Daily Development for Friday, March 31, 1995 (editor finally got the days straight)

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

MORTGAGES; PRIORITIES; EQUITABLE LIENS; RECEIVERS: Equity receiver is entitled to a lien for the costs and expenses of improvements, which lien is superior to the lien of the first mortgage.

Cagan v. Mutual Ben. LifeIns. Co., 28 F.3d 654 (7th Cir. 1994).

Equity receiver was appointed to marshall assets of persons who were imprisoned for fraud. Equity receiver spent more than $350,000 to satisfy local housing codes in an effort to make the property profitable. Although the court concludes that this was a reasonable effort to preserve and enhance the value of the property, the attempt failed. District court approved a receiver's lien on the real estate superior to the lien of the first mortgagee. First mortgagee was then permitted to commence foreclosure proceedings with its chosen receiver. First mortgagee argued that equity receiver stepped into the shoes of the owner and, therefore, could not obtain a lien for the cost of improvements superior to the interest of the first mortgagee. There was no evidence indicating that the equity receiver's work diminished the net value of the real estate.

The Seventh Circuit concluded that failure to give such a prior lien would insure that no investment would be made by an equity receiver. To argue that the equity receiver should be willing to take a second lien reflects ignorance of the economics of the transaction. Even where a receiver is successful in improving the property's value, the value may not grow beyond the amount of the first mortgage lien. No receiver would take a risk that the new money invested would lead to equivalen residual value in excess of the first mortgage lien, and therefore desirable improvements would never get made.

Comment: Many lien theory states continue to require that mortgagees seek collection of rents prior to foreclosure only through a receivership. Some lawyers have regarded the receivership device as a useless anachronism of no real meaning. This case indicates that the presence of a receiver can make a real difference in the interests of the parties. If the receiver can "prime" the first lien in efforts to maintain the property, then the borrower's estate has a greater measure of protection than might have been anticipated.

Note, however, that the receiver here was not appointed pursuant to the mortgagee's behest, but for other purposes. The case does not establish categorically that the receiver appointed to manage and collect rents can spend more than rental income and have a "priming" lien for those expenditures. If so, this would be news in many quarters.

Note, however, that the court comments that the lender apparently had the option to have a receiver appointed "of its own choosing." Would this have made a difference? Apparently the court thinks so. But is the duty of a mortgagee-initiated receiver different than an "ordinary" receiver? Don't both have an obligation to preserve the property pending foreclosure?

Practice Tip: The case might give some lenders pause in determining whether it is best to seek a receiver, and avoid "mortgagee in possession" status, to go ahead and take possession prior to foreclosure where local law permits, or simply to leave the rents alone pre-foreclosure.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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