Real Estate Finance Outline - DOC by mrdildine

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									Real Estate Finance
1.Rights and Duties of the Parties prior to Foreclosure
a. Mortgage Law Theories (3) i. Title Theory – mortgagee received legal title to land, rents and profits. 1. In U.S., Mortgagee holds title for security purposes 2. In some states mortgagor has right of possession until default. 3. In order for lender to take possession, must get a court order. (no self help) ii. Lien Theory (Maj.) – Mortgagee acquires a lien and mortgagor retains legal and equitable title and right of possession until foreclosure. 1. You cannot deprive a person of their estate without a foreclosure in a lien theory state. iii. Intermediate Theory – mortgagor has legal title until default where legal title passes to the mortgagee. b. Other ways of acquiring possession: i. At the consent of the mortgagor ii. A mortgagee who makes a peaceful purchase of a foreclosed property at an invalid foreclosure sale retains possession until a valid sale is accomplished. iii. When a mortgagor abandons the real estate, the mortgagee’s interest kicks in. 1. [Public policy supports possession] c. Liability of a Mortgagee in possession i. Until foreclosure, mortgagee must act with regard to junior encumbrances and holders 1. Mortgagee is liable for injuries done through the property 2. Mortgagee has to apply rents and profits of mortgagor to his debt. 3. Mortgagee is responsible to the mortgagor for maintenance of the property. 4. Must do what a reasonable owner would do with the property (i.e. try and rent the property) d. Mortgages and possession status i. Title conveyed by a trustee deed relates back to the date when the deed was executed.1 1. Liens, leases, that are subordinate to the deed of trust, are extinguished by a foreclosure sale. e. Senior vs. Subordinate i. Lease Prior to Mortgage2 – A lease, duly recorded before a mortgage, is superior to the mortgage. 1. Such a lease cannot be extinguished by a foreclosure sale 2. If lease contains purchase option, option must be subordinate to mortgage.3

Dover Mobile Estates v. Fiber Form Products, Inc – D entered into lease with X.. X encumbered the property to Y. X defaulted. P bought property at the foreclosure sale, expecting D’s lease to go with it. Later D gave 30 day notice and left. P tried to sue for the lost rent on the lease. H: Because the lease was subordinate to the deed of trust it was extinguished at the foreclosure sale. Title conveyed by a trustee deed relates back to the date when the trust was executed so the purchaser at the trustee sale takes title free and clear. Additionally when a LL allows a tenant to stay after the a lease is terminated, a month to month lease is formed in the absence of a new lease. 2 When the leasee is a major player such as target they can try and get it both ways. When they make their lease they declare that although they are senior they can renegotiate or have the exit option at foreclosure. 3 If the option was not subordinate to the mortgage, it would kill part of the security interest a mortgage creates.


3. A prior lease can be subordinated to a subsequent mortgage if a subordination agreement is signed. 4. In title and intermediate states, if the mortgage defaults, the mortgagee can require leasee to make all future rent payments to the mortgagee.4 a. Privity of Estate5 makes leasee liable to subsequent mortgagee for rents. b. Mortgagee must demand payment for it to be due. ii. Lease Junior to the Mortgage – A lease recorded after the mortgage. 1. Lease is extinguished at foreclosure sale. 2. In title and intermediate states, mortgagee has right to evict leasee as soon as default occurs in mortgage payments. a. Also available in lien states if clause is included in the lease. b. Mortgagee can also give leasee a choice to make payments directly to the mortgagee or move out. 3. If mortgagee enters under his mortgage and leasee remains, a month to month lease is created. f. Varying Priorities by Agreement 6 i. Subordination Agreement – a party having an interest in real estate consents to a reduction in priority to another holding. 1. Usually separated signed document ii. Nondisturbance Agreement – a mortgagee holding a senior lien agrees that in the event of foreclosure, the purchaser will permit the tenant to remain under current lease. iii. Attornment Agreement – Tenant agrees with the mortgagee that in the event of a foreclosure or transfer of interest to new owner, the tenant shall be bound to the purchaser by the terms of the lease for the balance of time remaining 7 1. Puts the tenant and the lender in direct privity of contract. Gives lender the right to demand payment. iv. Subordination, Nondisturbance, Attornment Agreement – The tenant agrees to subordinate his lease to the mortgage, if the mortgagee does not disturb his lease and furthermore the tenant agrees to be bound by the terms, conditions and duration of the lease to the new purchaser. g. Security Interest in Rents i. In lien theory states, collateral agreements are used to give mortgages a security interest in rents and profits. ii. When a mortgagee assigns the rent and profits it is valid when: 1. Majority: When a mortgagee records a mortgage that includes assigning of rents, the mortgage is superior to any subsequent party who seeks a security interest in the lease.8 2. Minority: The mortgagee has to record such assignment and take additional action to enforce it. iii. States Approaches to Assignments 9
4 5

Cannot do this in a lien theory state because no title is transferred. Privity --- The connection or relationship between two parties, each having a legally recognized interest in the same subject matter (such as a transaction, proceeding, or piece of property); mutuality of interest 6 Different parties might want different priority preferences. A party who invests a lot of money and effort into a leased property could want further protection, where a party who is subjected to a pro LL contract could want to escape on foreclosure. 7 The diffenrce between an attorunemnt agreement and a non-disturbance agreement is that the attournment saying that the tenant will abide by the lease and the non-disturb is saying the owner will abide by the lease. 8 In the Matter of Millette – D owned a building that they mortgaged from X. D got sued by P and they owed him a lot of money. Y entered into a lease with D for their building. X found out and want Y to pay them instead. H: the court went with the majority and held that because the lease had been recorded with the assignments that the rent did not have to go to Y. Furthermore, by responding to the garnishment, they did takes the proper steps for the minority rule.


1. Absolute Assignments – the mortgagee obtains a present title to the rents even though it cannot be enacted until the mortgagor defaults. 10 a. Must have language intending to transfer immediately assignor’s rights and title to rent. 2. American Common Law Approach – Lender has only inchoate11 rights on rents until he takes action. a. Until you take some effective approach to collecting the rents, or asserting his rights he has nothing. 3. ―Middle Ground‖ Appraoch (Trend) – An assignment of rents is effective between original parties at execution and perfected as between third parties when recorded. a. Right to commence collection requires: i. Default and satisfaction of conditions in mortgage and; ii. Delivery of demand to rents to all parties that have a mortgage or leases on the property. 4. Restatement Approach – effective between parties when recorded and perfected against 3rd parties upon execution and delivery. a. Can collect rents after default and a delivery do demand for rents to mortgagor, holder of equity of redemption and each person who holds a mortgage on the real estate. iv. Mortgage in Possession 1. Generally – Mortgagee who acquires possession is liable to third parties (Mortgage must have dominion and control). a. Collecting rents alone will not count as control. 12 h. Receiverships i. Generally – Involves a third party or a judicial appointment taking possession of mortgaged property to repair or preserve the property and to collect rents ii. Purposes: 1. Mortgagee avoids accounting and liability burdens associated with taking possession. 2. Entry by receivership does not automatically terminate junior leases. 3. In a lien state, they are important because of the unavailability of ejectment. 4. Can help reestablish a cash flow with rents. iii. When can a receivership be used? 1. Restatement – a. Default; b. Property is worth less than the debt and; c. Waste i. Voluntary waste – affirmative destruction of the property. Active ii. Permissive waste – do not make repairs or pay taxes. Failure to act

Three crucial steps to determine rights: STEP 1 – when does the assignment become effective between mortgagee and mortgagor; STEP 2 – When does the lien become effective against other who acquire interest in the real estate; STEP 3 – When does the mortgagor have the right to collect the rents and profits. 10 Step 1: Absolute rights go to the lender; Step 2: When it is recorded it is against the rest of the world Step 3: When it is in default. 11 Incohate rights or interest is interest in real estate which is not present interest but which may ripen into a vested estate if not barred, extinguished or divested. 12 Coleman v. Hoffman – P had a child that was hurt on property. X owned real estate and they defaulted. The lender (L) began to collect rents. Y collected rents for L. L also hired Z to do repairs before the injury. At foreclosure proceedings Z bough the property. P is trying to sue Z,Y, and L. Held: Y is not liable because all they did was collect renst. This is not enough to be in control or have dominion over the property. L is liable because they received the renst and they hired people to fix the property. They appear to be in control. Z also as the purchaser and caretaker of the property is liable. Note. No liable. This was a ruling against MSJ.


2. Receivership provision – clause in the contract saying that in default a receiver will be used. a. In serious Lien theory state holds these agreement against public policy. b. Trend is towards enforcing receivership clause. c. Some states have statutes that give receiverships in default d. If no statute, common law applies. iv. Exparte receivership 1. Generally -- Receivership is given without giving the defendant the opportunity to be heard. a. Takes property away without hearing. (D has 10 days after taking possession).


v. What can a receiver do once appointed? 1. Take rents 2. Rent property14 3. In title theory states, they can terminate a junior lease.15 4. In lien theory state, receiver takes property subject to junior and senior leases unless a. Lease violates the mortgage or;16 i. Senior leases requires actual knowledge not constructive17 b. Was made while former mortgagor was in default AND not commercially reasonable. Waste i. What Constitutes Waste? (5 types) 1. Physical Damage to the property a. i.e. demolishing valuable improvements, fixtures, removal of timber if not necessary 2. Failure to make necessary repairs a. If destruction is caused by natural causes (earthquake, hurricane) courts hold no duty to repair. 3. Failure of mortgagor to pay property taxes a. Majority -- Such taxes a prior lien and this puts the property in risk of foreclosure. b. Minority – failure to pay taxes is not waste 4. Failure of mortgagor to comply with mortgage covenants regarding the condition of the premises. a. i.e. promises to construct improvements or insure the property against casualty loss or demolish undesirable structures. 5. Failure of the mortgagor to give rents to the mortgagee when a valid mortgage on the rents has been enforced. a. Known as “waste of rents” ii. Remedies for Waste 1. Generally – Damages, injunctions, and foreclosures a. The mortgagee may never recover more than the loan balance no matter what the waste.18

13 14

You might want this so that the defaulter has no notice of possession and they cannot take their money and flee. A new leases under a receiver will sign a non-disturbance agreement with E1 so that they can stay past the foreclosure sale. 15 I.e. there is a sweetheart lease between old LL and tenant for $5 when the property is worth $1000, signed a month before receiver. 16 There usually is a provision that says all leases have to be approved by Lender or E1. The tenant is on constructive notice of this. 17 Must mail letter saying what was in the mortgage. 18 This is because the mortgagee only needs the security back.


b. The actual harm done by the waste is the ceiling for damages i. Either cost of repair or reduction in FMV. c. All lien theory states and come title theory states hold that damages may not exceed the security impaired. d. Title States – Pay for the diminution in value so long as it does not exceed the debt. 19 2. Measuring Damages (Lien states) a. Debt Equivalency rule i. No damages unless impairment reduces property below the balanced owed on mortgage. b. Reasonable Margin of Security Rule i. Damages if property’s value has fallen so much that mortgagee’s margin of security is unreasonably low. c. Original loan-to-value ration rule i. Court asks what the original loan-to-value ration was at time of original loan and the allow damages to restore ratio to same level. 20 d. Pre-waste loan-to-value rule i. Mortgagee is entitled to L/V ration just prior to the waste. (Similar as above)21 e. Scheduled loan-to-value ration i. Same as above except mortgagee is entitled to get same payments as if all payments had been made on time and the value had not changed.

