The Supreme Court of Michigan recently held that the full credit bid rule did not bar contract claims brought by a mortgagee against non-borrower third parties. The Michigan Supreme Court also held that the closing instructions at issue constituted a contract upon which a breach of contract claim could be brought.

A copy of the opinion is available at:  Link to Opinion.

The plaintiff lender partially financed four properties and shortly after closing, all four borrowers defaulted. The lender foreclosed by advertisement and subsequently bought all four properties at sheriff’s sale. Two of the purchases were by full credit bids. The lender then sold the properties to bona fide purchasers at what is asserted to be a loss of approximately $7 million.

The lender eventually discovered that the loans were based on fraudulently inflated appraisals and the purchasers were straw buyers paid for their participation. The lender sued the title insurance company, which had issued closing protection letters that promised to reimburse the lender for actual losses incurred in connection with the closes if they arose from fraud or dishonesty. The lender also sued the closing agent alleging that it had violated the terms of the closing instructions.

The trial court granted the defendant title insurer’s and closing agent’s motions for summary disposition of the plaintiff lender’s breach of contract, after the plaintiff lender voluntarily dismissed its negligent misrepresentation claim.

The Court of Appeals affirmed with respect to the closing agent and reversed in part with respect to the title insurance company. The Court of Appeals held that the plaintiff lender’s claim against the title insurance company relating to the properties on which it had made full credit bids was barred by New Freedom Mtg Corp v. Globe Mtg Corp, 281 Mich App 63 (2008).

As you may recall, in Michigan, a mortgagee that elects to foreclose by advertisement may bid on the property at the sale. However, the mortgagee is not required to make a cash bid. Instead, a mortgagee can make a bid on credit because any cash it tenders would be returned to it and thus payment to the sheriff would be an idle gesture.

New Freedom held that when a mortgagee takes title to property pursuant to a full credit bid – in the amount of the entire debt then due — at a foreclosure sale, the mortgage debt is satisfied and the mortgage is extinguished, precluding the mortgagee from later claiming that the property was worth less than the bid.

The Court of Appeals concluded that the trial court properly granted summary disposition on the remaining two properties, for both defendants, because the plaintiff lender failed to produce evidence that created a question of fact regarding whether the closing agent knew of or participated in the underlying fraud. The Court of Appeals also concluded that the plaintiff lender had not established a link between the closing agent’s alleged violations of the closing instructions and the claimed damages.

The Michigan Supreme Court first held that the Court of Appeals erred by finding that the full credit bid rule barred the plaintiff lender’s claims against the defendants.  The Michigan Supreme Court held that, although the full credit bid rule is not a statute, it bears a relationship to the foreclosure by advertisement and anti-deficiency statutes, which were designed to govern the relationship between, and establish the rights and liabilities of the mortgagee and mortgagor.

Following the holdings of Alliance Mortgage Co v. Rothwell, 10 Cal 4th 1226 (1995) and Kolodge v. Boyd, 88 Cal App 4th 349 (2001), the Michigan Supreme Court found there was no apparent justification for extending the protections of the full credit bid rule to alter the contractual rights and liabilities between a mortgagee and non-borrower third parties.

Accordingly, the Court held, the full credit bid rule does not bar contract claims by a mortgagee against non-borrower third parties, and the New Freedom ruling was overruled to the extent that it conflicted with this decision.

Thus, the Michigan Supreme Court ruled that the Court of Appeals erred by concluding that the plaintiff lender’s full credit bid barred its contract claims against the defendants.  The Court also ruled that the closing instructions agreed to by the plaintiff lender and the closing agent constituted a contract upon which a breach of contract claim could be brought. Finally, the Michigan Supreme Court held that the lower courts erred by relying on New Freedom to interpret the credit protection letters given that the terms of the letters in New Freedom greatly differed from the instant case.

The Michigan Supreme Court found that the closing instructions agreed to by the plaintiff lender and the closing agent were contracts upon which a breach of contract action could lie.

The instructions here required the closing agent to contact the plaintiff lender immediately if it could not comply with the instructions, and specified that the closing agent would be financially liable for any loss resulting from its failure to follow the instructions. Alterations or amendments to the instructions had to be in writing, faxed with a confirmation receipt and changes had to be initialed.  The Michigan Supreme Court found that the closing instructions satisfied all of the elements of a valid contract.

The Michigan Supreme Court also held that the Court of Appeals erred to the extent it concluded that the contracts between plaintiff lender and the closing agent were modified by the closing protection letters between the plaintiff lender and the title insurance company. The closing agent was not a party to the closing protection letters, and the plaintiff lender and the closing agent did not mutually agree to modify the obligations under the closing instructions.

Instead, the Court held, the contract evidenced by the closing protection letter merely provided the limitations on the title insurance company’s agreement to indemnify the plaintiff lender for any errors arising from the closing on behalf of the closing agent.

The Michigan Supreme Court found that the trial court and Court of Appeals erred by imposing additional requirements on the plaintiff that were not found in the plain language of the parties’ closing protection letters (“CPL”).

As you may recall, a closing protection letter is a contract whereby the title company agrees to indemnify the lender for any losses caused by the failure of the closing agent to follow the lender’s closing instructions.

Under the CPLs in this case, the title insurance company agreed to reimburse the plaintiff lender for actual losses the plaintiff lender incurred in connection with the closings when conducted by a closing agent authorized to issue title insurance for the company when the loss arose out of fraud or dishonestly of the issuing agent handling plaintiff lender’s funds or documents in connection with the closings.

The Michigan Supreme Court held that the lower courts erred by concluding that the plaintiff lender was required to present evidence of concealed disbursements, shortages, or unpaid prior lien holders, and also erred in concluding that the title insurance company, as a matter of law, could not be liable based on the fraud or dishonesty of the closing agent.

Lastly, the Michigan Supreme Court found that the trial court and Court of Appeals also erred by relying on New Freedom to interpret the CPLs.

The title insurer in New Freedom was liable for actual losses arising out of the fraud or dishonesty of the issuing agent in handling the funds or documents. Yet, the CPLs here provided that the title insurance company was liable for actual losses arising out of fraud or dishonesty of the issuing agent handling the funds or documents.

The inclusion of the word “in” in the New Freedom CPLs limited the fraudulent or dishonest activities by a closing agent to conduct associated with handling the mortgage company’s funds or documents.  Because the word “in” was not included in the CPLs here, the indemnification coverage was broadened to any acts of fraud or dishonesty by the closing agent related to a closing.

As a result, the Michigan Supreme Court held that the plaintiff lender should be allowed on remand to offer evidence that the closing agent engaged in fraud or dishonesty in handling the HUD-1 settlement statements at closing.

Accordingly, the Michigan Supreme Court reversed the ruling of the Court of Appeals and remanded to the trial court for reconsideration of whether summary disposition was appropriate.