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Navigating through foreclosure law complexities.

Lenders can avoid some foreclosure pitfalls if they have a working familiarity with the finer points of state foreclosure law.

Particularly in these times, with the economy performing so poorly and unemployment remaining stubbornly high, mortgage lenders would be wise to become more familiar with the legal procedures involved in foreclosing on real estate collateral. Being familiar with these legal procedures will help a lender communicate in a more meaningful way with legal counsel and hopefully help to avoid the pitfalls and costs associated with mortgage foreclosures. This article addresses some of the fundamental issues involved in foreclosing on real estate in the state of Pennsylvania.

Mortgage foreclosure lawsuit vs. lawsuit under the note

In standard loan documentation, the borrower signs a note, whereby the borrower promises to repay the loan. The borrower also signs a mortgage, whereby the borrower gives the lender a lien on the homeowner's property, which can be foreclosed if the individual fails to pay the loan. Accordingly, the note represents the borrower's promise to pay and the mortgage represents the lender's security for the borrower's promise to pay. Because the lender holds both a note and a mortgage from the borrower, the lender faced with a delinquent loan must decide whether to sue under the note or to sue under the mortgage (i.e., foreclose the mortgage).

If the borrower or any guarantor has personal liability for the loan, or if the mortgage encumbers multiple parcels of real estate located in different counties, a lender will almost always be better off suing under the note because of Pennsylvania's Deficiency Judgment Act.

Pennsylvania's deficiency judgment procedures provide that if the lender is the successful bidder at the sheriff's sale for the property and then wants to pursue the borrower or any guarantors personally after the sale has occurred, the lender must first petition the court to fix the fair market value of the real estate in question. Under this procedure, the court will determine the fair market value of the property sold at sheriff's sale and the value determined by the court will be deducted from the sum owed to the lender.

The petition to fix fair market value must be filed within six months of the date of delivery of the sheriff's deed (although it would be more prudent to file it within six months of the actual sale.) This procedure, which is set forth in Pennsylvania's Deficiency Judgment Act, is designed to prevent the lender from obtaining a windfall. Such a windfall could arise if the lender obtained title to the mortgaged property at sheriff's sale (which might be worth the amount of the outstanding loan), and then pursued the borrower personally for the unpaid loan without giving the borrower credit for the value of the property sold at sheriff's sale.

The Pennsylvania courts have held that prior to filing a petition to fix fair market value, the lender must have first obtained a "personal judgment" against the borrower. Only a lawsuit based on the borrower's liability under the note will result in such a personal judgment. A mortgage foreclosure lawsuit will not result in a personal judgment. Accordingly, a major advantage of the lawsuit based on the borrower's liability under the note is that it results in a personal judgment.

If the lender's mortgage encumbers separate parcels of real estate located in a number of different counties, and the lender acquires one of the parcels at a sheriff's sale, the lender must also petition to fix fair market value prior to holding a sheriff's sale on the next parcel of real estate. This is because Pennsylvania's Deficiency Judgment Act requires an "accounting" of the value of the mortgaged real estate purchased by the lender at foreclosure sale prior to allowing the lender to pursue the subsequent foreclosures. As previously mentioned, this procedure is designed to prevent the lender from obtaining a windfall in foreclosing on the initial parcel of property, which might be worth the outstanding amount of the loan, but then pursuing sheriff's sales against the other encumbered real estate without giving the borrower credit for the property previously sold at sheriff's sale.

A successful lawsuit under the note also has the advantage of resulting in a lien on all of the borrower's real property in the county where a judgment is entered, or any county where the judgment is transferred. A judgment in a mortgage foreclosure lawsuit will not result in a lien on any property other than the mortgaged property.

Advantage of a mortgage foreclosure lawsuit

If the borrower has transferred the mortgaged property following the original loan closing, there is at least one distinct advantage to bringing a mortgage foreclosure lawsuit in lieu of a lawsuit on the note. In a mortgage foreclosure lawsuit, the lender may refrain from naming the original borrower in the foreclosure complaint if the lender expressly releases the original borrower from all liability for the debt secured by the mortgage. This is extremely helpful if the original borrower is involved in bankruptcy proceedings.

