By Matthew Hector
The July 2011 Illinois State Bar Association Commercial Banking, Collections, and Bankruptcy Section newsletter included an article entitled, "Taking deficiency judgments in foreclosure." [1] Its main premise is that the Illinois Mortgage Foreclosure Law (IMFL) does not give courts discretion to refuse to enter deficiency judgments. I disagree. While the author is correct that section 15-1508 of the IMFL states that a court "shall" enter a personal judgment for deficiency, the equitable powers of the court can still trump the command language of section 15-1508.
It is well-established that courts hearing mortgage foreclosure actions have broad discretion in approving or denying the confirmation of a mortgage foreclosure sale. [2] The IMFL provides that a court may deny confirmation of sale if "justice was otherwise not done." [3] This catch-all phrase allows the court to consider the totality of the circumstances surrounding the foreclosure action and the sheriff's sale. More often than not, the foreclosing lender is repurchasing the property at the sheriff's sale. The sheer volume of foreclosures and the instability of the housing market has kept many investors away from foreclosure auctions. What was once a lucrative way to acquire property is now a coin toss - it is entirely possible that the purchased property will lose equity as the market continues to deteriorate.
The declining housing market is also indicative of the artificial inflation of property values in Illinois. The housing bubble drove prices up higher than they should have been. As more loans are scrutinized, it also seems that a significant amount of mortgage fraud took place. In many instances, this mortgage fraud was used to inflate a property's value, allowing buyers to cash out money at closing. These inflated values served as comparison values for further fraudulent appraisals, creating a perpetual motion machine designed to artificially inflate housing prices. When 49% of Chicago mortgages (not including the suburbs) are underwater, it becomes readily apparent that the market couldn't truly support those inflated values.
These inflated values become particularly important when reviewing the case law that discusses section 15-1508. A good starting point is JP Morgan Chase Bank v. Fankhauser. [4]In Fankhauser, the court examines several other cases where courts refuse to confirm a sale based on the discrepancy between the amount bid at auction and the value of the debt. That number is the potential deficiency. It is also interesting that the Fankhauser court holds that a mortgagor is entitled to an evidentiary hearing as to the fairness of a judicial sale, even when that mortgagor has failed to appear in the case until after the foreclosure sale's conclusion. [5] The case clearly establishes the broad, equitable powers of trial courts.
But do those powers allow trial courts to avoid the "shall" language of section 15-1508(e)? The article [6] cites two cases that predate the IMFL to support its position that whether a deficiency issues is not a matter of equity, but one of contractual interpretation. [7] The fact that both cases predate the IMFL, is merely an interesting footnote, at least as far as the article is concerned. [8] It would appear that when a promissory note allows for a deficiency against its maker, or that when a statute allows for the pursuit of a deficiency judgment, then so-called fairness does not come into play. Or does it? Section 15-1508(b) gives the court broad powers to deny confirmation of sale. [9] Section 15-1508(b)(iv)(2) provides that the confirmation order may include a deficiency judgment. [10] This language seems to suggest that including such a judgment is not required. The article, however, soldiers on.
The article argues that even more potentially fatal to the pro-equity argument is the holding in Bank of Benton v. Cogdill, which also predates the passage of the IMFL. [11] The Bank of Benton court held that, "the right to secure a deficiency judgment in any foreclosure proceeding is clear, provided that the mortgagee receives only one full satisfaction." [12] Certainly, we don't want to abrogate anyone's rights. Instead, let's examine the context of these opinions. In each and every one of these cases, the IMFL did not apply. None of the cases recite the standard for confirming a judicial sale. None of the cases even mentions the confirmation of the sale. Each case discusses something akin to a report of sale. Many of the issues in these deficiency judgment cases arose at what would be a modern confirmation of sale hearing. Moreover, the cases cited in the article [13] were decided at times when the nation was not experiencing the utter collapse of a housing bubble that artificially inflated home values. The deficiencies mentioned in the cases do not "shock the conscience." [14]
As Fankhauser establishes, trial courts have broad, equitable powers when it comes to deciding whether to confirm a sheriff's sale. [15] This may leave many judges stuck with a Hobson's choice. If they confirm the sale, they may be bound by the mandatory language of section 15-1508(e), utterly unable to deny a deficiency, no matter how large. If they refuse to confirm sales where the property is significantly underwater, the property may become stuck in a loop where it can never be sold. Each day that a property is in foreclosure adds to the total amount due under the note. Per diem interest accrues faster than one would imagine. Continually denying confirmation would result in an ever-increasing amount due, creating larger and larger disparities between the sale price and the loan balance. Add to that the fact that our trial courts are flooded with foreclosure matters. There is almost an incentive to confirm and get cases off the docket.
