
   Under the New York statutory insurance covenant, the mortgagee is
not required to collect insurance proceeds from the insurer to apply
them to the debt. In Crossland Mortgage Corp. v. Douglas,506 the
mortgagee began foreclosure after the destruction of a house by fire.
The mortgagors claimed that the mortgagee’s “failure to seek payment
under a fire insurance policy insuring its interest in the property
constituted a complete defense and setoff” against the foreclosure
claim. The court rejected the “contention that the availability of fire
insurance proceeds is an affirmative defense to a foreclosure action,”
calling this position “novel” and concluding that the mortgagee was
not required to pursue insurance proceeds before foreclosing. 507

              [I]   Loss Payable Endorsement
   The preceding two subsections considered the right of a mortgagee
to proceeds of insurance when claiming under a “union” or standard
endorsement. If, instead, the mortgagee’s claim is under an open or
loss payable endorsement, the mortgagee has no interest other than as
assignee of the mortgagor-owner. If the interest of the latter is
extinguished, there is nothing that can pass to the mortgagee, and
an extinguishment of the interest of the mortgagor is an extinguish-
ment of the interest of both.508 A Missouri court has explained the
rationale for this interpretation:

504.      Pantano v. Md. Plaza P’ship, 507 N.W.2d 484 (Neb. 1993).
505.      NEB. REV. STAT. § 76-1013.
506.      Crossland Mortgage Corp. v. Douglas, 706 N.Y.S.2d 273 (App. Div. 3d
          Dep’t 2000).
507.      Id. at 274.
508.      Reynolds v. London & Lancashire Fire Ins. Co., 60 P. 467 (Cal. 1900);
          Prudential Ins. Co. v. German Mut. Fire Ins. Ass’n, 60 S.W.2d 1008



(Friedman on Contracts, Rel. #7, 5/09)   3–109
§ 3:7.2                        FRIEDMAN    ON   CONTRACTS

       If the clause in question is to be construed as an ordinary open
       mortgage clause then whatever rights the plaintiff had as mort-
       gagee were terminated when the property was deeded to it under
       foreclosure. It then became the owner but the defendant did not
       insure it as such and no rule of construction justifies this court in
       writing into the policy coverage of an interest that was not
                                                509
       stipulated to be insured by the parties.

   Just as in the case of a standard mortgage endorsement, a loss payee
mortgagee who bids the full amount of the debt loses any right to
insurance.510

             [J]   Liability of Mortgagee for Insurance Premiums
    Cases have arisen with respect to the liability of a mortgagee for
payment of premiums on insurance supplied by a mortgagor. Under a
loss payable clause the mortgagee is clearly not liable. 511 The standard
mortgagee endorsement is more difficult because of its language, that
is, that the interest of the mortgagee in the insurance shall not be
invalidated by any act or neglect of the mortgagor, provided that if the
mortgagor shall fail to pay a premium the mortgagee shall on demand
pay the same. Under the majority rule “provided” is held a condition,
not a covenant, that is, if the mortgagee does not choose to pay, the
insurance is invalidated as to him.512 The minority and older cases
construe the clause as a covenant by the mortgagee to pay.513 The
mortgagee should obviously require a standard or “union” endorsement.




          (Mo. Ct. App. 1933); Burner v. Mut. Protective Ass’n, 185 S.E. 222 (W. Va.
          1936). Contra German Ins. Co. v. Churchill, 26 Ill. App. 206 (1887).
          Burner deemed a mortgagee’s acquisition of title a merger of the mortgage.
          The case apparently involved a loss payable clause, but this is not clear.
              In Lutheran B’hood v. Hooten, 237 So. 2d 23 (Fla. Dist. Ct. App. 1970),
          which also apparently involved a loss payable endorsement, mortgagee
          foreclosed and recovered deficiency judgment and was held entitled to
          recover the proceeds of insurance.
509.      Prudential Ins. Co. v. German Mut. Fire Ins. Ass’n, 60 S.W.2d 1008, 1010
          (Mo. Ct. App. 1933).
510.      Universal Mortgage Co. v. Prudential Ins. Co., 799 F.2d 458 (9th Cir.
          1986) (and cases discussed; bid in error in ignorance of interior damage to
          structure).
511.      Stevens Ins., Inc. v. Howells, 155 Mont. 494, 473 P.2d 523 (1970) (applied
          to vendor); Wharen v. Markle Banking & Trust Co., 20 A.2d 885
          (Pa. Super. Ct. 1941).
512.      Coykendall v. Blackmer, 146 N.Y.S. 631 (App. Div. 3d Dep’t 1914); see
          Stoddart v. Black, 8 P.2d 305 (Kan. 1932); Gen. Credit Corp. v. Imperial
          Cas. & Indem. Co., 95 N.W.2d 145 (Neb. 1959).
513.      Stoddart v. Black, 8 P.2d 305 (Kan. 1932).



                                      3–110
                             Mortgage Financing                                  § 3:7.2

              [K] Installment Land Contracts
   An installment land contract “provides for payment of the purchase
price in installments with periodic interest on the unpaid balance thereof,
possession to the vendee at the time of execution thereof, risk of loss and
responsibility for procuring fire and liability insurance and payment of
real property taxes on the vendee, but retention of title in the vendors
until the purchase price is paid in full.”514 As the above quote suggests,
when the land includes valuable improvements, the installment land
contract often requires the purchaser to buy and maintain fire insurance.
Resolving the conflicting claims of vendor and purchaser to insurance
proceeds has proven nettlesome, with inconsistent judicial decisions
largely due to uncertainty as to the characterization of the installment
land contract. It is widely recognized that the installment land contract is
a mortgage substitute, but classically courts have not treated such
contracts as mortgages per se or as equitable mortgages. Rather, they
have applied the general body of contract law to such contracts.
   The purchaser is not entitled to a mortgagor ’s rights to use the
insurance proceeds for restoration when the policy is issued in the
vendor’s name only because the New York statutory covenant does not
apply515 and there is no such right at common law.516 The purchaser,
however, is entitled to have the insurance proceeds on a policy he
purchases reduce the balance remaining on the purchase price. This is
true even if the purchaser is in default in making payments at the time
of the fire.517 Likewise, if the purchaser is in possession during a
redemption period following the entry of a judgment of forfeiture, the
purchaser is entitled to the insurance proceeds stemming from a
casualty taking place during the redemption period. 518
   Courts sometimes apply mortgage rules for casualty insurance to
installment land contract disputes. A New York court has held that the


514.      Meade v. N. Country Co-Op. Ins. Co., 487 N.Y.S.2d 983, 984 (Sup. Ct.
          Franklin County 1985), aff ’d, 501 N.Y.S.2d 944 (App. Div. 3d Dep’t 1986).
515.      See section 3:7.2[B] supra.
516.      Upham v. Lowry, 485 N.Y.S.2d 680 (Sup. Ct. Madison County 1985)
          (rejecting argument N.Y. REAL PROP. LAW § 254(4)(a) should apply because
          land contract is the “equivalent” of a mortgage).
517.      Madero v. Henness, 607 N.Y.S.2d 153, 155 (App. Div. 3d Dep’t 1994)
          (purchasers entitled to specific performance; vendors must accept insur-
          ance proceeds in payment of remaining price because purchasers’ default
          was “not sufficiently egregious to trigger the agreement’s forfeiture provi-
          sions”). In Upham v. Lowry, 485 N.Y.S.2d 680 (Sup. Ct. Madison County
          1985), the vendors conceded that the purchasers were entitled to apply the
          proceeds to reduce the contract balance.
518.      In re Kelly, 51 B.R. 9 (Bankr. E.D. Mich. 1984) (vendor took possession
          pursuant to forfeiture judgment seven days after windstorm destroyed barn;
          forfeiture has effect of eliminating purchaser’s debt, equivalent to foreclosure
          of mortgage that yields a price equal to full amount of mortgage debt).



(Friedman on Contracts, Rel. #7, 5/09)   3–111
§ 3:7.3                      FRIEDMAN   ON   CONTRACTS

vendor under a land contract is treated as a mortgagee under a fire
insurance policy obtained by the purchaser, which named the purcha-
ser as owner of the property and the vendor as “mortgagee or secured
party.”519 The insurer denied the purchaser ’s claim due to the pur-
chaser ’s misconduct, but the court ruled that the insurer was liable to
the vendor under a standard mortgagee clause, with the insurer
holding subrogation rights against the purchaser to the extent of any
payments made to the vendor. The court observed that the parties’
relationship was “the functional equivalent of a mortgagor-mortgagee
relationship.”520 Similarly, another New York court held that a policy
insuring a vendor and a purchaser “as interest may appear” was not
voided as to the vendor by reason of the purchaser ’s arson.521
   In an appropriate case, the vendor can recover on an insurance
policy obtained by the purchaser even though the policy does not name
or mention the vendor. In Marbach v. Gnadl,522 the contract obligated
the purchasers “as additional security to keep all buildings on aforesaid
premises insured in such company or companies as the said party of
the first part may direct for at least the sum of unpaid balance of
purchase price.”523 A forfeiture provision in the installment land
contract entitled the vendors to terminate the contract for a breach
by the purchasers and to retain all payments in liquidation of damages
sustained. The purchasers obtained insurance and after a fire they
defaulted in making payments, prompting the vendors to declare a
forfeiture. Both the vendors and the purchasers claimed the insurance
proceeds. The court allowed the vendors to recover the insurance
proceeds, up to the unpaid balanace due on the contract, reasoning
that they had an equitable lien upon the insurance policies. The vendors’
declaration of forfeiture voided the contract as of the time of the breach,
not ab initio. On forfeiture, the vendors were entitled to the land, and
after the damage the insurance proceeds stood in its place.

   § 3:7.3        Building Removal
   The New York statutory form mortgage provides:
   3.     That no building on the premises shall be removed or demol-
          ished without the consent of the mortgagee.524



519.      Meade v. N. Country Co-Op. Ins. Co., 501 N.Y.S.2d 944 (App. Div. 3d
          Dep’t 1986).
520.      Id. at 946.
521.      Richardson v. Providence Wash. Ins. Co., 237 N.Y.S.2d 893 (Sup. Ct.
          Tompkins County 1963).
522.      Marbach v. Gnadl, 219 N.E.2d 572 (Ill. App. Ct. 1966).
523.      Id.
524.      N.Y. REAL PROP. LAW § 258, Sch. M.



                                   3–112
                             Mortgage Financing                              § 3:7.3

   The purpose of the clause is to give the mortgagee “notice and an
opportunity to safeguard his security interest in the event the mortgagor
intend[s] to remove or demolish the structure on the mortgaged prop-
erty.”525 Thus, the mortgagee’s consent is unnecessary if the government
condemns a structure, ordering its demolition as a safety hazard.526
Likewise, this clause does not obligate the mortgagor to take affirmative
steps to prevent strangers from demolishing or injuring a building.527
   This covenant may be amplified by forbidding material alterations
of the buildings on the premises, requiring the mortgagor to maintain
the premises in a state of repair and in accordance with requirements
of law, and permitting the mortgagee’s inspection to ascertain com-
pliance with these obligations. In the absence of this addition and a
satisfactory acceleration clause, a mortgagor is not bound to rebuild or
repair structures destroyed by fire or otherwise damaged without his
fault,528 and such condition does not authorize acceleration of the
mortgage debt.529
   When the mortgage allows acceleration for the removal of build-
ings, the failure to make repairs, or the making of alterations without
the mortgagee’s consent, the mortgagee must prove impairment of
security in order to accelerate and foreclose.530 Impairment may exist
even though the mortgagee is adequately secured if the removal or
change substantially reduced the property value.531


525.      Mortgagee’s consent is unnecessary if the structure is condemned as a
          hazard. Bodwitch v. Allen, 459 N.Y.S.2d 148, 150 (App. Div. 4th Dep’t
          1983).
526.      Id. (demolition apparently needed due to casualty; mortgagor collected
          insurance proceeds).
527.      Garliner v. Glicken, 196 N.Y.S.2d 784 (Sup. Ct. Monroe County 1960)
          (claim that mortgagor failed “to provide adequate guards or watchmen
          against vandalism,” thus permitting “cottages in effect to become sub-
          stantially demolished”).
528.      Kirkorian v. Grafton Co-op Bank, 44 N.E.2d 665 (Mass. 1942) (hurricane
          damage).
529.      Campbell v. Macomb, 4 Johns. Ch. 534, 537 (N.Y. 1820); Brayton v.
          Pappas, 383 N.Y.S.2d 723 (App. Div. 4th Dep’t 1976); Sidrane v. F.D.R.
          Realty Corp., 61 N.Y.S.2d 828, 831 (Sup. Ct.), aff ’d, 73 N.E.2d 550 (N.Y.
          1947).
530.      United States v. Angel, 362 F. Supp. 445 (E.D. Pa. 1973) (mortgagee must
          prove impairment to foreclose for failure to maintain and repair); Bart v.
          Streuli, 52 P.2d 922 (Cal. 1935) (covenant against removal or demolition of
          any building; foreclosure denied when mortgagor removed front porch as
          part of scheme of improvement, thereby enhancing value of premises);
          Loughery v. Catalano, 191 N.Y.S. 436 (Sup. Ct. Bronx County 1921)
          (alterations that did not change character of building and enhanced its
          value), aff ’d, 201 N.Y.S. 919 (App. Div. 1st Dep’t 1923).
531.      Laber v. Minassian, 511 N.Y.S.2d 516 (Sup. Ct. 1987) (removal of gas
          station; value with improvements was $233,000 and value without was
          $220,000; debt was far less).



(Friedman on Contracts, Rel. #7, 5/09)   3–113
§ 3:7.4                        FRIEDMAN     ON   CONTRACTS

   § 3:7.4          Acceleration of Debt
   The New York statutory form mortgage provides:
   4.     That the whole of said principal sum and interest shall
          become due at the option of the mortgagee: after default in
          the payment of any installment of principal or of interest
          for ___ days; or after default in the payment of any tax, water
          rate or assessment for ___ days after notice and demand; or
          after default after notice and demand either in assigning and
          delivering the policies insuring the buildings against loss by
          fire or in reimbursing the mortgagee for premiums paid on
          such insurance, as hereinbefore provided; or after default upon
          request in furnishing a statement of the amount due on the
          mortgage and whether any offsets or defenses exist against the
          mortgage debt, as hereinafter provided.532
    The blanks for numbers of days are to be filled in. Failure to do so
raises a substantial risk that the mortgagee has no right to accelerate
the debt for the first two reasons mentioned in the clause. One court
held that a failure to fill in blanks relating to the “grace period” implied
a right in the mortgagee to declare the mortgage due within a reason-
able time after default.533 There appears to be no justification for this
result. Delivery of an executed contract, with blanks, implies authority
to fill in the blanks as the parties contemplated, 534 particularly where
the blanks are purely formal.535 But, where the blanks indicate a
failure even to consider the matter in question, the entire clause is
disregarded, as if it were not part of the contract.536




532.      N.Y. REAL PROP. LAW § 258, Sch. M.
533.      Genton Realty Corp. v. Balsamo, 132 N.Y.L.J. 12, Oct. 18, 1954 (Sup. Ct.
          1954). Compare Grayson v. LaBranche, 225 A.2d 922 (N.H. 1967) (buyer
          entitled to benefit of mortgage contingency, which had blank, not filled in,
          for amount of loan).
534.      Roe v. Town Mut. Fire Ins. Co., 78 Mo. App. 452, 455 (1899); Natlo v. Bear
          Ridge Lake Corp., 142 N.Y.S.2d 504 (Sup. Ct. Westchester County 1955);
          Sec. Bank v. Hawk, 517 N.E.2d 886 (Ohio 1988) (description subsequently
          filled in); Tosh v. Witts, 113 A.2d 226 (Pa. 1955); 2 S. W ILLISTON,
          CONTRACTS § 275 (3d ed. 1959); 15 id. § 1909 (3d ed. 1961) (but compare
          4 id. § 585 (3d ed. 1961)).
535.      Kinney v. Schmitt, 12 Hun. 521 (N.Y. 1878) (blank could be filled in with
          “his” or “her”).
536.      Realty Corp. v. Park Cent. Valet, Inc., 297 N.Y.S. 40 (App. Div. 1st Dep’t
          1937) (provision that lease might be renewed “for term of years”); see Starr
          v. Holck, 28 N.W.2d 289, 292 (Mich. 1947); 17 C.J.S. Contracts § 65
          (1963). But see Tunkel v. Filippone, 66 A.2d 339 (N.J. Super. Ct. App. Div.
          1949).



                                      3–114
                             Mortgage Financing                             § 3:7.4

   This clause requires no notice before accelerating for nonpayment
of an installment of principal or of interest.537 The court in Charter
One Bank, FSB v. Leone538 explained:

       [W]here, as here, a mortgage contains an acceleration clause in
       statutory form, neither notice of default nor demand for payment is a
       condition precedent to the commencement of a foreclosure action,
       as plaintiff’s act of commencing the action and the filing of a lis
       pendens constitutes a valid election to accelerate the maturity of the
                                                        539
       unpaid principal balance and accrued interest.

   Notwithstanding the mortgagor ’s lack of a legal right to notice of
acceleration under the statutory form for default in paying principal
and interest, the mortgagee nevertheless should follow the practice of
giving notice to the mortgagor, even for five or ten days, for nonpay-
ment of all monetary defaults, just in case the payment is misdirected
or the amount of the payment is incorrect. For nonmonetary repairs,
involving repair construction, curing violations, etc., the notice should
be longer, but should provide that the mortgagor ’s beginning with
promptness and continuing with reasonable diligence and continuity
should prevent acceleration. The mortgagor should be permitted to
pay assessments in installments where permitted and to challenge any
taxes or other impositions before any lien or penalty is incurred.
   The acceleration clause is necessary because the doctrine of antici-
patory breach, as the basis for immediate action against one who
repudiates an executory contract, has no application to contracts for
the payment of money only. Accordingly, the failure of a mortgagor to
meet installments of principal or interest, or to pay taxes, assess-
ments, or insurance will not cause the whole debt to mature at once
upon default, absent a provision in the mortgage to such effect. 540



537.      Albertina Realty Co. v. Rosbro Realty Corp., 180 N.E. 176, 177 (N.Y.
          1932); Hudson City Sav. Inst. v. Burton, 451 N.Y.S.2d 855, 856 (App. Div.
          3d Dep’t 1982).
538.      Charter One Bank, FSB v. Leone, 845 N.Y.S.2d 513 (App. Div. 3d Dep’t
          2007).
539.      Id. at 514 (citations omitted).
540.      Terrell v. Cheatham, 255 S.W. 262 (Ky. 1923); Better v. Williams, 102 A.2d
          750 (Md. 1954); Pa. Co. for Ins. on Lives v. Broadway Stevens Co., 148 A.
          575 (N.J. Ch. 1930); Indian River Islands Corp. v. Mfrs. Trust Co., 2
          N.Y.S.2d 860 (App. Div. 1st Dep’t 1938); Crouse v. Nantucket Vill. Dev.
          Co., 460 N.E.2d 1389 (Ohio Ct. App. 1983); 88 U. PA. L. REV. 94 (1939);
          55 AM. JUR. 2D Mortgages § 371 (1971); 59 C.J.S. Mortgages § 495(3)(a)
          (1949); 1 C. WILTSIE, MORTGAGE FORECLOSURES § 39 (5th ed. 1939).
              Acceleration was permitted despite absence of an acceleration clause
          where monthly payments were in default for several years. Gonzales v.
          Tama, 749 P.2d 1116 (N.M. 1988).



(Friedman on Contracts, Rel. #7, 5/09)   3–115
§ 3:7.4                         FRIEDMAN     ON   CONTRACTS

Similarly, a provision for acceleration for failure to pay interest or taxes
does not permit acceleration for failure to pay installments of
principal.541
   The New York covenant explicitly requires notice before accelerat-
ing for nonpayment of taxes, water, or assessments.542 When notice of
acceleration is given, or required to be given, a notice that the debt may
be accelerated is insufficient.543 The notice must be given to the
mortgagor or there must be some unequivocal overt act that accom-
plishes an election.544
   Taxes have been held in default under these clauses as soon as the
taxes begin to bear interest.545 A mortgagor ’s breach of other cov-
enants in the mortgage does not, per se, permit acceleration of the
mortgage debt.546 Accordingly, the acceleration clause is sometimes
expanded to cover a breach of any of the mortgagor ’s covenants, so
that the mortgage debt may be declared due and payable on breach of
any covenant on the mortgagor ’s part that is included in the mortgage.
A sentence is sometimes added to the effect that any right the
mortgagee may otherwise have for breach of covenant or for injunctive
relief is not thereby impaired.
   A court may refuse to enforce an acceleration clause where refusal
does not impair the mortgagee’s security. This was true in case of



              Where a mortgage, but not the accompanying note, contains an
          acceleration clause there is conflict on the effect of this clause on the
          note. Some hold the acceleration is limited to a mortgage foreclosure.
          Others hold the clause permits advancement of the debt for all purposes.
          See authorities collected in Poultrymen’s Serv. Corp. v. Brown, 185 A.2d
          706 (N.J. Super. Ct. 1962); Note, 15 ALA. L. REV. 549 (1963).
              The question does not arise where the acceleration clause is incorpo-
          rated in the note by reference, as by a provision permitting the holder of the
          note to accelerate in case of any default that would permit acceleration of
          the mortgage, or where the note also contains an acceleration clause.
              In the absence of an acceleration provision, the statute of limitations
          runs separately to each installment as it becomes due. Visioneering, Inc.
          Profit Sharing Trust v. Belle River Joint Venture, 386 N.W.2d 185 (Mich.
          Ct. App. 1986). If there is no election to accelerate, the statute does not
          begin to run until the last date for payment of the principal. In re Lake
          Townsend Aviation, Inc., 361 S.E.2d 409 (N.C. Ct. App. 1987).
541.      S.D. Walker, Inc. v. Brigantine Beach Hotel Corp., 129 A.2d 758 (N.J.
          Super. Ct. 1957).
542.      Cent. Nat’l Bank v. Paton, 439 N.Y.S.2d 619 (Sup. Ct. Otsego County
          1981).
543.      Ogden v. Gibraltar Sav. Ass’n, 640 S.W.2d 232 (Tex. 1982).
544.      446 W. 44th St., Inc. v. Riverland Holding Corp., 44 N.Y.S.2d 766 (App.
          Div. 1st Dep’t 1943).
545.      Nylen v. Geeraert, 226 A.2d 878 (Md. 1967). Accord Bishop v. Brown, 325
          N.W.2d 594, 598 (Mich. Ct. App. 1982).
546.      Bodwitch v. Allen, 459 N.Y.S.2d 148 (App. Div. 4th Dep’t 1983).



                                       3–116
                             Mortgage Financing                                  § 3:7.4

failure to pay real estate taxes and maintain hazard insurance. 547 It
has also been held true in case of removal of buildings548 or waste.549
Equity has denied acceleration when its strict enforcement would
impose an unconscionable hardship on the mortgagor and give the
mortgagee an unconscionable advantage.550
    The right to accelerate may be waived. 551 If a pattern of late
payments leads the mortgagor to believe it may continue, he may be
entitled to notice and warning before the mortgagee elects to accel-
erate.552 This would not apply if the mortgagee has made continual
objections and warnings to the mortgagor or if the mortgage provides
for acceleration without notice.553 A mortgage clause providing that a
waiver of a right to accelerate upon one default shall not constitute a




547.      Brady v. Edgar, 415 So. 2d 141 (Fla. Dist. Ct. App. 1982).
548.      See supra section 3:7.3.
549.      See infra section 3:8.1.
550.      United States v. Forrester, 118 F. Supp. 401, 412 (W.D. Ark. 1954). Mid-
          State Trust II v. Jackson, 854 S.W.2d 734 (Ark. Ct. App. 1993); 59 C.J.S.
          Mortgages § 495(6) (1949).
               Cf. the discussion at infra notes 565–68, particularly Cardozo, J. in Graf
          v. Hope Bldg. Corp., 174 N.E. 884, 886 (N.Y. 1930).
551.      Nassau Trust Co. v. Montrose Concrete Prod. Corp., 436 N.E.2d 1265
          (N.Y. 1982) (may not withdraw oral waiver without reasonable notice).
          A valid tender of enough to expunge a default is a defense to foreclosure.
          Call v. LaBrie, 498 N.Y.S.2d 652 (App. Div. 4th Dep’t 1986). Acceptance of
          part payments after acceleration has barred foreclosure. Amerifirst Fed.
          Sav. & Loan Ass’n v. Century 21 Commodore Plaza, Inc., 416 So. 2d 45
          (Fla. Dist. Ct. App. 1982). The same applies to acceptance of a full
          installment. Rawhide Farms v. Darby, 589 S.W.2d 210 (Ark. 1979).
               Acceleration is disallowed when payment of an installment is impos-
          sible. Fowler v. White, 295 S.E.2d 83 (Ga. 1982) (no executor appointed for
          deceased mortgagee).
               A statute permitting waiver of notice to accelerate (ME. REV. STAT. ANN.
          tit. 11, § 3-511 (1964)) has been enforced. Maine Sav. Bank v. Chee, 576
          A.2d 1358 (Me. 1990).
552.      Miller v. Uhrick, 706 P.2d 739 (Ariz. 1985), approved, 707 P.2d 309 (Ariz.
          1985); First Fed. Sav. & Loan Ass’n v. Stone, 467 N.E.2d 1226 (Ind. Ct.
          App. 1984); Smith v. Smith, 352 P.2d 1036 (Kan. 1960). See also Caulder v.
          Lewis, 338 S.E.2d 837 (S.C. 1985). But cf. Mariash v. Bastianich, 452
          N.Y.S.2d 190 (App. Div. 1st Dep’t 1982).
               This is the rule with respect to late payments of rent. 2 MILTON R.
          FRIEDMAN, FRIEDMAN ON LEASES § 16:5.1 (Patrick A. Randolph, Jr., ed., 5th
          ed. PLI 2006).
553.      Trs. of Wash.-Idaho-Mont. Carpenters-Employers Ret. Trust Fund v. Galleria
          P’ship, 780 P.2d 608, 613–14 (Mont. 1989) (enforcement of anti-waiver
          clause); Caulder v. Lewis, 338 S.E.2d 837 (S.C. 1986); Allendale Furniture
          Co. v. Carolina Commercial Bank, 325 S.E.2d 530 (S.C. 1985). For the
          comparable rule with respect to rents, see 2 MILTON R. FRIEDMAN, FRIEDMAN
          ON LEASES § 16:5.1 (Patrick A. Randolph, Jr., ed., 5th ed. PLI 2006).




(Friedman on Contracts, Rel. #7, 5/09)   3–117
§ 3:7.4                         FRIEDMAN    ON   CONTRACTS

waiver at another time has been enforced,554 but the circumstances
and the jurisdictions in which non-waiver clauses are enforced is the
subject of considerable variation.555
   Some acceleration clauses provide that the mortgage will become
due and payable a specified number of days after default. The majority
cases hold this clause is not self-operative, but is for the benefit of the
mortgagee, who has the option to accelerate or not.556 Acceleration
requires an affirmative act or election by the mortgagee, which
may consist of an unequivocal declaration by the mortgagee to the
mortgagor that he is exercising the option.557 Until such election,
tender of payment by the mortgagor is permitted.558 In the case of
co-mortgagees, the election to accelerate must be made by both to be
effective.559


554.      Fed. Nat’l Mortgage Ass’n v. Cobb, 738 F. Supp. 1220 (N.D. Ind. 1990);
          Farris v. Jim Walter Homes, Inc., 519 So. 2d 1338 (Ala. 1988); First Fed.
          Sav. & Loan Ass’n v. Stone, 467 N.E.2d 1126 (Ind. Ct. App. 1984); Postal
          Sav. & Loan Ass’n v. Freel, 698 P.2d 382 (Kan. Ct. App. 1984); Price v. First
          Fed. Sav. Bank, 822 S.W.2d 422 (Ky. Ct. App. 1992); Gaul v. Olympia
          Fitness Ctr., Inc., 623 N.E.2d 1281, 1286 (Ohio Ct. App. 1993).
555.      See Dorn v. Robinson, 762 P.2d 566 (Ariz. Ct. App. 1988), particularly
          when a time of the essence clause is included. See also M.J.G. Props. v.
          Hurley, 537 N.E.2d 165, 166 (Mass. App. Ct. 1989). For comparable
          disclaimer clauses in leases, see 2 MILTON R. FRIEDMAN, FRIEDMAN ON
          LEASES § 16:5.2 (Patrick A. Randolph, Jr., ed., 5th ed. PLI 2006).
556.      Peter Fuller Enters., Inc. v. Manchester Sav. Bank, 152 A.2d 179 (N.H.
          1959); Seligman v. Burg, 251 N.Y.S. 689 (App. Div. 2d Dep’t 1931); 6 S.
          WILLISTON, CONTRACTS § 2025 (rev. ed. 1938), see Frenzel v. Frenzel, 260
          Iowa 1076, 152 N.W.2d 157 (1967). Cases pro and con are collected in 159
          A.L.R. 1077 (1945); usury, as affected by acceleration clause, Annot., 66
          A.L.R.3d 650–716 (1975); late charges, Annot., 63 A.L.R.3d 50 (1975).
              A provision for acceleration without notice was enforced. David v. Sun
          Fed. Sav. & Loan Ass’n, 461 So. 2d 93 (Fla. 1984); Allendale Furniture Co.
          v. Carolina Commercial Bank, 325 S.E.2d 530 (S.C. 1985).
557.      Moss v. McDonald, 772 P.2d 626 (Colo. Ct. App. 1988); Butter v. Melrose
          Sav. Bank, 435 N.E.2d 1057 (Mass. App. Ct. 1982); Miller v. Jones, 635
          S.W.2d 360 (Mo. Ct. App. 1982); Comer v. Hargrave, 598 P.2d 213 (N.M.
          1979); 5 A.L.R.2d 968, 970 (1949).
              For mortgagee’s ambiguous behavior as a bar to acceleration, see First
          Fed. Sav. & Loan Ass’n v. Stone, 467 N.E.2d 1226 (Ind. Ct. App. 1984).
558.      Yelen v. Bankers Trust Co., 476 So. 2d 767 (Fla. Dist. Ct. App. 1985); Kent
          v. Pipic, 462 N.W.2d 800 (Mich. Ct. App. 1990); Overholt v. Merchs. &
          Planters Bank, 637 S.W.2d 463 (Tenn. App. 1982).
559.      Cresco Realty Co. v. Clark, 112 N.Y.S. 550 (App. Div. 2d Dep’t 1908);
          Lapidus v. Kollel Avreichim Torah Veyirah, 451 N.Y.S.2d 958 (Sup. Ct.
          Sullivan County 1982).
              The New York cases were distinguished in Creamer v. Aultman, 445
          So. 2d 382 (Fla. Dist. Ct. App. 1984), where the owner made half
          payments to each co-owner, was up to date with one but not the other.
          The latter was permitted to accelerate and foreclose his part on joining the
          co-owner as defendant. The court relied on English cases.



                                       3–118
                             Mortgage Financing                               § 3:7.4

   Provisions for payment of late charges are enforceable prior to
acceleration,560 but not thereafter, when the mortgagee may refuse
to accept installment payments.561 “Default interest,” that is, higher
interest after the mortgagor ’s failure to pay at a specified time, has
been held enforceable in some cases, but not in others. 562



560.      Sec. Mut. Life Ins. Co. v. Contemporary Real Estate Assocs., 979 F.2d 329
          (3d Cir. 1992) (citing cases); Mack Fin. Corp. v. Ireson, 789 F.2d 1083
          (4th Cir. 1986); FDIC v. MFP Realty, 870 F. Supp. 451 (D. Conn. 1994);
          In re Tavern Motor Inn, Inc., 69 B.R. 138 (Bankr. D. Vt. 1987); In re
          Richardson, 63 B.R. 112 (Bankr. W.D. Va. 1986); Bowery Sav. Bank v.
          Layman, 233 N.E.2d 492 (Ind. Ct. App. 1968); Centerbank v. D’Assaro,
          600 N.Y.S.2d 1015 (Sup. Ct. Suffolk County 1993). See O’Malley, Late-
          Payment Charges: Meeting the Requirements of Liquidated Damages, 27
          STAN. L. REV. 1133 (1975).
              Bona fide late charges were held non-usurious. Li v. Astoria Fed. Sav. &
          Loan Ass’n, 438 N.Y.S.2d 865 (App. Div. 2d Dep’t 1981). They are
          enforceable if in compensation for administration expenses and the cost
          of money withheld. Crest Sav. & Loan Ass’n v. Mason, 891 A.2d 120 (N.J.
          Super. Ct. Ch. Div. 1990); NELSON & WILSON, REAL ESTATE FINANCE LAW,
          443 et seq. (2d ed. 1985), and are not waived by accepting late payments.
          Basciano v. Toyet Realty Corp., 561 N.Y.S.2d 252 (App. Div. 1st Dep’t
          1990). Contra Swindell v. Fed. Nat’l Mortgage Ass’n, 409 S.E.2d 892 (N.C.
          1991). A late charge amounting to $60 a month on a monthly rent of $150
          was held unconscionable. N. Am. Inv. Co. v. Lawson, 854 P.2d 384 (Okla.
          Ct. Ap. 1993).
              Late charges have been approved in bankruptcy. See BANKRUPTCY CODE
          § 506(b) (1979); In re LHD Realty Corp., 726 F.2d 327, 333 (7th Cir. 1984);
          Shadhali v. Hintlian, 41 Conn. App. 225, 675 A.2d 3 (1996).
561.      Sec. Mut. Life Ins. Co. v. Contemporary Real Estate Assocs., 979 F.2d 329
          (3d Cir. 1992) (suggesting possibility of contra result if mortgage so
          provides); In re Tavern Motor Inn, Inc., note 560 supra. A mortgagee suing
          under acceleration for the entire debt is not entitled to late charges on an
          installment. Reis v. Decker, 516 N.Y.S.2d 851 (County Ct. Delaware
          County 1987). Somewhat comparable is a New Jersey case holding late
          charges were applicable to payment of rent but not to nonpayment.
          Fanarjian v. Moskowitz, 568 A.2d 94 (N.J. Super. Ct. 1989).
              Late charges were held inapplicable to the balance of the mortgage debt,
          that is, to the balloon payment. The mortgage entitled mortgagee to
          attorneys fees. A different result would give double recovery. Trustco
          Bank v. 37 Clark St., Inc., 599 N.Y.S.2d 404 (Sup. Ct. Saratoga County
          1993).
562.      Eyde Bros. Dev. Co. v. Equitable Life Ins. Co., 697 F. Supp. 1431 (W.D.
          Mich. 1988), allowed default interest. In re Entz-White Lumber & Supply,
          Inc., 850 F.2d 1338 (9th Cir. 1988), held that a debtor may cure a defaulted
          mortgage note at the contract interest rate as opposed to the default rate,
          because curing is supposed to return a claim to its pre-fault condition and
          is not supposed to enable the mortgagee to impose its distribution scheme
          on the bankruptcy court. Conversely, in dicta, In re LHD Realty Corp., 726
          F.2d 327 (7th Cir. 1984), suggests that a mortgagee may have an allowable
          claim for a late charge designed to cover the extra expense involved in
          handling delinquent installments.



