The Test Case
On April 12, the Missouri Supreme Court squarely faced the question of whether it would continue the common law rule of basing the amount of deficiency after real estate foreclosure on the foreclosure price paid, even if “bid-in” by the foreclosing lender, or change the rule to base the deficiency on the property’s fair market value. First Bank v. Fischer & Frichtel, Inc., (Mo. en banc, April 12, 2012).
In this case, the lender foreclosed upon real estate securing a loan with a balance of $1,133,875 and bid $466,000 as the only foreclosure sale bidder. In the suit to enforce the deficiency, the debtor presented testimony that the fair market value of the real estate at the time of foreclosure was $918,000. The trial court instructed the jury that the measure of damages should be based upon the fair market value of the property and the jury applied that instructions and awarded the lender only $215,875 (plus interest and attorney’s fees), the trial court, however, granted the bank’s motion for a new trial because the jury instruction was not consistent with established Missouri common law.
The debtor appealed to the Missouri Court of Appeals, which affirmed the ruling of the trial court on the basis of the 70-year precedent in Drannek Realty Co. v. Nathan Frank, Inc., 139 S.W. 2d 926 (Mo. 1940). The Court of Appeals, however, appeared to be uncomfortable with the holding. It acknowledged that the foreclosure process commonly failed to produce the fair market value for the foreclosed real estate and ordered the case transferred to the Missouri Supreme Court under the Supreme Court rule that allows a court of appeals to transfer a case “… because of the general interest or importance of a question involved in the case or for the purpose of reexamining existing law.”
The Missouri Supreme Court Decision
The Missouri Supreme Court affirmed the trial court’s decision and upheld the precedent that the foreclosure price is used to measure the deficiency and not the fair market value of the property. The Court pointed out that if a foreclosure sale price is so inadequate as to raise an inference of fraud, then the foreclosure sale can be voided by an action filed by the debtor for that purpose but that Missouri does not permit a debtor to raise the question of adequacy of foreclosure price in a deficiency action.
Although the Court’s ruling is good news for commercial lenders, who could have been faced with being required to have full-blown trials to determine fair market value of foreclosed-upon property when attempting to obtain a deficiency judgment, several of the comments by the Court indicate that the issue is not completely resolved:
- The Court emphasized that this case involved a sophisticated commercial debtor that had more than 60 years of experience in the real estate industry and obviously knew Missouri foreclosure law procedures and principles. The Court, however, acknowledged that the process by which a lender could bid-in a portion of the loan while the debtor must make a cash bid could be a problem for the ordinary bidder such as a homeowner or small business owner because the minimum time period between notice of foreclosure and sale is typically insufficient to allow the ordinary debtor or other potential bidders to secure financing. The Court noted that the policy reasons raised by the debtor in Fischer would be more legitimately made by “… individuals and small businesses that have no realistic ability to bid themselves, not … a sophisticated business entity ….” (Slip Opinion at p. 12)
- The bank had made extraordinary efforts to rehabilitate the loan. The bank extended the maturity date six times and only thereafter, due to the increased risk caused by the declining real estate market, insisted on a higher interest rate, a renewal fee and a personal guarantee or a substantial increase in the amount of principal that the debtor would be required to pay against the loan each time it sold a lot. The debtor and the bank could not agree on a further extension. A bank, however, that would be less accommodating to its borrower might not receive the favored treatment given the bank in Fischer.
- The Court noted that each jurisdiction cited by the debtor that changed from basing the deficiency on the foreclosure price to basing it on property’s fair market value made the change by statute and not by judicial decision.
- The Court acknowledged that it had not reexamined the standard for voiding a foreclosure sale (the standard being if the foreclosure sale “shocks the conscience”) for more than 60 years, implying that the standard could be ripe for reexamination. Based on the above, it is conceivable that an individual or a small business owner faced with a foreclosure sale in which the price “bid-in” by the foreclosing lender is substantially less than the property’s provable fair market value could make a convincing argument that the fair market value approach should be judicially adopted. The dissenting opinion filed by the chief judge of the Court could be a road map for a more sympathetic debtor to distinguish Fischer and to challenge the courts to address the century-old doctrine once more.
Although the Fischer decision is good news for commercial lenders, this drama is not necessarily ended. We will report on future developments.