A Road Map For Secured Lenders Post-Liu

The District of Columbia Court of Appeals recently sent a new set of shockwaves through the mortgage industry in the nation’s capital when it released its March 1, 2018, decision in Andrea Liu v. U.S. Bank National Association. Having held over three years ago that condominium associations have “superpriority” liens for unpaid assessments and can wipe out first mortgages by foreclosing on those liens, the court in its recent Liu decision went an unexpected step farther: An association’s foreclosure would wipe out the first mortgage even if the association expressly stated that it intended for the foreclosure to be held subject to that mortgage. Secured lenders who thought they might have dodged the bullet now find themselves fighting for the validity of their security interests.

Two questions have become particularly relevant: How did we get to this point, and how might secured lenders defend against this threat?

Genesis of a Potential Crisis

In 2014, the D.C. Court of Appeals issued its decision in Chase Plaza Condominium Association v. JPMorgan Chase Bank NA, which addressed the effect of a condominium association’s foreclosure sale in the District of Columbia. The Chase Plaza court explained that D.C. Code § 42-1903.13 entitled a condominium association to foreclose and then apply the sale proceeds first to the six months of assessments considered a “superpriority” lien under D.C. law. Moreover, the court reasoned that because the superpriority lien had seniority over a lender’s first mortgage on the same property, the association’s foreclosure would extinguish that mortgage. If the sales proceeds were insufficient to pay the outstanding balance of the mortgage, then the secured lender would be left with a potentially hefty unsecured debt.

In light of the uncertainty regarding the interpretation of D.C. Code § 42-1903.13, condominium associations wishing to foreclose on a unit developed a practice of expressly indicating that the property would be sold at a foreclosure sale subject to the lender’s mortgage. This practice, however, turned out to be less than foolproof.

A Surprising Rebuke of Industry Practice

In Liu, the advertisements of sale, the memorandum of sale to Andrea Liu, and the deed of trust all specified that the condominium association sale was made subject to the first deed of trust. These statements followed the community association industry’s standard practice at the time. As a result of these supposed unequivocal statements, the secured lender in Liu argued that it was “abundantly clear” that Ms. Liu purchased the property subject to its first mortgage.

The D.C. Court of Appeals rejected that argument based on a surprising reading of D.C. Code § 42-1903.13. The court explained that D.C. Code § 42-1901.07 prevented parties from varying the terms of a condominium association superpriority lien sale by agreement. Based on that unexpected reasoning, the Liu court held that notwithstanding the repeated, express representations made by the association indicating that the first mortgage would survive the association’s foreclosure sale, Ms. Liu bought the property free and clear of the first mortgage (for a sales price representing a tiny fraction of the property’s market value). To say that most industry observers were shocked by this reading of D.C. law would be an understatement.

Immediate Impact of Liu Decision

The practical impact of the Liu court’s holding is that a condominium association’s sale, even if made explicitly subject to a first deed of trust, might not be actually treated as subject to that deed of trust. Secured lenders who have reasonably relied on express representations made by an association that their lien interests would remain intact have suddenly learned that their reliance might have been misplaced.

The D.C. condominium association sale statute was amended in April 2017 to require parties to specify at the outset whether a sale would be a superpriority sale that extinguished all other liens, or a sale for more than the superpriority amount that would be subject to a first deed of trust. For sales prior to that date, however, the Liu decision adds a significant amount of uncertainty. It appears that pre-2017 condominium association sales might now be treated as extinguishing first deeds of trust, even if all parties thought otherwise at the time of sale.

The Liu decision presents an enormous amount of uncertainty as to the enforceability of preforeclosure mortgages and whether such mortgages survived condominium association foreclosure sales. It is certainly within the realm of possibility that condominium sale purchasers will now claim that they own their property outright, causing a new wave of litigation in the District of Columbia. However, the D.C. Court of Appeals is currently faced with a petition for an en banc review of the Liu decision, which might provide a future means for this decision to change.

Second Decision Provides Potential Road Map for Secured Lenders

Despite the prevailing uncertainty following the decision in Liu, the D.C. Court of Appeals has provided some guidance that should give secured lenders some solace moving forward. In U.S. Bank NA v. Green Parks LLC, issued 12 days after Liu (on March 13, 2018), the D.C. Court of Appeals shed some light on what secured lenders can do to avoid the outcome in Liu. In fact, two of the justices that decided Green Parks also authored the Liu decision, including the chief justice of the court.

Green Parks followed a similar factual background as in Liu. In 2013, a condominium association foreclosed on its statutory lien but advertised its sale and described it in the memorandum of purchase and deed as having taken place “subject to” U.S. Bank’s deed of trust.

After the D.C. Court of Appeals issued its decision in Chase Plaza, U.S. Bank brought an action to establish the validity of its security interest in relation to Green Parks, which bought the property at the foreclosure sale. Green Parks filed a counterclaim, seeking a judgment that, under Chase Plaza, it had acquired title to the property free and clear of U.S. Bank’s interest. U.S. Bank responded to the counterclaim with an answer that raised affirmative equitable defenses — including unconscionability and unclean hands — and moved to dismiss, citing the extensive evidence that the association intended to foreclose on a lien that was subordinate to U.S. Bank’s interest.

In considering U.S. Bank’s motion, the trial court flipped the script. It first converted the motion to dismiss to a motion for summary judgment and denied it. It then went even further by dismissing U.S. Bank’s counterclaim and granting summary judgment against U.S. Bank, even though Green Parks had not requested that relief.

On appeal, the D.C. Court of Appeals quickly reasoned that the trial court’s order was incorrect because it failed to provide the parties with proper notice that it was considering granting summary judgment and because it failed to view the evidence in the light most favorable to U.S. Bank in granting summary judgment for Green Parks. But especially noteworthy is how the court framed the prejudice U.S. Bank suffered as a result of these actions. In the court’s words, “The surprise entry of judgment was not harmless for it deprived the Bank of an adequate opportunity to dodge the bullet.”

Additional Guidance from the D.C. Court of Appeals

The Court of Appeals also noted that Liu left an important question unsettled: What happens if an association forecloses on a lien greater than the six months of unpaid assessments given superpriority status under D.C. law? The Green Parks court described it as an open question as to whether such a lien is “entirely lower in priority than a first deed of trust or whether a portion of the lien enjoys super-priority status.”

Furthermore, the Green Parks decision instructed that, on remand, the trial court had to consider the merits of U.S. Bank’s arguments that the association’s foreclosure sale should be set aside based on equitable doctrines such as unclean hands or unconscionability. While Liu may have established the legal priority of the association’s lien, U.S. Bank’s arguments that the sale was invalid based on equitable defenses were still to be decided.

How Should Secured Lenders Proceed Going Forward?

Going forward, secured lenders now have a road map as to how to protect their deeds of trust on condominiums in the District of Columbia that have been placed in jeopardy as a result of an association’s foreclosure. The first step is determining whether the association included more than six months of unpaid assessments in its advertised lien amount. According to the Green Parks court, such a foreclosure may mean that the entire association lien is subordinate to the deed of trust. Second, and independently, lenders can raise equitable defenses to the association’s foreclosure sale and seek to have it invalidated on those grounds. If the Liu decision remains unchanged by an en banc review, secured lenders might be following this road map far more often than they initially expected.

Republished with permission. This article first appeared in Law360 on April 17, 2018.