Bid Evaluation
§ 13.1Introduction to Bid Evaluation
Prior to bidding at a nonjudicial foreclosure sale, a mortgagee or third-party bidder must determine how much to bid based on the value of the collateral in light of factors such as the condition of the improvements on the mortgaged property, occupancy of the mortgaged property, casualty damage to the mortgaged property, environmental issues, the priority of the lien being foreclosed, and other exceptions to title based on recorded documents. This process of formulating a strategy for bidding at a foreclosure sale is more challenging for a third-party bidder than the mortgagee. Based on its underwriting practice and loan servicing, the mortgagee has significant information about the mortgaged property. A third-party bidder is usually confined to public records and viewing the property from a location away from the mortgaged property.
§ 13.2Bidder Checklist and Considerations
This section addresses issues to be considered by the foreclosure bidder when formulating a strategy for bidding at a foreclosure sale.
§ 13.2:1Mortgagee vs. Third-Party Bidder
The mortgagee and third-party bidder have the same legal rights as a purchaser at a nonjudicial foreclosure sale. Their positions, however, are not comparable. The mortgagee as lender has funded a loan secured by the property. Prior to making the loan, the lender has underwritten the loan to determine the creditworthiness of the borrower and any guarantors and the value of the property. The lender obtains a title commitment, which is reviewed and approved, in order to obtain a loan policy insuring its lien position upon closing the loan. Prior to closing of the loan and throughout the loan term, including upon an event of default, the lender often has the right to inspect the physical condition of the property and to review inspection reports, service contracts, and leases. The mortgagee, through its loan documents, imposes on the borrower the obligations to maintain the property and complete any mortgagee-required repairs, pay the ad valorem taxes and insurance premiums, and deliver operating statements and other information relating to the property. Upon an event of default and prior to directing the trustee to conduct a foreclosure sale, the mortgagee will take additional steps, such as obtaining a current title run, appraisal, and inspection and environmental reports. Armed with this information, the mortgagee will formulate a strategy for bidding at the foreclosure sale.
A third-party bidder will learn about the public sale when notice of sale is posted at the courthouse and filed with the county clerk, stating that the property will be sold at public auction on the first Tuesday of the month no sooner than twenty-one days from the date of the posting and filing of the notice. Tex. Prop. Code § 51.002(b). In addition, the county will post the date, time, and location of the sale on the same website page as the posted notice. Tex. Prop. Code § 51.002(f–1). The borrower, mortgagee, and trustee are not required to give any information to third parties interested in bidding at the public auction.
The mortgagee has the option to obtain a pre-foreclosure appraisal when formulating a strategy for bidding at foreclosure. The mortgagee has several reasons for taking this step. The mortgagee must determine whether there is sufficient equity in the property to justify the expense of foreclosing and likely being the high bidder at the foreclosure sale. The mortgagee must also determine the property’s anticipated “holding time” and resale costs. This analysis assists the mortgagee in determining the price at which the mortgagee would sell its note or stop bidding at a foreclosure sale to let a third party acquire the property, assuming there are third parties interested in purchasing the note or bidding at the foreclosure sale. A mortgagee foreclosing a subordinate lien must consider the amounts of all prior liens. A subordinate lienholder typically bids the market value of the property less the balance owed on prior liens. All mortgagees must consider the amounts of delinquent or accrued property taxes which will remain on the property after foreclosure when formulating their bid strategy. See section 13.5 below for a discussion of prior liens and section 13.6 below for a discussion of wraparound secured debt.
A mortgagee has no duty to provide the mortgagor with a copy of the mortgagee’s appraisal unless the mortgagee agrees to provide the appraisal in the loan agreement documents. See Everson v. Mineola Community Bank, S.S.B., No. 12-05-334 CV, 2006 WL 2106959, at *2 (Tex. App.—Tyler July 31, 2006, pet. denied) (mem. op.). The mortgagee’s appraisal will be subject to discovery in postforeclosure litigation.
Ordering an appraisal should be one of the first steps in the process of formulating a bid strategy. See form 13-1 in this chapter for a letter engaging an appraiser.
A third-party bidder has the same issues as the mortgagee with respect to determining the value of the mortgaged property, but is not in a position to obtain an appraisal of the mortgaged property. Without access to the mortgaged property or information about the condition of the mortgaged property, a third-party bidder may obtain a “broker’s opinion of value” using information based on comparable sales of similar property.
The Texas Occupancy Code defines “broker” to include persons who provide estimates of worth not constituting an appraisal, but which are provided in the person’s ordinary course of business and are related to the actual or potential acquisition or disposition of an interest in real property. See Tex. Occ. Code § 1101.002(1)(A)(xi).
Importance of Appraisal for Deficiency Suit: An appraisal allows the lender to evaluate in advance whether a suit against the obligor or guarantor could be thwarted under Texas Property Code sections 51.003 through 51.005. The mortgagee runs the risk that the appraiser will appraise the mortgaged property for a higher value than the lender’s expectations. This higher value may cause the mortgagee to bid higher than planned at the foreclosure sale or make it more difficult for the lender to defend a bid in a lesser amount than the appraised value in post-foreclosure legal challenges (wrongful foreclosures, bankruptcy actions, or deficiency suits). See section 13.7 below and chapter 17 in this manual.
