Property

Fact pattern

A owns a tract of land known as Whiteacre. In Year One, A mortgages Whiteacre to a local bank for $600,000. The first mortgage contains a clause allowing the bank to make additional advances to A throughout the life of the mortgage, on the same terms as the initial loan. The bank is not required to make these advances, but has discretion to do so upon A’s request. The bank properly records this mortgage in the appropriate government records office as required by law

In Year Two, A takes out a second mortgage on Whiteacre for $200,000 through a local credit union. The credit union properly records the second mortgage in the appropriate government records office, as required by law. 

In Year Three, A asks the bank for an additional advance of $100,000, which the bank provides. When the bank makes this advance, it is aware of the second mortgage on Whiteacre. 

In Year Four, A sells Whiteacre to B, who is aware of the two mortgages on the property. A does not pay any of the mortgage debt with the sale proceeds, nor does B assume any of A’s debt.  Neither the bank nor the credit union releases its mortgage on Whiteacre. B thus takes Whiteacre subject to both mortgages. 

In Year Five, A defaults on both the bank loan and the credit union loan. The bank forecloses on Whiteacre, and a third party buys Whiteacre at the foreclosure sale for $600,000. The fair market value of Whiteacre at the time of the sale is $625,000.

The applicable law includes the following statute: 

Deficiency: 

(a) Upon the sale of any real property at foreclosure, each creditor with a security interest in the property may recover against the debtor for any deficiency remaining after the foreclosure sale. 

(b) Each creditor’s total recovery is limited to the difference between the debt owed to that creditor at the time of the foreclosure sale and the fair market value of the property at the time of the foreclosure sale.

At the time of the foreclosure sale, A owes the bank $600,000, which consists of $500,000 remaining on the initial bank loan, plus $100,000 remaining on the additional advance made by the bank. At the same time, A’s balance due on the credit union loan is $150,000. The costs associated with the foreclosure sale, including attorney’s fees, total $5,000.

Questions

1. How should the foreclosure sale proceeds be distributed? Explain.
2. In the absence of the deficiency statute, what liabilities will A and B, respectively, have on the loans after the foreclosure sale proceeds are distributed? Explain.
3. If the deficiency statute is applied, what liabilities will A and B, respectively, have on the loans after the foreclosure sale proceeds are distributed? Explain.