(Friedman on Contracts, Rel. #7, 5/09)   3–119
§ 3:7.4                         FRIEDMAN    ON   CONTRACTS

   Minority states distinguish between notice by the mortgagee (1) of
an election to accelerate, which they do not require or whose waiver
they permit,563 and (2) of an intent to foreclose after a completed
acceleration, which they do require.
   When no definite time is specified a mortgagee’s election to accel-
erate must be made within a reasonable time after the event that gives
rise to the right to accelerate.
   A mortgagee who accelerates the mortgage debt may retract the
acceleration,564 but not over the mortgagor ’s objection, when the
mortgagor has changed his position in reliance on the acceleration. 565
   Once the mortgage debt has been accelerated by reason of default,
may the acceleration be annulled by payment of the pre-acceleration
arrears? The cases are split when the acceleration was based on
nonpayment of interest or an installment of principal.566 There is
less reluctance to annul an acceleration that was based on nonpay-
ment of taxes,567 because “the punctual payment of interest has an
importance to the lender as affecting his way of life, perhaps the very


563.      Carpenter v. Riley, 675 P.2d 900 (Kan. 1984); Cortez v. Brownsville Nat’l
          Bank, 664 S.W.2d 805 (Tex. Civ. App. 1984).
564.      In re Adu-Kofi, 94 B.R. 14 (D.R.I. 1988).
565.      Kilpatrick v. Germania Life Ins. Co., 75 N.E. 1124 (N.Y. 1905);
          W. Portland Dev. Co. v. Ward Cook, Inc., 424 P.2d 212 (Or. 1967); 59
          C.J.S. Mortgages § 495(6)(c) (1949).
566.      Nonannulment: Fed. Home Loan Mortgage Corp. v. Dutch Lane Assocs.,
          775 F. Supp. 133, 139 (S.D.N.Y. 1991); Bank of Honolulu v. Anderson, 654
          P.2d 1370, 1376 (Haw. Ct. App. 1982); Graf v. Hope Bldg. Corp., 171 N.E.
          884 (N.Y. 1930); Salishan Hills, Inc. v. Krieger, 660 P.2d 160 (Or. Ct. App.
          1983); Bell Fed. Sav. & Loan Ass’n v. Laura Lanes, Inc., 435 A.2d 1285 (Pa.
          Super. Ct. 1981) (noting that commercial property was involved). Contra
          Console v. Torchinsky, 116 A. 613 (Conn. 1922).
              For the tendency of New York cases to distinguish Graf on equitable
          grounds, see Karas v. Wasserman, 458 N.Y.S.2d 280, 281–82 (App. Div. 3d
          Dep’t 1982); Fairmont Assocs. v. Fairmont Estates, 472 N.Y.S.2d 208
          (App. Div. 3d Dep’t 1984).
567.      Balducci v. Eberly, 500 A.2d 1042, 1049 (Md. 1985) (payment of delin-
          quent taxes prior to commencement of the foreclosure action bars accel-
          eration and foreclosure); Foothill Ind. Bank v. Mikkelson, 623 P.2d 748
          (Wyo. 1981) (recognizing same rule, but finding taxes not paid when
          foreclosure began). See dissenting opinion of Cardozo, J., in Graf v.
          Hope Bldg. Corp., 171 N.E. 884, 887 (N.Y. 1930). Contra Derechinsky v.
          Epstein, 130 A. 720 (N.J. Ch. 1925), aff ’d, 131 A. 922 (N.J. 1926).
              ALASKA STAT. § 34.20.070(b) (1990) permits an obligor under a note
          secured by a deed of trust to terminate a non-judicial sale and undo the
          effect of an acceleration clause by paying all preacceleration arrears. The
          statute may be invoked no more than twice. Hagberg v. Alaska Nat’l Bank,
          585 P.2d 559 (Alaska 1978). COLO. REV. STAT. § 38-39-118 (1990) is a
          similar statute, applicable to mortgage foreclosures, but not to an action on
          the note only. Smith v. Certified Realty Corp., 585 P.2d 293 (Colo. Ct. App.
          1978).



                                       3–120
                             Mortgage Financing                               § 3:7.4

means for his support, whereas the importance of payment of the taxes
is merely as an assurance of security.”568 In bankruptcy cases, annul-
ment of acceleration may be permitted even where state courts would
hold otherwise.569 Statutes in a number of states permit reinstatement
of an accelerated mortgage debt prior to a foreclosure sale on payment
of arrears without acceleration.570
   The dominant cases hold that the mortgagee’s acceptance of an
installment payment after acceleration is a waiver of acceleration,
absent some compelling reason to the contrary.571
   If a mortgage provides for payment of an installment at a specified
time, or permits acceleration at a specified time for nonpayment, and
also includes a provision for late charges if payment is not made at a
later time, which provision governs? The few cases are not in accord.
Some allow the mortgagee to treat the mortgagor as in default before
the date on which a late charge is assessable, 572 but others allow the
mortgagor the benefit of a grace period, durning which acceleration is
precluded.573 It would be well to clarify this in the mortgage.
   Some mortgages make nonpayment of taxes a default that permits
foreclosure with no prior notice. But payment before foreclosure
precludes foreclosure.574
   The mortgagor may direct, when making payment, whether his
payment is to be applied to principal, interest, or taxes, and the
mortgagee is bound by this direction.575



568.      Cardozo, J., in Graf v. Hope Bldg. Corp., 171 N.E. 884, 887 (N.Y. 1930).
569.      See In re Stokes, 39 B.R. 336 (Bankr. E.D. Va. 1984); In re Wilder, 22 B.R.
          294 (Bankr. M.D. Ga. 1982); In re Taddeo, 9 B.R. 299 (Bankr. E.D.N.Y.
          1981). Contra In re LaPaglia, 8 B.R. 937 (Bankr. E.D.N.Y. 1981).
570.      See statutes collected in In re LaPaglia, 8 B.R. 937, 945 (Bankr. E.D.N.Y.
          1981). A statutory modification that eliminated a mortgagor ’s right to
          reinstate a mortgage was held “substantial,” as distinguished from “pro-
          cedural,” and was denied retroactive effect. Wash. Nat’l Ins. Co. v. Sher-
          wood Assocs., 795 P.2d 665 (Utah Ct. App. 1990).
571.      See In re Parks, 193 B.R. 361, 365–66 (Bankr. N.D. Ala. 1995).
572.      E.g., Auto-Plaza, Inc. v. Cent. Bank, 394 So. 2d 6 (Ala. 1980) (fifteen-day
          late payment charge does not create “grace period”; allowing acceleration
          when mortgagor tendered payment three days late).
573.      Baypoint Mortgage v. Crest Premium Real Estate Inv. Ret. Trust, 214 Cal.
          Rptr. 531 (Ct. App. 1985) (time not of the essence with respect to payment
          on first of month due to late payment fee); Fed. Home Loan Mortgage
          Corp. v. Taylor, 318 So. 2d 203 (Fla. Dist. Ct. App. 1975) (late payment fee
          creates “grace period” within which mortgagor may pay installment “with-
          out further obligation”; acceleration not allowed when mortgagor tendered
          installment before late charge was due and mortgagee had accepted prior
          past-due installments with late charges included).
574.      Eberly v. Balducci, 484 A.2d 1043 (Md. Ct. Spec. App. 1984).
575.      Cent. Nat’l Bank v. Paton, 439 N.Y.S.2d 619 (Sup. Ct. Otsego County
          1981); Bank of Cal. v. Webb, 94 N.Y. 467, 472 (1884).



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  The mortgagor ’s payment by mail is not operative as payment
unless received, or the mortgagee had consented to payment by
mail.576

   § 3:7.5         Appointment of Receiver
   The New York statutory form mortgage provides:
   5.     That the holder of this mortgage, in any action to foreclose it,
          shall be entitled to the appointment of a receiver.577
   This clause entitles the mortgagee to the judicial appointment of a
receiver without notice or regard to adequacy of the security of the
debt.578 Under the statutory construction, the mortgagee “shall be
entitled, without notice and without regard to adequacy of any security
of the debt, to the appointment of a receiver of the rents and profits of
the premises covered by the mortgage.”579 The New York practice of
dispensing with notice does not deprive a mortgagor of due process. 580
Under this clause, the mortgagee’s procurement of a receiver does not
require him to show probable success in the foreclosure action. 581
   Without the receivership clause the mortgagee must move for a
receiver on notice and on proof of inadequacy of the security. 582 In
federal courts a showing of more than inadequacy of security and
doubtful financial standing of the debtor is necessary to warrant a




576.      Cornwell v. Bank of Am. Trust & Sav. Ass’n, 274 Cal. Rptr. 322 (4th Dist.
          Ct. App. 1990).
577.      N.Y. REAL PROP. LAW § 258, Sch. M.
578.      Baker v. Bloom, 536 N.Y.S.2d 267 (App. Div. 3d Dep’t 1989).
579.      N.Y. REAL PROP. LAW § 254(10).
580.      Foxfire Enters., Inc. v. Enter. Holding Corp., 837 F.2d 597 (2d Cir. 1988)
          (ex parte appointment of receiver to collect rents in mortgage foreclosure
          action).
581.      Meyer v. Indian Hill Farm, Inc., 258 F.2d 287 (2d Cir. 1958) (New York
          law); 366 Fourth St. Corp. v. Foxfire Enters., Inc., 540 N.Y.S.2d 489 (App.
          Div. 2d Dep’t 1989).
              Life Ins. Co. v. Hodroft Assocs., 606 A.2d 1150 (N.J. Super. Ct. 1992),
          departs from earlier New Jersey cases and grants a receiver on a comparable
          clause. If noted, the mortgagor was not liable on the mortgage debt.
              Despite the clause a court has discretionary power to deny the applica-
          tion. See Home Title Ins. Co. v. Isaac Scherman Holding Corp., 267 N.Y.S.
          84 (App. Div. 2d Dep’t 1933) (delayed application).
              Appointment of a prepetition receiver is not a preferential transfer in
          New York. In re Fin. Ctr. Assocs., L.P., 140 B.R. 828 (Bankr. E.D.N.Y.
          1992).
582.      First Nat’l Bank v. Caputo, 507 N.Y.S.2d 516 (App. Div. 3d Dep’t 1986)
          (consent by owners/mortgagors, makes no difference when tenant in
          possession objected and mortgage did not authorize appointment of
          receiver).



                                      3–122
                             Mortgage Financing                                § 3:7.5

receiver.583 But when a federal bankruptcy court applies state law, as it
must in determining whether a property interest has been perfected,584
mortgagees filing a claim to cash collateral in the form of rental
income585 entitles the mortgagee to recover rental income where
this would be true under state law.586 Where the mortgagee is the
Department of Housing and Urban Development (HUD), a federal
interest is involved and federal, not state, law applies.587 In many
jurisdictions a mortgage provision for appointment of a receiver does
not entitle a mortgagee to a receiver as a matter of right. These cases
hold that the parties cannot force a court of equity to grant a remedy to
a party who does not need it.588
   The receivership clause may also contain the following obligations
of an owner of the premises:
   1.     To pay to the receiver the use and occupational value of the
          premises.
  Absent such provision, the owner may occupy the premises free
during the pendency of a foreclosure.589


583.      Chase Manhattan Bank, N.A. v. Turabo Shopping Ctr., Inc., 683 F.2d 25
          (1st Cir. 1982). But cf. In re Westwood Plaza Apts., Ltd., 154 B.R. 916
          (Bankr. E.D.Tex. 1993).
               For the Minnesota law, see In re Johnson, 108 B.R. 689 (Bankr. D.
          Minn. 1989).
               In Florida, appointment of a receiver is a matter of judicial discretion
          not a matter of right. Barnett Bank v. Steinberg, 632 So. 2d 233 (Fla. Dist.
          Ct. App. 1994).
               Appointment of a receiver is by federal standards, though once ap-
          pointed his powers are those of the state. For the federal standards, see
          Midwest Sav. Ass’n v. Riversbend Assocs. P ’ship, 724 F. Supp. 661
          (D. Minn. 1989).
584.      Butner v. United States, 440 U.S. 48, 55 (1979).
585.      BANKRUPTCY CODE § 546(b).
586.      Va. Beach Fed. Sav. & Loan Ass’n v. Wood, 901 F.2d 849 (10th Cir. 1990).
587.      In re Westwood Plaza Apts., Ltd., 154 B.R. 916 (Bankr. E.D.Tex. 1993)
          (assignment of rents to mortgagee operated automatically on mortgagor ’s
          default).
588.      See Barclays Bank P.L.C. v. Davidson Ave. Assocs., 644 A.2d 685 (N.J.
          Super. Ct. 1994) (citing many other states); 3 R. POWELL, REAL PROPERTY
          ¶ 465 (1994); 59 C.J.S. Mortgages § 663 (1949).
               A prepetition demand by mortgagee had the same effect under a Florida
          statute that makes mortgagor ’s assignment of rents absolute upon mort-
          gagor’s default and mortgagee’s written demand. In re 163rd St. Mini
          Storage, Inc., 113 B.R. 87 (Bankr. S.D. Fla. 1990).
589.      Holmes v. Gravenhorst, 188 N.E. 285 (N.Y. 1933); 50 YALE L.J. 1424, 1433,
          1442 (1941). But see Greenebaum Sons Bank & Trust Co. v. Kingsbury, 248
          Ill. App. 321 (1928) (owners of cooperative apartments liable for rent).
               Though a mortgagee may obtain a receiver without notice, the owner ’s
          liability for rent, or use and occupational value may be fixed only after
          notice. Essex v. Newman, 632 N.Y.S.2d 636 (App. Div. 2d Dep’t 1995).



(Friedman on Contracts, Rel. #7, 5/09)   3–123
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   2.     To permit the mortgagee, in event of default, to take posses-
          sion of the premises and collect rent from the tenants and use
          and occupational value from an owner in possession.
   This clause, however, is not effective for its stated purpose in New
York590 and in a number of other states where a mortgage is deemed a
lien, as distinguished from the “title” theory states.591 In those states,
a mortgagee’s right to possession can be predicated only upon a
consent of the owner given after default or by the mortgagee’s
impounding the rents by receivership or otherwise. Despite this
general rule, several states have held that a mortgage default plus a
mortgagee’s demand entitles the mortgagee to the rents.592 The same


               A mortgage provision entitling a receiver to rent and “use and occupa-
          tional value” was one factor in disregarding a twenty-year lease at $1.00 a
          month rent. N.Y. City Cmty. Pres. Corp. v. Michelin Assocs., 496 N.Y.S.2d
          530 (App. Div. 2d Dep’t 1985).
590.      Dime Sav. Bank v. Altman, 9 N.E.2d 778 (N.Y. 1937); Sullivan v. Rosson,
          119 N.E. 405 (N.Y. 1918); 1180 Anderson Ave. Realty Corp. v. Mina
          Equities Corp., 465 N.Y.S.2d 511 (App. Div. 1st Dep’t 1983) (entry on
          default, without permission, illegal).
591.      In re Vill. Props., Ltd., 723 F.2d 441 (5th Cir. 1984) (Texas law); Prudential
          Ins. Co. of Am. v. Fifty Assocs., 503 F.2d 925 (9th Cir. 1974); In re
          Ventura-Louise Props., 490 F.2d 1141 (9th Cir. 1974) (California law);
          Democratic Cent. Comm. v. Wash. Met. Area Transit Comm., 21 F.3d
          1145 (D.C. 1994) (District of Columbia law); In re Keller, 150 B.R. 836
          (Bankr. N.D. Ga. 1993) (Georgia law); In re Harbour Point Ltd. P’ship, 132
          B.R. 501 (Bankr. D.D.C. 1991) (Virginia law; distinguishes assignment for
          security from unconditional assignment); In re Raleigh/Spring Forest
          Apartments Assocs., 118 B.R. 42, 44 (Bankr. E.D.N.C. 1990); In re
          Winzenburg, 61 B.R. 141 (Bankr. N.D. Iowa 1986) (cites Iowa cases);
          In re Gotta, 47 B.R. 198, 203 (Bankr. W.D. Wis. 1985); In re Stuckenberg,
          374 F. Supp. 15 (E.D. Mo. 1974) (Missouri law); In re DiToro, 17 B.R. 836
          (Bankr. E.D. Pa. 1982); Fed. Nat’l Mortgage Ass’n v. Kostrunek, 228
          F. Supp. 777 (S.D. Iowa 1964); Bevins v. Peoples Bank & Trust Co., 671
          P.2d 875 (Alaska 1983); Roosevelt Sav. Bank v. State Farm Fire & Cas. Co.,
          556 P.2d 823 (Ariz. Ct. App. 1976); Comerica Bank-Ill. v. Harris Bank, 673
          N.E.2d 380 (Ill. App. Ct. 1996) (either actual or constructive possession is
          possession); Marcon v. First Fed. Sav. & Loan Ass’n, 374 N.E.2d 1028
          (Ill. App. Ct. 1978); Wolf v. Greek Am. Realty Co., 190 N.E.2d 135
          (Ill. App. Ct. 1963); Mut. Benefit Life Ins. Co. v. Frantz Klodt & Son,
          Inc., 237 N.W.2d 350 (Minn. 1975); Taylor v. Brennan, 621 S.W.2d 592
          (Tex. 1981); Taylor v. Brennan, 605 S.W.2d 657 (Tex. Civ. App. 1980); Nat’l
          Bank v. Equity Investors, 546 P.2d 440, 448 (Wash. 1976); Wuorinen v.
          City Fed. Sav. & Loan Ass’n, 191 N.W.2d 27 (Wis. 1971).
592.      In re Wheaton Oaks Office Ltd. Partners, 27 F.3d 1234 (7th Cir. 1994); Fed.
          Home Loan Mortgage v. Tarrytown Corp., 822 F. Supp. 137 (S.D.N.Y.
          1993). Accord Fed. Home Loan Mortgage Corp. v. Dutch Lane Assocs.,
          775 F. Supp. 133 (S.D.N.Y. 1991) (distinguishing cases where the rent
          assignment was only for security); In re 5028 Wis. Ave. Assocs., 167 B.R.
          699 (Bankr. D.D.C. 1994) (rents to be used by mortgagee for maintaining
          property; landlord’s demand before bankruptcy effective); In re Seaside Co.,



                                       3–124
                             Mortgage Financing                                § 3:7.5

was true where a foreclosure was begun before a stay caused by the
mortgagor ’s bankruptcy.593
   3.     To hold the rents and profits of the premises, after default, in
          trust to pay taxes, carrying charges, and for service of the
          mortgage debt.
   In many states there is now a tendency for the mortgage to provide
that the rents belong to the mortgagee immediately on default by the
mortgagor and notice of the default by the mortgagee to the mortga-
gor.594 This avoids the necessity of a receivership, but query if it




          152 B.R. 878 (Bankr. E.D. Pa. 1993) (Pennsylvania law). A clause entitling
          the mortgagee to the gross rents, giving him discretion to apply them or
          not to operation expenses was enforced. In re Union Partners, 165 B.R.
          553 (Bankr. E.D. Pa. 1994) (Pennsylvania law).
              This was true even though the instrument permitted the mortgagor to
          use the rents until default and despite the mortgagor ’s filing for bank-
          ruptcy a few days after the default. In re Scotsdale Med. Pavilion, 159 B.R.
          295 (B.A.P. 9th Cir. 1993).
              The distinction between an absolute assignment and one “for further
          security” was also made in In re Vienna Park Props., 136 B.R. 43 (Bankr.
          S.D.N.Y. 1992) (Virginia law). Vienna Park distinguishes between a mort-
          gagee’s perfection of a right to rent, which may be merely by recordation,
          and its enforcement. The case determines the mortgagee’s right in bank-
          ruptcy of the mortgagor. Vienna Park determined that mortgagee’s right to
          rents failed because it was not enforced prior to bankruptcy. (Accord In re
          Vienna Park, 976 F.2d 106 (2d Cir. 1992)). Following Vienna Park, 136 B.R.
          at 54, In re Mount Pleasant Ltd. P’ship, 144 B.R. 727 (Bankr. W.D. Mich.
          1992), ruled that perfection of a lien is putting third parties on notice,
          while its enforcement realizes the right; and that mortgagee’s notice in
          bankruptcy (while a stay is in force) has the same effect. Mt. Pleasant was
          disregarded on the basis of MICH. COMP. LAWS ANN. § 554.232 (1988);
          In re Newberry Square, 175 B.R. 910 (Bankr. E.D. Mich. 1994). Connecti-
          cut is in accord with Vienna Park on the distinction of assignment and
          perfection of the right to rents. It held that an assignment of existing and
          future rents was sufficient to vest a right to the rents without more,
          prevailing over a creditor under CONN. GEN. STAT. § 49-10 (1994).
593.      In re Northwest Commons, Inc., 136 B.R. 215 (Bankr. E.D. Mo. 1991)
          (noting demand was made before tenant’s bankruptcy); In re S. Pointe
          Assocs., 161 B.R. 224 (Bankr. E.D. Mo. 1993) (mortgagee had also
          demanded rents from tenants); Bevins v. Peoples Bank & Trust Co., 671
          P.2d 875 (Alaska 1983).
594.      Until the mortgagee takes actual possession it has no right to the rents.
          In re Ledgemere Land Corp., 116 B.R. 338 (Bankr. D. Mass. 1990). But it
          has also been held in Massachusetts, a title state, that mortgagor ’s default
          and mortgagee’s demand establish mortgagee’s right to rents, although
          there was no collection until after mortgagor ’s bankruptcy. In re White
          Plains Dev. Corp., 136 B.R. 93 (Bankr. S.D.N.Y. 1992) (Massachusetts
          law).



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assures the tenants who pay the rents that they will receive the
maintenance and services they are entitled to from the mortgagor.
A federal court sitting in New York enforced such a clause.595 But a
clause stating it is absolute but permitting the mortgagor to collect
rents until a default or otherwise, qualifying its enforcement, is
construed as merely for security and not an absolute assignment. 596
In Colorado and New Jersey an assignment of rents clause in a
mortgage may be self-executing upon default, as distinguished from
a pledge of rents as a security device that requires affirmative action by
the mortgagee.597 In Indiana an assignment of rents to a mortgagee as
security, followed by a mortgagor ’s default, a foreclosure, and appoint-
ment of a receiver, did not give title to the rents to the mortgagee where all
this was followed by the mortgagor ’s bankruptcy under Chapter 11, with
the mortgagor as a debtor in possession. The mortgagee’s receiver was
held a mere custodian of the rents without title. Title was held in the



              In practical terms, the difference between a “lien theory” and a “title
          theory” as to the nature of a mortgage is that under the latter the
          mortgagee may enter into possession of the mortgaged premises upon
          default and before foreclosure, whereas under the “lien theory” there is no
          right of possession; the mortgagee must await sale of the mortgaged
          property and obtain satisfaction of the mortgagor ’s debt from the proceeds
          of sale. Maglione v. BancBoston Mortgage Corp., 557 N.E.2d 756, 758
          (Mass. App. Ct. 1990).
595.      In re Carmania Corp., 154 B.R. 160 (Bankr. S.D.N.Y. 1993). Accord, In re
          McCann, 140 B.R. 926 (Bankr. E.D. Mass. 1992) (Ohio law). See Ran-
          dolph, Recognizing Lender’s Rents Interests in Bankruptcy, 27 REAL PROP.,
          PROB. & TR. J. 281 (1992); Randolph, The Mortgagee’s Interest in Rents:
          Some Policy Considerations and Proposals, 29 KAN. L. REV. 1 (1980).
596.      United States v. Redevelopment Agency, 926 F. Supp. 928 (N.D. Cal.
          1995); In re Koula Enters., Ltd., 197 B.R. 753 (Bankr. E.D.N.Y. 1996); In re
          Turtle Creek Ltd., 194 B.R. 267 (Bankr. N.D. Ala. 1996); In re Raleigh/
          Spring Forest Apartments Assocs., 118 B.R. 42 (Bankr. E.D.N.C. 1990).
597.      McArthur Executive Assocs. v. State Farms Life Ins. Co., 190 B.R. 189
          (Bankr. D.N.J. 1995); In re Princeton Overlook Joint Venture, 143 B.R. 625
          (Bankr. D.N.J. 1992) (extended discussion of cases); In re Pine Lake Vill.
          Apartment Co., 17 B.R. 829, 833 (Bankr. S.D.N.Y. 1982); Great W. Life
          Ins. Co. v. Raintree Ins., 837 P.2d 267 (Colo. Ct. App. 1992); Int’l Bus.
          Machs. Corp. v. Axinn, 676 A.2d 552 (N.J. Super. Ct. 1996); Stanton v.
          Metro. Lumber Co., 152 A. 653 (N.J. Ch. 1930); Paramount Bldg. & Loan
          Ass’n v. Sacks, 152 A. 457 (N.J. Ch. 1930).
              Even in Florida, a pledge of rents requires a mortgagee to take posses-
          sion or obtain a receiver. In re Ormand Beach Assocs., Ltd. P’ship, 204 B.R.
          336 (Bankr. D. Conn) (citing Florida cases).
              Wisconsin upholds provisions entitling a mortgagee to rents on default,
          although it disapproves of them because they afford an easy way of evading
          the lien theory. In re Century Inv. Fund VIII Ltd. P’ship, 937 F.2d 371, 377
          (7th Cir. 1991). In Century the court noted that the mortgagee had taken
          further affirmative action.



                                      3–126
                             Mortgage Financing                                  § 3:7.5

estate of the debtor.598 In Delaware, a lien state, an absolute assignment
was held merely for security in the face of inconsistent language. The
case noted that some title states would reach the same result.599 Iowa
holds that a mortgage that grants rents, in distinction to pledging them,
entitles the mortgagee, as against the mortgagor, to rents from the
inception of the mortgage with no further action by the mortgagee.600
Other states hold that an unconditional assignment of rents to the
mortgagee entitles the mortgagee without more, other than possible
remand, on the mortgagor ’s default.601 In a “title” state then the mort-
gagee is automatically entitled to the rents on the mortgagor ’s default,602
but this is not always true in the bankruptcy of the mortgagor.603
   A mortgagee who was barred from enforcing his right to rents, by
reason of an automatic stay in the bankruptcy of his mortgagor, was
held entitled to receive rents collected by the trustee in bankruptcy
after the stay was lifted.604
   The effect of the mortgagor ’s bankruptcy on the mortgagee’s
right to post-petition rents should be noted. In a title theory state, a


598.      In re Willows of Ceventry, Ltd. P’ship, 154 B.R. 959 (Bankr. N.D. Ind. 1993).
599.      In re Guardian Realty Group, 205 B.R. 1 (Bankr. D.D.C. 1997) (Delaware
          law).
600.      In re Porter, 90 B.R. 399 (N.D. Iowa 1988); Fed. Land Bank v. Lower, 421
          N.W.2d 126 (Iowa 1988).
601.      Fed. Deposit Ins. Corp. v. Int’l Prop. Mortgage, Inc., 929 F.2d 1033 (5th
          Cir. 1991) (applying Texas law); In re Somero, 122 B.R. 643 (Bankr. D. Me.
          1991); In re Galvin, 120 B.R. 767 (Bankr. D. Vt. 1990) (said to be minority
          rule); In re Townside Partners, 125 B.R. 8 (Bankr. W.D. Va. 1991).
               Kansas and Virginia have statutes protecting a mortgage that includes
          an assignment of rent, or a separate assignment of rent, and makes it
          unnecessary to take possession or have a receiver appointed. KAN. STAT.
          § 8-2343 (1991) (effective May 23, 1991); In re Kan. Office Assocs. Ltd.,
          173 B.R. 745 (Bankr. D. Kan. 1994). This in effect overrules In re Wiston
          Ltd. P’ship, 141 B.R. 429, 432 (Bankr. D. Kan. 1992); VA. CODE ANN.
          § 55-22-1 (Laws 1992, ch. 667).
               The Virginia statute fully protects a mortgagee who records a mortgage
          that includes an assignment of rent and makes it unnecessary to take
          possession or have a receiver appointed. The responsibility and disadvan-
          tages of a mortgagee taking possession are noted in In re Hall Coltree
          Assocs., 146 B.R. 675, 677 (Bankr. E.D. Va. 1992). Similar to the Virginia
          statute is 1991 Kan. Sess. Laws. ch. 161, at 1067–68, which in effect
          overrules In re Wiston Ltd. P’ship, 141 B.R. 429, 432 (Bankr. D. Kan.
          1992), appealed, 147 B.R. 575 (Bankr. D. Kan. 1992).
602.      See In re Epco Newport News Assocs., 14 B.R. 990, 995 (Bankr. S.D.N.Y.
          1981). See also Kelley/Lehr & Assocs., Inc. v. O’Brien, 551 N.E.2d 419
          (Ill. App. Ct. 1990), discussing the distinction in this respect between lien
          and title states and the effect of the Illinois change from title to lien state.
603.      See In re Turtle Creek Ltd., 194 B.R. 267 (Bankr. N.D. Ala. 1996)
          (Alabama law); In re Lyons, 193 B.R. 637 (Bankr. D. Mass. 1996).
604.      Hoelting Enters. v. Tailridge Investors, L.P., 844 P.2d 745 (Kan. Ct. App.
          1993); In re Sam A. Tisci, Inc., 133 B.R. 857 (Bankr. N.D. Ohio 1991).



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mortgagee’s right accrues on default in the mortgage, which is not
changed by bankruptcy.605 In the lien states there is a split. There it has
been held that bankruptcy of the mortgagor, and its consequent auto-
matic stay, does not bar the mortgagee’s right to rents if he files a post-
petition notice of this claim under section 546(b) of the Bankruptcy
Code.606 However, there is solid authority contra.607
   By obtaining a receiver instead of being a mortgagee in possession
the mortgagee avoids the responsibility of a mortgagee in possession.
A mortgagee in possession has the right and duty to collect rents and is
liable for waste or gross mismanagement of the property or its
depreciation due to a failure to make necessary and proper repairs. 608
   The right of a mortgagee in possession or a receiver to collect rents
that are past due when the receiver is appointed or the mortgagee takes
possession is the subject of slight authority.609



605.      In re McCutchen, 115 B.R. 126 (Bankr. W.D. Tenn. 1990) (construing
          TENN. CODE ANN. § 66-26-116 (Acts 1989, ch. 213, § 30)); In re Epco
          Newport News Assocs., 14 B.R. 990 (Bankr. S.D.N.Y. 1981).
606.      In re Colter, Inc., 46 B.R. 510 (Bankr. D. Colo. 1984). Saline State Bank v.
          Mahloch, 834 F.2d 690 (8th Cir. 1987) (construing Nebraska law),
          involved Chapter 11 proceedings that were begun before the mortgage
          went into default. It held that the mortgagee’s right to rents did not accrue
          upon the post-petition default, but not until the mortgagee’s application to
          sequester the rents.
607.      In re Winzenburg, 61 B.R. 141 (Bankr. N.D. Iowa 1986); In re Gotta, 47
          B.R. 198 (Bankr. W.D. Wis. 1985). Commerce Bank v. Mountain View
          Vill., Inc., 5 F.3d 34 (3d Cir. 1993); In re Westport-Sandpiper Assocs. Ltd.
          P’ship, 116 B.R. 355 (Bankr. D. Conn. 1990).
              Saline State Bank v. Mahloch, 834 F.2d 690 (8th Cir. 1987) (construing
          Nebraska law), involved Chapter 11 proceedings that were begun before
          the mortgage went into default. It held that the mortgagee’s right to rents
          did not accrue upon the post-petition default, but not until the mortgagee’s
          application to sequester the rents.
608.      In re Raleigh/Spring Forest Apartments Assocs., 118 B.R. 42, 44–45
          (Bankr. E.D.N.C. 1990); Marcon v. First Fed. Sav. & Loan Ass’n, 374
          N.E.2d 1028, 1030 (Ill. App. Ct. 1978); Prince v. Brown, 856 P.2d 589
          (Okla. Ct. App. 1993); 3 R. POWELL, REAL PROPERTY ¶ 454 (1994).
              Mortgagee’s suggestion of the name of a receiver who is subsequently
          appointed does not make the receiver an agent of the mortgagee or make
          the mortgagee liable for deterioration of the property during the receiver-
          ship. In re Greenlief Apts., Ltd., 158 B.R. 456 (Bankr. S.D. Ohio 1993).
              Acceptance of rent by a mortgagee in possession does not convert him
          into a landlord or preclude him from purchasing at foreclosure and
          terminating a lease. Reilly v. Firestone Tire & Rubber Co., 764 F.2d 167,
          172 (3d Cir. 1985); 51C C.J.S. Landlord & Tenant § 93(5), at 309 (1968).
609.      MDFC Loan Corp. v. La Salle Nat’l Bank, 834 F. Supp. 275 (N.D. Ill.
          1993), awarded such rents to the receiver after a good discussion and citing
          older cases that are not clearly applicable. It remarked that a mortgagor in
          default is in no position to object to back rents being applied to the debt,
          but indicates a different position if nonpayment was due to collusion.



                                       3–128
                             Mortgage Financing                                § 3:7.5

   A substantial mortgage of commercial property may include a broad
rent pledge covering “rents, issues, revenues, and profits,” or the like. If
the mortgagor operates a business that generates income from the
operation of real estate, as well as from business operations, there may
be a conflict on what is included in the rent pledge. The scope of rent
pledges by hotels has proven to be a vexing problem. The majority
cases hold that income from hotel rooms is not rent.610 One case ruled
that room charges were not rent, but were included in “issues and
revenues.”611 Income from the restaurant and bar was not included,
nor was income from the sale of tangible items.
   Similar problems arise for other businesses. Revenues from a
nursing home were deemed based mainly on service and not rent. 612
Income of a golf course—fees, receipts of bar and restaurant, and
sales—were not rent.613 A storage bin agreement was held a lease and
payments thereunder cash collateral.614 “Tipping fees,” that is, charges



610.      In re Tollman-Hundley Dalton, L.P., 162 B.R. 26 (Bankr. N.D. Ga. 1993);
          In re Shore Haven Motor Inn, Inc., 124 B.R. 617 (Bankr. S.D. Fla. 1991);
          In re Punta Gorda Assocs., 137 B.R. 535 (Bankr. M.D. Fla. 1992); In re
          Nendels-Medfor Joint Venture, 127 B.R. 658 (Bankr. D. Or. 1991) (also
          holding income from food and beverages not rent; distinguishing In re
          Mid-City Hotel Assocs., on ground of broad language quoted above).
          Contra In re T-H New Orleans Ltd. P’ship, 148 B.R. 456 (E.D. La.
          1992); In re S.F. Drake Hotel Assocs., 131 B.R. 156 (Bankr. N.D. Cal.
          1991). See Donahue & Edwards, The Treatment of Assignments of Rents
          in Bankruptcy; Emerging Issues Relating to Perfections, Cash Collateral,
          and Plan Confirmation, 48 BUS. LAW. 633, 639–40 (1993). The majority
          cases are the subject of an extended criticism for their reasoning as well as
          their result in diluting a lender ’s security and making financing difficult
          for hotels. Boyce, Hotel Revenues in Bankruptcy: An Analysis and Analytic
          Framework, 28 REAL PROP. PROBATE & TR. J., 535–92 (Fall 1993).
611.      In re Mid-City Hotel Assocs., 114 B.R. 634 (Bankr. D. Minn. 1990). In
          Great W. Life Ins. Co. v. Raintree Ins., 837 P.2d 267 (Colo. Ct. App. 1992),
          the assignment clause was broad enough to include the entire hotel
          income. Accord In re Churchill Props., Ltd. P’ship, 164 B.R. 607 (Bankr.
          N.D. 1994) (“rent issues and profits sufficient to make hotel income
          rents”); Great W. Life & Annuity Assurance Co. v. Park Imperial Canton,
          Ltd., 177 B.R. 843 (Bankr. N.D. Ohio 1994) (“profit,” as distinguished
          from rent, includes hotel revenues—room revenues, food, beverages, etc.;
          remanded to determine if filing sufficient under Ohio statute); Travelers
          Ins. Co. v. First Nat’l Bank, 621 N.E.2d 209 (Ill. App. Ct. 1993) (same),
          contra In re Tri-Growth Centre City, Ltd., 133 B.R. 524 (Bankr. S.D. Cal.
          1991).
              In re Kearney Hotel Partners, 92 B.R. 95, 99 (Bankr. S.D.N.Y. 1988),
          indicates that longer hotel stays and other circumstances may make hotel
          income rent more of a lease.
612.      In re Hillside Assocs., Ltd. P’ship, 121 B.R. 23 (B.A.P. 9th Cir. 1990).
613.      In re McCann, 140 B.R. 926 (Bankr. D. Mass. 1992) (Ohio law).
614.      In re Safeguard Self-Storage Trust, 2 F.3d 967 (9th Cir. 1993) (California
          law).