Selection of Appraiser: Care should be taken in selecting the appraiser, since the appraisal will be discoverable in any subsequent litigation or bankruptcy proceedings. The appraiser should be a good witness. If possible, the appraiser should be a member of a recognized appraisal society, such as the American Institute of Real Estate Appraisers. In some counties, the only expert available may be a real estate broker who will be able to obtain more information from the lender than a third-party bidder as referenced above.
Property Condition: The potential bidder will want to access the mortgaged property to determine the physical condition of the improvements and to confirm that there are no environmental problems associated with the property. While the mortgagee should have a contractual right of access under its deed of trust, the third-party bidder has no right of access to the property. A third-party bidder’s request made to the borrower or lender to inspect the mortgaged property and review the borrower’s or mortgagee’s records as to the property’s condition will likely be denied. A third-party bidder can make inquiries of governmental agencies regarding the existence and current status of permits (such as building permits, certificates of occupancy, code violations history, underground storage tank registrations, and licenses). The mortgagee and third-party bidder should consider having an environmental assessment even if limited to public records. Without assurances that it will be the high bidder, a third-party bidder will want to minimize the costs incurred to obtain information about the property. See section 14.10 in this manual regarding warranties of title and chapter 35 for a discussion of environmental issues.
Property Description and Survey: The mortgagee should review any surveys of the property in its loan files. A survey may indicate encroachments, boundary line conflicts, overlaps, protrusions, and other due diligence information (for example, improvement square footage, parking space count, flood plain lines, appurtenant easements, location of easements, and other encumbrances). The recorded deed of trust may reference the existing survey and thus put a third-party bidder on notice of matters reflected by this unrecorded document. References to a survey in the recorded deed of trust only makes a third-party bidder aware that a survey exists. It does not afford the third-party bidder the opportunity to review the survey. See section 14.10 in this manual regarding warranties of title acquired at foreclosure.
Deed and Title Insurance: The mortgagee has the benefit of its mortgagee title insurance. In Texas, the Loan Policy of Title Insurance provides at Condition 2:
2.Continuation of Insurance. The coverage of this policy shall continue in force as of Date of Policy in favor of an Insured [i.e., the mortgagee] after acquisition of the Title by an Insured or after conveyance by an Insured, but only so long as the Insured retains an estate or interest in the Land, or holds an obligation secured by a purchase money Mortgage given by a purchaser from the Insured, or only so long as the Insured shall have liability by reason of warranties in any transfer or conveyance of the Title. This policy shall not continue in force in favor of any purchaser from the Insured of either (i) an estate or interest in the Land, or (ii) an obligation secured by a purchase money Mortgage given to the Insured.
Texas Department of Insurance, The Basic Manual of Rules, Rates and Forms for the Writing of Title Insurance in the State of Texas, form T-2 (last updated Nov. 1, 2024), available at www.tdi.texas.gov/title/documents/form_t-02.pdf.
The loan policy will convert to an owner’s policy where the lender is the highest bidder at the foreclosure sale. “The coverage of this policy shall continue in force as of Date of Policy in favor of an Insured…” means that the title company will not insure against any claims based on occurrences after the date of the loan policy. For instance, if there is a federal tax lien filed against the property after the date of the policy and it survives foreclosure, the loan policy will not provide insurance coverage for costs incurred to remove the IRS lien.
A third-party purchaser does not step into the position of the lender with respect to its loan policy coverage. A third-party purchaser can purchase an owner’s policy incident to the foreclosure sale. Most underwriters will not provide owner’s title insurance to a foreclosure sale purchaser. The usual practice is for the third-party purchaser to accept the trustee’s deed and not obtain title insurance coverage or obtain an owner’s policy based on a title commitment subject to exceptions for any defect in the foreclosure process and any liens or encumbrances not clearly removed from the property by the foreclosure sale.
Third-Party Bidder’s Title Insurance Checklist: In the event a title underwriter is found that will issue to a third-party bidder an Owner’s Policy of Title Insurance, the following checklist items must be addressed by the third-party bidder: (1) before bidding at the foreclosure sale, a title commitment and pro forma policy with all desired endorsements should be issued and the conditions to a policy’s issuance should be thoroughly reviewed with the underwriter; (2) to the extent available, a copy of the foreclosure sale documents (for example, deed, affidavit, notices, and letters) should be obtained and furnished to the underwriter for its approval before bidding at the foreclosure sale; (3) a list and copy of all documents required by the title underwriter to issue its policy should be obtained, and arrangements should be made for their execution and delivery to the underwriter; (4) a representative of the title underwriter will likely need to be in attendance to witness the foreclosure sale; (5) the means and timing of payment of the title insurance premium to the title underwriter must be confirmed; and (6) acceptable arrangements for timing and delivery to the title underwriter’s representative of the foreclosure sale deed for recording with the county clerk must be made with the trustee. A title commitment for an owner’s policy will include the “survey exception” and exception for “rights of parties in possession” because the title company will not have access to information required to delete these standard exceptions, such as a current survey or certified rent roll. Consequently, a third-party bidder has these added risks and no title insurance to cover them. See section 14.10 in this manual regarding warranties of title acquired at foreclosure, form 4-7 for a letter requesting a title search, and form 4-10 for a letter requesting a search of UCC records.
