I'll be discussing this case, and
the one for Wednesday's DD, Stanton, and several others at the California Bar
Real Property Section Retreat this Saturday.
Daily Development for Friday, April
26, 2002
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; INSURANCE; FULL CREDIT
BID: Mortgagee's full credit bid precludes resort to insurance proceeds for
pre-foreclosure damage.
Norwest Mortgage, Inc. v. State Farm
Fire & Casualty Col, 188 Cal. Rptr.2d 367 (Cal. App. 2002)
Borrowers were in default and in
bankruptcy. Mortgagee obtained relief
to foreclose, but prior to foreclosure the property was severely damaged by
fire. The borrowers' claim was $81,000
and the probable value of the property was around $11,000. Borrowers maintained an insurance policy
with a mortgage clause providing that the mortgagee would receive the loss
payable "as interests appear."
The court does not indicate whether the policy included other language consistent
with a "standard mortgage clause," but modernly it would be
extraordinary if the policy did not contain such language. Further, the way the case works out, the
rest of the language of the clause likely made little difference.
The borrowers didn't even bother to
submit a claim, aware that the mortgagee likely would absorb any insurance
proceeds. But the mortgagee got wind of
the situation and did submit a timely claim.
Thereafter, prior to the insurer's
processing of the claim, the mortgagee
foreclosed on the property.
In California, in a nonjudicial
foreclosure, no deficiency judgment is available. Perhaps for this reason, when mortgagee retained a foreclosure
agent to carry out the foreclosure, neither party spent much time evaluating
whether the property was worth the amount of the claim, and the agent, on
behalf of the mortgagee, simply bid in the $81,000 debt at the foreclosure
sale. There were no other bidders.
(What a surprise!!)
Shortly thereafter, the insurance
company - the only party that was paying attention to what was happening -
denied the claim on the grounds that the property had not been reduced in value
below the amount of the mortgagee's interest.
Since the mortgagee's recovery for pre-foreclosure damages is limited to
any injury to its security interest, the mortgagee had no claim.
Nothing loathe, the mortgagee simply
notified the foreclosure agent to "rescind" the prior sale and to
notice up another foreclosure sale and to "publish" another bid. The court is not clear what
"publish" meant in this context.
In any event, the mortgagee's letter made clear to the agent that the
value of the property, due to the fire damage, was only $11,000, and that the
agent was to bid that amount at this new sale.
The mortgagee then notified the insurance company that it had rescinded the
sale and that a new sale was scheduled.
By the time of the new sale, the
mortgagee had replaced the original agent with a new one, even though it had
had extensive correspondence with the original agent. Perhaps the parties were already circling wagons concerning
liability for the prior error. In any
event, the new foreclosure agent leapt right into the breach and, contrary to
lender's instructions, again bid in the debt.
When mortgagee discovered this, it instructed the agent not to record
the foreclosure deed and to hold a new sale.
The agent nevertheless, apparently negligently, recorded the deed. (Can you say "comedy of errors?)
Ultimately, the second agent
scheduled a third sale, and this time bid the reduced amount. One suspects that no one was surprised when
the insurer refused to honor this third sale and rejected the insurance claim.
What is surprising, however, is that
the mortgagee elected to litigate the issue, and to appeal when it lost
below. The only fact that could explain
such an expedition is that some California appeals courts have been very
hostile, in other contexts, to the
concept of the full credit bid marring mortgagee's rights, can explain this
excursion. See, e.g. Kolodge v. Boyd,
2001 WL 328564 (Cal. App., 1st Dist. 4/5/01)
(the DD for 4/13/01; Alliance Mortg.
v. Rothwell, 34 Cal. Rptr.2d 700 (Cal.
App. 1994), (which the editor excoriated in a DD for 4/27/95, and which was
significantly modified on appeal, 44 Cal. Rptr. 2d 352 (Cal. 1995) (the DD for
4/27/95).
In any event, the mortgagee didn't
manage to get to those judges this time, and the California Court of Appeals,
following California precedent, held
that the mortgagee was bound by its full credit bid in the first sale. It could not unilateraly rescind that
sale. The mortgagor's consent was
required, and of course the mortgagor probably had never even been made aware
of what was going on. (Note that the
mortgagor conceivably might have had a claim here, but it would have had to
show that the value following the fire was other than that suggested by the
mortgagee's bid.)
Here, of course, the mortgagee was
aware that the fire had occurred. But
the court, in dicta, (following Supreme Court dicta) went on to conclude that
notice of the damage is irrelevant: "Actual or constructive notice of
property damage is irrelevant because the full credit bid, once made,
extinguishes the debts secured by the insurance policy."
Comment 1: As suggested, the result
was foreordained. But the dicta at the
end, holding that the lender would be precluded from demonstrating lack of any
notice of the injury, is a result to which the editor objects.
The editor has expressed these views
in his article on this subject: "The Mortgagee's Interest in Casualty Loss
Proceeds; Evolving Rules and Risks,"
32 ABA Real Property, Probate
& Trust Law Journal, 1 (1997).
The editor believes that where the
damage occurs so close to the time of foreclosure, is hidden by mortgagor,
or is otherwise undiscoverable by virtue of reasonable efforts to
inspect, the mortgagee ought to be permitted to avoid the sale and to resell
the property in order to preserve its insurance claim. (The editor expressed no opinion as to
whether the mortgagee ought to seek judicial validation of its actions before
conducting the new sale - which the mortgagee did not do here, and which might
have been a good and money-saving idea.)
The result in the case is consistent
with the Restatement of Mortgages, which posits that the lender should be
barred by its bid even where it had no knowledge. The rationale for the Restatement of Mortgages position is that
the benefits of finality are worth the small risk of the lender occasionally
not becoming aware of damage prior to foreclosure, since careful lenders can
obtain the right to inspect the property in the mortgage instrument and can conduct
a final inspection just prior to sale.
The editor readily admits that his
position would not have resulted in a different outcome here. One would assume that a $70,000 fire likely
would have been readily observable simply by a drive by inspection of an
$80,000 house.
Comment 2: As the author has
indicated in comments to the DD cited above, the mortgagee does presumably
obtain an advantage by bidding the full credit amount. Other bidders are deterred from
participating.
The fact that other bidders don't
appear at the sale is not necessarily conclusive. It would not be too unusual for a potential bidder with an
interest in the property to call the foreclosure agent to inquire whether the
lender is bidding in the debt and, if the answer was affirmative, thereafter
ignoring the sale.
In any event, even if it is true
that most of the time the foreclosure sale is a mere formality, and that few
other bidders show much interest in most of these sales, the fact is that it is
a required formality, and not an idle exercise. Although we have reduced the elimination of the equity of
redemption to a relatively simple ritual, we are still carrying out an
important legal act and the rituals have meaning.
Readers are urged to respond, comment, and
argue with the daily development or the editor's comments about it.
Items in the Daily Development section generally
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