The well-publicized rise in defaults of subprime mortgages has created ample opportunities to purchase real estate at bargain prices. With foreclosure sales seemingly being scheduled on a daily basis, we frequently receive calls from clients wanting us to walk them through the potential pitfalls in the foreclosure bidding process. There are risks, so a potential bidder should learn as much as possible about the property and the process prior to placing the first bid.

A Binding Contract

In a traditional residential real estate purchase transaction, a willing buyer and a willing seller enter into a negotiated contract which customarily provides that the buyer may terminate the contract if the results of a property inspection or title examination are not satisfactory. At a foreclosure sale, the final highest bid creates a binding contract on the terms set forth in the Notice of Sale regardless of defects in the physical condition of the property or the title. Accordingly, the high bidder has no right to terminate the contract after the bid becomes final. If the high bidder refuses to close due to the physical condition of the property or the status of the title to the property, the foreclosure trustee has the right to hold the bidder to the contract and seek to recover all damages incurred due to the bidder's default. Consequently, before making a bid that ultimately could create a binding contract with no exit options, a prudent bidder will consider several issues.

Title Issues

Although a foreclosure sale may satisfy certain debts encumbering the property, the sale does not necessarily satisfy all such debts and will not cure other preexisting or superior liens or title defects. Property at a foreclosure sale is sold subject to all prior or superior liens and encumbrances. If, for example, the deed of trust being foreclosed is a second-lien deed of trust, the high bidder will take title to the property subject to the first-lien deed of trust. Also, if a property owner has defaulted on a mortgage, there is high probability that the owner has defaulted on other obligations, giving rise to the possibility of judgment liens against the owner which may take priority over the deed of trust being foreclosed. Further, even if the deed of trust being foreclosed was recorded prior to other liens, the other liens may be superior and will survive the foreclosure if the deed of trust being foreclosed was subordinated to the later lien, or if the later lien has "super" priority status (such as a tax lien). Additionally, the lender whose deed of trust is being foreclosed may not have searched title to the property carefully when making the loan, and the title may be subject to a serious, or even fatal, title defect; alternately, the lender may have known of the defect and obtained a lender's title insurance policy insuring the lender against loss resulting from the title defect. In either event, the foreclosure will not cure such a defect, the bidder will take title subject to such defect, and the bidder may find that he or she cannot obtain an owner's title insurance policy insuring against the defect because an owner's policy is subject to more stringent underwriting criteria than a lender's policy. Finally, as mentioned above, the foreclosed property will be sold subject to unpaid taxes, so any title search also should include a detailed review of the property tax records. Prior to bidding, therefore, a prudent bidder will examine title to the property to determine what liens and encumbrances exist against the property and will survive the foreclosure.

Procedural Issues

Foreclosure sales must be conducted in strict compliance with detailed sale procedures imposed by statute. If the proper procedure is not followed, the winning bidder may become embroiled in litigation with the former owner claiming ownership of the property or with a lienholder claiming its lien was not extinguished due to the failure of the foreclosing trustee to follow one or more of the required procedures. Any title examination, therefore, should include an investigation into the foreclosure trustee's compliance with the complicated procedures mandated by all applicable statutes.

Environmental Issues

Beyond the physical condition of the property being foreclosed, a prudent bidder will be concerned about the environmental condition of the property, something not generally ascertainable by a brief visit to the property prior to the sale. Under current law, owners of real property with environmental contamination may be liable for the costs of cleaning up the contamination regardless of whether or not the owner caused the contamination or knew of it at the time the property was purchased. The law generally exempts an "innocent owner" from clean-up liability for certain types of contamination, but, to qualify as an "innocent owner," the owner must have made "all appropriate inquiries" by having a qualified person investigate the property for the possible existence of contamination prior to purchase. Some of this investigation will involve a review of the public records, but an on-site examination also is required. This may not be possible when purchasing at a foreclosure sale due to the lack of legal access to the property and the structures located thereon prior to closing. An interested bidder, therefore, should consult an attorney to evaluate the steps that may be taken and what environmental risks are involved.

The Holdover Owner

Once the high bidder has closed on the purchase, it's not always smooth sailing. Often, owners who have been the subject of a foreclosure, having essentially nothing to lose, no desire to leave their home, and no reason to take care of the property, will not vacate the property willingly. If the previous owner rented the property to tenants prior to the foreclosure, the tenants also may have no motivation to vacate or maintain the property. Since self-help eviction is not permissible in North Carolina for residential properties, the foreclosure purchaser is left with the unenviable task of evicting the occupants through legal proceedings. This can be costly and time-consuming, thereby delaying the purchaser's ability to access the property to inspect its physical condition and begin desired renovations, while giving the disgruntled occupant more time in which to damage the property. Quick and decisive legal action is required to gain exclusive possession of the property.

Conclusion

The subprime lending situation has resulted in the possibility of purchasing desirable residential properties for "fire-sale" prices at foreclosure sales. In order to protect against the risks discussed above, a prudent bidder interested in buying property at a foreclosure sale will, prior to making a bid, spend the time and money necessary to conduct, to the extent possible, the same investigations conducted by buyers in traditional real estate purchase transactions. Otherwise, the bidder may not get the bargain envisioned.

For further information about bidding at foreclosure sales, contact Samuel B. Franck, William E. Martin, Clifford P. Parson, C. H. Pope, Jr., Clint D. Routson, or Stanley M. Sams.