(Friedman on Contracts, Rel. #7, 5/09)   3–129
§ 3:7.6                        FRIEDMAN    ON   CONTRACTS

for depositing waste in a land fill, are not “rents or profits of property,”
but instead are revenues derived from a business operation.615

   § 3:7.6         Payment of Taxes and Charges
   The New York statutory form mortgage provides:
   6.     That the mortgagor will pay all taxes, assessments or water
          rates, and in default thereof, the mortgagee may pay the
          same.616
   The statutory construction makes the mortgagee’s advances for
these purposes additions to the mortgage debt.617 This part of the
statute is unnecessary. It merely codifies the mortgagee’s common law
rights.618 Advances so made by the holder of a junior mortgage remain
subordinate, under the majority rule, to the lien of a paramount
mortgage.619 If the tax is legal on its face, it is immaterial that the



615.      In re W. Chestnut Realty, Inc., 173 B.R. 322 (Bankr. E.D. Pa. 1994).
616.      N.Y. REAL PROP. LAW § 258, Sch. M.
617.      N.Y. REAL PROP. LAW § 254(6) (if mortgagee pays taxes, “the mortgagor will
          repay the same with interest, and the same shall be liens on said premises
          and secured by the mortgage”).
618.      In re Plunket, 191 B.R. 768 (Bankr. E.D. Wis. 1995); Stafford v. Russell,
          255 P.2d 814 (Cal. 2d Dist. Ct. App. 1953); Sidenberg v. Ely, 90 N.Y. 257
          (1882); Pa. Co. for Ins. on Lives v. Bergson, 159 A. 32 (Pa. 1932); accord
          Scult v. Bergen Valley Builders, Inc., 197 A.2d 704 (N.J. Super. Ct. 1964);
          3 T. COOLEY, TAXATION § 1263 (4th ed. 1924); Annot., 60 A.L.R. 425
          (1929); Annot., 84 A.L.R. 1366 (1933); Annot., 123 A.L.R. 1248 (1939);
          55 AM. JUR. 2d Mortgages §§ 2 & 4, 295 (1971).
              The mortgagee is entitled to reimbursement only on showing he paid
          the taxes. Law v. Dewoskin, 447 S.W.2d 361 (Tenn. 1969).
619.      Pearmain v. Mass. Hosp. Life Ins. Co., 92 N.E. 497 (Mass. 1910); Laventall
          v. Pomerantz, 188 N.E. 271 (N.Y. 1933); Buskirk v. State-Planters Bank &
          Trust Co., 169 S.E. 738 (W. Va. 1933); Annot., 61 A.L.R. 587, 604 (1929);
          Annot., 106 A.L.R. 1212, 1222 (1937); Annot., 123 A.L.R. 1248, 1261
          (1939).
              Mortgagee’s claim for tax payments is part of the mortgage debt and is
          unenforceable after foreclosure satisfies the mortgage debt. Plunkett, 191
          B.R. 768; 55 AM. JUR. 2d Mortgages § 548 (1971).
              It is immaterial whether the mortgage expressly permits the mortgagee
          to add the advance to the mortgage debt, Buskirk, 169 S.E. 738, or includes
          no such provision, Pearmain, 92 N.E. 497. A junior mortgagee who pays
          the taxes thereby bars the senior mortgagee from foreclosing for nonpay-
          ment, and may not thereafter assert their existence as against the senior
          mortgagee, Laventall, 188 N.E. 271.
              A mortgagor cannot buy a tax title and assert it successfully against a
          mortgagee. Danforth v. Gautreau, 556 A.2d 217 (Me. 1989) (mortgagor
          failed to pay real estate taxes).
              The minority cases are collected in Annot., 84 A.L.R. 1366, 1393
          (1933).



                                      3–130
                             Mortgage Financing                                 § 3:7.7

mortgagor claims that it is invalid. The mortgagee need not contest its
legality at his own expense or let it go unpaid at his peril. 620
    The liquidation of charges for real estate taxes, water charges, and
assessments is necessary because the liens of these items are para-
mount to existing mortgages.621
    A mortgage is paramount to a federal tax lien subsequently filed
against the mortgagor.622 Advances made by the holder of such
mortgage for taxes, water, insurance, and other charges are also
paramount to the federal tax lien, even though the advances were
made after the federal lien was filed. This is one change effected by the
Federal Tax Lien Act of 1966.623 Before this, advances made after the
filing of the federal lien were subordinate thereto, although made to
protect a prior mortgage.624

    § 3:7.7          Estoppel Certificate
   The New York statutory form mortgage provides:
   7.     That the mortgagor within ___ days upon request in person or
          within ___ days upon request by mail will furnish a written
          statement duly acknowledged of the amount due on this mort-
          gage and whether any offsets or defenses exist against the
          mortgage debt.625


620.      Garland v. Fed. Land Bank, 140 A.2d 568 (N.H. 1958) (and authorities
          collected). Cf. Strong v. Merchs. Mut. Ins. Co., 309 N.E.2d 510 (Mass.
          App. Ct. 1974) (mortgagee entitled to treat insurer ’s improper cancellation
          of insurance as default by mortgagor).
621.      Sec. Building & Loan Ass’n v. Carey, 18 N.Y.S.2d 511 (App. Div. 4th Dep’t
          1940), aff ’d, 36 N.E.2d 690 (N.Y. 1941); see Annot., 75 A.L.R.2d 1121
          (1961). Contra, as to water charges, Higley v. City of Sacramento, 149
          F. Supp. 118 (N.D. Cal. 1957).
              A provision for payment of taxes when due was held enforceable,
          although no tax foreclosure was possible for three years. Resolution Trust
          Corp. v. Friesen, 783 F. Supp. 1292 (D. Kan. 1992).
622.      I.R.C. § 6323(a) (1954). A requirement that mortgagor pay all taxes and
          assessments that may become liens was held inapplicable to income taxes.
          Denise v. Paxson, 413 S.E.2d 433 (Ga. 1992).
              A statute requiring the notice of federal lien to contain a description of
          the property is not binding on the federal government. The notice was held
          sufficient as against a subsequently recorded mortgage. United States v.
          Union Cent. Life Ins. Co., 368 U.S. 291 (1961).
623.      I.R.C. § 6323(e) (1954) (as amended in 1966 by Pub. L. No. 89-719).
624.      United States v. Buffalo Sav. Bank, 371 U.S. 228 (1963) (advances for taxes)
          discussed at length in Creedon, On Mortgage Foreclosures and Federal Tax
          Liens, 18 BUS. LAW. 1117 (1963); United States v. Bond, 279 F.2d 837 (4th
          Cir. 1960), noted in 13 STAN. L. REV. 389 (1961) (same); First Fed. Sav. &
          Loan Ass’n v. Lewis, 218 N.Y.S.2d 857 (App. Div. 2d Dep’t 1961) (tax and
          insurance advances). Contra Fischer v. Hoyer, 121 N.W.2d 788 (N.D. 1963).
625.      N.Y. REAL PROP. LAW § 258, Sch. M.



(Friedman on Contracts, Rel. #7, 5/09)   3–131
§ 3:7.7                          FRIEDMAN     ON   CONTRACTS

   This statement is known as an “estoppel certificate.” A mortgage
securing a bond is a nonnegotiable instrument and an assignee takes
subject to any defenses good as against the mortgagee. 626 In New York
the assignee is also subject to any latent equities that may exist in
favor of unknown third parties.627 This rule is limited almost entirely
to New York.628 The same is true where the mortgage secures a
nonnegotiable note.629 This rule does not apply to agreements that
are merely collateral to the mortgage and are not a part of the
consideration that was the basis or foundation of the mortgage or
was expressed in the mortgage.630 No well-advised party will accept an
assignment of such mortgage without an estoppel certificate, and this
clause entitles the mortgagee to one whenever the occasion requires.
   More points should be noted about assignments of mortgages. An
assignment of a mortgage or other security agreement, without
including the mortgage note or bond or other evidence of the debt, is
a nullity and vests no rights in the assignee. 631 Conversely, one who
pays a mortgage note, negotiable or not, or a mortgage bond without
obtaining a surrender of such instrument is chargeable with notice of
its possible assignment to a third person or some other defect in the
payee’s position, and runs the risk of having to pay again to the then-
owner of the instrument.632 An assignor of a mortgage warrants by
implication that the mortgage is what it purports to be, that is, an
existing valid legal obligation enforceable against the property ostensibly


626.      In re Levine, 23 B.R. 410, 413 (Bankr. S.D.N.Y 1982); Atl. Seabord Co. v.
          Borough of Seaside Park, 115 A.2d 110 (N.J. Super. Ct. 1955); Liebowitz v.
          Arrow Roofing Co., 182 N.E. 58 (N.Y. 1932); Kommel v. Herb-Gner Const.
          Co., 176 N.E. 413 (N.Y. 1931); TRW-Title Ins. Co. v. Stewart Title Guar.
          Co., 832 S.W.2d 344 (Tenn. Ct. App. 1991); 59 C.J.S Mortgages § 368
          (1949).
              For a discussion of estoppel certificates, the effect of duress in obtaining
          them, and of the assignee’s knowledge of defenses, see Hammelburger v.
          Foursome Inn-Corp., 431 N.E.2d 278 (N.Y. 1981).
627.      In re Levine, 23 B.R. 410 (Bankr. S.D.N.Y. 1982); Schafer v. Reilly, 50 N.Y.
          61 (1872); 55 AM. JUR. 2d Mortgages § 1042 (1996). Protection against the
          debtor is possible by an estoppel certificate from the debtor. This is not
          possible against unknown third persons.
628.      55 AM. JUR. 2d Mortgages § 1303 (1971); 59 C.J.S Mortgages § 371 (1948).
629.      Holly Hill Acres, Ltd. v. Charter Bank, 314 So. 2d 209 (Fla. Dist. Ct. App.
          1975); Mid-State Homes, Inc. v. Donnelly, 574 P.2d 1036 (Okla. 1978).
630.      McCune v. Gross, 105 A.2d 367 (Pa. 1954).
631.      In re Hurricane Resort Co., 30 B.R. 258 (Bankr. S.D. Fla. 1983); Kluge v.
          Fugazy, 536 N.Y.S.2d 92 (App. Div. 2d Dep’t 1988).
632.      Assets Realization Co. v. Clark, 98 N.E. 457 (N.Y. 1912); see also Rodgers
          v. Seattle-First Bank, 697 P.2d 1009 (Wash. Ct. App. 1985); R ESTATEMENT
          (SECOND) OF CONTRACTS § 338 comment h (1981). But payment of a
          mortgage to the named mortgagee, without notice of its assignment, was
          held effective to discharge the mortgage. Sixty St. Francis St., Inc. v. Am.
          Sav. & Loan Ass’n, 554 So. 2d 1003 (Ala. 1989).



                                        3–132
                             Mortgage Financing                               § 3:7.9

secured thereby, without guaranteeing its collection.633 Adding “without
recourse” to the assignment indicates merely that there is no guaranty
the debtor will pay the debt, but does not eliminate the implied
representation that the mortgage is valid and effective.634

    § 3:7.8          Notices
   The New York statutory form mortgage provides:
   8.     That notice and demand or request may be in writing and may
          be served in person or by mail.635
   In the absence of this provision, notice or demand by a mortgagee,
or under any agreement or statute, generally must be made in
person.636 This may be as difficult at times as the service of process.

    § 3:7.9          Warranty of Title
   The New York statutory form mortgage provides:
   9.     That the mortgagor warrants the title to the premises. 637
    Without such covenant the mortgage does not impliedly warrant
title; it operates only upon the present right of the mortgagor and an
after-acquired right or title does not inure to the benefit of the
mortgagee.638 But, if there is an express warranty of title in the
mortgage, then if an interest that the mortgage purports to cover is
not owned by the mortgagor at the inception of the mortgage, the
mortgagor ’s subsequent acquisition of such interest brings the same
under the mortgage, on theory of estoppel.




633.      Gen. Elec. Credit Corp. v. Air Flow Indus., Inc., 432 So. 2d 607 (Fla. Dist.
          Ct. App. 1983); 5 H. TIFFANY, REAL PROPERTY § 1448 (3d ed. 1939);
          9 G. THOMPSON, REAL PROPERTY § 4792, at 578 (repl. 1958); 59 C.J.S
          Mortgages § 365 (1949); 6 AM. JUR. 2d Assignments § 107 (1963). The
          same applies to assignment of a contract of sale.
634.      Gen. Elec. Credit Corp. v. Air Flow Indus., Inc., 432 So. 2d 607 (Fla. Dist.
          Ct. App. 1983); 6 AM. JUR. 2d Assignments § 107 (1963).
635.      N.Y. REAL PROP. LAW § 258, Sch. M.
636.      Steinhardt v. Bingham, 75 N.E. 403 (N.Y. 1905) (seller ’s contract obliga-
          tion to give buyer notice of name of steamship and quantity of goods
          “within five days of the date of bill of lading” requires actual notice).
637.      N.Y. REAL PROP. LAW § 258, Sch. M.
638.      Smyth v. Rowe, 33 Hun. 422 (1st Dep’t 1884), aff ’d, 98 N.Y. 665 (1885).
          But compare Robinson Shore Dev. Co. v. Gallagher, 128 A.2d 884, 887–88
          (N.J. Super. Ct. Ch. Div.), aff ’d, 133 A.2d 353 (N.J. Super. Ct. App. Div.
          1957), rev’d on other grounds, 138 A.2d 726 (N.J. 1958).
              Operation of the warranty on after-acquired title may involve priorities
          vis-à-vis bona fide purchasers. See section 8:12[D].



(Friedman on Contracts, Rel. #7, 5/09)   3–133
§ 3:8                         FRIEDMAN     ON   CONTRACTS

   The cases conflict on the application of this rule to purchase money
mortgages. 639 Some courts have distinguished purchase money
mortgages from others, refusing to apply the doctrine of estoppel by
deed, reasoning that any initial shortage results from the mortgagee-
vendor ’s failure to convey enough.640 This would not apply where the
purchase money mortgage runs to a third person advancing part of the
purchase price.

§ 3:8        Other Mortgage Clauses
    The following sections discuss additional clauses, besides the
New York statutory clauses in their original or amplified versions,
which mortgagees often add to their instruments, in New York and in
other states.
    In New York, where the statutory form is amplified and added to, a
provision may be included to the effect that the additional provisions
shall be deemed in addition to and not exclusive of the statutory
provisions, and that the latter shall receive the statutory construction.
The purpose of this clause is to avoid the few questionable decisions that
limit a statutory construction to mortgages following the statutory form
literally.641

   § 3:8.1        Waste
   Most mortgage covenants have a waste clause, which in its simplest
form merely codifies the mortgagor ’s common law obligation not to
commit waste: either voluntary waste, which consists of the mortga-
gor removing or damaging improvements; or permissive waste,
which consists of the mortgagor failing to make necessary repairs or


639.    Milton R. Friedman, Creation and Effect of Personal Liability on Mortgage
        Debts in New York, 50 YALE L.J. 224, 244 (1940).
640.    Robinson Shore Dev. Co. v. Gallagher, 133 A.2d 353 (N.J. Super. Ct. App.
        Div. 1957), rev’d on other grounds, 138 A.2d 726 (N.J. 1958), holds that
        where both deed and purchase money mortgage, which are part of the same
        transaction, contain covenants of title, the mortgagee is not entitled to a
        lien on an after-acquired title of the mortgagor, but is restricted to the title
        that he had conveyed to the mortgagor.
             A grantee is not estopped from recovering against his grantor on a
        covenant against encumbrances by reason of a similar covenant in a
        purchase money mortgage running from the grantee to the grantor. Haynes
        v. Stevens, 11 N.H. 28 (1840). But where the purchase money mortgage
        contains a warranty of title, and the deed is without warranty, an after-
        acquired title of the mortgagor inures to the benefit of the mortgagee.
        Saunders v. Publishers’ Paper Co., 208 F. 441 (D.N.H. 1913).
641.    Williams v. Wisner Bldg. Co., 200 N.Y.S. 802 (Sup. Ct. N.Y. County 1923),
        aff ’d, 203 N.Y.S. 959 (App. Div. 1st Dep’t 1924); Leakey v. Schwing, 270
        N.Y.S. 69 (County Ct. Jefferson County 1934); see N.Y. LEGIS. DOC. No.
        65(H)41 (1945).



                                      3–134
                             Mortgage Financing                                § 3:8.1

otherwise take proper care of the property. Permissive waste generally
includes keeping the property in reasonable and customary repair, but
does not include restoration or rebuilding occasioned by a major
casualty. The impairment may be by physical damage to the property
or economic loss to the mortgagee.642 A California court held it was
not waste for a mortgagor to fail to repair damage to buildings from an
earthquake and a fire.643
   Most waste actions against mortgagors take place after the mort-
gagee has acquired title to the property through foreclosure. In most
states, a mortgagee may maintain an action for waste prior to fore-
closure and prior to any default by the mortgagor in paying the debt. 644
This applies whether the state is a lien or title state. 645 The owner of
the property is liable for waste whether or not he is liable on the
mortgage debt646 and even though he is solvent.647
   The mortgagee’s recovery for waste prior to foreclosure is limited to
the sum then owing on the mortgage debt648 and must be applied
toward the mortgage debt.649


642.      See Travelers Ins. Co. v. 633 Third Assocs., 14 F.3d 114 (2d Cir. 1994);
          Genesco, Inc. v. Monumental Life Ins. Co., 577 F. Supp. 72, 84 (D.S.C.
          1983), aff ’d, 747 F.2d 253 (4th Cir. 1984).
643.      Krone v. Goff, 127 Cal. Rptr. 390 (Ct. App. 2d Dist. 1975) (fire not due to
          mortgagor ’s negligence; mortgagee, a purchase-money mortgagee, would
          have been barred from recovery of deficiency judgment by anti-deficiency
          judgment statute). Cf. Watson, Impairment of Purchase Money Security by
          Disaster and Anti-Deficiency Judgment: The Sounds of Silence, 47 L A. B.
          BULL. 146 (1972).
644.      Jaffe-Spindler Co. v. Genesco, Inc., 747 F.2d 253 (4th Cir. 1984) (failure to
          repair roof, which led to constructive eviction of shopping center tenant,
          constitutes waste); McCorristin v. Salmon Signs, 582 A.2d 1271 (N.J.
          Super. Ct. 1991); Syracuse Sav. Bank v. Onondaga Silk Co., 14 N.Y.S.2d
          356 (Sup. Ct. Onondaga County 1939).
              For cases requiring mortgagee to foreclose and establish a deficiency as
          a prerequisite to recovery of damages for waste, see Hummer v. R.C.
          Huffman Constr. Co., 63 F.2d 372, 374 (7th Cir. 1933).
645.      Genesco, Inc. v. Monumental Life Ins. Co., 577 F. Supp. 72, 84 (D.S.C.
          1983), aff ’d, 747 F.2d 253 (4th Cir. 1984).
646.      Jaffe-Spindler Co. v. Genesco, Inc., 747 F.2d 253 (4th Cir. 1984) (non-
          recourse mortgage); Jowdy v. Guerin, 457 P.2d 745, 748–49 (Ariz. Ct. App.
          1969); Prudential Ins. Co. v. Spencer ’s Kenosha Bowl, Inc., 404 N.W.2d
          109 (Wis. 1987) (in lien states mortgagee recovers only to extent of
          deficiency of purchase price in foreclosure of mortgage).
647.      Hummer v. R.C. Huffman Constr. Co., 63 F.2d 372, 375 (7th Cir. 1933);
          Syracuse Sav. Bank v. Onondaga Silk Co., 14 N.Y.S.2d 356 (Sup. Ct.
          Onondaga County 1939); City of Toledo v. Brown, 200 N.E. 750, 752
          (Ohio 1936).
648.      Brayton v. Pappas, 383 N.Y.S.2d 723 (App. Div. 4th Dep’t 1976); Planters
          Bank v. Lummus Cotton Gin Co., 128 S.E. 876, 882 (S.C. 1925).
649.      Genesco, Inc. v. Monumental Life Ins. Co., 577 F. Supp. 72, 86 (D.S.C.
          1983), aff ’d, 747 F.2d 253 (4th Cir. 1984).



(Friedman on Contracts, Rel. #7, 5/09)   3–135
§ 3:8.1                          FRIEDMAN     ON   CONTRACTS

   Under one line of cases, waste is actionable only if there is
impairment of security.650 This is the majority rule in lien theory
jurisdictions, which hold that the mortgagee does not have title to the
mortgaged property, only a lien.651 The competing line of authority
allows an action for waste prior to foreclosure, regardless of how well-
secured the mortgagee happens to be. The value of any security
remaining after any such recovery and application is immaterial,
because the mortgagee bargained for such security.652
   The measure of damages for waste is either the cost to restore the
premises or the decrease in market value resulting from the waste. 653
A mortgagee who is out of possession need not mitigate damages. 654
   Foreclosure and sale changes the analysis with respect to a mort-
gagee’s waste claim. A mortgagee’s bid for the full amount of the
mortgage debt bars a claim for waste because he cannot thereafter
establish a claim for impairment of security.655 This “full credit bid
rule,” however, does not necessarily bar other actions the mortgagee
may have against the mortgagor.656 A mortgagee who bid the full
amount of the debt in foreclosure was barred from recovering damages



650.      In re Tremblay, 43 B.R. 221 (Bankr. D. Vt. 1984); Douglas v. Lowery, 266
          N.E.2d 107 (Ill. App. Ct. 1971); Brayton v. Pappas, 383 N.Y.S.2d 723 (App.
          Div. 4th Dep’t 1976); Frio Inv., Inc. v. 4M-IRC/Rohde, 705 S.W.2d 784
          (Tex. Ct. App. – San Antonio 1986) (removal of dilapidated buildings). Frio
          Investments states the rule is based on the mortgagee’s non-ownership of
          the property, id. at 786, suggesting that the rule might be different in a title
          state.
651.      See Leipziger, The Mortgagee’s Remedies for Waste, 64 CALIF. L. REV. 1086,
          1097 (1976).
652.      Hummer v. R.C. Huffman Constr. Co., 63 F.2d 372, 374–75 (7th Cir.
          1933); W. & R. Inv. Co. v. Edwards Supply Co., 24 N.E.2d 518, 519 (Mass.
          1939).
653.      Genesco, Inc. v. Monumental Life Ins. Co., 577 F. Supp. 72, 86 (D.S.C.
          1983), aff ’d, 747 F.2d 253 (4th Cir. 1984); Jowdy v. Guerin, 457 P.2d 745,
          749 (Ariz. Ct. App. 1969); Bell v. First Columbus Nat’l Bank, 493 So. 2d
          964 (Miss. 1986).
              A similar rule applies to a tenant’s liability for the condition of leased
          premises at expiration of the term. See 2 MILTON R. FRIEDMAN, FRIEDMAN
          ON LEASES § 18:1, at 18–19 to 18–23 (Patrick A. Randolph, Jr., ed., 5th ed.
          PLI 2006).
654.      Genesco, Inc. v. Monumental Life Ins. Co., 577 F. Supp. 72, 87 (D.S.C.
          1983) (mortgagee has no duty to repair leaking roof), aff ’d, 747 F.2d 253
          (4th Cir. 1984).
655.      Sumitomo Bank v. Taurus Developers, Inc., 229 Cal. Rptr. 719 (4th Dist.
          Ct. App. 1986); W. & R. Inv. Co. v. Edwards Supply Co., 24 N.E.2d 518
          (Mass. 1939); Monte Enters., Inc. v. Kavanaugh, 303 S.E.2d 194 (N.C. Ct.
          App. 1983).
656.      Sumitomo Bank v. Taurus Developers, Inc., 229 Cal. Rptr. 719 (4th Dist. Ct.
          App. 1986) (barring waste action, but allowing claim against mortgagor-
          developer for negligence in building condominium project with defects).



                                        3–136
                             Mortgage Financing                              § 3:8.2

despite his claim that the value of the property was less. 657 When the
mortgagee purchases at foreclosure for a price less than the outstand-
ing debt, his waste action against the mortgagor is preserved to the
extent of the deficiency.658
   In California, an action for “bad faith waste” against the mortgagor
survives a foreclosure, despite the anti-deficiency judgment, to the
extent that the foreclosure price is less than the debt.659
   Whether nonpayment of real estate taxes is waste is the subject of
conflicting cases.660 The Restatement takes the position that it is
waste when the mortgagor “fails to pay before delinquency property
taxes or governmental assessments secured by a lien having priority
over the mortgage.”661 The issue usually is important only if the
mortgage is non-recourse or is subject to anti-deficiency judgment
legislation.

    § 3:8.2          Non-Recourse
   In substantial commercial transactions it is very common for the
parties to include a nonrecourse provision in the promissory note and
mortgage that purports to release the mortgagor from all personal




657.      Chrysler Capital Realty, Inc. v. Grella, 942 F.2d 160 (2d Cir. 1991)
          (Michigan law), relying on Whitestone Sav. & Loan Ass’n v. Allstate Ins.
          Co., 270 N.E.2d 694 (N.Y. 1971) (mortgagee who bid full amount of debt
          precluded from recovering insurance proceeds for pre-foreclosure fire).
658.      A similar analysis follows with respect to a mortgagee’s claim against a
          third party who causes injury to the mortgage property. See Moseley v.
          Bi-Lo Supermarket, Inc., 341 So. 2d 222 (Fla. Dist. Ct. App. 1976) (after
          settlement of foreclosure action, mortgagee allowed to pursue action
          against judgment creditor of mortgagor based on pre-foreclosure damage
          incident to writ of execution). For mortgagee’s recovery generally against
          mortgagor, its right to participate in mortgagor ’s recovery against third
          party guilty of the waste, and the effect of mortgagor ’s settlement with
          third parties on mortgagee’s rights, see Stevenson v. Goodson, 924 P.2d
          339, 348–53 (Utah 1996). Leipziger, The Mortgagee’s Remedies for Waste,
          64 CAL. L. REV. 1086 (1976), is a comprehensive consideration of the entire
          subject.
659.      Hickman v. Mulder, 130 Cal. Rptr. 304 (4th Dist. Ct. App. 1976)
          (permissive waste by failure to preserve quality of agricultural land).
660.      E.g., Travelers Ins. Co. v. 633 Third Assocs., 14 F.3d 114, 123 (2d Cir.
          1994) (New York law; nonpayment is waste); N. Am. Sec. Life Ins. Co. v.
          Harris Trust & Sav. Bank, 859 F. Supp. 1163 (N.D. Ill. 1994) (nonpayment
          is waste); Nippon Credit Bank v. 1333 North Cal. Boulevard, 103 Cal.
          Rptr. 2d 421 (Ct. App. 1st Dist. 2001) (nonpayment is waste if in bad
          faith); Chetek State Bank v. Barberg, 489 N.W.2d 385 (Wis. Ct. App. 1992)
          (nonpayment of interest and taxes not waste; distinguishes cases author-
          izing appointment of receiver for nonpayment).
661.      RESTATEMENT (THIRD) OF PROPERTY ( Mortgages) § 4.6(a)(3) (1997).



(Friedman on Contracts, Rel. #7, 5/09)   3–137
§ 3:8.2                        FRIEDMAN    ON   CONTRACTS

liability.662 The mortgage instruments may validly provide that the
mortgagor will not be personally liable for the mortgage debt, thus
limiting the remedy of the mortgage to the mortgaged premises. 663
    In the past, clauses for this purpose tended to give the mortgagor a
complete release. A complete non-recourse mortgage leaves the mort-
gagor with the beneficial interest in the property, but subjects the
lender to the risk of loss from all possible uninsured harm to the
property, including failure to repair, failure to comply with all federal
and local laws, misuse of the income of the property, etc.
    Today, few institutional lenders make complete non-recourse loans.
Modern non-recourse provisions generally have express “carve-outs,”
which call for personal liability of the mortgagor for various, specified
claims.
    A provision making the mortgage nonrecourse does not absolve the
mortgagor from personal liability for waste, although at times the
nature of waste may not be certain. 664 This is a default rule; a
mortgagee may seek to include an express carve-out for waste, but
in its absence many courts will protect the mortgagee from at least
some types of serious waste. In Travelers Insurance Co. v. 633 Third
Associates,665 a broadly worded non-recourse provision barred “any
action or proceeding wherein damages or any money judgment shall be
sought . . ., except a foreclosure action against the Mortgaged Prop-
erty.” The mortgagee brought an action based on the mortgagor ’s
failure to pay real property taxes. The court ruled that this language
precluded a tort action for damages for waste, but largely unwound
this determination by holding in a subsequent appeal that the mort-
gagee could pursue claims in equity, seeking injunctive relief and
specific performance of the mortgagor ’s promise to pay taxes.666
Decisions such as Travelers demonstrate why mortgagees are better
served by drafting express, precise carve-outs for waste, rather than
leaving the matter to the courts.



662.      This is exemplified in section 4.03(c)(ii) of the contract of sale for
          New York office, commercial, and multi-family residential premises,
          prepared by the Real Property Committee of the Association of the Bar
          of the City of New York, distributed by Julius Blumberg, Inc. (Form No.
          154), New York, N.Y. 10013.
663.      Bedian v. Cohn, 134 N.E.2d 532 (Ill. App. Ct. 1956).
664.      See Travelers Ins. Co. v. 633 Third Assocs., 14 F.3d 114 (2d Cir. 1994).
665.      Travelers Ins. Co. v. 633 Third Assocs., 973 F.2d 82 (2d Cir. 1992).
666.      Travelers Ins. Co. v. 633 Third Assocs., 14 F.3d 114 (2d Cir. 1994). Query,
          would the clause in Travelers absolve a mortgagor from liability from an
          express clause not to remove buildings? In other words, to what extent will
          an exculpatory clause be enforced? See 2 MILTON R. FRIEDMAN, FRIEDMAN
          ON LEASES, ch. 17, Exculpatory Clauses (Patrick A. Randolph, Jr., ed.,
          5th ed. PLI 2006).



                                      3–138
                             Mortgage Financing                           § 3:8.2

   Some mortgage commitments expressly exclude waste from the
nonrecourse provision and specify many other detailed items excluded
from the mortgagor ’s exculpation.667 The mortgagee seeks to limit the
release to the mortgage debt alone, preserving personal liability for
waste or the financial equivalent of waste. A sample clause for this
purpose appears below:

       A     (1)   Notwithstanding anything to the contrary contained in
                   this mortgage, except as set forth in Subdivision B of
                   this Article, the obligation of the mortgagor for pay-
                   ment of the mortgage debt is limited solely to recourse
                   against the property secured by this mortgage; and in
                   no event shall the mortgagor be personally liable for
                   breach of this mortgage or the obligation hereby
                   secured.
             (2)   The provisions of Subdivision A(1) shall apply to any
                   bond, note, or collateral instrument evidencing the debt
                   secured by this mortgage.
       The provisions of Subdivision A of this Article shall not apply to
       any liability the mortgagor might have, but for said Subdivision A,
       for the commission of waste to the mortgaged premises or for the
       breach of any obligation of the mortgagor under this mortgage, or
       any instrument referred to in Subdivision A(2) of this Article, by:
       cancelling or modifying any lease, collecting any rent in advance of
       the current monthly rent, or failure to apply the net proceeds of
       any insurance against casualty or the net award of partial con-
       demnation, which shall be paid to or applied on behalf of the
       mortgagor, to repair or restoration of the premises damaged by an
       event insured so against or by such condemnation, or for failing to
       hold the rents and profits of the mortgaged premises, after default,
       in trust to pay for real estate taxes, carrying charges of said
       premises, and for service of the mortgage debt.

   It is unnecessary to include in the foregoing clause any reference to
possible fraud or affirmative misrepresentation by the mortgagor in
obtaining the mortgage because of the mortgagee’s other remedies for
this.
   Some lenders agree to non-recourse, but insert so many carve-outs
as to leave the exculpation from liability with little value. 668



667.       A good discussion of the general subject appears in Edwards, Commercial
           Loan Commitments: A Borrower’s Perspective, REAL PROP., PROB. & TR. J.
           28–30 (July/Aug. 1994).
668.       See the items listed and discussed in Morrison & Senn, Carving Up the
           “Carve-Outs” in Nonrecourse Loans, REAL PROP., PROB. & TR. J., May/
           June 1958.



