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Michigan Court of Appeals Ruling

Oct 4, 2016

Gregg A. Nathanson, Esq.

Michigan Court of Appeals Upholds Lease Termination but Not Applicability of Full Credit Bid Rule in Judicial Foreclosure Action

The Michigan Court of Appeals recently ruled that a foreclosing mortgage terminates all leases at the end of the foreclosure redemption period, but that the full credit bid rule does not apply to extinguish judicially foreclosed mortgages. Sturgis Building LLC vs Kirsch Industrial Park LLC (Michigan Court of Appeals, August 9, 2016).

Background
This case involves an industrial park in Sturgis, Michigan owned by Kirsch. Kirsch borrowed nearly $3 million from its seller, Sturgis to finance the purchase. To collateralize the loan, Kirsch granted Sturgis a first mortgage upon the property and an assignment of rents and a security interest in the leases. After closing, Kirsch entered into a new lease with an existing tenant and leases with three new tenants.

Kirsch defaulted. Sturgis filed a judicial foreclosure and began collecting rents from tenants pursuant to the assignment. The Court entered an order of judicial foreclosure and Sturgis purchased the property at the county clerk sale. Following expiration of the redemption period, the prime tenant refused to pay rent, claiming that the foreclosure sale had terminated their lease. In addition, Kirsch claimed that Sturgis’ purchase of the property at the foreclosure sale constituted a “full credit bid” and therefore, the mortgage was extinguished along with Kirsch’s obligation to pay Sturgis’ costs and attorney fees.

Post-Foreclosure Lease Status
The foreclosure judgment provided that “the sale shall be free and clear of all easements, liens, encumbrances and claims arising since the date the mortgage was recorded.” A “lease” falls within the definition of an “encumbrance.” A lease is also a “claim” to the property. Under Michigan law, a lease entered into after mortgage creation terminates at the end of the redemption period unless the mortgagor redeems the property. In this case, the Sturgis mortgage pre-dated the leases and the borrower Kirsch did not redeem the property. The leases were therefore terminated when the redemption period expired.

Full Credit Bid Rule
The full credit bid rule has been described as follows:
When a lender bids at a foreclosure sale, it is not required to pay cash, but rather is permitted to make a credit bid because any cash tendered would be returned to it. If this credit bid is equal to the unpaid principal and interest on the mortgage plus the costs of foreclosure, this is known as a ‘full credit bid.’ When a mortgagee makes a full credit bid, the mortgage debt is satisfied, and the mortgage is extinguished.

All prior Michigan cases applying the full credit bid rule to extinguish mortgages at the time of the foreclosure sale, involve statutory foreclosures by advertisement and sheriff’s sales. This case involves a judicial foreclosure, which is equitable in nature. The court could find no precedent to extend the full credit bid rule to judicial foreclosure actions, and refused to do so.

The court noted numerous differences between a foreclosure by advertisement vs. and foreclosure by judicial action. In a foreclosure by advertisement, after notice is posted for four successive weeks, the property is sold. Court involvement is not required. With a judicial foreclosure, the property is not sold until after a complaint has been filed and a court order entered. The decision stressed the court’s integral role in participating in the foreclosure and calculating the debt amount. Therefore, even though the mortgagee bid the full amount of its debt, the mortgage was not extinguished by the judicial foreclosure sale. Therefore, the court could rely on the mortgage provisions requiring the borrower to pay the lender’s post-sale costs and attorney fees incurred in an action to enforce the borrower’s payment obligations.

Takeaway
Under these circumstances, title examiners might be well advised to read the court order to determine whether it addresses extinguishment of the judicially foreclosed mortgage and, if it does not, then also require a discharge of the mortgage at the time of the sale

The information contained herein does not attempt to give specific legal advice. For advice in particular situations, the services of a competent real estate attorney should be obtained. These materials are the exclusive property of Gregg A. Nathanson, Esq., and no reprint or other use of the information contained herein is permitted without Mr. Nathanson’s express prior written authorization. Gregg Nathanson may be contacted by email: gregg.nathanson@couzens.com, telephone 248-489-8600, or regular mail: Couzens Lansky, 39395 W. 12 Mile, Suite 200, Farmington Hills, Michigan 48331.

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