The Massachusetts Court of Appeals recently held that a foreclosing lender must use reasonable efforts to get the best price and, when those efforts reveal the potential to develop the property to increase the sale price, the lender should take such potential into account and share it with prospective bidders.

Don’t get nervous lenders. The decision does not mean the minimum value at a foreclosure is the value that could be achieved through developing the property. The decision in Property Acquisition Group v. Ivester, of course, is more nuanced because it’s driven by the facts of the case. The Court did not decide whether the lender violated its duty of good faith and reasonable diligence in conducting the foreclosure, so the case is ongoing.

However, this decision is noteworthy for two reasons. First, it is a wake-up call for lenders to make sure they take reasonable actions to get the best price. Second, it reminds us of the rules of the game in Massachusetts foreclosures, including the grey areas where lenders can get tripped up trying to realize on their collateral.

Duty to Act Reasonably to Get the Best Price

The Court stated that the duty of the lender is to do what a reasonable person would do to achieve the highest price possible to protect the interests of the borrower.

“When reasonable efforts to value the property reveal potential for development that could enhance the price of the property, the mortgagee should consider that potential and share it with prospective bidders.”

Whoa, slippery slope alert!  That could be interpreted as turning conventional wisdom on its head.

Does that mean you have to value the property based on what could reasonably be developed instead of what currently exists? The Court seemed to soften this “potential development” angle by acknowledging that “undeveloped properties are not to be valued as if the reasonably likely future uses already exist.” The Court also noted that “potential uses must be reasonably likely to be considered” and the potential price could be discounted “for the likelihood of their being realized.”

The Court reasoned that having some awareness of the fair market value of the property helps the lender determine the opening bid and whether to postpone the auction to protect the borrower’s interests. The lender in this case admitted in discovery it took no steps to determine the fair market value of the property before the auction. Say what? This is not a good fact for the lender. The Court’s comment on it was “no diligence is not reasonable diligence.”

So what is a lender supposed to do? The Court didn’t say you need to obtain an appraisal. The decision provided that the lender must in some way ascertain fair market value in order to satisfy its duty of good faith and reasonable diligence in selling the property. That could mean obtain an appraisal, contact a broker for a valuation or market information, or something similar.

Background of the Case

A borrower defaulted on its residential mortgage loan and the lender, Fannie Mae, sold the property to a third party at a foreclosure auction. The opening bid price at the auction was $329,000.  The winning bid was $355,000.  The assessed value was $361,900.

The borrower filed suit, claiming the lender did not satisfy its duty to exercise good faith and reasonable diligence in conducting the foreclosure sale. During the trial after the auction, the borrower’s expert appraised the property at $975,000, and the buyer’s expert at $385,000. All valuations concluded that the highest and best use of the property was as vacant land, developable into as many as four single family homes.

The trial court dismissed the case on a summary judgement motion. The trial court concluded that the borrower did not have enough evidence to prove the lender breached its duty. The judge reasoned that the lender had no obligation “to consider anything other than the value of the property as it was presently zoned and used.”

The Appeals Court instead found that the borrower had raised material disputes of fact as to whether the lender complied with its duty. The record showed that evidence exists of an inadequate price and other evidence that the lender:

  1. failed to take any steps to determine the current fair market value of the property before the auction sale;
  2. did not consider the development potential of the property or share that potential with potential bidders or in advertising; and
  3. did not take any steps other than compliance with statutory mandates.

Foreclosure Standards

The Appeals Court gave us a primer on the standards applicable to Massachusetts foreclosures:

  • The power of sale in a foreclosure permits a lender to foreclose without judicial oversight.
  • A foreclosing lender must exercise good faith and use reasonable diligence to protect the interests of the borrower.
  • The duty of good faith and reasonable diligence is not satisfied merely by following statutory requirements.
  • A lender must get for the property as much as it can reasonably, and do what a reasonable person would be expected to do to accomplish that result.
  • The mere inadequacy of a foreclosure sale price, alone, does not necessarily prove an absence of good faith or reasonable diligence; however, inadequacy of price may be considered with other evidence to support a finding of fraud or lack of reasonable diligence.