Real Property: Mortgages: Foreclosure: Effect of Foreclosure on various interests

Effect of foreclosure on various interests:

• Foreclosure will terminate interests junior to the mortgage being foreclosed but will not affect senior interests. (This means that junior lienholders will be paid in descending order with proceeds from the sale, assuming funds are leftover after full satisfaction of superior claims. Junior lienholders should be able to proceed for a deficiency judgment. But once foreclosure of a superior claim has occurred, with the proceeds distributed appropriately, junior lienholders can no longer look the Blackacre for satisfaction.)

• Those with interest subordinate to those of the foreclosing party are necessary parties to the foreclosure actions.
• The debtor-mortgagor is also considered a necessary party and must be joined, particularly if creditor wishes to proceed against debtor for a personal deficiency judgment.
• Failure to include a necessary party results in the preservation of that party’s claim, despite the foreclosure and sale. Thus, if a necessary party is not joined, his mortgage will remain on the land.

• Foreclosure does not affect any interest senior to the mortgage being foreclosed. The buyer at the sale takes subject to such interest. This means that the buyer is NOT personally liable on senior debt, but as a practical matter, if the senior mortgage is not paid, sooner or later, the senior creditor will foreclose on the land.

• EX: Assume the same set of facts as in the previous hypo: Blackacre has an FMV of $50,000 and is subject to 3 mortgages executed by its owner, Madge. First Bank, with first priority is owed $30,000. Second Bank, with second priority is owed $15,000, and Third Bank, with third priority, is owed $10,000. Now, however, suppose that it is Second Bank’s mortgage that is being foreclosed. (First Bank’s mortgage exists, but it is either not in default or its holder has not yet taken action to foreclose it.) Foreclosure does not affect any interest senior to the mortgage being foreclosed.

(1) Thus foreclosure of Second Bank’s mortgage will not affect First Bank’s mortgage.

(2) First Bank’s mortgage will continue on Blackacre in the hands of the foreclosure sale buyer.

The foreclosure sale buyer is not personally liable to First Bank, but if the senior debt is not paid, First Bank CAN foreclose on Blackacre.

The foreclosure sale buyer has a strong incentive to pay off First Bank’s lien to avoid another foreclosure action.

Bidding at the foreclosure sale brought by Second Bank: Buyer should bid up to $20,000, which represents Blackacre’s FMV of $50,000 minus $30,000 needed to pay off First Bank’s mortgage.

Distribution of proceeds from the sale: $15,000 will go to Second Bank. $5,000 goes to Third Bank. Third Bank should try for a deficiency judgment against debtor.