Foreclosures are occurring at an astounding rate. Many lawyers, not just those who practice in the area of foreclosure, will be fielding a wide variety of real property questions from their clients.
With foreclosures on real property occurring in record-breaking numbers, lawyers practicing in all areas should be familiar with the foreclosure process. A client may call with questions about purchasing real property at or after a foreclosure sale. Clients who have granted a lender a mortgage interest to secure debt may have questions. Clients who face foreclosure on their homes will want to know their options, how the foreclosure process works, and how long it takes. Many lawyers, not just those who practice in the area of foreclosure, will be fielding these client calls. Even real estate lawyers who have familiarity with foreclosure law may not, for example, recall the specifics of redemption or the details of recent legislative changes.1 This article will provide practitioners with a general overview of the foreclosure process under current law.
There are two ways to foreclose on real property in Minnesota: by action and by advertisement. Foreclosure by action is governed by Minnesota Statutes Chapters 581 and 582 (general provisions), as well as parts of Chapter 550. Foreclosures by advertisement are governed by Chapters 580 and 582. Each method has its advantages and disadvantages. Foreclosure by action typically takes longer and costs more than a foreclosure by advertisement. Assuming a six-month redemption period (more on redemption below), an uncontested foreclosure by action takes around 10 months from start to finish, where a foreclosure by advertisement with the same redemption period takes only eight months.2 Foreclosure by action, however, allows the foreclosing party to preserve a deficiency judgment against the debtor and provides an opportunity to resolve any title issues. On the other hand, foreclosure by advertisement is usually quicker and less expensive, but in most cases the foreclosing creditor will not be able to preserve a deficiency judgment against the debtor. A more detailed look at the two methods of foreclosure follows.
Foreclosure by Action
To foreclose by action, the foreclosing creditor commences litigation in the county in which the real property is located. The foreclosing creditor usually names as defendants the debtor, the owners of the property, any guarantors, and any other party with an interest in the property, including both junior and senior lienholders. The most common way to identify other parties who might have an interest in the property is to order title work, which can consist of either a title commitment or an owners-and-encumbrances report (aka an “O&E”). It can take between one to seven days to obtain adequate title work, depending on the kind of title work ordered and the number of interests appearing of record against the property. Immediately after filing the summons and complaint, the foreclosing party records a notice of lis pendens with the county recorder (if the property is abstract) or the registrar of titles (if the property is registered, i.e., Torrens). Recording a notice of lis pendens puts the world on notice that the foreclosing creditor has commenced an action affecting the real property described in the notice. Once recorded, the lis pendens “cuts off” the number of parties the foreclosing creditor must add to the litigation because, generally, any interest recorded against the property after the lis pendens was recorded will be extinguished by the foreclosure, even if the party holding that interest is not named in the lawsuit.
Once the summons and complaint have been filed and the lis pendens has been recorded, the foreclosure by action proceeds much like any other lawsuit in terms of motion deadlines, discovery, and trial. But many foreclosures by action are not contested, or if they are, summary judgment is appropriate because often there is no genuine issue of material fact. The typical foreclosure case involves a simple and undisputed fact pattern: lender loans money to borrower, borrower grants the lender a mortgage interest to secure the loan, borrower defaults by failing to make payments, and the borrower’s default entitles the lender to accelerate the loan (i.e., demand payment in full immediately) and foreclose. As a result, borrowers sometimes do not answer the complaint.
If successful in the litigation (whether by default judgment, summary judgment, or, in rare cases, after a trial), the court will issue an order for decree of foreclosure. A typical order for decree of foreclosure determines the amount of the debt, establishes the priority of liens against the property, instructs the sheriff of the county where the property is located to sell the property at a public auction, and identifies the distribution of proceeds generated by the sale. The foreclosing party will deliver a copy of the order to the sheriff and choose a time and date for the sale.
Once the sale time and date have been set, the foreclosing creditor will prepare a notice of the sale. The information required to be in the notice of sale in a foreclosure by action is specified in Minn. Stat. § 550.18. The notice will contain such information as the identity of the creditor and the debtor, a description of the property, a reference to the order for decree of foreclosure and any judgment entered, and the location, date, and time of the sale. The notice will then be served on the defendants and any occupants of the property. Other papers may also be served, such as advice for homeowners or tenants in foreclosure, though these are required only in a foreclosure by advertisement. Before the sale, the notice must also be posted and published for six consecutive weeks in the county where the property is located. Notices are posted in three public places (e.g., the sheriff’s office, the post office, and city hall) and published in official legal newspapers.