Granted, lenders could stop repurchasing the properties for less than a full credit bid. Certainly, the lender believed that the property was worth that inflated price when the loan was issued. Property values have yet to stabilize, and the added volume of foreclosures means that we may see further decline before the market rebounds. The debate really shifts to the question of, "who bears the burden of the depressed market?" This is where the court's equitable powers can truly come into play. There is nothing in the law that prohibits courts from conditioning confirmation in such a way that maximizes fairness. If a judge conditioned confirmation of a sale upon the bank not seeking a deficiency in the foreclosure matter, then that would theoretically be within the court's powers. That conditioned confirmation would not preclude the lender from later pursuing the borrower for his obligations under the note. If the note provides for recourse, then certainly the lender may attempt to pursue that debt in a separate lawsuit.
The current urban legend is that lenders aren't pursuing deficiency judgments. The article [16] indicates something a bit different - a frustration with a system that is not granting such judgments. The truth is likely somewhere in between. Based on my reading of the law, there is no clear precedent under the IMFL that prohibits courts from refusing to grant a deficiency judgment. The standard mortgage foreclosure complaint seems to hedge as to whether the plaintiff will seek a deficiency. Either it states, "no deficiency will be sought against those who have received a Chapter 7 discharge," or perhaps "a deficiency judgment may be requested against those who have not received a Chapter 7 discharge." Very rarely does the complaint specifically request the remedy. Section 15-1598(e)(ii) seems to require that a deficiency be "requested in the complaint." Language that hedges, hems and haws about whether a deficiency will ultimately be requested, and language that seeks to avoid violating the protections of the automatic bankruptcy stay does not amount to a request.
Given that there is limited IMFL case law on this point, and given that many mortgage foreclosure complaints do not specifically request a deficiency judgment, this issue is far from settled. If the court's equitable powers allow it to deny confirmation where an unconscionable result would issue, what is preventing it from conditioning confirmation upon not issuing a deficiency judgment? As mentioned above, it would not preclude a separate lawsuit sounding in breach of contract. Foreclosure defense attorneys and consumer protection attorneys alike would do well to fight excessive deficiency judgments.
[1] Available at http://www.isba.org/sections/commercial/newsletter/2011/07/takingdeficiencyjudgmentsinforeclos (last visited August 12, 2011).
[2] See JP Morgan Chase Bank v. Fankhauser, 383 Ill. App. 3d 254 (2nd Dist 2008).
[3] 735 ILCS 5/15-1508(b)(iv).
[5] Fankhauser, 383 Ill. App. 3d at 265.
[7] See Eiger v. Hunt, 282 Ill. App. 399 (1st Dist. 1935)(holding that the right to a deficiency judgment does not rest on equity principles, but on the legal obligations of the note's maker); see also Farmer City State Bank v. Champaign National Bank, 138 Ill. App. 3d 847 (4th Dist. 1985)(following Eiger v. Hunt).
[10] 735 ILCS 5/15-1508(b)(iv)(2).
[11] Bank of Benton v. Cogdill, 118 Ill. App. 3d 280 (5th Dist. 1983).
[14] Fankhauser, 383 Ill. App. 3d at 264.
[15] See fn5. See also Citicorp Savings of Illinois v. First Chicago Trust Company of Illinois, 269 Ill. App. 3d. 293, 300 (1st Dist. 1995)(holding that "a court is justified in refusing to approve a judicial sale if unfairness is shown which is prejudicial to an interested party").
