Daily Development for Thursday, April 7, 1999

MORTGAGES; PRIORITY; SUBDIVISIONS: Mortgagee's release of mortgage lien on lots created by subdivision occuring after the mortgage does not render the mortgagee liable to recognize platted common area and access easement on balance of secured property when bank later forecloses on that property, even where bank mortgage financed the subdivision..

Sun Valley Hot Springs Ranch v. Kelsey, 962 P.2d 1041 (Idaho 1998).

Bank obtained a mortgage on a parcel of property concerning which a plat was subsequently recorded and a declaration of covenants, conditions and restrictions was subsequently filed. Upon the transfer of two individual lots, the bank released its mortgage on those two lots only. Mortgagor then defaulted and the bank foreclosed its mortgage, obtaining title to the property, which it transferred to one of the defendants.

A transferee of an individual lot filed this case claiming that the bank's successor had an obligation to complete construction of the subdivision and to convey to the lot owners the common areas and access rights.

The lot owner first claimed that the bank's release of the lots at the time of purchase necessarily included a release of the common area and access easement rights created by the subdivision plat and the declaration. The court concluded that the bank was a bona fide purchaser, since the bank's knowledge that mortgagor intended to create common area and access rights was not a legally recognizable interest that would constitute an adverse claim on the property. As a bona fide purchaser, the bank's interest had priority over the subdivision plat and the declaration, and was not subject to any burden imposed by them.

The lot owner next argued that the bank's release of the individual lots constituted the bank's implied consent to the plat and to the rights created thereby. However, since the release did not mention the common areas or access rights, and specifically provided that it released only the lots themselves, the court concluded that the release did not, either expressly or impliedly, include any common area or access easement rights.

Finally, the court concluded that the bank was not equitably estopped from foreclosing upon the common areas and access rights, concluding that there was no detrimental reliance since the lot owners had notice (through the HUD property report) at the time of their purchase that their interests were subject to a blanket mortgage.

The court thus distinguished an old Illinois supreme court case, Smith v. Heath, 102 Ill. 130 (1882), which otherwise involved facts very similar to the instant case. In Smith, the lender financed a subdivision and ultimately released a number of the lots, but still had a mortgage on the common area a central square. It is unclear whether some of the lots also were still encumbered. Then the subdivision developer defaulted, and the mortgagee attempted to foreclose on the central square as well as other property. The owners of the released lots objected, and the court held that the mortgagee should have known that when the developer released the individukal lots the parties released believed that the mortgagee was also releasing its mortgage on the central square on which their lots fronted.

Because, in the instant case, the owners of lots knew that the property remained subject to the development mortgage, due to the HUD statement, the arguments supporting estoppel were not present.

Comment 1: Obviously there are some potential equitable marshalling issues here. The developer's land probably ought to go to foreclosure before the central square, in order to protect the easement rights of the parties who already paid for their lots and obtained releases. But if we assume that the debt is going to swallow up all available security, then any equitable marshalling argument will be moot.

Comment 2: Of course, as a matter of law, the mortgagee's rights have priority over any junior easement or coownership claims, and the mortgagee can foreclose on the square. But what about the equitable issues? The precedent case, although old, is very intriguing. In that case, one assumes that the mortgage was recorded and the buyers of the released lots at least had constructive knowledge of it. But the court held that the mortgagee "must have known" that parties acquiring parcels in the subdivision expected to be able to use the common areas.

The court here holds that the HUD property statement provided a clear warning to the lot purchasers that their interest in the central square was at risk under the developer's warning. The court does not give us the exact language of the disclosure, nor does it indicate whether the buyers were represented by counsel. But it is unlikely, in a western state like Idaho, that the buyers had counsel. They may not even have had a broker, since they were buying into a new subdivision development.

Under normal circumstances the editor is a great supporter of the proposition that courts ought to look to the documents, and not the equities. But the editor puts on another hat when thinking about unrepresented residential real estate purchasers. Disclosure laws are useful, but they are not a panacea.

In this case, the home purchasers' properties have been rendered either valueless or significantly impaired in value due to the default of the developer after the home purchasers paid for their homes and obtained releases from the developer's mortgage. There is a good argument that they believed that their releases insulated them from the risk of such a loss. The editor would not accept the existence of a HUD property report as conclusive on the question of whether the mortgagee realistically expected that the buyers understood that they still had that risk. The editor would prefer that the court to look more closely at the evidence on a case by case basis.

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