Foreclosures-by-Lawsuit Likely to Increase Following New Supreme Court Decision

 

Residential foreclosures in Washington probably just became more difficult and expensive for lenders.

In a usual foreclosure, when the borrower stops paying the mortgage, the lender directs a third-party “trustee” of the deed-of-trust (mortgage) to go through the foreclosure process.  This process rarely involves the courts.  Instead, there is a “non-judicial” process under Washington law, under which the trustee (a) notifies the borrower of the foreclosure proceedings, (b) gives the borrower an opportunity to bring the loan current, then (c) sells the property on the courthouse steps if the borrower does not bring the loan current.  Many lenders around the country have hired a company called Mortgage Electronic Registration System (“MERS”) to direct trustees to perform such non-judicial foreclosures, rather than the lenders themselves directing the trustee to perform the non-judicial foreclosure.

But in the recent decision Bain v. Metro. Mortg. Group Inc., the Washington Supreme Court ruled that MERS does not have the legal authority to appoint a trustee to foreclose deeds-of-trust in this usual non-judicial manner.

What will be the effect of the Bain decision?  Since it was only issued on August 16, its actual effect in the market is still unknown.  But the decision will certainly create a large amount of uncertainty about how to complete a non-judicial foreclosure involving MERS, or in some cases, whether a non-judicial foreclosure can legally be done at all.

Bain likely means many more lenders will opt to foreclose “judicially,” which is a foreclosure-by-lawsuit procedure.  In a judicial foreclosure, the lender sues the borrower directly, asking the court to order the Sheriff to sell the property.  Unfortunately for defaulting homeowners, this judicial foreclosure process also allows the lender to seek a “deficiency judgment,” i.e. a money judgment against the homeowner for the amount the lender is still owed after the sale of the property.  If such deficiency judgments are taken against homeowners, lenders can engage in involuntary collection procedures, such as garnishment of homeowners’ wages and bank accounts and seizure/sale of the homeowners’ other real estate.  This is a major departure from the non-judicial foreclosure process, which precludes the foreclosing lender from obtaining a deficiency judgment.

The chief downside of deficiency judgments for lenders is twofold: First, after the Sheriff sells the property, the lender has to give the homeowner one year to “redeem,” i.e. bring the loan current; whereas if the lender waives its right to the deficiency judgment, it only has to give the borrower eight months to redeem.  Second, the average defaulting homeowner has historically been broke, so a deficiency judgment would likely net very little cash recovery.

But in the current market, many people are “strategically” defaulting, meaning they have the ability to pay the mortgage, but have made the business decision to quit paying given the real estate market.  Deficiency judgments might well be attractive to banks foreclosing on strategically-defaulting homeowners because (a) it costs the bank only a little more time and money to obtain the deficiency judgment versus waiving it and (b) most strategically-defaulting homeowners will have the ability to pay some or all of the deficiency, either before or after the judgment is taken.

Before the Bain decision, judicial foreclosures were usually slower and more expensive for lenders, causing them to usually opt for the non-judicial process.  But given the difficulty and uncertainty Bain creates for lenders, expect to see an increase in judicial foreclosures and deficiency judgments.

Beresford Booth (425.776.4100), www.beresfordlaw.com

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