PROPERTY LAW: Mortgages, Merger, and Mayhem: Foreclosing Mortgagee's Omission of Junior Lienholder
July 19, 2011
Steve Friedman, Senior Attorney, National Legal Research Group
In recent years, dubious mortgage practices and lax lending standards contributed to a housing bubble that eventually burst and thrust the economy into the worst economic downturn since the Great Depression; as a result, there have been a record number of foreclosures. Despite the time-sensitive nature of foreclosure proceedings and related litigation, foreclosing parties need to be careful about checking the land records and verifying that all interested parties have notice of the foreclosure proceedings.
The doctrine of merger provides that "[w]henever a greater and a less estate coincide and meet in one and the same person, without any intermediate estate, the less is immediately merged in the greater, and thus annihilated." 31 C.J.S. Estates § 153 (Westlaw database updated June 2011). Applying the merger doctrine to the mortgage context, when the mortgagee acquires legal title to the subject property by way of foreclosure, the mortgage lien merges with the legal title, and the lien is extinguished as a matter of law. See Citizens State Bank of New Castle v. Countrywide Home Loans, No. 76S03-1009-CV-515, 2011 WL 2566451, at *2 (Ind. June 29, 2011); Am. Family Mut. Ins. v. Welton, 926 F. Supp. 811, 816-17 (S.D. Ind. 1996).
Significantly, however, if a junior lienholder is not made a party to the foreclosure action, then neither the foreclosure nor a subsequent sale of the subject property can be enforced against such junior lienholder. See Citizens State Bank, 2011 WL 2566451, at *3, *5. Accordingly, when a foreclosing entity fails to include a junior lienholder in its foreclosure action, the junior liens remain attached to the property regardless of the foreclosure purchaser's knowledge or intent. See id. at *1, *4.
In an effort to deal with this potentially unfair scenario, "a number of jurisdictions advance the view that 'whether a merger has occurred depends on the intent of the parties, especially the one in whom the interests unite. If merger is against that party's best interest, it will not be deemed intended by the parties.'" Id. at *2 (quoting 1 Grant S. Nelson & Dale A. Whitman, Real Estate Finance Law § 6.15 (5th ed. 2007)); accord 55 Am. Jur. 2d Mortgages §§ 751, 1225 (Westlaw database updated May 2011). In other words, if there is no merger, then the foreclosing party's original lien remains intact and maintains its priority over all junior lienholders. See Citizens State Bank, 2011 WL 2566451, at *3.
Clearly, an express provision in a deed given in lieu of foreclosure that the deed shall not merge with the mortgage prevents such a merger. See 55 Am. Jur. 2d, supra, § 1226 (citing Riley v. S. Somers Dev., 644 N.Y.S.2d 784 (App. Div. 1996)). Yet such intent may be implied as well. See id. § 1225 (citing Edney v. Jensen, 216 N.W. 812 (Neb. 1927)).
Nevertheless, the foreclosing party cannot take advantage of the above-stated exception to the merger doctrine where it clearly, albeit implicitly, manifested its intent to merge its mortgage lien and legal title to the subject property by transferring fee simple title to the subject parcel, free from all encumbrances, to a third party. See, e.g., Citizens State Bank, 2011 WL 2566451, at *5 (citing Constr. Mach. of Ark. v. Roberts, 819 S.W.2d 268, 270 (Ark. 1991); Downstate Nat'l Bank v. Elmore, 587 N.E.2d 90, 94 (Ill. App. Ct. 1992); Thorp Consumer Disc. v. Hartigan, 683 N.E.2d 373, 377 n.3 (Ohio Ct. App. 1996)).
Consequently, if the foreclosure purchaser then conveys the property to a third party, claiming it to be free from all encumbrances, the foreclosure purchaser may be liable for breach of contract. See id. at *6.