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Seth M. Rotenberg: A change in default remedies in Md. foreclosure sales

In a case of first impression that will affect foreclosure procedure throughout Maryland, the Court of Special Appeals recently held that if the purchaser at a foreclosure auction defaults in its obligation to close on the purchase of the property, the trustees may not declare the deposit forfeited and also resell the property at the risk and expense of the defaulting purchaser, even if the advertisement of sale so provides. Greentree Series V, Inc. v. Hofmeister, 222 Md.App. 557 (2015).

Factual background

The case arose from a foreclosure sale of property in Anne Arundel County. Greentree, with a bid of $172,000, was the high bidder, and it paid a $33,197 deposit to the trustees. The advertised terms of sale required Greentree to pay the balance of the purchase price within 10 days following the circuit court’s ratification of the sale. The foreclosure advertisement also stated, “If payment of the balance does not take place within ten days of ratification, the deposit will be forfeited and property will be resold at the risk and expense of the defaulting purchaser.”

The sale was ratified by the Circuit Court for Anne Arundel County, but Greentree failed to proceed to closing. In response to a petition by the trustees, the court entered an order directing that the property be resold at Greentree’s risk and expense, and declaring that the deposit was forfeited. At the resale auction, Greentree was again the successful bidder, with a bid of $244,000, and it paid a $35,000 deposit to the trustees. After the sale was ratified by the court, Greentree again failed to proceed to closing.  The court again ordered a resale of the property, but on the day of the scheduled resale, Greentree and the trustees closed on the purchase of the property, as was permitted by the court order.

Overruling the auditor’s report, the Circuit Court for Anne Arundel County held that Greentree’s deposit from the first sale should be forfeited.

Court of Special Appeals opinion

Greentree appealed to the Court of Special Appeals. In its published opinion, the court began its analysis by noting that general contract principles apply to judicial sales. In a foreclosure sale, the court is the seller and the trustee is the court’s agent. The successful bid at the foreclosure auction is an offer by the purchaser to purchase the property, the court’s ratification of the sale constitutes the court’s acceptance of the offer and, upon the court’s ratification, the contract is final.

The primary aspect of general contract law applicable to this case was whether the remedies to which the trustees were entitled constituted liquidated damages or if they were a penalty. The remedy of liquidated damages is valid and enforceable, while a penalty is not. The Court of Special Appeals cited three elements of a valid liquidated damages clause: (1) the remedy provides for a sum certain; (2) the amount of the stated sum “must reasonably be compensation for the damages anticipated by the breach”; and (3) the clause is a binding agreement made before the fact, and the amount of stated damages “may not be altered to correspond to actual damages determined after the fact.”

The Court of Special Appeals held the two remedies available to the trustees (forfeiture of the deposit and resale of the property at the risk and expense of the defaulting purchaser), when “read in tandem,” do not meet any of the criteria for a valid liquidated damages clause.

The court then considered whether the doctrine of “unclean hands,” which bars a party from seeking relief in a court of equity if the party has “engaged in fraudulent, illegal, or inequitable conduct,” applied to Greentree. The court stated that merely defaulting under a contractual obligation (which Greentree had done) does not constitute unclean hands so as to prevent a party from asserting claims. Therefore, Greentree was not barred from asserting its claims by that doctrine.

The court then turned to Greentree’s main claim, which was that under Maryland Rule 14-305(g) the circuit court did not have the authority to order both the forfeiture of the deposit and the resale of the property at Greentree’s risk and expense. The court noted the specific language of that rule, which states that “[i]f the purchaser defaults, the court, on application and after notice to the purchaser, may order a resale at the risk and expense of the purchaser or may take any other appropriate action.” The circuit court had read this rule to permit a resale at the purchaser’s risk as well as other action. The Court of Special Appeals specifically rejected this approach, reasoning that the use of the disjunctive (“or”) rather than a conjunctive in the text of this rule gave the circuit court the authority to order either a resale of the property at the risk and expense of the purchaser or other appropriate action but not both.

However, and quite significantly, the Court of Special Appeals noted in a footnote that “[n]othing in this opinion should be interpreted as preventing the Trustee or mortgagor, in the event of a default by a foreclosure sale purchaser, from utilizing the deposit to offset any losses occasioned by a resale.”  Thus, it would seem that foreclosure trustees have the authority to retain the deposit until the damages from a resale are known, and then to apply some or all of the deposit against their damages. If a resale produced a higher price, then the trustees would need to return some or all of the deposit.

Important principles

As important as this holding relating to remedies is, this decision is also significant because the Court of Special Appeals articulated the following principles that are important in the foreclosure process:

  • General contract principles apply to a foreclosure sale. This has implications respecting the rights of the parties, including the point at which equitable conversion takes place and the circumstances under which the purchaser may be entitled to possession of the property prior to closing.
  • There are three elements of a valid enforceable liquidated damage clause.
  • The doctrine of “unclean hands” does not apply to breach of contract.

Practice note

Rarely are trustees successful in pursuing defaulting purchasers at foreclosure sales for more than the deposits posted at the sales. Often, purchasers have no assets other than the deposit. Therefore, foreclosure advertisements should provide that if the purchaser defaults, the deposit is to be retained by the trustees as liquidated damages, and the trustees will have no other remedy.

In giving up a virtually illusory right, the trustees may solidify their ability to keep the deposit, regardless of how much a resale may bring.

Seth M. Rotenberg is a member of the Real Estate Practice Group at Gordon Feinblatt LLC.  He may be reached at srotenberg@gfrlaw.com or (410) 576-4179.  The author expresses his thanks to Edward J. Levin, chairman of the Real Estate Practice Group, for his kind assistance.