Appellate Decision Unwinds Foreclosure Purchase

It is well-settled that a purchaser of real property takes title subject to the outcome of a lawsuit of which that purchaser has actual knowledge. It is equally well-settled that this rule does not apply to appeals. Until now. On June 12, 2015, the Appellate Division, Fourth Department, handed down a decision that, unless reversed or modified by the Court of Appeals, is likely to send shock waves throughout the real estate industry—with direct and dramatic impact on conveyances, real estate lending, mortgage foreclosures, and title insurance.

In Altshuler Shaham Provident Funds v. GML Tower,1 the Fourth Department unwound a foreclosure sale of real property—three years after the closing—setting aside not only the referee’s deed to the successful bidder, but also a subsequent deed to its affiliate, in deference to a decision of the Court of Appeals which changed the long-standing interpretation of the subordination penalty under Section 22 of the Lien Law.2

The Fourth Department directed a new public auction notwithstanding that (a) the original foreclosure sale and resulting delivery of the referee’s deed occurred prior to the plaintiff’s appeal, (b) plaintiff failed to obtain a stay during the pendency of its appeal, and (c) plaintiff’s notice of pendency expired prior to the delivery of the referee’s deed.

Foreclosure and Sale

By way of background, in 2005, GML Tower, GML Syracuse, and GML Addis purchased three parcels of improved real property in Syracuse. In 2007, plaintiff loaned approximately $10 million to defendant Ameris Holdings and one of its subsidiaries, GML Tower, to (i) repay the then-outstanding balance of the acquisition loan ($5.5 million) and (ii) finance the construction of improvements to one of the properties ($4.5 million). Plaintiff did not file the 2007 loan agreement or a 2008 amendment, as mandated by Lien Law §22. Meanwhile, construction began on the property and contractors and subcontractors filed mechanic’s liens.

In December 2008, plaintiff commenced a foreclosure action and, as required, filed a notice of pendency. Following motions and cross-motions for summary judgment, the Supreme Court found that, although some of plaintiff’s mortgage loan was used to repay the $5.5 million balance of the acquisition loan, the entirety of plaintiff’s $10 million mortgage was subject to the subordination penalty of Lien Law §22 due to plaintiff’s failure to file the building loan agreement and the 2008 amendment. As a result, plaintiff’s mortgage was subordinated to the mechanic’s liens filed against the property. The Fourth Department affirmed.3

While plaintiff sought leave to appeal to the Court of Appeals, the parties consented to entry of a judgment of foreclosure and sale with the mechanic’s liens having priority over plaintiff’s mortgage. The parties agreed to stay execution of the judgment pending the outcome of plaintiff’s appeal. Meanwhile, plaintiff’s notice of pendency expired. Ultimately, plaintiff’s motions for leave to appeal were denied.

After plaintiff was denied leave to appeal, one of the mechanic’s lienors, defendant Hayner Hoyt Corporation, moved to vacate the stay and cause the public auction of the property. With the consent of all parties, the Supreme Court vacated the stay. On June 6, 2012, the tower building was sold at public auction to Hayner Hoyt. Plaintiff did not bid at the auction. Twelve days later (on June 18, 2012), Hayner Hoyt transferred the property to an affiliated entity, Symphony Tower. On July 13, 2012, the Supreme Court confirmed the referee’s report of sale. Plaintiff then sought and obtained leave to appeal to the Court of Appeals. At no time did the plaintiff obtain a stay pending appeal.

On July 11, 2013, in a widely lauded landmark decision affecting both the lending and construction industries, the Court of Appeals in Altshuler held the subordination penalty of Lien Law §22 applies only to funds loaned to pay for improvements, not to funds used to acquire the property or, as here, to refinance an existing acquisition loan. Consequently, the Court of Appeals held that $5.5 million advanced by plaintiff and used to repay the acquisition loan “was not subject to the subordination penalty” and the mortgage lender was entitled to priority over the mechanic’s liens for that amount.

Plaintiff then filed another (successive) notice of pendency and, even though the property had been sold at public auction and then sold again to the purchaser’s affiliate, plaintiff moved in the Supreme Court for an order unwinding the prior public auction—vacating not only the referee’s deed to Hayner Hoyt, but also the subsequent deed to Symphony Tower—and directing a new foreclosure sale.

