SC Lawyer, January 2009, #3. Prudent Bidding at a Foreclosure Sale.

• Author: By Clifford P. Parson and C. Joseph Roof

South Carolina Lawyer

2009.

SC Lawyer, January 2009, #3.

Prudent Bidding at a Foreclosure Sale

South Carolina LawyerJanuary 2009Prudent Bidding at a Foreclosure SaleBy Clifford P. Parson and C. Joseph RoofThe well-publicized rise in defaults of subprime mortgages has created tempting opportunities to purchase real estate at bargain prices. With foreclosure sales being scheduled on a daily basis, foreclosure attorneys frequently receive calls from clients and others wanting to be walked through the potential pitfalls in the foreclosure bidding process. There are risks, so a potential bidder should learn as much as possible about the property and the process prior to placing the first bid.

A binding contract

In a traditional residential real estate purchase transaction, a willing buyer and a willing seller enter into a negotiated contract that customarily provides that the buyer may terminate the contract if the results of a property inspection or title examination are not satisfactory. At a foreclosure sale, the final highest bid creates a binding contract on the terms set forth in the Notice of Sale regardless of defects in the physical condition of the property or the title. Although masters-in-equity and special referees are unlikely to compel compliance with a bid, the bidder runs the obvious risk of forfeiting a significant deposit since the high bidder has no right to terminate the contract. If the successful bidder refuses to close due to the physical condition of the property or the status of the title to the property, the selling court may have the technical right to hold the bidder to the contract and seek to recover all damages incurred due to the bidder's default. Failure to timely comply with the bid may render the sale subject to attack. FNMA v. Brooks, 304 S.C. 506, 405 S.E.2d 604 (Court of Appeals - 1991). Consequently, before making a bid that ultimately could create a binding contract with no good exit options, a prudent bidder should consider several issues.

Title issues

Although a foreclosure sale may satisfy certain debts encumbering the property, the sale does not necessarily satisfy all such debts and will not cure other preexisting or superior liens or title defects. Property at a foreclosure sale is sold subject to all prior or senior liens and encumbrances. If, for example, the mortgage being foreclosed is a second-lien mortgage, the high bidder will take title to the property subject to the first-lien mortgage. Also, if a property owner has defaulted on a mortgage, there is high probability that the owner has defaulted on other obligations, giving rise to the possibility of judgment liens against the owner that could (depending upon time of entry) take priority over the mortgage being foreclosed. This is more likely in the foreclosure of a second mortgage. Further, even if the mortgage being foreclosed was recorded prior to other liens, the other liens may be superior and may survive the foreclosure if the mortgage being foreclosed was subordinated to the later lien, or if the later lien has "super" priority status (such as a tax lien). Additionally, the lender whose mortgage is being foreclosed may not have had the title to the property carefully searched when making the loan, and the title may be subject to a serious, or even fatal, title defect; alternately, the lender may have known of the defect and obtained a lender's title insurance policy insuring the lender against loss resulting from the title defect. In either event, the foreclosure will not cure such a defect, the bidder will take title subject to such defect, and the bidder may find that he or she cannot obtain an owner's title insurance policy insuring against the defect because an owner's policy is usually subject to more stringent underwriting criteria than a lender's policy. Finally, as mentioned above, the foreclosed property will be sold subject to unpaid taxes, so any title search also should include a detailed review of the property tax records. Prior to bidding, a prudent bidder will examine the title to the property to determine what liens and encumbrances exist against the property and which, if any, survive the foreclosure. A purchaser not a party to the action becomes a party as a purchaser at the sale and is assumed to have notice of all things disclosed by the record, especially the terms and conditions of the decree of sale. Ex parte Hutto et. al. v. Hutto et. al., 185 S.C. 283, 194 S.E. 15 (1937).

Procedural issues

Foreclosure sales must be conducted in strict compliance with detailed procedures imposed by court order and statute. Rule 71 and Ex parte Moore, 352 S.C. 508, 575 S. E. 2d 561 (2003). If the proper procedure is not followed, the successful bidder may become embroiled in litigation, with the former owner claiming ownership of the property or with a lienholder claiming its lien was not extinguished due to the failure of the foreclosing mortgagee to follow one or more of the required procedures. Therefore, any title examination should include an investigation into compliance with the complicated procedures mandated by all applicable rules and statutes. While SCRCP 71 succinctly summarizes the proceedings for judicial sales, it generally defers to those processes "required by law" so as to avoid running afoul of unaltered rules and cases.

Environmental issues

Beyond the physical condition of the property being foreclosed, a prudent bidder will be concerned about the environmental condition of the property, something not generally ascertainable by a brief visit to the property prior to the sale. Under current law, owners of real property with environmental contamination may be liable for the costs of cleaning up the contamination regardless of whether the owner caused the contamination or knew of it at the time the property was purchased. The law generally exempts an "innocent owner" from clean-up liability for certain types of contamination, but the term "innocent owner" is a demanding, statutorily defined term and the owner must (among other things) have made "all appropriate inquiries" by having a qualified person investigate the property for the possible existence of contamination prior to purchase. Some of this investigation will involve a review of the public records, but an on-site examination also is required. This may not be possible when purchasing at a foreclosure sale due to the lack of legal access to the property and the structures located thereon prior to closing. An interested bidder should consult an attorney with expertise in environmental issues to evaluate the steps that may be taken and what risks are involved.

The holdover owner

Once the successful bidder has closed on the purchase, it's not always smooth sailing. Often, owners who have been the subject of a foreclosure, having essentially nothing to lose, no desire to leave their home, and no reason to take care of the property, will not willingly vacate. If the previous owner rented the property to tenants prior to the foreclosure, the tenants may also have no motivation to vacate or maintain the property. The foreclosure purchaser is then left with the unenviable task of evicting the occupants through legal proceedings. This can be costly and time-consuming, delaying the purchaser's ability to access the property to inspect its physical condition and begin desired renovations, while giving the disgruntled occupant more time in which to damage the property. Quick and decisive legal action is required to gain exclusive possession of the property.

Conclusion

The subprime lending situation has resulted in the possibility of purchasing desirable residential properties for "fire-sale" prices at foreclosure sales. In order to protect against the risks discussed above, a prudent bidder interested in buying property at a foreclosure sale will, prior to making a bid, spend the time and money necessary to conduct, to the extent possible, the same investigations conducted by buyers in traditional real estate purchase transactions. Otherwise, the bidder may not get the anticipated bargain. Foreclosure sales may call for the clearest application of caveat emptor.