THE END IS NOT ALWAYS THE END IN FORECLOSURES

Some have been taught that New York law says: "If you come up short at the foreclosure sale, pursue a deficiency judgment at once, otherwise write off the shortfall, because you can not collect it from a borrower or guarantor any other way". That is even less the ironclad rule, due to a recent case.

Since 1995, fire insurance proceeds have been placed in a different category than foreclosure sales proceeds, because of the assignment-of-proceeds clause in the standard form of New York real property mortgage (and in properly drafted cooperative loan security agreements and UCC-1 financing statements and riders). The two leading cases are Melino v. National Grange Mutual Ins. Co., and L.G.H. Enterprises, Inc., v. Kadillac Mortgage Bankers, Ltd., both involving casualty losses post-foreclosure sale.

In these cases, defaulting borrowers both argued the traditional rule: foreclosure sale extinguishes the mortgage and note obligation, therefore lender (successful bidder at sale) has no rights against borrower under the (now-extinguished) mortgage. The only remedy lender had was an action for a deficiency judgment, and it was too late to bring one (deficiency judgment must be applied for within 90 days post-sale).

Both Appellate Divisions (2d and 3d) rejected the position of the defaulting borrowers. Although the lender has no rights as loss-payee under the insurance policy, the lender does have rights as assignee of proceeds under the mortgage document itself ("absent a showing of fraud, duress, undue influence or illegality" as the court said in the Melino case).

Three years later, GMS Capital and SRC Holdings Corp v Siegmund Spiegel/Baldur Peter, PC, expanded matters further. This Second Department case holds that, even where no deficiency judgment is sought, an assignment of rights by the borrower to the lender is not extinguished and the benefit of those rights, post-foreclosure, belongs to the lender. GMS gave a mortgage loan on a recently-remodeled house, reserving to itself in the mortgage documents any claims for damage or injury to the house. Post-foreclosure, no deficiency judgment was sought, as borrower had gone bankrupt during the foreclosure proceedings and the debt was discharged; a formal deficiency judgment would have been useless. However, GMS made an inspection of the house and found that the borrower's architect had been negligent. GMS sued the architect, who defended on the grounds that only the borrower had a claim against him, not GMS. The Appellate Division, affirming the lower court, allowed the suit to proceed. The Court said that the borrower had assigned her rights to GMS, and, notwithstanding her bankruptcy and the fact that to deficiency judgment was sought, the assignment stands, and GMS has whatever rights borrower had.

We suggest that every mortgage and cooperative apartment loan security agreement be carefully examined, and the fullest assignment of rights by the borrower be included. We are happy to assist you and your staff in this process. Re-drafting, which can be quickly and easily accomplished, is recommended for documents currently in use.