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Court of Special Appeals Holds that Forfeiture of Deposit Posted at a Foreclosure Sale is an Unenforceable Penalty

A version of this article was published in The Daily Record on July 23, 2015.

On April 29, 2015, the Court of Special Appeals held that a deposit posted by a purchaser at a foreclosure sale may not be forfeited if the purchaser does not close as required and the advertisement of sale provides for an alternate remedy. Greentree Series V, Inc. v. Hofmeister, 222 Md.App. 557 (2015).

Factual Background

The Greentree case arose from a foreclosure sale of property in Anne Arundel County in which Greentree was the successful bidder with a bid of $172,000. Greentree paid a deposit to the trustees in the amount of $33,197, and the terms of sale in the foreclosure advertisement required Greentree to pay the balance of the purchase price within 10 days following the circuit court’s ratification of the sale. The foreclosure advertisement also stated, “If payment of the balance does not take place within ten days of ratification, the deposit will be forfeited and property will be resold at the risk and expense of the defaulting purchaser.” After the sale was ratified by the Circuit Court for Anne Arundel County, Greentree failed to proceed to closing. In response to a petition by the trustees, the court entered an order directing that the property be resold at Greentree’s risk and expense, and declaring that the deposit was forfeited.

At the resale auction of the property, Greentree was again the successful bidder, with a bid of $244,000, and it paid a $35,000 deposit to the trustees. After the sale was ratified by the court, Greentree again failed to close. The court again ordered a resale of the property, but that order provided that the trustees had the discretion to go to closing with Greentree at any time prior to the actual resale. On the day of the scheduled resale, Greentree and the trustees closed on the purchase of the property.

In the auditor’s report to the court, the auditor ruled that Greentree’s deposit of $33,197 from the first sale should be returned to Greentree and that the $35,000 deposit from the second sale should be credited to Greentree, thus denying the forfeiture of either deposit. The trustees and the secured party filed exceptions to the auditor’s report, contending that Greentree was not entitled to the return of the $33,197 deposit from the first sale.

Decision of the Circuit Court

The circuit court considered this issue from two perspectives: contract law and equitable principles. Contract law principles, the court held, did not support the forfeiture of the deposit, even though the terms of the foreclosure sale provided for it. The court noted that the secured party had suffered no loss as a result of the resale because the increase in the sale price from the first sale to the second sale exceeded the aggregate of the expenses incurred by the trustees related to the resale and additional interest that accrued during the delay. Thus, the court held that “forfeiting the deposit pursuant to the first sale advertisement would be akin to enforcing a penalty.” The court further noted that because the actual damages “were ascertainable at the time of the resale, the deposit forfeiture provision in the first sale advertisement, which is considered a liquidated damages clause, is unenforceable.”

Under equitable principles, however, the court held that the forfeiture of the first deposit was proper. The court noted that in applying funds received at a foreclosure sale, priority is to be given to protecting the interests of the mortgagor and the mortgagee. Their interests are, therefore, paramount to the interest of the purchaser. Because the forfeiture of the deposit would be applied to the underlying debt, it would benefit the mortgagor by reducing the amount of the mortgagor’s deficiency.

Therefore, applying the priorities in favor of the mortgagor over the purchaser mandates that the deposit be forfeited. The court also alluded to the equitable doctrine of unclean hands and noted that Greentree’s defaults in its obligations to conduct closing within the required time in both the first and the second sales militated against granting Greentree the relief of a refund of its deposit. Therefore, the circuit court held that the first deposit should be forfeited.

Opinion of the Court of Special Appeals

Greentree appealed to the Court of Special Appeals, where it argued that the circuit court did not have the discretion to order both the forfeiture of Greentree’s first deposit as well as a resale at Greentree’s risk and expense upon its failure to close after the first sale.

The Court of Special Appeals noted that, as a preliminary matter, it would address two subsidiary issues: (i) whether, under contract principles, Greentree’s deposit could be forfeited based upon its breach of the foreclosure sale terms, and (ii) whether the equitable doctrine of unclean hands precluded Greentree from obtaining relief from the forfeiture of its deposit.

The Court of Special Appeals began its analysis by noting that general contract principles apply to judicial sales. In a foreclosure sale, the court is the seller and the trustee is the court’s agent. The successful bid at the foreclosure auction is an offer by the purchaser to purchase the property, the court’s ratification of the sale constitutes the court’s acceptance of the offer, and upon the court’s ratification the contract is final.

The primary aspect of general contract law applicable to this case was the issue of whether the remedies to which the trustees were entitled constituted liquidated damages or a penalty. The remedy of liquidated damages is valid and enforceable, while a penalty is not. The Court of Special Appeals cited three elements of a valid liquidated damages clause: (1) the remedy provides for a sum certain; (2) the amount of the stated sum “must reasonably be compensation for the damages anticipated by the breach”; and (3) the clause is a binding agreement made before the fact, and the amount of stated damages “may not be altered to correspond to actual damages determined after the fact.”