Recent Construction Activities: If there has been recent construction activity at the mortgaged property, there is the possibility of prior in time constitutional and statutory mechanic’s and materialmen’s liens based upon a time of inception predating the recording of the deed of trust being foreclosed. Tex. Const. art. XVI, § 37; Tex. Prop. Code ch. 53. See sections 4.8 and 4.9 in this manual for a discussion of mechanic’s liens. There is also a risk that an unpaid contractor may be able to assert a superior right to remove “readily removable” fixtures from the mortgaged property. In calculating their foreclosure sale bids, bidders must consider the loss in market value of the mortgaged property if there are subordinate mechanic’s liens that have preferential rights to remove readily removable fixtures. See GCI GP, LLC v. Stewart Title Guaranty Co., 290 S.W.3d 287 (Tex. App.—Houston [1st Dist.] 2009, no pet.). See section 4.9:6 in this manual for a discussion of “removable.”
Tenants and Parties in Possession: The mortgaged property may be occupied at the time of the foreclosure sale by tenants under written or oral leases. A third-party bidder will not have access to the leases and will not be able to determine whether tenants have rights that survive the foreclosure sale. Creditors of tenants may have security interests in removable, tenant-installed fixtures that have priority under Texas Business and Commerce Code section 9.334(d)–(g) over the mortgagee’s lien. See section 15.9 in this manual for a discussion of tenants and their rights in the premises following foreclosure and section 10.9 concerning trespass to try title.
Property Taxes: In determining its maximum bid, a bidder must factor in as a reduction to market value the amount of delinquent property taxes, including interest and penalties, as well as property taxes accrued on the mortgaged property for the current year. A third-party bidder will be able to obtain this information from most taxing authorities’ websites. See chapter 24 in this manual regarding ad valorem tax liens, form 4-8 for a preforeclosure checklist for title update and tax lien search, and form 4-9 for a letter to the taxing jurisdiction to be used by the lienholder.
Prior Liens: If the lien being foreclosed is subordinate to other deed of trust liens, the status of these other liens should be investigated and determined before bidding at the foreclosure sale. The bidder must determine how much equity exists above the balance owing on all prior liens. The bidder must determine whether it will have the option to continue making payments on the prior lien loans or will be forced to pay off one or more of these liens. See section 4.11 in this manual for a discussion of junior liens.
Attendance: Trustees are not obligated to make any agreements or representations to a third-party bidder. With this understanding, the third-party bidder may contact the trustee and ask for information about the time of sale, who will be conducting the sale, and whether a substitute trustee will be appointed to conduct the sale. If possible, the third-party bidder should plan to meet the trustee in advance of the sale. Regardless of any agreements with the trustee, a third-party bidder should be at the location of the public sale well in advance of “the earliest time at which the sale will begin” set out in notice of sale under Tex. Prop. Code § 51.002(b). See form 14-2 announcing reasonable terms for a foreclosure sale. See section 14.10:4 for a discussion of the status of a foreclosure sale purchaser and inadvertent warranties by trustee or mortgagee.
Method of Bid Payment: Although Texas Property Code section 51.002 does not provide that the sale be for cash, most deeds of trust require that the sale be to the “highest bidder for cash.” This contractual requirement has been upheld. See Kirkman v. Amarillo Savings Ass’n, 483 S.W.2d 302, 308–09 (Tex. App.—Amarillo 1972, writ ref’d n.r.e.). Pursuant to Texas Property Code section 51.0075(f), the purchase price for a foreclosure sale is “due and payable without delay on acceptance of the bid or within such reasonable time as may be agreed upon by the purchaser and trustee.” Tex. Prop. Code § 51.0075(f).
A prospective bidder must be prepared to tender cash at the sale if cash is required by the deed of trust and the trustee. The trustee is not required to accept a credit bid but may extend credit to selected buyers. Valley International Properties v. Ray, 586 S.W.2d 898, 901 (Tex. App.—Corpus Christi–Edinburg 1979, no writ); French v. May, 484 S.W.2d 420, 425 (Tex. App.—Corpus Christi–Edinburg 1972, writ ref’d n.r.e.). Absent a contractual requirement for cash, cashier’s checks are acceptable. Wertz v. Richardson Heights Bank & Trust, 495 S.W.2d 572, 574 (Tex. 1973); Humble National Bank v. DCV, Inc., 933 S.W.2d 224, 237–38 (Tex. App.—Houston [14th Dist.] 1996, writ denied).
Third-party bidders can attempt to contact the trustee in advance of the foreclosure sale to confirm the allowable time and means of payment that will be required by the trustee. See section 14.4:3 in this manual regarding the terms of the foreclosure sale.
See form 13-2 in this chapter for a bid calculation worksheet.
Utilities and Telephone Numbers: Establishment of service as of foreclosure sale and continuation of telephone numbers for site management should be arranged by the bidder with the utility companies before the foreclosure sale. See section 15.8 in this manual for a discussion of utility service.
Access and Security: In advance of its bid, both the mortgagee and third-party bidder must plan the steps it will take on becoming the owner of the mortgaged property to gain immediate access to the mortgaged property and to institute new means of securing the property, such as guard/security services, fire alarm services, change of locks, reissuance of keys, and change of alarm codes. If personal property is located in the mortgaged property, ownership and third-party lien claims must be investigated and responsibility for removal, security, or storage of personal property determined.
