Mortgage lenders in the District were dealt a severe — but not fatal — blow last month by the District of Columbia Court of Appeals. The court ruled that when a condominium forecloses on its “super-priority lien,” it literally wipes out the security interests of the first mortgage holder.
Condo associations have the right to impose a lien against units for non-payment of the condo fee. The District’s Condominium Act provides that even when a lender forecloses, the association is entitled to six months of individual unit assessments. The law makes it clear that this lien is higher in priority than even a first mortgage.
Brian York bought a condo unit in Chase Plaza on Connecticut Avenue NW in July 2005, according to court documents. He received a $280,000 loan that ultimately ended up with JP Morgan Chase. By late 2008, York was delinquent both on his mortgage payments and the monthly condo fee, court documents say. A title search obtained by the condo association indicated three outstanding liens: the first deed of trust to JP Morgan, a second mortgage for $60,000 and the condo lien for $9,415.
Chase Plaza foreclosed on the unit, seeking to recover six months of unpaid assessments. A limited liability company purchased the unit at the foreclosure sale for $10,000.
The Court of Appeals wrestled with the legal question of whether the foreclosure sale by the Chase Plaza condominium extinguished the lender’s first deed of trust.
The high court relied on general principles of foreclosure law: “Liens with lower priority are extinguished if a valid foreclosure sale yields proceeds insufficient to satisfy a higher-priority lien.”
Typically, that legal concept applies when a first trust forecloses and wipes out any subordinate loans, such as second trust home equity loans. But in Chase Plaza Condominium Association v. JP Morgan Chase Bank, the court was faced with this question: Does that same principle apply when a condo association forecloses? Will a purchase of $10,000 effectively wipe out a considerably larger mortgage? The three judges who conducted the hearing said yes.
JP Morgan will most likely seek what is known as an “en bank” hearing, asking the entire nine judge court to review the decision. Additionally, the bank claims that the foreclosure sale should be invalidated because the purchase price was unconscionably low, and the high court sent the case back to the trial court to make that decision.
So the issue will not be finally resolved for months — if not years. Suffice it to say, however, until there is a reversal, the law is very clear: A condo that forecloses on its six month super-priority lien will effectively extinguish a first trust mortgage — or any other mortgage that is behind the condo lien.
This issue is not limited to the District. Courts throughout the country are addressing this same issue. The primary reason for this level of activity is that banks have been notoriously slow in pursuing foreclosure against their own mortgage borrowers. This has created serious financial pressures on condominium associations. It is an unfortunate fact that when condo owners are delinquent in their monthly mortgage payment, they will also refrain from paying the condo assessments. As a result, the condo cannot afford to maintain the property; the grass is not cut, the snow is not shoveled and often the master insurance policy is not paid. Values decline, causing even more owners to default. A downward spiraling effect takes place, where the end result is that many associations have no alternative but to file for bankruptcy relief.
Why would a bank foreclosure help to curb this problem? If the bank foreclosed, either a new owner or the bank itself would be obligated to start paying the monthly assessment, thereby stopping the hemorrhaging.
Is it fair for the bank to lose a large loan to a $10,000 purchaser at the foreclosure sale? There are at least three ways to look at it.
First, the banks should stop playing the game of chicken: Who will foreclose first, the bank or the condo? If the borrower is delinquent, the bank should go through the mediation process and either work out an acceptable arrangement or foreclose on the unit.
Second, when faced with the possible condo foreclosure, the bank can arrange to pay the six months lien (the $9,415 in the Chase Plaza case). Many lenders are already doing this so as to preserve their prior security position. Those funds are added to what the borrower already owes the bank.
Third, the banks can begin to escrow condo fees from their condo borrowers. To avoid losing their security interests in a tax sale, lenders often require borrowers to pay into escrow moneys that the bank will use to pay the real estate taxes when they become due. The Court of Appeals suggested that “there is support for the idea that lenders can decrease the risk that their mortgage liens will be extinguished, by among other things creating an escrow requirement.”
The matter is far from settled. Until then, Chase Plaza is the law in the District. Unlesss banks become more proactive and begin the foreclosure process earlier, they may lose their security.