Defaulted Note But No Foreclosure Permitted: A “Zombie Mortgage” in Wisconsin

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A recent Wisconsin Court of Appeals opinion, MidCountry Bank v. Bork, 371 Wis. 2d 564 (2016), serves as a reminder for  lenders and attorneys that judicial foreclosure in Wisconsin (and many other states) is an equitable remedy -- which a court may either choose to grant or deny. 

In MidCountry Bank, the appellate court upheld the lower court's decision to deny MidCountry Bank (“MidCountry”) the right to foreclose on the Borks’ (husband and wife) real property in Wisconsin after another court, in Minnesota, ruled that MidCountry’s loan officer had breached a fiduciary duty owed to the Borks, and that the Borks were entitled to $636,000 in damages (the amount of the loan from MidCountry on their Wisconsin property). The Borks had a long-standing and close relationship with their loan officer at MidCountry, and owned and operated a tree farm in Minnesota. The loan officer arranged a refinancing, in 2005, of the Borks’ existing business and personal loans with MidCountry, which was partially secured by a mortgage on the Borks’ Wisconsin property.   

            But the Minnesota court also held that MidCountry was entitled to a $4.3 million judgment on the total outstanding defaulted loans. There was no dispute that the Borks’ note and mortgage with MidCountry on the Wisconsin property were valid and enforceable, or that the loan on the property was in default for failure to make the scheduled payments.

The Wisconsin appellate court granted summary judgment to MidCountry on the issue of default under the Wisconsin mortgage but agreed with the lower court’s decision that "it would be inequitable to allow MidCountry to benefit from its breach of fiduciary duty by foreclosing upon the Wisconsin property." The appellate court noted that in Wisconsin, “The court may exercise its discretion to ensure that no injustice is done to any of the parties, even after a foreclosure sale is affirmed.” But the court also noted that:

MidCountry is still owed the amount outstanding on the note, and it retains a security interest in the Borks’ Wisconsin property. The effect of the circuit court’s decision was simply to preclude foreclosure as a means of enforcing that security interest, due to the apparent breach of fiduciary duty committed by one of the bank’s employees.

The appellate court further stated that:

The Wisconsin property remains encumbered as a result of the mortgage. In addition, MidCountry now has a Minnesota judgment well in excess of the Wisconsin property’s value. It may attempt to enforce that foreign judgment in accordance with WIS. STAT. § 806.24 [enforcement of foreign judgments] and WIS. STAT. ch. 815 [enforcement of judgments by execution], subject to any other applicable laws or defenses that may be raised by the Borks regarding such enforcement attempts.

In a footnote to the appellate court’s decision, the court concluded as follows:

As far as we can tell, nothing that has occurred in this foreclosure action affects the parties’ rights and obligations under the note, with the exception that foreclosure is no longer a viable means for MidCountry’s enforcement of its security interest. We recognize that the circuit court made certain remarks about the evidence presented in the Minnesota action, including that Larson [MidCountry’s  loan officer] engaged in clandestine efforts to secure financing that involved a negative amortization. However, to our knowledge the Borks have not been successful in seeking to void, rescind, or otherwise invalidate the underlying note.

The appellate court also added cryptically, in another footnote to its decision, that:

The encumbrance may become significant if, for example, the Borks attempt to sell or otherwise transfer the property.

For mortgage lenders, the key lesson of the MidCountry Bank decision is that borrowers can raise equitable arguments at any time in a foreclosure action.  For attorneys, the decision also serves as a reminder why it is prudent when providing legal opinions on mortgages to limit or qualify the opinions so that it is clear that they are subject to general principles of equity. 

Note that the appellate court stated that a foreclosure could be avoided even after the sale has been confirmed. Also, as noted above, the court alluded to the problem that would occur if the Borks subsequently attempted to sell or transfer the property. This is an interesting – and troublesome – issue, to which the court did not suggest any resolution. Obviously a potential purchaser would require that the mortgage not appear of record as a condition to buying the property. But the result of the court’s decision in MidCountry Bank is the creation of a true “zombie mortgage,” i.e., the mortgage remains of record without a conceivable method (at least in the court’s view) of removing it even though the borrower remains liable for the unpaid debt, with any unpaid amount continuing to accrue interest under the terms of the note. This is hardly the way to provide stability in real estate titles based on certainty, finality and confidence in the foreclosure process.

 

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Jack Murray
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