(Friedman on Contracts, Rel. #7, 5/09)   3–139
§ 3:8.2                        FRIEDMAN    ON   CONTRACTS

   Waste is not the only implied exception from the non-recourse
provision. An Ohio court has ruled that a non-recourse clause does not
bar the effect of an assignment of rent clause.669
   The non-recourse provision should provide for personal liability for
liens affecting the property that are superior to the mortgage; and for
liens subordinate to the mortgage, which are likely to involve personal
liability of the mortgagor, except to the extent that the proceeds thereof
have been applied to improvements.670 Query, should reference be
made at this point to fraud or affirmative misrepresentation in
obtaining the mortgage because the mortgagee has remedies for these?
It has also been suggested that the carve-outs should include bad-faith
cancellation of leases and unknown environmental problems. 671
For some of these, reference is made to “milking” and the absolute
assignment of rent to a mortgagee.
   In effect, the diversity as to the nature and extent of carve-outs
means that there are not just two types of mortgage loans: recourse
and non-recourse. Rather, there is a broad spectrum ranging from
unlimited personal liability to “complete non-recourse,” that is, no
express carve-outs. In considering where to position itself within that
spectrum, the mortgagee should give thought to the fiscal responsi-
bility of the mortgagor, as well as to the amount of the equity vested in
that party.
   A clause excusing a mortgagor from liability for principal and
interest leaves the mortgagor liable for other, possibly substantial,
obligations.672 A line of Florida cases deal with variations of clauses
providing that the mortgaged property is the “sole security” for the
debt, highlighting the need for careful drafting if the mortgagor desires
a non-recourse loan.673



669.      Prudential Ins. Co. v. Corporate Circle., Ltd., 658 N.E.2d 1066 (Ohio Ct.
          App. 1995) (lender entitled to rents under assignment of leases from time
          it commenced foreclosure action, notwithstanding nonrecourse provision).
670.      See Morrison & Senn, Carving Up the “Carve-outs” in Nonrecourse
          Loans, REAL PROP., PROB. & TR. J., May/June 1995, at 9–12.
671.      These are included in a more extended discussion in Stein, Nonrecourse
          Carveouts: How Far Is Far Enough?, 1997 REAL ESTATE REV. at 3 (Winter
          1997).
672.      See Fed. Home Mortgage v. Inland Indus., 869 F. Supp. 99 (D. Mass. 1994)
          (mortgagee may collect late fees, attorneys’ fees, and other items under
          clause barring personal liability for principal and interest, but expressly
          preserving personal liability “for the payment of all other amounts payable
          under the Note and for the performance of all other covenants” in
          mortgage).
673.      Mellor v. Goldberg, 658 So. 2d 1162 (Fla. Dist. Ct. App. 1995) (language
          stating land “shall be the sole security for the indebtedness . . . and a
          deficiency judgment shall not be obtained against the mortgagor in the
          event of foreclosure” is ambiguous; parol evidence is admissible to



                                      3–140
                             Mortgage Financing                                 § 3:8.3

   The use of nominees or straw men to execute mortgage instru-
ments in order to insulate the real party in interest from liability for
the mortgage debt, is an alternative to mortgage execution by the real
party in interest with the addition of non-recourse provisions. 674

    § 3:8.3          Maintenance of Premises in Good Condition
   In 1984, New York added a new statutory construction for a
mortgagor ’s covenant to maintain the premises and improvements
in “good condition or repair” for a mortgage on property with resi-
dences for four or more families.675 Such a covenant means the
mortgagor must keep the property “free from violations of applicable
municipal or state laws, codes or regulations.”676 If a government
agency certifies to the existence of a violation “involving a serious
danger to the health and safety of the occupants” of the mortgaged
property, the mortgagee is authorized to acclerate the debt and fore-
close, unless the mortgagor cures the violation within a reasonable
period of time, which is not less than thirty days.677 A 2008 amend-
ment extended the construction to authorize acceleration and fore-
closure upon the judicial appointment of an administrator, at the
instance of tenants, to collect rents and apply them to remedy
conditions dangerous to life, health, or safety.678
   A clause permitting the mortgagee to declare the mortgage debt due
and payable for failure to maintain the premises in a state of repair is
generally not enforced unless the deterioration has impaired the
mortgagee’s security.679



          determine whether parties intended to allow mortgagee to bring action on
          the note); Thomas v. Hartman, 553 So. 2d 1256 (Fla. Dist. Ct. App. 1989)
          (language stating land “shall be the sole security for the note” does not bar
          personal judgment on debt); Heim v. Kirkland, 356 So. 2d 850 (Fla. Dist.
          Ct. App. 1979) (language stating land was sole security with no further
          recourse against the maker-mortgagor bars any claim for deficiency);
          Policastro v. Rudt, 180 So. 2d 472 (Fla. Dist. Ct. App. 1965) (personal
          judgment precluded by language in mortgage stating land shall be “sole
          security for payment of all sums” evidenced by note and mortgagor shall
          not “be personally liable” on note, even though note itself had no such
          language).
674.      The use of nominees and straws is discussed in sections 6:1 and 6:1.3.
675.      N.Y. REAL PROP. LAW § 254(4-a).
676.      Id.
677.      Id.
678.      N.Y. Laws 2008, ch. 529, § 1, codified at N.Y. REAL PROP. LAW § 254(4-a)
          (cross referencing to N.Y. Real Property Actions and Proceedings article 7-a).
679.      United States v. Angel, 362 F. Supp. 445 (E.D. Pa. 1973) (mortgagee must
          prove impairment to foreclose for failure to maintain and repair); Bart v.
          Streuli, 52 P.2d 922 (Cal. 1935) (covenant against removal or demolition of
          any building; foreclosure denied when mortgagor removed front porch as



(Friedman on Contracts, Rel. #7, 5/09)   3–141
§ 3:8.4                         FRIEDMAN     ON   CONTRACTS

   § 3:8.4          Prepayment
   Under a rule known as “perfect tender in time,” a mortgagor is not
allowed to prepay the debt without the mortgagee’s consent. An owner
has no implied right to prepay even on tendering full interest to
maturity.680


          part of scheme of improvement, thereby enhancing value of premises);
          Loughery v. Catalano, 191 N.Y.S. 436 (Sup. Ct. Bronx County 1921)
          (alterations that did not change character of building and enhanced its
          value), aff ’d, 201 N.Y.S. 919 (App. Div. 1st Dep’t 1923).
680.      Eyde Bros. Dev. Co. v. Equitable Life Ins. Co., 697 F. Supp. 1431 (W.D.
          Mich. 1988); In re Brannon, 683 So. 2d 994 (Ala. 1996); McCarty v.
          Mellinkoff, 4 P.2d 595 (Cal. Dist. Ct. App. 1931); Dugan v. Grzybowski,
          332 A.2d 97 (Conn. 1973); Lindsay Realty Corp. v. Bellina, 320 So. 2d 572
          (La. Ct. App. 1975) (installment sale; collecting authorities); Trahant v.
          Perry, 149 N.E. 149 (Mass. 1925); Chapp v. Paterson, 397 P.2d 5 (Nev.
          1964); Patterson v. Tirollo, 581 A.2d 74 (N.H. 1990); Troncone v. Canelli,
          538 N.Y.S.2d 39 (App. Div. 2d Dep’t 1989); Young v. Sodara, 456 S.E.2d 31
          (W. Va. 1995); 5 H. TIFFANY, REAL PROPERTY § 1472 (3d ed. 1939); 59 C.J.S.
           Mortgages § 447 (1949). A mortgage payable “within” a specified time may
          be paid off at any time. However, a mortgage that is payable “within” a
          specified number of years is not so prepayable if it calls for installments in
          an amount that will evenly amortize the debt by the end of the specified
          time. See Bloomfield Sav. Bank v. Howard S. Stainton & Co., 159 A.2d 443
          (N.J. Super. Ct. 1960); Los Quatros, Inc. v. State Farm Life Ins. Co., 800
          P.2d 184 (N.M. 1990); Mahoney v. Furches, 454 A.2d 1117, 1119
          (Pa. Super. Ct. 1983), rev’d, 468 A.2d 458 (Pa. 1983); Annot., Construction
          and Effect as to Interest Due of Real Estate Mortgage Clause Authorizing
          Mortgagor to Prepay Principal Debt, 86 A.L.R.3d 599 (1978); Poommipanit
          v. Sloan, 510 N.W.2d 542 (Neb. Ct. App. 1993) (installment contract of
          sale; collecting cases); 55 AM. JUR. 2d Mortgages § 397 (1971).
              In Mahoney v. Furches, 468 A.2d 458 (Pa. 1983), a purchase money
          mortgagor sought without success (1) to subdivide and sell parts of the
          mortgaged property, and then (2) to prepay the debt. Neither was provided
          for in the mortgage. The court ruled that a right of prepayment depends on
          the language in the mortgage and the intent of the parties. It held a
          mortgage, otherwise silent, is presumably prepayable. Hatcher v. Rose, 407
          S.E.2d 172 (N.C. 1991), is in accord, rev’g 389 S.E.2d 442 (N.C. Ct. App.
          1990). This was said to conform to the early common law rule. Alexander,
          Mortgage Prepayment: The Trial of Common Sense, 72 CORNELL L. REV.
          288, 292 et seq. (1987) [hereinafter Alexander]. See also the dissent in
          Brannon, 683 So. 2d 994. But the common-law rule is a matter of dispute.
          See Hatcher v. Rose, 407 S.E.2d 172, 177 (N.C. 1991). Mahoney was a
          hard case and, it is submitted, makes bad law. A presumption of prepay-
          ment is a retroactive change in the law that may wreak havoc on existing
          mortgages, and future mortgages prepared on old forms. For a discussion
          and authorities on the retroactive and prospective effects of overruling
          decisions, see Mendes v. Johnson, 389 A.2d 781, 787 et seq. (D.C. 1978);
          Erhard v. F.W. Woolworth Co., 372 N.E.2d 1277 (Mass. 1978); Van Dyke v.
          Chappell, 818 P.2d 1023 (Utah 1991). There has been no custom to
          expressly negate a right of prepayment (despite Connolley and Hartford Life
          Ins. Co., cited infra this note) except when giving a mortgagor a qualified



                                       3–142
                             Mortgage Financing                                § 3:8.4




          right (e.g., no prepayment for three years). Prepayment may abort an
          investment, and an installment sale that triggers an otherwise avoidable
          capital gains tax on a mortgagee. The court’s statement that a contra rule
          would be a restraint on alienation strikes the author as correct, but not the
          majority of courts that rule on the converse situation of payment under
          due-on-sale clauses.
              For an extensive discussion and collection of authorities, see Metro.
          Life Ins. Co. v. Promenade Towers Hous. Corp., 581 A.2d 846 (Md. Ct.
          Spec. App. 1990); Alexander, supra. Metropolitan Life Ins. Co. was affirmed
          in a comprehensive opinion with many more authorities and a background
          of Maryland law, sub nom. Promenade Towers Mut. Hous. Corp. v. Metro.
          Life Ins. Co., 597 A.2d 1377 (Md. 1991).
              Prepayment can impose daunting economic sacrifices upon a mort-
          gagee, not the least of which include the loss of the bargained-for rate of
          return, an increased tax burden, and unanticipated costs occasioned by the
          need to reinvest the principal, and, for those creditors anxious to ensure
          regular payments not unlike an annuity, it undoes the mortgagee’s purpose
          in making the loan. Arthur v. Burkich, 520 N.Y.S.2d 638, 639 (App. Div.
          3d Dep’t 1987).
              Under statutes relating to residential property, Florida and North
          Carolina permit prepayment without penalty if it is not expressly forbid-
          den by the mortgage. FLA. STAT. § 697.06 (1990); MO. REV. STAT. § 408.036
          (Laws 1990, H.B. 1125 § A). An Illinois statute forbids a prepayment
          penalty when the interest rate exceeds 8%. 815 ILL. COMP. STAT. 205/
          4(n)(2)(a) (1993). Massachusetts permits prepayment of a first mortgage on
          a dwelling of three or less households occupied by the mortgagor. M ASS.
          GEN. LAWS ch. 183, § 57 (1991). New Jersey permits prepayment at any
          time without penalty. N.J. STAT. § 46:10B-2 (1989). North Carolina
          permits prepayment without penalty when the mortgage makes no refer-
          ence to prepayment. N.C. GEN. STAT. § 24-2-4 (1994). A Maryland statute
          is similar. MD. CODE ANN., REAL PROP. § 24-2.4 (Laws 1991, ch. 409). A
          Tennessee statute makes the right of prepayment governed by the contract
          between the parties. TENN. CODE ANN. § 47-14-108 (1990). A Texas statute
          that limits prepayment penalties when the interest exceeds a specified
          amount made unenforceable a mortgage clause that forbade any prepayment
          when the mortgage interest exceeded that specified in the statute. Groseclose
          v. Rum, 860 S.W.2d 554 (Tex. Civ. App. 1993). Many more detailed statutes
          relating to residential mortgages are collected and discussed in Baldwin,
          Prepayment Penalties, 40 VAND. L. REV. 409, 430–34 (1987); Alexander,
          supra, at 324–28, 334–36.
              A provision permitting prepayment at two specified times did not
          permit prepayment at other times. Metro. Life Ins. Co. v. Strnad, 876
          P.2d 1362 (Kan. 1994).
              A right to prepay if the owner paid an additional 2% premium was held
          not to justify the mortgagee’s retention of this 2% when payment was
          effected by mortgagee’s resort to proceeds of fire insurance. Chestnut Corp.
          v. Bankers Bond & Mortgage Co., 149 A.2d 48 (Pa. 1959). Accord, as to
          eminent domain, Associated Schs., Inc. v. Dade County, 209 So. 2d 489
          (Fla. Dist. Ct. App. 1968); see Berenato v. Bell Sav. & Loan Ass’n, 419 A.2d
          620 (Pa. Super. Ct. 1980) (discussing cases on eminent domain and
          insurance proceeds). But a mortgagee’s right to a prepayment premium
          on exercising an election to accelerate the mortgage debt on a sale of the



(Friedman on Contracts, Rel. #7, 5/09)   3–143
§ 3:8.4                         FRIEDMAN     ON   CONTRACTS

   It follows that an express right to pay the principal does not include
a right to make part payment.681 The importance of a prepayment
right was highlighted in a case upholding a mortgagee’s right to exact a
bonus of $2,000 as a condition of accepting prepayment of a mortgage
on which less than $15,000 was owing.682 The cases hold generally


          property was left open in Kadner v. Shields, 97 Cal. Rptr. 742 (2d Dist. Ct.
          App. 1971).
              A mortgage clause permitting prepayment of 20% of principal each year
          was held to prevail over another clause requiring monthly payments of
          $1,491.15 “or more.” Aronoff v. W. Fed. Sav. & Loan Ass’n, 470 P.2d 889
          (Colo. Ct. App. 1970).
              A contract providing for monthly payments of not less than $223.84
          was held to permit prepayment of the balance as part of any monthly
          payment. Peters v. Fenner, 199 N.W.2d 795 (Minn. 1972).
              A provision for releases from the mortgage in parcels, on specified
          payments, has been held the equivalent of a right to prepay. A requirement
          that mortgagor file a subdivision map before becoming entitled to releases
          was held inapplicable to payment of the entire mortgage. Davlick Constr.
          Co. v. Krohn Assocs., Inc., 242 N.Y.S.2d 647 (Sup. Ct. Nassau County
          1963).
              A provision expressly forbidding prepayment is valid. Stouffer Hotel
          Co. v. Teachers Ins. & Annuity Ass’n, 737 F. Supp. 1553, 1561 (M.D. Fla.
          1990); Connolley v. Harrison, 327 A.2d 787 (Md. Ct. Spec. App. 1974);
          Hartford Life Ins. Co. v. Randall, 583 P.2d 1126 (Or. 1978); McCausland v.
          Bankers Life Ins. Co., 757 P.2d 941 (Wash. 1988) (no prepayment for
          seven years).
              A prepayment premium, during the first five years, of one year ’s
          interest of the sum prepaid in excess of 20% of the original principal,
          was held no unjust enrichment. Lazzareschi Inv. Co. v. S.F. Fed. Sav. &
          Loan Ass’n, 99 Cal. Rptr. 417 (Ct. App. 1971); Century Fed. Sav. & Loan
          Ass’n v. Madorsky, 353 So. 2d 868 (Fla. Dist. Ct. App. 1977). See also
          Williams v. Fassler, 167 Cal. Rptr. 545 (5th Dist. Ct. App. 1980).
              For cases in accord, see 86 A.L.R.3d 599, 613 (1978).
              Annot., Validity and Construction of Provision of Mortgage or Other
          Real Estate Financing Contract Prohibiting Prepayment for a Fixed Period
          of Time, 81 A.L.R.4th 423 (1990).
681.      First Phila. Realty Corp. v. Albany Sav. Bank, 609 F. Supp. 207 (E.D. Pa.
          1985).
682.      Feldman v. Kings Highway Sav. Bank, 102 N.Y.S.2d 306 (App. Div.
          2d Dep’t), aff ’d, 102 N.E.2d 835 (N.Y. 1951); accord Lindsay Realty
          Corp. v. Bellina, 320 So. 2d 572 (La. Ct. App. 1975) (installment sale;
          collecting authorities); see authorities in Dugan v. Grzybowski, 332 A.2d
          97 (Conn. 1973).
              A mortgage payable “within” a specified time may be paid off at any
          time. However, a mortgage that is payable “within” a specified number of
          years is not so prepayable if it calls for installments in an amount that will
          evenly amortize the debt by the end of the specified time. See Bloomfield
          Sav. Bank v. Howard S. Stainton & Co., 159 A.2d 443 (N.J. Super. Ct.
          1960); Mahoney v. Furches, 454 A.2d 1117, 1119 (Pa. Super. Ct. 1983),
          rev’d on other grounds, 468 A.2d 458 (Pa. 1983); Annot., Construction and
          Effect as to Interest Due of Real Estate Mortgage Clause Authorizing
          Mortgagor to Prepay Principal Debt, 86 A.L.R.3d 599 (1978).



                                       3–144
                             Mortgage Financing                               § 3:8.4

that in case of prepayment, either under a right given in the mortgage
or under an agreement made thereafter, a premium is properly
collectible that, when added to the interest, does not bring the
aggregate payments above the legal maximum for the original term
of the mortgage, but that when payment is involuntary, as where the
mortgagee elects to accelerate, the sum payable may not bring the
interest above the legal maximum to the date of payment. 683 Prepay-
ment requires payment of only such interest as accrues to the date of


683.      McCae Mgmt. Corp. v. Merchs. Nat’l Bank, 553 N.E.2d 884 (Ind. Ct. App.
          1990); Mut. Life Ins. Co. v. Hilander, 403 S.W.2d 260 (Ky. 1966);
          Connolley v. Harrison, 327 A.2d 787 (Md. Ct. Spec. App. 1974); Chapp
          v. Paterson, 397 P.2d 5, 8 (Nev. 1964); Bloomfield Sav. Bank v. Howard
          S. Stainton & Co., 159 A.2d 443 (N.J. Super. Ct. 1960); Feldman v. Kings
          Highway Sav. Bank, 102 N.Y.S.2d 306 (App. Div. 2d Dep’t), aff ’d, 102
          N.E.2d 835 (N.Y. 1951); Lyons v. Nat’l Sav. Bank, 113 N.Y.S.2d 695 (App.
          Div. 3d Dep’t 1952); Annot., 130 A.L.R. 73 (1941); Annot., 75 A.L.R.2d
          1265 (1961). See also Williams v. Fassler, 167 Cal. Rptr. 545 (5th Dist. Ct.
          App. 1980). But see In re Fin. Ctr. Assocs., L.P., 140 B.R. 829 (Bankr.
          E.D.N.Y. 1992); Baldwin, Prepayment Penalties, 40 VAND. L. REV. 409,
          420–24 (1987); Comment, Secured Real Estate Loan Prepayment and the
          Prepayment Penalty, 51 CALIF. L. REV. 923, 925–26 (1963).
              An institutional mortgagee is justified in requiring a reasonable pre-
          mium for prepayment by reason of loss of interest pending reinvestment of
          the money. Furthermore, although the borrower pays the cost of the loan,
          putting a mortgage on the company’s books entails expense, if only in
          overhead. Prepayment may be more serious to the holder of a purchase
          money mortgage given in connection with an installment sale, under
          which the seller-mortgagee returns as income that percentage of the
          buyer ’s payments that the gross profit on the sale bears to the total
          contract price. I.R.C. § 453(b) (1954). In this situation prepayment may
          substantially alter the mortgagee’s tax position to his possible detriment.
          Chapp v. Paterson, 397 P.2d 5 (Nev. 1964).
              In Williams v. Fassler, 167 Cal. Rptr. 545 (5th Dist. Ct. App. 1980), a
          50% penalty on the amount voluntarily prepaid was held not unconscion-
          able where reasonably related to vendor ’s anticipated increased tax
          liability. A prepayment charge of about $2.5 million on a mortgage of
          $15 million was disallowed in bankruptcy as unreasonable. In re Skyler
          Ridge, 80 B.R. 500 (Bankr. C.D. Cal. 1987). Cf. Teachers Ins. & Annuity
          Ass’n v. Butler, 626 F. Supp. 1229 (S.D.N.Y. 1986). A detailed criticism of
          Skyler Ridge appears in Stark, Prepayment Charges in Jeopardy: The
          Unhappy and Uncertain Legacy of In re Skyler Ridge, 24 REAL PROP.,
          PROB. & TR. J. 191 (1989), for its “blatant result-oriented basis.” There
          are other instances in which very high recoveries have been denied where
          they are based on prospective damages. Under present and prior bank-
          ruptcy laws landlords have been limited in recovery based on future rents
          under long term leases. Bankruptcy Reform Act of 1978, § 502(b)(6);
          2 MILTON R. FRIEDMAN, FRIEDMAN ON LEASES § 16:2.4 (Patrick A.
          Randolph, Jr., ed., 5th ed. PLI 2006). Landlords have been denied
          enforcement in tenant bankruptcy of lease provisions authorizing cancel-
          lation of the lease on tenant’s bankruptcy. Enforcement would give
          landlord the “bonus value” of the lease and prevent continuance of



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§ 3:8.4                         FRIEDMAN    ON   CONTRACTS

payment.684 But interest paid in advance, in accord with a requirement
for payment in advance, is not refundable.685
    A mortgagor ’s right to prepay the mortgage debt without penalty
and without payment of interest beyond the time of payment may be
created by language stating that payment shall be “on or before” or
“within” a specified time or “not less then” a specified amount.686 If
prepayment is for the full amount of the mortgage debt the interest on
this debt ceases after this payment. The same is true of partial
prepayments under most mortgages,687 but this may be unclear in
the face of required prepayment premiums. If the mortgage is an
installment mortgage (that is, providing for fixed payments applicable
first to interest and then to principal) and the mortgagor makes a
payment as of right, larger than the installment due, the mortgage
principal is reduced more than that contemplated by the original
schedule and the mortgagee is entitled only to lesser interest than
that computed upon the original payment schedule.



          tenant’s business, that might create assets for tenant’s other creditors.
          Bankruptcy Reform Act of 1978 §§ 365(b)(2), 365(e)(1); FRIEDMAN, supra.
          After breach of a contract of sale of real property the wronged party has at
          times recovered, and at times been denied, increased financial charges
          occasioned by the breach.
              Annot., Construction and Effect as to Interest Due of Real Estate
          Mortgage Clause Authorizing Mortgagor to Prepay Principal Debt, 86
          A.L.R.3d 599 (1978).
684.      Fortson v. Burns, 479 S.W.2d 722 (Tex. Civ. App. 1972).
685.      Shelly v. Bristol Sav. Bank, 26 A. 474 (Conn. 1893); Wishnoff v. Guardian
          Sav. & Loan Ass’n, 339 N.E.2d 494 (Ill. App. Ct. 1975); Crowley v. Kolsky,
          57 S.W. 386 (Tenn. Ct. App. 1900).
686.      Tryon v. Carter, 94 Eng. Rep. 1069 (K.B. 1734); L.A. Inv. Co. v. Wilson, 185
          P. 853 (Cal. 1919); Garner v. Sisson Props., 31 S.E.2d 400 (Ga. 1944);
          Peters v. Fenner, 199 N.W.2d 795 (Minn. 1972); Brenner v. Neu, 170
          N.E.2d 897, 899 (Ill. App. Ct. 1960); In re John & Cherry Sts., 19 Wend.
          659, 13 N.Y. Com. L. Rpts. 741 (N.Y. Sup. Ct. 1839); Beth-June, Inc. v.
          Wil-Avon Merch. Mart, 233 A.2d 620 (Pa. Super. Ct. 1967); Alexander,
          Mortgage Prepayment: The Trial of Common Sense, 72 CORNELL L. REV.
          288, 318 (1987).
              But “unless sooner paid” created a prepayment right was held a factual
          question. Troncone v. Canelli, 538 N.Y.S.2d 39 (App. Div. 2d Dep’t 1989)
          (denying summary judgment). Contra Matimer v. Grundy County Nat’l
          Bank, 607 N.E.2d 294 (Ill. App. Ct. 1992) (gives right to prepay).
              Providing for interest payments “on or before” the fifteenth of a month
          gave no right to prepay the principal. Comarron W. Props. v. Lincoln Loan
          Co., 860 P.2d 871 (Or. Ct. App. 1993) (installment sale of realty; distin-
          guishing Phillips v. Johnson, 514 P.2d 1337, 1344 (Or. 1973), on this
          ground).
687.      See generally Annot., Construction and Effect as to Interest Due on Real
          Estate Mortgage Clause Authorizing Mortgagor to Prepay Principal Debt, 86
          A.L.R.3d 599–624 (1978); 45 AM. JUR. 2d Interest § 99 (1969).



                                      3–146
                             Mortgage Financing                               § 3:8.4

    The right to prepay the mortgage is often subject to a prepayment
premium. Cases generally hold that the premium is applicable to
voluntary prepayment and not to condemnation awards or insurance
proceeds, but the mortgage terms may provide otherwise. The pre-
mium may be substantial when computed to preserve the mortgagee’s
bargain. If interest rates fall, the premium may be the difference
between the rate on government bonds with a maturity close to that
of the mortgage and the mortgage rate computed to the expiration of
the original mortgage term. At the least this sum may be discounted to
its then-value.
    An obligation to pay a prepayment premium is generally limited to
a voluntary prepayment by the mortgagor and does not apply, inter
alia, to a mortgagee’s right to proceeds of insurance, a condemnation
award, or to payment under a due-on-sale clause, or other form of
acceleration. 688 But a provision expressly making a prepayment



688.      In re LHD Realty Corp., 726 F.2d 327 (7th Cir. 1984); Eyde Bros. Dev. Co.
          v. Equitable Life Ins. Co., 697 F. Supp. 1431 (W.D. Mich. 1988); In re
          Pinebrook, Ltd., 85 B.R. 160 (Bankr. M.D. Fla. 1988); Ferriera v. Yared, 588
          N.E.2d 1370 (Mass. App. Ct. 1992); George H. Nutman, Inc. v. Aetna Bus.
          Credit, Inc., 453 N.Y.S.2d 586 (Sup. Ct. Queens County 1982) (accelera-
          tion). See cases collected in Pac. Trust Co. v. Fid. Sav. & Loan Ass’n, 229
          Cal. Rptr. 269, 273 (6th Dist. Ct. App. 1986). A right to prepay if the
          owner paid an additional 2% premium was held not to justify the
          mortgagee’s retention of this 2% when payment was effected by mort-
          gagee’s resort to proceeds of fire insurance. Chestnut Corp. v. Bankers
          Bond & Mortgage Co., 149 A.2d 48 (Pa. 1959) (dictum that parties may
          agree otherwise). Accord, as to eminent domain, Associated Schs., Inc. v.
          Dade County, 209 So. 2d 489 (Fla. Dist. Ct. App. 1968); DeKalb County v.
          United Family Life Ins. Co., 219 S.E.2d 707 (Ga. 1975) (during period
          mortgage closed to prepayment); Vill. of Rosemont v. Maywood-Proviso
          State Bank, 501 N.E.2d 859 (Ill. App. Ct. 1986) (despite application of
          prepayment clause to transfer by operation of law; collects cases); Jala
          Corp. v. Berkeley Sav. & Loan Ass’n, 250 A.2d 150 (N.J. Super. Ct. App.
          Div. 1969); Silverman v. State, 370 N.Y.S.2d 234 (App. Div. 3d Dep’t
          1975); and to a sale induced by a threat of condemnation, Landohio Corp.
          v. Nw. Mut. Life Mortgage & Realty Investors, 431 F. Supp. 475 (N.D. Ohio
          1976). See also cases in Eyde v. Empire Fed. Sav. Bank, 701 F. Supp. 126,
          129 (E.D. Mich. 1988); First Ind. Fed. Sav. Bank v. Md. Dev. Co., 509
          N.E.2d 253 (Ind. Ct. App. 1987). But see 84 A.L.R.3d 946 (1978).
          A condemnor is generally not liable for a prepayment premium. See id.
          Payment under protest is not a condition of recovery of an improper
          payment. Schmidt v. Interstate Fed. Sav. & Loan Ass’n, 421 F. Supp. 1016
          (D.D.C. 1976).
              Prepayment premium has been denied to a mortgagee enforcing a due-
          on-sale cause, Eyde v. Equitable Life Assurance Soc’y, 697 F. Supp. 1430
          (W.D. Mich. 1988); Abramoff v. Life Ins. Co., 92 B.R. 698 (Bankr. W.D.
          Tex. 1988); Tan v. Cal. Fed. Sav. & Loan Ass’n, 189 Cal. Rptr. 775 (Ct. App.
          1983); Slevin Container Corp. v. Provident Fed. Sav. & Loan Ass’n, 424



(Friedman on Contracts, Rel. #7, 5/09)   3–147
§ 3:8.4                         FRIEDMAN    ON   CONTRACTS

premium applicable to involuntary prepayment has been enforced, 689
but not in bankruptcy of the debtor.690 A prepayment premium was
held enforceable after an intentional default for the purpose of avoiding
the prepayment premium.691 Retraction of acceleration, when per-
mitted, restores the mortgagee’s right to a prepayment premium. 692


          N.E.2d 939 (Ill. App. Ct. 1981); Los Quatros, Inc. v. State Farm Life Ins.
          Co., 800 P.2d 184 (N.M. 1990); McCausland v. Bankers Life Ins. Co., 757
          P.2d 941 (Wash. 1988). Contra Warrington 611 Assocs. v. Aetna Life Ins.
          Co., 705 F. Supp. 229 (D.N.J. 1989) (Pennsylvania law). The question was
          left open in Kadner v. Shields, 97 Cal. Rptr. 742 (2d Dist. Ct. App. 1971).
          The premium was allowed in a case applying federal law to a federal
          savings and loan association. Borenstein v. Franklin Soc’y Fed. Sav. & Loan
          Ass’n, N.Y.L.J., Mar. 22, 1978, at 7, col. 2 (Sup. Ct.). Some statutes codify
          the rule that bars a prepayment premium after acceleration of residential
          mortgages under a due-on-sale clause. See N.Y. REAL PROP. LAW § 254(4-a).
          The New York statute has been held retroactive. Rogers v. Williamsburgh
          Sav. Bank, 361 N.Y.S.2d 531 (Dist. Ct. Suffolk County 1974). But cf.
          Borenstein, supra. When mortgagor ’s sale would permit mortgagee to
          invoke a due-on-sale clause, a voluntary prepayment before the sale has
          permitted mortgagee to collect the prepayment premium. First Nat’l Bank
          v. Equitable Life Assurance Soc’y, 510 N.E.2d 650 (Ill. App. Ct. 1987); First
          Ind. Fed. Sav. Bank v. Md. Dev. Co., 509 N.E.2d 253 (Ind. Ct. App. 1987).
          Mortgagee’s refusal to consent to such sale was immaterial. First Indiana,
          supra. This would seem to penalize an owner for avoiding acceleration and
          a subsequent useless foreclosure action. For due-on-sale clauses generally,
          see section 3:3.1.
              The rule is codified, as to condemnation, in CAL. CIV. PROC. CODE
          § 1265.240; MASS. GEN. LAWS ch. 183, § 57. Other statutes require the
          condemnor to pay prepayment charges. ARIZ. REV. STAT. ANN. § 11-965;
          CONN. GEN. STAT. § 8-282 (1983); OKLA. STAT. tit. 27, § 10; S.C. CODE
          ANN. § 28-11-30.
              Prepayment premium is generally denied to a mortgagee when prepay-
          ment is made for a reason other than under the mortgagor ’s option.
          Annot., 86 A.L.R.3d 599, 605 (1978).
689.      In re Fin. Ctr. Assocs., L.P., 140 B.R. 835 (Bankr. E.D.N.Y. 1992); Eyde v.
          Equitable Life Assurance Soc’y, 697 F. Supp. 1430 (W.D. Mich. 1988);
          Teachers Ins. & Annuity Ass’n v. Butler, 626 F. Supp. 1229 (S.D.N.Y.
          1986); Pac. Trust Co. v. Fid. Sav. & Loan Ass’n, 229 Cal. Rptr. 269 (6th
          Dist. Ct. App. 1986) (redemption by junior mortgagee); Golden Forest
          Props., Inc. v. Columbia Sav. & Loan Ass’n, 248 Cal. Rptr. 316 (2d Dist.
          Ct. App. 1988) (purchase by junior mortgagee at trustee’s sale).
              Provision in the same contract for a prepayment penalty, late charges,
          and an increased rate of interest after a default have all been enforced.
          TMG Life Ins. Co. v. Ashner, 898 P.2d 1145, 1161 (Kan. Ct. App. 1995).
690.      In re Ridgewood Apartments, Ltd., 174 B.R. 712 (Bankr. S.D. Ohio 1994).
691.      Eyde v. Empire Fed. Sav. Bank, 701 F. Supp. 126 (E.D. Mich. 1988). Contra
          Eyde v. Equitable Life Assurance Soc’y, 697 F. Supp. 1430 (W.D. Mich.
          1988); Fla. Nat’l Bank v. Bankatlantic, 557 So. 2d 596 (Fla. Dist. Ct. App.
          1990), aff ’d, 589 So. 2d 255 (Fla. 1991).
              But see Ferriera v. Yared, 588 N.E.2d 1370 (Mass. App. Ct. 1992);
          Rodgers v. Rainier Nat’l Bank, 757 P.2d 976 (Wash. 1988).
692.      In re Adu-Kofi, 94 B.R. 14 (Bankr. D.R.I. 1988).



                                       3–148
                             Mortgage Financing                              § 3:8.4

   Some statutes and regulations entitle a homeowner to prepay at a
modest or no premium.693 Federal regulations, however, may preempt
state statutes that prohibit prepayment premiums. A New Jersey case,
Glukowsky v. Equity One, Inc.,694 considered prepayment penalties
charged on alternative mortgage transactions (AMTs). An AMT is any
home mortgage loan with an interest rate or finance charge that may
be adjusted or renegotiated. Beginning in the 1980s, home lenders
began offering various types of AMTs as alternatives to the standard
self-amortizing fixed-rate loan. Many states prohibited state-chartered
financial institutions from offering AMTs or imposed substantial
restrictions on such loans. In contrast, federal regulations allowed
federally chartered lenders to offer AMTs. Congress enacted the
Alternative Mortgage Transaction Parity Act of 1982 to allow state-
chartered institutions to offer AMTs. The act grants rulemaking
authority to the Office of Thrift Supervision (OTS) to prevent dis-
crimination against state-chartered institutions. In 1996, the OTS
enacted a regulation authorizing state lenders to charge prepayment
penalties in AMTs. This regulation conflicted with a New Jersey
statute, which prohibited prepayment penalties. The regulation, if
valid, preempted conflicting state laws. In Glukowsky, a borrower
obtained a balloon loan in 1999 and sold his home in 2001. The loan
documents provided for a 2% prepayment fee, which the borrower
paid under protest. The appellate division held for the borrower on
the ground that the OTS regulation was beyond the scope of the
agency ’s rulemaking authority. In a four-to-three decision, the
Supreme Court reversed, reasoning that the OTS is entitled to
substantial deference in deciding how to enforce the Parity Act. The
OTS rescinded the regulation effective July 2003. After reexamining
the issue, it concluded that preemption of state prepayment laws was
not essential to achieve the goals of the Parity Act. Nonetheless, the
regulation was valid and enforceable when it applied, between 1996
and 2003.
   When the mortgagor has the right to prepay without a premium, it
may be necessary to determine whether a charge imposed by the lender
is a prepayment charge or a premium. To facilitate prepayment,
institutional lenders generally provide a payoff statement upon




693.      38 C.F.R. § 36.4310 (no premium or fee for loans insured by Veterans
          Administration); MO. REV. STAT. § 408.036 (forbids penalty after five years
          and allows maximum of 2% until then); N.J.STAT. § 46:10B-2 (no penalty);
          N.Y. B ANKING LAW § 393(2) (allowing limited penalty during first
          twelve months for loans from savings and loan associations).
694.      Glukowsky v. Equity One, Inc., 848 A.2d 747 (N.J. 2004).



(Friedman on Contracts, Rel. #7, 5/09)   3–149
§ 3:8.4                        FRIEDMAN    ON   CONTRACTS

request, and they sometimes charge a fee for such statements. Courts
have rejected borrowers’ contentions that such fees are proscribed
prepayment charges.695
    Partial payment of a mortgage generally reduces the interest payable
thereafter to that accruing on the diminished principal. It was so held
under a mortgage making installment payments applicable first to
interest and then to principal, and also giving the mortgagor a right of
partial prepayment.696 The Connecticut Supreme Court noted that
the mortgagee could bar this only by using one of three methods: a
mortgage barring prepayment; a mortgage to secure an aggregate sum
of the principal, plus an amount equal to the interest for the entire
term; or a mortgage including a prepayment premium.
    When a mortgage requires interest at higher than the market rate it
is to the mortgagor ’s advantage to pay off the mortgage and refinance
at current rates. If the mortgage does not permit prepayment, the
mortgagee need not accept payment.697 Any right to voluntary pre-
payment probably requires payment of a premium. 698 If the mortgagor
defaults on an installment and the mortgagee accelerates maturity of
the entire debt, the mortgagee is generally not entitled to the prepay-
ment premium.699 The mortgagor is tempted, therefore, to try to
escape from the onus of a high interest rate by defaulting on an




695.      Krause v. GE Capital Mortgage Serv., Inc., 731 N.E.2d 302 (Ill. App. Ct.
          2000) (borrower gets first payoff statement free, but pays $15 for each
          additional statement and pays $10 if sent by fax); Colangelo v. Nw.
          Mortgage, Inc., 598 N.W.2d 14 (Minn. Ct. App. 1999) ($10 fax fee is for
          special service; borrower can prepay without payoff statement or by getting
          one through mail); Cappellini v. Mellon Mortgage Co., 991 F. Supp. 31
          (D. Mass. 1997) ($25 payoff statement fee and $15 fax fee are not
          prepayment charges; payoff statements are often used for purposes other
          than prepaying loan, such as financial planning).
696.      Dugan v. Grzybowski, 332 A.2d 97 (Conn. 1973), 45 AM. JUR. 2d Interest
          § 99 (1978). But see Ziello v. Superior Court, 42 Cal. Rptr. 2d 251 (Ct.
          App. 1995).
              Annot., Construction and Effect as to Interest Due of Real Estate
          Mortgage Clause Authorizing Mortgagor to Prepay Principal Debt, 86
          A.L.R.3d 599 (1978).
697.      A borrower who reneged on a loan commitment was held liable for the
          difference between the contract rate and the market rate for borrowers.
          Teachers Ins. & Annuity Ass’n v. Butler, 626 F. Supp. 1229 (S.D.N.Y.
          1986). Cf. In re Skyler Ridge, 80 B.R. 500 (Bankr. C.D. Cal. 1987).
698.      If not forbidden by statute the mortgage may provide otherwise.
699.      See Trident Ctr. v. Conn. Gen. Life Ins. Co., 847 F.2d 564 (9th Cir. 1988);
          Teachers Ins. & Annuity Ass’n v. Butler, 626 F. Supp. 1229 (S.D.N.Y.
          1986). For the business disadvantages of default by a mortgagor, see
          Trident, 847 F.2d at 568.



