Ind Sup Ct Holds Failure to Name Second-Lienholder in Foreclosure May Result in Buyer Taking Subject To

The Indiana Supreme Court recently held that a mortgage lender who failed to make a junior lienholder a party to a foreclosure action could not institute a new and subsequent foreclosure action against the junior lienholder, because the first mortgage lender's lien was extinguished by the doctrine of merger.


A copy of the opinion is available at:

http://www.in.gov/judiciary/opinions/pdf/06291102rdr.pdf
Countrywide Home Loans, Inc. ("Countrywide") foreclosed on a property, bid its judgment and took title to the property by way of a sheriff's deed.

In error, Countrywide did not make Citizens State Bank of New Castle ("Citizens") a party to the foreclosure action, although Citizens held a judgment lien on the property. Countrywide then conveyed title to the
property to Federal National Mortgage Association ("FNMA").

When Countrywide discovered Citizens' judgment lien, Countrywide filed an action titled "Complaint for Strict Foreclosure," seeking to foreclose Citizens' interest in the subject property. Citizens filed a separate action against FNMA attempting to foreclose on its judgment lien. The two actions were consolidated, each side moved for summary judgment, and the trial court granted the motion brought by Countrywide and FNMA.

Citizens appealed and the appellate court reversed, on the grounds that through the doctrine of merger, Countrywide's lien was extinguished. The Indiana Supreme Court granted transfer, vacating the opinion of the appellate court.

As you may recall, the doctrine of merger provides that when one party acquires both a lien on and legal title to a property, the two interests merge, and the lien is extinguished. However, merger may produce an arguably unfair result where it operates to give a junior lienholder priority over a senior lienholder. Therefore, an exception to the doctrine of merger provides that merger will not take place if it is against the best interests of the party in whom the interests merge.

The Court began its analysis by nothing that, under Indiana law, a junior lienholder not made a party to a foreclosure action is not bound by the foreclosure. In such circumstances, a purchaser at a foreclosure sale takes the property subject to the junior lienholder's interest.

Next, the Court scrutinized the merger and anti-merger doctrines. It concluded that although courts must presume that the mortgagee intended the result that it was in its best interest, that presumption can be rebutted by evidence finding that a merger had been expressly agreed to.

The Court found such evidence here. When Countrywide conveyed its interest in the property to FNMA, it used language which indicated that the title conveyed was free from all encumbrances. The Court reasoned that Countrywide could only make such a conveyance if Countrywide's lien had been extinguished through merger.

Because "Countrywide demonstrated that it intended a merger of its interests," the Court held that Countrywide was not entitled to the remedy of strict foreclosure. Thus, the decision of the trial court was reversed.