9.5 Real Property Foreclosures

• Library: The Virginia Lawyer: A Deskbook for Practitioners (Virginia CLE) (2018 Ed.)

9.5 REAL PROPERTY FORECLOSURES ⁵⁸⁸

9.501 Deed of Trust.

A. Lien on the Collateral Securing a Loan. The primary method for lenders to acquire a consensual lien against real estate in Virginia is through a deed of trust, by which the owner of real estate conveys its legal title to a trustee, in trust, to secure an indebtedness.

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The owner of the property and the borrower on the loan secured by the deed of trust usually are the same person, but need not be, since the property owner may have agreed to pledge the property to secure a third party's debt. For this reason, the term "borrower" generally will be used in this section to refer to the person who is indebted on the note, but "owner" will be used where the context requires. For example, the notice of sale must be sent to the property owner whether or not the owner also is the borrower; however, good practice mandates that it also be sent to the borrower.

B. Default. Upon default in the payment of the debt secured by a deed of trust, the real estate becomes subject to sale under the power of sale conferred upon the trustee named in the deed of trust. The lender has the right to accelerate, or demand full payment of, the indebtedness and to instruct the trustee to sell the property securing the debt. The lender may be required under the terms of the note or deed of trust to give the borrower notice of default and of the borrower's right to cure before instructing the trustee to sell the property. ⁵⁸⁹

C. Reinstatement. Certain loans may be reinstated either because of policies of the loan guarantor (VA, FHA) or specific language in the deed of trust (FNMA, FHLMC, uniform deed of trust). The right to reinstate a loan does not exist unless specifically granted by the note or deed of trust.

D. Legal Versus Equitable Title. The owner of real estate possesses both legal and equitable title to real estate. Legal title is defined as "one which is complete and perfect so far as regards the apparent right of ownership and possession, but which carries no beneficial interest in the property, another person being equitably entitled thereto"; equitable title is defined as the beneficial interest of one person whom equity regards as the real owner, although the legal title is vested in another. ⁵⁹⁰ When the owner pledges real estate as collateral for a debt, he or she transfers legal title to a third party, in trust, for the benefit of the lender. The instrument transferring the real estate to a third party in trust is the deed of trust, a contract, in which the legal title and the power of sale are conveyed to a trustee or trustees.

The trustee has no right to exercise the power of sale or to obtain possession until the borrower defaults under the terms of the note or deed of

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trust and then only for the purpose of selling the property at foreclosure or preserving the property until sale. Other than those powers set forth in title 55 of the Virginia Code, the trustee has no powers except those conferred by the deed of trust. ⁵⁹¹

When a default occurs there is no change in title; the property merely becomes eligible to be sold under the power of sale originally conferred on the trustee by the owner. Thus, the lender has the right to have the property sold and the proceeds of the sale applied to the debt. Upon the strikedown of the bid, equitable title passes to the purchaser, subject to defeasance if the purchaser defaults by failing to close. Legal title passes to the purchaser upon delivery of the deed at closing.

E. Defects in the Deed of Trust. The deed of trust must be examined for any irregularities. The trustee should confirm that all necessary grantors in the deed of trust have executed the document. Failure of the owner or owners of the real estate to execute the deed of trust could result in less than a complete conveyance to the trustee of all outstanding interests in the property. To ensure a conveyance of the correct property, the deed of trust must contain a complete and accurate description of the real estate; however, "[w]here even a stranger to the deed of trust, by following the reference in the deed, could locate the property to his satisfaction, under Virginia law no more is required." ⁵⁹² The deed of trust also should describe the indebtedness it is securing; however, inaccuracy of the amount of the debt has been held not to affect the validity of the deed of trust. ⁵⁹³

F. Reformation Actions. Reformation is available to reform a written instrument to make it conform to the true agreement. ⁵⁹⁴ If a deed of trust contains a substantial defect, the trustee may not have acquired legal title. In those cases, the trustee or the lender should file an action to reform the deed of trust.

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9.502 Trustee.

