By Jeffrey R. Schmitt
On April 12th, Missouri’s highest court granted lenders across the state a victory by ruling that banks only need to give defaulted borrowers, in foreclosure, credit for the amount of the foreclosure bid, as opposed to the fair market value of the property. The ruling is consistent with existing Missouri precedent, which, for decades, has maintained that the sale price of a foreclosed property is determinative with respect to the deficiency owed by the borrower to the bank, which is the remaining balance on the loan for which the lender can sue.
In the case, First Bank v. Fischer & Frichtel, the borrower, Fischer & Frichtel, a Missouri real estate developer, defaulted on loans to First Bank, which then foreclosed on properties securing the loan. First Bank purchased the property at the foreclosure sale. The lender proceeded to sue the borrower for the deficiency balance remaining on the loan. The borrower defended the case by alleging that the proper method of determining the deficiency was not the sale price at the foreclosure sale, but rather, the fair market value of the property. In so doing, the borrower essentially sought a modification of existing Missouri law with respect to calculations for suing on deficiency against a defaulted borrower. Fischer & Frichtel maintained that Missouri should align itself with other states which require a lender to determine the fair market value of the foreclosed property and apply that amount, which is generally higher than the foreclosure price, to the loan balance before suing a borrower.
The borrower argued that the current law often grants lenders a windfall after a foreclosure. Foreclosure sales require cash buyers on the day of the sale, except that the foreclosing lender can simply bid as a credit against the amount of the indebtedness owed by the borrower. This allows lenders to often easily outbid potential purchasers who may not have cash readily available. If the lenders obtain the properties at a depressed sale price at the foreclosure, they can then resell the property to a third party, in an arms-length transaction, and are entitled to keep any profits from the resale of the foreclosed property, without applying those profits to the borrower’s loan balance.
The Supreme Court disagreed, and struck down the borrower’s attempt to modify the state’s legal precedent, holding that, under the circumstances, the price paid by First Bank at its foreclosure was determinative of the deficiency and the borrower was not permitted to contest that sale price as part of the bank’s suit to recover the balance on the loan. The Court noted several times that this was a commercial loan transaction, with a sophisticated borrower, as opposed to a residential foreclosure, where a homeowner is threatened with the loss of a home and may not have access to credit or other means sufficient to recover their property, either prior to or at the sale. The Court also noted that the borrower had not alleged any irregularities or improprieties with respect to the foreclosure procedures, which, if present, could raise some issue as to whether the misconduct or irregularity led to chilled bidding or a depressed sale price at the foreclosure. The borrower’s case was further damaged by its failure to raise the matter of the sale price in a post-foreclosure suit to challenge the sale, which option it did not exercise, as opposed to raising it as a defense in a lawsuit by the bank for the deficiency.
Finally, the Court hinted that the matter might be better raised with the legislature, in order to change the foreclosure statutes, rather than asking the courts to change the existing method of calculating a deficiency. This method of changing the law was the case in several of the states that, unlike Missouri, dictate that a lender determine the fair market value of the property and deduct that amount from the loan balance.
The Court’s decision was highly anticipated by lenders throughout the state, who can rest assured that their current foreclosure and deficiency practices may be continued in compliance with Missouri law. Despite the borrower’s arguments in this recent case, foreclosures rarely result in substantial windfalls for lenders. Foreclosures, of course, do not occur without a default on a loan, which means the lender starts the process in a compromised position. Even if the lender repurchases the property at the foreclosure sale, the purchase price of the particular piece of property at a foreclosure, even at the fair market value, may be significantly less than the amount of the indebtedness. Lenders are required to incur costs and expenses throughout the foreclosure process and in seeking a deficiency judgment, and if they purchase a property at the foreclosure sale, have the added burden of maintaining and listing the property, which may be distressed as well. Many times, banks never recover a deficiency, or any of its increased expenses, from a borrower because of bankruptcy or the borrower’s mere inability to pay anything further to reduce the debt.
Posted by Attorney Jeffrey R. Schmitt. Schmitt leads the firm’s Title Litigation practice group and practices in commercial litigation including banking, real estate, construction, and other matters for businesses and individuals .
04/19/12 2:48 PM
Filed under Banking and Finance, Litigation, Real Estate | Comments Off