by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
This discussion pertains to the new Restatement of Land Security, which is certainly a major development in the American common law of real estate. The new Restatement of Servitudes likely will rival it in significance when it is complete. The posting is a bit longer than normal, so I am going to count it as the Daily Development for Monday, May 27, which is Memorial Day, and Tuesday, May 28. I am posting in on Friday, May 24, so you will have an opportunity to digest it and, I hope, to comment on it. The Reporters are both DIRT readers and participants, and I am sure that they will welcome your comments. Here is the Report.
Professors Dale Whitman and Grant Nelson, Reporters for the American Law Institute project on writing a new Restatement of the Law of Land Security, have almost completed their work. The American Law Institute has signed off on a final working draft, leaving a few "clean up" issues to the Reporters. Thus, in sum, we now have a new Restatement of the law of land security, and we'd better get used to it. It will be coming to your town soon.
Last week Dale made a presentation on the salient features of the new Restatement at the ABA Spring CLE Meeting. Dale has provided to me a slightly updated version of the summary that he supplied in connection with that presentation. In his transmitting message, he indicated that he had formatted it so that we could post it on DIRT in its entirety. I am doing so. (Note the copyright mark.)
But I am sure that Dale did not expect me to post this document without a few comments of my own, which I here post.
1. In many ways, the Restatement clarifies minor discrepencies that have grown up in some jurisdictions and identifies a central channel of desired policy that is generally very helpful to market functions. One innovative idea that I think is appropriate as a common law development is the identification of a right in the mortgagor, faced with a non-prepayable mortgage, to provide substitute security in order to free the existing mortgaged property for other uses even though the secured debt must remain alive.
2. In several important particulars, Dale and Grant have determined not to "restate" the common law, but to write a new statement of law, tracking what they believe to be the consensus of legislative enactments around the country. Here are three important ones:
a. All installment land contract devices (contracts for deed) are deemed to be equitable mortgages and can be executed upon only through foreclosure. Forfeiture under such contracts without foreclosure is prohibited.
b. The "optional/obligatory" rule is abolished, and future advances clauses generally are valid and enjoy the priority of the recordation of the mortgage containing them, but the borrower has the right to terminate the future advances arrangement by notice to the lender.
c. Mortgagees have a duty to provide an "estoppel certificate" report on the loan balance and status of payments to any person who has an interest in the land security.
In each case, I think that the change the Dale and Grant have made is salutory, but I am not sure that I'm comfortable with the change arising as a function of the common law, influenced by the Restatement. Established practices tend to develop around established rules, and I think the common should change property rules only incrementally. Each of the changes here would have dramatic consequences in many states. I can understand the legislature of those states making the policy decision to invoke the change, but I think that writing a Restatement rule that urges the courts to carry out the change encourages judicial activism in real estate law that is not warranted by the difficulties the old rules create.
I must admit, however, that I haven't lived with the concept for as long as those who actively participated in the drafting of the Restatement. As Dennis Miller says: "That's just my opinion, I could be wrong."
Here is Dale's and Grant's report:
The following is a brief summary of some of the innovations and interesting features of these drafts. It does not contain the actual black letter of the sections, and should not be taken as a complete description of the content of the sections.
Sec. 1.1. Personal liability. No personal liability is necessary to a valid mortgage obligation; non-recourse mortgages are valid.
Existing law is consistent with this section. However, many mortgages on income property today are either full recourse or are non-recourse but have numerous carve- outs. In addition, the mortgagor may be personally liable on covenants in the mortgage itself, even if liability on the promissory note is excluded.
Sec. 1.2. Consideration. Consideration is not necessary for a valid mortgage, provided the underlying obligation is enforceable. A mortgage can secure a preexisting obligation.
The case law is full of statements that a mortgage must be founded on consideration, but this seems plainly wrong. The mortgage, after all, is merely security for an obligation. It's true that the obligation may need to be supported by consideration under the law of contracts, but if the obligation is enforceable, the mortgage should be equally enforceable. Even if the obligation is not enforceable (for example, a promissory note given as a gift for no consideration), the mortgage itself is enforceable if intended as a gift and is not tainted by fraud, mistake, undue influence, duress, or the like.
When a mortgage secures a preexisting debt, it may be arguable whether consideration is present or not, but under the Restatement the question is irrelevant; the mortgage is generally enforceable.
Sec. 1.3. Obligations of third parties. A mortgage can secure an obligation owed by someone other than the mortgagor. Mortgages securing debts of third parties are common and are recognized by the Restatement as enforceable. The third party's promise to pay may be contemporaneous or antecedent, as provided in Sec. 1.2.
Sec. 1.4. Non-monetary obligations. Mortgages can secure only obligations that are measurable in money or reducible to monetary value.