3. Waste by non-assuming grantee, successive owners, non-recourse loans etc. a. If a mortgage prohibits the mortgagee form going after the mortgagor for liability of debt, they may go after him for waste depending on the wording. 23 i. CA: no recovery unless done in “bad faith” b. Successor owners may be liable for waste even if they did not assume the mortgage debt and have no liability on it. 24 i. Leasehold tenants or persons with no possessory interest do not have waste liability unless they caused it. 4. Waste by Third parties a. Generally – No liability for waste by third parties unless they had notice of the mortgage. i. Constructive notice of recorded deed is usually insufficient. 5. Bad Faith Waste

19 20

: In Mass. MR  ME for 300K. Property is worth 400K. MR commits waste of 90K. MR pays ME 90K. X gets a loan from Y for 80K and the property is worth 100K (the L/V = 80%). In the subsequent five years the loan balance is paid off to 70K and the property incrases in value to 120K. X commits waste bringing the value down to 80K. Y is entitled to 80% of 80K or 64K. Sy Y can get 6K form X to bring the 70K debt down to 64K. This ensures that Y gets his security interest. 21 Same as above except instead of 80/100 it is 70/120K. The amount just prior to the waste. 22 Same as above except the L/V is 70/100 or debt paid / original value. 23 Nipon case where D and P had mortgage that had no liability clause where D did not pay taxes and P went after D for waste and was awarded punitives. 24 Prudential Insurance v. Spencer’s – MR had a mortgage with P. D assumed the mortgage subject to which meant they did not assume liability for the debt. MR still has liability. D defaulted and P foreclosed. P bought the property at foreclosure for half the price that it was worth. (IT IS VERT IMPORTANT THAT WHEN A LENDER FORECLSOES AND THEY WANT TO BUT BACK THEY DO NOT MAKE A FULL CREIT BID) D committed waste. The court held that P could go against D for waste even though they had no liability on the debt. It is bad public policy to allow people to have no responsibility for upkeep.



a. Generally – This is waste that is intentionally done. It could be done in order to try and make a profit. It is a tort and can be given punitive damages along with other damages. Insurance Proceeds and Real Estate Taxes i. Insurance proceeds are for replacement or property not the debt. ii. Mortgagee are entitled to claim insurance proceeds if the mortgage requires insurance 1. If mortgagor voluntarily got insurnsance, mortgagee has no claim. 2. If the mortgage does require insurance and mortgagor fails to include mortgagee’s name, mortgagee still has a claim to proceeds. 3. The ceiling is the amount of debt owed. iii. Two Types of Policies 1. The Loss Payable Policy (almost never used) a. Issued to the mortgagor b. Specifies that the loss is payable to the mortgagee and mortgagor as their interest may appear c. Mortgagee is an appointee of mortgagor i. If mortgagor breached condition that bars recover, mortgagee’s recovery is also barred. 2. The Standard Mortgage Policy a. Covers mortgage b. Act of mortgagor cannot invalidate mortgagee right to recovery. iv. Restoration of Premises 1. Majority: mortgagor has no right to insist proceeds be used to rebuild; it is at the mortgagee discretion. a. If proceeds used for the debt, there is no requirement that restoration would impair security or the value of the destroyed land is greater than the debt. 2. Minority (Restatement): Absent a provision in the mortgage, if in the remaining time left on the mortgage, the property can be rebuilt with the proceeds and/or other funds, the mortgagee holds the proceeds subject to the mortgagor’s request to toward restoration on reasonable conditions. a. If a provision exists it may be enforced or disregarded as unconscionable. 3. CA: Unless you required insurance in mortgage, you have no right to the proceeds. a. However, if it is not required they can contract around that by saying if it is not required and you still take it out, the lender can contract that they get first dibs up the amount of debt. b. If the lender has a clause that says they get to chose, it has to be done in good faith. You may only apply the money to the debt if rebuilding would impair the security of the lender. v. Mortgagee Purchase at Foreclosure Sale – Effect on Insurance proceeds25 1. Loss Payable Policy a. If the mortgagee bids at sale for the amount of the debt, the security is no longer needed and the mortgagees interest is destroyed  no recovery for insurance proceeds 2. Standard Mortgage Policy a. If the loss occurs AFTER the foreclosure sale purchase by the mortgagee for the amount of the debt  mortgagee is permitted to recover. b. If the loss occurs BEFORE sale  no recovery c. What if the mortgagee did not know of loss at sale? (3 options):


Hypo: MR E1 for 200K. there is a fire which reduces down to 140K. 130K insurance policy. Option 1 for E1, go after proceeds and foreclose. Option 2, foreclose and go after proceeds from defiency suite.


i. Set aside the foreclosure sale ii. Reforming the mortgagee bid to reflect the actual value of the property after loss iii. Recover insurance proceeds.


Transfer and Discharge
a. Transfer of Mortgage Interest 26 i. Generally:27 1. Mortgagor’s interest is freely transferable. 2. Cannot escape liability to the grantee. 3. Mortgagor usually remains bound to pay the debt. ii. Transfer Subject to the Mortgage 1. Generally: Grantee does not become personally liable to mortgagee or mortgagor. a. Can get a deficiency judgment against grantee iii. Assumption Transfers 1. Generally: Grantee becomes personally liable for payment of the mortgage debt. a. However MR is not off the hook for liability with this transfer; he is still liable. 2. How do you create an assumption? a. Typically it is in the deed. (Look for language of liability) i. i.e. “Which grantee assumes and agrees to pay according to its terms”. 28 ii. It does not have to say “assume”; just has to place liability b. Or it could be through a direct agreement with GE and ME. i. GE will sign a separate agreement with ME. c. Minority: “implied Assumption”  if you put subject to language an assumption is implied. You have to state that you do not want an assumption. d. Each of these are enforceable because of Third party Beneficiary 3. Break in the Chain a. Hypo  MR has a mortgage in favor of E1. G1 assumes from MR. G2 assumes from G1. i. 3rd Party Creditor Beneficiary Theory – E1 is viewed as the C/B of the MR  G1 transfers and the G1G2 transfer. E1 is permitted to stand in the shoes of MR to reach G1 and is permitted to do the same for G2. ii. What is G1 did not assume but took “subject to”? – Split 1. Restatement 1 of Contracts requires: a. The promisee must be personally liable and


During times when there is high interest rates it is common for purchasers and owners of property to just “take over” a mortgage loan. Using this method holds the interest rate at the original mortgage and reduces transactional costs. 27 Middleton v. Hancock -- MR had a loan with ME for a shopping center. Later after the note had been paid down, MR sold the property to GE. In the sale GE agreed to take over payments. In the original mortgage there was a due on sale clause that said a separate buyer would have to get permission before selling which ME granted. GE began to default in its payments. Because there was no assumption of the mortgage, ME reminded MR that they were still liable. MR began to make payments. GE refused to make any payments. MR brought this action seeking to 1) get reimbursed for the money be paid and 2) to foreclose on the property to assist in the repayments. Held: The court held that GE never assumed the mortgage and therefore never assumed liability. The language must be very specific in a transfer; the language did not meet this requirement. If the grantee is not liable t\he property is liable and therefore the MR-surety is liable. Because this was a “subject to” transfer there is only one option that being subrogation. He would have to pay in full, which he is not done. But GE did not assume the note so he has no liability. 28 This language would not be present with a “subject to” transfer. Although they would want language saying that it was a GWD.


b. Intended to benefit E1 2. Restatement 2 requires a. Intention to benefit E1 (much easier)

iv. Rights of Grantor Against Grantee 1. Subrogation (right to stand in someone else’s shoes) a. Subject to: Mortgagor may pay off mortgage debt. He then can foreclose on property and apply the foreclosure sale proceeds to the cost of the mortgage pay off. i. Key: must pay debt in full. 29 b. Assuming: Mortgagor may pay off mortgage debt in full. He then may sue the grantee on the note or may foreclose the mortgage against the grantee and get a deficiency judgment against grantee. i. Key: Must pay debt in full. c. Note: There is no such thing a partial subrogation. 2. Reimbursement a. Subject to: not available. b. Assuming: If the mortgagor pays any part of the debt, the mortgagor may immediately sue the grantee for reimbursement i. This is different from subrogation by 1. it is not secured by the mortgaged real estate and 2. it does not require full payment 3. Exoneration a. Assuming: If the debt is due or in default, the mortgagor may get a court order i. You have to sue for eth whole amount but you do not have to put any money down. v. Assuming Grantee’s defenses against mortgagee 1. Generally: An assuming or “subject to” grantee may not use any defenses that the mortgagor had against the mortgagee. a. Courts want to avoid unjust enrichment. vi. Rights of Mortgagee against assuming Grantee 1. Generally: ME can go after GE for the entire debt or a deficiency judgment after foreclosure.30 vii. Surety Defenses 1. A surety (MR) is generally discharged in the following circumstances: a. If the ME releases GE from liability b. ME releases some or all of the real estate form liability.31 c. Impairing MR’s right to realize on the security of the mortgage d. Modifying the interest rate or terms of payment or e. Extending the time to maturity of the mortgage loan 2. A reservation of rights clause may be exceed in scope by one of the above actions.32
29 30

