Strict Foreclosure: Forfeiture
• Historical foreclosure method
• Mortgagee held fee simple title subject to condition subsequent
• Once mortgagor defaulted, mortgagor forfeited its future interest
(i.e., the right to re-enter and terminate Mortgagee’s estate)
– Problem: The Chancellor (Equity) sometimes allowed the mortgagor to
have a “reasonable time” after Law Day to repay the loan, “redeem” the
land, and recover title
• This created uncertainty for mortgagees: “When can I be sure,
after mortgagor default, that I have clear title to the land?”
• Problem with strict foreclosure: mortgagee is unjustly
enriched if FMV of mortgaged land >>> balance of debt
(this results in forfeiture of mortgagor’s “equity” in land)
• As a result, modern American law in nearly all states
requires foreclosure to occur by sale (public auction)
– Lender can apply proceeds to: 1) costs of sale, 2) satisfaction
of debt owed to foreclosing lender, and 3) satisfaction of any
junior liens extinguished by the foreclosure sale
– Any surplus belongs to (and must be returned to) mortgagor
Strict Foreclosure in Equity
• After “Law Day,” ME could petition the
Chancellor to set a new “drop-dead” date, in
Equity, for MR to repay
• If MR failed to pay by that new date, MR’s
right of redemption was “foreclosed” forever
(i.e., MR’s title was forfeited)
– It was irrelevant whether value of mortgaged
land >> balance of the mortgage debt
Henry VIII
(Hans Holbein)
Strict Foreclosure
• Strict foreclosure still exists and is still used in VT, CT (is in
fact the primary method of foreclosure in CT)
• However, if mortgagor introduces evidence that land’s FMV
>>> balance of debt, court must determine the property’s
FMV [p. 694]
– If court concludes land is worth >>> debt (i.e., sale would likely
produce surplus), court must order sale of the mortgaged land
Judicial Foreclosure
Modern Foreclosure Choices
• Judicial foreclosure (permitted in all states)
– Required (only method) in: AR, CT, DE, FL, IL, IN, IA, KS, KY,
LA, NY, NJ, ND, OH, PA, SC, VT (homes), WI
• “Power of sale” foreclosure (permitted in 30 states)
– Only if state statute allows, and only if mortgage/deed of trust
contains a “power of sale”
– Mortgage: sale conducted by mortgagee
– Deed of trust: sale conducted by named trustee, on behalf of
lender/beneficiary
• Judicial foreclosure sale is typically a sheriff’s sale
– Public auction, minimal advertising (typically legal notice published
in local newspaper classified ads)
– Typical terms: Cash sale, “as is” (though the foreclosing creditor
may “credit bid” against the judgment amount)
– Land goes to high bidder, after the court “confirms” the sale
• Until sale occurs, MR can redeem its title by paying off the
full balance of debt
– If applicable, MR can prevent the sale by curing default and
reinstating the mortgage (if state law or loan documents permit)
• After default, mortgagee brings a judicial action to
foreclose mortgage debt. Issues:
– Is the debt valid?
– Is Mortgagor in default?
– What is the unpaid balance due?
– Does mortgagee have the right to foreclose (e.g., is the
mortgagee the person entitled to enforce the debt, and has
the debt been properly accelerated)?
• After court enters judgment (often a default), court
orders execution sale (sheriff’s sale)
Effect of a Foreclosure Sale
• At a foreclosure sale, the buyer gets title as it existed on the
day that the foreclosing creditor acquired its lien. The sale:
– Extinguishes the lien of the foreclosing creditor
– Extinguishes any subordinate (junior) liens or interests
– Transfers the mortgagor’s interest to the high bidder, free of the
extinguished liens
– The extinguished liens against the land are transferred to the
proceeds of the sale (in the same order of priority)
• Mortgagor owns land subject to
– First priority mortgage held by Bank One (debt = $100,000)
– Second priority mortgage held by Bank Two (debt = $50,000)
– Third priority judgment lien held by Creditor (judgment amount
= $50,000)
• Mortgagor defaults to Bank One, which forecloses (at
sale, land is sold to Buyer for $175,000)
– Buyer gets title free and clear of all three liens, which attach to
sale proceeds in same order of priority
• BankTwo can foreclose its junior mortgage lien, but its
foreclosure sale will NOT affect the lien of the senior
lienholder (BankOne)
– Buyer at sale will get title free and clear of BankTwo’s lien, but
subject to BankOne’s senior lien
• Thus, while BankTwo can join BankOne as a party to its
judicial foreclosure action, it does not have to do so
– BankOne is a proper party but not a necessary one
– Even if BankTwo does join BankOne as a party, BankTwo can’t
force BankOne to foreclose its senior lien
Judicial Foreclosure: Problem 2
• Wells owns Blueacre, subject to:
– A first mortgage held by BankOne (debt = $150,000)
– Second mortgage held by BankTwo (debt = $100,000)
– A lease in favor of Crouch
• Wells defaults to BankTwo
• Q: Can BankTwo foreclose as a junior lienor?
