Are non-judicial sales unconstitutional? The super-priority lien and its influence on state foreclosure statutes.

• Author: Prsha, Ryan
• Position: LAW SUMMARY

1. INTRODUCTION

   As part of an ongoing balancing act between the interests of mortgage creditors and homeowners' associations, twenty states have implemented a "super-priority" lien that allows homeowners' association dues and assessments to take precedent over the property's mortgage in the event of a foreclosure. (1) Although originally intended to give mortgage creditors an incentive to pay off the association dues themselves, this lien has led to several unintended consequences. (2) Courts have accepted the concept of non-judicial foreclosure. (3) However, due to a federal district court decision interpreting the super-priority lien, the constitutionality of these sales could soon be put into question. (4)

   In 2015, the U.S. District Court for the District of Nevada cited a landmark civil rights case from Missouri, Shelley v. Kraemer, (5) and ruled that a private, non-judicial foreclosure sale was a state action. (6) This, in turn, subjected the sale to the Due Process Clause of the U.S. Constitution (7) and subsequently put in jeopardy the concept of non-judicial foreclosure. (8) Although this decision's effect is currently confined to the State of Nevada, there are nineteen other states, including Missouri, that have yet to make a decision on how to handle the super-priority lien. (9) If Nevada's Shelley justification is invoked in the remaining district courts, there could be widespread implications for all non-judicial foreclosure statutes across the country.

   Part II of this Note discusses the background necessary to understand the super-priority lien and its constitutional implications in regards to non-judicial foreclosure. Part III reviews the recent developments that have given rise to this issue. Part IV discusses the ramifications of the manner in which the super-priority lien is being handled and how the court's methodology could potentially affect the constitutionality of non-judicial foreclosure.

2. LEGAL BACKGROUND

   In order to fully understand the implications that the super-priority lien has created for non-judicial foreclosure, it is necessary to discuss the predicates on which the issue stands. This Part will first examine the foreclosure process and how it relates to the super-priority lien. Next, it will explore the constitutional grounds that the district courts have relied on, including the concepts of state action and non-judicial foreclosure.

   1. The Basics: What Is a Lien and How Does It Work?

      A lien is a notice attached to a property informing others that the property titleholder owes a creditor money, and the property has been put up as collateral for the debt. (10) If the owner fails to pay back what is owed, the creditor (11) may foreclose on the property and use the proceeds of the sale to pay off what is left of the balance. (12) If more than one lien is put on the property, each lien is given a priority order in which the debt will be paid off. (13) The debt with the higher priority is the senior lien, and those with lower priority are considered its junior. (14) As soon as a senior creditor forecloses, all subordinate junior liens on that property are effectively extinguished. (15) However, when a junior creditor forecloses, all senior liens remain intact. (16) Therefore, while a junior creditor can still foreclose, the new buyer receives the property already burdened by the senior liens. (17) Consequently, any property foreclosed by a junior creditor is worth less than market value because the new buyer must pay off all senior liens to clear title. (18)

      The priority order of liens is well established under a combination of equitable jurisdiction and statutory law. (19) Real estate taxes owed on the property always take first priority. (20) Historically, any mortgage on the property will take first priority after the taxes have been paid off. (21) Inevitably, all other liens fall somewhere further down the priority pecking order. (22) On paper, this system makes a great deal of sense. The mortgage providers typically have much more capital invested in the property than any of the other creditors, so it is logical to prioritize their debt. In practice, however, several issues have developed with junior liens--especially those imposed by homeowners' and condo associations.