When he pays it off, he will probably wait to see if property values increases because now he holds the mortgage. Reasoning is that an assuming transfer from MR to GE creates a surety in MR meaning he can go after GE if not paid. This is so because MR has a debt to ME. If GE assumes the debt, he then is indebted to ME. 31 Depending on the value of the debt all or part of the debt will be discharged. If the debt is worth 100K and the property is worth 150K and ME forgives 60K only 10K of the debt is released. 32 First Federal Savings and Loan Association v. Arena – MR and ME had a mortgage with a reservation of rights clause. MR transferred the property to GE. Before the transfer ME and GE agreed to a higher interest rate and longer mortgage terms. GE


3. Note: It is not always a release when GE and ME change the agreement because sometime it is for the benefit of MR such as lowering interest rates. 4. Subject to: If MR gives Blackacre to GE subject to, and GE and ME make a prejudicial agreement MR is released on the date of the modification u33p to the value of the Blackacre. b. Impact on Mortgagor of “Deals” Between Grantee and Mortgagee Mortgagee Action Release of assuming grantee Release of the security property from the mortgage Impairment of the security Modification of loan terms Case Law Mortgagor is completely discharged Mortgagor is discharged to extent of value of property Mortgagor is discharged to extent of loss of value of property Mortgagor is completely discharged if grantee assumed, or discharged to extent of property’s value if grantee did not assume Mortgagor is completely discharged if grantee assumed

Extension to time to pay

i. When GE and ME make a deal, without MR consent, that is prejudicial to MR, MR duty is discharged.34 ii. Agreements that Modify Security 1. If GE and ME agree to modify security, MR will be let off the hook the debt minus the value of what was given up.35 2. If ME releases a lien on a property:36 a. Minority: MAR duty is completely discharged b. Majority: MR is released minus the value of the property iii. All these problems are solved if MR gives consent. 1. Cannot exceed scope of consent. c. Due on Sale Clauses i. Types of Clauses 1. Due on Sale
defaulted and ME foreclosed and tried to bring suite against GE and MR. Held: Even though the mortgage had a reservation of rights clause, the higher interest rate and term of payment exceed the scope of the clause. MR did not have the chance or opportunity to agree to such terms. MR duty is discharged. We construe against the drafter which would be ME lawyers. Te consent in inapplicable. This turned into a default rule case. So the modifications were prejudicial which meant that we need to know whether it was a subject to or assumption transfer. KEY FOR TEST. 33 I.e. If the loan was for 100K and the FMV was for 120K, at the time of medication MR would have no liability. If however the FMV was 70K, MR would have 30k of personal liability remaining. NOTE: this will not effect MR unless there is a foreclosure and a defiencny judgment or ME is suing on the note. HYPO 2: MR to ME for 100K. MR to GE. FMV = 70K. (subject to loan). Foreclosure sale  bought for 65K. MR on the hook for 30K. If bought for 85K, MR on the hook for 15K. 34 Not all agreements will discharge MR. For example if GE and ME agree to a reduction in interest rate, this would benefit MR. No relase. 35 Mortgage of 200K. Doe not matter whether Ass. or S/T. Blackacre has a house with land. GE goes to ME and says I own 2 parcels that are close to each other and I am building a large building and I want to make a bigger parking. Please allow me (GE) to tear down building on Blackacre. If they do this MR is left off the hook to the extent of the value of the property. MR is let off the hook minus the value of the destruction. i.e. before demo  220K. Demo took it down to 80K. MAR is off the hook 140K from 200K. MR only has 60K left of liability. 36 Hypo: MR  ME 200K on White and Blackacre. MR  GE. ME agrees with GE to release the lien on white acre. What about MR. WA was worth 120K. BA was worth 100K. Minority: MR has no more liability. Majority: MR’s liability is reduced by 120K


2. Due on Encumbrance 3. Increased Interest on Sale ii. Pre-Garn ST. German Act 1. Majority: DOS clauses were per se reasonable unless the MRA could show the lender used unconscionable conduct. 2. Minority: Must be reasonable on a case by case basis. iii. The Garn-ST. Germain Act 1. Generally: Preempts state law and makes DOS clauses generally enforceable. 2. Lender covered a. The act covers any person or government agency making a real property loan. 3. Loans covered a. Every loan, mortgage, advance or credit sale secured by a lien on a real property 4. Types of Transfer Restrictions covered a. Only preempts state law for DOS clauses b. Not covered: i. Clauses that allow lender to collect a fee or; ii. Increase interest rate 5. Transfers in Which DOS Enforcement is Prohibited (Must be on four unit dwellings or less) a. Creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property. i. Means barrower who owns a home can lease, second mortgage, etc. b. A transfer by devise, descent, or operation of law on the death of a joint tenant or the tenant entirety. i. A lender cannot call the loan in if the transfer to G1 if G1 was a JT in the original ownership. c. The granting of a leasehold interest of three years or less not containing an option to purchase d. A transfer to a relative resulting from death of the barrower e. A transfer where the spouse or children of the barrower become owner of the property. f. A transfer from a divorce, when one spouse becomes owner of the property 6. Estoppel a. If the mortgagee delays acceleration of the mortgage debt for a significant period of time, he may be estopped from asserting the clause later. b. Factors: i. Improvements to the home ii. Length of time iii. Commercial relationships 7. Release of the Original Mortgagor Under the Act a. When a mortgagee waives its right to accelerate under the DOS clause, and transferee assumes mortgage, the mortgagor is released from liability on mortgage debt. i. This happens when there is an assumption, adjusted interest rate (not subject to). d. Payment of the Mortgage Debt i. Generally: 1. Two different payor parties


a. Those who are primarily responsible: person who owns equity of redemption.


iii. iv. v.

vi. vii.

b. Those who are no primarily responsible: when these people pay off the loan it becomes assigned to them. 38 2. When the person who is primarily responsible pays off the debt, it is discharged upon the ME giving a suitable document discharging the mortgage a. If this documents is not given, fines may be imposed on the lender. 3. If a person who is not primarily responsible pays off the mortgage it assigns the obligation and the mortgage to the payor. a. Based on principle of subrogation. Tender 1. Generally: An offer to the ME to pay off the debt 2. Stops interest from running on mortgage debt. 3. Entitles payor a release or an assignment of the mortgage 4. Tender must be kept good (party must be ready and willing to pay) Majority: There is no-common law right to prepay a mortgage debt before it is due unless the terms expressly authorize prepayment. Minority (trend): Prepayment is permitted where contract is silent. Lock-in clauses  specifically prohibits prepayment before a certain date or at all. 1. Courts uniformly enforce. 2. Defeasance Clause: barrower has right to substitute treasury security equal to the value of the real estate. If the barrower tenders, treasury bills, the lender will release the mortgage. MR is still liable on the debt though so that if ME isn’t paid, MR is liable. (allows MR to sell the real estate). 39 Partial Release Clause  Usually happens where lender has mortgage on a subdivision and allows mortgage to pay off certain lots as he sells. Them. Prepayment Fees 1. Mortgagee contracts a charge if the mortgagor wants to buy in full early (more common in commercial mortgages). a. Generally courts enforce prepayment fees. 2. Reasons: a. First, mortgagees fixed costs for making a loan are not recouped if paid in full early but are done so with the full maturity of the loan. b. Second, prevents the barrower form shopping around for loans. 3. Judicial Attacks on Prepayment Fees a. Some argue that they are a charge for returning the money instead of and not interest for the right to use the money b. They are no considered a restraint on alienation. c. They can be a form of liquidated damages. 4. Acceleration by Mortgagee After Default (commercial) a. 1st Generation (maj.): If a mortgagor defaults and ME accelerates the debt, ME cannot collect prepayment fees if caused by an honest ability to pay. i. If a mortgagor intently defaults to accelerate debt, courts will most likely enforce fee.


Hypo: MR has a loan with E1 and E2. He transfers to GR. GR cannot pay off the mortgage on E1 because that would wipe out E2. This is unjust enrichment 38 An example of this is a second mortgage who pays of the first mortgage which is in default, so that they may dictate when the foreclosure sale will be. 39 i.e. MR has a mortgage on building and ME has mortgage with lien. MR sells to X. MR takes out T-Bills. ME has security interest in the T-bill. This is now ME’s security interest.


b. 2nd Generation (new and min.): Courts have held a prepayment fee valid upon acceleration where it was contracted for in the mortgage. 5. Other Involuntary Payments a. Courts refuse payment where prepayment is involuntary (i.e. casualty loss) under 1st generation. 40 Under 2nd generation lenders could collect. b. For some reason prepayments fees are never included in their forms and do not apply. 6. Prepayment Fees in Bankruptcy a. This will be decided by a bankruptcy court. e. Merger, Deed in Lieu of Foreclosure and Related Problems i. Merger 1. Generally: when a mortgagee’s interest and fee title (the land) coincide in the same person, the mortgage merges into a fee title. The mortgage and, sometimes, the debt are destroyed. 41 a. Courts do not want unjust enrichment. 2. Mortgagee Purchase at a Junior Sale42 a. Rest.  Follows unjust enrichment rule. (Centers around how much land is worth) i. ME will be prevented to recover on a mortgage where unjust enrichment would result. 1. If FMV was equal to or greater than debt – can’t sue 2. If FMV is less than the debt – sue. b. Avoidance of Merger i. If junior and senior mortgages are in default, mortgagee can bring both simultaneously at Judicial Sale 1. If sale brought less than sum of both debts, mortgagee can bring get a deficiency judgment. ii. This will NOT work at a power of sale foreclosure because you cannot combine debts. 3. Mortgagee purchase at senior sale a. The purchase of a senior mortgage by a lender does not destroy the later ability to collect on a junior mortgage. i. They do not factor the junior mortgage into the sale price. 4. Notes on Deeds in Lieu of Merger a. Generally: When a foreclosure is impending, the barrower may offer simply to deed to property to the lender. i. Advantages  avoid foreclosure or judicial sale costs and time; no statutory right of redemption. Helps MR avoid a personal liability. Avoids harming your credit rating (CA advantage because no PL). b. If the senior mortgagee accepts the deed and there is a junior mortgage:

