By Kevin Dobie, Esq.

Liebo, Weingarden, Dobie & Barbee PLLP

USFN Member (MN)

and by Jennifer West, Esq.

Southlaw PC *

USFN Member (IA, KS, MO, NE)

The practice of nonjudicial foreclosures in the United States, at least in the 8th Circuit, has been altered to the extent the process involves a junior lien held by the United States after the  8th Circuit Court of Appeals issued an order affirming a Missouri federal court decision. In July 2023, the 8th Circuit Court of Appeals affirmed in Show Me State Premium Homes v. McDonnell the lower court’s determination that when the United States has a subordinate lien (other than a federal tax lien), the holder of the senior interest must foreclose its lien by judicial action to eliminate the subordinate interest of the United States. 2022 WL 970890 (E.D. Mo. Mar. 31, 2022) affirmed 74 F.4th 911 (8th Cir. 2023).

The ruling may be a case of unintended consequences. Prior practices involving the foreclosure and removal of government liens in all nonjudicial states are now being called into question. Show Me involved a nonjudicial county tax lien foreclosure in Missouri where the Department of Housing and Urban Development had two junior mortgages. Although the senior interest foreclosed by a nonjudicial sale was a county tax lien, the ruling applies to senior mortgage and deed of trust foreclosures. The case is binding in the 8th Circuit, but its impact is likely larger because some title insurers have interpreted the ruling to apply to any nonjudicial foreclosure proceedings nationwide. Thus, all states that use nonjudicial mortgage foreclosures as the primary foreclosure method must take note.

The Missouri federal district court in Show Me held that for any property where the United States has a junior lien “28 U.S.C. § 2410(c) prohibits the extinguishment of property interests of the United States by a nonjudicial tax sale.” In other words, the court held if the United States has a junior lien (e.g., HUD second mortgage, USDA second mortgage, etc.), the statute requires the senior lienholder to name the United States as a defendant, foreclose by judicial action, and seek a judicial foreclosure sale to eliminate the junior federal lien. The decision was appealed, and the 8th Circuit affirmed the district court’s decision in July 2023.[1]

Prior to Show Me, servicers, insurers, and foreclosure counsel had relied on the holding in U.S. v. Brosnan, 363 U.S. 237 (1960), in which the U.S. Supreme Court explained that nonjudicial foreclosures eliminate junior federal liens using whatever state elimination method is available. Since then, title underwriters have been insuring nonjudicial foreclosures involving subordinate government liens. The federal statute at issue in Brosnan and Show Me, 28 U.S.C. § 2410, provides that despite the usual immunity from lawsuits, the United States waives its immunity in cases of foreclosures and other real property related lawsuits - essentially, the statute provides that parties may sue the United States in foreclosures and other real property lawsuits despite the usual rule that private parties may not sue the United States. The statute does not say that a party must sue the United States to foreclose but that it is permitted. After Brosnan, the statute was modified in 1966 to give the United States one year to redeem and to require a judicial sale where a party forecloses by judicial action. The amended statute did not, however, according to its plain language, require a judicial foreclosure in every case. Servicers, insurers, and practitioners continued to rely on the holding in Brosnan, i.e., and continued to foreclose by nonjudicial proceedings. If the servicer chose to foreclose by action, the servicer had to seek judicial sale and had to give the United States one year to redeem. 

In Show Me, the parties and the courts did not focus their discussion on Brosnan, and due to the unique posture of the case, there is room to argue in the future that Brosnan is still good law. Unfortunately, until then, title insurers are likely to follow Show Me. The ripple effect of this ruling is ongoing, and it is unclear how the various federal agencies are going to handle nonjudicial foreclosures involving property in which the United States holds a lien. For now, several title insurance underwriters have taken the position that nonjudicial foreclosure of property is insufficient to eliminate and junior government liens, except federal tax liens.[2] Moreover, any litigation to quiet title following a nonjudicial foreclosure sale could be removed to federal court. If the United States pursues such a case, that might be an opportunity to argue that Brosnan remains valid law.

In the meantime, Show Me has already changed the nonjudicial foreclosure landscape. Many firms within the 8th Circuit have been requesting judicial foreclosure approval, and servicers have likely seen significant increases in the number of judicial foreclosures involving government liens. This will almost certainly impact servicers in several respects. Judicial foreclosures will take much longer - in Missouri and Minnesota, a nonjudicial foreclosure takes two to three months while an uncontested judicial foreclosure can take nine to twelve months, plus the United States has a year to redeem. Some firms have been successful in working with U.S. Attorneys to obtain consent judgments from the United States in an effort to streamline the judicial process, but the process is still longer than a nonjudicial proceeding. Judicial foreclosures also require more attorney time and increase the costs of foreclosure. Another likely consequence will be an increase in the number of contested cases after a judicial foreclosure is filed because it is easier for a foreclosure defendant to contest a foreclosure when a court action is already pending.

As for recently completed nonjudicial foreclosures, the hope is that counsel and servicers will not be forced to examine past sales and determine whether any corrective action needs to take place. While it is expected that title insurance underwriters will address insurability questions in the near future, the requirements will continue to evolve as the various government agencies develop internal post-ruling procedures. Currently, many pending nonjudicial foreclosure sales have been canceled if the property is subject to a junior federal lien, and judicial foreclosure proceedings have been initiated. A minor consolation is this decision does not affect foreclosures with junior federal tax liens (e.g., IRS liens) because those liens can be eliminated through nonjudicial foreclosures authorized by a separate statute—26 U.S.C. § 7425.

The number of properties with other junior federal liens (e.g., HUD second mortgage, USDA second mortgage, etc.) that fall under Section 2410 is considerable. Filing judicial foreclosures in cases involving Partial HUD junior mortgage claims flies in the face of logic and is of little benefit to HUD or the borrower. After all, servicers are likely to convey many of the REO properties to HUD after the foreclosure, and the delay only increases the HUD insurance claim amount. Thus, HUD should be interested in setting up a waiver program to help reduce the cost and risks of foreclosure-related losses. HUD and other government agencies could consider this ruling as an opportunity to streamline and clarify internal procedures to permit nonjudicial foreclosure, at least in some circumstances. In fact, 28 U.S.C. § 2410(e) contemplates a method by which a release of a government lien may be requested. Consistent procedures for either requesting a release of lien or granting permission to proceed nonjudicially where a partial HUD claim exists would resolve many of these issues and is likely the most cost-effective solution for all interested parties.

With FHA and VA using partial claim junior mortgages for COVID forbearance deferrals, this decision is already having an outsized impact on servicers and insurers. Servicers will continue to see a lot more foreclosures with junior federal liens proceeding judicially unless the government agencies can develop a concise process to address an inevitable, increased bottleneck in our courts following this decision.

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USFNews - Sept. 20

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