Finding and Reversal

The Supreme Court, emphasizing (and criticizing) plaintiff’s failure to maintain a valid and operative notice of pendency or to obtain a stay pending appeal, denied the motion. The court found there was no “oppression, injustice or fundamental unfairness” to justify the court’s exercise of its discretionary equitable powers to undo the foreclosure sale or otherwise modify the judgment of foreclosure and sale. Citing the important case of Da Silva v. Musso,4 the court held that a purchaser with knowledge of a pending appeal affecting title is nevertheless a good-faith purchaser where there is no outstanding notice of pendency or stay pending appeal. The court specifically noted plaintiff’s “strategic calculation” not to post an undertaking or take some other action to preserve the status quo during the pendency of the appeal.

The Fourth Department disagreed and reversed.

Notwithstanding that: (i) plaintiff failed to file the building loan agreement and amendment as required by Lien Law §22, (ii) plaintiff failed to preserve its rights by maintaining the notice of pendency of the foreclosure action and/or obtaining a stay of the foreclosure sale pending its appeal on priority, and (iii) the property was purchased at a public auction conducted pursuant to a valid judgment of foreclosure and sale, and then re-sold to an affiliate of the successful bidder, the Fourth Department vacated the foreclosure sale and nullified the transfer of the property to Hayner Hoyt and the subsequent transfer of the property to Symphony Tower.

After some not-so-veiled disapproval of the Court of Appeals for not taking up the case when plaintiff first appealed (“[h]ad plaintiff been able to appeal this Court’s order initially…the priorities would have been established before any judicial sale occurred, and there would have been no need for subsequent litigation to set aside the sale”), the Fourth Department held that Hayner Hoyt and Symphony Tower both had actual knowledge of the “ongoing litigation” and the “potential risks in buying the property.”

While recognizing that actual knowledge of a pending appeal “is not legally significant and that, in the absence of a valid notice of pendency, the owner’s ability to transfer clear title to the disputed property remains unimpaired,” the Fourth Department nevertheless concluded that Hayner Hoyt’s and Symphony Tower’s knowledge of the ongoing appellate litigation should be considered in balancing the equities, and that the prejudice to Symphony Tower did not outweigh the prejudice to plaintiff.

This is a dramatic and unsettling outcome, far more so than appears on first blush. Ordinarily, a third party is bound by the outcome of an action of which that party has actual knowledge.5However, this rule does not extend to appeals. In Da Silva, the Court of Appeals held that a purchaser with actual knowledge of a pending appeal in an action involving a claim against real property does not take the property subject to such appeal where the original complaint was dismissed and no notice of pendency or stay of enforcement was in place.

In Aubrey Equities, the First Department held that the successful bidder who bid at a public foreclosure sale with knowledge that an appeal was pending is entitled, as a good-faith purchaser for value, to retain title to the property where the underlying judgment of foreclosure and sale was reversed but the appellant failed to obtain a stay during the pendency of the appeal.6

Under these well-settled decisions, an innocent third party—not merely the purchaser at auction, but its lender, title insurer, and subsequent tenants (not to mention any subsequent purchaser)—could rely on the sanctity of any judgment rendered in any foreclosure action, even if there were a pending appeal, provided the appellant did not obtain a stay of enforcement.7 This time-honored rule is crucial for the orderly completion of mortgage foreclosure actions and the disposition of distressed real estate ancillary thereto. Indeed, it lies at the heart of real estate law.

The transfer of title to property in foreclosure takes place only after a judgment of foreclosure and sale has been entered, the sale properly advertised, and the public auction conducted, with the successful bidder proceeding to closing—all in reliance on the finality and certainty of the foreclosure judgment, the absence of a stay pending appeal, and the law. In the foreclosure context, title insurers underwrite on the legal import of the judgment of foreclosure and sale; it extinguishes, as a matter of law, the interests of all subordinate parties defendant in the foreclosure action—including the former owner, all subordinate mortgagees, mechanic’s lienors, judgment creditors, certain taxing authorities, as well as all tenants and occupants.