40 41

Westmark Commercial Mortgage Fund v. Teenform Ass. – This is an involuntary prepayment case. Merger Doctrine: When a lender owns the senior and junior mortgage and foreclosures on the junior and HE is the purchaser at the foreclosure sale, the senior debt disappears. The rationale is that when P who is the lender bought at the sale, they subtracted the amount due on the senior loan. 42 Hypo: MR has a mortgage with E1 (200k) and E2 (100K). E1 who has the senior mortgage, purchases E2 mortgage at a foreclosure sale for 100k. The property is worth 300K. E1 now as both mortgages and security. They should merge. We do not allow E1 to collect on the senior mortgage because he can sell the property and get his money back.. if he could sell the property and sue MR he would be unjustly enriched. If however the FMV was below the debt, then he would not be unjustly enriched and could sue.


i. Majority: Courts hold that there is no merger and E1 has the property and the mortgage. He can foreclose 1. If proceeds at foreclosure sale are in access of both debts, E1 get the excess. ii. Minority: E1 has the property and the mortgage and there is a merger and the mortgage and E1 debt is destroyed. E2 now has the senior loan. (Creates unjust enrichment in E2)


Foreclosure 43
a. Determining the Foreclosure Amount: Problems of Acceleration i. Generally: Virtually all mortgages have an acceleration clause which allow them to collect the whole of the debt upon default. 1. Default enacting an acceleration clause can be triggered by: not paying interest or installments, not paying taxes or maintaining insurance, or triggering a DOS clause. ii. Notice as a Condition Precedent 1. Common Law: Notice is not required for valid consideration; only requires an overt act evidencing the enactment of the acceleration. a. Under Judicial Sale, commencement of action would be enough. 2. Restatement (trend): Acceleration becomes effective on the date specified in a written notice by the mortgagee to mortgagor delivered after default. 3. Minority: Must send letter out stating intention to accelerate and second letter saying that you have accelerated. 4. Tender before or After Acceleration a. If the mortgagor tenders arrearages prior to valid acceleration, the mortgage is reinstated. b. After acceleration only full tender will suffice; partial payments will only be used to pay off the mortgage debt. iii. Judicial Limits on Acceleration 1. Waiver a. A failure to accelerate upon the first default does not waive acceleration for later defaults b. However, a consistent pattern of waiver will. i. i.e. nice person who lets you pay late all the time. 44 2. Estoppel a. Lender could be estopped where lender assured MR that the acceleration and foreclosure would be postponed. i. Distinguished from long pattern of waiver. 3. Abandonment a. Happens when lender has right to accelerates and does but then after acceleration the ME accepts payments, etc. for a number of months; lender could have abandon right to accelerate. 4. Hardship as a ground a. Majority: A mortgagor will not be relieved from the enforcement of an acceleration clause for a default occurring because of his negligence,


**** In CA we will foreclosure judicially when 1) We do not know the number or place of the mortgages and liens on the property; 2) When we want a deficiency judgment. Four or five states say that when you close by power of sale you waive DJ. 44 To not waive and be nice you could send a letter saying that you will not longer accept late payments. A lot of lenders, including Sallie Mae and Freddie Mac, put in anti-waiver language. However you can waive an anti-waive language.


inadvertence, mistake or accident unless the mortgagee is guilty of fraud, bad faith, or unconscionability. 45 b. Minority: Mortgagor will be protected from defaults that are made by mistake, accident while acting in good faith or in unusual circumstances beyond MR’s control. 46 iv. Statutory and Regulatory Limitations 1. State Statutes a. Many states have enacted “arrearages legislation” which allows the defaulting MR to cure the default and defeat acceleration prior to acceleration. (CA says can tender arreages up to five days before the foreclosure sale) i. Cure can be in the form of paying the debt, taxes, insurance, etc. ii. In some states arreages only apply to residential loans. iii. In two or three states, they say you can only do this twice a year to avoid barrowers doing this chronically. 2. FHA a. Allows a defaulting MR defeat a foreclosure proceeding if the MR brings the mortgage current (including taxes, attorney and foreclosure fees) 3. Fannie Mae and Freddie Mac a. Puts on harsher restrictions for acceleration: i. Must have detailed mailed notice and a 30 day grace period. ii. A MR may pay arrearages and attorney fees 5 days prior to foreclosure to defeat sale. b. Judicial Foreclosure i. Generally: usual method of foreclosure in 40% of the states. Purpose is to put foreclosure sale buyer in the place of the MR at the time of the signing of the mortgage that was foreclosed. ii. Why use Judicial Foreclosure: 1. When the mortgage form does not contain a power of sale clause. This makes JF a necessity. 2. Jf may be necessary to correct defects in the mortgage. a. i.e. there is an error in the legal description of the land. 3. When the mortgage is in a absolute deed. 4. Where there are other liens and the priority is uncertain. iii. How do you bring a party in? 1. Put them in the petition and have them served. 2. Lis Pendens a. Common law: a purchaser of real estate takes the real estate subject to pending litigation on the real estate. b. Statutory: same but litigation must be filed with the real estate office to give constructive notice. iv. The Necessary—Proper Party Distinction 1. Necessary Parties

Graf v. Hope Building Corp. -- MR had a quarterly installment payment mortgage with ME. ME would make regular payments and had no missed. MR went to Europe on a trip and left his secretary to pay the installment on the mortgage. She miscalculated by appx. $400. the bookkeeper discovered the mistake and told ME that MR would pay when he retruend. The bookkeeper never told MR and the 20 day default period lapsed. One day after the grace period ME accelerated the debt. When MR received notice of error he tendered payment of the balance but ME refused. Held: The court did not want to disrupt and otherwise valid contract an agreement. The acceleration was enforceable. 46 Federal Home Loan Mortgage Corp. v. Taylor – the court held that where D who had missed a payment but was stationed in eth air force overseas and had a child that was hospitalized had made “good faith efforts” to make the debt right. The court reinstated the mortgage.


a. A party is necessary if failure to include them will not accomplish the purposes of the foreclosure. b. All persons junior to the mortgage are necessary parties. i. This includes: junior lienors, junior leasees and easement holders. ii. The original mortgage holder should also be included incase of a DJ. 2. Proper Parties a. It is proper to include parties whose interest will be cut off or affected by the foreclosure. i. Most obvious is a lien holder who is senior to the mortgaged being foreclosed. v. The Senior Lienholder as a Party 1. Generally: Senior Lienholder cannot be made a party without his consent. a. Consent is not needed where foreclosing ME is seeking amount and terms of senior OR where the senior priority status in unclear. b. Under a minority E1 can be brought in by E2 if the E1 mortgage is in default with E2. However this takes the advantage away from being priority 1. Normally this will not happen. i. E1 can asked to be dismiss from the foreclosure. vi. The Lessee as a Party 1. Generally: If the lease is senior to a mortgage being foreclosed, the lease is unaffected. If it is junior, the lease terminates. vii. The Omitted Party Problem 1. The following are situations where a omitted necessary party is bound by the foreclosure proceeding: a. In a “race” notice jurisdiction where the necessary party acquired interest prior to foreclosure but does not record. b. In “notice” or “race-notice” where necessary party acquires before foreclosure but does not record and foreclosure sale purchaser buys without notice of unrecorded interest. c. Where lis pendens doctrine operates to bind necessary party who acquires interest after commencement of legal proceeding. 2. The Omitted Owner a. If the owner of the equity of redemption is not included, the proceeding is void and that person’s right to redeem is unaffected. i. He can pay the mortgage debt. 3. The Omitted Junior Lienor and the Foreclosure Sale Purchaser a. The Junior Lienor’s Remedies (2 remedies) i. He can foreclose the junior mortgage subject to the first OR;47 ii. He may redeem by paying the foreclosure purchaser the amount of mortgage debt. ** 1. This right is to the purchase of the senior lien not the right to the land. b. The Foreclosure Sale Purchaser’s Remedies (3 remedies) i. He can foreclose the senior mortgage as an assignee of the rights of the senior mortgage OR;


If this occurs the buyer at the junior mortgage foreclosure sale buys the land subject to the first mortgage in favor of the person who bought the land at the senior sale. That person is now the senior mortgagee. The balance owing on it is the amount owing on it prior to the first foreclosure sale. If the buyer at the first sale paid less the debt, Buyer1 will get a windfall if buyer 2 pays more. If not, buyer1 will eat his investment and lose the land.


ii. He may redeem by paying the junior lienor the amount of the lien48 OR; 1. If the redemption is denied he can bring an action in equity. iii. In limited circumstances he may get a strict foreclosure. 1. If ordered the junior lien will be canceled unless the junior pays off the senior mortgage debt within a court given period of time. c. Junior Lienor vs. Foreclosure Sale Purchaser i. If both the JF and P choose to redeem, the purchaser will prevail. 4. Omitted Parties: Statutory Redemption vs. Equitable redemption a. The Omitted Owner and Statutory Redemption i. The omitted owner does not have the option of choosing between equitable and statutory redemption. Because: 1. ER accrues at mortgage maturtaity and ends at a valid foreclosure. 2. SR begins only with a valid foreclosure. b. The Omitted Junior Lienor and Statutory Redemption i. An omitted junior lienor like and omitted owner, may exercise only the equitable right to redeem. c. Power of Sale Foreclosure i. Generally: After varying degrees of notice, the property in default is sold 1. The sale terminates junior interest to the mortgage being foreclosed and puts the buyer in the shoes of the MR at the time of the mortgage. 2. Saves time and costs that judicial sales incur. 3. Notice requirements (no majority) a. May simply be notice of default or notice of foreclosure or combination of the two. b. Some states require notice by personal service by mail c. Few states only require publication. d. No states offers an opportunity for a hearing prior to foreclosure. ii. Reason why Power of Sale Titles are less Stable 1. Presence of judge at judicial foreclosure reduces errors that arise in an unsupervised setting. 49 2. Presence of adversarial parties at JF decreases procedural defects 3. JF has a degree of judicial finanaility that PoS does not. iii. Ways to Challenge Power of Sale Foreclosure 1. iv. Specific Defects 1. Sale Price a. Inadequacy of the sale price will, usually, not invalidate a sale, absent farud, unfair dealing, or other irregularities. b. Standards (2) i. Restatement View: Price must be “grossly inadequate” 1. Absent other factors, must be under 20% of the FMV. ii. The price must “shock the conscience of the court”

Even though the omitted junior lienor can redeem by paying P, P can also redeem by paying E2 off. Between the two, P will win because P is now in the position of MR. 49 In a JF, you can contest or default. You can appeal once the trial court decision has been made. You could win or loose. In 45 days, in no appeal, the judgment is final. Finality is achieved very quickly. In a power of sale state, the finality does not come until the statutory period for an grievance is over which could be years.


