MBE Tip of the Day: Real Property

Answer to the Real Property MBE Question

Subject: Real Property

Legal Issue: Mortgage priority and foreclosure

Legal Rule and Analysis: When considering how foreclosure proceeds are distributed, the priority of the various interests must be determined.  All interests senior to the foreclosed interest will remain on the property, while all interests junior to the foreclosed interest will be paid off.  If the sale did not generate enough money to pay off all of the junior interests, then the junior interest holder can still sue the debtor personally.  To determine priority, the relevant recording act must be considered.  The common law rule is first in time, first in right.  However, recording acts have the ability to change the result by protecting a subsequent interest holder.  Thus, even if a party acquires a mortgage after another, that party could still end up with priority if it meets the requirements for protection under the recording act.

In this case, we are told that the jurisdiction has a notice recording act.  This means that a bank that obtains a mortgage after a different bank could still have priority if it did not have notice of the earlier mortgages.  Here, Bank A was the first to acquire a mortgage and it recorded, putting all subsequent parties on notice of this mortgage.  Bank A will therefore have the highest priority.  Bank B was second to obtain a mortgage, but it didn’t immediately record its interest.  This leaves Bank B vulnerable.  And in fact, Bank C obtained a mortgage before Bank B recorded.  We are told that Bank C did not have any actual or inquiry notice of any other mortgages. It would have record notice of Bank A’s interest, but not Bank B’s.

Therefore, Bank C has priority over Bank B.  Bank B recorded its interest too late.  The order of priority is:

Bank A
Bank C
Bank B

Since Bank C is the one who foreclosed, this makes Bank A a senior interest and Bank B a junior interest.  The proceeds of the sale will first satisfy Bank C’s outstanding debt and then the remainder will be applied to Bank B’s interest.  The amount will not be sufficient to cover all of Bank B’s interest, and so Bank B will be able to go after the man personally for the deficiency.  As a senior interest, Bank A’s mortgage will remain on the property.

Bar Exam Tip: If you have trouble determining who will be paid first in a priority dispute, first figure out the order of priority (Bank A, Bank C, Bank B, as noted above). Next, put a star next to the party foreclosing (Bank C) and draw an arrow down. That “starred party” will be paid first. Then the money only moves down. So, Bank B will be paid next and anything leftover would go to the mortgagor (the man, in this case). Some students wonder why Bank A is not paid. Bank A is not prejudiced at all because Bank A’s interest still encumbers the property.

Conclusion: The proceeds will pay off Bank C’s mortgage and as much of Bank B’s interest as possible.  Bank B can then go after the man personally for the deficiency.  Bank A’s interest will remain on the property.

Look at the answer choices provided. Choose an answer choice that matches your conclusion. Review the other answer choices provided. 

The answer choice (C) is therefore correct. (A) is incorrect because recording a mortgage is not mandatory in order to allow a lender to collect foreclosure proceeds.  Bank C can still collect even though it never recorded. Recording puts others on notice and is beneficial, but is not a prerequisite to collection. (B) is incorrect because Bank B holds a mortgage that is junior in priority to Bank C.  Therefore, Bank C’s foreclosure serves to wipe out Bank B’s mortgage, and the proceeds will be applied to Bank B.  (D) is incorrect because Bank B cannot sue the investor for the deficiency.  The investor is not a debtor on the mortgage that Bank B holds, and therefore the investor is not personally liable.

MBE Tip: Understand the importance that priority rules play in many different topics!  Priority rules aren’t just applicable to who owns a piece of property.  They can also be relevant to determine which mortgage or other sort of interest hold priority over another.  A strong knowledge of recording acts becomes necessary in both of these situations.  Further, priority plays a role in other subjects as well, including secured transactions.  Therefore, this is a very important topic to learn as it will help you pick up points in many different places.