What Happens When One Lienholder Forecloses but the Other Doesn’t, Part 1

In this two-part series, we explore what happens when one property lienholder forecloses while another lienholder chooses not to or can’t foreclose within the same action.

This first article explores the process when a senior lienholder forecloses a property that includes junior liens.  In this scenario, the junior lienholder can’t prevent foreclosure of its lien.  Because of that, the junior lienholder should evaluate and act to protect its financial interest even if it doesn’t file its own claim on debt and for foreclosure.

‍The Junior Lienholder

‍This scenario is common: A first mortgage holder forecloses its lien and must foreclose all junior interests to transfer clear title via a sheriff's deed.  The junior lienholder wishes to protect its interest in any sheriff sale proceeds while spending as little as possible since it’s statistically unlikely that it will recover any surplus funds.  If the junior lienholder does nothing, the lien will be foreclosed without that lienholder having rights to any sale proceeds.  Instead, the proceeds from the sheriff sale will be paid to the mortgage debtor according to I.C. § 32-30-10-14.

While junior lien distributions are considered in the statute, the junior lienholder must assert a valid interest and be recognized in the court's judgment order. This is typically accomplished when the junior lienholder files a general answer that confirms its junior lien status and asks the court to recognize its priority above that of other junior liens as well as over that of the mortgage debtor. This must be followed by securing a judgment entry setting forth its junior lien interest in sheriff sale proceeds.

‍Best Practices

‍Once judgment is entered, the junior lienholder should re-evaluate whether there is any equity in the real estate such that control of the sales price or ownership of the real estate itself is required.  To ensure that the real estate sells for a specific price, the junior lienholder is required to bid for it with certified funds in the full amount of the purchase price. As the housing market continues to improve to the point of securing formerly unsecured liens, cash bids on behalf of junior lienholders have become more common.

Attorneys, lienholders, and sheriffs must know the proper procedures to ensure that these sales run smoothly and generate the desired outcome for junior lienholders.  Best practices often involve ensuring that judgment includes a provision that orders the senior lienholder to release its payoff information in advance of sale to avoid any regulatory or statutory concerns that could delay providing that information to the junior lienholder without borrower authorization.

It is also important to know that often only one specified bid can be placed in these situations.  Once real estate is secured by the junior lienholder by virtue of its highest bid, that lienholder may request that paid funds that exceed the senior lienholder's total payoff be distributed back to them pursuant to the judgment entry.  In doing so, junior lienholders may be required to establish their debt amount through affidavits depending on the procedures set by the Judge who is hearing the matter.

Check back next week for part two.  We will explore what happens when a junior lienholder forecloses and the senior lienholder doesn’t want to join the action to assert its own default.

‍To read part two in this series, please click here.