1. These are not based upon a certain percentage.50 2. Time of Sale (2 situations) a. A sale is held on a different day pr hour than specified in the notice of sale b. The actual sale may be held at a time that is unusual day or hour for the community. c. Greater the degree of misconduct, more likely the sale will be set aside. 3. Place of Sale a. If the sale is not held on county land in which the property is located, the sale is VOID. 4. Sale by Parcel or Bulk a. Whether a property is sold in bulk or parcels must be done for the advantage of the mortgagor. i. Usually means done in parcels because it opens the floor to more bidders. ii. A violation will make the sale VOIDABLE. 5. Chilled Bidding a. Where mortgagee or trustee under deed of trust demonstrates irregular conduct that suppresses bidding, the sale will be set aside. (sale is VOID) b. Two situations usually i. ME and trustee are in collusion ii. An action or failure to act that results in lower bidding. 6. Mortgagee Purchase Under Mortgage with PoS a. If PoS is contained in the mortgage, ME cannot purchase at that sale. v. Trustee’s Duties Under Deed of Trust 1. Trustee has a fiduciary duty to the ME and MR. 2. Trustee’s role with respect to the sale a. So long as the trustee is not employed by the ME or closely associated, the ME, in every jurisdiction, may purchase at the sale. b. Trustee may not purchase at his sale without consent of MR. i. Sale is VOIDABLE c. Trustee is an employee or Part Owner of Mortgagee i. Alt.1 Some courts hold in this situation that a purchase by the ME is an indirect purchase by the trustee and is VOIDABLE ii. Alt.2  where trustee has a close relatsionship with ME, deed of trust becomes a mortgage and law of mortgages applies. ME purchase at sale is voidable iii. Alt.3  Sale is good by ME. 1. Burden is on Trustee to prove “faithfulness to the trust”. 3. Duty to Disclose Defects (split) a. Many jurisdictions take a caveat emptor approach holding that the trustee owes no duty except to refrain from hampering the sale i. He does not have to answer any questions but if he does, his answers must be accurate. 4. Failure to Provide Notice a. If there is a duty to provide notice and the trustee fails to do so, the junior lienor is an omitted party. vi. State Court Remedies to Attack PoS 1. They can get a suit against to set aide foreclosure a. Some court require that MR tender into the court amount owed on debt.

As a rule of thumb courts hardly ever set aside a sale if the sale price is over 50% of the value.


b. This would be where there is defects. c. If there is a BFP and: i. the sale is voidable, this remedy does not apply ii. if the sale is void, the remedy is available (does not matter if there is a BFP). 2. They can get a suit in equity to enjoin a sale a. Where it is a substantive defect for the right to foreclose you bring this suit. i. This might be done if the debt is for more than is really required or they are asking for more than the debt. ii. This is a challenge to the right to foreclose. b. Some courts require that MR tender into the court amount owed on debt. i. Nelson said a bond. This protects the defendant from being wrongfully enjoined. ii. If you ask for a permanent injunction, you do not need a bond. 3. They can get an action for damages against the ME or Trustee. a. This is like a tort. This action is normally brought where the person at the sale is treated as a bona fide purchaser for value, the debtor only option is to sue the foreclosing mortgagee or trustee for damages because he cannot get the land back. vii. Who is a Bona Fide Purchaser 1. If sale purchaser is unrelated to ME, he can take free of defect if the purchaser: a. has no actual notice of the defects; b. is not on reasonable notice from recorded documents and; c. The defects are not such that a person attending the sale, exercising reasonable car would have been aware of. viii. Damages For Wrongful Foreclosure 1. Generally: If the sale has been completed and the mortgagor or junior lienor cannot bring a suit to set aside, the next remedy would be to collect damages against the foreclosing mortgagor or trustee. 2. Measure of Damages – Mortgagor a. Differences between FMV and the aggregate amount of the liens as of the date of the defective foreclosure. 3. Suit for Damage by Junior Lienor a. Difference between FMV and any senior liens from the date of the wrongful foreclosure. d. The Uniform Nonjudcial Foreclosure Act i. Generally: Effort to make foreclosure proceedings and rights uniform. ii. Methods of Foreclosure (3 methods at creditor disposal) 1. Auction Sale – self-explanatory, conducted by creditor representative. 2. Negotiated Sale – This is similar to the sale of other real estate property a. Real estate is listed with broker b. ME gets offer and presents to debtor and other lien holders and they can either approve or disapprove c. If they disapprove ME can either: i. Stop negotiated sale and use different method ii. Exclude the objecting party from the effect of the sale so that he will be unaffected by the sale iii. Pay off the objecting party 1. Usually only used when objecting party has a very small debt owed to them.


3. Foreclosure by Appraisal – Does not liquidate property but leaves it in the hands of the ME who will have the burden of liquidating it after the FS. a. Kind of like a strict foreclosure. iii. Notice Provisions 1. Two Notice System a. Step 1 Debtors (not other junior interests) are given a default and 30-day period to cure before notice of foreclosure is issued. i. After cure period, ME can accelerate the debt and give notice of foreclosure. b. Step 2  Original notice of foreclosure must be given to all parties whose interest will be extinguished. i. FS cannot occur within 90 days of notice ii. In effect 120 days is required for the whole process. c. During 90 day period there is a right to redeem real estate by paying accelerated debt. iv. Due Process Concerns 1. Notice must be delivered to all those who have an interest or are put at risk by the foreclosure. a. Any other person who wishes to be notified of the sale may file a “request of notice” in public records office. 2. Residential Debtors have a right to an informal meeting to present reasons why the sale should not go forward. a. Meeting is only at request. v. Redemption 1. Act authorizes equitable redemption until the date of foreclosure 2. Post-foreclosure redemption is not allowed. vi. Deficiency Liability 1. Act permits recovery of a deficiency by the foreclosing creditor if there is no personal liability on the obligation. a. Exception: residential debtors who act n good-faith are exempt. e. Disposition of Foreclosure Surplus i. Generally: Surplus represents what is left of the real estate 1. Liens and other interests terminated by the foreclosure attach to the surplus in the priority they enjoyed prior to foreclosure. 2. The foreclosed MR claim is junior to all holders of valid interest. ii. Rule: Only those whose interest was terminated by the FS have a claim to the surplus 1. Senior liens to the foreclosure sale have no claim on the surplus. iii. Rule: Junior liens not in default can share immediately in the surplus. f. Reacquisition of Title by Holder of the Equity of Redemption and Related Issues i. What happens when a defaulting mortgagor or equity holder purchases at foreclosure? 1. A MR or other equity holder who purchases at a foreclosure sale, acquire title subject to any junior liens on the property. 2. If MR grants to G1, and G1 defaults on the mortgage, if G1 purchases at a FS, he takes land subject to junior liens. 3. Exception: If MR purchases property from the FS purchaser, the liens are revived UNLESS the FS purchaser is bona fide. a. This is known at the filter rule under the Restatement. b. A lender can never be a BFP. 4. Policy a. Morally


b. If the MR had paid off the senior lien the right way he would still be subject to the junior liens. ii. What happens if a junior interest purchases at the FS? 1. A junior interest who purchases the senior lien at a FS, purchases the property free from the holder of the equity of redemption and any interests that were junior to the foreclosed lien. g. Statutory Redemption (“You must die in order to live!”) i. Generally: SR varies from state to state. Some SR is available under either a JF or POS foreclosure or both. 1. CA  JF only (junior liens have no SRR) 2. MN  JF or POS (strict priority approach) ii. Two example methods 1. Strict Priority Approach a. MR has a period where only he can redeem. If this period lapses each junior lien holder has a 5 day window to pay the sale price AND each of any lien of a lien holder who redeemed in a previous 5 day period.51 2. The Scramble Method a. During redemption period any interest may redeem. b. If MR redeems, the period ends. iii. Redemption by MR: Revival of Liens 1. Majority: when MR redeems by statute, revive all existing liens prior to FS (even deficiency lines) 2. Minority: Same as above for junior liens but deficiency liens are not revived. 3. Non-Revival Statutes a. Weak no-revival: a junior lienor can sue on the note and get a judgment lien. A judgment lien has an after acquire property feature so when MR gets a piece of land, it immediately attaches. i. Problem for E2: Loses priority status. 52 b. Strong no-revival: Once a junior lienor is wiped out by the FS, he no longer has any right to the property in dispute. CANNOT attach to the same property. i. He can get a JL and attach it to a different piece of property owed by MR. ii. If MR has land in a different county, E2 must record judgment in that county for it to attach. iv. Redemption by Junior Lienor: Revival of Liens 1. Majority: No revival of junior liens. h. Anti-Deficiency Legislation 53

Hypo: MR first mortgage to E1 for 120k, second for 25k to E2, third for 40k to J.L.3, and a fourth of 45k to E4. At the sale, P buys and pays 120k. Assume that the land is worth 200k. Under the Minnesota law, suppose that MR does nothing. Then the statute says that each of the junior liens, in order of their priority get 5 day periods to claim statutory redemption. E2 can go to P and pay 120k plus interest and stuff, then JL can pay E2 145k (120k plus 25k for E1’s lien), then E4 can go to JL and pay him 185k. Now suppose that E2 lets this time period pass. JL can then go to P and get the land for 120k. A person who doesn’t use their 5 day period is now out of the picture. Now suppose that MR waives his right and P buys. Three or four days after MR waives his right, a big shopping center goes up right next to the land. Who wins? E4, because there is no one to take it away from him. Nelson says that this almost never happens, it is in theory. Nelson says the last shall be first. Otherwise, if the property is only worth 200k, then E4 will probably pass. Normally, the people down at the bottom don’t redeem 52 i.e. MR to E1. MR to e2. MR with a judgment lien to JL. E1 forecloses. E2 gets a JL. He is now behind JL in priority.

