In this two-part series, we explore what happens when one property lienholder forecloses while another chooses not to or cannot foreclose within the same action.
Part 1 explored the process and risks posed for junior lienholders when a senior lienholder forecloses a property that includes junior liens. This second article explores what happens when a junior lienholder files foreclosure on property with a senior lien. In this scenario, if the senior lienholder does not protect its lien, it risks losing its security interest altogether by failing to respond to the complaint and having a default judgment taken against it.
An essential aspect of Indiana law is that a senior lien can be defaulted and stripped if the senior lienholder is properly served and does not assert its interest within the time frame allotted under trial rules. If defaulted, the burden is on the defaulted party to present both a legally recognized reason for failing to answer under trial rule 60(B) and a meritorious defense to its underlying claim of priority.
While recorded documents and evidence of the debt itself may often present an acceptable defense, it is often more difficult to find a legally recognized reason for failing to respond. This is because of case law that defines qualifying mistakes and excusable neglect. Often times, defaulted parties are left at the mercy of the court as to whether they may be permitted to overturn a default judgment, even if the evidence would have otherwise clearly provided them with priority. This is not a position in which any senior lienholder wants to find itself. It is essential that senior lienholders quickly and efficiently process any summons and engage counsel to protect them.
The Senior Lien
Once counsel is engaged, and presuming default has not occurred, protecting a senior lien is initially a straightforward process. Counsel will file a responsive pleading that asserts that its client holds a senior lien, that it does not seek to foreclose its senior lien then, and that the plaintiff must proceed “subject to” the senior lien interest. Counsel may also reserve the right to amend its answer later if preconditions to foreclosure are completed and the borrower defaults on the underlying loan. Reserving the right to amend allows full cross- and counterclaims related to foreclosing the senior lien.
In contrast, it is more challenging to ensure that both junior lien plaintiffs and the courts are aware of what is required for full protection of the senior lien. Specifically, while the term “subject to” has been used as far back as cases decided in the 1800s, its intent and application are often misunderstood. While a senior lien can be defaulted for not responding to a foreclosure complaint, the junior lien doesn’t otherwise have any legal authority to release an uncontested senior lien that has properly responded. The senior lienholder cannot prevent the junior lienholder from proceeding on its claims, but it can stop it from foreclosing out the senior mortgage. Proper protection of the senior lien should ensure that the senior mortgage survives and remains an active lien on the property, even after a junior lien foreclosure sale.
Under Indiana case law, choosing not to foreclose the senior lien also means that the senior lien foregoes any right to surplus sale proceeds from the junior lienholder’s sheriff sale. In that situation, the senior lienholder is opting instead to ensure that its full debt is paid before any property transfers. While the junior lienholder that purchases the property at a judicial sale is not required to pay off the still existing senior lien, title to the property is not marketable until the senior lien is released. Therefore, as a practical matter, payoff is often imminent. If the payoff does not happen quickly enough, the senior lienholder can file its own foreclosure action against the new owner. Because it is a first-recorded interest that survives the junior foreclosure judgment and sheriff sale, the senior lien remains superior to the new owner’s title interest.
Today’s Housing Market
In years past, it was relatively uncommon to see junior lienholders foreclosing subject to the first priority mortgage holder. But it is happening more now, thanks to changes in the housing market that include improved housing values and alternative homeowner’s and condominium association strategies. The housing market effect is a simple equity analysis – if property values have increased to a point of securing previously unsecured junior mortgages, it may be advantageous to seek foreclosure, obtain title, and pay off the senior lienholder.
Moreover, homeowner’s and condominium associations holding junior liens are now using foreclosure as a way to remove non-paying homeowners and retain the property for rental until the first mortgage forecloses.
Servicers must understand the importance not only of engaging counsel in time to respond to junior lien complaints, but also to ensure that counsel remains retained through judgment. This makes sure that judgment terms designed to notify potential judicial sale buyers of the existing senior lien interest are drafted properly. Doing so also helps avoid future litigation.