A. Impartiality. It is well established that a trustee is the agent for both the lender and the borrower and must act with fairness and impartiality. ⁵⁹⁵ In Mayo v. Wells Fargo Bank, N.A., ⁵⁹⁶ the United States District Court for the Eastern District of Virginia examined the scope of common law duties imposed on Virginia foreclosure trustees and found that the only common law duty consistently recognized by the Virginia Supreme Court is the duty of impartiality.

B. Powers and Duties. The powers and duties of the trustee are governed by the deed of trust and the minimum statutory requirements for foreclosures, which are set forth in sections 64.2-1309 and 55-59.1 through 55-59.4 of the Virginia Code.

9.503 How the Lien Is Established. Upon execution by the grantor(s) and recordation in the land records of the circuit court for the jurisdiction in which the property is located, a deed of trust establishes a lien on the subject property. Recordation of the deed of trust is not essential to the validity of the deed of trust as between the parties. However, an unrecorded deed of trust does not establish a lien on the subject property as to other creditors and purchasers of the grantor. An unrecorded deed of trust will not provide the lender with a priority position against other creditors who record their liens even if they are subsequent in time. ⁵⁹⁷

9.504 Priorities.

A. Purchase Money Deed of Trust. Purchase money deeds of trust provide lenders with a valuable protection for the priority of their liens. A purchase money deed of trust is defined as a deed of trust given concurrently with a conveyance of land to secure the balance of the unpaid purchase price. ⁵⁹⁸ It is not necessary that the deed and purchase money deed of trust be executed at the same time, as long as they were executed as part of one continuous transaction. The dates of the two documents do not have to be the same, but the intent of the parties must be that they represent one continuous

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transaction. ⁵⁹⁹ The impact and consequence of a purchase money deed of trust is the priority it obtains over prior judgments docketed against the grantor, which ensures that the lender will be paid first out of the foreclosure under its first lien purchase money deed of trust.

B. Other Deeds of Trust.

1. In General. It is very important to determine whether there are other deeds of trust recorded against the property. If there is a prior recorded deed of trust, the trustee must decide whether the sale will be subject to the prior deed of trust or if the proceeds of sale will be used first to pay the prior deed of trust, with any excess then applied to the foreclosing deed of trust. This latter procedure is permitted by Kaplan v. Ruffin, ⁶⁰⁰ but it is disfavored and is rarely used. If there are subordinate liens, good practice mandates sending notice of the sale to such lienholders, and the Virginia Code requires notice to certain subordinate's lienholders. ⁶⁰¹

2. Subject to Prior Liens. If the property is to be sold subject to a prior lien, the notice of sale (advertisement) should state whether the sale is subject to prior deeds of trust or prior liens and identify the liens by deed book and page, instrument number, or judgment number. ⁶⁰² The purchaser needs to understand that a prior encumbrance will survive the foreclosure sale and must be paid by the purchaser to be released to obtain clear title.

The trustee should attempt to ascertain the payoff of the prior lien to avoid any claim that the bidding was chilled because this information was not available, but failure to do so does not prevent the sale from proceeding. ⁶⁰³ Upon foreclosure of a junior deed of trust subject to a prior lien, any surplus in the proceeds of sale will be paid down to subordinate lienholders according to their priority, and the purchaser will be responsible for paying off the prior lien. Failure to pay off or otherwise address the prior lien could result in the purchaser losing the property if the prior lienholder initiates foreclosure of its deed of trust or initiates a judicial sale to collect a judgment.

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3. Wrap-Around Deed of Trust. In a wrap-around deed of trust, the second deed of trust lender agrees to make the payments due under the first deed of trust. The borrower's payments under the wrap-around deed of trust must be sufficient to cover both trusts. A foreclosure of the wrap-around deed of trust is the same as a foreclosure under a standard second deed of trust with the knowledge that the first deed of trust also is in default. Even though the requirements for foreclosing under a wrap-around deed of trust are the same as under any other deed of trust, the second deed of trust lender must realize that the first deed of trust lender also may be foreclosing or may subsequently foreclose. The trustee should announce in his or her advertisement and at sale that this sale is being conducted subject to the prior lien.

9.505 Mortgages. The terms "mortgage" and "deed of trust" are often used interchangeably, though there are legal differences. At common law the traditional mortgage vested legal title conditionally in the lender, with the equitable...