An American Peril: The Status of Unreasonable Homeowner Association Sales in the State of Nevada
The Nevada Supreme Court’s Ruling in SFR Invs. Pool 1, LLC v. U.S. Bank, N.A., 334 P.3d 408, 409 turned the mortgage lending industry on its head in the State of Nevada. If you haven’t heard by now, that case allowed (potentially) investors to spend pennies on the dollar for homes. Provided the foreclosing entity, the Home Owners Association “HOA”, legally followed the foreclosure process under NRS 116, investors purchased these properties free and clear of the Lender’s Deed of Trust.
Typical sale prices investors paid for these HOA homes, prior to September 18 2014, ranged from $1,000.00 to $20,000.00, with estimated fair market values of the same Properties ranging between $60,000.00 to $1,000,000.00. Investors paid these low prices because the investors themselves believed that a HOA foreclosure sales had no effect on the Bank’s interest in the property.
But even assuming that the legal community knew, prior to the SFR decision, that an HOA Foreclosure sale could extinguish a Bank’s interest in the property, would it have been reasonable to assume that a potential investor could purchase the property for 5% of its value while extinguishing a mortgage worth 80% or more of that same property? Of course not - based on the principal that we must conduct ourselves in a reasonable manner.
Our society is rooted in capitalistic ideology. Americans generally believe that there is plenty of opportunity to make and obtain wealth, even if doing so damages others. Yet equally rooted in our society is the notion of fairness to one another when we pursue our own self-fulfilling financial goals. For instance, the Sherman Act (anti-trust laws) was the country’s response to robber-barons like John D. Rockefeller who obtained wealth at the expense of others. America encourages her people to create wealth and if that means exploiting others to do it, then so be it as long as its reasonable. Perhaps nowhere in our sociality is this “American Peril” better illustrated then through the long standing legal doctrine of “Commercial Reasonableness”.
In the context of foreclosure sales, it is not whether a foreclosure is commercially reasonable; rather it depends on whether the foreclosing party (the party who seeks to extinguish another party’s interest in the property usually a Lender or a HOA) acted fraudulently, oppressively, or unfairly. (For simplification I will refer to this fraudulently, oppressively, or unfairness standard as “misconduct”). Thus this legal test compels the foreclosing Party to act “reasonable”.
This reasonable standard creates a legal paradox with the current status of HOA foreclosure litigation in the state of Nevada. If you ask any lay person off the street if they think its fair to sell a house for $4,000.00 and not pay a lender who has an interest in the same house for $300,000.00 their answer would undoubtedly be "no". Still, thousands of these types of scenarios are currently being litigated in this State.
To illustrate this point better, consider this following hypothetical: Home Buyer purchases a home and secures a mortgage from a Lender in the amount of $220,000.00. The mortgage is a 30 year mortgage and the deal was executed in 1990. It is now 2018. The Lender has paid the principal down to an amount of only $5,000.00. In the interim, the fair market value of the property increased to $250,000.00 meaning the Home Owner has approximately $245,000.00 of equity in her home. The Homeowner then for whatever reason defaults on the terms of the loan. The Lender is within its contractual rights to foreclose upon the Property and choses to do so. Assume this sale occurred in the State of Nevada and that the Mortgagor correctly followed the procedural requirements under NRS 107 before foreclosing on the property. However, a third party buyer at the foreclosure sale made a bid of only $20,000.00. This bid was sufficient in amount to satisfy the loan amount due to the Lender, but there are very little excess proceeds and the Home Buyer retains none of their equity. The third party buyer then retains possession of the property free and clear. The Mortgagee then sues for equitable relief.
It is easy to see the issue with this scenario. Although the Bank followed the foreclosure process required under the law, the sale was unreasonable because it destroyed 28 years of the Home Owners hard work and the equity that hard work procured. It goes back to that "American Peril": you can make money, but you can’t be unreasonable.
Unfortunately this scenario is the exact scenario hundreds of lenders found themselves in when the Nevada Supreme Court issued its ruling in SFR.
So is an HOA foreclosure sale invalid if the HOA purchase price was grossly inadequate compared to the fair market value of the Property? Not exactly. In SHADOW WOOD HOMEOWNERS ASSOCIATION, INC. v. NEW YORK COMMUNITY BANCORP, INC., 132 Nev. Adv. Op. 5, 366 P.3d 1105, 1113 (January 28, 2016) the Nevada Supreme Court examined for the first time the, unreasonableness standard of HOA foreclosure sales. The case articulated that in order to invalidate a HOA foreclose sale, which potentially extinguished a Lender's interest in the Property foreclosed upon, the Lender must show two things: 1) The sale price must be less then the fair market value of the Property; and, 2) the HOA must have acted frequently oppressively or unfairly in the manner in which it foreclosed. Shadow Wood also cited to the Third Restatement of Property Law. (A restatement is imply a summarized explanation of case law), which explains the Courts throughout the County are generally warranted in setting aside a foreclose sale if the sales price is 20% or less then the fair market value of the Property.
Because the Shadow Wood Court’s citation to the restatement was in a footnote, there was confusion in Nevada’s legal community as to whether the Supreme Court adopted a black letter law rule where District Court’s where allowed to set aside a HOA foreclosure sale of the sales price was less then 20% of the Property’s value without an additional showing of fraud oppression or unfairness. However as subsequent Holding in by the Nevada Supreme Court in Nationstar Mortgage, LLC, V. Saticoy Bay LLC Series 2227 Shadow Canyon, No. 70382 (Nov. 2017), put that issue to rest. There the Court rejected the augment that Shadow Wood compelled the HOA to follow the commercial reasonableness standard under Article 9 of the uniform commercial code. Meaning that the HOA is not required to obtain the highest price at one of its HOA foreclosure says, and the HOA need only set a property for sale in conformance with NRS 116 and whatever price it receives is sufficient.
The Court in Nationstar Mortgage also rejected the idea that a sale 20% or less of the fair market value by itself allowed district Courts to set aside a sale without the lender providing additional evidence that the HOA acted fraudulently, oppressively, of unfairly. Thus the speculated black letter law rule was not adopted.
That not to say the Nationstar Mortgage Court did no provide the mechanism for invalidating a sale on an unreasonable foreclosure sale. To do so the lender must show inadequately of price and that the sale HOA acted fraudulently, oppressively, or unfairly. This two-part test is a sliding scale - meaning if the sales price is grossly inadequate to the fair market value of the property (20% or below), then the lender need only show minimal evidence of misconduct. The greater the sales price, the more evidence the lender must produce of misconduct by the HOA.
But the the question still remains, what exactly constitutes misconduct behavior by the HOA while foreclosing on the Property. The Court in Nation Star Mortgage partially answers that question. If the HOA failed to send required notices to Banks before foreclosing, an HOA’s representation that the scale will have no effect on the Banks Deed of Trust, 3) Collusion between the HOA and the purchaser at its sale, 4) If the HOA refused to accept the highest bidder at one of its sales, or 5) if the HOA misrepresents the sale date to the public. All of thee are examples of misconduct by an HOA, but more examples may exist depending on a particular case . If the lender can provide evidence of one of these, or a similarly, situations and the sales price was low compared to the Fair Market Value of the Property, then the lender should prevail in litigation.
Bottom line is that the old American Peril is alive and well in regards to HOA foreclosure sales in the state of Nevada. Lenders can prevail if the sale is unreasonable, but they must show something more than simply a low foreclosure sale - they must also show misconduct. What constitutes misconduct became clearer in 2017, but Nevada’s legal community will not obtain a more concrete definition until the Nevada Supreme Court has more opportunities to examine the facts of each one of these cases.