• Q: If BankTwo brings a judicial foreclosure, does it have to join
BankOne as a party to that action? Does it have to join Crouch?
• Does Bank Two have to join Crouch
(the tenant) as a party to the
foreclosure?
– Key Questions: Is Crouch’s lease junior
to the Bank Two mortgage or senior to it?
Does Crouch have a “nondisturbance”
agreement with Bank Two?
• If Bank Two’s mortgage is senior and
it wants to terminate Crouch’s lease,
he must be joined as a party
“Necessary” Parties: Problem 2
• In a judicial foreclosure, BankTwo MUST join as a party (1) the
mortgagor and (2) any other person that holds an interest that
can and should be extinguished by the sale. This includes:
– Wells (mortgagor)
– Any persons holding liens junior to BankTwo
– Any persons holding subordinate interests in the land (e.g., tenants like
Crouch) that can and should be extinguished by the sale
• Thus, BankTwo must conduct a title search prior to foreclosure,
to identify all such “necessary” parties
• Wells owns Blueacre
– First mortgage: BankOne ($150K)
– Second mortgage: BankTwo ($100K)
• BankTwo brings a judicial
foreclosure after default by Wells
• At the sale, Trump buys the land for
a high bid of $200K
• How should the sale proceeds be
distributed?
Problem
2(b)
“Proper” Parties
• In Problem #2, Bank One is not a “necessary” party
– Bank One has priority over Bank Two; Bank Two’s foreclosure
sale will have no effect on Bank One’s lien (buyer at sale will
take subject to Bank One’s senior mortgage lien)
• Bank One is a “proper” party, however
– Bank Two can join Bank One as a party for the purpose of
establishing the amount due on Bank One’s mortgage (bidder
at sale needs to know this information)
• B/c Trump takes title subject to BankOne’s senior mortgage
lien, that lien is still valid against the land
• Thus, Bank One’s lien does not attach to the sale proceeds
• Distribution of proceeds:
– First: costs of sale
– Second: BankTwo gets the next $100K of sale proceeds (in
satisfaction of its debt)
– Third: Any subordinate lienholder(s), in order of their priority
– Fourth: Wells (mortgagor)
• Suppose Trump didn’t know of BankOne’s mortgage,
and “overpaid” b/c he thought he’d receive clear title
• Would he have a claim against BankTwo for
nondisclosure of the senior mortgage?
– No; buyer at judicial foreclosure sale takes “as is,” w/out
warranty or representation as to quality of title being conveyed
– BankOne’s mortgage was recorded, so Trump had
constructive notice of it
– BankTwo has no duty to disclose any senior lien (bidders are
expected to investigate title, like any other potential buyer)
• Bank2 makes three arguments:
– 1) Our lien was not extinguished by
Bank1’s foreclosure sale
– 2) Because we weren’t joined as a
party, the sale to Trump was entirely
invalid/void
– 3) We can now pay off the $150K that
Wells owed to Bank1, at which point we
will have fee simple title to the land
• Which arguments (if any) are correct?
The Omitted Party: Problem 3
• Wells owns land, subject to:
– First mortgage held by Bank1 ($150K)
– 2nd mortgage held by Bank2 ($100K)
• Wells defaults to Bank1, which forecloses judicially
– Wells is named as a party, but Bank2 is not (Bank1 missed
Bank2’s lien in its title search)
– After judgment, Trump buys the land at the sheriff’s sale for
high bid = $150,000
• Bank2’s first argument is
correct!
