“What Do You Mean That I Can’t Foreclose My Mortgage and Sue the Guarantor at the Same Time? Since When?”: Finance, Insolvency & Restructuring Alert
The answer is, “since April 17, 2012.” On that day, the Michigan Court of Appeals, Michigan’s intermediate appellate court, issued its opinion in Greenville Lafayette, LLC v. Elgin State Bank (Case No. 308450), which reversed a decision of the Montcalm County Circuit Court on the scope of Michigan’s “one action” rule applicable to mortgage foreclosure by advertisement proceedings, MCL 600.3204(1)(b). This statutory provision prohibits the commencement and continuation of foreclosure by advertisement proceedings when “an action or proceedings, at law” have been instituted “to recover the debt secured by the mortgage or any part of the mortgage.” If such an action or proceeding has been commenced and is pending, it must be discontinued before the foreclosure proceeding can be begun. Alternatively, if such an action has resulted in the entry of a money judgment on the mortgage debt, then the foreclosure proceeding may only be commenced if an execution on that judgment “has been returned unsatisfied, in whole or in part.” Id. The rationale for this rule is to prohibit harassment of the mortgagor by requiring it to defend two proceedings at once and to forbid a double recovery on the debt. See, e.g., Lee v. Clary, 38 Mich. 223, 227 (1878); Larzelere v. Starkweather, 38 Mich. 96 (1878).
In 1970, the Sixth Circuit Court of Appeals in United States v. Leslie, 421 F.2d 763 (6th Cir. 1970) held that this statutory one-action rule did not bar the mortgagee, the U.S. Small Business Administration, from foreclosing on mortgaged realty owned by a corporation and separately commencing a civil action for a money judgment against to individual guarantors of the mortgage debt owed by the corporation as the principal obligor. In arriving at this conclusion, the Sixth Circuit found that the guaranty obligation was “separate” from the mortgage indebtedness and the civil action was brought against the two individual guarantors and not against the corporate debtor. Id. at 766. See also Mazur v. Young, 507 F.3d 1013, 1018 (6th Cir. 2007)(discussing the Leslie decision and well-settled Michigan law that a guaranty is an “independent, collateral agreement” separate from the mortgage note); Church & Church, Inc. v. A-1 Carpentry, 281 Mich.App. 330, 766 N.W.2d 30 (2008).
The Michigan Court of Appeals’ Greenville Lafayette decision has thrown the Leslie decision and its progeny, as well as established Michigan foreclosure and collection practices into a cocked hat by holding that the “one-action” rule of MCL 600.3204(1)(b) prohibits the commencement or continuation of a civil action for a money judgment against guarantors of a principal obligor’s indebtedness at the same time that a mortgage foreclosure by advertisement proceeding is pending. The Court of Appeals imposed an overly literal and broad construction of the one-action rule by holding that, because the definition of the mortgage debt in the loan documents before it included a boilerplate reference to debt arising under “guaranties,” then the prohibition contained in MCL 600.3204(1)(b) applied to invalidate the foreclosure. In effect, the court elevated form over substance, finding that the “mortgage debt” referred to in the statute was the same obligation that arose under the guaranties of the two individuals who are the debtor’s principals.
The authors posit that this expansion of the one-action rule’s scope made by the Court of Appeals is unwarranted and mistaken. The Court of Appeals focused upon a boilerplate definition of the debt in the mortgage loan documents, a definition that undoubtedly is contained in numerous commercial mortgage loan documents rather than concentrating on the legal separateness of the primary obligor/mortgagor and the two individual guarantors. The Court of Appeals’ reasoning failed to recognize the purpose of the one-action rule in crafting its decision—by permitting the two proceedings to be simultaneously prosecuted, there would have been no threat of harassment of the mortgagor nor would there be a possibility of double recovery. Any money judgment entered against the guarantors would be reduced, dollar-for-dollar, by the amount bid at the foreclosure sale to purchase the property. The Sixth Circuit Court of Appeals articulated this public policy in its Mazur decision where the court described an analogous land contract foreclosure proceeding:
“‘[T]he guaranty is an obligation separate from the mortgage note’ and… under Michigan law, a creditor may simultaneously proceed against a guarantor and foreclose on a mortgaged property. . . .That a guaranty agreement is an independent, collateral agreement is what allows a [creditor] to proceed against a guarantor without having first exhausted the foreclosure remedy against the buyer. Allowing [creditor] to proceed against a guarantor in a foreclosure context is simply expeditious, because the guarantor will still be liable for any deficiency that remains after foreclosure.”
Mazur, supra at 1019.
It is hoped that the mortgagee in the Greenville Lafayette litigation will seek leave to appeal from this decision to the Michigan Supreme Court and that this court grants leave to appeal. In the meantime, mortgagees who desire to commence simultaneously foreclosure by advertisement proceedings and a collection action against guarantors must proceed cautiously. First, these creditors must review their mortgage loan documentation with respect to troubled borrowers to determine whether there exists the boilerplate inclusion of guaranty indebtedness in the definition of the mortgage debt. If this language is present, then these mortgagees must determine if it is prudent for them to commence and complete a foreclosure by advertisement with respect to the mortgaged realty and then file a complaint for a money judgment against the guarantors. This may be the safest alternative, given that foreclosure proceedings from the date of first publication of the notice of foreclosure to the date of sale can be as short as four weeks. If guaranty indebtedness is not included in the definition of the mortgage debt in the loan documentation, then the Greenville Lafayette decision should not prohibit these mortgagees from simultaneously proceeding against the realty and the guarantors