Molly F. Jacobson-greany, Setting Aside Nonjudicial Foreclosure Sales: Extending the Rule to Cover Both Intrinsic and Extrinsic Fraud or Unfairness

• Publication year: 2011

SETTING ASIDE NONJUDICIAL FORECLOSURE SALES: EXTENDING THE RULE TO COVER BOTH INTRINSIC AND EXTRINSIC FRAUD OR UNFAIRNESS

Molly F. Jacobson-Greany^*

PREFACE ........................................................................................................ 141

INTRODUCTION .............................................................................................. 143

I. THE STATUTORY GROUNDS FOR NONJUDICIAL FORECLOSURE

SALES ................................................................................................. 144

II. THE NONJUDICIAL FORECLOSURE PROCESS IN GENERAL .................. 145

III. THE THREEFOLD PURPOSE BEHIND STATUTORY NONJUDICIAL

FORECLOSURE SCHEMES .................................................................... 150

IV. GROUNDS FOR SETTING ASIDE NONJUDICIAL FORECLOSURE SALES .. 151

A. Statutory Rules Relating to the Set Aside of Nonjudicial

Foreclosure Sales ....................................................................... 152

B. The Common-Law Rule Governing the Set Aside of

Nonjudicial Foreclosure Sales ................................................... 154

C. The Existing Rules Requiring Intrinsic Irregularity Pose

Significant Problems for Debtors ............................................... 156

V. IN A MAJORITY OF STATES, THE PLAIN LANGUAGE OF THE COMMON-LAW RULE DOES NOT PRECLUDE ITS APPLICATION IN SITUATIONS INVOLVING EXTRINSIC FRAUD ....................................... 160

VI. EXTENDING THE RULE MAKES SENSE BECAUSE COURTS OF EQUITY DO NOT ALLOW WRONGDOERS TO PROFIT FROM THEIR WRONGS IN OTHER SITUATIONS ......................................................... 161

VII. SETTING ASIDE NONJUDICIAL FORECLOSURE SALES DUE TO EXTRINSIC FRAUD OR UNFAIRNESS MAKES SENSE BECAUSE COURTS OF EQUITY ALREADY SET ASIDE JUDGMENTS OBTAINED

BY EXTRINSIC FRAUD OR MISTAKE .................................................... 164

VIII. EXTENDING THE RULE COMPORTS WITH THE POLICY OF PROTECTING DEBTORS FROM THE WRONGFUL LOSS OF THEIR PROPERTY .......................................................................................... 167

IX. EXTENDING THE RULE TO INCLUDE EXTRINSIC FRAUD WOULD NOT DIMINISH THE PROTECTIONS AFFORDED TO BONA FIDE PURCHASERS TO PROVIDE FINALITY IN SALES ................................... 171

X. ALTHOUGH AN EXTENSION OF THE RULE MAY AFFECT THE

CREDITOR'S ABILITY TO HAVE A QUICK AND INEXPENSIVE REMEDY, AT LEAST TO SOME DEGREE, THE COURTS SHOULD ALLOCATE THIS RISK TO THE CREDITOR ............................................ 174

CONCLUSION .................................................................................................. 179

ABSTRACT

Twenty-nine states have enacted statutes allowing lenders to foreclose on a mortgage or deed of trust privately, under power of sale, without filing a lawsuit. These sales are wholly devoid of judicial oversight. Debtors who encounter irregularities or fraud in the sale process can seek to set the sale aside after it has already taken place. However, courts will only vacate the sale if the irregularities or fraud are intrinsic to the sale process itself, such as when collusive bidding takes place at the auction. This limitation poses significant problems for debtors who encounter irregularities or fraud outside the strict confines of the sale proceeding. The problem is especially relevant for debtors who need to refinance to avert the sale. Courts should extend the current rule to include situations of extrinsic fraud or unfairness for a number of reasons. Although an extension of the rule may theoretically pose some problems for creditors, the problems would likely not materialize. Moreover, in balancing the interests of creditors, debtors, and bona fide purchasers, it would be fairest to allocate the risk to creditors.

PREFACE

Imagine that you own a parcel of property that has been in your family for a hundred years. It consists of fifteen acres, formerly surrounded by orchards, in the heart of a sprawling urban area. You lease the real property to a tenant who has constructed a mobile home park on the property with your permission. The tenant, a sophisticated business person, runs the mobile home park and pays rent on the ground lease every month.

Five years ago, you borrowed $700,000 from Bank A when you needed money for unrelated business projects, and you pledged the real property as collateral. Now you are having some cash flow problems and you are behind in your payments to the bank.

