SFR Investments Pool 1, LLC v. U.S. Bank Decision

The Nevada Supreme Court issued its ruling on the HOA super-priority lien issue on September 18, 2014, in SFR Investments Pool 1, LLC v. U.S. Bank., N.A., Case No. 63078.  This was an extremely important decision, and one that will have lasting effects on HOAs in Nevada. The Court’s holding was generally HOA-friendly. However, the opinion was not conclusive as to all the issues surrounding foreclosure of assessments and lien priority. The Court left certain issues unresolved, and still other issues have arisen since the ruling.

The Court held (1) that an HOA’s super-priority lien is a true priority lien such that its foreclosure extinguishes a first deed of trust, and (2) that an HOA’s super-priority lien can be foreclosed nonjudicially. These holdings are, indeed, a victory for HOAs. The Court clarified that the super-priority lien is senior to a first deed of trust, and thus an association’s foreclosure will properly extinguish a first deed of trust. It rejected the Bank’s argument that the super-priority is merely a payment priority, in that it only receives super-priority status when the beneficiary of the first deed of trust forecloses. Rather, the Court stated the statute creates a true priority lien, not a payment priority. The Court acknowledged that this is a mechanism by which HOAs are afforded the ability to enforce the collection of unpaid assessments, rather than being forced either to increase the assessment burden on other homeowners or reduce the services the HOA provides. The Court was also unsympathetic to the Bank’s argument that it is unfair to allow a relatively small lien to extinguish a first deed of trust securing hundreds of thousands of dollars of debt. The Court outlined options the Bank could have taken to protect itself – it could have paid off the amount of the HOA lien or established an escrow account for assessments.

The Court held that an HOA may foreclose its lien by nonjudicial foreclosure sale.  The nonjudicial foreclosure process outlined in NRS 116.31162 through NRS 116.31168 is the process by which an association may lawfully foreclose its lien.  The Court clarified an HOA can nonjudicially foreclose on its entire lien, not just the “subpriority” portion. (This phrase was adopted by the Court to distinguish the portion of an association’s lien not represented by the nine months of unpaid assessments. This amount will be discussed in further detail below.) Also, the option of foreclosing judicially is available under Chapter 116 as well. While an association is not required to institute a civil action to trigger the nine-month look back for the super-priority amount, it may still foreclose through the judicial process.

While the holding of the Supreme Court was that an HOA is not required to foreclose its lien through the judicial process and may foreclosure nonjudicially, three dissenting justices concluded that a civil judicial foreclosure complaint must be filed in order to enforce the super-priority portion of the lien. This is not binding precedent, nor is it part of the case law. However, the reasoning may be cited as persuasive authority when arguing that the Court’s holding should be limited or overturned.

This line of reasoning is especially important to note because the lender in SFR has filed a Petition for Rehearing, requesting that the Court withdraw its prior opinion, grant a new oral argument, and rule that a first deed of trust can be extinguished by an HOA lien foreclosure only if the HOA forecloses judicially.  The lender argued that the Supreme Court “misapprehends” the critical role judicial foreclosure plays in the enforcement provisions of Chapter 116.  Unless the legislature amends the statutes, the law of Nevada is that the super priority lien is a true priority lien, the foreclosure of which extinguishes a first deed of trust, and such lien can be foreclosed upon non-judicially.

An important issue the Court’s decision raises is that of notice to lenders. The Court outlines the process an HOA must follow in order to give proper notice in accordance with the statutory requirements and holds that this process does not offend lenders’ rights to due process. However, some title companies assert that the issue of adequate notice was not addressed by the Court. As a result, certain title companies will not insure title on HOA foreclosure sale properties absent payoff to the lender, even with a quiet title order, until the Court or legislature clarifies what notice is required.

Regardless of the fact that the statute vests the title of the Unit in the purchaser at the foreclosure sale, the absence of title insurance can be problematic.  First, if an association obtains the property by credit bid, there are no sale proceeds with which the lender could be paid so that a reconveyance could be obtained to satisfy a title insurance company.  Second, whether third party purchasers remain willing to purchase properties at HOA foreclosures with questionable ability to obtain title insurance, even with a quiet title order, remains to be seen.  This may come down to whether the properties are able to be leased and/or just how much risk a third party purchaser is willing to take in acquiring a property it may have trouble conveying without title insurance.