                                      3–150
                             Mortgage Financing                              § 3:8.4

installment to compel acceleration.700 It is not easy for the mortgagee
to counter this unless there is a right to partial foreclosure. In
New York there is a statutory right, when the entire debt is not due,
to foreclose against the property to satisfy the amount of the debt then
due, subject to the continuing lien of the mortgage against the property
for the debt not then due and unpaid.701 Outside New York the
amount of relevant law is sparse and not consistent.702 In New York
the reported cases indicate little use of partial foreclosure. When
partial foreclosure is not available, mortgagees have sought to collect
the rents of the property when available without foreclosure or consent
of the mortgagor.
   A provision often sought by a mortgagor is the right of prepayment,
to be available whenever refinancing may be in order. This right is
often conditioned upon prior written notice of between thirty and
ninety days and payment of some additional sum in order to com-
pensate the mortgagee for the delay, trouble, and expense of reinvest-
ment. In some mortgages, there may be a right of partial prepayment,
usually in multiples of at least several thousand dollars, thus avoiding
a necessity on the mortgagee’s part of accepting sums too small for
practical use.
   Suppose a mortgagor who has a right to prepay in whole or in part on,
for example, thirty days’ notice, gives notice of an election to prepay the
entire mortgage debt or a substantial part of it. May the mortgagor
withdraw the election? The mortgagee may have taken steps or made
commitments in anticipation of receipt of the money. Under the usual
prepayment clause, it would appear that the mortgagor may rescind his
election. For this reason it may be advisable to provide that the mortga-
gor’s election to prepay shall, ipso facto, make the mortgage debt become
due at the time and to the extent of the mortgagor ’s election.
   A sample prepayment clause reads as follows.

                                    CLAUSE 3-10

                                Prepayment Clause

    Any owner of the mortgaged premises shall be privileged to prepay
    the debt hereby secured [in full or in multiples of $__] on at least__
    days’ prior written notice to the Mortgagee.


700.      N.Y. REAL PROP. ACTS. LAW § 1351; Golden v. Ramapo Improvement Corp.,
          432 N.Y.S.2d 238 (App. Div. 2d Dep’t 1980) (background of statute). Accord
          MINN. STAT. § 580.09. No splitting of a cause of action is involved because
          part of the debt is not due. Golden, 432 N.Y.S.2d at 241.
701.      3 R. POWELL, REAL PROPERTY ¶ 463 (4) (1990). N.J. REV. STAT. § 2A:50-40 is
          similar to the New York statute.
702.      Baker v. Bloom, 536 N.Y.S.2d 267 (App. Div. 3d Dep’t 1989).



(Friedman on Contracts, Rel. #7, 5/09)   3–151
§ 3:8.5                        FRIEDMAN    ON   CONTRACTS

   On the giving of such notice that a specified sum shall be prepaid,
   such sum, together with the interest thereon accrued, shall become
   due and payable hereunder at the time in such notice specified
   with the same force and effect as if this mortgage made such sum
   payable at the time in such notice specified.
   Any partial prepayment of the debt hereby secured shall be
   credited to the final installment or installments due hereunder,
   and shall not postpone the accrual of any installment of interest or
   principal becoming due after such prepayment.

    If a mortgage requires installment payments, and permits an owner
to prepay part of the debt, there may be a question of whether an owner
who has made partial prepayment may rightfully skip paying one or
more installments, on the ground that these were covered by the
prepayment. The mortgagee could never be certain just when he could
expect the next payment. The little authority on point indicates that
partial prepayment does not postpone the installment next due but is
to be credited against the final payment.703 It is best for the mortgage to
avoid any question by specifying how, in this respect, partial prepayment
is to be treated, as in the final paragraph of the preceding form.

   § 3:8.5          “Brundage” Clause
   The Brundage clause permits acceleration of the debt in the event of
any change in state or local laws “for the taxation of mortgages or
mortgage debts for state or local purposes, or the manner of the
collection of any such taxes.”704 The clause has apparently been used
since 1888 and was named after an upstate New York assemblyman


703.      Annot., 89 A.L.R.3d 947 (1979). Contra Gulf Life Ins. Co. v. Pringle, 216
          So. 2d 468 (Fla. Dist. Ct. App. 1968). Cf. Terraqua Corp. v. Emigrant
          Indus. Sav. Bank, 76 N.Y.S.2d 610 (App. Div. 1st Dep’t 1948) (mortgagee’s
          receipt of proceeds of insurance, in reduction of mortgage, held not to
          postpone accrual of subsequent amortizations).
              The same rule obtains with respect to prepayment under installment
          contracts of sale. Carpenter v. Winn, 566 P.2d 370 (Colo. Ct. App. 1977);
          Edward v. Smith, 322 S.W.2d 770 (Mo. 1959); De Villiers v. Balcomb, 446
          P.2d 220 (N.M. 1968); Zerkel v. Lindsey, 528 P.2d 1041 (Or. 1974); Annot.,
          89 A.L.R.3d 947 (1979); 77 AM. JUR. 2d Vendor and Purchaser § 303
          (1975). Snide v. Larrow, 464 N.E.2d 480 (N.Y. 1984), recognizes the rule
          that application of payment may be directed by debtor in absence of such
          direction, and absent any such direction presumptively to that part of the
          debt first to become due.
              There is no prepayment right by implication under an installment
          contract of sale of realty. Cimarron W. Props. v. Livoln Loan Co., 860 P.2d
          871 (Or. Ct. App. 1993).
704.      Oppenheim v. McGovern, 100 N.Y.S. 712 (App. Div. 1st Dep’t 1906)
          (quoting full clause).



                                      3–152
                             Mortgage Financing                                 § 3:8.6

who sponsored a bill that directed assessors to tax an owner of real estate
only for its value in excess of the amount of mortgages thereon.705
Because the Brundage clause is not included in the statutory short-form
mortgage, courts have held that a lender may not add it to a mortgage
on the basis that it is “implied as a part of the mortgage called for by the
contract.”706

    § 3:8.6          Sale in One Parcel
   This clause provides for the sale of the mortgaged premises in one
parcel in the event of foreclosure. It seeks to overcome any rule that
only so much of the premises shall be sold as shall be necessary to pay
the mortgage debt.707 The reason for requiring a sale in parcels rather
than a whole, where feasible, is to open the sale to more bidders,
obtain better prices, and permit the mortgagor to redeem part of the
property if unable to redeem the whole.708
   In the absence of this clause, there is no general requirement that
an undivided parcel must be sold in foreclosure in parcels, 709 but the
outcome will turn on the particular circumstances involving the
property, including its conveyancing history and mortgage.
   The “sale in one parcel” clause is not necessarily effective where
several parcels are included in a single mortgage. 710


705.      See Wolfman, Book Review, 13 BAR BULL. N.Y. COUNTY LAW. a. 106, 108
          (1955).
706.      Ansorge v. Belfer, 161 N.E. 450 (N.Y. 1928).
707.      Where the mortgaged tract is laid out in parcels the sale should be in
          parcels. Ellsworth v. Lockwood, 42 N.Y. 89, 101 (1870); Ames v. Lock-
          wood, 13 How. Pr. 555 (N.Y. 1856).
              A sale in two parcels was held regular where authorized by the mortgage.
          Keever v. Gen. Elec. Credit Corp., 234 S.E.2d 696 (Ga. Ct. App. 1977).
              Statutes that specify separate sales of farms and tracts have been held
          subject to waiver, where appropriate, by mortgage clauses. John W.
          Swenson & Sons, Inc. v. Aetna Life Ins. Co., 571 F. Supp. 895, 901
          (D. Minn. 1983); George v. Fed. Land Bank, 501 So. 2d 432 (Ala. 1986);
          Ames v. Pardue, 389 So. 2d 927, 930 n.1 (Ala. 1980); Metro. Life Ins. Co. v.
          Foote, 290 N.W.2d 158, 160 (Mich. Ct. App. 1980).
708.      J.H. Morris, Inc. v. Indian Hills, Inc., 212 So. 2d 831, 843 (Ala. 1968); 2 C.
          WILTSIE, MORTGAGE FORECLOSURES § 685 (5th ed. 1939).
              The rule is judge-made but incorporated in many statutes and rules of
          court. See WILTSIE § 682. In New York, premises within the same city lot
          are to be sold together. N.Y. REAL PROP. ACTS. LAW § 231(5). For qualifica-
          tions of the rule, see Lamerson v. Marion, 8 Barb. 9 (N.Y. 1850); Griswold
          v. Fowler, 24 Barb. 135 (N.Y. 1857); WILTSIE § 682 et seq.
709.      Dixon v. Farm Credit Bank, 689 So. 2d 135 (Ala. Ct. Civ. App. 1996).
710.      N.Y. REAL PROP. ACTS. LAW § 231(5): “5. If the property consists of two or
          more distinct buildings, farms or lots, they shall be sold separately, unless
          otherwise ordered by the court; but where two or more buildings are
          situated in the same city lot, they shall be sold together.” The California,
          Minnesota, and North Dakota statutes permit waiver. CAL. CIV. CODE



(Friedman on Contracts, Rel. #7, 5/09)   3–153
§ 3:8.7                        FRIEDMAN    ON   CONTRACTS

   § 3:8.7          Lien Clause
    This provides that if the mortgage is recorded less than four months
after completion of improvements, repairs, or alterations to the
premises (the time within which notice of mechanics’ liens may be
filed)711 the mortgagor will receive advances on the mortgage loan
and the right to receive such advances in trust, first, for the payment
of these items. By including this provision, the mortgagee takes
precedence over mechanics’ liens filed within the time specified, and
the party supplying the work or materials is protected by the trust
fund.712 The words “the right to receive such advances,” added in
1942, protect potential lienors against frustration of this protection by
assignment of advances prior to their actual receipt. The lien clause is
unnecessary in a purchase money mortgage.713
    The Texas mechanic’s lien statute requires the owner to retain 10%
of the contract price for “30 days after the work is completed.”714 To
reach the retained funds, mechanics must file a lien affidavit within
that thirty-day period.715 The time for a subcontractor to file a lien
affidavit runs from the termination of the general contract. In Page v.
Structural Wood Components, Inc.,716 a subcontractor completed its
work on a remodeling project in mid-March. Other work continued
and, after a dispute between the owner and the general contractor, the
owner terminated the general contract on April 14. Thirty-one days
later (May 15) the subcontractor filed a lien affidavit. The owner
hired replacement contractors, who finished the remodeling work on
July 21. The trial court and court of appeals held the lien affidavit was
timely-filed, reasoning that the retainage period continues until com-
pletion of all work contemplated by the original contract, even if
accomplished by a replacement contractor. The supreme court re-
versed, interpreting the statute to restrict retainage and lien filings to
individual contracts. Two justices vigorously dissented.




          § 2924g(b) (“When the property consists of several known lots or parcels,
          they shall be sold separately unless the deed of trust or mortgage provides
          otherwise.”); In re Kjeldahl, 52 B.R. 916 (Bankr. D. Minn. 1985); Prod.
          Credit Ass’n v. Henderson, 429 N.W.2d 421 (N.D. 1988).
711.      N.Y. LIEN LAW § 10(1). The four-month period applies to work on a single-
          family dwelling. For work on other improvements, a mechanic’s lien may
          be filed within eight months of completion. Id.
712.      N.Y. LIEN LAW § 13(5).
713.      Shilowitz v. Wadler, 261 N.Y.S. 351 (App. Div. 3d Dep’t 1932).
714.      TEX. PROP. CODE § 53.101.
715.      Id. § 53.103.
716.      Page v. Structural Wood Components, Inc., 102 S.W.3d 720 (Tex. 2003).



                                      3–154
                             Mortgage Financing                               § 3:8.9

    § 3:8.8          Condemnation
   A condemnation clause is generally added to entitle the mortgagee
to all payments, to the extent of the mortgage indebtedness, plus his
counsel fees, for a taking of the property or any appurtenances, or for a
change of grade. A mortgagee has first right to condemnation awards
without this provision,717 but would not otherwise be entitled to an
award for change of grade.718 A mortgagee has been held to have a lien
on the mortgagor ’s claim against a third party for damages to the
mortgaged premises.719
   In case of partial condemnation, an apparent majority holds the
mortgagee is entitled to the entire award up to the amount of the
mortgage debt.720 But some courts award a mortgagee no more than
enough to avoid impairment of his security.721

    § 3:8.9          Attorneys’ Fees
   Another clause provides that if the mortgagee participates in any
legal proceedings affecting the mortgage, other than an action to
foreclose the mortgage or collect the mortgage debt, the mortgagee’s
expenses of litigation shall be added to the mortgage debt. This clause




717.      Muldoon v. Mid-Bronx Holding Corp., 39 N.E.2d 217, 218 (N.Y. 1942).
718.      Nat’l City Bank v. Cleveland & Buffalo Transit Co., 289 N.Y.S. 405 (App.
          Div. 4th Dep’t 1936). For a note on what constitutes change of grade, see
          Annot., 156 A.L.R. 416 (1945).
719.      L.A. Trust & Sav. Bank v. Bortenstein, 190 P. 850 (2d Dist. Ct. App. 1920)
          (lien on judgment for damage by flood occasioned city ’s tortious acts). The
          case stands possibly alone and is said to be “judge-made law.” McMurray,
          A Review of Recent California Decisions in the Law of Property, 9 CALIF. L.
          REV. 447, 453 (1921).
              A mortgage clause assigning “all award” to the mortgagee was held to
          transfer a claim for restoration against the United States as tenant.
          Sampson v. United States, 529 F.2d 1299 (Ct. Cl.), cert. denied, 426
          U.S. 921 (1976).
720.      Chicago v. Salinger, 52 N.E.2d 184 (Ill. 1933); In re City of New York
          (Houghton Ave.), 193 N.E. 539 (N.Y. 1934); In re Woods Run Ave., 43 Pa.
          Super. 475 (1910).
721.      Swanson v. United States, 156 F.2d 442 (9th Cir. 1946); People v. Redwood
          Baseline Ltd., 149 Cal. Rptr. 11, 17 (4th Dist. Ct. App. 1978) (mortgagees
          entitled to part of award even though property value after condemnation
          exceeded debts); N.J. Transp. Comm’r v. Kastner, 433 A.2d 448 (N.J. Super.
          Ct. 1981); Teague, Condemnation of Mortgaged Property, 44 TEX. L. REV.
          1535, 1540 et seq. (1966). See generally Leipziger, The Mortgagee’s
          Remedies for Waste, 64 CALIF. L. REV. 1086, 1097 (1976); Miller, Valuation
          of the Mortgagee’s Interest upon Partial Condemnation, 15 L OY. L.A. L.
          REV. 227 (1982).



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§ 3:8.10                          FRIEDMAN    ON   CONTRACTS

is enforceable. Provisions for attorneys’ fees are valid where not
forbidden by local law.722
   A provision for attorneys’ fees is applicable to litigation other than
to enforce the mortgage, in which protection of the mortgage lien is
necessary.723

   § 3:8.10            Corporate Execution
   Prior to 1963, in the case of a mortgage made by a corporation
under New York statutory law required consent by the holders of at
least two-thirds of the corporate stock entitled to vote thereon. 724 It
was then customary for a corporate mortgage to contain a recital of
such shareholder consent. This was sufficient to create a presumption
of compliance with a statutory requirement that became conclusive
after one year if the proceeds of the loan were paid to the corpora-
tion.725 Under present statutory law, no vote or consent of stock-
holders is required for a corporate mortgage unless the certificate of
incorporation provides otherwise.726 Accordingly, it is now prudent for
a New York mortgage made by a corporation to recite approval by the
board of directors and an affirmation that the certificate of incorpora-
tion requires no other action, including shareholder approval. 727

   § 3:8.11            Lease Modification
   An “anti-milking” clause provides that no important lease shall be
modified, cancelled, or merged in the fee without the mortgagee’s
consent. The clause may define such a lease as one with a rent over
$10,000 a year and an unexpired term of over two years. Without such
provision, mortgagees were helpless during the 1930s when a mortga-
gor ’s last act before foreclosure might be the cancellation of an



722.       United States v. Pioneer Am. Ins. Co., 374 U.S. 84 (1963); In re Am.
           Motor Prods. Corp., 98 F.2d 774 (2d Cir. 1938); City of Utica v. Gold
           Medal Packing Corp., 283 N.Y.S.2d 603 (Sup. Ct. Oneida County 1967).
723.       Engelsberg v. Cinderella Homes, Inc., 192 N.Y.S.2d 317 (Sup. Ct. Queens
           County 1959) (sets forth clause).
724.       Former N.Y. STOCK CORP. LAW § 16.
725.       Former N.Y. STOCK CORP. LAW § 17.
726.       N.Y. BUS. CORP. LAW § 202(a)(5) (corporation has power, “subject to any
           limitations provided in this chapter or any other statute of this state or its
           certificate of incorporation,” to “mortgage or pledge, or create a security
           interest in, all or any of its property, or any interest therein, wherever
           situated”).
727.       See N.Y. BUS. CORP. LAW § 911: “The board may authorize any mortgage or
           pledge of, or the creation of a security interest in, all or any part of the
           corporate property, or any interest therein, wherever situated. Unless the
           certificate of incorporation provides otherwise, no vote or consent of
           shareholders shall be required to approve such action by the board.”



                                        3–156
                            Mortgage Financing                              § 3:8.11

important lease in return for a substantial payment.728 Sometimes the
purpose of this provision is effected otherwise by collateral assignment
of an important lease to the mortgagee.729 The clause may also forbid
the mortgagor to collect substantial amounts of rent in advance and
thereby interfere with the administration of a foreclosure receiver or a
mortgagee in possession.730 It may also entitle the mortgagee to
statements of the financial operation of the premises and a summary
of leases. Savings banks tend increasingly to require this data, often at
the suggestion of state banking supervisors, in order to keep informed
about their collateral.
   A New York statute, which became effective on July 1, 1960,
permits restriction of an owner ’s power as against a mortgagee,
without the mortgagee’s consent, to cancel, abridge, or otherwise
modify leases or subleases, or accept prepayment of rent.731 Under
this statute, a provision in a recorded mortgage or agreement affecting
a mortgage which so limits an owner, binds existing tenants and
subtenants after their receipt of written notice and a copy of the
provision. After July 1, 1960, the recordation of such a mortgage or
agreement is made sufficient notice to a tenant or subtenant who
acquires his interest after such recordation. The statute is inapplicable
to leases and subleases that are primarily for residential purposes or
that have, at the time of the restriction, an unexpired term of less than


728.      City Bank Farmers Trust Co. v. C.R.H. Bldg. Corp., 36 N.E.2d 683 (N.Y.
          1941); Katzen v. Eight-Twenty Park Ave. Corp., 28 N.Y.S.2d 105 (Sup. Ct.
          N.Y. County), aff ’d, 29 N.Y.S.2d 144 (App. Div. 1st Dep’t 1941); 50 YALE
          L.J. 1424, 1437–38 (1941); 46 HARV. L. REV. 491, 494 et seq. (1933); see 2
          G. GLENN, MORTGAGES § 183 et seq. (1943); G. OSBORNE, MORTGAGES
          § 158 (1951). Contra First Nat’l Bank v. Gordon, 4 N.E.2d 504 (Ill. App.
          Ct. 1936).
              An express covenant by a mortgagor not to cancel or modify leases was
          enforced in Mut. Life Ins. Co. v. Gotham Silk Hosiery Co., 39 N.Y.S.2d
          310 (Sup. Ct. N.Y. County), aff ’d, 43 N.Y.S.2d 514 (App. Div. 1st Dep’t
          1943).
729.      The collateral assignment does not preclude the landlord-mortgagor-
          assignor from enforcing the lease against a tenant while the mortgage is
          in good standing. Fifty States Mgmt. Corp. v. Pioneer Auto Parks, Inc., 355
          N.Y.S.2d 856 (App. Div. 4th Dep’t 1974).
              The collateral assignment bars any modification or cancellation of the
          lease without consent of the mortgagee-assignee. F.W. Woolworth Co. v.
          Buford-Clairmont Co., 769 F.2d 1548, 1554–55 (11th Cir. 1985) (and
          authorities cited).
730.      This clause was enforced in eviction proceedings by a receiver against
          tenants. Dickens v. Smith, 180 N.Y.S.2d 565 (Mun. Ct. Manhattan 1958).
              A similar clause in a recorded New Jersey mortgage was enforced
          against tenants under subsequent subordinate leases. Payment of rents
          in advance was held not binding on the mortgagee. Kirkeby Corp. v. Cross
          Bridge Towers, 219 A.2d 343 (N.J. Super. Ct. 1966).
731.      N.Y. REAL PROP. LAW § 291-f.



(Friedman on Contracts, Rel. #7, 5/09)   3–157
§ 3:8.12                         FRIEDMAN    ON   CONTRACTS

five years. The statute is also inapplicable to a present assignment of
rent.732 After a present assignment, landlord and tenant may not
cancel the lease as against the assignee.733

   § 3:8.12            Survival of Mortgagor’s Liability
    Sometimes a “survival clause” is added to prevent a release of the
personal liability of the mortgagor or a subsequent obligor by events
subsequent to a conveyance of the premises. In general, an agreement
between the mortgagee and a subsequent owner of the premises
extending the time of payment of the mortgage or otherwise modifying
its terms without the consent of the mortgagor, releases the latter from
personal liability. If the subsequent owner assumed the mortgage by an
agreement made with the mortgagor, the subsequent agreement dis-
charges the mortgagor completely;734 otherwise, the release is to the
extent of the value of the property at the time of the modification
agreement.735 A conveyance of the mortgaged property by a subse-
quent owner to the mortgagee, in settlement of a foreclosure, has also
released the original mortgagor.736 It may be wondered how the only
party liable on an instrument can be treated like a surety. The answer
is that, in legal theory, after a conveyance the land is deemed primarily



732.       The statute specifies that a stipulation with respect to it should mention
           the statute. But E. N.Y. Sav. Bank v. 520 W. 57th St. Corp., 611 N.Y.S.2d
           459 (Sup. Ct. 1994), holds that a provision in a mortgage that was
           somewhat similar to the statute without mentioning it barred a mortgagor
           of a residential cooperative tenant building from reducing rents after
           application of a receiver in a foreclosure action.
733.       Poughkeepsie Sav. Bank v. R&G Sloane Mfg. Co., 445 N.Y.S.2d 560 (App.
           Div. 2d Dep’t 1981). Accord Darling Shop v. Nelson Realty Co., 79 So. 2d
           793, 797–98 (Ala. 1954).
734.       Moss v. McDonald, 772 P.2d 626 (Col. Ct. App. 1988); Calvo v. Davies, 73
           N.Y. 211 (1878).
               An assuming grantee’s demolition of buildings, with the mortgagee’s
           consent, released the mortgagor. Lundquist v. Nelson, 395 N.Y.S.2d 568
           (App. Div. 4th Dep’t 1977). The rule with respect to leases differs. A lease
           that permits tenant to assign only with landlord’s consent is deemed to
           imply that landlord may consent. Consequently, such consent does not
           release a surety. See 1 MILTON R. FRIEDMAN, FRIEDMAN ON LEASES § 7:5.2
           (Patrick A. Randolph, Jr., ed., 5th ed. PLI 2006). Here, regardless of
           consent, demolition was a substantial impairment of security.
735.       First Fed. Sav. & Loan Ass’n v. Arena, 406 N.E.2d 1279 (Ind. Ct. App.
           1980); Murray v. Marshall, 94 N.Y. 611 (1884); Branch Banking & Trust
           Co. v. Kenyon Inv. Corp., 332 S.E.2d 186, 193 (N.C. Ct. App. 1985).
               The release is limited in this situation because the mortgagor, who paid
           the mortgage debt, would have a limited right of reimbursement or
           subrogation, that is, against the mortgaged property.
736.       Prigal v. Kearn, 557 So. 2d 647 (Fla. Dist. Ct. App. 1990) (mortgagee then
           resold property at twice amount of mortgage).



                                       3–158
                            Mortgage Financing                               § 3:8.12

liable for the debt and the mortgagor only secondarily so. 737 The
survival clause provides, in the event of any agreement between
the mortgagee and a subsequent owner modifying the mortgage, that
the liability of the mortgagor shall continue nevertheless but modified
in accordance with the tenor of the agreement. This provision is
valid.738 The clause may further provide that after a conveyance of
the premises the mortgagee shall not be required, as a result of any
demand by the mortgagor, to foreclose the mortgage or enforce pay-
ment of the mortgage debt.739 This rule, just mentioned, releasing a
mortgagor, has been carried to this extreme: if the mortgage falls due
after a conveyance by the mortgagor and continues in existence though
not formally extended, and the mortgagee accepts an installment of
interest a few days before it is fully earned, there is a rebuttable
presumption of an extension of the mortgage to the date when such
interest will be so earned, with a possible release of the mortgagor. 740
Accordingly, some mortgages lacking a full survival clause preclude

737.      See generally Milton R. Friedman, Discharge of Personal Liability on Mort-
          gage Debts in New York, 52 YALE L.J. 771 (1943); Stevens, Extension
          Agreements in the “Subject To” Mortgage Situation, 15 U. CIN. L. REV.
          58–60 (1941); Annot., 41 A.L.R. 277 (1926); Annot., 72 A.L.R. 389 (1931);
          Annot., 81 A.L.R. 1016 (1932); Annot., 112 A.L.R. 1324 (1938); 59 C.J.S.
          Mortgages § 400 (1949); 55 AM. JUR. 2d Mortgages § 1391 (1971).
738.      Kohn v. Beggi, 264 N.Y.S. 274 (Sup. Ct. N.Y. County 1933). The clause is
          construed strictly against the mortgagee, First Fed. Sav. & Loan Ass’n v.
          Arena, 406 N.E.2d 1279 (Ind. Ct. App. 1980); Mut. Life Ins. Co. v.
          Rothschild, 160 N.Y.S. 164 (Sup. Ct. N.Y. County 1916), modified, 163
          N.Y.S. 1124 (App. Div. 1st Dep’t 1917), aff ’d, 123 N.E. 880 (N.Y. 1919);
          Excelsior Sav. Bank v. Brill, 163 N.Y.S. 1017 (App. Div. 1st Dep’t 1917),
          aff ’d sub nom. Excelsior Sav. Bank v. Cohen, 127 N.E. 912 (N.Y. 1920),
          and is inapplicable to a modification beyond the scope of the consent, First
          Fed. Sav. & Loan, 406 N.E.2d 1279; Schuck v. Kings Realty Co., 23
          N.Y.S.2d 764 (App. Div. 2d Dep’t 1940), aff ’d, 34 N.E.2d 907 (N.Y.
          1941). See generally Milton R. Friedman, Discharge of Personal Liability
          on Mortgage Debts in New York, 52 YALE L.J. 771, 788 (1943).
               First Fed. Sav. & Loan released a mortgagor because of a modification
          agreement between mortgagee and a subsequent owner. Strict construction
          of a survival clause against mortgagee was based on an apparently unin-
          tended significance of a comma. Punctuation is not often given this
          importance in determination of intent. See 2 MILTON R. FRIEDMAN,
          FRIEDMAN ON LEASES § 26:5.6 (Patrick A. Randolph, Jr., ed., 5th ed. PLI
          2006); 3 A. CORBIN, CONTRACTS § 552, at 209 (1960); 26 C.J.S. Deeds
          § 88 (1956).
739.      Thus, avoiding the possible effect of Pain v. Packard, 13 Johns. 174 (Sup.
          Ct. 1816), a rule applicable in a minority of the states. See A. STEARNS,
          SURETYSHIP § 16 (4th ed. 1934); 10 S. WILLISTON, CONTRACTS § 1236
          (3d ed. 1967); Milton R. Friedman, Discharge of Personal Liability on
          Mortgage Debts in New York, 52 YALE L.J. 771, at 796 (1943).
740.      Germania Life Ins. Co. v. Casey, 90 N.Y.S. 418 (App. Div. 1st Dep’t 1904),
          aff ’d, 76 N.E. 1095 (N.Y. 1906). The rule is in disfavor. Kings County Trust
          Co. v. Giovinco, 194 N.E. 60 (N.Y. 1934); Milton R. Friedman, Discharge



(Friedman on Contracts, Rel. #7, 5/09)   3–159
§ 3:8.13                           FRIEDMAN     ON   CONTRACTS

this possibility by a provision that in such event the mortgagee shall
have the right to return unearned interest or apply it in reduction of
principal.

   § 3:8.13             Escrow Deposits
    Many mortgages, particularly those on houses, require the mortga-
gor to make periodic deposits with the mortgagee to accumulate funds
for payment of taxes and, often, insurance premiums.741 These provi-
sions do not supersede any obligation of the mortgagor to pay taxes,
and impose no liability on the mortgagee if the deposits are insuffi-
cient.742 Nor is the mortgagee obligated to seek a separate tax assess-
ment if the assessment of the mortgaged premises includes other
property.743 A mortgagee with sufficient payments from the mortgagor,
who fails to pay the taxes, is guilty of breach of fiduciary duty and liable
to the mortgagor for damages.744 A general acceleration clause, permit-
ting its exercise for any breach, was held applicable to a mortgagor ’s
failure to make deposits for taxes and insurance premiums.745
    Some authority entitles the mortgagor to interest on these funds.746
Other authority is contra.747 A New York statute, applicable to a




           of Personal Liability on Mortgage Debts in New York, 52 YALE L.J. 771, 784
           (1943).
               Cases pro and con are collected in Shelly v. Bristol Sav. Bank, 26 A. 474,
           476 (Conn. 1893).
741.       A general discussion of this is in Annot., Rights in Funds Representing
           Escrow Payments Made by Mortgagor in Advance to Cover Taxes or
           Insurance, 50 A.L.R.3d 697 (1973). A mortgagee’s right to such deposits
           is restricted by CAL. CIV. CODE § 2954 (1990)
742.       Merrimack Indus. Trust v. First Nat’l Bank, 427 A.2d 500 (N.H. 1981).
743.       Id.
744.       Davis v. Dime Sav. Bank, 557 N.Y.S.2d 775 (App. Div. 3d Dep’t 1990).
745.       Cramer v. Metro. Fed. Sav. & Loan Ass’n, 258 N.W.2d 20 (Mich. 1977),
           cert. denied, 436 U.S. 958 (1978).
746.       Carpenter v. Suffolk Franklin Sav. Bank, 291 N.E.2d 609 (Mass. 1973);
           Tierney v. Whitestone Sav. & Loan Ass’n, 353 N.Y.S.2d 104 (Civ. Ct.
           Queens County 1974); MASS. GEN. LAWS ch. 183, § 61 (1977); see
           Comment, 23 SYRACUSE L. REV. 845 (1972).
               Derenco, Inc. v. Benjamin Franklin Fed. Sav. & Loan Ass’n, 577 P.2d
           477 (Or. 1978), noted in 13 REAL PROP., PROB. & TR. J. 814 (1978) (good
           discussion and collection of cases), a class action, held mortgagors entitled
           to interest at passbook rates on tax and insurance deposits made under
           compulsion, but not on insurance deposits made voluntarily. The decision
           is based on unjust enrichment-quasi contract and constructive trust. The
           court stated it is the first case of last resort in the country to hold this after
           a trial.
747.       Tucker v. Pulaski Fed. Sav. & Loan Ass’n, 481 S.W.2d 725 (Ark. 1972);
           Zelickman v. Bell Fed. Sav. & Loan Ass’n, 301 N.E.2d 47 (Ill. App. Ct. 1973);



                                          3–160
                            Mortgage Financing                               § 3:8.14

mortgage on a one- to six-family residence occupied by the owner and
located in New York State, requires a mortgage investment institution
to pay interest on the average deposits, at a rate to be fixed by the State
Banking Board, but at no less than 2% per annum.748 This has been
extended to residence property owned by a cooperative corporation. 749
These deposits may not be reached by creditors of the mortgagor. 750

    § 3:8.14           Transferable Development Rights
   In Newport Associates, Inc. v. Solow,751 a zoning law permitted a
landowner to improve his land with a building with floor space equal
to (1) the maximum allowed such land under the applicable zoning
law, plus (2) unutilized floor space of adjoining property that was
under lease to such owner.752 The owner held one parcel in fee simple
and held a long-term leasehold in a contiguous parcel. Pursuant to the
zoning law, he transferred development rights from the leasehold
parcel to the fee parcel. The court held that this appropriation of
space, made without the lessor ’s consent, barred full use of the
allowable floor space of the leased premises for an indefinite period.
Under this rule, a mortgagor could presumably divert to adjoining
property unutilized space within the mortgaged premises, to the
prejudice of a mortgagee. A clause, for inclusion in a mortgage,



          Surrey Strathmore Corp. v. Dollar Sav. Bank, 325 N.E.2d 527 (N.Y. 1975);
          Raab v. Bowery Sav. Bank, 355 N.Y.S.2d 748 (Civ. Ct. N.Y. County 1974).
              This represents the majority rule by far. See cases collected in Derenco,
          Inc. v. Benjamin Franklin Fed. Sav. & Loan Ass’n, 577 P.2d 477, 493 n.19
          (Or. 1978).
748.      N.Y. GEN. OBLIG. LAW § 5-601.
              This statute applies to mortgages made after its effective date, July 1,
          1974, and to those theretofore made unless the latter expressly provide no
          interest is to be paid. This statute was fully upheld in Jamaica Sav. Bank v.
          Lefkowitz, 390 F. Supp. 1357 (E.D.N.Y.), aff ’d, 423 U.S. 802 (1975), and in
          Fed. Nat’l Mortgage Ass’n v. Lefkowitz, 390 F. Supp. 1364 (S.D.N.Y. 1975).
          Jamaica deemed it unnecessary to determine, as did Carpenter v. Suffolk
          Franklin Sav. Bank, 291 N.E.2d 609 (Mass. 1973), that the deposits were a
          trust fund.
              The Massachusetts statute, MASS. GEN. LAWS ch. 183, § 61, is applic-
          able to a first mortgage on a dwelling of four or fewer units occupied in
          whole or in part by the mortgagor.
              CONN. GEN. STAT. § 49-2a (but cf. id. § 49-2c) applies to owner-
          occupied residential property of up to four units and housing cooperatives
          occupied solely by shareholders thereof.
749.      N.Y. GEN. OBLIG. LAW § 5-601, as amended by N.Y. Laws 1979, ch. 32.
750.      In re Simon, 167 F. Supp. 214 (E.D.N.Y. 1958). See Jamaica Sav. Bank v.
          Lefkowitz, 390 F. Supp. 1357, 1361 (E.D.N.Y. 1975).
751.      Newport Assocs., Inc. v. Solow, 283 N.E.2d 600 (N.Y. 1972), cert. denied,
          410 U.S. 931 (1973).
752.      Id.



