Daily Development for Monday, November 11, 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

This item is based on material originally reported by Roger Bernhardt in the California CEB Real Property Reporter. That report was substantially revised by Dale Whitman in connection with a program that Dale, Roger and I did for the American College of Mortgage Attorneys, and I've revised it again. I'm not sure whether the Reporter's Comments are those of Roger or Dale, but I believe that they likely are Dale's, as they take the position of the Restatement of Servitudes, on which Dale served as Reporter. Ed.

PRIORITIES; PURCHASE MONEY MORTGAGE; REATTACHING LIEN: When original owner of property, who transferred it to others who then defaulted, repurchases it after foreclosure with new purchase money loan, that lien has priority over a wiped-out junior lien that revives and reattaches to property.

DMC, Inc. v Downey Savings & Loan Ass'n, 99 Cal.App.4th 190, 120 Cal.Rprt.2d 761 (2002)

After obtaining two loans secured by deeds of trust on her property, Henry transferred the property to her parents. When they defaulted on the first loan, the lender foreclosed and acquired title, extinguishing DMC's second mortgage. Two months later, Henry repurchased the property from the foreclosure sale purchaser. To do so, she obtained a new loan, secured by a trust deed on the property from Downey S & L. A year later, DMC sued to foreclose judicially its second lien. The trial court granted Downey's motion for summary judgment, holding that even if DMC's second trust deed reattached to the property, it remained junior to Downey's new purchase money trust deed.

The court of appeal affirmed. Despite California's "first in time, first in right" approach to lien priority, under an equitable analysis, "the new senior lien holder would not have advanced the substantial funds necessary for the repurchase if it was not assured that it would have the rights and remedies associated with lien priority." 99 Cal.App.4th at 199. The foreclosure extinguished DMC's lien, and without Downey's new loan DMC would have been left holding a wiped-out junior lien without any legal claim to repayment. It was only because of the money advanced by Downey, therefore, that DMC's lien was revived, thereby retaining its original place in the order of priority.

Reporter's Comment: The court's conclusion is correct, but there are several doubtful steps in its reasoning. For one, it seemed to mix up two different concepts of "purchase-money mortgage." The court used the definition of "purchase-money mortgage" found in Cal. Code of Civil Proc. 580b, which is part of California's famous antideficiency statute. That statute's definition of purchase money is confined to owner-occupied, one-to-four-unit dwellings. But the presumption of priority for purchase-money mortgages is by no means so confined. As Restatement (Third) of Property (Mortgages) 7.2 provides:

A purchase money mortgage has priority over any mortgage, lien or other claim that attaches to the real estate but is created by or arises against the purchaser-mortgagor prior to the purchaser- mortgagor's acquisition of title to the real estate.

California Civil Code 2898 says substantially the same thing. Whether the real estate is owner-occupied or consists of one-to-four unit dwellings is completely immaterial. The usual illustration of the principle is the case of a person who has preexisting judgments entered against him or her, and who now buys real estate by means of a purchase-money mortgage. The judgments, in most states, will attach to the real estate as soon as the purchaser acquires them, but they will be subordinate to the mortgage. That is fair enough, for if the lender had not supplied the mortgage, the purchaser probably could not have bought the real estate, in which case the judgment creditors would still have had a lien on nothing at all.

The revived junior lien in this case is quite like judgment liens mentioned above; in the Restatement's terms, it arose "against the purchaser-mortgagor priority to the purchaser-mortgagor's acquisition of title to the real estate." It seems sensible to reach the same result as with judgment liens.

Reporter's Comment 2: That leads to the other issue: should the court have recognized the reattachment of the junior liens at all, even in a subordinate position? Restatement (Third) of Property (Mortgages) deals with that issue, too. 4.9(a) provides:

A holder of the equity of redemption who purchases real estate at a foreclosure sale of any lien on the real estate acquires title subject to any lien or other interest that was junior to the foreclosed lien.

The obvious reason for this rule is to prevent unjust enrichment; the contrary result would allow the owner-mortgagor to go through a foreclosure, "cleanse" the property of its junior liens, and end up still owning it! However, the DMC case doesn't quite fit the rule, for Henry did not buy the property at the foreclosure sale. Instead, the lender who held and foreclosed the first mortgage loan was the successful bidder.

Henry bought the property back from that lender two months later. There is no suggestion in the opinion of collusion between Henry and the lender, nor that she had any advance arrangement with them to buy the house back.

