Sloppy Service, Subsequent Title Transfer In Foreclosure Process Leaves Lender Holding The Bag On $111K+ Error

A recent ruling by the Indiana Court of Appeals may be of some interest to title agents and examiners (who are already in the unenviable position of being expected to insure title to homes that have a foreclosure judgment and foreclosure deed in its chain of title), and to some real estate operators (those who profitably dabble in the "trafficking" of seemingly worthless judgment liens on properties in foreclosure). The following facts have been taken from the ruling:

1. Countrywide made a loan secured by a mortgage on a home on April 27, 2005.
2. On June 9, 2006, CSB, an unsecured lender, obtained a default judgment against homeowners in the sum of $111,499.38 based upon a promissory note executed by the homeowners in favor of CSB. CSB recorded its judgment and obtained a lien on homeowner's property, inferior in priority to Countrywide's mortgage.
3. Thereafter, Countrywide filed its complaint to foreclose mortgage against homeowners on August 28, 2006, and obtained a judgment of foreclosure on October 30, 2006.
4. Countrywide did not name CSB as a defendant in its complaint to foreclose despite the fact that CSB had properly recorded its default judgment against homeowners.
5. Therefore, CSB neither was made a party to nor had notice of the foreclosure action.
6. Countrywide obtained title to the real estate following a sheriff's sale on February 22, 2007, and later recorded such title on March 15, 2007.
7. Countrywide subsequently transferred title to the real estate to FNMA by deed recorded on May 3, 2007.
8. After learning of CSB's judgment lien against the property, Countrywide filed its complaint for strict foreclosure against CSB on October 2, 2007. Countrywide sought an order foreclosing CSB's equity of redemption and interest in the real estate.
9. CSB answered the complaint and also filed its own complaint to foreclose its judgment lien on the property naming FNMA and the Steuben County Treasurer as defendants.

Question: Which lender has priority and entitled to prevail in this matter?

Answer: If you said Countrywide, you're wrong.

The general rule applicable in Indiana, as well as in most (if not all) other states, can be generally, described as follows:

• When junior lienholders are not made parties to the action, the foreclosure and sale cannot be enforced against them, and they are not precluded from exercising any right of redemption.
• However, the rule then allows the foreclosing mortgagee to prevent junior lienholders from stepping up in priority as against the subject property, by allowing it (the foreclosing mortgagee) to re-foreclose on the property, and thereby giving it first crack at any money generated by foreclosure on the property, ahead of any junior lienholders, until it has been paid what it is owed in full.
• In Indiana (and possibly other states???), the right to conduct this re-foreclosure action is limited solely to the foreclosing mortgagee who acquires the property at the initial foreclosure sale (in this case, Countrywide, the foreclosing lender).

In this case, the fact that there was a screw-up (presumably by Countrywide's foreclosure attorney) in failing to name and properly serve CSB in the foreclosure lawsuit, standing alone, was not fatal to Countrywide's mortgage lien priority as against CSB's later-acquired and recorded judgment lien. What sank Countrywide (and/or FNMA) in this case was the fact that this initial screw-up was then followed, arguably, by a second screw-up. That is, the transfer of the property by Countrywide (the winning bidder at the foreclosure sale) to FNMA without the benefit of a title search.(1) The court held that this subsequent transfer extinguished Countrywide's right to assert its mortgage against the now no-longer-inferior $111,499.38 judgment lien held by CSB.(2)

For the ruling, see Citizens State Bank of New Castle v. Countrywide Home Loans, Inc.

(1) From the court's ruling:

• Contrary to Countrywide and FNMA's suggestion, we conclude that Brightwell correctly states Indiana law regarding priority rights when a foreclosing mortgagee sells the property to a third party. We hold that while Countrywide's mortgage lien was preserved after it acquired title to the property via sheriff's sale, Countrywide's right to assert the mortgage against CSB was extinguished upon subsequent transfer of the property to FNMA and, thus, the mortgage-assertion right did not pass to FNMA. When property is transferred for value or resold to a third party, that party cannot then assert what was formerly a superior mortgage lien position against the judgment lien. Rather, the third party takes the property subject to the valid judgment lien.

It is undeniable that there are plenty of judgment lienholders that have ostensibly been foreclosed by the owner/holder of a superior 1st mortgage. However, if the judgment lienholder wasn't served in the foreclosure action (much like CSB in this case), or if there was "sloppy" service attempted on the judgment lienholder that was so ineffectual so as to render it void, this ruling may support the proposition that the lien has not been extinguished, and is still "alive," thereby possibly giving:

• title examiners, agents, insurers another issue to sweat about when underwriting a title insurance policy on a foreclosed property, and
• clever real estate operators who seek out and buy these liens (usually at a steep discount) one more potentially profit-pocketing opportunity.

(2) For another case where a major lender's sloppiness in a foreclosure action, despite its priority position as against another party to the suit, left itself holding the bag, see Creditor's Failure To Record Request For Notice Allows Ex-Homeowner To Snatch Away Surplus Out From Under Subordinate Lienholder After F'closure Sale.