After the notice has been served, posted, and published, the sheriff will sell the property at a public auction. The auction is held at the sheriff’s office, usually at 10:00 a.m. Anyone can attend and bid at the sale. The foreclosing creditor can “credit bid,” that is, bid up to the amount of the secured debt without paying cash to the sheriff. All other bidders must pay by cash or certified funds. In the vast majority of cases, the highest bidder at the sale is the foreclosing creditor.
Once bidding is complete, the party with the highest bid receives a sheriff’s report of sale. The report includes the time and date of the sale, a description of the property, the name of the highest bidder, the amount of the bid, and borrower’s length of time to redeem. The highest bidder must then ask the court to confirm the sale. Confirmation hearings are almost never contested. If all goes well for the foreclosing creditor, the court will enter an order confirming the sale. The foreclosing creditor will take the confirmation order to the sheriff, who will then issue a sheriff’s certificate of sale in accordance with the order confirming the sale. The certificate of sale contains much of the same information as the report of sale. The certificate of sale, which the highest bidder must record, is effectively a deed to the property (subject to redemption rights, which are discussed below). If no one redeems the property, title to the property vests in the holder of the certificate of sale. Title will be free and clear of the defendants’ interests in the property. Note, however, that foreclosure will not affect liens that are senior to the lien held by the foreclosing creditor.
Foreclosure by Advertisement
The foreclosing creditor does not have to start a lawsuit to foreclose by advertisement. In fact, in a foreclosure by advertisement, there should be no court involvement at all. Rather, the first thing the foreclosing creditor will do is record a notice of pendency and power of attorney to foreclose. The notice of pendency is the equivalent of the notice of lis pendens in a foreclosure by action. The power of attorney authorizes the foreclosing creditor’s attorney to foreclose on behalf of the creditor.
With the notice of pendency and power of attorney recorded, the foreclosing party can begin publication of the notice of foreclosure sale. The information that must be in a notice of sale in a foreclosure by advertisement is set forth in Minn. Stat. § 580.04 and the newly enacted § 580.025 (regarding foreclosure data). In a foreclosure by advertisement, the notice may contain more specific information than the notice in a foreclosure by action, but the basic information is generally the same. In a foreclosure by advertisement, the notice must be published for six consecutive weeks in a legal newspaper in the county in which the real property is located. The foreclosing creditor must also serve the notice of foreclosure sale on the occupants of the property, who may not be the owners. Indeed, the foreclosing creditor is not required to serve the owner of the property, though the owner is typically an occupant. In practice, however, most lenders serve the owner of the property regardless of whether the owner is an occupant. Similarly, the foreclosing party need not serve the notice of foreclosure on junior lienholders, unless the junior lienholder has recorded a request for notice of foreclosure. But again, most foreclosing creditors serve junior lienholders regardless of whether a legal obligation to do so exists. They do so for at least two reasons. First, serving the owner and junior lienholders encourages redemption (which foreclosing creditors usually want to occur). After all, it is difficult for a party to redeem if the party does not know about the sale. Second, serving junior lienholders ensures that their interests will be extinguished in case the title work failed to reveal a request for notice filed by a junior lienholder.
After service and publication of the notice of foreclosure sale, the sheriff will sell the property at public auction. The auction in a foreclosure by advertisement is identical to the auction in a foreclosure by action, except that the highest bidder receives a sheriff’s certificate of sale, instead of a report of sale. Accordingly, the highest bidder at the sale of a foreclosure by advertisement does not need a court to confirm the sale. The highest bidder will record the certificate of sale and wait to see if anyone redeems within the next six months, usually. If no one redeems, title to the property vests in the holder of the certificate of sale.
So Why Would Anyone Foreclose by Action?
Foreclosing creditors may choose to foreclose by action for several reasons. First, if there are title issues with the property, the foreclosing creditor will often choose foreclosure by action so that a court can resolve the title issues. Second, if the foreclosing creditor has other claims against the borrower or third parties, foreclosing by action provides an opportunity for the foreclosing creditor to resolve these claims in one action. Third, if the foreclosure appears complicated, the foreclosing creditor may choose foreclosure by action because, unlike foreclosure by advertisement, the amount of attorneys’ fees that the foreclosing creditor can collect is not capped (although the fees must be reasonable). But the most common reason to foreclose by action is to preserve the foreclosing creditor’s right to pursue the borrower for any deficiency.