Tenants and Tenants’ Deposits: If tenants of the former owner are in occupancy of the mortgaged property after the foreclosure sale, the bidder must advise each of these people as to whether their leases have been terminated by the foreclosure or whether continued occupancy will be permitted and on what terms. (See sections 15.9:1 and 15.9:4 in this manual concerning the rights of certain residential tenants to remain on the property following foreclosure and section 15.9:2 for protections for military service members and spouses.) As to terminated tenancies, instructions must be given as to removal of tenants’ personal property, removal or nonremoval of fixtures, and return of the premises to good condition. See also section 4.15 regarding security deposits, sections 10.9 and 15.9 for a discussion of trespass to try title and eviction, form 15-5 for a letter to a tenant accepting lease, and form 15-6 for a letter to a tenant at sufferance.
Insurance: Both the mortgagee and third-party bidder must have its insurance program in place to take effect immediately upon its acquisition of title to the mortgaged property. Whether the property is vacant or unoccupied will be a factor in arranging proper insurance coverage. If the premises are occupied by tenants, insurance obligations by tenants to the new owner and by the new owner to the tenants must be established, effective as of acquisition of title at the foreclosure sale.
Management: As with security, a clear understanding as to how the property will be managed, commencing at the moment of acquisition of title at the foreclosure sale, is important.
§ 13.2:6Foreclosure Sale of Property Subject to Oil or Gas Lease
In 2015, the Texas legislature adopted Texas Property Code chapter 66, which addressed the effect of a foreclosure of a deed of trust lien on an oil or gas lease executed and recorded before a foreclosure sale. See Tex. Prop. Code ch. 66. Section 66.001(b) provides that, notwithstanding any other law, an oil or gas lease covering real property subject to a security instrument that has been foreclosed remains in effect after the foreclosure sale if the oil or gas lease has not terminated or expired on its own terms and was executed and recorded in the real property records of the county before the foreclosure sale. Section 66.001(b) further provides that an interest of the mortgagor or the mortgagor’s assigns in the oil or gas lease, including a right to receive royalties or other payments that become due and payable after the date of the foreclosure, passes to the purchaser of the foreclosed property to the extent that the security instrument under which the real property was foreclosed had priority over the interest in the oil or gas lease of the mortgagor or the mortgagor’s assigns. Tex. Prop. Code § 66.001(b).
Section 66.001(c) provides that, notwithstanding subsection (b), if real property that includes the mineral interest in hydrocarbons together with the surface overlying such mineral interest is subject to both an oil or gas lease and security instrument and the security interest is foreclosed, the foreclosure sale terminates and extinguishes any right granted under the oil or gas lease for the lessee to use the surface of the real property to the extent that the security instrument under which the real property was foreclosed had priority over the rights of the lessee under the oil or gas lease. Tex. Prop. Code § 66.001(c).
Section 66.001(d) provides that an agreement, including a subordination agreement, between a lessee of an oil or gas lease and a mortgagee of real property or the lessee of an oil or gas lease and the purchaser of foreclosed real property controls over any conflicting provision of this section. Section 66.001(d) further prohibits an agreement between a mortgagor and mortgagee from modifying the application of this section unless the affected lessee agrees to the modification. Tex. Prop. Code § 66.001(d).
Section 66.001(e) provides that this section does not apply to a security instrument that does not attach to a mineral interest in hydrocarbons in the mortgaged real property. Tex. Prop. Code § 66.001(e).
§ 13.3Effect of Postforeclosure Review on Bidding
§ 13.3:1BFP v. RTC and Fraudulent Transfers
The general rule is that mere inadequacy of consideration does not render a foreclosure sale void if the sale is conducted in accordance with Texas Property Code section 51.002 and the terms of the deed of trust. See Tarrant Savings Ass’n v. Lucky Homes, Inc., 390 S.W.2d 473, 475 (Tex. 1965). The Texas Supreme Court in American Savings & Loan Ass’n of Houston v. Musick, 531 S.W.2d 581, 587 (Tex. 1975), added the requirement that there must be a causal connection between the grossly inadequate price and the irregularity of the sale. See Forestier v. San Antonio Savings Ass’n, 564 S.W.2d 160, 165 (Tex. App.—El Paso 1978, writ ref’d n.r.e.). See section 14.8 in this manual.
Section 548 of the Bankruptcy Code permits transfers that occurred within two years of filing bankruptcy to be set aside if the debtor was insolvent at the time of the transfer and the debtor received “less than a reasonably equivalent value” in exchange for the transfer. 11 U.S.C. § 548(a)(1)(B)(i). Such transfers are termed “fraudulent transfers” in that they deplete the bankrupt’s estate of value that otherwise might be available for the bankrupt’s unsecured creditors.
In BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), the Supreme Court eliminated the “fair market value” test previously set out in Durrett v. Washington National Insurance Co., 621 F.2d 201 (5th Cir. 1980), for the “reasonably equivalent value” test. The court noted that section 548 does not refer to “market value.” The court reasoned that fair market value is not typically obtained in a forced-sale context. The court found that section 548 did not embrace a fair market value bid test in the context of a foreclosure sale. The court also refused to substitute a “fair forced sale” test. The court held that, for purposes of section 548, “reasonably equivalent value” at a foreclosure sale means “the price in fact received at the foreclosure sale, so long as all the requirements of the State’s foreclosure laws have been complied with.” BFP, 511 U.S. at 545.
