1. Mortgagees, Mortgagors, Purchasers, and the Equity of Redemption. In the mortgage transaction, property (real or personal) is transferred as security for a loan. If the loan is repaid according to the terms of the loan agreement, the security transfer may be said to lapse: the borrower-mortgagor, on repayment, regains whatever interest he had in the mortgaged property before he mortgaged it. If the borrower defaults on his payments, the mortgagee may look to the mortgaged property for satisfaction of the debt. In most states today the typical procedure is for the mortgagee to take possession of the property, sell it and apply the proceeds of sale, after deduction of his expenses, to the debt. If the property has been sold for more than enough to cover the debt and expenses, the surplus is remitted to the mortgagor (or to the holders of junior security interests in the property or to the mortgagor's trustee in bankruptcy or other representative of creditors in insolvency proceedings). If the proceeds of the sale do not cover the expenses and pay the debt in full, the mortgagor (or his insolvent estate) is liable for the deficiency. (For an account of the historical development of the mortgagee's rights against the security after default, see 2 G. Gilmore, Security Interests in Personal Property §43.2 (1965).)3
During the period while the loan is outstanding, the mortgage transaction creates what may be called a divided interest in the mortgaged property. It is no longer fully the mortgagor's: he stands to lose it entirely if he does not make payments on the loan as they become due. It is not yet the mortgagee's: he cannot sell it until there has been a default under the loan agreement. The mortgagor's interest is called his "equity of redemption." That term, which came into use during the seventeenth century, reflects a great deal of history. The early land mortgage was, in form, a conveyance of the land to the mortgagee, to become absolute on the mortgagor's default. The seventeenth-century equity courts, however, allowed the mortgagor, on tender of the debt even long after default, to "redeem" the land from the mortgagee. Hence, equity of redemption.4
Either the mortgagee or the mortgagor may elect to sell his interest in the mortgaged property before the loan has been repaid. In this discussion we shall not be concerned with the mortgagee's sale of his interest, although it may avoid confusion to point out that the mortgagee's sale of his security interest is always ancillary to an assignment of the debt secured and has nothing to do with a sale of the property after default. It should also be kept in mind that the borrower-mortgagor, by selling the property, does not escape liability on the debt. If he sells the property without authority from the mortgagee, the sale may be a default under the loan agreement; however, whether he sells with or without authority, he remains liable to pay the debt.5
In this country there is a universal requirement that the mortgagee must file or record his mortgage with a public official as a condition of protection against third parties. If the mortgage has not been properly filed, a purchaser of the mortgaged property from the mortgagor, who is himself without notice of the mortgage, will take the property free of the mortgage. In such a case the mortgagee has lost his security interest in the property and is left with his money claim against the borrower-mortgagor under the loan agreement. However, if the mortgage has been properly filed and if the mortgagee has not authorized the mortgagor to sell the property free of the mortgage, the purchaser will take subject to the mortgage. That is to say, his purchase will not cut off the mortgagee's interest in the property; he acquires only the mortgagor's interest. Such a transaction is often referred to, as it was in the opinion in Vrooman v. Turner, as a purchase or sale of the mortgagor's equity of redemption. In the balance of our discussion we shall assume that the purchaser (or grantee) from the mortgagor acquires only the mortgagor's interest or equity. We shall also assume that the mortgage security is land. (Theoretically the Vrooman v. Turner situation could arise where the mortgage covered personal property, but it is in the highest degree unlikely that the situation would ever come up except in the context of a land mortgage).6
Let us assume that A owns land which is subject to a mortgage securing a debt of $10,000. The debt has ten years to run before it is to be fully repaid. B wants to buy the land and A is willing to sell. They agree that the land is worth $20,000. How are they to carry out the transaction?7
The simplest way is to payoff the mortgage debt before or at the time of the sale. A pays the mortgagee $10,000, discharges the mortgage and sells the land to B for $20,000. Or B pays $10,000 to the mortgagee and $10,000 to A and in that way acquires the land free of A's mortgage. B may now borrow $10,000 and mortgage the land as security, but the new B mortgage has nothing to do with the old A mortgage. No doubt today the overwhelming number of land transactions of this kind are carried out by paying off A's mortgage first and letting B find his own financing.8
