A topic that was top-of-mind in the foreclosure industry in the past year has become more relevant in REO-land.
For the longest time, those involved in the title and mortgage industries have operated under the belief that state law governs the rights of the United States whenever there is a non-judicial foreclosure of a senior lien that purports to extinguish a non-IRS Junior Federal Lien on the property (See United States v. Brosnan, 363 U.S. 237 (1960).
However, last year the U.S. Court of Appeals for the 8th Circuit issued an order affirming a Missouri federal court decision in Show Me State Premium Homes v. McDonell, 74 F.4th 911 (8th Cir. 2023). Here, the plaintiff acquired property that had been the subject of a non-judicial tax sale and filed suit in federal court to quiet its title. The United States was named as a defendant because at the time of the tax sale the property was encumbered by two mortgages in favor of the Department of Housing and Urban Development. The United States moved to dismiss arguing that federal law (which had been amended after 1960) prohibits an entity from extinguishing its interest through a non-judicial sale. The Missouri court, and later the 8th Circuit, agreed.
In reliance on the holding in Show Me State Premium Homes v. McDonell, the U.S. Department of Justice asserted that non-judicial foreclosures have no effect on Non-IRS Junior Federal Liens held by the United States. Clearly, the proverbial line in the sand was drawn.
This circles back to the REO world in that titles to foreclosed properties now may have significant title objections that just months ago were not considered title objections at all. In a foreclosure action, the foreclosing lender or servicer may choose to not clear certain title objections prior to the sale since it is possible that a 3rd party may be the successful bidder at foreclosure, and therefore be responsible for clearing title or paying-off liens. This saves the foreclosing lender time and money.
However, now, pushing the “Non-IRS Junior Federal Liens held by the United States”-can down the road may not be helpful. The junior mortgage held by HUD in Show Me State Premium Homes v. McDonell is an example of a common such lien. Now, the decision of how, and when, to clear these types of objections is something that an REO seller should address with their foreclosure colleagues so that there is alignment from throughout the lifecycle of a file, from foreclosure to REO.
Some clients have chosen to initiate a judicial foreclosure sale where the pre-foreclosure title search reveals a Non-IRS Junior Federal Liens held by the United States, even though the respective state law allows for a non-judicial sale. This results in clear title at REO. Other clients have chosen to seek releases at the foreclosure stage, which clears this specific objection. Another option, which granted would be more acceptable for cash REO purchasers, is allowing an exception in the final REO owners title insurance policy. So REO title would be clear, just except for a Non-IRS Junior Federal Lien held by the United States.
But ultimately, leaving a Non-IRS Junior Federal Liens held by the United States to be addressed at the REO stage is more likely to cause delays and frustration, as of course at that time there is an REO buyer, realtors and usually a lender all waiting for the federal government to sign a release.
Stuart Gordan
REO & Closing Group Managing Partner
McCalla Raymer Leibert Pierce, LLP