Most non-monetary obligations qualify under this test. For example, a promise to provide support and care to an elderly person can be reduced to a monetary amount with the aid of actuarial tables and other evidence. However, the value of some promises (e.g., to provide love and affection) is inherently so subjective that a mortgage cannot secure such a promise.
Sec. 1.5. Description of the obligation. A mortgage need not describe the obligation it secures, nor recite the amount. It must identify the mortgagee, as against subsequent grantees.
This section is considerably more liberal than the statutes of some states that require the recitation of information about the secured obligation. However, amount and other features of the obligation nearly always change over time, making the recitation in the mortgage of little value. The reason that the mortgagee must be identified is that subsequent parties (junior mortgagees, grantees, etc.) who acquire interests in the land can make inquiry of the mortgagee first, and hence can discover the true status of the mortgage.
Sec. 1.6. Duty to provide statement of the mortgage's status. Upon a request made for good cause, the mortgagee must provide information in writing about the obligation and the mortgage.
The information that must be disclosed includes (1) the amount owing; (2) the current interest rate, and the basis for adjustment of that rate if it is adjustable; (3) the amount of any additional fees or charges owed; (4) whether the mortgagee considers the obligation to be in default or to be accelerated; (5) if the mortgage provides for future advances or reserves a right in the mortgagee to modify the mortgage, whether any notice has been issued to the mortgagee to terminate such advances or modification rights; (6) the amounts of any funds held in escrow or impound accounts; and (7) the identity and address of any person who has acquired an interest in the mortgage or the obligation it secures. Many states have statutes requiring similar disclosures.
Sec. 2.1 Validity of future advance mortgages. Future advance mortgages are valid; the principal amount may be limited by a statement in the mortgage. Many states have statutes requiring a statement in a future advance mortgage or the note limiting the amount of future advances, but the Restatement does not require that any ceiling be stated. Even if a ceiling is stated, certain items may exceed it, including accrued interest, costs of collection, attorneys fees, and advances for the protection of the security (Sec. 2.2).
The mortgage will continue to exist even if the balance is reduced to zero, unless the parties intend that the mortgage be discharged. (This provision is intended to facilitate line-of-credit loans).
Sec. 2.2. Advances for protection of the security. Advances by a mortgagee to protect the security can be added to the principal balance even without a clause in the mortgage so providing. Expenditures may be to protect the value of the real estate (e.g., insurance premiums, repairs) or to protect against assertion of prior liens (e.g., property taxes). These expenditures have the priority of the original mortgage (except that a payment of a prior lien may get its priority, under the doctrine of subrogation).
The mortgagee may recover advances for protection either by foreclosing the mortgage, suing on the debt, or suing independently for reimbursement of the advance.
Sec. 2.3. Priority of future advances. All future advances take the priority of the original mortgage; the optional/obligatory advance doctrine is abolished. However, the mortgagor can give the mortgagee a notice at any time cutting off all future advances and capping the principal balance at its current level. This cutoff notice procedure has been implemented by statute in about a dozen states, but the Restatement proposes that it be judicially recognized.
The cutoff notice procedure is not available if terminating future advances would unreasonably jeopardize the mortgagee s security, or would prevent the mortgagee from fulfilling its contractual duty to other persons to make further advances. See Grant S. Nelson & Dale A. Whitman, Rethinking Future Advance Mortgages: A Brief for the Restatement Approach, 44 Duke L.J. 657 (1995).
Sec. 2.4. Dragnet clauses. Advances are secured under a dragnet clause only if they the are similar in character to the original loan, the mortgage describes them with reasonable specificity, or the parties specifically agree at the time of the advance that it is secured by the mortgage.
Sec. 3.1. Redemption and clogging. All persons with interests subordinate to the mortgage have a right to redeem it until they are foreclosed. Any contemporaneous agreement that impairs this right is ineffective. However, a mortgage clause giving the mortgagee an interest in the mortgagor s real estate is valid unless it's expressly dependent on default. (The objective of this last provision is to permit mortgagees to take equity positions in the real estate security.)
Sec. 3.2. Absolute deed as a mortgage. An absolute deed can be treated as a mortgage if intended to serve as security, based on the totality of the circumstances. Factors to consider include the parties statements, disparity between the price paid and the property s value, and such acts by the grantor as retention of possession, payment of taxes, making of improvements after the sale, etc. Parol evidence is admissible to establish these facts, and to tie the mortgage to any other documents indicating that the deed was intended as security.
Sec. 3.3. Conditional sale as a mortgage. The same principles apply to a conditional sale (a deed plus a right or option in the grantor to repurchase the property).