Another way is for B to buy A's interest (or equity) subject to the mortgage. This seems to have been more common in the past than it is today but this way of carrying out the transaction has by no means disappeared. If interest rates have risen since A executed his mortgage, it is obviously to B's interest to take over A's mortgage at the lower rate. If interest rates have fallen, the mortgagee would prefer to keep the mortgage alive and refuse to be paid off; whether or not he can rightfully refuse prepayment depends on the terms of the mortgage and loan agreement. For these reasons, or for no reason, transactions continue to appear in which B buys A's equity subject to the existing mortgage. We have already noted that A continues liable for the debt although he no longer owns the land. We may now turn to the relationship between B, the new owner of the land (or A's equity in it), and the mortgagee.9
It was long ago accepted as a matter of legal doctrine that there was a difference between a transaction in which B, as part of his purchase of A's equity, assumed the mortgage debt (i.e., promised A that he would pay the debt) and one in which B did not assume the debt. In the latter case he was oddly described as a "non-assuming grantee." We shall presently return to the "assuming grantee" but it is first necessary to inquire into the situation of the grantee who did not assume.10
What happens if, after equity has been sold to B (a non-assuming grantee), there is a default in the payment on the mortgage debt? Clearly (as we tend to say when dealing with obscure matters) the mortgagee can either sue A on the debt or he can foreclose the mortgage on the land in B's hands (i.e., have the land sold). Thus B stands to lose the land unless the mortgage payments are kept up (that is what we meant by saying that he bought the land, or A's equity, "subject to" the mortgage). But, as between B and A, which of them was supposed to pay? The answer to that question is that, in all probability, B was supposed to pay. It is theoretically possible to imagine an agreement between A and B under which A sold his equity to B and agreed to go on making the mortgage payments himself. In such a case, reverting to our hypothetical case of the land worth $20,000 subject to a mortgage debt of$10,000, B would presumably have paid A $20,000 for the land and trusted A to go on paying the mortgagee until the debt was discharged. In the real world B, whether or not he assumed the debt, did not pay A $20,000 and hope for the best; he paid him $10,000 and took over the mortgage payments himself. (From which, as the astute reader will have deduced, it must follow that, if the mortgagee on default collects the $10,000 from A instead of foreclosing the mortgage by having the land sold, then A will succeed to the mortgagee's interest and can himself foreclose the mortgage against B. The cases so hold. If they did not so hold, B would end up by acquiring land valued at $20,000 for which he had paid only $10,000.)11
Thus the non-assuming grantee will lose the land if there is a default in paying down the mortgage debt and furthermore has, in connection with his purchase of the mortgagor's equity, almost certainly taken over payment of the debt himself. What then is the difference between a purchase of the equity by a grantee who assumes the debt and a purchase by a grantee who does not assume? The difference lies in the grantee's liability for a deficiency judgment if, on a foreclosure sale, the land sells for less than the amount of the debt. A, the original mortgagor, always remains liable for any deficiency. If he sells his equity to a grantee who assumes the debt, the grantee is also liable for the deficiency. If the mortgagee collects the deficiency from A in the first instance, A can recover over from the grantee on his assumption. If the grantee does not assume the debt, he will lose the land unless he keeps up the payments but he will not become liable for the deficiency. Thus, it might be said, the non-assuming grantee limits his liability to the amount of his investment in the land. If he concludes at any time that the land is not worth the additional amount he will have to pay to discharge the mortgage, he can stop paying and let the land go, thus cutting his loss.12
In a period of rising land values, there is (factually) no difference between the situation of the assuming grantee and that of the non-assuming grantee. Presumably the land will always be worth more than the mortgage debt so that, if it is sold on foreclosure, there will be no resulting claim for a deficiency. It will always be to the grantee's interest to pay the mortgage debt, whether or not he has assumed it, .and acquire the undivided ownership of the land. If land values fall during the term of the mortgage, the ultimate liability for a deficiency judgement shifts from the mortgagor to the grantee who assumes the debt; it remains with the mortgagor if the grantee does not assume.13
