Please ensure Javascript is enabled for purposes of website accessibility

Deed in lieu of foreclosure signed at closing is void

Maryland’s top court has ruled that lenders cannot execute a deed in lieu of foreclosure as a condition of approving the loan before the borrower has defaulted on the mortgage.

In an opinion on Friday, the Court of Appeals vacated an earlier decision from the Montgomery County Circuit Court in favor of the lender and remanded the case to that court for further proceedings.

The court said using the deed in lieu of foreclosure instrument — where a borrower hands over the property deed to the lender once the mortgage is in default instead of going through foreclosure proceedings — at the outset of a mortgage “clogs the equity of redemption.”

Since late medieval times, the court said, the right to equity of redemption has existed, allowing a borrower, in the event of default, to pay in full prior to foreclosure, retaining title to the property. Courts have routinely denied creditors’ attempts to cut off that right as a precondition of mortgage origination, wrote Judge Lynne A. Battaglia for the court.

In the case of a default, a borrower generally has the opportunity to negotiate a short sale, where the bank sells the house for less than what the borrower owes to alleviate added debt. “To require the borrower, however, as a condition of obtaining financing, to surrender the equity of redemption in advance places the lender in a ‘heads I win, tails you lose’ position,” Battaglia wrote.

In 2005, C. Phillip Johnson Full Gospel Ministries Inc. purchased a Martinsville, Va., property from the Catholic Diocese of Richmond to use as a church. Ministries needed a loan for the property and turned to Investors Financial Services Inc., a Silver Spring-based firm, for financing.

As part of the loan, Ministries issued a promissory note to Investors Financial for $93,000 to pay for the property. It secured the note with two deeds — a deed of trust and a deed in lieu of foreclosure, which Ministries had to sign at closing.

The deed in lieu of foreclosure said that if the borrowers were two payments past due and did not contact the lender’s counsel to make payment arrangements, the land would automatically become property of the lender.

Months later, Ministries defaulted on the loan and the deed in lieu of foreclosure was recorded in the Virginia land records without foreclosure proceedings.

“Precisely preventing that kind of injustice of taking the home away after one or two missed payments is exactly why the foreclosure process began,” said Jessica Weber, an attorney with the Public Justice Center in Baltimore, a nonprofit legal advocacy organization that seeks to enforce the rights of people who suffer injustice because of poverty or discrimination.

 The court invited the Public Justice Center to file an amicus brief. Weber said the center’s main concern was the implication for residential mortgages, and she said the center was pleased the court’s opinion seems to apply to residential mortgages.

Ministries filed a complaint in the Montgomery County Circuit Court, asking the court to consider whether the deed was invalid for lack of consideration. The circuit court dismissed two other counts — breach of contract regarding late fees and unjust enrichment.

The court ruled that because the contract was executed under a seal, there was adequate consideration, and the judgment was issued in favor of Investors Financial.

In the case before the Court of Appeals, the state’s top court said the dispositive issue was whether a deed in lieu of foreclosure executed at closing “is valid as an absolute conveyance, rather than a mortgage, under Maryland law.”

“Most importantly, for this case, under Maryland statutory law and Virginia common law, a deed in lieu of foreclosure executed as security at the time of loan origination is a mortgage, not an absolute conveyance, regardless of whether the deed purports on its face to be absolute,” Battaglia wrote.

“Foreclosure proceedings in the present case, therefore, must have been initiated before Ministries’ interest in the Property could have been extinguished,” she wrote.

WHAT THE COURT HELD

Case:

C. Phillip Johnson Full Gospel Ministries Inc. v Investors Financial Services LLC, No. 115, Sept. Term 2008. Reported. Opinion by Battaglia, J. Filed Jan. 31, 2011.

Issue:

Is a deed in lieu of foreclosure executed as a precondition to originating a loan, before any default in the loan, valid under Maryland law, to support conveyance of marketable title upon default, but without the foreclosure?

Holding:

No; a deed in lieu of foreclosure may not be executed at the outset of a mortgage, before any default occurs, as it clogs the equity of redemption.

Counsel:

Eric H. Kirchman for petitioner; Alan D. Eisler for respondent.

RecordFax#11-0128-20