Mountain Law: Lien priority fundamentals

Reproduced from the Summit Daily News, April 28, 2008, by permission of the author, Noah Klug.

Any person interested in foreclosures should understand lien priority fundamentals. Here’s an introduction.

A “lien” is a legally protected interest that a creditor has in a debtor’s property. One common type of lien is a deed of trust (or mortgage) recorded to secure repayment of a loan. There are many other types of liens.

All liens against a property can be ranked in order of priority. Generally, lien priority is determined by the order in which the liens were recorded in the office of the clerk and recorder. Some liens, such as tax liens, homeowner association assessment liens and mechanics’ liens, are given special priority by statute, meaning that they can sometimes “jump ahead” in priority over liens that were recorded earlier.

Any creditor who holds a lien, regardless of the lien’s priority, can potentially force sale of the encumbered property through foreclosure proceedings to satisfy the debt. The rights of competing lienholders in the foreclosure depend on whether their liens are senior or junior to the lien being foreclosed.

A lien senior in priority to a lien being foreclosed continues to encumber the property after the foreclosure. For example, if a property has two liens encumbering it and the second lien forecloses, the first lien remains in place after the foreclosure. This is a trap for the unwary buyer, who might purchase a property at a foreclosure sale not realizing that his title will be subject to one or more liens. The buyer is then forced to make arrangements to pay the liens or those liens could be foreclosed.

In contrast to the holder of a senior lien, whose interest is not threatened by foreclosure of a junior lien, the holder of a lien junior in priority to a lien being foreclosed must either “redeem” the property within a specified time after the sale or his lien will terminate. For example, if there are two liens against a property and the first lien forecloses, the holder of the second lien can redeem by paying the amount of the high bid at the foreclosure sale (plus interest). The second lienholder would then receive deed to the property free and clear of the first lien. If the junior lienholder in this example does not redeem, his lien will no longer encumber the property after the foreclosure. This doesn’t mean that the debtor no longer owes him money; it means that the property is no longer collateral for the debt and he must enforce the debt using remedies other than foreclosure (such as suing for breach of contract).

Matters get more complicated if there are multiple liens junior to the lien being foreclosed, but the principles are the same: Junior lienholders, starting with the most senior, must, in turn, pay the amount of the high bid at the sale plus all senior liens that redeemed ahead of them or their liens will be terminated. For example, if there are three liens encumbering a property and the first lien forecloses, the holder of the second lien can redeem by paying the amount of the high bid at the sale. The holder of the third lien can then redeem by paying the amount of the high bid at the sale plus the amount of the second lien (if the second lien redeemed). The high bidder or last to redeem gets deed to the property.

When faced with foreclosure of a senior lien, a junior lienholder should determine how much equity is in the property, which is the difference between the property’s fair market value and the amount necessary to redeem. If there is little or no equity, redemption is usually inadvisable because it would cost more than could realistically be recovered by later sale of the property (taking into account sales commissions and holding costs). If there is sufficient equity in the property, it might be worth redeeming to save a junior lien because the cost to redeem could potentially be recovered by later sale.

Lien priority affects many aspects of the complex foreclosure process. This article is intended as a general overview; consult a real estate attorney for advice on your particular situation.

Noah Klug is an attorney with Bauer & Burns, P.C. He may be reached at 970-453-2734 or Noah@BreckenridgeLawyer.com. For a general overview of the residential foreclosure process in Colorado, go to www.BreckenridgeLawyer.com and click on “A Summary of the Foreclosure Process”.