In Case of First Impression, Michigan Court of Appeals Rules that Foreclosure by Advertisement Sale Surplus Funds Must Be Distributed According to Priority of Interests in the Foreclosed Property

On May 9, 2017, the Michigan Court of Appeals issued an opinion in ‘In re $55,336.17 Surplus Funds.  The Surplus Fund case is important as the Court was called on to interpret the procedure for distributing foreclosure sale surplus funds and determining the priority of parties claiming an interest in the surplus funds.

Background

The case involves real property located in Brighton, Michigan.  In 2003, the decedent, Kathryn Kroth, and her husband, Thomas Kroth, granted a mortgage on the real property to National City Mortgage Services Co. (“First Mortgage”). In 2008, the decedent and her husband granted a second mortgage on the property in favor of National City Bank (“Second Mortgage”). After a series of mergers, PNC Bank, NA (“PNC”) came to hold both the First and Second Mortgages as the successor-in-interest.

Mr. and Mrs. Kroth both passed away in 2014, with Mr. Kroth predeceasing Mrs. Kroth.  Following a default in the payment of the First Mortgage, PNC initiated foreclosure of the property by advertisement proceedings. The property was purchased at the September 2, 2015 sheriff’s sale by a third party that satisfied the First Mortgage and left a surplus of $55,336.17.

In October 2015, PNC filed a verified claim for the surplus funds as a holder of the Second Mortgage, which had a balance of $119,538.40.  Under MCL 600.3252, the surplus funds were deposited with the court.  MCL 600.3252 provides as follows:

[i]f after any sale of real estate, made as herein prescribed, there shall remain in the hands of the officer or other person making the sale, any surplus money after satisfying the mortgage on which the real estate was sold, and payment of the costs and expenses of the foreclosure and sale, the surplus shall be paid over by the officer or other person on demand, to the mortgagor, his legal representatives or assigns, unless at the time of the sale, or before the surplus shall be so paid over, some claimant or claimants, shall file with the person so making the sale, a claim or claims, in writing, duly verified by the oath of the claimant, his agent, or attorney, that the claimant has a subsequent mortgage or lien encumbering the real estate, or some part thereof, and stating the amount thereof unpaid, setting forth the facts and nature of the same, in which case the person so making the sale, shall forthwith upon receiving the claim, pay the surplus to, and file the written claim with the clerk of the circuit court of the county in which the sale is so made; and thereupon any person or persons interested in the surplus, may apply to the court for an order to take proofs of the facts and circumstances contained in the claim or claims so filed. Thereafter, the court shall summon the claimant or claimants, party, or parties interested in the surplus, to appear before him at a time and place to be by him named, and attend the taking of the proof, and the claimant or claimants or party interested who shall appear may examine witnesses and produce such proof as they or either of them may see fit, and the court shall thereupon make an order in the premises directing the disposition of the surplus moneys or payment thereof in accordance with the rights of the claimant or claimants or persons interested.

In December 2015, the Estate of Mrs. Kroth (“Estate”) filed a notice of claim with the circuit court for the surplus funds as a person of interest.   PNC moved for disbursement of the surplus funds in its favor and the Estate objected.  The Estate argued that nothing in MCL 600.3252 established a senior interest in PNC to the surplus funds as a junior mortgagee.  The Estate argued that the foreclosure of the First Mortgage extinguished PNC’s second mortgage rendering PNC as “just a creditor” without a remaining security interest in the property.  Moreover, the Estate requested the trial court to distribute the surplus funds in accordance with the Estates and Protected Individuals Code (“EPIC”), MCL 700.1101 et seq.

The Court’s Decision

The Trial Court at a hearing on PNC’s motion examined the language of MCL 600.3252 and concluded that the statute’s explicit mention of subsequent mortgages directly contradicted the Estate’s claim that PNC was not entitled to priority.  The Trial Court rejected the Estate’s argument that PNC’s interests as junior mortgagee had been extinguished and instead concluded that the statute gave priority to the claims of junior mortgagees over the original mortgagor.  Thus, the Trial Court ordered the release of the surplus funds to PNC.

On Appeal

The Court of Appeals considered the Estate’s argument that PNC’s security interest in the property as junior mortgagee was extinguished on the date of the foreclosure sale.  The Appellate Court agreed that the issue was a matter of first impression but found that the Trial Court properly interpreted MCL 600.3252 as prioritizing the interest of junior mortgagee over a mortgagor.

In making its decision the Appellate Court first examined how courts interpret a statute recognizing that, “[i]f the language of a statute is clear and unambiguous, the statute must be enforced as written and no further judicial construction is permitted[,]” (quoting Whitman v City of Burton, 493 Mich 303, 311 (2013)), and that “[i]f the intent of the Legislature is not clear, courts must interpret statutes in a way that gives effect to every word, phrase, and clause in a statute and ‘avoid an interpretation that would render any part of the statute surplusage or nugatory.’” (quoting Haynes v Village of Beulah, 308 Mich App 465, 468 (2014) (citation omitted)).  The Appellate Court further indicated that “[w]ords and phrases used in a statute should be read in context with the entire act and assigned such meanings as to harmonize with the act as a whole.” City of Rockford v 63rd Dist Court, 286 Mich App 624, 627 (2009) (quotation marks and citation omitted) and that “[s]tatutes that relate to the same subject or that share a common purpose are in pari materia and must be read together as one law, even if they contain no reference to one another and were enacted on different dates.” Walters v Leech, 279 Mich App 707, 709-710 (2008).