Obtaining a deficiency judgment means that the creditor may pursue the borrower if the amount generated by the foreclosure sale is not enough to pay the secured debt in full. For example, assume that the borrower owes the foreclosing creditor $500,000 at the time of the foreclosure sale. And assume that the highest bidder at the foreclosure sale bid $400,000. Although the money generated by the foreclosure sale would go to the foreclosing creditor, the creditor is still owed $100,000. In a foreclosure by action, the foreclosing creditor may pursue the borrower for the $100,000 deficiency. In a foreclosure by advertisement, the foreclosing creditor would not be able to pursue the borrower for the deficiency (unless the redemption period was 12 months, which is rare). Of course, in the “real world,” the highest bidder in this example almost certainly would have been the foreclosing creditor, who would have credit bid. So there would not have been any cash to the foreclosing creditor. But even if the foreclosing creditor credit bid $400,000, and thus satisfied the debt to that extent, the deficiency would still be $100,000.
Two things should be noted about deficiencies. First, the deficiency is determined at the foreclosure sale, not at a subsequent sale. For example, assume the same facts as the previous scenario. If no one redeems the property, and the foreclosing creditor sells the property for $300,000, the deficiency is not $200,000 (the difference between the debt amount and the eventual sale of the property by the foreclosing creditor). The deficiency is still $100,000 because that was the shortfall at the foreclosure sale. Second, regardless of whether the foreclosing creditor forecloses by action or advertisement and regardless of the length of the redemption period, the foreclosing creditor does not, under current caselaw, lose a deficiency against any guarantors. This assumes, of course, that the foreclosing creditor did not bid the full amount of the debt at the foreclosure sale. The next section on bidding at the foreclosure sale will further discuss choosing between foreclosure by action and foreclosure by advertisement.
Bidding at the Sale
Before reviewing some bidding strategies, keep two things in mind. First, the debt owed to the foreclosing creditor is satisfied by the amount bid at the foreclosure sale. So if the debt owed to the foreclosing creditor is $500,000 as of the date of the foreclosure sale, and the foreclosing creditor bids $500,000 at the sale, the debt has been satisfied in full, at least as of that date. Second, the amount bid at the foreclosure sale is the amount that the borrower must pay to redeem the property (plus interest and some fees and costs). If the foreclosing creditor bids $1,000 at the foreclosure sale, the borrower must pay only $1,000 plus interest and some fees and costs to “buy back” the property, free and clear of the foreclosing creditor’s lien.
Example One: The debt owed to the foreclosing creditor is $500,000 and is secured by property worth $300,000. The borrower has no other significant assets and no ability to repay the debt. There are no guarantors (that is, parties other than the debtor who have promised to repay the loan). In short, the foreclosing creditor has no viable source of recovery other than the property. In this case, the foreclosing creditor has no reason to preserve a deficiency because there is no way to recover it. So the foreclosing creditor would likely foreclose by advertisement and bid the full amount of the debt.
Example Two: Assume the same facts as Example One, except that the borrower has a net worth of $1 million and owns other significant nonexempt property. Here, the foreclosing creditor would probably foreclose by action to preserve a deficiency against the borrower, bidding $300,000 at the foreclosure sale and pursuing the borrower for the deficiency of $200,000.
Example Three: The debt owed to the foreclosing creditor is $500,000 and is secured by property worth $300,000. The borrower has no other assets and no ability to pay the debt. But there is a guarantor with a net worth of $2 million. The foreclosing creditor could foreclose by advertisement because there is no need to preserve a deficiency against the borrower. And under current case law, foreclosure by advertisement does not result in a waiver of a deficiency against a guarantor. The foreclosing creditor would probably bid $300,000 at the foreclosure sale and pursue the guarantor for the deficiency of $200,000. On the other hand, the foreclosing creditor may want to get a judgment against the guarantor anyway, so the foreclosing creditor could foreclose by action and obtain a decree of foreclosure along with a judgment against the guarantor.
The foreclosing creditor’s successful high bid at the foreclosure sale does not end the foreclosure process. The borrower and creditors with a lien junior to the lien of the foreclosing creditor may redeem. For the borrower, redeeming means buying the property back from the holder of the sheriff’s certificate by paying the amount bid at the foreclosure sale plus interest and certain costs. For junior lienholders, redeeming means buying the property from the holder of the sheriff’s certificate by paying the amount bid plus the amounts paid by all other lienholders who have previously redeemed. (Examples follow.) If the borrower redeems, the foreclosing creditor’s lien against the property is released, but all junior liens remain on the property.