Under BFP, the foreclosure sale may be avoided under section 548 if the price paid is not reasonably equivalent to its actual foreclosure sale value and if the sale was the result of irregularities under state law that would permit judicial invalidation of the sale. The court defined the property’s actual value as being the price the property would have brought if the foreclosure sale had proceeded according to the state’s statutory foreclosure process. See BFP, 511 U.S. at 545–46.
§ 13.3:2Ninety-Day Preference Review
In Whittle Development, Inc. v. Branch Banking & Trust Co. (In re Whittle Development, Inc.), 463 B.R. 796 (Bankr. N.D. Tex. 2011), the bankruptcy court for the Northern District of Texas denied a preference defendant’s motion to dismiss a mortgagor’s claim that the foreclosure constituted a preference. The court found that the Supreme Court’s holding in BFP did not apply in preference actions. The court framed the issue as follows: “whether a debtor in possession can avoid a pre-petition real property foreclosure on the grounds that the foreclosure constituted a preferential transfer, even though the foreclosure sale complied with state law and was non-collusive.” Whittle Development, Inc., 463 B.R. at 767. The court noted:
Although the Code at time is “awkward, and even ungrammatical . . . that does not make it ambiguous.” (citation omitted). Therefore, looking at the unambiguous language of the statute, it would seem that the only thing that must be shown is that the creditor did, in fact, receive more from the pre-petition transfer than it would have under a Chapter 7 liquidation in order for § 547(b)(5)(A) to be satisfied.
Whittle Development, Inc., 463 B.R. at 800.
In Whittle, the mortgaged property was sold to a subsidiary of the mortgagee at a foreclosure sale within the section 547(b)(5)(A) ninety-day preference period for $1,220,000.00, leaving a deficiency of $1,181,513.27. See Whittle Development, Inc., 463 B.R. at 798. The debtor in possession alleged that the property was worth $3,300,000.00 and that Branch Banking & Trust was thus over secured by $1,100,000.00. Whittle Development, Inc., 463 B.R. at 798. The court cited the following rationale for this result set out in In re FIBSA Forwarding, Inc., 230 B.R. 334, 341 (Bankr. S.D. Tex. 1999), aff’d, 244 B.R. 94 (S.D. Tex. 1999):
The issue posed before the Supreme Court was a wholly different quality. If the court had ruled differently in BFP all transfers of real estate in a foreclosure sale could be declared fraudulent since the transfer would not, as a matter of law, yielded “reasonably equivalent value in exchange.” In dealing with preferential transfers, there is no such risk. If an otherwise valid foreclosure sale is found to enable a creditor to obtain more than he would in a chapter 7 liquidation, then the additional amount of benefit conferred to the creditor is simply brought back into the estate. The purchaser of the real estate at the foreclosure does not necessarily lose its property unless the purchaser is the creditor himself. This approach furthers the state’s interest in maintaining the security of titles without subverting the policy of the Code of maintaining equality among the creditors.
As a matter of policy, this is probably the optimal approach to this issue. As the court in FIBSA Forwarding, Inc. noted, a creditor who is able to foreclose prepetition may be able to achieve a windfall unless the debtor or the other creditors file an involuntary petition before the foreclosure. In re FIBSA Forwarding, Inc., 230 B.R. at 341. Such a result creates the so-called “race to the court house” that the Code tries to prevent. By allowing the trustee (or the debtor-in-possession in a chapter 11 case) to bring an avoidance action, a court risks wasting judicial resources on another evidentiary hearing to determine whether the foreclosure sale did result in a better outcome for the creditor than he might otherwise have received. Such a risk is marginal compared to the risk of a creditor is able to achieve a windfall profit at the expense of the estate by the mere virtue that she had the prescience to foreclose before a petition could be filed.
Whittle Development, Inc., 463 B.R. at 801–02. See also Villareal v. Showalter (In re Villarreal), 413 B.R. 633, 639–42 (Bankr. S.D. Tex. 2009) (court found that foreclosure resulted in a $3,250,000 windfall to lender). If the debtor in possession is successful in challenging the foreclosure sale as a preference, it may recover from the mortgagee the property subject to a lien for the amount the mortgagee has paid through its bid, or the value of the property in excess of the bid. See Alvin Arnold and Marshall Tracht, Construction and Development Financing § 6:141 (3d ed. 2001); Gerald L. Blanchard, Lender Liability: Law, Practice and Prevention § 11:19 (2013 ed.); and Joyce Palomar, Title Insurance Law § 14:18 (2013–14 ed.).
§ 13.3:3The Texas Uniform Fraudulent Transfer Act
The Texas Uniform Fraudulent Transfer Act (codified at Tex. Bus. & Com. Code §§ 24.001–.013) provides a safe harbor concerning regularly conducted, noncollusive foreclosure sales under deeds of trust. The statute provides that—
a person gives a reasonably equivalent value if the person acquires an interest of the debtor in an asset pursuant to a regularly conducted, noncollusive foreclosure sale or execution of a power of sale for the acquisition or disposition of the interest of the debtor upon default under a mortgage, deed of trust, or security agreement.
Tex. Bus. & Com. Code § 24.004(b).
See section 14.8:4 in this manual for a discussion of the Texas Uniform Fraudulent Transfer Act.