California 1) 726(a)  one action rule 20

i. Two Methods of Common Law Right54 1. ME may obtain personal judgment on MR property and if deficiency remains, foreclose on the mortgaged real estate OR; 2. ME forecloses on the real estate and then gets a DJ if a debt remains. 3. Notes: a. Some states, like CA, have a One Action Rule which makes you choose option 2. In CA you have to choose option 2 (security first rule). b. A few states have Election of Remedies Rule saying that you cannot do both at once and you must choose a rout and stay with it. Must stay with it till the bitter end. ii. One Action Rule 1. Must go after security first before anything else a. We do not want to hit the debtor with a multiplicity of suits b. We want the creditor to go after the security first. iii. Four Methods by Statutes 1. No DJ after Power of Sale Foreclosure a. Generally: If you choose to foreclose by POS, not DJ available. b. If you foreclose judicially you can get a DJ. c. If you get a DJ first, the only way you can foreclose is by JS. 55 2. No DJ on a Purchase-Money Mortgage a. Generally: Any time a seller of real estate (vendor) takes back a PMM, there is no DJ i. Applies to both residential and commercial b. If the PMM is for a 3rd party56 and the property is a1-4 residence, no DJ i. If it is more than that (i.e. an apartment building), DJ is available. c. CA case law says that a refinanced mortgage is not a PMM, thus subject to DJ. iv. Waiver (May an MR or grantee waive right against a DJ) 1. Generally: All post-default waivers are unenforceable 2. Exception: Spangler v. Fair Value Rule 1. Generally: If E1 forecloses and buys at the sale and there is debt still owed not covered by the sale price, the DJ is the FMV minus the debt (FMV – debt). a. Policy: We do not want E1 to be unjustly enriched. 57

2) 726(b)  Fair value 3) 580(d)  No DJ after PoS 4) 580(b)  No DJ on a PMM Mortgage

The Restatement, follow the majority of jurisdictions which allow either method. Some states do not allow for This “election of remedies” and require ME to do both at the same time, with the limitation that they only may collect the amount of the debt. 55 If all a state had was this rule, can they sue on the note? Yes. It is not a non-recourse debt. SO you can sue on the note and have no intention of getting a foreclosure. So you can get a DJ and if there is still debt left they have to use a judicial foreclosure 56 A 3rd party would be like if I bought a house from a person and a bank gave the money to the vendor. The bank is the third party. This is opposed to where the buyer gave money to the vendor and financed it between them. The vendor takes the mortgage instead of the bank. 57 - Hypo: MR to E1 for 400K. It is foreclosed. P buys at the sale. E1 bids 225K at sale. Normal rule is that if E1 seeks a DJ, how do we measure it? Amount of debt minus price at sale. There was a thinking that there would be unjust enrichment if the FMV was much greater. We do not want E1 to have a property worth 350K and then want a DJ for 175K from MR. If Nelson buy at the sale then E1 would not be unjustly enriched. If E1 seeks a DJ we will measure it differently. You measure it FMV of the real estate and the debt. So if the property is worth 325K and the debt is 400Km we will grant a DJ for E1 for 75K. Can you produce a surplus with fair value. No you cannot. So there is FMV of 450k, there cannot be a grant of 50K to MR


4.The Use of Mortgage Substitutes: The Absolute Deed; the Conditional Sale; and the Installment Land Contract
a. Rule Against Clogging i. Foreclosure is a debtors right as well as a lenders remedy. Clogging isn’t trying to get around that right. ii. Generally: An agreement by the MR that is part of the original mortgage transaction and that purports to cutoff or modify the right of redemption is unenforceable and void. iii. Option to purchase58 1. Generally: enforceable so long as it is not based upon default. 2. Restatement: Allows an option to purchase by ME, only if the option is NOT dependent upon MR default. iv. Fully Executed Subsequent Transactions 1. Generally: does not violate the clogging doctrine 2. Deed in Lieu – permissible (does not kill junior liens) a. This is where MR gives up deed to property in order not to be foreclosed.59 3. Cannot make subsequent agreement where MR gives ME QC deed to be recorded in the event of another default – inadmissible. b. The Absolute Deed i. Generally: Lender takes absolute title to the real estate, with typically, an oral agreement that if barrower pays in full the property will be conveyed to barrower. ii. Absolute Deed Unaccompanied by a Collateral Writing: Extrinsic Evidence 1. Rule: Parol evidence is allowed to show that an absolute deed was intended to serve as security for a debt or obligation. a. Usually no extrinsic evidence that would change the terms of a written instrument. 2. Burden of Proof a. Majority: clear and convincing b. Minority: mere preponderance c. Policy: We want writings. 3. Factors that Establish an Absolute Deed as a Mortgage a. Generally: No single factor is controlling b. Presence of a Debt or Obligation c. Actual Statements by the Parties d. Disparity between the amount received by the grantor and the FMV of the land conveyed60

Hypo: MR gets 10K from E1. E1 says we like the prospects of this development and want sort of a piece of the action. Instead of charging you 6.5% we will charge you 3% IF you give us the option 100% or 50% pr 25%. Why is this a clog on the equity of redemption? MR is saying ex ante, I am waiving my right to be foreclosed. The retort is that lenders are not using this for defaults but for the success. 59 MR defaults on a mortgage in favor of ME. MR gives ME a quiteclaim deed and the ME will release MR of the mortgage debt. Both the deed and mortgage a recorded. Two weeks later MR tries to pay the debt in full. RESULT: MR debt was terminated so there was no longer a right to redeem. 60 Flack v. McClure -- Flack owns arrears on house that she has. She puts house on the Markey. McClure come by are interest in buying it. Initially they establish an earnest money agreement for 80K. However the McClure cannot qualify for a loan. Flack needed money later for her daughter. Flack delivered the deed to the McClure and they gave flack 9K. Later there is a foreclosure sale to P. P owns property. The jurisdiction they are in has statutory redemption. The McClure go to P and say they


i. This is the most significant factor. The greater the disparity between the money received and the FMV of the land, the more likely that it is mortgage. e. Possession i. Usually if you give up possession it indicates a sale ( and vis versa) f. Payment of Real Estate Taxes g. Improvement by Grantor h. Nature of Parties 4. Effect of Establishing an AD a. Once established it will be treated as a regular mortgage iii. Absolute Deed With Collateral Writing of Defeasance 1. Rule: If CW contains language of defeasance or a promise to recovery upon payment AND if court is convinced the two documents were part of a single transaction, the transaction will be treated as a mortgage. 2. Parol evidence may always be used to establish the two instruments 3. Timing of Writings a. Must be executed at the same time. b. If executed after absolute deed, mortgage is not barred of the parties agreed to a defeasance at the time of executing the deed. c. The Conditional Sale i. Generally: This contains an absolute deed with second writing with no mention of defeasance, rather is a contract or option to resell to the grantor the property described. ii. Two Common Forms 1. A sale and conveyance of the land by the grantor to grantee with an option in grantor to repurchase it 2. A sale and conveyance by grantor to grantee and a lease by grantee to grantor with an option in grantor to repurchase. iii. Reasons For Use 1. Usually done because of the desire of the lender/grantee to avoid barrower/grantor’s equity of redemption. iv. Use of Extrinsic Evidence 1. Rule: EE can be used to show that conditional sale was intended as a security transaction d. The Installment Land Contract (Also called “contract for deed”) i. Generally: Vendee goes into possession and agrees to make monthly payment to vendor until balance is piad off. Vendor holds the deed until land is paid off. ii. Remedies for Breach 1. Forfeiture Remedy – Nearly all ILCs have a provision that declares time is of the essence and in the case of default, vendee retains property and all prior payment (vendee interest is extinguished). 2. Specific Performance for the price – Vendor tenders title to the land and vendee is ordered to pay remaining balance and possibly other costs such as interest, damages, etc. a. Some courts require an acceleration clause b. This remedy is usually used where the vendor has assets to cover the debt and the real estate values is low.

own the property and they try and redeem. Flack finds a lawyer and says that she did not sell her property fro 9K and she wants to redeem. She argues it was a security not a sale. Held: There was no sale of the property, it was for security. Flack has the right to redeem. Factors indicated a security: price, testimony in deposition


3. Specific Performance for the Installments Due – gives vendor past installments plus interest. a. Usually used in the absence of acceleration clause. 4. Foreclosure of the Vendee’s Rights – Allows vendor to treat contract like mortgage and get a judicial sale. If the sale brings more than the purchase price, the excess goes to the vendee. 5. Strict Foreclosure – If vendee does not pay balance in statutory period of time, vendee right is done and vendor gets the land. 6. Suit for Damages – Generally damages are measured by the difference between the contract price and the FMV. a. This is only available where the vendee has abandoned the land. iii. Comments on the Forfeiture Remedy 1. Generally: Courts used to routinely enforce these provisions in favor of the vendee. TODAY, not as routine and not often. a. The modern trend is to treat these as mortgage contracts. 2. Legislative Limitations a. Grace Period – Some states mandate a grace period where defaulting vendee can pay his overdue installments or arrearages. Some of these states require in order to terminate vendee’s rights, there must be a judicial foreclosure. i. Failure to pay, results in forfeiture of the land and payments 3. Judicial Limitations a. Waiver by Vendor i. If a vendor accepts one or more late payments, he may have been held to waive is right to forfeiture. 1. This is used by a vendee bringing a counter-claim against the vendor b. Estoppel i. A vendor may be estopped where it is equitable. 1. i.e. indicating the vendee not to worry about forfeiture due to default and not getting an auxillary loan, then going forward with the forfeiture anyway  Vendor would be estopped. c. Recognition of an Equity of Redemption i. Some courts hold that a vendee in default should have a reasonable time to pay the debt or the arrearages. d. Restitution i. In jurisdiction without equity of redemption or where vendee does not have the means to redeem, courts may require the vendor to give back payments made in order to keep the property. e. Foreclosure as a Mortgage i. Some jurisdictions treat the installment land contract as a mortgage ii. In these jurisdictions forfeiture can occur in two ways 1. Where the vendee has abandoned the property 2. Or where vendee has paid only a minimal amount toward the contract price and the security has been jeopardized.


