"First Bank v. Fischer & Frichtel, Inc".

"When a borrower defaults on a mortgage, the lender may recover the remaining debt by foreclosing on the mortgaged property. In a judicial foreclosurethe method used in most statesthe property is sold at auction under court supervision. If the proceeds are enough to cover the borrower's debt, the lender gets the proceeds, and the debt is satisfied. But if the proceeds are insufficient to cover the debt, the lender may obtain a deficiency judgment for the difference between the sale price and the amount owed. In this Business Case Study with Dissenting Opinion, we review First Bank v. Fischer &Frichtel, Inc.1 In this case, the lender was the only bidder at a judicial sale and bought the mortgaged property for far less than its fair market value. The Missouri Supreme Court had to determine the amount of the deficiency"

"CASE BACKGROUND

Fischer & Frichtel, Inc., is an experienced real estate developer based in Missouri. In June 2000, Fischer & Frichtel borrowed $2.58 million from First Bank in order to buy twenty-one lots of property for a residential development. Over the next five years, Fischer & Frichtel paid First Bank as it sold the lots, which served as collateral for the loan. When the housing market collapsed, however, Fischer & Frichtel was unable to pay First Bank for nine unsold lots. Through a series of negotiations, First Bank extended the loan's maturity date from July 1, 2003, to September 1, 2008. When the loan matured, Fischer & Frichtel defaulted, still owing $1.13 million. First Bank foreclosed on the unsold lots and was the only bidder at the judicial sale. First Bank's winning bid of $466,000 was based on its estimate of the lots' value, the depressed state of the real estate market, and the fact that it would have to sell the lots in bulk rather than individually. First Bank filed a suit seeking to recover the unpaid principal and interest on the loan. At trial, Fischer & Frichtel presented expert testimony showing that the lots' fair market value was $918,000. The trial judge instructed the jury that, if it found for First Bank, it "must award ... the balance due ... on the date of maturity, less the fair market value of the property at the time of the foreclosure sale, plus inter-est." Following the judge's instructions, the jury awarded First Bank $215,875. First Bank then moved for a new trial, arguing that it was entitled to the full difference between the sale price and the amount owed. The trial court granted First Bank's motion, and Fischer & Fric-htel appealed to the Missouri Supreme Court"

"MAJORITY OPINION

Laura Denvir STITH, Judge.

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Missouri and many * * * other states * * * require a debtor to pay as a deficiency the full difference between the debt and the foreclosure sale price. They do not permit a debtor to attack the sufficiency of the foreclosure sale price as part of the deficiency proceeding even if the debtor believes that the foreclosure sale price was inadequate. This does not mean Missouri does not give a debtor a mechanism for attacking an inadequate foreclosure sale price. Rather, a debtor who believes that the foreclosure sale price was inadequate can bring an action to void the foreclosure sale itself. If the sale stands, then it has been thought fair to require the debtor to pay any deficiency remaining based on the foreclosure sale price.

* * * *

Missouri permits the debtor to void a properly noticed and carried out foreclosure sale only by showing that "the inadequacy [of the sale price is] so gross that it shocks the conscience * * * and is in itself evidence of fraud." * * * Missouri's standard for proving that a foreclosure sale "shocks the conscience" is among the strictest in the country; more than one Missouri case has refused to set aside a sale that was only 20 to 30 percent of the fair market value * * *. [Emphasis added.] Fischer & Frichtel argues that this standard * * * almost inevitably leads to windfalls for lenders. Fischer & Frichtel suggests that the foreclosure process is unfair in part because cash must be offered for the property by the bidder. This is a problem for the ordinary bid-der, particularly a homeowner or small business owner, because the statutory minimum time period between notice of foreclosure and the actual sale is often less than a month, an insufficient amount of time to allow potential bidders to secure financing. Fischer & Frichtel notes that the lender does not have this financing problem, as it does not have to pay with cash, but instead simply may deduct the purchase price from the amount of principal the borrower owes. Because realistically the lender often will be the sole bid-der, it can buy the foreclosed property for far less than market value, sell theproperty at aprofit and thencollect a deficiencyfrom the borrower based on the below-market value it paid for the property.* * * ** * * While the foreclosure sale price was barely more than 50 per-cent of the fair market value later determined by the jury, the lender gave cogent reasons for its lower bid due to the depressed real estate market and the bulk nature of the sale, as of trial the lender had not been able to sell the property, and Fischer & Frichtel has not argued it could not have purchased the property at the foreclosure sale * * * .This is not a case, therefore, in which to consider a modification of the standard for setting aside a foreclosure sale solely due to inadequacy of price or whether a change should be made in the manner of determining a deficiency where the foreclosure price is less than the fair market value.

* * * *

For the reasons stated, the judgment of the trial court awarding a new trial is affirmed.

DISSENTING OPINION

Richard B. TEITELMAN, Chief Justice.

I respectfully dissent. The purpose of a damage award is to make the injured party whole without creating a windfall. Accordingly, in nearly every context in which a party sustains damage to or the loss of a property or business interest, Missouri law measures damages by reference to fair market value. Yet in the foreclosure context, Missouri law ignores the fair market value of the foreclosed property and, instead, measures the lender's damages with reference to the foreclosure sale price. Rather than making the injured party whole, this anomaly in the law of damages, in many cases, will require the defaulting party to subsidize a substantial windfall to the lender. Aside from the fact that this anomaly long has been a part of Missouri law, there is no other compelling reason for continued adherence to a measure of damages that too often enriches one party at the expense of another. Consequently, I would hold that damages in a deficiency action should be measured by reference to the fair market value of the foreclosed property.

* * * *

I would reverse the judgment sustaining First Bank's motion for a new trial and order the trial court to enter judgment consistent with the jury's finding that the fair market value of the foreclosed property was $918,000 and that Fischer & Fritchel therefore owed First Bank a deficiency of $215,875.

QUESTIONS FOR ANALYSIS

1.Law. What was the majority's decision? What were the reasons for its decision?

2.Law. Why did the dissent disagree with the majority? If the court had adopted the dissent's position, how would this have affected the result?

3.Ethics. Suppose that First Bank, the only bidder at the judicial sale, had submitted a winning bid of $1,000. Would First Bank's conduct have been ethical? Why or why not?

4.Economic Dimensions. Are there any reasons why the dissent's position might be more favorable for economic recovery from a recession? Explain your answer.

5.Implications for the Businessperson. What does the majority's ruling mean for a mortgagee that bids on a foreclosed property at a judicial sale? Explain your answer."