§ 13.4Casualty Loss and Effect on Bid
In connection with foreclosure proceedings, the mortgagee should confirm that the mortgaged improvements are insured and review the terms of the applicable insurance policies. If the mortgaged property is damaged by casualty before the foreclosure sale, the following questions should be answered: (1) Will the claim be settled before the foreclosure sale? (2) Who is entitled to the proceeds: the noteholder, the mortgagor, or the purchaser at the foreclosure sale? (3) Will a greater recovery be available if the proceeds are applied in reconstruction of the mortgaged property than if they are taken as a cash payment? (4) Will the insurer insist on the premises being repaired as opposed to its paying a cash settlement? (5) Do the policy and proceeds cover contents or trade fixtures not encumbered by the deed of trust? For additional information, see the following resources: William H. Locke, Jr., and Charles E. Comiskey, 11 Things You Wish You Had Known About Commercial Project Insurance, in State Bar of Tex., Advanced Real Estate Law Course (2013); William H. Locke, Jr., and Marilyn C. Maloney, Insurance Issues in Distressful Times, in State Bar of Tex., Advanced Real Estate Drafting Course (2011); William H. Locke, Jr., and Marilyn C. Maloney, Top Ten Insurance Tips for Mortgage Lending, in Mortgage Lending Institute, University of Texas School of Law (2011); William H. Locke, Jr., and Marilyn C. Maloney, Top 10 Insurance Tips for Lenders, 28 Practical Real Estate Lawyer 45 (2012); and 13 Williston on Contracts § 37:51 (2013).
A foreclosure sale does not extinguish a lien against the mortgaged property that has a higher priority than the lien being foreclosed. As a result, the debt secured by the prior lien remains against the mortgaged property. If this prior debt is not paid or otherwise resolved, the holder of this prior lien may proceed with foreclosure or other collection action to enforce its rights in the mortgaged property. While the successful bidder at a junior lien foreclosure takes the mortgaged property subject to and not in assumption of the debt secured by the prior lien, the existence of such debt will obviously affect the amount a party is willing to bid at a junior lien foreclosure sale. If the trustee is aware that the lien being foreclosed is a junior lien, it is good practice to announce at the foreclosure sale the existence of prior liens.
The foreclosure of wraparound debt involves significant issues under Texas law regarding the “true” amount of the debt being foreclosed, the position of the successful bidder following foreclosure, and the amount of any deficiency owing by the mortgagor after foreclosure.
A wraparound mortgage is a junior mortgage loan. The wraparound note includes in the principal all or part of the prior or superior indebtedness plus any additional secured debt that the lender loans to the borrower. The lender pays the prior underlying debt secured by a superior lien on the mortgaged property.
The wraparound loan documents may condition the lender’s payment of the underlying indebtedness on receipt of payment on the wraparound secured debt from the borrower. The wraparound loan documents may require the lender to advance all or a portion of the payments due on the underlying debt.
§ 13.6:2How Much Is Owed to Mortgagee?
In Greenland Vistas, Inc. v. Plantation Place Associates, 746 S.W.2d 923 (Tex. App.—Fort Worth 1988, no writ), the court of appeals reversed the trial court’s finding that a mortgagee’s demand for the unpaid principal balance of the wraparound note (as opposed to the true principal) constituted a charging of usurious interest. Greenland Vistas sold and financed Plantation Place Associates’ purchase of an apartment project. Plantation Place Associates executed a wraparound note for $2,707,433.96 payable to Greenland Vistas. The note included in its face principal amount the balance of $2,074,830.19 owed on an underlying third lien. The trial court held that the seller was not owed the face principal amount of the wraparound note but only the equity or the balance on the true principal (that is, the difference between the balance due on the wraparound secured debt and the balance due on the underlying debt). The trial court held that demanding the payment of the underlying debt amounted to a charging of interest and a usurious loan. The court of appeals found that the full principal of the wraparound secured debt was owed by Plantation Place Associates. Since the buyer received the full benefit of the property purchased, it had the full benefit of the principal of the wraparound note. The court of appeals found the following provisions of the wraparound loan documents supported its conclusion: (1) Greenland Vistas obligated itself in the wraparound loan documents to pay the underlying debt on the condition that Plantation Place was not in default on the wraparound loan, (2) the underlying debt was to be paid out of the payments on the wraparound note, (3) the wraparound maker could obtain the mortgaged property free of the lien of the underlying debt by paying the wraparound secured debt in full, and (4) the wraparound deed of trust authorized the seller to pay the underlying debt if the buyer did not make its payments on the wraparound note. The court of appeals found that the intent of the parties expressed in the loan documents was that the full face principal was owed and that although the seller could demand the full face amount, it could retain only the difference between the face amount and the amount required to be paid on the underlying debt. Greenland Vistas, 746 S.W.2d at 926–27; see also Tanner Development Co. v. Ferguson, 561 S.W.2d 777 (Tex. 1977); Nevels v. Harris, 102 S.W.2d 1046 (Tex. 1937) (court seeking to find “true principal” of debt for usury-rate purposes). See also the discussions of Summers v. Consolidated Capital Special Trust, 783 S.W.2d 580 (Tex. 1989), rev’d 737 S.W.2d 327 (Tex. App.—Houston [14th Dist.] 1987), and Lee v. O’Leary, 742 S.W.2d 28 (Tex. App.—Amarillo 1987), rev’d and remanded sub nom. Lee v. Key West Towers, Inc., 783 S.W.2d 586 (Tex. 1989).