The Court of Special Appeals held the two remedies available to the trustees (forfeiture of the deposit and resale of the property at the risk and expense of the defaulting purchaser) when “read in tandem” do not meet any of the criteria for a valid liquidated damages clause. The remedies do not satisfy the first element (that the remedy be a sum certain) because the damages resulting from the resale would not be known until the resale was completed. Likewise, the second and third elements were not satisfied because the trustees would receive the amount of the deposit regardless of the results of the resale (which might generate additional damages or might produce a higher purchase price). Therefore, the forfeiture of the deposit is considered a penalty, and it is not enforceable as a liquidated damages clause when it is an alternative remedy.

The Court of Special Appeals then considered whether the doctrine of “unclean hands” barred Greentree from asserting its claims. The doctrine bars a party from seeking relief in a court of equity if the party has “engaged in fraudulent, illegal, or inequitable conduct.” Although Greentree had twice failed to conduct closing on the purchase of the property within the time frame specified in the foreclosure advertisements, the Court of Special Appeals noted that merely defaulting under a contractual obligation does not constitute unclean hands so as to bar a party from asserting claims. Therefore, Greentree was not barred from asserting its claims by the doctrine of unclean hands.

The Court of Special Appeals then turned to Greentree’s main claim, which was that under Maryland Rule 14-305(g) the circuit court did not have the authority to order both the forfeiture of the deposit and the resale of the property at Greentree’s risk and expense.

The Court of Special Appeals rejected the predicate of the circuit court’s decision: that under Maryland Rule 14-305(g), in determining the relative priorities among claims to the deposit of a defaulting purchaser in a foreclosure, precedence should be accorded the interests of the mortgagor and mortgagee over the claims of the defaulting purchaser. Therefore, this could not serve as the basis for declaring the first deposit forfeited.

Finally, the Court of Special Appeals considered the specific language of Maryland Rule 14-305(g), which states that “[i]f the purchaser defaults, the court, on application and after notice to the purchaser, may order a resale at the risk and expense of the purchaser or may take any other appropriate action.” The circuit court had characterized the forfeiture of the deposit as an “other appropriate action,” so that in addition to the explicit authority under Rule 14-305(g) to order a resale, it could also declare the deposit forfeited.

The Court of Special Appeals specifically rejected this position, reasoning that the use of the disjunctive (“or”), rather than a conjunctive, in the text of this rule gave the circuit court the authority to order either a resale of the property at the risk and expense of the purchaser, or other appropriate action, but not both.

Summary

In summary, the Court of Special Appeals held that forfeiture of a deposit in a foreclosure sale constitutes an unenforceable penalty, rather than an enforceable liquidated damage clause when an alternative remedy is available to the trustees. Additionally, Maryland Rule 14-305(g) grants authority to a court to order a resale at the risk and expense of the defaulting purchaser, or other relief, but not both. However, and quite significantly, the Court of Special Appeals noted in a footnote that “[n]othing in this opinion should be interpreted as preventing the Trustee or mortgagor, in the event of a default by a foreclosure sale purchaser, from utilizing the deposit to offset any losses occasioned by a resale.” Thus, it would seem that the trustee would have the authority to retain the deposit until the damages from a resale are known, and then collect some or all of those damages from the deposit. If a resale produced a higher price, then the trustees would need to return some or all of the deposit.

Principles Stated by the Court of Special Appeals

As important as these holdings about forfeiture of deposits posted at foreclosure sales are, this decision is also significant because the Court of Special Appeals articulated the following principles that are important to bear in mind in the foreclosure process generally:

1. General contract principles apply to a foreclosure sale, with the court being the seller, the trustee being the court’s agent, the successful bid at the conclusion of the auction being an offer to purchase, and the court’s ratification of the sale being the court’s acceptance of the offer and finalization of the contract. This structure may affect the rights of the parties, including the point at which equitable conversion takes place and the circumstances under which the purchaser is entitled to possession of the property prior to closing.

2. There are three elements of a valid enforceable liquidated damages clause: (a) the remedy provides for a sum certain; (b) the amount of the stated sum “must reasonably be compensation for the damages anticipated by the breach”; and (c) the clause is a binding agreement made before the fact, and the amount of stated damages “may not be altered to correspond to actual damages determined after the fact.”

3. The doctrine of “unclean hands” applies to fraudulent, illegal, or inequitable conduct, but it does not apply to breach of contract.

Although these principles are stated in various other opinions, the Greentree decision presents them all in a single case where they are tied together and serve as the basis for the Court of Special Appeals’ holdings.

Seth Rotenberg (410-576-4179) wrote this article, a version of which was published in The Daily Record, Baltimore, Maryland on July 23, 2015.

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Date

11.04.15

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