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§ 3:8.14                         FRIEDMAN    ON   CONTRACTS

forbidding this is set forth below. It involves development rights,
colloquially called “air rights.”753

                                   CLAUSE 3-11

                           Development Rights Clause

   Mortgagor shall not permit the mortgaged premises or any part
   thereof to be used to qualify for fulfillment of any municipal or
   other governmental requirements for the construction or mainte-
   nance of any building, structure, or other improvement on premises
   not mortgaged hereunder; and mortgagor hereby assigns to mort-
   gagee all rights to consent to such use. No building or other
   improvement now or hereafter constructed on the mortgaged
   premises shall rely on any premises not mortgaged hereunder in
   order to qualify for fulfillment of any municipal or other govern-
   mental requirements. Mortgagor shall not impair, or permit impair-
   ment of, the integrity of the mortgaged premises as a single zoning
   lot or lots separate and apart from other premises. Any attempt
   by mortgagor to violate any of the provisions of this paragraph
   shall be void.754

   Without such a clause, a court might protect the mortgagee under
some circumstances. In a Florida case, the mortgagor ’s transfer of
development rights, which diminished the value of the property and
made the mortgagee’s lien insufficient security, resulted in giving the




753.       For more on air and development rights and a list of relevant authorities,
           see 1 MILTON R. FRIEDMAN, FRIEDMAN ON LEASES § 3:2.2[G] (Patrick A.
           Randolph, Jr., ed., 5th ed. PLI 2006). See also Brennan, Lots of Air—A
           Subdivision in the Sky, REAL PROP., PROB. & TR. J. 24–30 (1955); Pfister,
           Airspace: A New Dimension in Property Law, 1960 U. ILL. L. FORUM
           303–13; Note, Conveyance and Taxation of Air Rights, 64 COLUM. L. REV.
           338–54 (validity of air right conveyances, method of execution, drafting
           problems, tax consequences); Bell, Air Rights, 23 ILL. L. REV. 250 (1928);
           Ball, Landscape Above the Surface, 39 YALE L.J. 616 (1930); Liebman,
           Development of Air Rights, N.Y.L.J., Nov. 12, 13, 14, 15 (1968); E. Morris,
           Air Rights: Fertile Field, N.Y.L.J., Apr. 13, 14, 15, 16 (1970); Richards,
           Transferable Development Rights: Corrective, Catastrophe or Curiosity, 12
           REAL ESTATE L.J. 26 (1983); Pedowitz, Transfer of Air Rights and Develop-
           ment Rights, 9 REAL PROP., PROB. & TR. J. 183 (1974); Pedowitz, Transfer-
           able Development Rights, 19 REAL PROP., PROB. & TR. J. 604 (1984).
754.       Based on a clause made available through the courtesy of B. Harrison
           Frankel, Esq., of the New York Bar. A comparable provision should be
           included in any lease that could empower the tenant to appropriate
           unutilized space in the leased property for the benefit of other property.



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mortgagee a lien on the property to which the rights were
transferred.755

§ 3:9         Junior Mortgages
   The foregoing discussion is as applicable to a second or junior
mortgage as to a first mortgage. But it is customary to include in junior
mortgages a provision to the effect that (1) any default in the first
mortgage shall, ipso facto, constitute a default in the junior mortgage
and permit its foreclosure,756 and (2) the mortgagee may cure any
default in the first mortgage and add the cost thereof, with interest, to
the junior indebtedness. This clause is virtually standard and unobjec-
tionable, provided its phraseology permits foreclosure only after ex-
piration of any grace period in the first mortgage.
   A junior mortgage occasionally provides that if the amount of any
prior mortgage is increased, a sum equal to such increase will be paid
in reduction of the junior mortgage. A provision of this type is apt to be
a form of right to prepay the junior mortgage, depending on its
language, and should be considered in this light. It has been held
that the prior mortgagee is not obligated to see that this payment is
made. The court found it unnecessary to determine the mortgagor ’s
liability for this payment or whether the failure to make this payment
made the lien of the junior mortgage paramount to the extent of the
increase in the senior mortgage.757 The clause entitling a junior
mortgagee to a payment in reduction of his mortgage, equal to any
increase in the prior mortgage, was held inapplicable to a situation in
which the senior mortgagee elected to apply the proceeds of fire
insurance in reduction of his mortgage and then reloaned a similar
sum to the mortgagor at an increased rate of interest. 758 In a
Kentucky case a first mortgage was subordinated to a bank mortgage
that was not to exceed $125,000. Subsequently, the bank mortgage



755.      Gordon v. Flamingo Holding P’ship, 624 So. 2d 294 (Fla. Dist. Ct. App.
          1993). The court noted that this remedy would be sparingly applied.
756.      A mortgagor under a junior mortgage was relieved from acceleration, based
          on a clause of this nature, where the mortgagor paid interest on the senior
          mortgage after its due date but before expiration of the grace period
          permitted by the senior mortgage. Trowbridge v. Malex Realty Corp., 191
          N.Y.S. 97 (App. Div. 1st Dep’t 1921).
             A clause making breach of a paramount mortgage automatically a
          default in a junior mortgage was enforced in Crescent Beach Co. v.
          Conzelman, 321 So. 2d 437 (Fla. Dist. Ct. App. 1975).
757.      Zelnick v. Kings County Sav. Bank, 218 N.Y.S.2d 876 (Sup. Ct. N.Y.
          County 1961), aff ’d, 224 N.Y.S.2d 270 (App. Div. 1st Dep’t 1962).
758.      Zelnick v. Kings County Sav. Bank, 232 N.Y.S.2d 541 (Sup. Ct. N.Y.
          County 1962).



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was increased to $200,000 without consulting the subordinated
mortgagee. In a foreclosure action the bank applied the proceeds of
sale first to its debt above $125,000. This was held improper for lack
of fair dealing. The result could have been explained on the ground of
marshalling assets.759
    A provision in a mortgage forbade the making of junior mortgages.
It was held that a junior mortgage made despite the provision was not
void but merely permitted acceleration of the prior mortgage, treating
the provision as a due-on-sale clause. The matter arose in the bank-
ruptcy of the mortgagor who made the junior mortgage but never-
theless claimed it was void. If true this would have made the junior
debt an unsecured claim.760 Another mortgage permitted acceleration
if the property was sold or transferred. The clause did not refer to
encumbrances. A divided court held that making a junior mortgage
was permissible, but its enforcement by foreclosure permitted accel-
eration of the senior mortgage.761
    A mortgagee’s covenant to subordinate to another mortgage, and
any renewals or consolidations thereof, on payment of $31,500, was
held to require more than one subordination and payment, on the
ground that “consolidation” contemplates additional funding and,
therefore, more than one mortgage.762
    Occasionally, where the senior mortgage requires periodic amorti-
zations, an additional clause is included in a junior mortgage. In-
asmuch as every payment in reduction of the first mortgage increases
the security of the junior mortgagee, the latter is interested in seeing
such amortizations made. The clause requires additional payments on
the junior mortgage in a sum equal to any amortizations unpaid on
the senior mortgage, regardless of any waiver thereof by the senior
mortgagee, and, further, that these additional payments shall not
affect the regular payments, if any, required under the junior mortgage.
In the absence of such a clause, a waiver of amortization by the senior
mortgagee would prevent a junior mortgagee from invoking a clause




759.    Ranier v. Mount Sterling Nat’l Bank, 812 S.W.2d 154 (Ky. 1991). The
        subordination agreement did not require reduction of the subordinated
        mortgage by any increase in the paramount mortgage.
760.    In re Henson, 103 F.3d 470 (5th Cir. 1997).
761.    Unifirst Fed. Sav. & Loan Ass’n v. Tower Loan, Inc., 524 So. 2d 290 (Miss.
        1986). One reason for barring a junior mortgage is similar to that involving
        a due-on-sale clause. Other reasons are that payments on a junior lien may
        exhausts funds necessary to pay the senior mortgage, particularly where
        the first mortgage is nonrecourse.
762.    Statland Holliday, Inc. v. Stendig Dev. Corp., 362 N.Y.S.2d 2 (App. Div. 1st
        Dep’t 1974).



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                              Mortgage Financing                            § 3:9

under which a default in a senior mortgage becomes, ipso facto, a
default in the junior mortgage.763
   A sample subordination clause for inclusion in a junior mortgage is
provided below.

                                    CLAUSE 3-12

                   Subordination Clause in Junior Mortgage

    This mortgage is subject and subordinate to a certain mortgage
    covering said premises, dated _______________, made by
    _______________ to _______________, and recorded on
    _______________, in the Office of _______________ in Book __
    at page ___, which mortgage was given to secure the sum of
    $_______ and interest at the rate of _______%, on which mortgage
    there is now owing the sum of $________, with interest from
    _____________.
    If said prior mortgage shall be in default for any reason, and should
    said default continue for ten (10) days or more, or should any suit
    be commenced to foreclose said prior mortgage, then the amount
    secured by this mortgage and the accompanying note shall be due
    and payable at the option of the owner or holder of this mortgage. If
    said prior mortgage shall be in default by reason of nonpayment of
    the principal or interest, or any part thereof, or otherwise, the
    owner or holder of this mortgage may cure such default and the
    cost of curing such default, with interest at the rate of _______% per
    annum from the time of the advance or advances therefore, shall be
    added to the indebtedness secured by this mortgage and the
    accompanying note, and may be collected thereunder at any
    time after the time of such advance or advances therefore.
    If payment of the principal or interest or any part of principal or
    interest, secured by said prior mortgage shall not be made at the
    time in said prior mortgage specified, then regardless of any
    postponement, extension, indulgence, or forgiveness thereof which
    may be agreed to or acquiesced in by the holder of said prior
    mortgage, a sum equal to the amount of such principal or part
    thereof shall immediately become due and payable in reduction of
    this mortgage, provided, however, that nothing herein contained
    shall be deemed or construed to entitle the owner or holder of this


763.      Bohland v. Horn, 153 A. 588 (N.J. Ch. 1931); accord 100 Eighth Ave.
          Corp. v. Morgenstern, 150 N.Y.S.2d 471 (Sup. Ct. Kings County 1956),
          modified, 164 N.Y.S.2d 812 (App. Div. 2d Dep’t 1957) (agreement reducing
          amortizations under senior mortgage); Guleserian v. Fields, 351 Mass.
          238, 218 N.E.2d 397 (1966) (same).



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§ 3:9                        FRIEDMAN    ON   CONTRACTS

   mortgage to any payment in excess of the sum hereby secured and
   accrued interest.

   This clause does not contemplate an increase in the prior mortgage,
with a compensatory reduction of the junior mortgage, as described
above.
   A paramount mortgage may be modified or extended by agreement
between the mortgagee and the owner, without the consent of a junior
mortgagee and without affecting the priority of the respective liens. 764
The agreement may include a waiver of amortizations765 as well as an
increase in interest rate766 without giving the junior mortgagee a right
to foreclose. A paramount mortgage may be consolidated with another
without consent of a junior mortgagee, or an agreement between the
paramount mortgagee and the mortgagor may increase the interest
rate of the paramount mortgage, also without consent of a junior
mortgagee.
   Such modifications, however, are ineffective as to a junior mort-
gagee to the extent that they increase the amount of the paramount
mortgage unless the junior mortgagee has subordinated its lien or
consented to them.767 The agreement is nonbinding on the junior
mortgagee in an action to foreclose the paramount mortgage and cut




764.    Resolution Trust Corp. v. BVS Dev., Inc., 42 F.3d 1206 (9th Cir. 1994)
        (term of construction mortgage extended five months); Barbano v. Cent.-
        Hudson Steamboat Co., 47 F.2d 160 (2d Cir. 1931); Eurovest Ltd. v. 13290
        Biscayne Island Terrace Corp., 559 So. 2d 1198 (Fla. Dist. Ct. App. 1990);
        Aetna Cas. & Sur. Co. v. Valdosta Fed. Sav. & Loan Ass’n, 333 S.E.2d 849
        (Ga. Ct. App. 1985) (modification of mortgage; release of mortgagor no
        novation); Guleserian v. Fields, 218 N.E.2d 397 (Mass. 1966) (and cases
        collected); Hyman v. Hauff, 21 N.Y.S. 984 (C.P.), aff ’d on other grounds, 33
        N.E. 735 (N.Y. 1893); Meislin, Extension Agreements and the Rights of
        Junior Mortgagees, 42 VA. L. REV. 939, 943 n.17 (1956). But see Citizens &
        S. Nat’l Bank v. Smith, 284 S.E.2d 770 (S.C. 1981) (priority lost).
        Execution of a renewal note is not, without more, a discharge of the
        original debt but only an extension of time for its payment. In re Lambert
        Enters., Inc., 21 B.R. 529 (Bankr. W.D. Va. 1982).
765.    Guleserian v. Fields, 218 N.E.2d 397 (Mass. 1966); 100 Eighth Ave. Corp.
        v. Morgenstern, 150 N.Y.S.2d 471 (Sup. Ct. Kings County 1956), modified,
        164 N.Y.S.2d 812 (App. Div. 2d Dep’t 1957).
766.    Barbano v. Cent.-Hudson Steamboat Co., 47 F.2d 160 (2d Cir. 1931); 100
        Eighth Ave. Corp. v. Morgenstern, 150 N.Y.S.2d 471 (Sup. Ct. Kings
        County 1956), modified, 164 N.Y.S.2d 812 (App. Div. 2d Dep’t 1957).
767.    Shane v. Winter Hill Fed. Sav. & Loan Ass’n, 492 N.E.2d 92 (Mass. 1986);
        Société Générale v. Charles & Co., 597 N.Y.S.2d 1004, 1008 (Sup. Ct. N.Y.
        County 1993) (consolidation of two mortgages on condominium does not
        deprive condominium association of its statutory priority over all mort-
        gages except first mortgage).



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                              Mortgage Financing                                  § 3:9

off the junior lien if it is prejudicial to the junior lienor.768 Moreover, in
an extreme case, where the change in the paramount mortgage has
substantially impaired the security interest of the junior mortgage, the
lien of the latter has been elevated above the paramount mortgage. 769
In this situation some authorities subordinate only that part of the
modification that is prejudicial to the junior mortgage. 770
   A similar result follows under the discharge rules applicable to
mortgage notes governed by Article 3 of the Uniform Commercial
Code. An agreement that impairs recourse or collateral discharges a
secondary obligor, except where liability is preserved by a prior consent
provision incorporated in the note or otherwise given.771
   A similar analysis applies to priority disputes between tenants and
mortgagees when mortgages are modified or consolidated. The exten-
sion and consolidation of mortgages does not affect the priority of an
earlier mortgage over a subordinate lease or other interest. 772
   The holder of a first mortgage has been held entitled to subordinate
its mortgage to a lease, in exercising its business judgment that its
interest would be served by foreclosing subject to the continuation of
this lease. Junior lienors had sought to set aside the subordination,
presumably in the belief that the property would be more valuable if
free of the lease.773



768.      Remodeling & Constr. Corp. v. Melker, 65 N.Y.S.2d 738 (Sup. Ct. Kings
          County), aff ’d, 64 N.Y.S.2d 175 (App. Div. 2d Dep’t 1946); see Barbano v.
          Cent.-Hudson Steamboat Co., 47 F.2d 160, 162–63 (2d Cir. 1931); Empire
          Trust Co. v. Park-Lexington Corp., 276 N.Y.S. 586, 592 (App. Div. 1st
          Dep’t 1934); Diamond v. Tau Holding Corp., 226 N.Y.S. 129, 132 (Sup.
          Ct. N.Y. County 1927).
              In an action by a second mortgagee to foreclose, and to redeem from a
          prior mortgage, an extension of the prior mortgage was held no reason for
          denial of relief when the plaintiff had neither actual nor constructive notice
          of the extension of the first mortgage when he acquired the second.
          Wheeler v. Menold, 47 N.W. 871 (Iowa 1891).
769.      Gluskin v. Atl. Sav. & Loan Ass’n, 108 Cal. Rptr. 318 (Ct. App. 1973) (term
          of construction mortgage shortened from thirty years to ten months;
          interest rate increased).
770.      Lennar Ne. Partners v. Buice, 57 Cal. Rptr. 2d 435 (Ct. App. 1996); Shultis
          v. Woodstock Land Dev. Assocs., 594 N.Y.S.2d 890 (App. Div. 3d Dep’t
          1993).
771.      U.C.C. § 3-605. See Crown Life Ins. Co. v. Haag, Ltd. P’ship, 929 P.2d 42
          (Colo. 1996) (interpreting former U.C.C. § 3-606(1)(b).
772.      UMB Bank & Trust Co. v. S.H.M. W. Parking Corp., 581 N.Y.S.2d 324
          (App. Div. 1st Dep’t 1992); Dominion Fin. Corp. v. 275 Wash. St. Corp.,
          316 N.Y.S.2d 803, 806 (Sup. Ct. Westchester County 1970).
773.      Landau v. W. Pa. Nat’l Bank, 282 A.2d 335 (Pa. 1971). An alternative
          reason was that the parties seeking to rescind the subordination, which
          would lead to termination of the lease, had “either negotiated or ratified
          the lease,” to which they were legally bound as lessors.



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§ 3:9                        FRIEDMAN     ON   CONTRACTS

   Recordation of a first mortgage gave a junior mortgagee continuous
notice of a superior lien, although an assignment of the first mortgage
was not recorded until after recordation of the junior mortgage. 774
   Holders of various liens may alter the order of priority by agreement
between themselves, without consent of the mortgagor-owner.775 A
subordination agreement is subject to the statute of frauds, 776 but the
statute may be inapplicable where there is an equitable estoppel after
an advance made in reliance on a subordination. 777
   In a Virginia case, a purchaser under a sale-leaseback arrangement
fraudulenty induced the seller to sign a subordination agreement. 778
The purpose of the subordination was to obtain a new mortgage that
would prime the seller ’s purchase money mortgage. The court held
that the subordination agreement was voidable and that under the
Virginia third-party beneficiary statute779 the seller has a rescission
right that she could assert against the new mortgagee, even though
that lender lacked notice of the fraud. Query whether this result could


            Substantially contra to Landau is G.B. Seeley’s Son, Inc. v. Fulton-
        Edison, Inc., 382 N.Y.S.2d 516 (App. Div. 2d Dep’t 1976). It holds that, at
        the insistence of the mortgagor, the holder of a mortgage (1) must join and
        cut off a subordinate tenant in foreclosure, and (2) could not subordinate
        the mortgage to the lease without the mortgagor ’s consent. The court cited
        N.Y. REAL PROP. ACTS. LAW § 1311, which requires a foreclosing mortgagee
        to join a tenant he claims to be subordinate. However, there is no
        requirement that the mortgagee make this claim. The case is inconsistent
        with Metropolitan Life Ins. Co. v. Childs Co., 130 N.E. 295 (N.Y. 1921),
        despite a statutory change since Metropolitan Life. The latter case holds a
        foreclosing paramount mortgagee has the option of cutting off or confirm-
        ing a subordinate lease. In Seeley, the court may have been influenced by
        the fact that the plaintiff in foreclosure, an assignee of the mortgage, was
        an alter ego of the tenant.
            Accord with Metropolitan Life, 130 N.E. 295, and stating the majority
        rule requires joinder of a subordinate tenant to cut off his lease is Citizens
        Bank & Trust Co. v. Bros. Constr. & Mfg., Inc., 859 P.2d 394 (Kan. Ct.
        App. 1993) (citing contra cases). A lease paramount to a mortgage is
        unaffected by foreclosure of a subordinate mortgage.
774.    Bank W. v. Henderson, 874 P.2d 632 (Kan. 1994).
775.    Graydon v. Colonial Bank-Gulf Coast Region, 597 So. 2d 1345 (Ala.
        1992); Oakes v. Mich. Oil Co., 476 So. 2d 618 (Ala. 1985); Morgan v.
        Kline, 42 N.W. 558 (Iowa 1889); Putnam v. Broten, 232 N.W. 749 (N.D.
        1930).
776.    L&R Realty v. Conn. Nat’l Bank, 732 A.2d 181 (Conn. App. Ct. 1999)
        (statute of frauds bars enforcement of bank’s oral agreement to subordinate
        mortgage to future construction mortgage); Metrobank for Sav. v. Nat’l
        Cmty. Bank, 620 A.2d 433 (N.J. Super. Ct. 1993). Contra N. Ga. Sav. &
        Loan Ass’n v. Corbeil, 339 S.E.2d 779 (Ga. Ct. App. 1986).
777.    See Metrobank for Sav. v. Nat’l Cmty. Bank, 620 A.2d 433, 439 (N.J.
        Super. Ct. 1993).
778.    Ashmore v. Herbie Morewitz, Inc., 475 S.E.2d 271 (Va. 1996).
779.    VA. CODE § 55-22.



                                     3–168
                              Mortgage Financing                                  § 3:9

have been obtained in the absence of the statute on the ground of an
agency relation? If so, it might be applicable to fraudulent delivery of
other instruments, for example, delivery of a deed, etc.
   A mortgage whose proceeds were used to satisfy a prior mortgage
may generally be subrogated to the lien of the prior mortgage as against
intervening liens,780 except where the intervening liens may be
adversely affected.781 In the ordinary case, the lender who refinances




780.      S. Colonial Mortgage Co. v. Medeiros, 347 So. 2d 736 (Fla. Dist. Ct. App.
          1977); Davis v. Johnson, 246 S.E.2d 297 (Ga. 1978); Gutermuth v.
          Ropiecki, 387 A.2d 385 (N.J. Super. Ct. Ch. Div. 1977) (subrogation to
          prior judgments as well as mortgages); Resolution Trust Corp. v. Barnhart,
          862 P.2d 1243 (N.M. 1993); King v. Pelkofski, 229 N.E.2d 435 (N.Y. 1967);
          Wagner v. Maenza, 636 N.Y.S.2d 857 (App. Div. 2d Dep’t 1996); Dedes v.
          Strictland, 414 S.E.2d 134 (S.C. 1992); Auto Acceptance & Loan Corp. v.
          Taus, 137 N.W.2d 452 (Wis. 1965). Cf. Betts v. Brown, 136 S.E.2d 365 (Ga.
          1964). Full subrogation to the lien of a first mortgage was enforced, despite
          an underpayment, where this was due to an error by the original first
          mortgagee. Mut. Life Ins. Co. v. Grissett, 500 F. Supp. 159 (M.D. Ala.
          1980).
              A variance of this is the rule that a new mortgage that secures the old
          debt does not extinguish the original lien. Marine Bank v. Hietpas, Inc.,
          439 N.W.2d 604 (Wis. Ct. App. 1989).
              This principle was applied where the proceeds of a mortgage, nullified
          by defective execution, were mostly applied to satisfy an existing mortgage.
          The mortgagee was given a lien to the extent of the earlier mortgage.
          Assocs. Fin. Serv. Co. v. Bennett, 611 So. 2d 973 (Miss. 1992).
              In La. Nat’l Bank v. Belello, 577 So. 2d 1099 (La. Ct. App. 1991), the
          proceeds of a third mortgage were used to pay off a first mortgage. This was
          held not to advance the third mortgage above the second. The court noted
          the alleged existence of a verbal subordination, which it found did not exist
          and it cast doubt on the effect of a verbal subordination if it did exist. The
          court denied that this was an unjust enrichment of the second mortgagee.
          Subrogation was not discussed.
781.      Gen. Builders Supply Co. v. Arlington Coop. Bank, 271 N.E.2d 342 (Mass.
          1971).
              A lender who advances money and takes a mortgage as security may be
          subrogated to the priority rights of an old mortgage by assignment or
          subordination, but does not take priority if he knows of the existence of a
          junior mortgage. Metrobank for Sav. v. Nat’l Cmty. Bank, 620 A.2d 433
          (N.J. Super. Ct. 1993).
              An unrecorded mortgage, whose proceeds were used to discharge
          another mortgage, was held subordinate to the rights of the mortgagor ’s
          trustee in bankruptcy. In re Bridge, 18 F.3d 195 (3d Cir. 1994) (New Jersey
          law). Contra, as to mechanic’s lien. First Nat’l Bank v. Cardinal Roofing &
          Siding, Inc., 630 So. 2d 1101 (Fla. Dist. Ct. App. 1949).
              A Federal tax lien filed after erroneous discharge of a mortgage (for
          mistaken belief of its payment) was held prior to a subsequent reinstate-
          ment of the mortgage on the ground that the government was a hypothe-
          tical judgment creditor. In re Haas, 31 F.3d 1081 (11th Cir. 1994).



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§ 3:9                        FRIEDMAN    ON   CONTRACTS

the prior mortgage is ignorant of the intervening lien due to a faulty
title search. Eastern Savings Bank v. Pappas 782 is illustrative. In
Eastern Savings Bank, a landowner executed a deed of trust to secure
a loan for $159,000 in 1990. In 1998, the owner refinanced the debt
with a new $168,000 loan from a different lender; several years later
judgment creditors filed judgment liens against the owner. The owner
defaulted, and the refinancing lender commenced foreclosure. Its title
search failed to disclose the liens; it thus had constructive, but not
actual, notice of the intervening liens. The trial court held that the
judgment creditors had the prior lien under the “first in time, first in
right” principle, but the appellate court reversed. Under equitable
subrogation, the refinancing lender had priority to the extent (and
only to the extent) of the debt it refinanced.
    Often the refinancing lender ’s ignorance of the intervening lien is
due to negligence, either on its part or on the part of its agent. Courts
commonly hold that proof of negligence makes no difference in the
outcome—the negligent lender is still subrogated to the senior lien. 783
    If, however, the refinancing lender has actual knowledge of the
intervening lien but made the loan anyway, equitable subrogation
might not be available. Although the Restatement sanctions equitable




782.    E. Sav. Bank v. Pappas, 829 A.2d 953 (D.C. 2003) (following R ESTATEMENT
        (THIRD) OF PROPERTY (Mortgages) § 7.6 (1997)).
783.    In Houston v. Bank of Am. Fed. Sav. Bank, 78 P.3d 71 (Nev. 2003), a bank
        agreed to refinance a mortgage loan, ordering a title report, which disclosed
        no defects. Twenty-seven days later, the bank funded the loan. Earlier on
        the day the bank filed its mortgage for recordation, plaintiffs, who were
        suing the owner, filed a prejudgment writ of attachment, which supple-
        mented a lis pendens filed three days after completion of the title report.
        After obtaining judgment, plaintiffs sought a writ of execution in order to
        force a sale of the property. The court granted the bank priority over the
        plaintiffs’ lien by applying the doctrine of equitable subrogation. This
        allows the refinancing lender to retain the priority of the retired mortgage
        debt, up to the amount of that debt paid off by the new lender. In some
        states, the bank would not be entitled to equitable subrogation if it had
        actual notice of the intervening lien, had constructive notice, or had
        committed negligence. The court adopted the rule of R ESTATEMENT
        (THIRD) OF PROPERTY (Mortgages) § 7.6 (1997), which disregards notice
        and negligence, provided the junior lienholder is not prejudiced. Thus,
        under the Restatement approach, plaintiffs’ claim that the bank was
        negligent in failing to update the title report prior to closing the loan
        was not relevant. Accord, Lamb Excavation, Inc. v. Chase Manhattan
        Mortgage Corp., 95 P.3d 542 (Ariz. Ct. App. 2004) (applying equitable
        subrogation to grant priority to permanent lender over mechanics’ liens;
        court observed it did not matter whether permanent lender was negligent
        in failing to discover liens).



                                     3–170
                              Mortgage Financing                                    § 3:9

subrogation even in the face of actual knowledge, 784 the Washington
State Supreme Court has disagreed.785 This may be more easily
accomplished when the original mortgage specified the mortgagee’s
lien was “together with all renewals thereof.”786 This rule inures to the
benefit of an assignee of the superseding mortgage, 787 but not to
the benefit of one who assumes or is liable for the payment of the
intervening lien.788 The priority of the superseding mortgage is to the


784.      RESTATEMENT (THIRD) OF PROPERTY (Mortgages) § 7.6, comment e (1997):
             Most of the cases disqualify the payor who has actual knowledge of
             the intervening interest, although they do not consider constructive
             notice from the public records to impair the payor ’s right of
             subrogation. Under this Restatement, however, subrogation can
             be granted even if the payor had actual knowledge of the intervening
             interest; the payor ’s notice, actual or constructive, is not necessarily
             relevant. The question in such cases is whether the payor reason-
             ably expected to get security with a priority equal to the mortgage
             being paid.
              A number of states follow the minority position, espoused by the
          Restatement, that the refinancing lender ’s actual knowledge of an inter-
          vening lien is irrelevant. E.g., LaSalle Bank, N.I. v. First Am. Bank, 736
          N.E.2d 619 (Ill. App. Ct. 2000) (construction lender ’s knowledge of
          buyer’s contract of purchase with developer does not disqualify lender
          from invoking equitable subrogation when its proceeds paid off a prior
          mortgage).
785.      Kim v. Lee, 31 P.3d 665 (Wash. 2001) (title insurance company, which
          obtained actual knowledge of judgment lien between the time it issued
          commitment and the policy, is subordinate to lien).
786.      That was the situation in Hummel v. Hummel, 896 P.2d 1203 (Okla. Ct.
          App. 1995). There, husband and wife were liable on the original mortgage.
          Upon their divorce, the property was awarded to the ex-wife, and the ex-
          husband was given a junior mortgage. After this the first mortgage was
          renewed. Because the ex-husband was a co-signer, the rule that one cannot
          prefer a mortgage he owns to one he owes might appear to be applicable.
787.      Provident Coop. Bank v. James Talcott, Inc., 260 N.E.2d 903 (Mass. 1970).
788.      J. POMEROY, EQUITY JURISPRUDENCE § 1213 (5th ed. 1941); see Milton R.
          Friedman, Creation and Effect of Personal Liability on Mortgage Debts in
          New York, 50 YALE L.J. 224, 242 et seq. (1940); Note, Subrogation of
          Purchaser to Rights of Mortgagee, 48 YALE L.J. 683, 687 (1939).
              Another example of the “a mortgagor cannot prefer a mortgage he owns
          to a mortgage he owes but does not own” doctrine (Quackenbush v.
          Quackenbush, 225 N.Y. Supp. 152 (Sup. Ct. Cattaraugus County 1927)),
          is Milbrandt v. Huber, 440 N.W.2d 807 (Wis. 1989), and Peat Marwick,
          Mitchell & Co. v. Bates, 839 P.2d 208 (Okla. Ct. App. 1992). The doctrine
          may be illustrated by the following: (1) X buys Blackacre subject to a
          mortgage he does not assume; (2) X gives mortgage B, a second mortgage,
          which may or not be a purchase money mortgage, on which X is liable;
          (3) thereafter whether or not he still owns Blackacre, X becomes owner of
          mortgage A. As between X and the second mortgagee, mortgage B becomes
          a first mortgage and mortgage A a second. X’s liability on the second
          mortgage precludes any priority of mortgage A that X owns. See more cases
          discussed in Transamerica Fin. Serv., Inc. v. Lafferty, 856 P.2d 1188, 1193



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extent of the earlier mortgage, as of the time of its cancellation, less
any sums applicable in reduction of the superseding mortgage. 789
Under the same reasoning the discharge of a mortgage and its
simultaneous replacement by another, as by the substitution of a
construction mortgage by a permanent mortgage, does not subordinate
the new mortgage to interim liens, in the absence of paramount


        (Ariz. 1993). But see Ray v. Atkins, 421 S.E.2d 317 (Ga. Ct. App. 1992). A
        mortgagee cannot avoid result by “filter through,” that is by acquiring the
        mortgage from a bona fide purchaser. Chergosky v. Crosstown Bell, Inc.,
        463 N.W.2d 522 (Minn. 1990). The rule that one cannot prefer a mortgage
        he owns over one he owes has been applied where the mortgagor is liable
        on the junior mortgage. It has been logically suggested that the rule should
        also apply when he is not so liable, on the ground that his payment of the
        senior mortgage is merely paying the consideration for the property.
        Burkhart, Freeing Mortgages of Merger, 40 VAND. L. REV. 283, 362
        (1987). This would not apply after he sells the property. In fact, a borrower
        who sells the property subject to the mortgage and thereby allows its
        amount in reduction of the purchase price and thereafter pays off the
        mortgage would apparently be entitled to be subrogated to the lender ’s
        rights. Any other result would be an unjust enrichment of the then-owner
        of the property. See also In re Estate of Grozier, 587 N.E.2d 77 (Ill. App. Ct.
        1992).
            In Old Republic Ins. Co. v. Currie, 665 A.2d 1153 (N.J. Super. Ct.
        1995), a mortgagor lost title by foreclosure of a first mortgage and
        subsequently went bankrupt. Thereafter the former mortgagor repurchased
        the property, which was thereby held to reinstate a former junior mortgage
        by reason of a warranty of title in the junior mortgage. The warranty, made
        by the same former mortgagor, was not discharged in bankruptcy.
789.    Provident Coop. Bank v. James Talcott, Inc., 260 N.E.2d 903 (Mass. 1970).
        Assocs. Fin. Serv. Co. v. Bennett, 611 So. 2d 973 (Miss. 1992); Resolution
        Trust Corp. v. Barnhart, 862 P.2d 1243 (N.M. 1993).
            An example of this is ITT Diversified Credit Corp. v. First City Capital
        Corp., 737 S.W.2d 803 (Tex. 1987). There, a third lien was foreclosed. The
        first and third lienors had made an agreement exchanging their priorities.
        The former third lien was held prior to the second, but only to the amount
        of the former first lien.
            Another example is Fid. Union Title & Mortgage Guar. Co. v. Magni-
        fico, 151 A. 499 (N.J. Ch. 1930). There, a mortgage was given to secure a
        payment price, plus an additional cash advance, that is, it was a purchase
        money mortgage to the extent it secured payment of the purchase price.
        This mortgage was paramount to another purchase money mortgage but
        only to the extent that it was a purchase money mortgage. A judgment
        lienor against the mortgagor was held subordinate to both mortgages, but,
        subordinate to the first only to the extent it was a purchase money
        mortgage.
            See also the discussion and cases in In re Cliff ’s Ridge Skiing Corp.,
        123 B.R. 753, 767 (Bankr. W.D. Mich. 1991).
            Several cases, however, have upheld the priority of the superseding
        mortgage to its full extent, although larger than its predecessor. Young v.
        Shaver, 35 N.W. 625 (Iowa 1887) (old mortgage $400, new mortgage
        $600); Commercial Fed. Sav. & Loan Ass’n v. Grabenstein, 437 N.W.2d
        775 (Neb. 1989) (old mortgage $84,000, new mortgage $98,000).



