Daily Development for Tuesday, June 24, 2003
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

decision concludes that statutory provision that association lien
foreclosure is "subject to" the lien of an institutional first mortgagee
means that the foreclosure proceeds must first be applied to pay down the
institutional first mortgage before they can be applied to satisfy the lien.

Board of Directors v. Wachovia Bank, 2003 WL 21308907 (6/6/03)

This incredible decision will almost certainly be corrected by statute, and
can thereafter be filed simply as additional support for the editor's thesis
that more transactions-savvy lawyers need to be appointed to our nation's
appellate courts.  There are just too many appellate judges, former
prosecutors and tort lawyers, who slept their way through property class
dreaming of their future careers as "courtroom gladiators."

The Virginia statute, consistent with the approach of the Uniform
Condominium Act and Uniform Common Interest Ownership Act,
provides that association liens have priority as of the time of the
recording of the declaration except as to a small class of protected
interests - notably (for our purposes) the lien of a first mortgage or deed
of trust held by an institutional lender.  (The uniform acts to not stipulate
that the loan must be that of an institutional lender).

It appears from the case that Virginia permits private foreclosure of
condominium liens.  In this case, as likely has been done thousands of
times under these statutes nationwide, the association noticed a
foreclosure sale "subject to all existing liens."  It notified Bank of the
foreclosure.  Bank had a first deed of trust recorded in 1996, apparently
after the filing of the association's declaration.  The association intended
that the buyer at foreclosure would have to contend with the first
mortgagee upon purchasing the interest.

The bank filed a motion to enjoin the sale, seeking a declaration that the
association had an obligation to apply the proceeds of the sale first to
satisfaction of the Association's lien.

Amazingly, the Supreme Court of Virginia agreed with the lender's
position, concluding that the language of the Virginia statute should be
read to compel the application of the association's foreclosure proceeds
first to satisfaction of the bank lien.  Even more amazing is the fact that
the court says nothing about whether this sale would then be viewed as
the foreclosure of the bank's lien, and whether the bank has any
responsibility to comply with the provisions of law or contract to
accelerate its lien claim and establish a default prior to the foreclosure
that began as an association lien foreclosure.

The court notes that the statute itself says nothing about disbursement of
proceeds from lien foreclosures.  Instead, the court relies entirely upon
language in the Virginia Condominium statute that states that the lien of
a condominium statute shall be "subject to" the institutional first lien.

The court's rationale that good statutory construction compels the result
it reaches is derived from its view of the purposes that the legislature had
in mind when it prioritized first lien mortgages in the way that it did.
The analysis is so contrary to established American lien foreclosure
practices that you have to read it to believe it.  So here it is:

     "[W]e conclude that the General Assembly intended to balance
     the interests of the holder of a first deed of trust and those of a
     unit owners' association by providing . . . that the satisfaction of
     the institutional lender's first mortgage . . . be a term of the public
     sale of an individual condominium unit by the unit owners'
     association when seeking to satisfy its inferior lien for unpaid

     A contrary result permitting the sale proceeds to be used to satisfy
     the lien of the unit owners' association, other lesser
     encumbrances, and potentially disbursing the residue of the sale
     proceeds to the defaulting former owner, without applying those
     proceeds to satisfy the first deed of trust, would put the
     institutional lender holding the first deed of trust at a serious
     disadvantage with respect o its ability to protect its security
     interest in the condominium unit.  The purchaser and new owner
     of the condominium unit would have no obligation to pay the
     lender the sums unpaid on the lender's first deed of trust.  The
     lender would be placed at risk that the new owner might permit
     damages to the unit before the lender could foreclose.  The other
     detrimental possibilities are numerous and of great potential
     consequence, such as the prospect of inadequate fire insurance
     coverage in thee vent of unexpected fire damage to the unit.
     Additionally, the original owner would no longer own the unit
     and, thus, would have less incentive to satisfy the debt secured by
     the lender's deed of trust. . . "

The dissent adequately refutes the claims made in the above paragraph,
as could any law student who had completed a course in real estate
finance.  It explains that the "conflict" in the statutory language that the
majority uses as its touchstone is entirely made up, and that the statutory
analysis is specious and simply a cover for a policy based determination
that ought to be left to the legislature.  As to the senior lender's interest,
the dissent points out that the purchaser at lien foreclosure obviously has
the interest in protecting its investment by keeping up on the loan, while
the bank still has the old lender on the hook, thus enhancing the liklihood
of payment.  The dissent doesn't address the fire insurance argument, but
anyone with knowledge of loan instruments knows that even the most
basic mortgage, coupled with the standard lender's policy, gives the
lender the opportunity to obtain notice of a in insurance lapse and the
opportunity to advance monies secured by the mortgage to cure such
lapse and prevent any harm to the mortgagee's interest.

The dissent mentions, in a footnote, that the bank's lien here was a home
equity line of credit.  The statute says "first mortgages or deeds of trust"
so it appears that the original purchase money lien was paid off.  But
even worse would be the conclusion that even junior equity lenders are
treated as "first mortgagees" simply by being recorded prior to the
condominium lien default, even if they are junior to the purchase money
paper.  The court is unclear on this point.

Comment 1: One of the many things wrong with the opinion, as noted, is
the entire avoidance of the impact of this decision on future practice.
Here are a few of the unanswered questions:

1.  If, as it appears, the condominium lien foreclosure is a private action,
does this opinion create a duty to notify the senior institutional lender,
even if there is no contract right?

2.  If the senior lien has not been accelerated, is there still a duty to apply
the proceeds to pay off amounts not yet due?

3.  Most importantly, is this in fact a foreclosure of the senior lien, or
does the senior lien continue to exist, with the right to continually suck
up any proceeds from any lien foreclosure proceeding in the future?

Comment 2: Perhaps the above speculation will all be moot, since it
appears unlikely there will ever again be a condominium lien foreclosure
in Virginia while the court's ruling stands.  Would you?

This decision is so bad for condominiums, and by extension for lenders
with security interests in them, one must wonder why Wachovia Bank
paid a lawyer to take this position on its behalf.  Does Wachovia have no
lien interests in any other condominium units in Virginia?  If it does, this
decision, if it stands, will cost the Bank far more than it gains.

Comment 3: Although this is clearly a policy based reading of the statute,
it should be noted that interpreting the words "subject to" to mean
"conditioned on prior payment of" could conceivably alter the
construction of thousands of statutes around the country whose drafters
intended the more traditional result indicating that the foreclosure sale
would lead to a title encumbered by the prior interest.

Comment 4: So far as the editor can tell, until this case is either reheard
or reversed by legislation, condominium lien collections in Virginia will
be at a dead stop.  When everything gets cleaned up, unpaid liens in
many cases will have reached the point of uncollectability in many cases
because of the size, and the impact on the ability of associations to
conduct their maintenance duties will be put in jeopardy.   As Virginians
are learning in more ways than one:  when it rains, it pours.

Readers are encouraged to respond to or criticize this posting.

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