It is a fair guess that mortgagors and grantees who engage in such transactions are frequently unaware of the difference between a sale of the equity with an assumption and a sale without an assumption. Whether the grantee assumes or does not assume may be the result of accident rather than a result consciously bargained for. Non-professionals who are not lawyers are in the highest degree unlikely to understand what is at stake. It would be comforting to think that all lawyers who have been admitted to practice have the distinction between asssuming grantees and non-assuming grantees at their fingertips. If that were true, however, there would not be nearly as many cases as there are, and always have been, in which both the sale contract and the deed leave shrouded in doubt the question whether the grantee did or did not assume the debt.14
2. Assuming Grantees, Mortgages, and Third Party Beneficiary Doctrine. In the situation in which A mortgages his land and later conveys his equity of redemption to B who assumes the mortgage debt, most courts have allowed the mortgagee to proceed directly against B for a deficiency judgment. Mellen v. Whipple, 67 Mass. (1 Gray) 317 (1854), which is discussed in the Note following Lawrence v. Fox, supra p. 1333, as well as in the opinions delivered in that case, was exceptional in denying the mortgagee's direct action. Naturally, even the Massachusetts court would have concluded that if the mortgagee recovered a deficiency judgment against the original mortgagor, the mortgagor could recover the amount from the assuming grantee. Most courts saw no reason to require the successive suits and allowed the mortgagee to recover the deficiency from the assuming grantee in the course of his action to foreclose the mortgage.15
It is not so clear that the courts which allowed the direct action thought of it in terms of third party beneficiary doctrine. Thus, in a series of New York cases that antedated Lawrence v. Fox, the mortgagee's right to proceed directly against the assuming grantee was grounded on suretyship law, the third party beneficiary cases being dismissed as irrelevant. In Halsey v. Reed, 9 Paige 446,451 (N.Y. Ct. Chancery 1842), the Chancellor explained the result in this way:16
It is not necessary to inquire whether the holder of the bond and mortgage could have maintained an action at law against Halsey upon this promise, within the principle of the decisions in the case of Starkey v. Mill, (Style's Rep. 296,) Dutton v. Poole, (2 Levintz, 210,) and of Schermerhorn v. Venderheyden, (1 John. Rep. 139.) For whatever may have been their right at law, there is no doubt that in equity the assignees of the bond and mortgage would have the right to a decree against Halsey or his personal representatives for the deficiency, upon a foreclosure and sale of the mortgaged premises, if the proceeds of the sale should be found insufficient to pay the debt and costs. For it is a well settled principle of this court that the creditor is entitled to the benefit of the collateral obligations for the payment of the debt which any person standing in the situation of surety for others has received for his indemnity and to discharge him from such payment.
Indeed in Lawrence v. Fox itself the New York cases on mortgagee vs. assuming grantee were not mentioned in either the majority opinion or the dissenting opinion, both of which not only dealt at length with the New York precedents but also wrestled with Mellen v. Whipple in which the Massachusetts court put its refusal to allow the mortgagee's action squarely on the ground that the third party beneficiary doctrine was an exceptional and, on the whole, doubtful novelty that should be confined within narrow limits.18
3. The Situation in Vrooman v. Turner. What distinguishes cases like Vrooman v. Turner from the situation just discussed is that there have been two or more conveyances of the equity of redemption, that an intermediate grantee did not assume the mortgage debt and that the purchaser from the non-assuming grantee did assume it. Since a non-assuming grantee is not himself liable for a deficiency judgment, there is no rational explanation for his requiring the purchaser of the equity from him to assume the debt. However, as we have suggested earlier: (1) it is frequently unclear, as a factual matter, whether a grantee has or has not assumed the debt; (2) in any particular transaction neither the parties nor their lawyers may understand the esoterics of assumption vs. non-assumption. Thus one explanation. is that the non-assuming grantee requires the purchaser from him to assume the debt simply in order to be on the safe side; the alternative explanation is that nobody understood what was going on so that the assumption following a break in the chain is merely accidental.19
In Vrooman v. Turner the court refers to two pre-Lawrence v. Fox cases in which a break in the chain of assumptions had been held fatal. In King v. Whiteley, 10 Paige 465 (N.Y. Ct. Chancery 1843), it was held that the mortgagee could not recover a deficiency from the grantee who assumed after the break. In Trotter v. Hughes, 12 N.Y. 74 (1854), it was held that the original mortgagor could not recover either. In those cases the decisions were based on suretyship law in the light of Halsey v. Reid, discussed in the preceding section of this Note. In Vrooman v. Turner the court, in the light of Lawrence v. Fox, dealt with the question as one of third party beneficiary law. Does the conceptual shift from suretyship language to contract beneficiary language seem to you to make any difference?20