a. Four Types of Bankruptcy Proceedings i. Chapter 7 – Straight Bankruptcy (Most common) 1. Generally: entails liquidation of the debtor’s non-exempt assets to satisfy his creditors according to their priority.


a. Typically discharges debtor of most pre-bankruptcy debts. b. New rule: if you make more than 50K we will not let you use Chap. 7. ii. Chapter 11 – Corporate and Business Debtors 1. Generally: The goal is to rehabilitate instead of liquidate. Reorganization can result in extension and reduction of debts and broad judicial control over both secured and unsecured creditors. a. Through a plan, the debts are reduced and the debtor agrees to make payments on unsecured debt. The discharge comes when the chapter 11 plan is approved. iii. Chapter 13 – Rehabilitation for Individuals (Like Chap. 11) 1. Generally: rehabilitation by judicial control over secured and non-secured debt. a. May be used by any individual who owes less than 250K in unsecured debt and 750K in secured debt. b. This puts you on a plan for a number of years and if they stay on that plan, the debt will be forgiven. iv. Chapter 12 – Rehabilitation of the Family Farmer 1. Generally: Same remedies available to the family farmer if the aggregate of his debts are below 1.5 million. b. The Automatic Stay i. Under § 326(a)(1) of the Bankruptcy Perform Act, all foreclosure proceedings are automatically stayed by the filing of any type of bankruptcy proceedings. 1. Applies to JF and PoS foreclosures whether filed before or after bankruptcy proceedings. 2. If you have filed bankruptcy within last year and it got dismissed and then you file again, the stay will terminate after 30 days UNLESS the debtor files a motion saying that he is filing in good faith filing. ii. Straight Bankruptcy 1. Normally, the trustee of a SBP, will release a price of real estate where the debtor has no equity. a. If the FMV of the real estate does not exceed the amount of the mortgage debts, the trustee has not interest. b. If FMV exceeds the amounts of the debts trustee has an interest. i. If equity is found to exist, the court will sell the real estate by: 1. Subject to the existing mortgage or; 2. Free and clear of the existing mortgage and the mortgagee lien will be transferred to the sale of the proceeds. 2. Under Chapter 7 there is no bifurcation of debt. a. Lender gets a lien against the land and wait b. NO DJ because this is what a bankruptcy proceeding avoids. c. The Trustee’s Avoidance Powers i. Policy: Trustee represents the interest of the bankruptcy’s unsecured creditors. Her goal is to enlarge the asset pool. ii. Tools 1. Section 558 -- Gives the trustee any defense that would be available to the mortgagor whether or not the MR waived the defense a. i.e ME was fraudulent, usury, incapacity, etc. 2. Section 544(a)(3) -- Gives the trustee status as a bona fide purchaser of the property from the debtor. a. Result: Gives her priority over unrecorded mortgages.


3. Section 551 -- If a trustee avoids the rights of a senior lienor (i.e. by using 544(a)(3)), the trustee becomes subrogated to the senior lienor. 61 a. If E1 is replaced by T, E1 now joins the unsecured pool of creditors. 4. Section 548 – Transfers made by the debtor one year prior to the proceeding can be set aside if done in order to hinder, delay or defraud a creditor. 62 a. 548 has two sections i. Actual fraud 1. This is any transfer by a debtor within one year of bankruptcy with the intent to hinder of delay creditors can be set aside by the trustee. a. Let’s suppose that Nelson is a brain surgeon and he smell mal practice. He conveys his vacation home to his daughter. T can set it aside. 2. Key: do not have to show insolvency. ii. Constructive fraud 1. Any transfer made by a debtor within one year of bankruptcy while insolvent for less than reasonable equivalent value can be set aside by the trustee. 2. “Reasonable equivalent value” means at below 70% of FMV. a. Nelson takes the house in Utah and conveys to his daughter for 10K. Trustee can set that aside. 3. Key: must be insolvent. b. Mortgage to conceal Transfer i. X conveys 260K mortgage to Y for a house that is worth 250 in hopes that T will release the mortgage because there is not equity 5. Section 547 – Transfers of property made within 90 days of bankruptcy are voidable63 a. Insider provision i. Makes it a one year period ii. So if you sell a house and pay off the unrecorded ME and the one month later file for bankruptcy can T treat ME like an unsecured creditor d. Chapter 11 reorganization i. Generally: Debtor continues to operate that state as a debtor-in-possession. Parties in interest (creditors) may only obtain a trustee in the event of fraud, dishonesty, incompetence or gross mismanagement. 1. There is a string presumption against a trustee in Chapter 11 Cases. 2. If a trustee is appointed, the debtor in possession is entitled to the same avoidance powers as in Chapter 7. 3. They reorganize the debt by reducing unsecured debt, interest charges, and even reduce secured debt so long as it is not reduced below the value of the security. 64

i.e. MR has a mortgage for 10K with E1 who does not record. He has a second mortgage with E2 who records for 40K. MR defaults. Files for SBP. Trustee would subrogate for the senior lien so he would get the 10K from the FS. E1 would now become an unsecured creditor under T. 62 Trustee in this case has tow options because every state has a 558 law. So he can use this and 548. 63 Hypo: Nelson has a debt to two creditor for 50K each. And lets suppose Nelson owes 50K to Sorahan and let’s suppose he owes 50K to Johnson. What are Nelson’s assets? 5K in a bank account and 25K in a vacant lot. If we were to have chapter 7 right now they would each get 15 a piece. How does preference much this up? Suppose Nelson likes Sorahan better. Sorahan says give me a mortgage because I feel unsecured. Nelson gives mortgage for 50K to Sorahan. If that stands who gets what? Sorahan would get 25K from the lot and the 5 would be split. 64 If you have a 10M mortgage and the land is only worth 5M, in theory you can bifurcate to 5M on secured and 5M on secured. The unsecured gets wiped out. The debtor is guaranteed the value of the property of the date of the bankruptcy.


ii. Relief from Stay 1. The filing of a Chapter 11 proceeding stays any pending or future foreclosure proceeding. 2. Creditor who may bifurcate his debt under Chap. 11. 3. § 362 – Bankruptcy Court may terminate, annul, modify or condition such stay: a. 1) For cause, including lack of adequate protection of an interest in property of such mortgagee OR; i. This includes, failure to pay real estate taxes, or keep insurance. 1. Not single factor is determinative; discretionary ii. If protection is lacking there are 3 ways to provide for it: 1. Trustee may make periodic payments to the ME, in an amount sufficient to compensate for the decrease in value. 2. ME may be provided with an additional lien equal in value to the decrease in value as a result of the stay 3. Any other remedy that will be equivalent to the property’s interest. iii. ME does not have to be compensated for lost profits or opportunity costs due to the stay.* b. 2) With respect to a stay of an act against property, if: i. The mortgagor does not have any equity in such property; AND 1. Majority: Equity refers to the value of the property minus all encumbrances against it. 2. Minority: equity refers to the value of the property minus the lien which is seeking the stay and any lienor senior to the lien. ii. Such property is not necessary to an effective reorganization. 1. It is not enough for the debtor to argue that the property in order to purpose a reorganization. * 2. Rule: MR is required to demonstrate a “reasonable likelihood of a successful reorganization within a reasonable time period”. 4. Single Asset Real Estate Relief a. Single Asset Real Estate – a property other than a residential dwelling with four or fewer residential units, which generates substantially all of the gross income of a debtor and on which no substantial business is being conducted other than the business of operating the real estate; b. § 362 Relief i. Bankruptcy Court SHALL terminate, annul, modify, condition the stay UNLESS not later than 90 days after the filing the debtor: 1. filed a plan of reorganization that has a reasonable possibility of being confirmed or; 2. Commenced monthly payments to each creditor whose claim is secured by such real estate, AND are in an amount equal to the interest at current FMV on the value of the creditor’s interest. c. Benefit – SARE Debtors will be forced to either come up promptly with a reasonable reorganization plan, make payment or avoid making bankruptcy proceedings. 5. Absolute Priority Rule


