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
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