In French v. May, 484 S.W.2d 420 (Tex. App.—Corpus Christi–Edinburg 1972, writ ref’d n.r.e.), the court held that an assuming wraparound note maker assumes primary liability for the obligation assumed to the underlying noteholder. The underlying note maker has a cause of action against the wraparound note maker for recovery of sums paid by the underlying note maker on the underlying note. French, 484 S.W.2d at 424–25.
In Lyons v. Montgomery, 701 S.W.2d 641, 643–44 (Tex. 1985), the Texas Supreme Court held that a purchaser taking “subject to” a prior note and lien could recover damages against the defaulting prior note maker. In Newsom v. Starkey, 541 S.W.2d 468 (Tex. App.—Dallas 1976, writ ref’d n.r.e.), a wraparound note maker recovered against the wraparound noteholder for failing to pay the underlying note payments as was provided for in the wraparound deed of trust.
§ 13.6:3How Much Can Mortgagee Bid?
The Texas Supreme Court in Summers v. Consolidated Capital Special Trust, 783 S.W.2d 580, 583 (Tex. 1989), rev’d, 737 S.W.2d 327 (Tex. App.—Houston [14th Dist.] 1987), adopted the “outstanding balance” approach to computing the wraparound note balance at foreclosure. Under this method, the unpaid balance of the entire amount of principal of the wraparound note, including the principal of the wrapped debt and accrued interest, is owed at the foreclosure sale. The amount bid for the property at the sale, less any sale expenses, is credited to the outstanding balance of the wraparound note. If the bid exceeds the balance, a surplus results. If the unpaid balance exceeds the bid, a deficiency exists. The court chose this method over the “true debt” approach followed by the court of appeals. The supreme court said that the court of appeals’ approach would enable a debtor to obtain a windfall profit, escape any deficiency obligation, and leave the wraparound note payee still liable on the wrapped debt. The court of appeals determined that a foreclosure sale bid by the wraparound mortgagee on a wraparound note resulted in a surplus bid to be paid to the mortgagor rather than a deficiency liability against the mortgagor.
The Texas Supreme Court reversed the court of appeals, stating the following:
In adopting the “true debt” approach, the court of appeals confused the purchaser’s personal liability on the seller’s prior notes with the purchaser’s obligation to pay for the property pursuant to the express terms of its own agreement. It is true that [the debtor] did not agree to assume liability for the balance of the underlying four prior mortgages. That is, they did not become guarantors of that debt, additional makers on those notes, or undertake any other obligation which would render them legally liable to the holders of those earlier obligations. . . . But this reservation in no way affects [the debtor’s] obligation to [the wrap seller] for the entire amount of the fifth note.
Summers, 783 S.W.2d at 582. The supreme court also created an implied covenant “requiring the trustee to apply the proceeds first to the satisfaction of pre-existing debt before making any distribution to the mortgagor” unless there was an express agreement otherwise. Summers, 783 S.W.2d at 583.
If the wraparound mortgagee is considering or is forced to bid more than its “true principal,” in light of the holding in Summers, it will have to be prepared to pay cash to the underlying lienholder rather than entering a credit bid against the balance owing on the wrap note. This raises an interesting but unresolved issue as to what happens if the underlying note does not permit prepayment.
The Summers opinion was followed by Beach v. RTC, 821 S.W.2d 241, 243 (Tex. App.—Houston [1st Dist.] 1991, no writ), in which the court rejected the borrower’s argument that because the foreclosing mortgagee applied no part of the bid proceeds on the wraparound foreclosure to payment of the underlying note, the “true debt” approach should have been used rather than the “outstanding balance” method. See Janet L. Hunter, Note, Texas Adopts the “Outstanding Balance” Method of Calculating the Deficiency or Surplus After Foreclosure of a Wraparound Deed of Trust: Summers v. Consolidated Capital Special Trust, 783 S.W.2d 580 (Tex. 1989), 21 Tex. Tech. L. Rev. 873 (1990).
§ 13.6:4Does Bid at Foreclosure of Underlying Debt Affect Amount Owed on Wraparound Secured Debt?
In Lee v. O’Leary, the court of appeals held that the bid price at the foreclosure of an underlying and wrapped lien was immaterial in determining the balance owed on the wraparound secured debt. Lee v. O’Leary, 742 S.W.2d 28 (Tex. App.—Amarillo 1987), rev’d sub nom. Lee v. Key West Towers, Inc., 783 S.W.2d 586 (Tex. 1989).
The Texas Supreme Court reversed Lee v. O’Leary and held that, under the outstanding-balance approach adopted in Summers v. Consolidated Capital Special Trust, 783 S.W.2d 580 (Tex. 1989), Key West and Eid were liable to the Lees for the entire amount of the Lee note less the amount bid at foreclosure. Key West Towers, Inc., 783 S.W.2d at 588.
A later court of appeals decision makes it clear that a subsequent default on the wrapped note or notes does not excuse a prior default on the wraparound note or bar the wraparound note payee from obtaining a deficiency. See Hampton v. Minton, 785 S.W.2d 854, 859 (Tex. App.—Austin 1990, writ denied).