Redemption periods, i.e., the time in which the borrower must redeem or lose the property, can be 12 months, six months, two months, or five weeks. The most common redemption period is six months. A 12-month redemption period applies most commonly when the property foreclosed on is agricultural property or if the debt secured by the mortgage has been paid down by more than one-third. The borrower has two months to redeem when the foreclosing creditor forecloses under a voluntary foreclosure agreement. And five-week redemption periods apply to certain abandoned residential property. To reduce the redemption period to five weeks, the foreclosing creditor must obtain a court order. But the process for doing so has been made easier by the changes to Minn. Stat. § 582.032, effective August 1, 2008.
If the borrower does not redeem, any junior lienholder who has timely recorded a notice of intent to redeem may redeem the property. Each such junior lienholder has seven days to redeem in the order of the priority of the liens. For example, assume that there are four liens against the borrower’s property and the first lienholder forecloses. Also assume that the borrower’s redemption period expires on January 2 and that all three junior lienholders have timely recorded notices of intent to redeem. If the borrower does not redeem, then the next party in line to redeem is the second lienholder, who will have seven days to redeem (from January 3 through January 9), then the third lienholder will have seven days to redeem (from January 10 through January 16), and finally the fourth lienholder will have seven days to redeem (from January 17 through January 23). If none of the junior lienholders redeem, title vests in the foreclosing creditor. Note that this process is slightly different if mechanics liens are involved. Holders of mechanics liens, as a group, have one seven-day period in which to redeem; they do not each get their own seven-day period.
As stated earlier, the borrower can redeem by paying the amount bid at the sale plus interest and certain fees and costs. If the borrower does not redeem, then the first junior lienholder with a chance to redeem has to pay the same. If the first junior lienholder redeems, then any subsequent lienholder who wants to redeem must pay the amount bid at the sale, plus the amount owed to any prior redeeming junior lienholders. Here is an example. Assume the property has the following liens against it:
First Lien $500,000
Second Lien $300,000
Third Lien $200,000
Assume that the first lienholder foreclosed and bid $500,000 and that the borrower did not redeem. The second lienholder could redeem by paying $500,000 (setting aside interest, fees, and costs for purposes of this example). If the second lienholder redeemed, the third lienholder would have to pay the amount bid ($500,000) plus the amount owed on the second lien ($300,000). And if there were a fourth lienholder, the redemption price would be the bid price, plus the amount owed on the second and third liens. Note that redeeming junior lienholders have to pay only the prior liens that actually redeemed. So in this example, if the borrower did not redeem, nor did the second lienholder, then the third lienholder could redeem by paying the amount bid ($500,000).
Voluntary Foreclosure Agreements
The foreclosure process can be shortened through a voluntary foreclosure. To do so, the foreclosing creditor and the borrower must enter into a voluntary foreclosure agreement. Procedurally, a voluntary foreclosure is similar to a foreclosure by advertisement. But there are advantages to the lender: the notice of foreclosure sale needs to be published for only four weeks instead of six, and the borrower’s redemption period is only two months. An advantage to the borrower is that, in a voluntary foreclosure, the foreclosing creditor must agree to waive its right to a deficiency against the borrower. A disadvantage to the borrower is that the borrower has less time to redeem.
Regardless of your area of expertise, a basic understanding of real property foreclosures will enhance your practice. You will be able weigh options for clients who might be facing foreclosure and to explain the foreclosure process to them. You may also find that understanding foreclosures affects your drafting of documents, whether representing a lender, borrower, buyer, seller, or parties to a settlement agreement.
1 For an index to the recent changes to foreclosure law, see https://www. revisor.leg.state.mn.us/laws/?topic=103041.
2 These timelines assume that the foreclosure is not subject to the Farmer-Lender Mediation Act, which requires that the lender and farmer/borrower mediate before the lender forecloses.
‘Bailing Out’ the Homeowner:
Defending a Residential Mortgage Foreclosure
by Gregory D. Luce
Turmoil on Wall Street has focused on the financial companies that purchased, insured, and sold various mortgage-backed securities. On the other end of the turmoil are legions of homeowners facing foreclosure as a result of high-risk subprime mortgage loans, many of which were sold to borrowers without verification of income and without them being able to afford the resulting monthly payments.