It is much less clear that the junior lien should be revived in this setting. The foreclosing lender was, in effect, a BFP of the property. As Restatement 4.9, comment a states, "there are good reasons to allow the original holder of the equity of redemption to reacquire title from a bona fide purchaser free and clear of previous foreclosed interests. Under normal recording act principles, a bona fide purchaser of real estate that is subject to a prior unrecorded interest may transfer good title to a transferee even though that transferee has knowledge of that interest."

California used to have a statute providing for such revival following statutory redemption by the mortgagor (after a judicial foreclosure sale), but it has since been amended to now say just the opposite. See Cal. Code of Civ. Proc. 729.080(e). That statute puts this decision in the odd position of reviving a junior lien if, after a nonjudicial foreclosure sale, the mortgagor repurchases the property, but not if she redeems it after a judicial foreclosure sale.

Revival after a senior trustee sale is not self-evident. An extinguished junior mortgage lien is not like an unsatisfied money judgment waiting to attach to all after-acquired assets of the judgment debtor. Reattachment would be easy if the sold-out junior obtained a money judgment and then recorded that, but none of that occurred here (nor could it occur if the junior lien were a purchase money mortgage subject to Code of Civ. Proc. 580b, since that antideficiency statute would prevent the junior from obtaining a judgment).

Reporter's Comment 3: If these liens really do reattach, they may be difficult to find and insure against. There is no judgment lien against the named mortgagor anywhere in the records, and a chain-of-title search will not be all that helpful. Here, for instance, Sharon Henry was the record owner and trustor, but she then transferred title to her parents, who are the ones who defaulted; thus, the foreclosure sale was conducted against Henry's parents, the Finleys, who had been the owners of record for the previous 30 months; finally, Henry, rather than her parents, borrowed funds and (re)purchased the property three months after that. If you were now purchasing the property from Henry, would you expect your title company to know that a mortgage lien wiped out by a foreclosure against the Finleys had since been revived?

In conclusion: the court is surely correct that the purchase-money mortgage should have priority over the revived junior lien. There's very serious doubt as to whether the junior lien should have been considered revived at all.

Editor's Comment 1: The editor respectfully demurs from much of what is stated above. Although the editor agrees that there is certainly a problem with identifying from the record when a prior mortgagor has in fact repurchased the property, it is nevertheless certain that the mortgagor/purchaser is certainly aware of that fact, and there is no harm in permitting prior liens to reattach against the purchaser's interest.

The editor does concur that subsequent mortgagees funding the prior mortgagor's purchase may have some difficulty identifying this situation, but if they were aware that they would be primed by reattaching liens, they could easily take steps to ascertain whether the a borrower has suffered a prior foreclosure of property offered for mortgage. Presumably the purchase money lender already has done enough due diligence to discover that the borrower indeed has suffered an earlier foreclosure.

In this particular case, that information is a bit more difficult to get, since the borrower was no longer owner of the property at time of foreclosure, but likely it could have been discovered.

But where the information is unavailable as a practical matter, then the purchase money mortgagee should be treated as a BFP, of course.

Editor's Comment 2: The reporter's comments, however, go beyond simple questions of BFP status. The reporter would oppose reattachment here in any event. The editor disagrees.

In only a small number of cases will a mortgagor who has suffered a foreclosure of a property reaquire that property. The editor suspects that in a substantial percentage of these cases, the reaquisition is part of some original scheme to "foreclose away" unwanted junior liens. Particularly in California, which has anti- deficiency protection at every turn, it is quite possible that such schemes are being carried out in these cases. Permitting prior "sold out juniors" to reattach to any property so reaquired, even if reaquired at a point remote from the sale, does little injury to the transferability of that property, does no injury to the investment options of the mortgagor/repurchaser (who has a whole universe of other properties to buy) and prevents schemes to "foreclose away" juniors from working. What's wrong with all that? The editor likes the application of the rule here.

Editor's Comment 3: The editor would go even further and deny priority to the purchase money mortgage lien (assuming that it is not a BFP). Again, if the purchase money mortgagee is aware of the possible reattachment of the former lien, and the purpose of the "reattachment rule" is to discourage collusive foreclosures for the purpose of eliminating such prior liens, the policy behind the rule impresses the editor as a stronger concern than the policy that permits the purchase money lender "superpriority."

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

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