   2. The Role of Association Dues and Assessments

      Homeowners' and condo associations typically assess periodic dues on each property within their boundaries. (23) Depending on the property, the fees can range from just a few hundred dollars per month, to thousands of dollars over that span. (24) These dues are used for a variety of purposes that provide the community with both visual benefits, such as general neighborhood maintenance, and invisible benefits, such as property insurance for common areas. (25)

      Because an association's source of revenue is usually limited to common assessments, the surrounding residents of the community bear the consequences of default by a property owner of his or her assessment obligations. (26) In the event of a default, the association must either increase the fees for the remaining property owners or reduce the maintenance and services it provides. (27) Neither option is ideal, and as the months pass without payment, it becomes increasingly harder for the surrounding property owners to bear the weight of the cost. (28) In an attempt to mitigate this hardship, a unit or parcel within an association's boundary becomes subject to a lien in the amount of unpaid dues. (29) This lien, although vital to the continued operation of the association, is typically junior to the property's mortgage. (30)

      Because of the low priority, it is tremendously difficult for an association to foreclose on its lien. (31) Any rational potential buyer would be frightened by the prospect of paying off the remaining mortgage just to receive clear title. (32) Subsequently, the associations must typically wait for the senior mortgage provider to foreclose on the property in order for it to collect its debt. (33) If the mortgage foreclosure takes a long period of time, or if the foreclosure proceeds are inadequate to pay off the mortgage, then the association will once again be forced to bear the cost of the unpaid dues. (34)

      These delayed and inadequate proceedings have become more common in the aftermath of the subprime mortgage crisis. (35) In a soft housing market, mortgage creditors have an incentive to delay foreclosure in hopes of getting greater value from the property when the market recovers. (36) Additionally, delaying foreclosure allows the lender to avoid the legal obligation to pay off the ever-growing amount of unpaid association dues and assessments that have accrued. (37) The consequences of the existing priority system, which incentivize the mortgage provider to delay foreclosure, have proven to be "devastating to the community and the remaining residents." (38) Under this system, the mortgage provider can sit back and watch its collateral continue to be preserved by the various community-enhancing efforts of the surrounding property owners. (39) The lender is essentially receiving an unfair value "to the extent that [it] enjoys this benefit by virtue of a conscious decision to delay... foreclosure." (40)

   3. The Creation of the Super-Priority Lien

      Twenty different states have attempted to mitigate this unfair value by creating a super-priority lien status for association dues. (41) In these states, the fees owed to an association take priority over the mortgage, typically for up to six months worth of outstanding payments. (42) Some states, such as Missouri, have statutes that only apply to condominium associations. (43) Others, such as Nevada, have created statutes that apply for up to nine months of unpaid dues for any type of homeowners' association. (44) Despite these differences, the underlying motivation behind and subsequent implication of each statute remains fairly consistent from state to state. (45)

      For practical reasons, the associations' whole lien could not take priority over a mortgage. (46) The principle justification was that "complete priority for association liens could discourage common interest community development

      ... [because] [t]raditional first mortgage lenders might be reluctant to lend from a subordinate lien position if there was no 'cap' on the potential burden of the an [sic] association's assessment lien." (47) Therefore, the super-priority statute drafters were forced to come up with "an equitable balance between the need to enforce collection of unpaid assessments and the obvious necessity for protecting the priority of the security interests of lenders." (48) Drafters have generally struck this balance with a six to nine month period. (49)

      The drafters' primary assumption in striking this balance was that "if an association took action to enforce its lien and the unit/parcel owner failed to cure its assessment default, the first mortgage lender would promptly institute foreclosure proceedings and pay the prior six months of unpaid assessments to the association to satisfy the limited priority lien." (50) This would permit the mortgage lender to maintain its priority lien position and convey clear title in its foreclosure sale. (51) The failure of this theory ultimately leads to the non-judicial foreclosure issue that forms the crux of this Note.

   4. The Basics of Non-Judicial Foreclosure

      As stated above, when a property owner defaults on a loan in which the property was collateral, the creditor can foreclose on said property in order to recover the debt owed. (52) In most states, the primary method for creditors to collect their debt involves a process known as non-judicial foreclosure. (53) As the name suggests, non-judicial foreclosure does not require court action. (54) Instead, some minimal level of notice must typically be given to all interested parties before the sale can happen. (55) Once this notice requirement has been fulfilled, the...