Amber Hawkins, an attorney with the Legal Aid Society of Minneapolis, regularly represents homeowners facing foreclosure. Legal Aid began a mortgage foreclosure defense project recently through funding from the Institute for Foreclosure Legal Assistance, a joint project of the National Association of Consumer Advocates and the Center for Responsible Lending, based in Washington D.C.
In representing homeowners, Hawkins says a successful foreclosure defense may mean rescission of the mortgage loan and a substantially reduced obligation to the lender. In others, there may be no viable claims or defenses and, unless the lender voluntarily agrees to renegotiate the loan, the final option for the homeowner is to continue to live in the property, payment free, until the foreclosure process concludes.
For homeowners in foreclosure, Hawkins first determines if there are possible claims under the Truth in Lending Act (TILA). Congress enacted TILA in 1968 with the broad purpose of assuring “a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him and avoid the uninformed use of credit.” Claims under TILA generally result when loan terms were inaccurately disclosed to the borrower at the time of closing.
Rescission claims under TILA can be the most powerful claims in a foreclosure case. Successful rescission of a mortgage loan, for example, could mean stripping away the lender’s security and erasing any finance charges associated with the loan, including interest, leaving the borrower with only the obligation to repay the principal amount borrowed, minus lender fees and closing costs. Even then, the borrower is credited with prior payments on the loan on a dollar for dollar basis, without inclusion of interest.
“It’s a really powerful claim to have,” Hawkins says. “If you have a rescission claim, it’s very likely you can help that borrower. Put it this way, I’ve never turned one down.”
There are, however, limitations to TILA rescission claims, most significantly that such claims apply only to refinanced loans, not purchase money loans. TILA rescission claims also have a three-year statute of limitations, which runs from the date of closing of the loan. Finally, Hawkins says that Minnesota legal authority is unclear on whether a rescission claim can be made after a sheriff’s sale. Accordingly, clients who come to her after a sheriff’s sale may have more limited options under TILA.
Fraud is one option Hawkins looks for in a foreclosure case, particularly where a borrower was misled into signing up for a loan that was unaffordable from the start. In a recent case, Hawkins indicated her client had a net monthly income of $1,800 yet closed on a loan that required a monthly payment of $1,900. The mortgage broker in the case had promised better loan terms but, at closing, presented terms that the borrower could not afford. The broker then promised that a loan with better terms “is coming” and that the borrower should close on the current loan and refinance with a more favorable loan in a few months. After the “promised” loan did not materialize, the client defaulted and now faces foreclosure.
Hawkins stated that in cases such as this, she would likely assert a claim for fraud in the inducement for the loan, as well as claims under the Minnesota Prevention of Consumer Fraud Act.
Finally, whether or not the case presents viable TILA or fraud claims, Hawkins always reviews the recorded legal documents to determine if they accurately reflect the status and ownership of the loan. If the lender has not strictly followed the Minnesota statutory foreclosure procedures, Hawkins says she pursues legal action to derail the foreclosure. In such cases, the lender must start the foreclosure process over, ultimately buying the homeowner more time or leverage to negotiate a solution. Even for a small technical defect, Hawkins seeks relief for her clients.
“Foreclosure by advertisement is a privilege, not a right,” she says, referring to the non-judicial and expedient process that allows a lender to foreclose after publishing a notice of sale for six consecutive weeks. “If lenders want to take advantage of it, they need to follow the law to the letter.”
Most of the referrals to Hawkins and Legal Aid come from agencies that participate in a state-wide network of foreclosure prevention counselors. Legal Aid, the Volunteer Lawyers Network, and the Housing Preservation Project have also formed a foreclosure defense task force that meets monthly to discuss foreclosure cases and to attract other attorneys who can provide paid or pro bono representation of homeowners in foreclosure.
*Data for 2008 is projected
Minnesota Foreclosure Data from Foreclosures in Minnesota: A Report Based on County Sheriff’s Sale Data, dated April 29, 2008, prepared by HousingLink, a nonprofit distributor of affordable housing information. The report includes Minnesota foreclosure statistics and key observations regarding foreclosure data. See http://www.housinglink.org/
CHRISTOPHER CAMARDELLO is a shareholder with the law firm of Winthrop & Weinstine, PA, in Minneapolis. He represents secured and unsecured creditors in the key areas of bankruptcy, foreclosures, liquidations, banking litigation, and Article 9 transactions.