Cases like Vrooman v. Turner have reappeared in litigation during each period when land values have fallen and deficiency judgments have become important (most notably, of course, during the 1930s). No judicial consensus has ever emerged, but the tendency today seems to be in favor of allowing the mortgagee to sue. For example, in Somers v. Avant, 244 Ga. 460,261 S.E.2d 334 (1979), the Supreme Court of Georgia.held, on facts similar to those in Vrooman v. Turner, that a remote grantee who agreed to pay a mortgage not owed by his grantor was personally liable to the mortgagee. The Restatement Second, focusing on the intentions of the contracting parties, clearly rejects the rule of Vrooman v. Turner. See §304, Illustration 2 and §310, Illustration 2. In Schneider v. Ferrigno, 110 Conn. 86, 147 A. 303 (1929), Maltbie, J., put the case against Vrooman v. Turner as follows:21
. . . The basic question presented is, can the holder of a mortgage make liable one who, upon acquiring title to the premises, has assumed and agreed to pay that mortgage, despite the fact that in the chain of title from the original maker of the mortgage some owner of the equity of redemption has not assumed and agreed to pay it. Where such situations have come before the courts in the absence of statutory provision different conclusions have been reached. Those which deny a right of recovery advance various reasons. Wiltsie on Mortgage Foreclosure, Vol. 1 (4th Ed.) 5246, states that such a conclusion is based upon the fact that there is no consideration for the assumption, but that can hardly be so; the agreement to assume is but one term in the contract by which the lands are acquired and if that contract as a whole is supported by a valuable consideration it cannot be said that anyone term lacks such support. 2 Williston on Contracts, §386, suggests as the basis for the conclusion, that where the grantor of the equity of redemption was not himself liable by reason of an assumption of the mortgage and hence had no interest in the assumption of it by his grantee, the only intelligent object which can be attributed to him is to guard against a supposed or possible liability on his part, and he cannot be assumed to have intended to confer a benefit upon the holder of the mortgage; but it is difficult to see why, if his object is assumed to be to protect himself against a possible liability, his mental attitude is any different than it would be, had he sought to protect himself against a definite liability fixed by his own agreement to pay the mortgage. The cases which deny liability, such as the leading case of Vrooman v. Turner, 69 N.Y. 280, 285, do not seem fully to recognize the extent and force of the rule which permits a third party beneficiary to sue upon a contract as it has now been developed. The controlling test now is, was there any intent to confer a right of action upon the third party. Amer. Law Inst. Restatement, Contracts, §§133, 135; Byram Lumber & Supply Co. v. Page, 109 Conn. 256, 146 Atl. 293. If the grantor of the equity of redemption who has not assumed the mortgage has no obiect to protect himself, an intent to confer a right to sue upon the holder of the mortgage would be the most natural motive to assign to him in requiring his grantee to agree to pay it.
4. The Suretyship Analogy. In Vrooman v. Turner, Allen, J., remarks that the relationship of a grantor to his assuming grantee is like that of a "quasi surety" to a principal debtor. The same analogy is repeated in hundreds of other opinions. The thought is that the grantor, if he is forced to pay a deficiency claim, has a right to be reimbursed by the grantee just as a surety who pays the creditor has a right to be reimbursed by the principal debtor. Under suretyship law a surety is discharged if the creditor, without the surety's consent, enters into an agreement with the principal debtor to extend the time of payment. Another suretyship rule discharges the surety, at least to the extent of his loss, if the creditor holds collateral security which he could have applied to the debt and which has depreciated in value during the period of the creditor's forbearance to collect the debt. The theory of these, and other, suretyship defenses is that the creditor should not deal with the principal debtor without the surety's consent in any way that increases the risk assumed by the surety. Does it seem to you that a mortgagor who has sold his equity of redemption should be discharged from his liability for a deficiency claim if the mortgagee gives the present holder of the equity further time within which to pay? Or at all events discharged in the amount by which the value of the land has decreased during the period of forbearance? And should it make any difference whether the mortgagor's grantee did or did not assume the debt? See Kazunas v. Wright, 286 Ill. App. 554,4 N.E.2d 118 (1936), in which the court concluded that the mortgagee's extension of time to a non-assuming grantee discharged the original mortgagors.
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