Daily Development for
Tuesday, October 8, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

Thanks to Howard Lax, of the Michigan Bar, for forwarding this case.

MORTGAGES; "CLOGGING" EQUITY OF REDEMPTION; OPTIONS: Michigan court upholds option given to mortgagee by mortgagor contemporaneous with mortgage where purpose clearly is not to provide alternative form of realization upon security.

Blackwell Ford, Inc. v. Calhoun, No. 174443, 1996 Mich. App. LEXIS 303 (9/27/96)

As a general rule, the "anti-clogging" doctrine prohibits mortgage lenders from requiring borrowers to transfer to the lender interests in land other than those represented by the mortgage itself. The idea is that the lender has such a strong bargaining position regarding default remedies on the secured debt that the lender could induce the borrower to agree to an arrangement that would effectively nullify the "second chance" to redeem the property following default that is guaranteed by the concept of the equity of redemption.

Here, the property in question was owned by a landlord who had leased it to Ford, which had subleased it to Plaintiff (the court indicates that the sublease was "coterminous" with the main lease - which would render the sublease characterization questionable - but the court makes nothing of that issue). In its lease, Ford got a right of first refusal in the property. Subsequently, the Plaintiff subtenant determined that it wished to own the property, but the parties were concerned that Ford might exercise its right of first refusal if the Plaintiff actually contracted to buy it.

Consequently, the Landlord and Plaintiff entered into an arrangement whereby Plaintiff paid $175,000 to Landlord in exchange for an option to purchase the property for a variable price that exceeded $1.5 million. The term of this option extended beyond Ford's lease and first refusal rights by three months. The parties also agreed that Plaintiff could continue its tenancy as a tenant of Landlord for these three months. Technically, Plaintiff could exercise the option (and trigger a possible response by Ford) prior to the termination of Ford's lease, but this in fact did not happen.

At the time the parties entered into the option agreement, the Landlord also gave the Plaintiff a mortgage securing Landlord's obligation to return the option money if it failed to honor the option. The court indicates that the mortgage also was "designed to ensure [Landlord's] compliance with the option," but doesn't tell use how this was to be accomplished.

Following the expiration of the Ford lease, Plaintiff attempted to exercise the option, but Landlord refused to honor it, offerring to return the deposit. In response to Plaintiff's suit for specific performance, Landlord argued that the option was void as a clog on the equity of redemption embodied in the mortgage.

The trial court agreed with Landlord and voided the option, denying specific performance.

On appeal: held: reversed: The option was good.

The court viewed the case as distinct from those in which options are dishonored because they are attempts to "end run" the equity of redemption. The mortgage in this case would never take effect at a time when the Plaintiff was likely to exercise the option, and therefore could not be displaced by the option.

"[W]e do not here have a case of a mortgage agreement with a lurking option to purchase, whereby the mortgagee may swoop in and exercise the option following the commencement of foreclosure proceedings. Rather, we have an option to purchase with a lurking mortgage. If plaintiff exercises the option to purchase and defendants are unable to deliver title, a financial obligation, secured by the mortgage, comes into being. On this mortgage plaintiff could foreclose, but plaintiff would be unable to then exercise the option, bcause the option was, necessarily, already exercised."

The court is careful to indicate that it reaffirms the general notion of the "anti-clogging" policy in Michigan, but concludes simply that such policy has no relevance to the case at hand.

Comment: Modern scholars and commentators have been arguing for a less rigid, analytic approach to the clogging problem for some time. They have argued that the parties to a mortgage should be able to create interests in the mortgagee that do not frustrate the equity of redemption by taking effect, directly or indirectly, upon mortgage default.

The editor concurs, albeit cautiously. Transfers of interests simultaneous with, and part of, the overall loan transaction, are very likely to be attempts by the mortgagee to avoid some aspect of the equity of redemption, even though the purpose may be evident upon first examination. Normally, however, the mortgagor, in contesting the validity of the interest, will be in a position to explain how the interest operates as a "clog." We should not be overly concerned that inappropriate schemes will slip through the filter.

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