Daily Development for Tuesday , April 25, 2000

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

Note two different aspects of this case addressed in two items below. I'll address a third aspect in tomorrow's DD. This is the Second Circuit. It ought to have this stuff right. I think here they went one and one. What do you think?

MORTGAGES; DEFICIENCY; TRANSFEREE OF PROPERTY: A covenant to pay a mortgage debt contained in a mortgage does not run with the land to nonassuming grantees because it does not "touch and concern" the land.

In re Ormand Beach Associates Limited Partnership, 184 F.3d 143 (2d. Cir. 1999).

Lawyers assume that the rule set forth in this case is appropriate because it is a well accepted practice to recognize that owners have a choice of methods to transfer mortgaged property through an assumption of the mortgage debt or through a "subject to" transfer that does not involve personal liability for the debt on the part of the transferee. The transferee remains liable for waste and for violation of any of the "real" covenants that do touch and concern the land, such as a covenant to maintain the premises.

The question arises, then, whether the mortgagee can wrap up any transferees by providing in the mortgage that they are in fact bound to pay the debt, regardless of whether they expressly assume. Many mortgages contain such language, and lawyers scratch their heads over whether, in this modern age of easy enforceability of clear covenants, such provisions will be enforced. Note that the new Restatement of Servitudes theoretically does apply to covenants in mortgages and takes the position that the "touch and concern" rule does not apply. It may have special language exempting the "subject to/assumption" distinction, but the editor is not aware of that and, of course, the Restatement has not yet been finally published.

Now here's a case that can be cited that expressly denies relief against a nonassuming transferee where there is a multi million dollar deficiency claim at stake.

MORTGAGES; DUE ON SALE CLAUSE; ENFORCEABILITY: Second Circuit opinion states that due on sale clause does not run with the land, is not enforceable as against non assuming grantee.

In re Ormand Beach Associates Limited Partnership, 184 F.3d 143 (2d. Cir. 1999).

In 1986, perhaps in response to difficulties stemming from the 1986 Tax Reform Act, mortgagor, an entity dealing in limited partnership financings, transferred retirement community property subject to a $12 million mortgage containing a due on sale clause, taking elaborate pains to "disguise" the sale from the mortgagee. It set up a $18 million wrap around mortgage arrangement whereby the mortgagor continued to make payments to mortgagee, and did not record any of the documents, including the deeds. Further, it continued to manage the property through a subsidiary. The parties also didn't pay the Florida transfer tax on the transaction.

Later the lender went broke, the RTC took over, and ultimately another party acquired the loan from the RTC and sued for a deficiency claim. The owner of the property defended on the grounds that it had no liability on covenants in the mortgage obligating the owner to pay the debt. This issue is discussed above under the Heading, "Mortgages; Deficiency; Transferee of Property." The court found the owner was not liable for the deficiency.

The new mortgagee then tried the tack of claiming that the transferee somehow was liable for the deficiency because it took title "in violation of" the due on sale clause. The court doesn't really explain the argument here because it dismisses the whole thing out of hand by saying that the transferee, as a nonassuming grantee, is not bound by the due on sale clause because the due on sale clause, like the covenant to pay money, doesn't touch and concern the land. The court appears to be saying that if the transferee could itself transfer the property, this would not trigger the due on sale clause.

Comment 1: Since we don't know just how the mortgagee was going to use the due on sale clause to establish a deficiency claim anyway, its hard to know what to say about the court's ultimate conclusion. But the reasoning that the due on sale clause does not apply to nonassuming transferees, is certainly remarkable. It's probably accurate to say that, to the extent the clause is invoked for purposes of portfolio maintenance, at least, it doesn't touch and concern the land. The problem is that the clause typically isn't phrased as a covenant obligation of the mortgagor, but rather as an option of the mortgagee to accelerate upon transfer. The editor has always wondered why the clause is phrased in this way, instead of making transfer without notice and prior consent a breach of covenant, like the antiassignment clause in a lease, and perhaps this is the explanation. Whether by deliberate or accidental design, however, it would appear that the due on sale clause isn't a covenant at all, but rather an acceleration option that gives the lender the right to call the loan due and payable outside of the context of a violation of a covenant.

Comment 2: Even if the clause were deemed to be "unenforceable" as against the transferee as a matter of state covenants law, isn't it nevertheless rendered enforceable because of preemptive federal legislation under the GarnSt. Germaine Act?

Comment 3: What difference does all this make? Can't the mortgagee accelerate on the basis of the first transfer anyway? Normally, the answer would be yes, but the right to accelerate as to the first transfer might have been intentionally or equitably waived or barred by laches.

There are some common law cases that find that an antiassignment clause in a lease is waived permanently if waived once, but these cases usually are "special circumstance" cases and there is no reason to believe that if a mortgagee consented to one transfer but reserved rights to accelerate following subsequent transfers, a court would find the right to accelerate upon transfer permanently waived.

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

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