Posting for

Thursday, July 9, 1998

by: Bert Rush

brush@firstam.com

NOTICE REQUIREMENTS/DUE PROCESS/LEASES

Here's a case illustrating, once again, the unpredictability of litigation involving notice issues and leasehold estates.

The property involved is the Carson Square Shopping Center, a "strip mall," in Indianapolis. This property was owned by Carson Partners subject to a mortgage in favor of Bank One (f/k/a American Fletcher National Bank and Trust).

In June 1990 Como, Inc. (owner of a business known as "Primo Catering and Banquet Hall") entered into a lease for a 20,000 square foot space in the property. Originally the lease was to terminate in 12/95, but by virtue of later amendments Como had two consecutive options to renew for five years each. At the time the lease was entered into, the property needed substantial repairs--so it became the practice of Como to make repairs as needed, in exchange for rent abatement from Carson Partners.

Meanwhile, Carson Partners was in default under its mortgage to Bank One. In February 1991 Bank One filed for judicial foreclosure--but it did not name Como in the lawsuit and did not otherwise give Como notice of the action. So Como continued to make repairs and schedule events at Carson Square.

In 1993 Bank One obtained a judgment of forelosure--still without notice to Como--and assigned its mortgage and judgment for foreclosure to a new entity known as Carson Square, Inc., having one Edward Kopecky as its president. Carson Square, Inc. was the successful bidder at the ensuing sheriff's sale and, later the same day, Kopecky visited the Primo business to announce new ownership of the property and termination of the Como lease by foreclosure. Kopecky demanded payment of two months rent and, the next day, Como paid one month's rent which Carson Square accepted.

Como continued in possession, and continued to make repairs and to schedule events at Primo. But disputes arose when Carson Square demanded renegotiation of the lease--seeking to double the rent (formerly $3,500 per month) and refusing to recognize the two five-year options.

Soon Carson Square filed suit for a declaration that the foreclosure terminated Como's lease, and to repossess the property. Como counter-claimed seeking to enforce terms of its original lease and the two options, alleging that the trial court's judgment of foreclosure was not binding on Como because it was not named a party to the action.

The trial court granted summary judgment in favor of Carson Square, agreeing that acceptance of one month's rent had not ratified the lease between Como and Carson Partners, and ordering Carson Square entitled to possession.

Como appealed and the court of appeals reversed, finding in favor of Como. The court of appeals cited Bowlby v. NBD Bank, (Ind.Ct.App. 1994), 640 N.E.2d 1095, as authority for the proposition that a leasehold estate is a "property interest" for purposes of enforcing due process protections. In making this ruling, the court weighed the importance of the interests of Como against the burden to Bank One in joining Como to the foreclosure action--and giving Como the opportunity to have its objections (if any) heard--and said the scales tipped clearly in favor of Como. This decision was reported as Como, Inc. v. Carson Square, Inc., (Ind.Ct.App. 1995), 648 N.E.2d 1247.

The case was further appealed to the Indiana Supreme Court, where one of the justices (Selby) did not participate. The remaining four justices deadlocked--two wanting to rule in favor of Como on the due process issue, two wanting to rule against. So--under a procedural rule perhaps unique to Indiana--the decision of the court of appeal becomes the law of the case. See, Como, Inc. v. Carson Square, Inc., (Ind.Sup.Ct. 1997), 689 N.E.2d 725.

Some points: We've seen a number of cases in the past few years seeming to stretch due process to such limits that it's sometimes almost impossible for title underwriters to tell whether a given interest has been legally terminated by a judicial foreclosure/judgment/sheriff's sale.

Certainly we can be sympathetic to the plight of Como here, but in no event should Como be perceived as having a more formidable estate than that of its lessor and the mortgagor, Carson Partners. If Carson Partners was in default, what possible objection to foreclosure could Como muster that might have merit? Where's the beef?

This is not to trivialize the apparent fact that Como took a troubled site and made a success of it--perhaps to be unfairly taken advantage of by Carson Square. And maybe in fairness Como should have been on notice of the pending judicial foreclosure so that they might have been able to negotiate with Bank One and rescue their lease position. But who has such a duty to a junior lessee?

Como was in a position to prevent this dispute by negotiating a subordination of the existing mortgage to its lease--and may have been in an excellent position to do so when it came upon this "troubled" property in disrepair. Recall our discussions at recent Regional Counsel and Underwriter meetings about enforceability of subordination, non-disturbance and attornment provisions ("SNA's"). Como didn't protect its interests in negotiating its lease and later options.

Anyway...an interesting case of which employees and agents who do commercial transactions should be mindful.

Questions, comment, argument--just press the "reply" button and share your thoughts.

**********

Following our posting last Thursday Hal Miller (Burlington, VT) writes:

Bert, I'll be faxing you a recent trial court decision in Federal Court in Vermont that deals with a related issue with residential foreclosures. The Federal Court held that Vermont's foreclosure law was unconstitutional (at least as to tenants in possession) for due process notice provisions. According to Vermont law, once the foreclosure complaint is recorded in the land records, any acquiring an interest in the property subsequent to the filing of the complaint, takes subject to the foreclosure actions and any decree of foreclosure issued by the court.

This decision has the banks very concerned, especially if the defaulting borrower decides to suddenly lease his home (to his relatives possibly) shortly before the redemption period expires and before the foreclosing lender takes possession.

Reply to Hal: I'm surprised we don't see more notice disputes in our claims experience. We had one several years ago in a rural area of central California, where a couple disputed foreclosure of their home by the Farmers Home Admin. on grounds the trustee failed to mail a notice of default, and likewise failed to post a notice on the property, as required by Calif. statute. I went up to meet with them (with their attorney). The husband was a one-armed handyman and wife was a homemaker who worked seasonally packing tomatoes at a local plant. Turned out that at the time in question the husband was out of town working a construction job--so the wife was their witness. They had two mortgages, both of which had been delinquent. The wife explained the other mortgage (a first) started foreclosure, whereupon she brought it current with money received (just in time) from settlement of a lawsuit over loss of the husband's arm. Only reason she didn't reinstate the second mortgage (the one I was concerned with) was that she didn't know they were foreclosing. Then "all of a sudden" someone says they're foreclosed out. I thought she'd be a good witness--she carried herself well and you could sympathize with 'em--so the case worried me. Then, while driving back, it occurred to me she might be illiterate--seasonal worker at a packing plant. I told their attorney I thought the notices had been mailed and posted, but the wife confused them with the threatened foreclosure of the first mortgage--which she didn't worry about once it was reinstated. Never heard from them again. (Some of you claims counsel are saying to yourselves,"Schmuch! Shoulda surprised her in deposition!" You're probably right.)