Another important issue that the Court’s ruling raises is what exactly comprises the super-priority portion of an HOA lien. Arguably, the super-priority lien encompasses all attorney’s fees and costs associated with proceeding through the nonjudicial foreclosure process, as these are common expenses.

The Court did not specifically rule whether fees and costs are properly included in the super-priority lien amount.  On October 6, 2014, the Nevada Supreme Court heard oral argument on a case which addresses this issue.  While it is uncertain as to when and how the Court will rule, there is certainly an argument that the super-priority amount includes reasonable attorney’s fees and costs.  A report from the Joint Editorial Board for Uniform Real Property Acts suggests that attorney’s fees and costs are indeed included in the super-priority amount.  The Court relied on this commentary as persuasive authority on the issue of the establishment of a true priority lien, and it may rely on the report when determining what amounts are included in the super-priority portion.

Two more issues arise from the Court’s opinion. The first stems from mortgage savings clauses contained in most associations’ CC&Rs. The clause at issue in the case stated that no lien created by the nonpayment of assessments shall defeat or render invalid the rights of the beneficiary of a recorded first deed of trust encumbering a unit. The Court stated that this provision was inconsistent with the provisions of NRS 116, and nothing in the statute allowed an association to waive its right to a priority position for the super-priority lien. As such, these clauses are ineffective and unenforceable. Distinguishing a fairly recent Florida case, however, the Court noted that in situations where the CC&Rs were recorded before 1991, when NRS Chapter 116 was enacted, a first deed of trust holder might have a contractual right to enforce the mortgage savings clause and, if such were the case, a foreclosure on a lien for unpaid assessments would not extinguish the deed of trust.  In the Florida case, both the CC&Rs and the deed of trust were recorded prior to the enactment of the statute.  How the Court would conceivably rule in cases wherein the CC&Rs were recorded before 1991 but the deed of trust was recorded after 1991 was not addressed.

The second deals with situations in which the sale price at a foreclosure sale is “unreasonably” low, i.e. the amount paid at the HOA foreclosure sale is significantly less than the outstanding amount due on the first deed of trust or the property’s fair market value.  It is not clear whether a sale may be void if the sale is deemed as “commercially unreasonable” and leaves the lender with significant unsecured debt, as the Court did not directly address this issue. Fortunately, there is case law in Nevada which holds that mere inadequacy of price is insufficient to void a foreclosure sale, especially in the absence of any fraud/collusion on the part of the trustee and purchaser.  However, this defense will likely play out in any number of pending cases, as well as future cases, until such time as the Court makes a ruling on this issue – or the legislature passes any legislation which addresses this.

Other courts, which apparently disagree with the Nevada Supreme Court, are already considering alternative arguments in order to carve out exceptions to the SFR decision on extinguishment. In Washington & Sandhill HOA v. Bank of America, N.A., et al., Case No. CV-01845- GMN-GWF, issued only a week after SFR, the United States District Court, District of Nevada, ruled deeds of trust which are FHA insured are property of the federal government under the Supremacy Clause of the United States Constitution and, therefore, are not subject to the state law provisions of NRS Chapter 116.  Interestingly enough, the court either ignores, or is not aware of, the June 20, 2012 letter to mortgage companies and lenders from the U.S. Dept. of Housing and Urban Development which specifically instructs them to pay all HOA “fees” before conveyance.  Furthermore, mortgagees/lenders are also advised that when an owner defaults and foreclosure is necessary, all HOA assessments which are not extinguished must be paid.  Certainly, this letter cuts against the court’s interpretation and application of the Supremacy Clause to the super priority provisions of NRS Chapter 116.

Another alternative argument concerns whether the Supreme Court’s ruling applies only to HOA foreclosures going forward, and not to foreclosures which occurred prior to the ruling. This argument seems more applicable to those situations of whether a newly enacted statute has retroactive application, and not whether the Supreme Court’s legal interpretation of the super priority statute which has been in place for over 20 years applies only to future HOA foreclosures.  Moreover, there is nothing in the SFR decision to suggest the Court’s determination that the super priority statute creates a true priority lien, and not merely a payment priority, is limited in scope or time.

If you would like more information regarding the SFR decision or any issues discussed in this article, please contact Kern & Associates.

Leave a Reply