Hidden Threats to Lien Priority: How Mortgage Lenders Can Hold Their Ground

Residential mortgage lending has seemed to fare reasonably well in the thick of the pandemic due to stimulus and relief programs, but as pandemic-era relief recedes and foreclosures rise, hidden threats to a lender’s first priority lien status may become apparent and require resolution.

With foreclosures up 9% in the first quarter of 2021 versus the prior quarter, several recent cases highlight why lenders need to be aware of unique and sometimes regionally-specific issues such as superpriority liens securing homeowners and condominium associations’ (HOA) fees, or face unforeseen challenges when enforcing liens.

Knowledge is Power

In the recent case of Bank of N.Y. Mellon v. Meister Park Homeowners Association, the bank’s secured interest in a residential property was extinguished after an HOA foreclosed on its superpriority lien. Bank of New York Mellon (BNYM), the lender on the deed of trust, tried to set aside the sale, arguing that the HOA’s notice was inadequate to place BNYM on notice that the HOA was foreclosing on a superpriority interest. BNYM argued it was unaware that its interest could be extinguished, especially because the HOA repeatedly represented to BNYM in mortgagee protection clauses that BNYM’s deed of trust would be preserved.

Nevertheless, the U.S. District Court in Nevada upheld the foreclosure sale, finding that the Nevada statute providing superpriority status to HOA liens was sufficient to place BNYM on notice that its interest was at risk, and further holding that any representations made by the HOA would not override the statute.

Vigilance is the Price for Priority

The case of RFB Properties II, LLC v. Deutsche Bank Trust Company Americas before the D.C. Court of Appeals demonstrates why lenders need to stay on the alert for developments in case law to avoid surprises. In that case, an HOA foreclosed on its superpriority lien at a sale price reflecting that the property was subject to Deutsche Bank’s first lien, but a post-sale decision by the same D.C. court clarifying that foreclosing on HOA liens securing unpaid assessments in excess of the amount allowed superpriority would nonetheless extinguish all other liens in the property, caused the first lien to be extinguished. Deutsche Bank challenged the sale, but was unsuccessful.

Lenders should stay apprised of statutory developments that could threaten their priority status in jurisdictions affecting their collateral properties. Where the impact of a newly-enacted statute has not been tested in court, a lender notified of a sale to foreclose a lien potentially entitled to superpriority pursuant to such statute would be well-advised to preemptively tender full satisfaction of the estimated superpriority portion of such lien.

Note that HOAs don’t always have the high ground. In a recent decision in Nationstar Mortg. LLC v. Saticoy Bay LLC, the U.S. Court of Appeals for the Ninth Circuit found that federal law in form of the Federal Foreclosure Bar preempted Nevada’s superpriority lien scheme on property subject to a first deed of trust owned by the Federal Housing Finance Agency (FHFA). Preemption would presumably apply to any state’s lien laws, however, there are limits. Here, the court’s ruling was based on Fannie Mae’s ownership interest in the security instrument, its status as being in FHFA conservatorship, and its agency relationship with the servicer.

Looking Ahead

Although government stimulus and private relief programs have kept many mortgage loan borrowers afloat in the past year, the pandemic has created new market risks. Residential home prices are reaching dizzying heights as inventories of existing homes run low and the cost of new construction rises. Even low interest rates may not be enough to offset the increased burden on new homeowners, and inflation threatens to take a chunk of consumers’ funds that would otherwise go toward debt payments. With these risks comes the prospect of more foreclosure activity as we make our way out of the pandemic.

Armed with knowledge of legal precedent, mortgage lenders will be better positioned to understand the importance of identifying the laws and notice requirements governing their collateral, enabling them to more accurately gauge the risks posed by potential competing interests. Forewarned is forearmed, in the case of lien priorities.

Christine DeVito and Nicole Serratore, members of the Insolvency, Creditors’ Rights + Financial Products Practice Group of Davis+Gilbert, contributed to this post.

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