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What Does a Senior Lienholder Get When a Junior Lienholder Forecloses?

What does a senior lienholder get when a junior lienholder non-judicially forecloses on the property and the sale results in “surplus funds” that exceed the amount of the junior lien?

Nothing.  But it doesn’t lose anything either.

A recent opinion published by California’s First Appellate District — MTC Financial, Inc. v. Nationstar Mortgage — explains.

Facts

The borrower obtained two loans, each secured by a deed of trust on real property located in Hercules, California.  One loan was a single family mortgage in the amount of $205,080; the other was a home equity line of credit for $15,000.  Both deeds of trust were recorded in the county recorder’s office at the same time on the same date, with the first sequential instrument number given to the equity line and the second number given to the mortgage.  The deeds of trust themselves did not identify themselves as a “first” or “second” lien.

After a series of transfers, the equity line was assigned to Bank of New York Mellon, and the mortgage was assigned to Nationstar.

The borrower defaulted on the equity line, and the trustee conducted a non-judicial foreclosure sale, which generated proceeds of $105,000.  After payment of all funds due to Bank of New York Mellon and the fees and costs of sale, a surplus of $75,085.50 remained.

Three parties claimed entitlement to the surplus: the borrower, the homeowners’ association, and Nationstar.  The trustee deposited those funds with the court and initiated a lawsuit to have the court resolve the conflict between the claimants to the surplus funds.  The trustee asserted that because the same lender made the two loans, the equity line should be treated as a second, and the mortgage as a first.

After a hearing, the trial court ordered $13,572.79 to be distributed to the homeowners’ association, and the remainder to the borrower.  The court held that Nationstar, as a senior lienholder, was not entitled to any of the proceeds of the sale.

Nationstar appealed.

Court of Appeal’s Holding

The Court of Appeal affirmed.

The court referred to Civil Code section 2924k, which sets forth the formula governing the distribution of trustee sale proceeds — generally to: (1) costs and expenses of the sale; (2) payment of the obligation secured by the deed of trust which is the subject of the sale; (3) satisfaction of any junior liens in order of priority; and (4) the trustor (usually, the borrower).

The senior lienholder, the court held, is not entitled to any of the sale proceeds because the property is purchased at the sale “subject to” the first deed of trust.  That means that while the senior lienholder receives no proceeds from the sale, the senior lien remains fully intact on the property and becomes the problem of the property’s new owner.

The court held that Nationstar held the senior lien.  Priority is normally determined by the “first in time, first in right” rule, but that rule was not determinative here because both deeds of trust were signed and recorded at the same time.  The different instrument numbers were not significant because both deeds of trust were submitted and recorded at the same time on the same date — “the order in which they are indexed is not determinative of priority.”

The court held that the trial court correctly relied on the “apparent intent of the parties” to determine priority.  If the loans were made by different lenders, the liens probably would have had equal priority.  But because the lender was the same for both loans, the lender’s “reasonable expectation” was that the larger loan would be secured in first position.  The court also observed that equity lines are traditionally junior to mortgages.

Finally, the court rejected Nationstar’s argument that the distribution of sale proceeds resulted in “prejudice” to Nationstar or a “windfall” to the borrower.  Nationstar’s senior lien presumably still attached to the property.  And for the borrower who had lost the property, recovering a net $60,000 from the sale proceeds was no windfall.

Lesson

When a junior lienholder forecloses, a senior lienholder recovers nothing from the sale proceeds.  But the senior lien remains intact and the foreclosure buyer takes title to the property subject to the senior lien.

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