Thus, in examining MCL 600.3252, the Appellate Court interpreted that section in the context of the entire chapter titled “Foreclosure of Mortgage by Advertisement.  The Court then recognized the definition of a mortgage as “[a] conveyance of an interest in real estate to secure the performance of an obligation,” In re Van Duzer, 390 Mich 571, 577 (1973), typically a debt and stated that the very purpose of mortgage foreclosure is to ensure that the mortgagor’s debt, secured by a mortgage to a mortgagee, is satisfied.

The Court went on to state that MCL 600.3252 applies after a claimant declares that it has a subsequent mortgage or lien encumbering the real estate and that the claimant is thus entitled to the surplus of funds.  The Court further stated that MCL 600.3252 sets forth a: (i) general rule for distribution of the surplus amounts from the sale of foreclosed property, (ii) an exception to the general rule, and (iii) the process for resolution of issues that arise after the exception is invoked. The Court went on to say that under the plain language of the statute, all surplus proceeds must be paid on demand to “the mortgagor, his legal representatives or assigns,” unless another claimant makes a claim of, specifically, “a subsequent mortgage or lien encumbering the real estate.” MCL 600.3252; see Schwartz v Irons, 4 Mich App 628, 632 (1966).

The Court set forth the context in which the statute and the procedure regarding the surplus funds would apply as follows:

  • the statute applies when a junior mortgagee or lienholder holds an interest in the property at the time of the foreclosure sale;
  • once such a claimant has filed a claim to the surplus proceeds to the person conducting the sheriff sale, typically the sheriff, the person deposits the surplus funds with the clerk of the court MCL 600.3252;
  • “any person or persons interested in the surplus, mayapply to the court for an order to take proofs of the facts and circumstances contained in theclaim or claims so filed”MCL 600.3252; and
  • the circuit court will examine the proofs and enter an order distributing the surplus funds in accordance with the rights of the claimants and interested persons. MCL 600.3252

The Estate had argued in the Trial Court that as a result of the foreclosure of the First Mortgage, the Second Mortgage was extinguished and thus, PNC was no longer a subsequent mortgagee and could not make a claim to the surplus funds under MCL 600.3252.

The Court agreed with the Estate that the foreclosure of a senior mortgage extinguishes the lien of a junior mortgagee where the junior mortgagee does not exercise its right to redeem. Advanta Nat’l Bank v McClarty, 257 Mich App 113, 125 (2003) and that when property is not redeemed, “all right, title, and interest in the property vest[s]” in the purchaser. Trademark Props of Mich, LLC v Fed Nat’l Mtg Ass’n, 308 Mich App 132, 139 (2014).  The Appellate Court confirmed that after the sale of property, there is a statutory time period during which a junior mortgagee, amongst others, has a right to redeem the property[1].  The Court found, however, that PNC retained a right to claim a priority interest in the surplus funds over the mortgagor as a subsequent mortgagee or lienholder at the time of the foreclosure sale pursuant to the explicit language of MCL 600.3252.

In examining the Estate’s argument, the Court of Appeals held that to accept the Estate’s analysis would “render nugatory all of MCL 600.3252, which provides for nothing other than an avenue for junior mortgagees and lienholders to claim an interest in surplus funds following a foreclosure sale.”  The Court showed the Estate’s faulty interpretation by showing that there would be no claimants to support the application of MCL 600.3252 if the priority interest of all junior mortgagees and lienholders to the surplus proceeds was extinguished at the time of the foreclosure sale, along with their security interests in the property itself.  The Court held that “[i]t is clear that the surplus statute was intended to apply for the protection of subsequent mortgage claimants or lienholders,” Schwartz, 4 Mich App at 632, granting them a limited interest in foreclosure sale surplus proceeds superior to the mortgagor after a senior mortgage is satisfied and that this was not inconsistent with the extinguishment of their security interests in the real property itself.

Moreover, the Court stated that while not explicitly citing MCL 600.3252, the Court has previously held that a junior mortgagee is entitled to claim the surplus after the foreclosure of a senior mortgage. See e.g., Bank of America, NA v First American Title Ins Co, 499 Mich 74, 91 (2016), quoting Smith v General Mortg Corp, 402 Mich 125, 128-129; 261 NW2d 710 (1978) (“No one disputes that the mortgagee is entitled to recover only his debt. Any surplus value belongs to others, namely, the mortgagor or subsequent lienors.”); Citizens State Bank v Nakash, 287 Mich App 289, 295 (2010) (“[D]efendant’s bid on the foreclosed property was in excess of his recoverable interest, entitling plaintiff, as a junior mortgagee, to claim the surplus.”).

