ANALYSIS: As you may recall, The League filed a “friend of the court” brief with the Wisconsin Court of Appeals last spring, offering our support for Heartland Credit Union’s position in a case involving foreclosure procedures.
The appeals court has now released its opinion, reversing the trial court’s decision in part and sending the case back for further action. The decision is largely a win for Heartland.
This Courier will explain the facts and the appeals court’s decision, and then offer some takeaways for credit unions dealing with mortgages, subordination agreements and foreclosure sales.
Background
The case involved a company that borrowed money from an individual we’ll call the “junior lienholder”. It was secured by a recorded mortgage. The company later signed a promissory note with Heartland (“Note 1”), also secured by a recorded mortgage. The junior lienholder agreed to subordinate his mortgage to Heartland’s mortgage for Note 1. A few months later, the company signed a second promissory note with Heartland (“Note 2”).
The company defaulted on its debts to Heartland, and so Heartland sued, seeking a foreclosure judgment and a money judgment against the company for the amounts due under both Note 1 and Note 2. The junior lienholder was named as a defendant in the case because he was also a lienholder.
The circuit court entered a judgment of foreclosure on Heartland’s mortgage. The circuit court also entered judgment for Heartland for the amounts due under Note 1 and Note 2.
At a sheriff’s sale of the property, Heartland made a “credit bid” of $499,000 – which was more than was due to Heartland under Note 1, but less than the total amount due under Note 1 and Note 2 combined. (When a judgment creditor like Heartland bids on a property at a foreclosure sale, it can enter a credit bid rather than making a cash payment.)
Heartland filed a motion to confirm the sale, but the circuit court concluded that Heartland was not entitled to credit bid more than the amount due under Note 1. The court allowed Heartland to withdraw its motion to confirm the sale so that a second sheriff’s sale could be held.
Before that second sheriff’s sale could be conducted, the junior lienholder filed his own motion to confirm the first sheriff’s sale based on the credit bid made by Heartland. The circuit court granted the junior lienholder’s motion but did not confirm the sale based on Heartland’s credit bid of $499,000. Rather, at the junior lienholder’s request, the circuit court allowed Heartland to have a credit bid in the amount of $451,774.29 (the amount due to Heartland under Note 1) but required Heartland to pay the junior lienholder $47,225.71 in satisfaction of his junior lien (the difference between what was owed to Heartland under Note 1 and the $499,000 credit bid by Heartland).
Heartland appealed that decision, and The League filed its “friend of the court” brief to help support Heartland’s arguments. We strongly believed that the order to pay the junior lienholder was made in error.
The appeals court’s decision
The Wisconsin Court of Appeals decided that the circuit court was right in some ways and wrong in others. Two aspects of the decision are especially important:
- The appeals court decided that the lower court made a mistake in granting the junior lienholder’s motion to confirm the sheriff’s sale because the junior lienholder lacked authority as a junior lienholder to make that motion. That aspect of the decision is a key win for Heartland, because as the court explained, “Our decision necessarily requires reversal of the circuit court’s order that required Heartland to pay $47,225.71 to the junior lienholder to satisfy the junior lienholder’s junior lien.”
- The appeals court decided that the lower court was correct when it ruled that Heartland was not entitled to credit bid more than the amount due under Note 1. It reached that conclusion in large part because of the way the subordination agreement between the junior lienholder and Heartland was completed. The court held that it only gave priority to Note 1; it did not provide that the subordination extended to all future extensions of credit by Heartland. (That box on the form was not checked.) Therefore, the order of priority, under the court’s analysis, was 1) Heartland’s Note 1; 2) the junior lienholder’s mortgage lien; and 3) Heartland’s Note 2. Since Note 2 was junior to the junior lienholder’s mortgage, the amount of the credit bid could be no more than the amount due under Note 1, the appeals court decided.
The appeals court sent the case back to the Dane County Circuit Court to order a second sheriff’s sale of the property.
Takeaways for credit unions
The League’s outside counsel, the Husch Blackwell law firm, filed our “friend of the court” brief. They’ve analyzed the appeals court’s opinion, and they offer some key takeaways for other credit unions dealing with mortgages, subordination agreements, and foreclosure sales:
- Dragnet clauses. When subsequent extensions might be made after the first note and mortgage, make sure your documents have a dragnet clause, meaning language providing that the mortgage also secures future extensions of credit. The appeals court held that Heartland’s Note 2 was secured by the original mortgage under a dragnet clause. Because of the dragnet clause, Note 2 was held to also be secured by the mortgage accompanying Note 1.
- Subordination agreements. If there are prior lienholders in the mortgaged property when you enter into a mortgage loan/refinance that is to take the place of a senior mortgage loan, be sure to have the junior lienholders enter into subordination agreements. Also, be sure those subordination agreements make the junior’s lien subordinate to future extensions of credit.
In this case, the subordination agreement subordinated the junior lienholder to Note 1, but a box was not checked that would have provided for future extensions of credit to be subordinated, as well. Be sure to check that box / include language extending subordination to future extensions of credit. Because the box was not checked, Heartland’s Note 2 was not subordinated, and the junior lienholder had priority over it.
- Credit bids. The appeals court approved the use of a credit bid to purchase mortgaged property at a sheriff’s sale. However, be sure that the amount of a credit bid is no more than the amount adjudged due under the foreclosure judgment, for the note secured by the mortgage.
In this case, the appeals court reasoned that the credit bid could be no more than the amount declared due under Heartland’s Note 1. It held that the credit bid was invalid because it exceeded the amount due under that note.