Reliance is equally well founded on the existence of a valid notice of pendency to extinguish the interests of all non-parties that acquired their interests after the commencement of the action; the notice of pendency renders those parties, and their claims to the real estate, subject to the outcome of the action. That regularity, and the unfettered reliance thereon by third parties, should be unwavering and sacrosanct.

Complications

Now, under Altshuler, if any defendant merely files a notice of appeal (truly a ministerial act) from an otherwise final judgment of foreclosure and sale (or from an order confirming a referee’s report of sale), without obtaining a stay, the pendency of that appeal effectively serves as a long and dark cloud on title, preventing a bona fide purchaser in foreclosure from obtaining clean, insurable, title to the foreclosed property until all possible appeals are exhausted. That exhaustion, and that uncertainty, could endure for several years (as it did in Altshuler).

Altshuler serves to caution all foreclosure mortgagees, prospective purchasers, title insurers, and all other parties (such as new lenders, tenants, or contractors) acquiring an interest in the mortgaged property that their bona fide interests could be nullified long after the fact. This is likely to chill the willingness and ability of title insurance companies to issue insurance policies on foreclosed real estate while an appeal could be perfected or has been perfected and remains pending.

As a result, successful bidders in foreclosure—regardless of whether it is the foreclosing lender or a third-party purchaser—should be unwilling to close title in the absence of title insurance and may be unable thereafter to market the property for subsequent sale due to the mere pendency of an appeal. This promises severe adverse ramifications (might we say, potential enforcement and conveyancing paralysis) for foreclosing lenders and bona fide purchasers of foreclosed real estate.Altshuler indeed spreads grim and dark clouds over any real estate that is the subject of litigation.

Making matters more complicated is the fact that the order confirming the referee’s report of sale—the order that finally determines the foreclosure action—is not even available until months after the delivery of the referee’s deed. Thus, an appeal could be taken after the delivery of the deed (when no party had any reason to suspect an appeal) which, if successful, could nullify the conveyance and any subsequent transfer, years later. The purely ministerial act of filing a notice of appeal now has the potential, under Altshuler, to halt any foreclosure auction and its resulting conveyance (including the issuance of mortgage loans and title insurance), to say nothing of subsequent transfers.

The holding in Altshuler threatens to create uncertainty and risk in the market for properties obtained through foreclosure and frustrate a lender’s ability to avail itself of its contractual and statutory remedies. The repercussions are severe and unwarranted and, unless the precedent ofAltshuler is altered, could spread into any transfer of real estate that occurs in the face of an ongoing litigation affecting that real estate. For a case that has been to the Court of Appeals on two prior occasions, it may require a third trip to Albany to put foreclosing mortgagees, purchasers, title insurers, and the real estate community, at ease.

Endnotes:

1. 2015 WL 3648304, __ N.Y.S.3d __ (2015).

2. Section 22 requires any building loan agreement, and any modification thereto, to be filed in the county clerk’s office where the property is located. If a building loan agreement or any modification is not so filed, the interest of each party to the agreement becomes “subject to the lien and claim of a person who shall thereafter file a notice of lien under this chapter.” N.Y. Lien Law §22.

3. Altshuler, 28 Misc.3d 475 (Sup. Ct. Onondaga Co. 2010), aff’d 83 A.D.3d 1563 (4th Dept. 2011).

4. Da Silva v. Musso, 76 N.Y.2d 436 (1990).

5. Patterson v. Brown, 32 N.Y. 81, 96 (1865) (“Courts of equity do not relieve a party from the consequences of risks that he thus voluntarily assumes”); see also DeMaio v. Capozello, 3 N.Y.S.2d 363 (2d Dept. 2015) (holding a purchaser of real property who has actual knowledge of a pending lawsuit with respect to that property is bound by the outcome of that lawsuit); Cirami v. Taromina, 662 N.Y.S. 812 (2d Dept. 1997) (same).

6. Aubrey Equities, 247 A.D.2d 253.

7. See also CPLR 5523 (a court reversing or modifying a final judgment or order…may order restitution of property or rights lost by the judgment or order, except that where the title of a purchaser in good faith and for value would be affected, the court may order the value or the purchase price restored or deposited into court).

Richard S. Fries and Todd B. Marcus, New York Law Journal

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