– B/c Bank2 was not joined as a
party to the judicial foreclosure
action, Bank2 isn’t bound by the
result (no due process of law)
– Thus, the foreclosure sale did
not extinguish Bank2’s lien
(which remains valid against the
property)
• Argument 2 is incorrect!
– Wells (the mortgagor) was properly
joined, so the foreclosure sale is
valid against her (res judicata, Wells
can’t relitigate)
– Wells’s title thus passed to Trump
(buyer)
– Unfortunately for Trump, he took that
title subject to Bank2’s not-yetextinguished mortgage lien!
• Trump got Wells’s title (manifested by the “buyer’s hat”), but
he took it subject to Bank2’s mortgage (which was not
extinguished by the sale, as Bank2 wasn’t a party)
• Trump also got Bank1’s rights as senior mortgage lender, by
way of subrogation (manifested by the “lender’s hat”)
– The sale extinguished Bank1’s mortgage vs. Wells (who was
joined), but not vs. Bank2 (which was not joined as a party)
– As against Bank2, the Bank1 mortgage lien still exists and still has
priority vs. Bank2 (whose mortgage lien was junior)
– The defective sale is treated as an assignment by Bank1 of its
senior lien position to the buyer, Trump, by way of subrogation
The Omitted Party Problem:
Trump (Buyer) Now Wears “Two Hats”
Problem 3: Trump’s Options Now?
• Trump can redeem his title from Bank2’s
lien by paying it off in full ($100K)
– Trump would then have clear title
• Trump could instead choose to
“reforeclose” the senior mortgage (this
time, joining Bank2 as a party)
• Which option should Trump take? Why?
Problem 3: Options for BankTwo?
• Trump’s decision depends on the FMV of the land
• If FMV is => $250,000, Trump will likely just “redeem”
(wearing his “buyer” hat) by paying $100,000 to Bank2 to
satisfy its lien
– This will extinguish Bank2’s lien and clear Trump’s title
• If FMV is < $250,000, Trump will re-foreclose the first
mortgage (wearing his “lender” hat)
– This will put the burden on Bank2 to bid at the sale if Bank2
wants to protect its lien
• Note: Trump and Bank2 both have rights of
“redemption,” but their respective rights of redemption
aren’t the same
• Trump has right to redeem the fee title to the land, b/c he
purchased it at the first (defective) foreclosure sale
• By contrast, Bank2 only has the right to redeem its lien
(its interest as the junior lienholder)
• If Trump redeems his interest (by paying off Bank2’s
lien), then Bank2’s lien is extinguished!
• BankTwo can foreclose its junior lien
– Buyer at sale would get Trump’s title, but subject to Trump’s
rights as first mortgagee (Trump’s “lender hat”)
– Buyer would then have to pay off Trump’s senior mortgage lien
($150K) to gain clear title
• Bank2 could “redeem” its junior lien by paying Trump the
balance due on first mortgage ($150K)
– Trump would then hold fee title, but subject to both the $150K
senior lien and the $100K junior lien (both of which would then
held by Bank2)
– To redeem his title, Trump would have to pay off both liens
• Therefore, in Problem 3, Bank2’s third argument is
incorrect
– Bank2’s lien was not extinguished by the sale, so Bank2
can still act to redeem its lien
– But, Bank2 would be redeeming its subordinate lien, not
the mortgagor’s title
– The mortgagor’s title (Wells’s title) actually passed to
Trump (buyer) at the foreclosure sale, so only Trump can
redeem full title
Strict Foreclosure/Omitted Juniors
• Some states allow “strict foreclosure” to clean up the mess
caused by omission of the junior lienor (e.g., Pessin, p. 709)
– Court would order Bank2’s junior lien to be extinguished, unless
Bank2 paid off the senior mortgage within the time period set by
the court
– If Bank2 redeemed its lien within that period, Bank2 wouldn’t get
fee title; Bank2 would only get Trump’s right as first mortgagee
(by subrogation)
– Thus, Trump could still redeem fee title by paying off both liens
Judicial Foreclosure: Confirmation
• After the sale takes place, the court then must “confirm”
the sale
– Confirmation of the sale reflects a judicial conclusion that the
sale was properly conducted (was procedurally correct)
– Following confirmation, sheriff would deliver deed to the
property to the buyer