When a property owner stops making mortgage payments, the lender files a foreclosure action in court, seeking to have the loan paid in full. Through a series of hearings the lender strives to legally eliminate the interests of the borrower and those holding any junior or subordinate liens, and have the property sold to raise the money needed to pay the entire balance due on the mortgage loan. 

A foreclosure judgment confirms that the borrower is in default and the lender has the legal right to have the property sold by a sheriff’s sale, gives the time and place of the sheriff’s sale and indicates whether the lender has reserved the right to secure a deficiency judgment. A deficiency judgment is a judgment for the lender against the borrower for any amount still owed on the mortgage loan after the proceeds of the sheriff’s sale are applied to the debt.

The foreclosure judgment also specifies the length of the borrower’s redemption period; that is, the amount of time given to pay the entire mortgage debt and thus prevent the sheriff’s sale. In a foreclosure action, the lender often has the choice to ask for a deficiency judgment or forego the deficiency in exchange for a shorter redemption period for the borrower. For example, the redemption period for the foreclosure of a single-family home will be 12 months if the lender seeks a deficiency judgment and 6 months if the lender does not pursue the deficiency.

After the property is sold at the sheriff’s sale, the final step in the foreclosure process is a hearing for judicial confirmation of the sheriff’s sale. The primary purpose of this final hearing is to allow the court to ensure that the process was conducted in accordance with the law and that the property sold for a fair value.

Deficiency judgments 

While the common assumption is that any deficiency judgment against the borrower will equal the difference between the total amount the borrower owed and the winning bid at the sheriff’s sale, this is not what happens unless the court is satisfied that the successful bid was for "fair value." "Fair value" does not mean "fair market value," the value that the property might have at some remote future time, or the assessed value of the property. "Fair value" is a value that is not so inadequate as to shock the conscience of the court. It is the price that a person who is willing and able to buy the property would reasonably pay for it, not for purposes of speculation, but for the use to which the property has been put, or reasonably may be put.

For example, in one Wisconsin case, the court denied confirmation of a sale for $2,350 where the fair value was set at the amount of the mortgage debt ($4,800), the property was assessed at $4,525 and two real estate brokers had testified that the property could bring in $4,500 - $5,000 at a private, as opposed to a distress, sale. In another case, the lender bid $23,000 on a restaurant/bar property that had about $23,000 in unpaid real estate taxes. The lender’s appraiser valued the property at $46,800 but he appraised the property as a vacant building while the owner’s appraiser valued the property at $131,000. The trial court order confirming the sheriff’s sale was reversed and the matter was remanded for a new hearing because the court erroneously relied on the "vacant shell" appraisal.

Under Wis. Stat. § 846.165(2), if the property sells for less than the total amount due plus sale costs, the sale will not be confirmed and no judgment for deficiency rendered until the court is satisfied that the fair value of the property has been credited against the total mortgage debt. If the court finds that the price from the sheriff’s sale is inadequate, the court may determine the fair value and enter a deficiency judgment in the amount of the total mortgage debt (including interest and costs) less the fair value. On the other hand, the court may choose to order a resale of the property. In the event of a resale, the court may set the fair value as the "upset," or minimum, price.

Many of these principles were illustrated in the recent case of M&I Marshal & Ilsley Bank v. Peterson (No. 2010AP1093-FT, Ct. App. 2010). In 2009, M&I Marshall & Ilsley Bank (M&I) brought an action to foreclose the mortgage it held on Peterson’s residential rental property. The circuit court entered a judgment of foreclosure and granted M&I the right to pursue a deficiency judgment. M&I purchased the property at the sheriff’s sale for $96,485.39 and then sought judicial confirmation of the sale and a deficiency judgment against Peterson for $22,822.75.

At the judicial confirmation hearing, Peterson’s real estate broker testified that the property’s fair market value was $120,000, noting that its "fair value" would be somewhat less. M&I submitted a Broker Price Opinion (BPO) which estimated the sales price at $115,000 after 120 days or at $94,500 after a thirty-day quick sale. The court found the property’s fair market value was $120,000. The court then subtracted closing costs and commission and concluded the most Peterson could have reasonably expected on a sale was $112,000. Since the property would likely never sell for $120,000 in a distress sale and the property had been listed for six months without any offers, the court pegged the fair value at $110,000. $110,000 was credited against Peterson’s mortgage debt and M&I was awarded a deficiency judgment for the balance. The order confirming sale stated the fair value of the property was $110,000, but it also deducted $3,663.93 in unpaid property taxes so the credit against the mortgage debt was only $106,336.07.

Peterson appealed to the Wisconsin Court of Appeals, arguing the circuit court erred by reducing the property’s fair value from $112,000 to $110,000 and by subtracting the unpaid property taxes.

Under Wis. Stat. § 846.165(2), whenever a mortgaged property sells for less than the mortgage debt, the trial court must make a specific finding of the property’s fair value and must determine that the fair value has been credited toward the total amount due before confirming the sheriff’s sale. The Court concluded that the trial court properly exercised its discretion by setting the property’s fair value at $110,000. The Court found this was the product of a logical reasoning process that relied on M&I’s BPO, the testimony of Peterson’s real estate broker and the distressed sale situation. The court’s $2,000 reduction in fair value was only a 1.8 percent decrease and the Court indicated that is de minimis.

The Court of Appeals found that the circuit court erred when it subtracted the unpaid property taxes because the court never received the tax statements into evidence. Furthermore, M&I did not introduce any evidence at the confirmation hearing that the unpaid taxes affected the property’s fair value. Therefore the case was remanded to the circuit court with the instruction to set the fair value at $110,000.

Under those circumstances, M&I had the option to agree to credit Peterson’s mortgage balance with $110,000 and accept the judicial confirmation of the sheriff’s sale on those terms. If M&I declined to do so, a resale would have to be ordered by the court.

Observations

• Lenders apparently do not always bid in the total loan balance due at sheriff’s sales – in this case they bid in less. 
• The amount of the highest bid at a sheriff’s sale is not necessarily going to be the amount credited against the borrower’s loan balance. Instead it may be the fair value determined by the court that is offset against the debt. 
• In the Peterson case, the court looked to the lender’s BPO and the testimony of the property owner’s broker to establish fair value. 

Resources

For a review of the mortgage foreclosure process, visit the Wisconsin Foreclosure Assistance Resource Center and review the May 1999 Legal Update, "Mortgage Foreclosures," at www.wra.org/LU9905 and the March 2009 Legal Update, "Working with Distressed Sales," at www.wra.org/LU0903.

Debbi Conrad is Senior Attorney and Director of Legal Affairs for the WRA.