by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
randolphp@umkc.edu

MORTGAGES; WASTE; THIRD PARTY INJURY TO SECURITY: Mortgagees do not have a sufficient interest in mortgaged property to recover against third parties for trespass, encroachment, or private nuisance that impairs the mortgagee's security interest but may bring an action based upon unlawful impairment of security; action may lie, however, only where property is diminished in value to a point where it could not adequately secure the debt and action is performed without consent of mortgagor. Further, mortgagor's release of liability claims against party causing injury is valid against mortgagee.

Stevensen v. Goodson, 924 P.2d 339 (Utah 1996).

This case makes some important points about the law of waste which may compel mortgagees to look far more carefully at their rights to review and approve construction activity involving the mortgaged premises.

It was the crazy 80's. Plaintiffs sold a health club to developers and took back a purchase money mortgage. Developers subsequently attempted to develop land they owned adjacent to the health club, and hired an architect and contractor to perform the work. The health club sustained moderate damage as a result of efforts on the part of the contractor to install wall anchors for the new project on the health club property. Developers partially repaired the damage, and then released the architect and the contractor from all claims. Later, when developers defaulted on the mortgage debt to plaintiffs, plaintiffs discovered the damage and, along with their foreclosure action, brought suit against the architect and the contractor for trespass, nuisance and unlawful impairment of their security interest.

The Supreme Court of Utah affirmed judgment in favor of all defendants. Because plaintiffs held only a security interest in the property, they could not maintain an action for trespass, encroachment or nuisance, which require a possessory interest in property. The court recognized, for the first time in Utah, a cause of action for unlawful interference with a security interest, but substantially limited the application of that doctrine here.

First, the plaintiffs had to show that the property was damaged in such a way that the debt is no longer "adequately secured by the value remaining in the property." The court does not indicate what "adequately secured means," but the plaintiffs did not make a case to meet the standard in any event.

Second, the plaintiffs would have lost anyway because it was apparent here that the invasion of the mortgaged property by the architect and contractor was done with the consent of the mortgagors. The court held that, therefore, any remedy was in waste against the mortgagors themselves.

Perhaps the most interesting aspect of the case was the court's review of the trial courts conclusion that, in any event, the mortgagees were bound by the release entered into by the developers concerning the injury to the building. It is unclear to the editor why this issue was still in the case, as it appeared that the court had already concluded that the plaintiff mortgagees had no cause of action. But certain defendants had been dismissed from the case prior to the trial of other factual issues on the grounds of the release. Apparently the purpose of the release was to provide relief only to the contractor. It is not clear that the contractor paid anything to obtain the release other than the relatively insignificant cost of the repairs. But the parties were concerned that the contractor might also be liable later to others who might be found jointly and severally liable for the damage to the building, notwithstanding a release of the contractor alone. Consequently, the release purported to release the contractor and "all other persons and entities."

The court found first that a good faith release executed by the mortgagors would in fact be binding upon mortgagees. The court also pointed out that the mortgagor had a duty to apply the amounts received in any settlement proceeds in reduction of the mortgage debt. If the release were not effective against the mortgagee, and the mortgagor did not correctly apply the proceeds, the court pointed out, the party benefitted by the release would be subject to having to pay twice for the same injury. It appeared to deem this an unjust consequence. Further, the court pointed out that the mortgage did not require the mortgagors to notify the mortgagees of any injury to the property. To limit the scope of the release would compel the released parties to notify the mortgagee and secure its approval to any release, even when the mortgagee had not bargained for notice.

On the other hand, the court concluded that the general language of the release, operating to release "all other persons and entities," was not binding upon either mortgagor or mortgagee as a general principle of Utah law. Only named parties could be released.

Comment 1: The court ducks the hard issue of just how much injury to the mortgaged property is necessary before one concludes that the property does not adequately secure the debt. There is a variety of opinion on this point. The new Restatement of Land Security takes the position that the mortgagee is entitled to its original loan to value ratio. Others might argue that the mortgagee was counting on improvement in the value of the security as well as reduction of the debt over time, and is entitled to whatever "spread" results in the future. Consequently, any injury to the property value would be actionable. The court clearly rejects the latter approach, but doesn't necessarily adopt the Restatement approach.

Comment 2: The notion that the mortgagor would have to apply the proceeds of any settlement payment to direct reduction of the mortgage debt appears to be inconsistent with the notion that the mortgagee can only claim injury when the property's ability to secure the debt is impaired. If the damages are so small that the property adequately secures the debt even after the injury, why should the mortgagor have to reduce the mortgage with the proceeds? The court is somewhat brief in its discussion of this requirement, and perhaps will retreat from it in the future.

Comment 3: It appears further that mortgagees might want to take a clue from this case and to draft more extensive provisions protecting themselves in the event of injury to the property caused by third parties. They might want to limit expressly the ability of the mortgagor to compromise any claim without the mortgagee's formal consent and to impose a specific lien claim against any settlement proceeds. It is somewhat problematic whether outside parties would be viewed as having constructive knowledge of these restrictions in dealing with the mortgagor. The court implies that this would be the case, but, again, the discussion is so sketchy that is unreliable as a predictor of future opinions.

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