The Court stated that it was clear that “through MCL 600.3252, the Legislature intended to provide a limited avenue for collection of foreclosure sale surplus proceeds to subsequent mortgagees and
lienholders, whose security interests in real property have been extinguished by the foreclosure of a senior mortgage, independent of their option to redeem.”

The Appellate Court next examined the procedure set forth in MCL 600.3252 on how an interested party can make claim to foreclosure sale surplus funds and how a court determines the priority of the interested parties.

The Court first stated that by the plain language of MCL 600.3252, the surplus funds should be paid to the mortgagor, unless at the time of the sale or before the surplus shall be so paid over, a claim is filed by a subsequent mortgagee or lienholder.  The Court concluded that this provision provided a time period during which a subsequent mortgagee or lienholder may file a claim to the foreclosure sale surplus proceeds, without regard to a continuing security interest in the property itself or the statutory redemption period.

With respect to determining the priority of the interested parties, the Court shot down the Estate’s argument that MCL 600.3252 did not set forth where the surplus funds are to go, or how the court is to determine the priority of the claimants.  The Court found that language of MCL 600.3252’s final clause is unambiguous and clear in its direction. The statute plainly provides that the court shall enter an order “directing the disposition of the surplus moneys or payment thereof in accordance with the rights of the claimant or claimant of persons interested.” MCL 600.3252 (emphasis added).  The Court further stated that the Legislature limited claimants to junior mortgagees or lienholders, who held an interest in the foreclosed property at the time of the foreclosure sale.

The Court then went on to examine a court’s determination of interest priority in such cases. “In general, Michigan is a race-notice state under MCL 565.29[2], wherein the owner of an interest in land can protect his or her interest by properly recording it and the first to record an interest typically has priority over subsequent purchasers or interest holders.” Wells Fargo Bank, NA v SBC IV REO, LLC, 318 Mich App 72; 2016 WL 6990761 at 10 (2016), slip op at 11 (footnote added). The principle that the first interest owner to record obtains priority applies to liens and mortgages on real property. Coventry Parkhomes Condominium Ass’n v Federal Nat Mortg Ass’n, 298 Mich App 252, 256 (2012).  Thus, the Court held that each mortgagee to record holds an interest in the property that is superior to the mortgagor until that interest is extinguished either by satisfaction of the mortgage or default and foreclosure. Therefore, the Court concluded “that MCL 600.3252 requires the court to distribute surplus proceeds from a mortgage foreclosure sale by advertisement to any subsequent mortgagees or lienholders in accordance with their respective priorities under MCL 565.29 and related case law.”  The Court went on to state that while the interest of subsequent mortgagees or lienholders “may compete or conflict, MCL 600.3252 allows the court, in situations involving conflicting interests, to take proofs at a hearing and direct the disposition accordingly.” The Court concluded that any remaining balance can then be distributed to the mortgagor, his representatives or assigns.

The Court held that the Trial Court did not err when it entered an order distributing the surplus funds to PNC as there was no question that PNC’s Second Mortgage interest as a junior mortgagee was superior to the Estate’s interest, as the legal representative of the mortgagor.

The Court also shot down the Estate’s argument that the Trial Court could have turned over the surplus funds to the Estate and allowed PNC to file a creditor claim under the terms of EPIC.  The Appellate court found that MCL 600.3252 provides a clear avenue for junior mortgagees and lienholders to collect surplus proceeds before they are dispersed to the mortgagor, his representatives, or assigns and that the personal representative of the mortgagor’s estate stands in his shoes and has no greater interest than the mortgagor.

Conclusion

The Surplus Fund case is important as the Court confirmed that junior lienholders are entitled to make a claim on foreclosure sale surplus proceeds and that if there are multiple claimants, the Court will examine the priorities of any subsequent mortgagees or lienholders in accordance with their respective priorities under MCL 565.29 and related case law and that these parties will have a superior interest to the mortgagor so long as their interest has not been extinguished.

William Z. Kolobaric is an attorney with the law firm of Cummings, McClorey, Davis & Acho, P.L.C. where he focuses his practice on community association law, construction law, real estate law, creditor’s rights in bankruptcy and probate and estate planning. He has extensive experience in state and federal courts involving a wide scope of real estate, commercial litigation and creditor’s rights matters. He can be reached at (734) 261-2400 or wkolobaric@cmda-law.com. Please view The Michigan Community Association Law Blog at http://www.micondolaw.com for additional resources on Michigan Community Association Law.

[1] PNC argued that its security interest in the property was not extinguished until the expiration of the redemption period. The Appellate Court stated that while there is some support for PNC’s argument in this regard, it was unnecessary to resolve the issue to decide the case. In re $55,336.17 Surplus Funds, footnote 1.

[2] MCL 565.29, Michigan’s race-notice statute, provides:

Every conveyance of real estate within the state hereafter made, which shall not
be recorded as provided in this chapter, shall be void as against any subsequent
purchaser in good faith and for a valuable consideration, of the same real estate or
any portion thereof, whose conveyance shall be first duly recorded. The fact that
such first recorded conveyance is in the form or contains the terms of a deed of
quit-claim and release shall not affect the question of good faith of such
subsequent purchaser, or be of itself notice to him of any unrecorded conveyance
of the same real estate or any part thereof.

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