Sec. 3.4. Installment contracts. A contract for deed (real estate installment contract) is a mortgage; the real estate security can realized upon only by foreclosure. A forfeiture clause is regarded as an unenforceable clog on the equity redemption under Sec. 3.1.
Sec. 3.5. The negative pledge. An agreement not to encumber or transfer real estate is not a mortgage. The Restatement takes no position as to whether such agreements are enforceable by way of damages or injunction.
Sec. 4.1. The lien theory. A mortgage does not give the mortgagee possession, and a contrary agreement (giving the mortgagee possession at the time the mortgage is given) is unenforceable. (The lien theory of mortgages is adopted.) But a mortgagor may give possession later voluntarily or by abandoning the property.
Sec. 4.2. Assignments of rents. A mortgage on rents (or assignment of rents ) is enforceable; it may give the mortgagee access to the rents at any time, or upon default. It can be actuated simply by written demand to the mortgagor and the holders of any other mortgages.
Sec. 4.3. Receivers. A court may appoint a receiver if the obligation is in default, the real estate is inadequate to satisfy the obligation, and waste is being committed. It may also appoint a receiver if the mortgage contains an assignment of rents clause or authorizes a receiver upon default, even if the other conditions mentioned above are not met.
Sec. 4.4. Receivers disaffirmance of leases. A receiver may disaffirm a lease entered into while the mortgagor was in default, if the lease was not commercially reasonable.
Sec. 4.5. Priority among receivers. Receivers appointed under senior mortgages preempt receivers appointed under junior mortgages.
Sec. 4.6. Waste. Waste is broadly defined, and includes physical damage, failure to make reasonable repairs, failure to pay prior tax liens, failure to comply with mortgage covenants respecting the physical care of the property, and failure to turn over rents to which the mortgagee has a right.
If waste occurs and impairs the mortgagee s security, it may foreclose, seek an injunction, or seek damages. These remedies are available only if the mortgagee s security is impaired. Impairment of security is defined as a increase of the loan-to-value ratio above its scheduled level.
Sec. 4.7. Insurance and condemnation proceeds. The mortgagee has the right to casualty insurance proceeds (if the mortgage required the insurance) and eminent domain awards, to the extent security has been impaired. The test for impairment of security is the same as for waste under Sec. 4.6.
The mortgagee must apply the funds toward reduction of the mortgage debt. However, upon the mortgagor's request, the mortgagee must allow use of the funds for restoration of the property if feasible, unless the mortgage specifically provides the contrary. The mortgagee can impose reasonable conditions on the use of the funds for repair.
Sec. 4.8. Effect of default on right to insurance and condemnation proceeds. If the mortgage is in default, the mortgagee may claim casualty insurance or eminent domain proceeds to the extent of the amount due, or may foreclose and recover any deficiency from such proceeds.
Sec. 4.9. Mortgagor purchase at foreclosure. If the mortgagor purchases at the foreclosure sale, any junior liens are revived. This rule is necessary to prevent unjust enrichment of the mortgagor at the expense of the junior lienholders.
Sec. 5.1. Transfers with mortgage assumption. If a mortgage is assumed, the grantee and grantor are both personally liable, with the grantee being primarily liable and the grantor liable as a surety.
Sec. 5.2. Transfers without mortgage assumption. If the real estate is transferred without an assumption of the mortgage, only the grantor is personally liable, but the real estate becomes the primary source of payment.
Sec. 5.3. Modification of the debt after transfer of the real estate. After the real estate is transferred, the grantor is discharge from liability to the extent he or she suffers loss because the mortgagee modifies the obligation, grants an extension of time to pay, or releases the real estate from the mortgage. (Much of the prior case law gave the grantor a complete discharge, even if the modification was innocuous or even beneficial to the grantor.)
Sec. 5.4. Assignments of the mortgage and the debt. An assignment of the mortgage also transfers the debt, and vice versa (unless the parties have an intent not to transfer the other document). The purpose of this provision is to keep ownership of the mortgage and the debt together unless the parties consciously desire to separate them. If the mortgage is held by one who does not hold the debt, it cannot be foreclosed.
Sec. 5.5. Payment to the assignor after assignment of the mortgage and debt. If the debt has been transferred, payment to the transferor is good if made before the payor has notice of the transfer. This reverses much existing case law, which holds that the payor pays at his or her peril if a transfer of the debt has occurred before the payment.
Sec. 6.1. Prepayment. Prepayment is free unless the mortgage or note restrict or prohibit prepayment. This reverses the traditional presumption that prepayment is not allowed unless the documents expressly permit it.