§ 13.7Fair Market Value and Suits for Deficiencies
Texas Property Code sections 51.003 through 51.005 allow any person, against whom an action is brought to recover a deficiency, to request that the court determine the fair market value of the real property as of the date of the sale. See Tex. Prop. Code §§ 51.003–.005.
These statutes affect the strategy for bidding at foreclosure. If a mortgagee foresees a contested deficiency suit, the mortgagee may choose to bid the full fair market value rather than explain to a jury the reasons for a lower bid. In the event of contested bidding at the foreclosure sale, the mortgagee must be prepared to bid enough to prevent a third party from purchasing the collateral at a price below the fair market value, thus depriving the mortgagee of the benefits of possession of the collateral while reducing the deficiency the mortgagee can recover in a subsequent suit against the debtor. See chapter 17 in this manual for a discussion of suits for deficiency.
§ 13.8Redemption Rights of Mortgagor and Lienholders
In Texas, a regularly and validly conducted trustee’s sale cuts off both junior liens and estates in the collateral and any equity or right of redemption in favor of the mortgagor. Scott v. Dorothy B. Schneider Estate Trust, 783 S.W.2d 26, 28 (Tex. App.—Austin 1990, no writ); Rogers v. Fielder, 392 S.W.2d 797, 799–800 (Tex. App.—Fort Worth 1965, writ ref’d n.r.e.). Texas statutes grant the foreclosed property owner (and, in certain situations, the assignees and heirs of the property owner and junior lienholders) a statutory right of redemption in situations involving foreclosures of ad valorem tax liens (see Tex. Tax Code § 34.21), property owners’ associations assessment liens (see Tex. Prop. Code § 209.011), and condominium association’s assessment liens against residential condominiums that are purchased at foreclosure by condominium associations (see Tex. Prop. Code § 82.113). The statutory redemption periods vary from ninety days to two years, depending on the nature of the collateral and the type of lien foreclosed. The right of redemption is usually conditioned upon the foreclosed property owner paying, in addition to the winning bid amount, a redemption premium and other statutorily enumerated costs to the foreclosure sale purchaser. The statutes creating the redemption right may also restrict transfers of interest in the foreclosed property before the expiration of the redemption period (as, e.g., with property owners’ association assessment liens). See section 24.8 in this manual for discussion of redemption rights for tax lien foreclosures and section 30.5 for discussion of redemption rights incident to foreclosure of property owners’ association liens.
The existence and nature of any redemption rights that run in favor of the mortgagor (and other persons such as junior lienholders, if applicable) are considerations in formulating a bid strategy. Redemption rights will limit the market value of the collateral and the level of interest among potential third-party bidders. The exact impact of the redemption rights on any particular bidder will vary according to the specific redemption right in question and the bidder’s reasons for purchasing the property. For example, a bidder who hopes to acquire the mortgaged property for immediate use or a quick resale may well evaluate redemption rights differently than a bidder looking for a long-term investment. A potential bidder should determine in advance of the foreclosure sale whether any redemption rights exist and, if such rights do exist, how such affect the maximum price the bidder is willing to pay at the foreclosure sale.
§ 13.9Limitations on Purchaser’s Right to Possession of Property
A lease or other estate, such as an easement, that is prior in time to the foreclosed lien will survive foreclosure, absent a voluntary subordination by the holder of the lease or estate. The foreclosure sale purchaser acquires the property subject to such prior lease or estate. See section 4.12 in this manual. Leases and estates subordinate to the foreclosed lien are (absent any nondisturbance agreement) cut off by foreclosure of a prior lien. See section 4.13 in this manual. Recent federal and Texas statutes allow nondefaulting tenants under junior residential leases to remain on the property for statutorily defined periods of time following the foreclosure. See sections 15.9:1, 15.9:2, and 15.9:4. The purchaser at a foreclosure sale is generally entitled to immediate possession of the mortgaged property against the property owner and the holders of junior leases and estates, but (1) the right of possession may be subject to certain residential leases and (2) there is always the possibility that the foreclosed property owner or other third-party occupant may wrongfully refuse to vacate the property after foreclosure. Wrongful possession of the foreclosed property will necessitate eviction proceedings resulting in additional costs and delay in taking possession. As part of its strategy for bidding, the potential bidder should determine whether such issues exist and how they will affect the bid price. See section 15.9 for a discussion of a foreclosure purchaser’s right of possession.
Dysart, Sara E. “Buyer at Foreclosure (New Meaning to ‘Buyer Beware’).” Mortgage Lending Institute, 2010. Austin: University of Texas School of Law, 2010.
Hunter, Janet L. “Texas Adopts the ‘Outstanding Balance’ Method of Calculating the Deficiency or Surplus After Foreclosure of a Wraparound Deed of Trust: Summers v. Consolidated Capital Special Trust, 783 S.W.2d 580 (Tex. 1989).” Note, Texas Tech Law Review 21, no. 2 (1990): 873–96.
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Locke, William H., Jr., and Marilyn C. Maloney. “Insurance Issues in Distressful Times.” In Advanced Real Estate Drafting Course, 2011. Austin: State Bar of Texas, 2011.
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“Wrap-Around Financing: A Technique for Skirting the Usury Laws?” Note, Duke Law Journal (1972): 785–811.