                                     3–172
                              Mortgage Financing                               § 3:9

equities.790 Where the superseding mortgage is foreclosed with joinder
of a junior mortgage,791 joinder of a part owner of the property who
had not executed the superseding mortgage, or where the party
executing the superseding mortgage had a defective title,792 the situa-
tion is complicated.
   The rule of subrogation has been applied to a co-owner of the
property who paid the mortgage. Payment gives the payor the right to
foreclose against the non-paying co-owner.793
   Priority questions may arise if a mortgagee takes a new promissory
note from the borrower after recordation of a second lien. The new
note retains first priority if it constitutes a renewal of the original note.
The new note may represent a renewal even if there is a change in the
interest rate.794


790.      See Houston Lumber Co. v. Skaggs, 613 P.2d 416 (N.M. 1980).
              The release of a mortgage, followed by a new mortgage, continues the
          original lien when done in good faith and in ignorance of intervening liens
          without intention of releasing the lien of the original mortgage. This was
          true even for a mortgage for a larger amount. Commercial Fed. Sav. & Loan
          Ass’n v. Grabenstein, 437 N.W.2d 775 (Neb. 1989); 59 C.J.S. Mortgages
          § 281 (1949).
              A “replacement mortgage” was given priority over a mechanic’s lien
          that was filed in the interim between recording the original and replace-
          ment mortgages, although the original mortgage had not been released.
          This was based on intent. Stephens Wholesale Bldg. Supply, Inc. v.
          Birmingham Fed. Sav. & Loan Ass’n, 585 So. 2d 870 (Ala. 1991).
791.      In Levenson v. G.E. Capital Mortgage Serv., Inc., 643 A.2d 505 (Md. Ct.
          Spec. App. 1994), the superseding mortgage was larger than the mortgage
          it liquidated. Accordingly, its priority was retained over the subordinate
          interest because the subordinate interest was unknown to the superseding
          mortgagee, but the priority was limited to the superseded mortgage.
          However, the court noted that equitable subrogation is inchoate and
          does not exist until judicially noted—something that had not occurred
          at the judicial sale. It also noted that a purchaser at a foreclosure sale
          obtains no more than the mortgagee’s interest. The mortgagee bid $45,000
          at the sale—less than the mortgage debt. Held: the foreclosure was subject
          to the mortgagee’s equitable subrogation to the superseded mortgage and
          to the junior liens. The subrogated lien was held not to merge with the
          interest that mortgagee purchased at the foreclosure sale. Its $45,000 bid
          was to be applied to the mortgagee’s remaining lien. The opinion is an
          excellent discussion of the entire subject and cites virtually all the
          authorities and many cases.
792.      A superseding mortgage executed by part of the owners, the proceeds of
          which were used to discharge a prior mortgage executed by part of the
          owners, bound all the owners, even to the extent of that part of the
          proceeds that were used to improve the property. United Carolina Bank v.
          Beesley, 663 A.2d 574 (Me. 1995).
793.      Richards v. Suckle, 871 S.W.2d 239 (Tex. Civ. App. 1994).
794.      Rebel v. Nat’l City Bank, 598 N.E.2d 1108 (Ind. Ct. App. 1992); First Fid.
          Bank v. Bock, 652 A.2d 262 (N.J. Super. Ct. 1994) (relying on N.J. R EV.
          STAT. § 46:9-8.2).



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   Mortgages usually include warranties of title, and a mortgagee can
benefit from the doctrine of after-acquired title. In an Alabama case, a
second mortgagee gained priority over the first mortgagee when the
first mortgagee foreclosed and then conveyed title back to the
mortgagor.795
   A second mortgage will not be extinguished by foreclosure of a prior
mortgage, or its assignee, if the junior mortgage can show a collusive
or fraudulent scheme between the holder of the prior interest and the
mortgagor to eliminate the junior lien.796
   If the holder of two mortgages on the same property forecloses the
junior mortgage and purchases at the foreclosure sale, his bid is
presumably reduced by the amount of the senior mortgage; and if
the value of the property exceeds the amount of the senior mortgage,
and there is no agreement to the contra, the senior mortgage is
extinguished.797 “The primary issue in each case is whether the lender
in fact would be enriched unjustly if he were permitted to enforce the
debt.”798 When the holder of two mortgages forecloses the junior
mortgage, bids a fair price at the foreclosure sale, and is not unjustly
enriched, he may enforce the debt of the senior mortgage.799
   The owner of undeveloped or underdeveloped property may be
required by a purchaser to (1) accept a purchase money mortgage in
part payment, and (2) subordinate this mortgage to a prospective
construction mortgage to be made by a lending institution. If the
seller ’s hopes are fulfilled, his property will be sold and the subordina-
tion will result in the security of an improvement on the land. But a
very real risk exists that the proceeds of the construction loan will be
diverted from their intended purposes, leaving the subordinator with a
relatively large mortgage and without the security of the intended
improvement. Foreclosure of the construction mortgage and destruc-
tion of the subordinated mortgage are certain to follow. The law is
clear: absent collusion between construction mortgagee and mortga-
gor, or an express stipulation between lender and subordinator, the




795.    Ala. Home Mortgage Co. v. Harris, 582 So. 2d 1080 (Ala. 1991). Cf. Libby
        v. Brooks, 653 A.2d 422 (Me. 1995).
796.    See Aubrey Equities, Inc. v. SMZH 73d Assocs., 622 N.Y.S. 276 (App. Div.
        1st Dep’t 1995).
797.    Mid Kan. Sav. & Loan Ass’n v. Dynamic Dev. Corp., 804 P.2d 1310 (Ariz.
        1991); Centennial Square Ltd. v. Resolution Trust Co., 815 P.2d 1002
        (Colo. Ct. App. 1991); Tri-County Bank & Trust Co. v. Watts, 449 N.W.2d
        537 (Neb. 1989); Licursi v. Sweeney, 594 A.2d 396 (Vt. 1991).
798.    Burkhart, Freeing Mortgages of Merger, 40 VAND. L. REV. 283, 382 (1987).
799.    In re Richardson, 48 B.R. 141 (Bankr. E.D. Tenn. 1985).



                                   3–174
                              Mortgage Financing                                  § 3:9

lender ’s priority may generally not be dislodged by reason of diver-
sion.800 The result is contra in case of express conditions imposed on




800.      Grenada Ready-Mix Concrete, Inc. v. Watkins, 453 F. Supp. 1298 (N.D.
          Miss. 1978); Drobnick v. W. Fed. Sav. & Loan Ass’n, 479 P.2d 393 (Colo.
          Ct. App. 1970); Baldwin v. Bright Mortgage Co., 791 P.2d 1182 (Colo. Ct.
          App. 1989); Conn. Bank & Trust Co. v. Carriage Lane Assocs., 595 A.2d
          334 (Conn. 1991); First Conn. Small Bus. Inv. Co. v. Arba, Inc., 365 A.2d
          100 (Conn. 1976); Inversiones Inmobiliarias Internacionales de Orlando
          Sociedad Anomina v. Barnett Bank, 584 So. 2d 110 (Fla. Dist. Ct. App.
          1991); Rockhill v. United States, 418 A.2d 197 (Md. 1980); Hyatt v. Md.
          Fed. Sav. & Loan Ass’n, 402 A.2d 118 (Md. Ct. Spec. App. 1979); First
          Nat’l State Bank v. Carlyle House, Inc., 246 A.2d 22 (N.J. Super. Ct. 1968);
          Brooklyn Trust Co. v. Fairfield Gardens, Inc., 182 N.E. 231 (N.Y. 1932),
          and note thereon in 42 YALE L.J. 981 (1931); Tuscarora, Inc. v. B.V.A.
          Credit Corp., 241 S.E.2d 778 (Va. 1978); see Iowa Loan & Trust Co. v.
          Plewe, 209 N.W. 399 (Iowa 1926), and note thereon in 12 IOWA L. REV. 201
          (1927); and cases in Cambridge Acceptance Corp. v. Hockstein, 246 A.2d
          138, 140 (N.J. Super. Ct. App. Div. 1968); Daniels v. Big Horn Fed. Sav. &
          Loan Ass’n, 604 P.2d 1046 (Wyo. 1980). Cf. Fikes v. First Fed. Sav. & Loan
          Ass’n, 533 P.2d 251 (Alaska 1975); McWaters v. Frederick W. Berens, Inc.,
          238 S.E.2d 717 (Ga. Ct. App. 1977) (lender not liable to owner for paying
          contactor without inspecting work).
              In Inversiones Inmobiliarias, 584 So. 2d 110, a seller took back a
          purchase money mortgage for the full purchase price and was fully wiped
          out by the mortgage to which it had subordinated. The fact that the now
          paramount mortgagee released parts of the property without payment as
          part of a revolving credit arrangement with the builder was not deemed of
          importance.
              A lender is under no duty to supervise construction of projects it has
          financed. Resolution Trust Corp. v. BVS Dev., Inc., 42 F.3d 1206 (9th Cir.
          1994) (California law; loan of excess funds spent carelessly); Armetta v.
          Clevetrust Realty Investors, 359 So. 2d 540 (Fla. 4th Dist. Ct. App. 1978),
          distinguishing Connor v. Great W. Sav. & Loan Ass’n, 447 P.2d 609 (Cal.
          1968). It is not material that the lender charged a 1% inspection fee. Rice v.
          First Fed. Sav. & Loan Ass’n, 207 So. 2d 22 (Fla. Dist. Ct. App. 1968)
          (lender not liable for defect in construction).
              California has applied a rule of implied conditional subordination,
          making diversion of advances a lender ’s risk. See Middlebrook-Anderson
          Co. v. Sw. Sav. & Loan Ass’n, 96 Cal. Rptr. 338 (4th Dist. Ct. App. 1971).
              New Jersey differentiates between a commercial and consumer-type
          transaction. If there is no express provision therein for use of the loan
          money, the clause may be found ineffective to elevate a lender, whose
          advances were not used to benefit the property, to priority unless the clause
          was bargained for and understood. B.J.I. Corp. v. Larry W. Corp., 443 A.2d
          1096 (N.J. Super. Ct. Ch. Div. 1982).
              A buyer regularly bought undeveloped property with a small down
          payment and a purchase money mortgage for the balance. The mortgage
          permitted subordination to a new mortgage without specifying that the
          new mortgage be a construction loan. The buyer used the proceeds of the
          new mortgage for the down payment, kept the rest, and then abandoned



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§ 3:9                        FRIEDMAN    ON   CONTRACTS

the subordination.801 It has also been held that a lender ’s failure to
administer the loan in the conventional manner of construction loans
and masking a loan on the general credit of the borrower with the form
of a construction loan, estopped the lender from asserting the sub-
ordination.802 A mortgagee must advance the consideration for the
mortgage to the mortgagor, absent an agreement otherwise. If the
mortgagee has agreed to apply the consideration to payment of
encumbrances, the mortgagee is liable for failure to obtain releases
of these encumbrances or otherwise make distribution in accordance
with his agreement.803


        the property. The court construed the instruments by “surrounding
        circumstances” to indicate a construction loan was intended and held
        the escrow agent liable in damages. Burkons v. Ticor Title Ins. Co., 813
        P.2d 710 (Ariz. 1991).
801.    Colo. Nat’l Bank v. F.E. Biegert Co., 438 P.2d 506 (Colo. 1968).
            Provision for use of proceeds of a loan for construction was the issue in
        Mercantil Intercontinental, Inc. v. Generalbank, 601 So. 2d 293 (Fla. Dist.
        Ct. App. 1992) (and authorities cited), and the court authorized their use
        for incidental preliminary expenses of construction. G. Credit Co. v. Mid-
        West Land Dev., Inc., 485 P.2d 205 (Kan. 1971) (landlord’s “subordination
        of fee”).
            Where a construction mortgagee agrees with a subordinator to see that
        the proceeds of the loan are applied to construction, he will be held to his
        agreement and lose priority as to any advance not going into construction.
        Cambridge Acceptance Corp. v. Hockstein, 246 A.2d 138, 140 (N.J. Super.
        Ct. App. Div. 1968).
            Where a lienholder subordinated on a mortgagee’s promise to procure a
        similar subordination by another judgment creditor, eighteen months’
        delay in obtaining the other subordination agreement was held unreason-
        able. Keystone Bank v. Nuclear Magnetic Resonance Specialties, Inc., 366
        A.2d 251 (Pa. Super. Ct. 1976).
            Construction lender was liable to mortgagor for continuing to disburse
        funds after mortgagor ’s notification of a construction defect and request to
        stop. Davis v. Nevada Nat’l Bank, 737 P.2d 503 (Nev. 1987). Lender did not
        inspect. The court indicated lender might not be liable after an erroneous
        inspection. Cf., as to this, Rice v. First Fed. Sav. & Loan Ass’n, 207 So. 2d
        22 (Fla. Dist. Ct. App. 1968).
            An unconditional subordination placed no restrictions on the mortgage
        now paramount. The subordinated mortgage provided that the proceeds of
        the former would be used for improvements on the property. The now
        paramount mortgagee was not a party and was held not bound thereby.
        Roberts v. Harkins, 292 So. 2d 603 (Fla. Dist. Ct. App. 1974), cert. denied,
        302 So. 2d 417 (Fla. 1974).
            A first mortgagee was held liable to a second mortgagee for distributing
        the proceeds of its loan to the borrower after assuring the second mortgagee
        that its position would be unchanged after completion of an improvement.
        Pastor v. Lafayette Bldg. Ass’n, 567 So. 2d 793 (La. Ct. App. 1990).
802.    Cambridge Acceptance Corp. v. Hockstein, 246 A.2d 138 (N.J. Super. Ct.
        App. Div. 1968) (landlord’s “subordination of fee”).
803.    See Prudential Ins. Co. v. Executive Estates, Inc., 369 N.E.2d 1117 (Ind.
        Ct. App. 1977).



                                     3–176
                              Mortgage Financing                                § 3:9

    The subordination stipulation may well specify two other matters:
(1) Are the proceeds of the construction mortgage to be applied to
improve the mortgaged premises alone or to other property as well?
(2) How many subordinations are to be executed—one for a construc-
tion mortgage, another for the permanent mortgage, or more? Use of
the term “subordination instruments” may leave the matter in doubt.
    Future advances made under a prior mortgage, when required by its
terms, take priority over junior liens. If the advances are not so
required they nevertheless take precedence generally if the prior
mortgagee has no notice of the junior liens.804 Recordation of the
junior interest is not, as a rule, notice to the prior interest.805
    If a mortgagee retains the proceeds of the mortgage loan to advance
them during construction for the cost thereof, the mortgagee is
deemed an agent of the mortgagor, with liability for improper
advances.806
    A subordination is valid if made by the mortgagor and subordinator.
It is unnecessary for the party whose lien is thereby elevated to be a
party.807
    A junior mortgagee who perfects his right to the rents, as against a
paramount mortgagee, is entitled to keep the rents collected on his
behalf, but if a paramount mortgagee thereafter perfects his right to the
rent, he is entitled to the rents then uncollected and the rents there-
after payable, both to the exclusion of the junior mortgagee. 808 In this




804.      In re Johnson, 124 B.R. 648 (Bankr. E.D. Pa. 1991).
805.      Id.
806.      Garbish v. Malvern Fed. Sav. & Loan Ass’n, 517 A.2d 547 (Pa. Super. Ct.
          1986) (and cases discussed); First Nat’l Bank v. Wernhart, 555 N.W.2d 819
          (Wis. 1996); Note, Construction Lending: The Mortgagee’s Right to Inspect
          the Construction Project and Duty to Ensure Proper Disbursement of
          Constructive Loan Proceeds, 81 KY. L.J. 511 (1992–93) (cites many cases
          and concludes that cases putting mortgagee under implied obligation to
          inspect premises are in minority).
              A lender who was required to limit advances to work done, and
          therefore advanced less than requested sums, was not liable for overrun
          of costs when both borrower ’s architect and builder underpriced cost of
          construction. The construction loan agreement expressly provided against
          any trust relations between the parties. Nichols v. Chi. Title Ins. Co., 669
          N.E.2d 323 (Ohio Ct. App. 1995).
807.      S. Floridabanc Fed. Sav. & Loan Ass’n v. Buscemi, 529 So. 2d 303 (Fla. 4th
          Dist. Ct. App. 1988); Rose v. Provident Sav., Loan & Inv. Ass’n, 62 N.E.
          293 (Ind. Ct. App. 1901); Londner v. Perlman, 113 N.Y.S 420 (App. Div.
          1st Dep’t 1908), aff ’d mem., 92 N.E. 1090 (N.Y. 1910); Cummings v.
          Consol. Mineral Water Co., 61 A. 353 (R.I. 1905).
808.      Vecchiarelli v. Garsal Realty, Inc., 443 N.Y.S.2d 622 (Sup. Ct. 1980).



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§ 3:9                       FRIEDMAN   ON   CONTRACTS

situation the senior mortgagee’s right to rents depends on his obtain-
ing a receiver or an extension of an existing receivership.809
   On foreclosure of a junior mortgage any surplus goes to the
mortgagor rather than to the holder of a prior mortgage.810
   A wraparound mortgage is a junior mortgage that provides for
aggregate payments that are sufficient to pay (1) debt service on the
sum advanced under the mortgage (“advance” for this purpose possibly
meaning a purchase money obligation), plus (2) debt service on a prior
mortgage. The wraparound mortgage may be used when an existing
mortgage is relatively small, is not prepayable, or prepayable only at a
substantial premium. Inasmuch as interest on the wraparound is
usually higher than on the paramount mortgage, the wraparound
mortgagee who pays the lower interest on the paramount mortgage
receives a premium on the interest. If the wraparound mortgagee
collects the mortgage payments but fails to pay the paramount mort-
gagee, the mortgagor-owner is in substantial trouble. Questions of
usury have arisen in this connection.811
   When a wraparound mortgage is foreclosed the net proceeds of sale
are credited to the entire outstanding debt, including the wrapped
debt. This is true even though the mortgagor took the property subject
to and did not assume the wrapped debt. This is the “outstanding
balance” method, as distinguished from the “true debt” method.



809.    Depan, Eichenberger & Knowles, Inc. v. Greenbriar Props. I, 607 N.Y.S.2d.
        177 (3d Dep’t 1994). For discussion of receivership, see supra section
        3:7.5.
810.    Bohra v. Montgomery, 792 S.W.2d 360 (Ark. Ct. App. 1990).
811.    See Olster v. Comm’r, 751 F.2d 1168, 1170 n.2 (11th Cir. 1985); Prince
        George’s County v. McMahon, 477 A.2d 1218 (Md. Ct. Spec. App. 1984);
        Mitchell v. Trs. of United States Inv. Trust, 375 N.W.2d 424 (Mich. Ct.
        App. 1985) (and authorities collected in both cases).
            For problems of foreclosure and bidding in foreclosure of wraparound
        mortgage, see Armsey v. Channel Assocs., 299 Cal. Rptr. 509 (2d Dist. Ct.
        App. 1986). For computing deficiency judgments, see Lee v. O’Leary, 742
        S.W.2d 28 (Tex. Civ. App. 1987). See also Caraway, Unwrapping the
        Wraparound Mortgage Foreclosure Process, 47 WASH. & LEE L. REV. 1025
        (1990) (drafting and bidding suggestions).
            Prepayment of a wraparound mortgage did not imply an obligation by
        the wraparound mortgagee to pay off the underlying mortgage. Carroll v.
        Miller, 561 N.Y.S.2d 478 (App. Div. 2d Dep’t 1990), later opinion, 624
        N.Y.S.2d 627 (App. Div. 2d Dep’t 1995).
            A provision in a wraparound mortgage, required by a state attorney
        general in the conversion to cooperative apartments, that made nonpay-
        ment of the underlying mortgage a satisfaction of the wraparound pre-
        vailed over another provision in the wraparound that permitted
        redemption. 405 W. 57th St. Owners v. Coronet Props. Co., 616
        N.Y.S.2d 585 (App. Div. 1st Dep’t 1994); Gregory House Owners Corp.
        v. Coronet Props. Co., 616 N.Y.S.2d 586 (App. Div. 1st Dep’t 1994).



                                   3–178
                             Mortgage Financing                                § 3:10

Under this method a surplus results if the bid exceeds the entire
outstanding debt; if less there is a deficit.812
   Several cases involve agreements of cross-collateralization of several
mortgages and the effect of this on junior liens. In one case, Parsons
was the owner of two first mortgages, one on Parcel A and the other on
Parcel B. A bank held a blanket second mortgage covering both parcels.
Parsons, the bank, and the mortgagors joined in execution of an
agreement that made a default in one first mortgage a default in the
other. The court held that the combined debt of both first mortgages
was prior in lien to that of the junior mortgage.813 This will be
satisfactory to the owner of the first mortgages if the relation between
these mortgages and junior liens is clarified. But if a sale of one of the
mortgaged properties is contemplated, how will its prospective pur-
chaser react to the possibility that the mortgage on this property may
go into default by the acts and omissions of a stranger who owns other
mortgaged property? The situation is comparable to cross defaults
under leases. One may question the effect on all this of the bankruptcy
of one owner.814

§ 3:10          Discharge of Mortgage
   Mortgages have been cancelled and discharged by mistake or
otherwise without payment. As between a mortgagee and a mortgagor,
with no intervening rights, the mortgage is still valid and enforce-
able.815 Where the rights of third persons have intervened, the results
differ. If the discharge is by forgery of a third person, the mortgagee
prevails over an innocent party despite the latter ’s reliance on the
record, but if the discharge is due to the negligence of the mortgagee or
his reliance on some person with whom he is affiliated, the innocent


812.      Summers v. Consol. Capital Special Trust, 783 S.W.2d 580 (Tex. 1989).
813.      Parsons v. Biscayne Valley, Inc., 935 P.2d 218 (Kan. Ct. App. 1997). Parsons
          argued successfully that the bank’s execution of the agreement was
          consent to this effect and that otherwise its signature would have been
          unnecessary. The bank argued that its signature was made for the sole
          purpose of and in consideration for Parsons’ agreement to make no further
          advances on the first mortgage, and that a deficit on the first mortgage
          would be a third lien on the other property. In First State Bank v. Hoenke
          Nursery Co., 667 P.2d 1022 (Or. Ct. App. 1983), the facts were somewhat
          complicated but the result was comparable to Parsons. This litigation
          would have been unnecessary if the cross-collateralization agreement had
          recited that the junior mortgage would have been subordinate, or other-
          wise, to its full effect.
814.      See 1 MILTON R. FRIEDMAN, FRIEDMAN ON LEASES § 9:1.4 (Patrick A.
          Randolph, Jr., ed., 5th ed. PLI 2006); 2 id. § 16:1.
815.      Long Island Sav. Bank v. FSB, 596 N.Y.S.2d 808 (App. Div. 2d Dep’t 1993).
          This is no preference in bankruptcy. In re Billingsly, 175 B.R. 286 (Bankr.
          E.D. Ark. 1994).



(Friedman on Contracts, Rel. #7, 5/09)   3–179
§ 3:10.1                         FRIEDMAN    ON   CONTRACTS

party prevails.816 A mortgage that is mistakenly discharged may be re-
recorded and its position is restored as of the time of the
rerecording.817

   § 3:10.1           Merger
   A conveyance to the mortgagee or a transfer of the mortgage to
the fee owner unites both interests in a single hand and generally
discharges the mortgage by merger.818 But to have this result, the
transfer must be to the same person in the same capacity.819 A mortgage
executed by a husband on his property to his wife was held merged and
cancelled when the wife received the property under her husband’s
will.820
   A mortgagee who received a conveyance of the mortgaged property
was held to have an enforceable right in a policy of fire insurance that
had theretofore insured it “as to the interest of the mortgagee only.”821
Although the existence of merger is largely one of intent, 822 the union
of mortgage and realty in one who is primarily liable for the mortgage
debt is virtually certain to result in merger,823 except possibly, as
against intervening encumbrances.



816.       See the extended discussion of cases in In re O’Reilly, 30 B.R. 562 (Bankr.
           N.D. Ohio 1983), and the summary of cases in Sunrise Sav. & Loan Ass’n
           v. Giannetti, 524 So. 2d 697 (Fla. Dist. Ct. App. 1988); see also In re
           Cameron, 151 B.R. 303 (Bankr. D. Conn. 1993).
817.       In re Cameron, 151 B.R. 303 (Bankr. D. Conn. 1993); In re O’Reilly, 30
           B.R. 562 (Bankr. N.D. Ohio 1983). But re-recording when the mortgagor is
           insolvent within ninety days of its bankruptcy is a preferential transfer.
           In re Cameron.
818.       Lyman v. Gedney, 29 N.E. 282 (Ill. 1885); Close v. Martin, 94 N.E. 388
           (Mass. 1911); McLaughlin v. Nelson, 202 N.W. 871 (Neb. 1925); Tennen-
           berger v. Sozio, 136 A. 806 (N.J. Ch. 1927); Krekeler v. Aulbach, 64 N.Y.S.
           908 (App. Div. 1st Dep’t 1900), aff ’d, 62 N.E. 416 (N.Y. 1902); Greenfield
           v. Mills, 107 N.Y.S. 705 (App. Div. 2d Dep’t 1907); Summy v. Ramsey, 101
           P. 506 (Wash. 1909).
819.       Sturtevant v. Jaques, 96 Mass. 523 (1867); see Clark v. Rowell, 298 N.Y.S.
           232 (County Ct. Delaware County 1937). But see Larson v. Thomas, 215
           N.W. 927 (S.D. 1927) (no merger by purchase at foreclosure sale by holder
           of coordinate mortgage); Sautter v. Frick, 242 N.Y.S. 369 (App. Div. 4th
           Dep’t 1930), aff ’d, 177 N.E. 129 (N.Y. 1931) (holder of fourth, fifth, and
           seventh mortgages purchased on foreclosure of fifth; seventh not merged);
           In re Nochomov’s Estate, 132 N.Y.S.2d 720 (Sur. Ct. Kings County 1954).
           Equitable Sav. & Loan Ass’n v. Lenz, 436 N.W.2d 902 (Wis. Ct. App. 1989).
820.       In re Estate of Grozier, 587 N.E.2d 77 (Ill. App. Ct. 1992).
821.       Fort Scott Bldg. & Loan Ass’n v. Palatine Ins. Co., 86 P. 142 (Kan. 1906).
822.       First Nat’l Bank v. Gilbert Imported Hardwoods, 398 So. 2d 258 (Ala.
           1981).
823.       Waff Bros. v. Bank of N.C., 221 S.E.2d 273 (N.C. 1976), following Hussey
           v. Hill, 26 S.E. 919 (N.C. 1897).



                                       3–180
                            Mortgage Financing                                § 3:10.1

   A conveyance by a mortgagor to a mortgagee does not as a rule
merge the mortgage against junior liens.824 A conveyance to a mort-
gagee does not, by weight of authority, merge the mortgage as against
the intervening encumbrances.825 An intention to keep the mortgage
alive is presumed where this is to one’s interest.826 A few cases come
out the other way, applying merger to the mortgagee’s disadvantage. 827
   On a conveyance by a mortgagor to a mortgagee, merger of the
mortgage is a matter of intent, a strong presumption being against
merger. This permits the mortgagee-grantee to protect himself against
junior liens. But a mortgagee’s sale of the property thereafter was held
a merger, which protected a junior lien.828
   The fact that the same party is the record owner of both mortgage
and fee is no assurance of merger due to the possibility of an
unrecorded deed or an unrecorded assignment of the mortgage. In a




824.      Bank of Powell v. Peoples Bank, 503 So. 2d 845 (Ala. 1987); Tom Riley Law
          Firm v. Padzensky, 430 N.W.2d 416 (Iowa 1988); London Bank & Trust
          Co. v. Am. Fid. Bank & Trust Co., 697 S.W.2d 956 (Ky. Ct. App. 1985);
          Riggs v. Kellner, 716 S.W.2d 3 (Mo. Ct. App. 1986); Wietzki v. Wietzki, 437
          N.W.2d 449 (Neb. 1989) (conveyance by contract purchaser); Branch
          Banking & Trust Co. v. Home Fed. Sav. & Loan Ass’n, 354 S.E.2d 541
          (N.C. Ct. App. 1987); Westgard v. Farstad Oil, Inc., 437 N.W.2d 522 (N.D.
          1989); Citizens Sec. Bank v. Courtney, 572 P.2d 1302 (Okla. Ct. App.
          1977).
              The same was applied to a first mortgage without notifying the Internal
          Revenue Service, holder of a junior tax lien. See First Am. Title Ins. Co. v.
          United States, 848 F.2d 963 (9th Cir. 1988), and cases discussed. Accord,
          as to judgment creditor, Fed. Land Bank v. Colo. Nat’l Bank, 786 P.2d 514
          (Colo. Ct. App. 1989).
825.      Brightwell v. United States, 805 F. Supp. 1464 (S.D. Ind. 1992) (but
          indicates, at 1474, that if mortgagee sells the property he has no interest
          to protect and mortgage will merge against grantee); 6424 Corp. v.
          Commercial Exch. Prop., 217 Cal. Rptr. 803 (Ct. App. 1985); Barton v.
          Cannon, 489 P.2d 1021 (Idaho 1971); Fort Scott Bldg. & Loan Ass’n v.
          Palatine Ins. Co., 86 P. 142 (Kan. 1906); Fowler v. Carter, 425 P.2d 737
          (N.M. 1967); Small v. Cunningham, 120 N.W.2d 13 (N.D. 1963); Altabet
          v. Monroe Methodist Church, 777 P.2d 544 (Wash. Ct. App. 1989).
826.      In re B.F. Dewees, Inc., 404 F.2d 519 (3d Cir. 1968); Fed. Land Bank v.
          Colo. Nat’l Bank, 786 P.2d 514 (Colo. Ct. App. 1989); Overland-Wolf, Inc.
          v. Koory, 162 N.W.2d 889 (Neb. 1968).
827.      E.g., Janus Props., Inc. v. First Fla. Bank, 546 So. 2d 785 (Fla. Dist. Ct.
          App. 1989) (first mortgagee’s acceptance of warranty deed from mortgagor-
          owner elevated former second mortgage to first).
828.      Constr. Mach. v. Roberts, 819 S.W.2d 268 (Ark. 1991).
              New York cases holding that a mortgagor ’s conveyance to a mortgagee
          may either constitute a satisfaction of a mortgage or merely release
          mortgagor of liability, depending on intent, a question of fact, are collected
          in Egrini v. County of Suffolk, 599 N.Y.S.2d 457, 459 (Sup. Ct. Suffolk
          County 1993).



(Friedman on Contracts, Rel. #7, 5/09)   3–181
§ 3:10.2                         FRIEDMAN    ON   CONTRACTS

New York case, a mortgagee assigned his mortgage by an instrument
that was never recorded and thereafter acquired the fee. 829 The court
held that a purchaser of the real estate from the mortgagee took subject
to the mortgage and that no merger had occurred. This was on the
ground that although recordation of the assignment was necessary
under the recording acts to protect as against a subsequent purchaser
of the mortgage, recordation was unnecessary as against a subsequent
purchaser of the fee.830 Not all states would go so far.831
   A recital in such conveyance that the mortgage is not to merge will
generally be given effect.832 But an intention to this effect will not be
enforced where the result would be inequitable.833 Merger is generally
disfavored where its result will be inequitable. 834

   § 3:10.2           Deed in Lieu of Foreclosure
   At the time the parties enter into a mortgage, the mortgagor is not
allowed to waive his equity of redemption. 835 After default, the
situation is different. The parties may agree to a deed in lieu of
foreclosure. This relieves the mortgagor from the burden of foreclo-
sure, and perhaps releases the mortgagor from personal liability on the
mortgage debt. But any such conveyance is subject to strict scrutiny for




829.       Curtis v. Moore, 46 N.E. 168 (N.Y. 1897).
830.       Accord Thauer v. Smith, 250 N.W. 842 (Wis. 1933), noted in 29 ILL. L. REV.
           121 (1934). The possibility of the occurrence of this situation was
           discounted in Summy v. Ramsey, 101 P. 506 (Wash. 1909).
              Cf. Lloyd v. Chi. Title Ins. Co., 576 So. 2d 310 (Fla. Dist. Ct. App.
           1990), where a mortgage was assigned by unrecorded instrument and
           thereafter fraudulently released.
831.       Annot., 89 A.L.R. 171, 180 (1934); 7 U. FLA. L. REV. 93, 95 (1954).
832.       United States v. Joe Murray’s Point Lookout, 342 F. Supp. 92 (S.D.N.Y.
           1972); Abbott v. Curran, 98 N.Y. 665 (1885); Egan v. Engeman, 110 N.Y.S.
           366 (App. Div. 1st Dep’t 1908).
833.       In Cambridge Factors, Inc. v. Thompson, 626 N.Y.S.2d 259 (App. Div. 2d
           Dep’t 1995), where a first mortgage owned by the mortgagor in a sham
           corporation, was held merged as against a second mortgage. See Citizens
           Sec. Bank v. Courtney, 572 P.2d 1302 (Okla. Ct. App. 1977); Widett &
           Widett v. Snyder, 467 N.E.2d 1312 (Mass. 1984).
834.       See Clark v. Rowell, 298 N.Y.S. 232 (County Ct. Delaware County 1937).
           For an extended discussion of the historical background in England and the
           United States of merger and a criticism of merger as anachronism, see
           Burkhart, Freeing Mortgages of Merger, 40 VAND. L. REV. 283 (1987).
              An owner of realty who takes by assignment a mortgage affecting the
           premises may elect against a merger. See In re Nochomov’s Estate, 132
           N.Y.S.2d 720 (Sur. Ct. Kings County 1954). Cf. Flanagan v. Babineau, 125
           N.E.2d 231 (Mass. 1955).
835.       See supra section 3:1.



                                       3–182
                            Mortgage Financing                                § 3:10.2

its fairness and is subject to being overturned.836 A Florida case upheld a
conveyance to the mortgagee pursuant to the settlement of foreclosure
litigation.837 Title examiners must satisfy themselves of the fairness of a
conveyance of a deed in lieu of foreclosure and its freedom from being a




836.      Humble Oil & Ref. Co. v. Doerr, 303 A.2d 898, 908 (N.J. Super. Ct. 1973).
              For fairness of the transaction and adequacy of consideration, see Villa
          v. Rodriguez, 79 U.S. 323, 339 (1870); Galvin v. Johnson, 41 A.2d 113,
          116–17 (Conn. 1945); J&J Wall Sys., Inc. v. Shawmut First Bank & Trust
          Co., 594 N.E.2d 859 (Mass. 1992) (incomplete building worth less than
          mortgage). Releasing the mortgagor from liability may not be sufficient
          when the value of the property substantially exceeds the amount of the
          mortgage. For a good extended discussion, see Caron, Connecticut Deeds
          in Lieu of Foreclosure: Under Concerns and Title Issue, 64 C ONN. B.J. 433
          (1990). A more extended discussion appears in Murray, Deeds in Leiu of
          Foreclosure: Practical and Legal Considerations, 26 R EAL PROP., PROB. &
          TR. J. 459–534 (1991), including the danger of receiving the property with
          hazardous waste, transfer taxes, and compliance with the Foreign Invest-
          ment in Real Property Tax Act, where these are applicable, and some state
          statutes. A detailed study of the problems in actual and potential bank-
          ruptcy of the mortgagor in this situation appears in Roberts, Deeds in Lieu
          of Foreclosure, 2 MOD. REAL EST. TRANSACTIONS 1251 (ALI-ABA 4th ed.
          1983). Murray & Jacobson, Due Diligence and Deeds in Lieu of Fore-
          closure, REAL PROP., PROB. & TR. J. at 32 (May/June 1993) stress the
          importance of voiding the mortgage as against subordinate lienor, con-
          struction liens, etc. For this purpose, Murray advocates no release of the
          mortgage debt by a covenant not to sue, in lieu thereof, while both advocate
          a separate properly organized entity to take title. Jacobson suggests
          checking leases, security deposits thereunder, cash flow, insurance, labor-
          contracts, and permits (for food and liquor, etc.), and their transferability,
          personal property, business records—which is perhaps as if corporate stock
          rather than realty were being purchased.
837.      Rothschild Reserve Int’l, Inc. v. Silver, 830 So. 2d 224 (Fla. Dist. Ct. App.
          2002). In Rothschild, after a homeowner defaulted on a mortgage loan, the
          lender obtained a summary judgment for foreclosure. The parties then
          signed a settlement agreement, pursuant to which the borrower delivered a
          deed in escrow to the lender’s counsel. If the borrower paid the debt in full
          within two months, counsel would return the deed to him. Otherwise, the
          deed was to be effective and the borrower agreed to surrender possession.
          After failing to pay, the borrower claimed that the deed constituted a
          disguised mortgage, and thus he still had the right to redeem. The court
          rejected this argument, stating that agreements settling foreclosure actions
          should be valid and that the borrower had benefited from the agreement. The
          court interpreted a Florida statute providing all “conveyances . . . for the
          purpose or with the intention of securing the payment of money . . . shall be
          deemed and held mortgages.” FLA. STAT. ANN. § 697.01. The decision is of
          general applicability, however, because the statute merely codifies the gen-
          erally accepted principle of equitable or disguised mortgages.



