A basic goal of a foreclosure is to cause the secured property to be sold free and clear of any interests which attached after the execution or recording of the mortgage. This is the procedure designed to generate the highest price and presumably to make the lender whole. Because this approach is so elemental and inherent in the foreclosure process, servicers would typically assume that holders of subsequent, junior interests are all accounted for – through publication or notice in non-judicial states and via service of process in judicial jurisdictions.
Of course that is the way it is supposed to happen. Recalling the cliche, though, about the best laid plans…makes obvious that lack of perfection is not so uncommon. And when a junior party is missed, that person’s interest remains intact – untouched by the foreclosure action. In turn, the omission creates a title problem needing resolution.
First, how serious is this dilemma? It will require some attention in any event, but the answer is that it depends upon the interest which was missed. If the foreclosure is of a $500,000 mortgage on a house worth $800,000, that a $200 judgment was omitted will be of little consequence. If the untouched party, however, was a $300,000 junior mortgagee, a solution must be pursued because the property cannot be sold burdened by such an interest (which could and should otherwise have been extinguished by the foreclosure).
If the goal of the foreclosure was to extinguish all subordinate interests, how is it that such inferior parties could have been left out? The simple answer is twofold: either someone made a mistake, or there were special circumstances leading to a purposeful skipping of some party.
Although unwelcome, it is easy to observe how a junior party might be excluded. In judicial foreclosure states, for example, those possessed of interests subsequent to the mortgage are unearthed by a search of the land records – a foreclosure search. The people who did the search (title company, abstract company or attorney) could have just erred. Maybe they found everyone but there was a miscue when the search was typed. Perhaps an interest could have been misfiled but still been effective. Or, the party could have been known, but the process server stumbled so that jurisdiction was successfully attacked after the sale. For example, the process server didn’t notice a tenant on the third floor; or a partnership is somehow served as a corporation so service is no good; or when a person was served via a relative at the house, he or she later argued that there was no such relative — and somehow they win.
Then there is the (rarer) instance of the volitional act. The holder of a minor interest cannot readily be found in a case where speeding to a conclusion is particularly important. Locating this person will be very time consuming and is likely to fail, leading to an even more time consuming and expensive publication of the summons. So the servicer wisely elects to refrain from serving that party. Sensible though the decision may have been at the time, it preserves an interest which remains to be addressed only after the foreclosure auction.
Whatever form the post-sale efforts to dispose of the missed party (or parties) takes, who might need to pay for it? Assuming the omission was not by choice, the answer depends in part upon who was responsible for the junior interest being missed. If the process server erred, counsel who engaged them would no doubt attend to the cure; likewise, if the mistake eminated from counsel’s office. Where the fault is in the search, the title or abstract company could be expected to pay the cost, but perhaps only to the limit of their liability. It should be noted that a foreclosure search is not an insurance policy. In New York, for example, liability on a search is only up to $1,000. Insurance can be purchased as part of a search, but that is seldom done.
Having explored the prelude to ultimate resolution, the final actual comfort is that most often the interest of the omitted party can be extinguished after the sale in a new and separate action. These can be called by different names in the various states and precisely how long they take and what the procedures are should be the source of inquiry from servicer to its counsel in the particular jurisdiction.
Using New York as an example, the most common method to extinguish a preserved interest is denominated a “strict foreclosure.” Briefly discussing its essence should demystify the subject. Assuming that the omitted party was indeed subordinate, the only way it could have protected itself was to have redeemed the mortgage – paid it in full – thereby unburdening the property from the lien of the mortgage being foreclosed. This would preserve as viable a tenancy or a junior mortgage or judgment. The strict foreclosure, therefore, is a new action, naming the party omitted in the original foreclosure and offering it that right to redeem – the privilege it would have possessed had it been named in the original foreclosure, but something it was previously denied because of not being included. If the missed party does not redeem, then whatever interest it had is forever extinguished, just as it would have been had it been a defendant in the initial foreclosure.
As experienced servicers know, anything foreclosed in judicial states (like New York) can take some time and a strict foreclosure is certainly not immune to delay. Historically, these things would consume typically six months, and more with any problems or opposition. With courts now flooded with unprecedented volume in New York, many months are likely grafted on to the duration.
If the missed party was a tenant, must the servicer endure the duration of the strict foreclosure action with the tenant reposing at the premises rent free? As reviewed in an earlier Alert, they don’t have to pay rent, but case law (in New York) supports the proposition that they do have to pay its equivalent – “use and occupation” [NYCTL 1996-1 Commercial REO v. El Pequeno Restaurant Food Corp., 1 Misc.3d 574, 765 N.Y.S.2d 465 (Sup. Ct. Kings Co. 2003)]. It takes a special motion to pursue this and it does take some explaining to the court make the point, but knowing this remedy is available is well worthy. Servicers should ask that it be pursued whenever they are involved in a strict foreclosure against a tenant to determine if the relief is available in other states.
Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.