Sec. 6.2. Restrictions on prepayment. Clauses restricting or prohibiting prepayment are enforceable. Such clauses may either bar prepayment entirely or may impose a fee or penalty for prepayment. However, the mortgagor may free the real estate without prepayment of the debt if substitute security (that is substantially the equivalent of cash) is provided. See Dale A. Whitman, Mortgage Prepayment Clauses: An Economic and Legal Analysis, 40 UCLA L. Rev. 851 (1993).
Sec. 6.3. Prepayment from insurance or condemnation proceeds. No prepayment fee may be charged for prepayment from casualty insurance or eminent domain proceeds if the proceeds could feasibly have been used to restore the property instead.
Sec. 6.4. Payment and tender. Payment or tender of payment in full by the mortgagor discharges the mortgage, unless the parties intend to keep it in force (e.g., in a line of credit loan). Upon payment or tender, the mortgagee has a duty to provide a recordable release to the mortgagor. Payment by a junior lienor acts as an assignment of the mortgage to the junior lienor under the principle of subrogation.
Sec. 7.1. Foreclosure. Foreclosure terminates all interests in the real estate that are junior to the mortgage being foreclosed (if they are properly made parties); but foreclosure does not terminate interests senior to the mortgage being foreclosed.
Sec. 7.2. Purchase money mortgages. Purchase money mortgages have priority over any other interests attaching to the real estate before the purchaser acquires title. PMMs to vendors have priority over PMMs to third party lenders.
Sec. 7.3. Replacements and modifications of mortgages. A replacement mortgage retains the priority of the original mortgage except to the extent that any changes in it are materially prejudicial to intervening interests. The same is true of modifications of mortgages. A mortgagee can reserve the right to make prejudicial modifications without loss of priority; but a notice from the mortgagor (similar to a cutoff notice for future advances under Sec. 2.3) can cut off that right.
Sec. 7.4. Surplus. Surplus proceeds from a foreclosure sale are distributed to the junior interests in the order of their priority, and then to the mortgagor.
Sec. 7.5. After-acquired property. A mortgage on after-acquired property is valid, but is treated as unrecorded until the mortgagee records a notice that specifically identifies the property acquired.
Sec. 7.6. Subrogation. One who pays off another's mortgage debt in full is subrogated to the debt and the mortgage, if necessary to prevent unjust enrichment. Such situations include (1) a payment to protect the payor s interest; (2) a payment under a legal duty to do so; (3) a payment made on account misrepresentation or the like; and (4) a payment made at the request of the mortgage debtor. The volunteer rule is abolished.
Sec. 7.7. Subordination. A mortgagee may voluntarily subordinate the mortgage to some other interest. If the other interest does not yet exist, it must be described with reasonable specificity.
Sec. 7.8. Wraparound mortgages. When a wraparound mortgage is foreclosed, the foreclosing mortgagee may recover only the difference between the wrap debt and the underlying debt. Any foreclosure proceeds above that amount are distributed as surplus.
Sec. 8.1. Acceleration. A mortgage debt may be accelerated by notice after default (provided the mortgage or note contains an acceleration clause). Once accelerated, foreclosure of the mortgage may generally prevented only by payment in full, except as provided in the mortgage or by agreement of the parties.
Sec. 8.2. Suit on the debt. Once acceleration has occurred, the mortgagee may either sue on the debt or foreclose the mortgage. (Note that states having a one-action rule would not permit the former course of action.) However, the mortgagee may not pursue both courses of action simultaneously.
Sec. 8.3. Inadequate foreclosure price. A low foreclosure sale price will warrant a court in setting aside a foreclosure sale only if it is grossly inadequate (say, under 20% of value.)
Sec. 8.4. Deficiency judgments. After foreclosure the mortgagee may obtain a deficiency, but the mortgagee must give credit for the property's fair market value, even if the bid at the sale was below market value. (This fair value approach to deficiencies is embodied in statute in a number of states.)
Sec. 8.5. Merger. The merger doctrine does not apply to mortgages or affect the enforceability of a mortgage obligation. This approach should simplify the process of mortgagees obtaining deeds in lieu of foreclosure.
Sec. 8.6. Marshaling. The doctrine of marshaling determines the order of foreclosure when the mortgage covers more than one parcel. Its purpose is to protect junior interest- holders to the extent possible without impairing the rights of the foreclosing mortgagee. Parcels with no subordinate interests are foreclosed before parcels with subordinate interests. (The two funds rule.) Parcels with more recently-created subordinate interests are foreclosed before those with older subordinate interests. (The inverse order of alienation rule.) This section permits waivers of of the right to marshal, both in the subordinate mortgage and in the senior mortgage.
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 five years, these Reports annually have been collated, updated, indexed and bound into the Annual Survey of Developments in Real Estate Law, volumes 1-5, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Laprica Mims at the ABA. (312) 988 6233.
Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.