(Friedman on Contracts, Rel. #7, 5/09)   3–183
§ 3:10.2                          FRIEDMAN     ON   CONTRACTS

preferential payment or a fraudulent conveyance.838 On the other hand,
a mortgagee need not accept a deed at any time tendered by the mort-
gagor.839 The effect of the conveyance as a merger of the mortgage is
considered above.840
   A mortgagee acquiring title by foreclosure or deed in lieu of
foreclosure to non-residential property should consider the liability it
might acquire under environmental laws and under other statutes,
such as the Americans with Disabilities Act.841 A feasibility study of
the property by an expert would help the mortgagee determine its
course of action.
   The issue of merger of the mortgage and the fee often comes up in
the context of a deed in lieu of foreclosure. Ordinarily the question is
the status of junior liens created by the mortgagor. Junor leases are
similarly situated.842 Courts often protect the mortgagee from such
liens by refusing to find merger. This is especially likely when the deed
in lieu has an anti-merger clause, expressing the parties’ intent that
the mortgage shall continue in existence and merger shall not occur. In
an unusual case, a mortgagee sought to protect itself from its own debt


838.       Bankruptcy Code § 547; In re Carr, 34 B.R. 653 (Bankr. D. Conn. 1983), aff’d,
           40 B.R. 1067 (D. Conn. 1984); Caron, Connecticut Deeds in Lieu of Foreclo-
           sure, 64 CONN. B.J. 443–46 (1990); see generally Murray, note 836, supra.
               For this reason the American Land Title Association title policy, as of
           May 4, 1990, excludes from its coverage the effect on title of federal and
           state bankruptcy and insolvency laws. Although the mortgagee’s title
           insurance policy continues in effect after a foreclosure or a conveyance
           in lieu thereof, it is effective only as of its date of issuance; Murray, supra,
           suggests that because of the problems involved, the mortgagee procure a
           new policy as of the date of conveyance.
839.       In re Koeller, 170 B.R. 1019 (W.D. Mo. 1994); Bank of Boston Conn. v.
           Platz, 596 A.2d 31 (Conn. Super. Ct. 1991); Albany Sav. Bank v. Novak,
           574 N.Y.S.2d 140 (Sup. Ct. Orange County 1991); CUNA Mortgage v.
           Aafedt, 459 N.W.2d 801 (N.D. 1990).
               The reasons for this include the possibility of the conveyance being set
           aside in bankruptcy of the mortgagor, attack by creditors, and, principally,
           the fact that a creditor need not accept anything but cash. Bank of Boston
           Connecticut, 596 A.2d 31.
               This was applied in a case where the mortgage excused the mortgagor
           from liability on the mortgage debt. Brown v. Fin. Sav., 828 P.2d 412 (N.M.
           1992) (applying Texas law).
               In Koeller, 170 B.R. 1019, the holder of a deed of trust refused to accept
           property the owner sought to abandon because of fire damage. The holder
           would not assume liability for taxes, personal injury, and housing viola-
           tions. The court noted the holder of a deed of trust merely has a lien to
           satisfy the debt, and the owner remains the owner until acceptance.
840.       See section 3:10.1 supra.
841.       Americans with Disabilities Act, codified at 42 U.S.C. §§ 12101 to 12213.
842.       A deed in lieu of foreclosure did not merge the mortgagee’s rights against a
           subordinate tenant. GBJ, II v. First Ave. Inv. Corp., 520 N.W.2d 508 (Minn.
           1994).



                                         3–184
                             Mortgage Financing                               § 3:11

by denying merger. The court held for the mortgagee’s creditor, finding
merger notwithstanding the presence of an anti-merger clause in the
deed in lieu of foreclosure.843

§ 3:11          Mortgage Bond or Note
   Mortgage debt is evidenced in the great majority of states by a note.
In New York and a few other states the mortgage bond had been
traditional. It had been compulsory for trustees and lending institutions
because statutes authorizing their investments have referred only to
bonds and mortgages. This had been a disadvantage in the case of
corporate mortgages because a corporate bond was subject to federal
stamp tax upon its issue, its transfer, and again upon its renewal.844
In 1948, statutory changes in New York authorized mortgage notes as an
alternative to bonds.845 A transition to the general use of notes with
corporate mortgages was delayed by General Motors Acceptance Corp. v.
Higgins,846 which left some doubt between nontaxable corporate notes
and taxable corporate obligations. Since 1966, federal stamps have not
been required on corporate bonds or assignments or renewals thereof.
   The mortgage and an accompanying note or bond, as well as other
collateral instruments that are executed at the same time, are deemed
part of one transaction and are construed together. 847 In case of




843.      United States Leather, Inc. v. Mitchell Mfg. Group, Inc., 276 F.3d 782 (6th
          Cir. 2002) ($1.5 million judgment lien for unpaid purchase price of goods
          sold to mortgagee). In U.S. Leather, the mortgagee granted a security
          interest in the note and mortgage to its parent corporation, to secure debt
          owed to that corporation. The mortgagee’s creditor then brought an action
          to collect its debt. While the action was pending, mortgagor and mortgagee
          entered into their deed-in-lieu transaction. Next, the creditor obtained
          judgment and a judgment lien. The parent corporation claimed its security
          interest in the mortgage was superior to the judgment lien. The court
          disagreed, using merger to extinguish the mortgage. In effect, the court
          “pierced the corporate veil,” believing the parent and subsidiary had
          colluded to forestall collection of a just debt.
844.      Former I.R.C. §§ 4311, 4312, 4331 (1954), repealed by Act of June 21,
          1965, Pub. L. No. 89-44 § 401(a), 79 Stat. 136, 148.
845.      N.Y. BANKING LAW § 235(6).
846.      Gen. Motors Acceptance Corp. v. Higgins, 161 F.2d 593 (2d Cir.), cert.
          denied, 332 U.S. 810 (1947).
847.      Morgan Guar. Trust Co. v. Mowl, 705 A.2d 923 (Pa. Super. Ct. 1998)
          (mortgagee may not recover on bond after mortgagors satisfied judgment
          in foreclosure action by paying sheriff full amount on writ of execution;
          satisfaction of mortgage also represents satisfaction of bond when both
          instruments are executed on same day as part of same transaction). Metro.
          Life Ins. Co. v. Monroe Park, 442 A.2d 503, 509 (Del. Super. Ct. 1982).



(Friedman on Contracts, Rel. #7, 5/09)   3–185
§ 3:12                       FRIEDMAN    ON   CONTRACTS

inconsistency between the mortgage and the note or bond, the note or
bond prevails.848
   Acceptance of a new note, without increasing its amount, is no
discharge of a mortgage unless intended and the mortgage continues
as security for the obligation as so modified or extended.849

§ 3:12        Expenses of Mortgage
   The expense of a purchase money mortgage is the cost of giving
credit to the buyer. Accordingly, the cost of a loan is generally borne by
the borrower.850 It is fairly customary to apply this to purchase money
mortgages by providing in the contract of sale that the buyer will pay
seller’s attorney for preparing the mortgage papers. This is contemplated
by the Customs in New York County.851 Recording a short mortgage
may cost from $10 to $25. In New York and a handful of states, a state
mortgage recording tax involves a more substantial payment. 852
A requirement that the mortgagor pay the mortgage recording tax
does not make the mortgage usurious,853 even when the statute imposes
the tax on the mortgagee.854

§ 3:13        Release of Part of Mortgaged Premises
   A purchaser will find it virtually impossible to resell a part of his
property if it is subject to a blanket mortgage covering the entire




848.     Moss v. McDonald, 772 P.2d 626 (Colo. Ct. App. 1988); Adler v. Berko-
         witz, 175 N.E. 323 (N.Y. 1930), noted in 31 COLUM. L. REV. 328 (1931).
849.     In re Bogosian, 114 B.R. 7 (Bankr. D.R.I. 1990); United Bank v. Jefferson
         Indus. Bank, 791 P.2d 1250 (Colo. Ct. App. 1990); Nw. Bank Neb. Nat’l
         Ass’n v. Kizzier, 446 N.W.2d 204 (Neb. 1989).
850.     Smallwood v. Overseas Storage Co., 33 N.Y.S.2d 876, 881 (App. Div. 2d
         Dep’t 1942), aff ’d, 47 N.E.2d 435 (N.Y. 1943).
851.     See X and XI of Customs in Respect to Title Closings, Recommended by
         the Real Estate Board of New York, Inc., set forth in Appendix A of that
         document. The custom is not peculiar to New York. Miller, Hacking a Path
         Through the New York State Mortgage Tax Jungle, 43 ALB. L. REV. 37
         (1978).
852.     In New York there are state and New York City recording taxes that vary
         with the amount of the mortgage and the nature of the property. N.Y. TAX
         LAW §§ 253, 253-a; N.Y.C. ADMIN. CODE §§ 11-2601 to 11-2604.
853.     Lassman v. Jacobson, 146 N.W. 350 (Minn. 1914); Seamen’s Bank v.
         McCollough, 151 N.Y.S. 600 (App. Div. 1st Dep’t 1915), aff ’d, 117 N.E.
         1083 (N.Y. 1917); 1918F L.R.A. 383.
854.     Robertson Banking Co. v. Chamberlain, 228 F. 500 (5th Cir. 1916). Contra
         In re Elmore Cotton Mills, 217 F. 810 (S.D. Ala. 1914). For cases pro and
         con, see Annots., 21 A.L.R. 797, 883 (1922); 63 A.L.R. 823, 837 (1929);
         105 A.L.R. 795 (1936).



                                    3–186
                             Mortgage Financing                                § 3:13

premises.855 The mortgagee cannot be compelled to accept part of the
mortgage debt and release a corresponding part of the mortgaged
property.856 If the mortgagor intends to sell any one or more parts, it
will be necessary to provide in advance for the release of each parcel, at
the time of its sale, from the lien of the mortgage. Appropriate
provisions for this should be included in the purchase money mort-
gage.857 The provisions should entitle the mortgagor to an absolute
right to releases, subject to payment or other specified conditions.
Subjecting the releases to a mortgagee’s consent “not unreasonably to
be withheld” is unworkable.858
   Each released parcel should be adequately described or identified, to
enable preparation of a legally sufficient release and to avoid dispute
about the property to be released.859 A metes and bounds description
of each released parcel may be included in the mortgage. This is
unnecessary if the released parcels are shown on a map. A subdivision,
for instance, will be plotted on a map showing the dimensions of the
various lots and identifying them by numbers or letters. In this case, a
release may cover “Lot 1, as shown on a certain map. . . .” The
mortgagor may select the premises to be released unless the mortgage
provides otherwise.860
   The mortgagor is generally required to make a payment in reduc-
tion of the mortgage principal in order to obtain a partial release. The
amount of this payment may occasionally be the same for each parcel,
but where the parcels vary in size, location, and value, the considera-
tion for the releases will vary, and a release schedule is attached to the
mortgage showing the release price for each parcel. Inasmuch as each
release reduces the plottage or assemblage value of the unreleased
property and its security to the mortgage, the consideration for each
release is usually greater than the pro rata value of the particular
release parcel and may be 125% of such value. The release clause
usually provides for payment of a specified sum as this consideration,




855.      For the problems that can arise from an assumption of the entire mortgage
          by a grantee of part of the mortgaged premises, see supra section 3:3.
856.      Miller v. Fed. Land Bank, 587 F.2d 415 (9th Cir. 1978); R.I. Hosp. Trust
          Nat’l Bank v. Post, 544 N.E.2d 592 (Mass. App. Ct. 1989); Jones Land &
          Livestock Co. v. Fed. Land Bank, 733 P.2d 258 (Wyo. 1987). See supra
          section 3:8.4 (no general right to repay mortgage debt).
857.      For forms of release clauses, see supra sections 3:13.1, 3:13.2, and 3:13.3.
858.      See, e.g., Sun First Nat’l Bank v. Grinnell, 416 So. 2d 829 (Fla. Dist. Ct.
          App. 1982).
859.      An exhaustive annotation on release clauses appears in 41 A.L.R.3d 7
          (1971). For a comprehensive general discussion, see Eldridge v. Burns, 142
          Cal. Rptr. 845 (1st Dist. Ct. App. 1978).
860.      Burroughs v. Garner, 405 A.2d 301 (Md. Ct. Spec. App. 1979).



(Friedman on Contracts, Rel. #7, 5/09)   3–187
§ 3:13                        FRIEDMAN     ON   CONTRACTS

plus interest thereon accrued to date of payment. Some clauses have
not been this clear.861 The clause generally contemplates that a release
will be obtained on a sale of the parcel released, but a sale is not
invariable in this situation. A mortgagor entitled by the terms of his
mortgage to releases on paying a specified sum for each lot sold or
encumbered, was held entitled to releases on tender of this price even
though no sale or encumbrance was contemplated. 862
   A mortgagee’s right to payment for releases entitles him to pay-
ments made in the usual course, in accordance with the terms of the
mortgage. Payment of part of the mortgage debt, under compulsion of
foreclosure, is no such payment and creates no right to a release. 863
The same is presumably true of payments made from proceeds of
insurance or from an award for a partial taking in eminent domain.
These are, in effect, payments out of the mortgaged property, the
making of which dilutes the mortgagee’s security pro tanto. 864




861.     A clause authorizing release of lands worth $4,000 on payment of every
         $1,000 against principal and interest was held to entitle the mortgagor to
         release of lands worth four times the sum of principal and interest. See
         Chesapeake Isle, Inc. v. Rolling Hills Dev., Inc., 237 A.2d 1 (Md. 1968).
             Under a clause that seemed inconsistent, in providing for releases on
         payment of $1,152 per acre, and also providing for releases on payment “on
         the debt secured hereby,” mortgagor unsuccessfully claimed a right to
         release based on making the down payment. The court saw no reason for
         these provisions if mortgagor were entitled to an immediate release.
         Henderson Mill Ltd. v. McConnell, 229 S.E.2d 660 (Ga. 1976). Accord
         Agric. Alumni Seed Improvement Ass’n v. Diaz, 432 So. 2d 788 (Fla. Dist.
         Ct. App. 1983); Baldwin v. Benedict, 82 N.W. 956 (Iowa 1900).
862.     Geary v. Dade Dev. Corp., 280 N.E.2d 359 (N.Y. 1972). The mortgagee
         could not have been prejudiced by acceptance of the tender. He had sought
         a literal construction of the release clause in an effort to obtain a higher
         payment.
863.     Widmann v. Hammack, 187 P. 1091 (Wash. 1920). See also Tel. Sav. &
         Loan Ass’n v. Guar. Bank & Trust Co., 385 N.E.2d 97 (Ill. App. Ct. 1978).
             Provision for release of security on payment of a specified sum means
         payment in ordinary course of business prior to default, excluding insur-
         ance proceeds, condemnation awards, etc. See Myers v. Lewis State Bank,
         462 So. 2d 530, 533 (Fla. Dist. Ct. App. 1985).
864.     Fid. Trust Co. v. Brooklyn Props. Corp., 242 N.Y.S. 111, 114 (App. Div. 2d
         Dep’t 1930), indicates that a guaranty of part of a mortgage debt is not to
         be credited with the proceeds of insurance or a condemnation award nor
         with the amount of consideration paid for release of property from the
         mortgage lien. Smith v. Ferris, 39 N.E. 3 (N.Y. 1894), holds that remission
         of insurance proceeds to a mortgagee was not a payment “according to its
         terms” to be credited against a guaranty of part of a mortgage debt. The
         same is true of the proceeds of a foreclosure sale. Tel. Sav. & Loan Ass’n v.
         Guaranty Bank & Trust Co., 385 N.E.2d 97 (Ill. App. Ct. 1978).



                                      3–188
                             Mortgage Financing                                § 3:13

   It is generally held that a mortgagor ’s right under a release clause to
obtain partial releases is not affected by a default in the mortgage. 865
Cases inconsistent with this have been explained on the ground that
the mortgagor is entitled to a partial release, although in default under
the mortgage, if payment for the release would give the mortgagee all
he would be entitled to, absent a default, but not where the mortgagee
would not, such as interest, tax payments, or, in some cases, where the
mortgage debt has been accelerated.866 A New Jersey court, departing
from its precedents, denied a partial release where the mortgagor was
in default on the ground that one in substantial breach under an
executory contract may not enforce performance against a party not in
breach.867 It is desirable, therefore, from the mortgagee’s point of view,
to provide expressly that any right to partial releases shall lapse during
any such time as the mortgagee shall be in default. Under a provision
of this kind, a mortgagor is entitled to a release if he qualifies when he




865.      Harada v. Burns, 445 P.2d 376 (Haw. 1968), cert. denied, 393 U.S. 1106
          (1969); Eichorn v. Lunn, 816 P.2d 1226 (Wash. Ct. App. 1991). For
          minority cases, see Ryan v. Rizzo, 159 A. 272 (Conn. 1932); Dozier v.
          Shirley, 239 S.E.2d 343 (Ga. 1977) (minority rule); Burroughs v. Garner,
          405 A.2d 301 (Md. Ct. Spec. App. 1979); Moriello v. Matrix Prod. &
          Realty, Ltd., 385 N.Y.S.2d 391 (App. Div. 3d Dep’t 1976); City Bank
          Farmers Trust Co. v. Heckmann, 297 N.Y.S. 592 (Sup. Ct. Westchester
          County 1937); Horner v. Payne, 586 S.W.2d 101 (Tenn. 1979); Saunders v.
          Sharp, 840 P.2d 796, 803, 805 (Utah 1992) (despite pending foreclosure;
          citing cases); see also Eldridge v. Burns, 142 Cal. Rptr. 845, 856 (1st Dist.
          Ct. App. 1978). Contra R.I. Hosp. Trust Nat’l Bank v. Post, 544 N.E.2d
          592 (Mass. App. Ct. 1989); Eisenhart v. Schreimann, 889 S.W.2d 887, 894
          (Mo. Ct. App. 1994).
              Mortgagee’s claim of mortgagor ’s anticipatory breach, for nonpayment
          of installments, was no justification for mortgagee’s refusal to deliver
          partial releases. This, on the ground that the doctrine of anticipatory
          breach has no application to contracts for the payment of money only.
          Crouse v. Nantucket Vill. Dev. Co., 460 N.E.2d 1389 (Ohio Ct. App.
          1983).
              The same rule has been applied to entitle a purchaser to a release of a
          parcel from an installment contract, although in default under his con-
          tract. Columbia Dev., Inc. v. Watchie, 448 P.2d 360 (Or. 1968).
866.      See the discussion in Rolfes v. O’Connor, 844 P.2d 1230 (Colo. Ct. App.
          1992).
867.      Goldman S. Brunswick Partners v. Stern, 627 A.2d 1160 (N.J. Super. Ct.
          1993), relying on RESTATEMENT (SECOND) OF CONTRACTS § 237 (1981). Cf.
          R.I. Hosp. Trust Nat’l Bank v. Post, 544 N.E.2d 592 (Mass. 1989) (citing
          Massachusetts cases in accord).
              In Goldman the mortgage was nonrecourse and a release would reduce
          the mortgagee’s security because no payment was specified for the release.



(Friedman on Contracts, Rel. #7, 5/09)   3–189
§ 3:13                        FRIEDMAN    ON   CONTRACTS

requests it, despite a subsequent default.868 He is also entitled to a
release when the concomitant payment cures a default.869
   If the mortgage requires periodic amortizations, should these be
excused to the extent of payments made for partial releases? This is a
question of business judgment rather than of law, but the answer
should not be left in doubt.870 The mortgagee may well take the
position that inasmuch as the mortgage entitles him to payment in
full, by way of required amortizations over the term of the mortgage,
without releasing any security before such payment, an amortization
received for surrender of security should be in addition to periodic
amortizations. If the purchase money mortgage in question was given
as part of an installment sale, the mortgagee may be expected to refuse
to prejudice his tax position by accepting the entire purchase price in
the taxable year of the sale. This will impel him to refuse to give a
complete release of the mortgage during this period.871
   The owner ’s usual remedy for the mortgagee’s failure to deliver
partial releases is specific performance. A judgment for damages is also
possible.872 This raises the possibility of damages for loss of profits
and, in some situations, of punitive damages.
   The order of releases is of importance to the mortgagee, who may
become revested with title to the unreleased premises if the purcha-
ser’s venture fails and a foreclosure follows. Releases in haphazard
order may make the released and unreleased parcels resemble a
checkerboard and leave the unreleased property useless for any purpose


868.     Eldridge v. Burns, 142 Cal. Rptr. 845 (1st Dist. Ct. App. 1978); Saunders v.
         Sharp, 840 P.2d 796 (Utah 1992). Same, in the absence of such provision.
         Cassville-White Assocs., Ltd. v. Bartow Assocs., Inc., 258 S.E.2d 175 (Ga.
         Ct. App. 1979); Adair v. Kona Corp., 452 P.2d 449 (Haw. 1969).
             A provision entitling mortgagor to release of forty-two acres without
         payment was held to prevail over another provision that forbade any
         release while the mortgage should be in default. Willow Mountain Corp.
         v. Parker, 247 S.E.2d 11 (N.C. Ct. App. 1978). Accord Horner v. Payne, 586
         S.W.2d 101 (Tenn. 1979).
869.     Pioneer Nat’l Trust Co. v. Pioneer Nat’l Trust Co., 566 P.2d 312 (Ariz. Ct.
         App. 1977).
870.     The mortgage in White v. Spencer, 594 P.2d 609 (Colo. Ct. App. 1979),
         required annual amortizations of $9,000, and required payments of
         $12,857 for each 160 acres released. This was constructed to entitle the
         mortgagor with credit of the fixed amortizations against payments for the
         releases.
871.     I.R.C. § 453(b)(1) (1986) defines an installment sale as a disposition of
         property where at least one payment is to be received after the close of the
         taxable year in which the disposition occurs. This supersedes the former
         rule that limited an installment sale to one in which no more than 30% of
         the purchase price was paid during the taxable year in which the transac-
         tion occurred.
872.     Cassville-White Assocs., Ltd. v. Bartow Assocs., Inc., 258 S.E.2d 175 (Ga.
         Ct. App. 1979).



                                     3–190
                             Mortgage Financing                                § 3:13

other than that in which the mortgagor failed. Release of the front
parcels may make the rear parcels of doubtful use or value. If a tract is
to be subdivided, the seller-mortgagee may require the releases to be
begun at one end of the property and continue in order, so that at any
one time all the released parcels will be contiguous, or substantially so.
The developer may have reason to vary this pattern. If, for instance, he
begins building low-priced houses at one end and wants to shift to
expensive houses, he will probably want to do this at the other end. To
cover this situation, the mortgage may permit releases at both ends,
but require that subsequent releases at each end be contiguous.
“Contiguity” should not be carried to the extreme of preventing
releases of lots on opposite sides of the same street. The term
“contiguous” may lack a requisite definiteness.873
   A clause may provide for release of acres, on payment of a specified
sum, without expressing what parcels and in what order the releases
may be had. In this situation there is some authority to the effect that
the owner-mortgagor has the right of initial selection, with a burden
on the mortgagor to show that the requested release would prejudice
the mortgagee’s security; and in this event the process is to be
repeated, that is, the mortgagor is to make the initial selection, etc. 874
   Some cases hold a release of part of the mortgaged premises to be
severance of wholly-owned property, which may create easements by
implication.875 It may be good practice, in some cases, to negate the
possibility of such easements by providing for the inclusion of a clause,
such as the one below, in each release.


873.      A provision for release of plots with a minimum acreage but contiguous to
          a parcel previously released was held too indefinite for enforcement,
          although the basic contract of sale and conveyance was not invalidated.
          The reference to acres, which denotes areas but no particular shape, would,
          the court apparently concluded, have permitted the mortgagor to free from
          the mortgage all the property suitable for development and leave the rest,
          with no real security to the mortgagee. This, by selecting a parcel that
          merely touched a previously released parcel and wound around it in any
          fashion. Lawrence v. Shutt, 75 Cal. Rptr. 533 (4th Dist. Ct. App. 1969).
               In another connection “contiguous” was held applicable to land beyond
          a road. Grand Union Co. v. Laurel Plaza, Inc., 256 F. Supp. 78 (D. Md.),
          aff ’d, 369 F.2d 697 (4th Cir. 1966).
874.      White v. Spencer, 594 P.2d 609 (Colo. Ct. App. 1979). The explanation is
          that the release clause is for the mortgagor ’s benefit, but that the primary
          purpose of the mortgage is for the mortgagee’s security. Id.
               A provision giving the mortgagor an unfettered right of selection has
          been held not unenforceable for uncertainty. Lambert v. Jones, 540 S.W.2d
          256 (Tenn. Ct. App. 1976).
               First Equity Inv. Corp. v. United Serv. Corp., 386 S.E.2d 245 (S.C.
          1989), holds flatly that if the release is silent, the choice is with the
          mortgagor.
875.      See infra section 5:3.1.



(Friedman on Contracts, Rel. #7, 5/09)   3–191
§ 3:13.1                        FRIEDMAN    ON   CONTRACTS

                                  CLAUSE 3-13

       Clause to Avoid the Creation of Easement By Implication

   This instrument is given and accepted with the understanding that
   its execution and delivery shall create no rights, for the benefit of
   the premises hereby released in the premises which remain under
   the lien of said mortgage, by way of necessity or in the nature of an
   easement expressed or implied, or otherwise.

    This is not practical in the case of a subdivision where the
mortgagor-developer sells lots by reference to a map showing the
lots, as well as proposed streets, parks, and possibly other common
areas. The purchasers of lots expect easements in these common areas
and any effort to prevent their creation would probably also prevent
sales. The possibility of limiting street easements to abutting streets,
and to such other streets as are essential for reaching the nearest
public highway, is considered elsewhere.876
    If the mortgagee expects the mortgagor to pay the legal expenses of
preparing the releases, this, as well as the amount of such expense,
should be specified.
    In case of a subdivision, the mortgagor may contemplate eventual
dedication of the streets and other common areas, to the municipal-
ity.877 It may be desirable to donate part of the property for a school or
other public purposes. All this requires consent of the mortgagee, and
provision therefore should appear in the mortgage. If releases for these
purposes are to be without payment to the mortgagee, the mortgagee
will undoubtedly require that by the time he is called on to give any
such release, the mortgage principal will be reduced to such sum as
will assure its ultimate payment in full.

   § 3:13.1           Sample Forms of Release

                                  FORM 13-1878
   So long as this mortgage shall not be in default, any owner of the
   mortgaged premises shall be entitled on or after January 1,




876.       See infra section 10:7.2[C].
877.       See the third Form of Release, subdivisions (viii) and (ix).
878.       This form should be considered in light of the discussion in section 3:13
           supra, and should be compared with the comparable forms Forms 3-2 and
           3-3. Form 13-1, unlike Forms 3-2 and 3-3, does not require contiguity
           between the parcels released.



                                      3–192
                            Mortgage Financing                               § 3:13.1

    20___,879 upon ten days’ prior written notice to the holder of this
    mortgage, to a release from the lien of this mortgage of any of the
    parcels hereinbelow set forth, on payment, respectively, to the
    holder of this mortgage, in reduction of the principal sum hereby
    secured, of the sum set opposite such parcel below, together with
    interest accrued upon such payment to the date of such release, as
    such release parcels are shown on the attached map, marked
    “Schedule A”:


    Release Parcels            Considerations for Release

    A                          $____________
    B                          $____________
    etc.                       $__________

    Upon receipt of such payment, the holder of this mortgage shall
    deliver a proper partial release of mortgaged premises in the form
    set forth in Schedule B attached hereto.
    [Schedule A, as mentioned in foreword to the foregoing form, to be
    attached.]
    [Schedule B, consisting of form of release, to be attached. Con-
    sideration should be given to adding the clause quoted in Schedule
    A in section 3:13.2 below.]


                                   FORM 13-2880
    If the Mortgagor or any successor of the Mortgagor shall file a
    subdivision map of the mortgaged premises, with all necessary
    approvals thereof, showing lots (with the areas thereof specified)
    and roads thereon, the Mortgagee shall release parts of the
    premises from the lien of this mortgage, subject, however, to the
    following provisions:
    (i)    There shall be no right to releases until January 1, 20___.




879.       If the mortgage is a purchase money mortgage, which is likely in this
           situation, a release or releases during the calendar year in which the sale
           was made, accompanied by full payment on the balance of the mortgage
           debt, deprives the mortgagee of the income tax advantages of an install-
           ment sale.
880.       Form 13-2 should be considered in light of discussion in section 3:13
           supra, and should be compared with Forms 3-1 and 3-3.



(Friedman on Contracts, Rel. #7, 5/09)   3–193
§ 3:13.1                         FRIEDMAN    ON   CONTRACTS

   (ii)    A right to releases shall exist only while there is no default
           under this mortgage.
   (iii) No released parcel shall be less than ___ acres.
   (iv)    The Mortgagee shall be entitled to at least ten (10) days’ prior
           written notice before executing and delivering a release.
   (v)     There shall be no release of any parcel fronting on the
           __________ Highway to a depth of __________ feet, until
           the full satisfaction of the mortgage debt.
   (vi)    After the first release each subsequently released parcel shall
           be contiguous to the extent of at least 80% of its common lot
           line, to a parcel previously released.
   (vii) All releases shall be in the form set forth in Schedule A,
           annexed hereto.
   (viii) Simultaneously with the delivery of any such release, and as a
           condition precedent to the Mortgagee’s obligation to deliver
           the same, the Mortgagor or any subsequent owner of the
           mortgaged premises will pay the Mortgagee in reduction of
           the mortgage debt a sum computed at $____ per acre of the
           premises released, plus attorney’s fees of $_____ for each such
           release. No payment made under this subdivision shall have
           the effect of postponing payment of amortizations required by
           paragraph _______ of this mortgage.881 For the purpose of this
           paragraph, acreage shall be taken as the aggregate area of the
           lots to be released, excluding therefrom the area of any road
           abutting such lots to the center of such road.
   Schedule A, consisting of form of release, to be attached. This form
   may include the following:


                                     Schedule A
   This instrument is given and accepted with the understanding that
   its execution and delivery shall create no rights for the benefit of
   the premises hereby released, in the premises that remain under the
   lien of said mortgage, by way of necessity or in the nature of an
   easement expressed or implied, or otherwise, except that any
   owner of a lot or lots hereby released shall have an easement of
   ingress and egress, along any road abutting such lot or lots, to and


881.       The reference is to the provision requiring amortization payments regard-
           less of partial releases. The provision is contrary to the clause in Pioneer
           Nat’l Trust Co. v. Pioneer Nat’l Trust Co., 566 P.2d 312, 313 (Ariz. Ct.
           App. 1977), where the contract stated: “Payments for releases shall apply
           toward the next principal payment or payments due.”



                                       3–194
                            Mortgage Financing                              § 3:13.1

    from the released premises and the nearest public highway, as
    measured along such road, which easement shall terminate upon a
    completed dedication of such road.


                                     FORM 13-3
    Any owner of the mortgaged premises shall be entitled to releases
    of parts of the mortgaged premises from the lien hereof, on or after
    January 1, 20___, subject, however, to the further provisions of this
    paragraph:
    (i)    The Mortgagee shall have received in duplicate a subdivision
           map of the mortgaged premises, together with evidence of all
           necessary approvals thereof by governmental subdivisions and
           the due filing in the office of the Clerk of __________ County
           and the filing of any bond or bonds or deposit of any other
           security required by such governmental subdivisions.
    (ii)   Said map shall provide for [two] roads affording direct ingress
           and egress between the entire mortgaged premises and a
           public road. Said roads may be joined at the __________
           part of said premises.
    (iii) At the time of any such release the Mortgagor shall pay the
           Mortgagee a sum computed by dividing $_______882 by the
           number of acres to be released and multiplying the result by
           125%. Such sum shall be applied in reduction of the principal
           sum hereby secured, and shall be accompanied by a payment
           of the interest on such sum accrued to the date of payment.
           The release price for the last lots covered by this mortgage
           shall not exceed the balance of the principal and interest
           hereby secured at the time of such release. No payment made
           under this subdivision shall have the effect of postponing
           payment of amortizations required by paragraph _____ of
           this mortgage.883 For the purpose of this article, acreage shall
           be taken as the aggregate of the acre of the lots to be released,
           excluding therefrom the area of any road abutting such lots to
           the center of such road.
    (iv)   The Mortgagee shall not be obligated to deliver any release of
           less than _____ acres.




882.       This sum is the original amount of the mortgage debt.
883.       The reference is to the provision requiring amortization payments regard-
           less of partial releases. But see Pioneer Nat’l Trust Co. v. Pioneer Nat’l
           Trust Co., 566 P.2d 312 (Ariz. 1977).



(Friedman on Contracts, Rel. #7, 5/09)   3–195
§ 3:13.1                       FRIEDMAN    ON   CONTRACTS

   (v)     The Mortgagee shall not be obligated to deliver any release at
           a time when there shall be a default hereunder. The Mortgagor
           will give the Mortgagee at least ten (10) days’ prior written
           notice of a request for a release.
   (vi)    Any property released after the first release shall be contiguous
           to property theretofore released; and for this purpose a lot shall
           be deemed contiguous to a lot on the opposite side of a road
           as well as an adjoining lot. Notwithstanding the preceding
           sentence, the Mortgagor shall be entitled to a release of
           property fronting on the [northerly] part of the property and
           also at the most [southerly] part of the property, but in such
           event any subsequent released lot shall be contiguous to
           property theretofore released at either end of the mortgaged
           premises. Notwithstanding anything in this subdivision
           (vi), the Mortgagor shall be entitled to no release that shall
           make the aggregate highway frontage released a greater part of
           the original highway frontage, included in the lien hereof, than
           the aggregate area released shall bear to the area originally
           included in the lien hereof. For this purpose the original
           highway frontage shall be taken as _______ feet and the
           original area included in this mortgage shall be taken
           as _______ acres.
   (vii) Any such release shall be in the form set forth in Schedule
           A annexed hereto, and shall be prepared by the attorneys of
           the Mortgagee at a cost to the Mortgagor of $____ per release,
           regardless of the number of lots included in such release.
   (viii) If the Mortgagor shall have installed roads and drainage
           facilities or sewer lines on or under the mortgaged premises,
           all in conformity with said map, and with any and all relevant
           legal requirements, the Mortgagee will on request of the
           Mortgagor join, without charge by the Mortgagee, in a ded-
           ication of such roads, drainage facilities and sewers. Any
           instrument for this purpose shall be prepared by the Mortgagor
           at the Mortgagor’s expense and shall be reasonably satisfac-
           tory in form to the Mortgagee.
   (ix)    The Mortgagee will upon request of the Mortgagor consent,
           without charge to the Mortgagor, to the creation of such
           easements in the mortgaged property as may be reasonably
           necessary and appropriate for drainage purposes or for any
           utilities to be supplied to any building that may be hereafter
           erected upon any part of the mortgaged property; and will
           subordinate the lien of this mortgage to any such easements,
           provided, however, that no lien or charge shall be created
           thereby prior to the lien of this mortgage. Any instrument for




                                     3–196
                            Mortgage Financing                      § 3:13.1

          the purpose mentioned in this subdivision (ix) will be prepared
          by the Mortgagor at the expense of the Mortgagor and shall be
          reasonably satisfactory in form to the Mortgagee. The Mort-
          gagee shall execute the same without charge to the Mortgagor.
      Schedule A, consisting of a form of release to be attached, as per
    Schedule A attached to Form 13-2.




(Friedman on Contracts, Rel. #7, 5/09)   3–197

				
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