Borrowers in default of their mortgage payments are more likely to neglect their house and yard. This can affect foreclosure actions in two primary ways: third party purchasers might choose not to bid on property that is in bad shape and the local government can record a nuisance lien that has priority over even the first mortgage lien clients are servicing.
Nuisance liens are beneficial when they cause neighboring homeowners to maintain their properties, which protects the value of the collateral for mortgage loans that clients are servicing. The challenge arises when the homeowner who violates local codes is your borrower. This can rapidly become a costly proposition.
Kentucky has a set of statutes (K.R.S. §65.8801 to 65.8839) that establish the procedures for a “local government” both to create ordinances “to protect, promote, and improve the health, safety, and welfare of the citizens residing within the local governments of this state” and to establish a Code Enforcement Board with “the power to issue remedial orders and impose civil fines” to enforce a local government ordinance. The law also sets requirements for the procedures the Board must follow, which include conducting hearings, subpoenaing violators, witnesses, and evidence, and imposing civil fines. After the fine has become a “final non-appealable order” or a “final judgment of a court,” and a code enforcement officer executes an affidavit, a nuisance lien can be recorded against the mortgaged property.
These nuisance ordinances generally require homeowners to repair broken doors, windows, and roofs, to paint the house or other fixtures, and to clean up what is referred to in the statutes as “the accumulation of” junked or wrecked vehicles, uninhabited manufactured homes, rubbish, or the “excessive growth of weeds or grass.” Violating these code standards will constitute a civil offense and can result in civil fines, plus liability for repayment of “abatement costs” that the local government spends to fix the problem when the homeowner fails to remediate. These abatement costs are designated for remedial action like mowing the lawn, replacing doors or windows, and removing abandoned cars. The fines for code violations can be exorbitant, and we have seen cases where multiple $10,000 fines have been levied that totaled more than $70,000 on property with a tax value less than the fines.
Because these fines have priority over prior-recorded mortgages, the laws also have established a system of due process to give notice to lienholders to remediate and stop the nuisance lien process. To address due process, the law describes a “notification system” that each local government must create to give proper notice to lienholders and mortgage loan servicers. When the local government meets these notice requirements, the nuisance lien it files has priority over a prior-recorded mortgage. But the local government will not necessarily communicate effectively or efficiently that one of the properties securing your loan is in disrepair. Rather, the system is passive in nature and places most of the burden on the mortgage loan servicer.
Around a dozen cities in Kentucky have these systems in place, and it is up to servicers to register with each separate system. After registration, the cities are required to send notice at least monthly of properties that are subject to the code violation process. The notification will only list the property address, titleholder name(s), and information on the alleged violations. It will not list lienholders, so it is up to servicers to search each address to determine if there are code violations.
When a Nuisance Lien Has Been Filed
When you find one of your properties on the list, you have forty-five days from the date the notification first appeared to contact the city to work out a resolution of the issue. Keep in mind that the cities really do not want to be involved in the remediation process. They mainly want the phone calls complaining about the property to stop and a new homeowner to take over and maintain the house. If you remain proactive and optimistic, the city is more likely to be flexible with you. Also, this is where your inspectors can play a role in being “feet on the ground” to help confirm what work really needs to be done.
However, if a nuisance lien has been filed, and there is a large balance that now has priority over the mortgage loan you are servicing, our firm can perform extra work so the foreclosure can proceed. To begin, we will request a breakdown of the amount of the lien that is for fines and the amount that is for actual work done (the abatement costs). It is not uncommon to see a $40,000 lien comprised solely of fines where the city has done nothing to remediate. In that case, we will request that the fines be waived or reduced to as small an amount as possible, which we have succeeded in accomplishing in many cases. If the city refuses to compromise, however, we believe that a constitutional argument can be raised when the fine is exceedingly large. Some day that case might have to be litigated.
“Constant vigilance” is a term that applies here and is helpful in avoiding costly nuisance liens. The monthly inspections of property in foreclosure should account for the possibility of nuisance liens in Kentucky. If the inspector sees something that could pose a nuisance issue, that inspector should say something.