a. A court will never approve a plan unless unsecured creditors consent, or they are paid in full so long as the debtor takes does not take anything out of the plan i. The only way we will let Trump or approve a plan is if he gets nothing out of it or the unsecured creditors get paid in full or consent to Trump to owning some of the entity. 6. 1111(b) – Election a. You are E1 with 10M mortgage. FMV is 6M. Normally in Chap. 11 you are a secured creditor for 6M and unsecured for 4M. you get to vote as secured and unsecured creditor. Can out vote people. b. This says that they can say that we do not want to wear two hats. We want to take full 10M claim and leave it attached to Blackacre. Do not get to make this election right if the property is worth more than the debt. e. Chapter 13 Reorganization i. Generally: This is chapter 11 for individuals who have regular income and secured debt not over 750K and unsecured debt not over 250K. 1. Reorganization plans must be completed within 3 years (or 5 with courts approval). 2. Plans may entail: reduction in debt amounts, deferral payments 3. Real Estate mortgages can be made part of the plan against their consent and may have their claims modified so long as the following protection is provided: a. The ME must retain his lien and the value of the property to be distributed under the plan must not be less than the allowed amount of the secured claim OR; b. The property will be surrendered to the ME to secure the debt. 4. Rule: A real estate ME who holds a claim secured only by a lien on the debtor’s principal residence normally may not have its claim modified without its consent. a. If a claim is secured by other real estate or chattels modification and bifurcation is permitted.*** b. If you have a mortgage where the last payment is due before the plan is due, you can modify and bifurcate. 5. Rule: A Chapter 13 debtor will be allowed to de-accelerate a pre-petition acceleration. He will be able to pay off the arreages over the period of the plan so long as current mortgage installments are also being paid. 65*** a. This is not considered a modification. b. THIS IS A KEY ADVANTAGE OVER STATE LAW WHERE ARREAGES ARE DUE AT ONCE. f. Setting Aside Pre-Bankruptcy Foreclosures i. Foreclosure Sale as a Fraudulent Transfer 1. A trustee or debtor in possession can set aside a transfer under § 548 if: a. The debtor had an interest in property b. The transfer took place within a year of a bankruptcy filing c. The debtor was insolvent at the time of the transfer or the transfer caused insolvency
Hypo: 100K 1st mortgage. The debt if already in default and it has been accelerated. Getting ready to have the FS but before FS took place the debtor filed C13. Here is what he wanted to do.. the creditor had accelerated and the debtor said that he wanted to save his house and so, he asked to decelerate and restore payment schedule. In return he said that for the 3-5 years plan I will make monthly payments plus I will pay off all the arreages. The lender said that this violated 1322(b)(2). They argued that this was a modification of the debt. The 2nd circuit said, they were allowed to defeat acceleration by curing default and paying arreages. They said a cure is not a modification. Rule: A debtor can decelerate a mortgage debt in default if they pay regular mortgage payments and in 3-5 years pays off arreages


d. The debtor received “less than reasonable equivalent value.” i. Less than equivalent value means – the price in fact received at the foreclosure sale, sol long as all the requirements of the State’s foreclosure law have been complied with. ii. § 548 now provides no grounds for invalidating a noncollusive foreclosure sale based on a low price.66 1. In Re BFP – The FS price = reasonable equivalent value.67 ii. The Installment Land Contract as a Fraudulent Transfer 1. The BFP decision does not insulate an installment land contract. iii. The Foreclosure Sale as a Preference 1. Preferences – these are eligible transfers that may or may not favor one creditor over another. 2. Under § 547(b) a trustee may avoid a transaction if it was: a. A transfer of an interest of the debtor in property b. To or for the benefit of a creditor c. For or on account of an antecedent debt i. Debt made before transfer d. Made while the debtor was insolvent e. Made within 90 days before the commencement of bankruptcy and f. Which enables the creditor to realize more than it would have received in chapter 7 liquidation.


Some Priority Problems
a. Purchase Money Mortgage i. Two Types 1. Vendor PMM –seller takes cash form buyer and a mortgage on the property for remaining debt 2. Third Party PMM – third party supplies buyer with cash and takes back mortgage. ii. Purchase Money Mortgage Priority Rule 1. A PMM executed at time as deed of purchase is senior to any other lien that attaches to the property that arises against or is created by the buyer-MR prior to the latter’s acquisition of title. 2. Recording Act Problems a. Generally: PMM will prevail over buyers recorded liens even if it is unrecorded i. Policy: But for the ME giving money, JL would not have a piece of property to attach to. ii. May not however against subsequent recorded liens that come after that the sale. rd 3. Vendor 3 Party PMM Priority a. Generally: Vendor given priority over 3rd party PMM. i. Subject to recording acts and subsequent agreements. b. What if each mortgagee has notice of the other?

66 67

This does not negate the “shcok the conscience test” Since the FS has to abide by state law, which use the SoC test. In Re BFP -- BFP was a mortgagor. There was a 350K in favor of E1and a second in favor of E2 for 200K. The bottom falls out and there is a FS by E1. P buys. 356K goes to E1 and 77K goes to E2 who was the vendor. MR gets nothing. MR decides to file a Chapter 11 and exercise avoidance powers. BFP tells the Bankruptcy court that the transfer took place within a year when they were insolvent. P did not pay reasonable value. FMV was 750K and the price at FS was 433K (57% of value). They say that this was constructive fraud. At the S.C. there was a 5-4 split that said a foreclosure sale cannot be a fraudulent transfer unless it violated state law (which then it would set aside under 558). Whatever the FS price equals is the reasonable equivalent value


i. If a 3P or vendor knows about the other, he cannot gain priority by recording first because he has actual notice (can’t do it based on recording act) 1. vendor will prevail for other reasons. c. What if neither has notice of the other? i. Vendor will prevail because priority can only be granted to a subsequent purchaser without notice and the 3rd party and Vendor would be at the same time. d. If one mortgagee has notice and the other does not? i. The recoding act will govern rather than the vendor preference. 1. The party lacking notice is treated like a subsequent taker. 2. Thus, in a notice type recording act state, the lender who takes its mortgage without notice of the other’s mortgage prevails. e. Priority is Subject to the Parties Agreement i. Vendor preference is subject to any contrary agreement. iii. Replacement, Refinancing and Modification of Senior Mortgages: Effect on Junior Liens. 1. Replacement or refinance by Original Mortgagee a. A senior mortgagee who releases his mortgage or record and, as part of the same transaction, records a new mortgage retains the same priority except: i. If there is a material change to the mortgage or the obligation it secures is materially prejudicial to the intervening lienor OR; 1. Senior ME will loose can loose his priority over the part that is prejudicial to junior ME.68 ii. The senior mortgagee intent to subordinate his position. b. Recording Acts i. E2 can become senior if they are a BFP and they record before E1 records their modified mortgage. 2. Replacement or Refinancing by New Mortgagee a. Doctrine of Equitable Subrogation – Where a new mortgagee takes over previous senior ME mortgage, new mortgage retains priority position except: i. Unless it is materially prejudicial to the junior ME 1. There will only be a loss of seniority to the extent of the prejudice. ii. New ME intends to subordinate her position. b. Mechanic’s Liens, Construction Loans and Other Future Advanced Mortgages i. Mechanic’s Liens 1. Generally: give unpaid contractors and suppliers liens on improved property for unpaid materials and labor. 2. Two Major Types a. Pennsylvania Type – confers right of subcontractor a direct lien right measured by the value of his contribution. i. Payment to the GC is not payment to the SC. ii. This could result in double payment by the owner.69 b. New York System – Maximum amount of liens that may be collected out of the property is the amount of the contract price between the owner and GC.

MR to E1 for 100K. MR to E2 for 20K. E1 and MR modify the mortgage to 110K. E1 is senior to E2 only up to 100K, then E2 is senor over the modified 10K. 69 Could wind up paying the general contractor and the GC would not pay the subs. The subs would then file a lien against the property forcing the owner to pay twice.


i. Payment to the GC is a payment to the SC. 3. Risk of Purchaser a. The owner has no legal defenses b. Possible ways to protect i. Do not buy until the statutory 6 month period has expired. ii. Some title insurance policies will cover the lien (if not found) iii. Some states have a “visually evident” requirement –meaning liens are binding on a BFP if the improvements are visually evident. 4. Procedure a. Generally: Contractor must file and record a lien within 75 days (if claim is less that 1K) or 120 days (if claim is more than 1K). i. If the claim is not filed it is lost. ii. If filed, claimant will have between 6 months and a year to commence foreclosure proceedings. b. Lien Priority i. Date of Commencement – Majority of states allow claim to relate back to date of commencement of building. 1. Gives priority over interviewing lienior (like Visa) 2. All lien claimants are treated as having equal priority. ii. Date the Lender Provides Materials or Services – gives leinors a different priority date iii. Date of Filing Claim – rewards those who are quick to file. iv. Date of the GC – all claimants date relates back prior to commencement of building. ii. Construction Loans and Future Advances 1. Generally: a mortgage that secures future advances is one in which not all of the funds have been paid out but secured by same mortgage. (Construction loan is most common) a. Two Types: i. Mortgage specifies an amount as if it had already been paid out, only the funds are given later ii. May state initial advances and say that it also covers future advances although not known. (Dragnet) 2. Mortgage will secure a future advance only if the parties agree and if: a. Mortgage states repayment of future advances is secured; b. The person acquiring interest in the real estate has other notice of the parties agreement c. Mortgage states a monetary amount to be secured [and advances do not exceed amount of indebtedness] 3. Dragnet Provision – State that the property is covered by the mortgage will stand as security for any other loan made by the lender in the future. a. Does not cover preexisting debts b. Only debts with same type of character as of the original debt apply i. Home debt plus home debt put home repairs and car repairs do not. c. The future loan must refer to the dragnet provision in some jurisdictions i. If future debt is secured by other property it is assumed that parties did not intend the dragnet provision. d. Clause does not apply to debts originated by third parties that are later acquired by the mortgagee. e. Clause is killed when original debt is paid in full. f. If real estate is transferred, the clause is killed.


g. If there are several joint mortgagors, only future debts on which all the mortgagors are obligated will be covered by the dragnet clause. h. If the real estate is transferred to a grantee, subsequent loans by the same lender are not secured by the mortgage even if the grantee expressly assumed the mortgage. i. Restatement: A dragnet is enforceable only if the loan is of the same character of prior loan OR the second loan specifically refers back to the dragnet. j. Cut-off Provision i. About a dozen states have a provision where they can record and serve on the lender a notice that they do not wish for the dragnet provision to be effective anymore 1. Previous debts are still valid; subsequent advances are not. 4. Optional and Obligatory Advances a. Optional Advance – advance made at lender’s discretion b. Obligatory Advance – Advance mandated by contract c. Priority Rules i. Obligatory advances relate back to the date of original mortgage and are senior to subsequent liens. ii. Optional advances are junior to liens that advancing ME has notice of another attaching lien. iii. Restatement: It dies not matter, all advances relate back. 1. Negative Result: If E2 always knows they will come behind E1 advances they will either not deal with MR or have a higher interest rate. Solution: Cut-off provision a. Cut-off provision does not work against the following type of advances: i. Loans or advances made by the lender for the protection of their security (i.e. making improvements on the land, to finish building, waste, taxes, etc. ii. Loans that will benefit a 3rd party which the MR is under an obligation to do.


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