Confession of judgment

A variation of a lawsuit under the note is the confession of judgment lawsuit for money, which allows the lender to immediately obtain a judgment against the borrower. However, a lender can only confess judgment for money against a defaulting borrower if the loan documents expressly authorize the confession of judgment procedure, which is common for commercial loan documents in Pennsylvania.

With a confession of judgment, judgment is obtained immediately by the lender against the borrower without any adversary proceeding and the burden is on the borrower to challenge the judgment. One of the major benefits of the confession of judgment is that the lien of the judgment and any proceedings to enforce the lien (for example, a sheriff's sale of the mortgaged property and/or seizure of the borrower's bank accounts) will continue without interruption while any proceedings instituted by the borrower to challenge the judgment are pending. This is the case unless a stay is granted to the borrower by the court. Consequently, with a confession of judgment, it is theoretically possible to conduct the sheriff's sale prior to a court ever deciding the validity of a borrower's challenge to the "foreclosure" proceeding.

Lenders should be aware that there are restrictions against using confessed judgments to execute against residential real estate (one to two units), and legal counsel should be consulted prior to pursuing this course of action.

In summary, the confession of judgment procedure has the advantage of being fast, and because it is a variation of a lawsuit based on the note, it also has the advantage of resulting in a personal judgment.

Sheriff's sales notice

Once judgment against the borrower is obtained, the lender must comply with specific notice and advertising requirements before a sheriff's sale can be held. The Pennsylania rules require advertising in each of the three weeks prior to the sale, posting notice on the property and written notice to all parties having any record lien, any record interest or any other interest of which the judgment creditor has knowledge.

The general rule for lenders bidding on property being sold at a sheriff's sale is that the foreclosing lender should bid up to an amount equal to the lesser of (1) the fair market value of the property (determined by a recent appraisal) or (2) the sum of (a) the amount of the lien in question plus (b) all prior liens to be divested by the sale plus (c) costs. Note that under clause (2) of this formula, one cannot determine the maximum amount to bid without being certain of the priority of any potentially intervening liens.

The formula in the previous paragraph is designed so that the lender will keep bidding until the bidding reaches a point that will generate proceeds to the lender equal to the outstanding amount due under the loan. However, in any case, the lender will not normally bid higher than fair market value, because if it is the successful bidder at the sale, it cannot hope to obtain more than fair market value on a resale.

It is important for a lender to distinguish between the issue of whether a particular lien is divested at a sheriff's sale, as opposed to whether a particular lien is a superior lien for purposes of distribution of proceeds from the sale. The failure to distinguish these two concepts may result in the lender making erroneous bidding calculations. As noted, a lender in Pennsylvania should only take into account other liens in its bidding calculation if such other liens are both prior to the lender's lien and such other liens will be divested by the sale. Of course, prior liens that are not divested by the sale must be taken into consideration for the purpose of computing fair market value. Legal counsel should be consulted in connection with bidding calculations in any case where a prior lien is involved.

Transfer tax

Lenders should not forget the possibility that the transfer of title for the mortgaged property pursuant to a sheriff's sale may be subject to transfer tax. The Pennsylvania transfer tax statute exempts the lender from the tax if it is the successful bidder at the sale and the grantee on the sheriff's deed. (That is, a tax will be imposed if the lender's successful bid is assigned to an affiliate or a third party.) However, the transfer tax imposed by the city of Philadelphia is still due even if the lender acquires the property, unless the lender was the seller of the property that provided financing to the purchaser.

As the above discussion indicates, mortgage foreclosures are fraught with legal complexities. However, mortgage lenders who recognize the basic issues involved will be more likely to ask their attorneys the right questions and successfully avoid some of the pitfalls lurking in this area.

Robert A. Silverman is a partner in the Philadelphia law firm of Wolf, Block, Schorr and Solis-Cohen, practicing in the firm's Real Estate Department and Workout Group. Seth D. Geldzahler is an associate in the firm's Real Estate Department.
COPYRIGHT 1992 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Author:Silverman, Robert A.; Geldzahler, Seth D.
Publication:Mortgage Banking
Date:Feb 1, 1992
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