Bank A has started nonjudicial foreclosure proceedings and has set a date for the trustee's sale, which will occur in thirty days. But you're not worried because the property is worth $2 million encumbered by a ground lease and

$10 million without it. You have good credit, sufficient equity in the property to use it as collateral for a new loan, and a good business relationship with the commercial loan officer at Bank B.

You decide to refinance the property at a much lower interest rate to pay off the existing mortgage that is currently in default. The refinance will give you lower monthly payments that you can manage with your current cash flow situation. You apply for a loan at Bank B, which conditionally approves your loan. The timeframe is tight, so escrow will close the day before the scheduled auction. The escrow agent will release the appropriate funds to Bank A on that same day. Bank A will cancel the sale upon receipt of those funds.

You will avoid the foreclosure sale and keep your family property if you get this new loan. Bank B has set just one condition for final approval of your loan. All you need is a Tenant Estoppel Certificate signed by your tenant to confirm the existence of a lease and the amount of the monthly rent payments.¹

By the time you receive notice of this condition, the auction is ten days away.

You personally deliver the Tenant Estoppel Certificate to your tenant and ask him to sign it. The sale is nine days away. The tenant knows that you need the certificate to get the loan. He also knows that you need the loan to avoid the trustee's sale. You are not very concerned because the lease obligates the tenant to sign such a certificate. It seems like an innocuous request.

But, unbeknownst to you, the tenant wants you to lose the property at auction. The tenant wants to buy it. He knows a lot about real estate. He knows that he can buy the property cheaply at the auction, perhaps for sixty percent of its fair market value. So the tenant stalls in completing the certificate and tries to force the auction. But, all the while, he feigns pleasant cooperation to avoid raising suspicion.

The tenant tells you that he needs to send the Tenant Estoppel Certificate to his lawyer for review before he can sign it; he really wants to help and will work as fast as he can; he cannot get in touch with his lawyer but will keep trying; his lawyer wants to make some changes but the tenant does not know what they are; he understands your situation and will sign the certificate as soon as his lawyer approves. Almost a week passes and the sale is nearing. Escrow is supposed to close soon. You continue to follow up with your tenant.

You have known your tenant for twenty years. You are on friendly terms and know many of the same people. You have no reason to doubt his sincerity. You are confident that you will receive the document in time to close escrow. Bank B promises to fund the loan if it receives the Tenant Estoppel Certificate on or before the escrow date.

After more than a week of promises, just two days before the sale, the tenant leaves you a message stating that he has signed the Tenant Estoppel Certificate. Relieved, you call the tenant to ask when you can get it. The tenant does not answer the phone or return any of the multiple messages that you leave in the next twenty-four hours. The tenant is not at the property when you visit. In fact, the tenant never signed the estoppel certificate and has disappeared.

Frantic, the next morning, an hour before the sale, you and your lawyers make numerous attempts to locate your tenant. You also try unsuccessfully to

Agreements, in Commercial Real Estate Leases: Selected Issues in Drafting and Negotiating in Current negotiate with Bank A and Bank B for more time. Unfortunately, the sale takes place as scheduled. Your tenant was the only bidder who appeared at the sale. He purchased the property for a mere $700,000 (just seven percent of its unencumbered value).²

What can you do? Can you file a lawsuit to set the sale aside and reclaim your family property? Can you convince a court that your tenant's conduct is the kind of "fraud" or "unfairness" that would warrant a set aside of the sale? Probably not. The court will likely refuse to set the sale aside because the fraud or unfairness took place outside the sale proceedings themselves.

INTRODUCTION

This Article examines the distinction between intrinsic and extrinsic fraud or unfairness as a basis for setting aside nonjudicial foreclosure sales.³The Article focuses on situations where the wrongdoer committing the fraud or unfairness ultimately purchases the property at auction.

As a general rule, courts have been persuaded to set aside nonjudicial foreclosure sales when they involve fraud or unfairness intrinsic to the sale itself. Courts have declined to set sales aside when the fraud or unfairness occurs "dehors" the sale proceeding.⁴"Dehors" means "'out of; without; beyond; foreign to; unconnected with.'"⁵Not one reported case involves the set aside of a trustee's sale based on fraud or unfairness that affected the sale but occurred outside the limited confines of the sale proceedings.

The first part of this Article identifies the problem confronting debtors who have lost real property at a nonjudicial foreclosure sale due to fraud or unfairness that occurs outside the sale proceeding itself. The Article begins by briefly describing the statutory grounds for nonjudicial foreclosure sales and, in general terms, the...