Daily Development for
Wednesday, January 6, 1999
by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
Thanks again to the real Jack Murray at First American Title for this one.
MORTGAGES; WASTE: Mississippi considers, rejects, new Restatement approach on waste, adopts standard that mortgagee can claim waste when (and only when) fair market value of property has declined from time of mortgage conveyance due to actions of mortgagor.
McNeese v. Hutchinson, 1998 WL 850050 (Miss. 1998).
Mortgagor gave a purchase money mortgage to seller/mortgagee in 1988. The property was a residence with a swimming pool By 1995, the condition of the swimming pool had deteriorated to the point that the mortgagor elected to fill it in. Mortgagee claimed that this act reduced the value of the property by over $7000 and commenced a private foreclosure for waste.
Mortgagor responded with a suit to enjoin the foreclosure. The trial court found that the impact of filling in the swimming pool had reduced the value of the property by $2500, and that this constituted waste, but then exercised its equitable powers to order the foreclosure conditionally stayed to permit the mortgagor to rectify the situation by paying $2500 to the mortgagee as a prepayment on the mortgage note.
The mortgagor appealed, claiming that there was no waste because the trial court erred in finding that the value of the property had been reduced and arguing that, in any event there was no waste because a simple reduction in value is not enough to constitute waste.
On appeal: held: Reversed. Although the Court of Appeals found an adequate basis for the trial court's conclusion that there had been a $2500 reduction in value, it found that reduction in value was not in and of itself enough to establish waste. It embraced the test set forth in the caption and remanded for a determination of whether this test had been met. Even if the test had been met, the court also approved the trial courts "conditional stay" concept as an equitable way to address the issue.
In reaching its conclusion as to the proper standard for measuring waste in the mortgage context, the appeals court carefully evaluated the new work of Dale Whitman and Grant Nelson in and their advisors and the ALI in the new Restatement of Land Security. Section 4.6 of the Restatement is an inventive approach to the problem that separates the question of when waste occurs from the problem of what remedy is appropriate.
Section 4.6 (a) of the Restatement basically says that waste occurs when a mortgagor, without the mortgagee's consent, reduces the value of the security by an affirmative act (negligent or intentional), or by failing to maintain and repair the security in a reasonable fashion, or by violating specific maintenance covenants in the mortgage or by diverting rents.
But the fact that waste occurs does not give the mortgagee an automatic remedy under the Restatement. Section 4.6(b) of the Restatement provides that there can be no remedy unless the security of the mortgage has been impaired (or in the case of injunctive relief, likely will be impaired).
Under 4.6 (c ) of the Restatement, security is impaired in an ongoing mortgagor/mortgagee relationship only if the waste causes the loan to value ratio to exceed its "scheduled" level. This, of course, normally requires a comparison of the original loan to value ratio to the ratio what would exist at the time of waste if the mortgage had been regularly serviced. Assuming that the mortgagor has not otherwise defaulted, then, the test is simply whether the waste has brought the loan to value ratio to a figure higher than that existing at the time of the loan.
The Mississippi case apparently rejected the Restatement test as being two complex, since the Restatement test requires computation of the value of the security at two separate times. But it described the test, in rejecting it, as "helpful."
Comment 1: Isn't the Restatement right on target? It broadens the definition of waste somewhat to include permissive waste (failure to maintain reasonably), but it limits remedies to those situations in which the alleged waste has altered the reasonable security coverage expectations of the lender. If the property has risen in value substantially, or the loan has been paid down substantially, a reduction in the property's value may in fact still leave an adequate "cushion" for the mortgagee. The notes following Section 4.6 discuss many other aspects of how the test works.
Comment 2: Some mortgagees may argue that they fully expect that the ratio of loan to value will actually be reduced over time, and that they have factored this into their original interest rate computations. One response to this argument is that the mortgagees ought to be able to stipulate certain loan to value ratio expectations as to future times and require mortgagor action if those expectations are not met. Absent such specific language, they are left with the Restatement test. This is nothing more or less than the equivalent of performance standards for business loans.
The Restatement notes, at least on cursory review, do not discuss whether the mortgagee, by contract, can negotiate for a stiffer test than the original loan to value ratio that would result from payment according to schedule (except, of course, in the case of construction loans). One would assume that any agreement setting minimum expectations for ratios would be acceptable, at least in commercial loans, but the Restatement is somewhat borrower oriented in certain other areas, so the editor cautions that such expectation may not be warranted. Perhaps Dale Whitman, a regular DIRTer, can elaborate.
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