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Lenders Beware: the Nevada Supreme Court Holds That Foreclosures of Homeowners’ Association Liens May Extinguish First Priority Deeds of Trust

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By:  Bob L. Olson

Nevada has adopted the Uniform Common Interest Ownership Act of 1982 (the “Act”) which governs homeowners’ associations (“HOA”). One particular provision of that Act, enacted by Nevada in 1991 and later amended, and codified as NRS 116.3116 (the “Statute”), states that HOA liens are “prior to all other liens and encumbrances on a unit” except for, among other liens:

(b) A first security interest on the unit recorded before the date on which the assessment sought to be enforced became delinquent . . . :

NRS 116.3116(2)(b) (emphasis added).

At first glance the Statute unconditionally subordinates the HOA’s lien to a first priority mortgage or deed of trust (hereinafter “first priority lien” and the holder, the “mortgage holder”) recorded against the unit before the date on which the assessment sought to be enforced became delinquent. The Statute is not as simple as it seems because it later takes away part of the priority it gives to first priority lien holders. The Statute goes on to state that:

The [HOA] lien is also prior to all security interests described in paragraph (b) to the extent of any [maintenance and nuisance-abatement] charges incurred by the association on a unit pursuant to NRS 116.310312 and to the extent of the assessments for common expenses [i.e., HOA dues] based on the periodic budget adopted by the association pursuant to NRS 116.31156 which would have become due in the absence of acceleration during the 9 months immediately preceding institution of an action to enforce the lien, unless federal regulations adopted by the Federal Home Loan Mortgage Corporation or the Federal National Mortgage Association require a shorter period of priority for the lien. . . .

NRS 116.3116(2) (emphasis added).

Although the Statute has been in effect in Nevada since 1991, it had little effect until the recession, when defaults on both HOA dues and mortgage loans became common. Since then, the Statute’s granting the mortgage holder priority over the HOA and then taking away part of that priority has spawned a great deal of litigation in Nevada. Prior to the decision in SFR Investments Pool I, LLC v. U.S. Bank, N.A., (“SFR Investments”) lenders believed that the first priority lien survived a foreclosure sale by the HOA because of the express subordination provision of the Statute. A number of real estate speculators, however, have recently challenged the lenders’ view by purchasing property at HOA foreclosure sales and then suing the holders of the first priority liens for quiet title and declaratory relief. The real estate speculators’ position is that the sale of property at an HOA’s foreclosure sale extinguishes the first priority lien notwithstanding the express subordination contained in the Statute.

The Nevada Supreme Court was given an opportunity to interpret the Statute and rule on the competing priorities between the holder of a first priority lien and the purchaser of property at an HOA foreclosure sale in SFR Investments Pool I, LLC v. U.S. Bank, N.A., 130 Nev. Adv. Op. 75 (Sept. 18, 2014). There the appellant, a real estate speculator, purchased property at an HOA foreclosure sale for pennies on the dollar and later sued U.S. Bank alleging that the foreclosure sale by the HOA extinguished U.S. Bank’s first priority lien. The trial court dismissed the suit, holding that the HOA could not foreclose on its lien and extinguish the first priority lien unless it did so at a judicial foreclosure sale. SFR Investments Pool I, LLC (“SFR Investments”) then appealed to the Nevada Supreme Court.

The Nevada Supreme Court, in a four to three decision, reversed the trial court. In doing so, the Court held that:

  1. The Statute splits the lien of the HOA into a “superpriority piece” and a “subpriority piece.”
  2. The superpriority piece of the HOA’s lien consists of the “last nine months of unpaid HOA dues and maintenance and nuisance-abatement charges,” and is prior to the first priority lien.
  3. The subpriority piece consists of “all other HOA fees or assessments” and is subordinate to the first priority lien.
  4. The superpriority piece of the lien could be foreclosed upon non-judicially and such a sale will extinguish the first priority lien.
  5. Provisions contained in the Conditions Covenants & Restrictions (“CC&Rs”) for the HOA that subordinate the entire HOA lien to a first priority lien, often referred to as “mortgagee protection clauses,” are unenforceable under the Act.

The majority was not persuaded by U.S. Bank’s argument that the foreclosure notices prepared by the HOA did not indicate that it was only foreclosing on the superpriority portion of the HOA’s lien, nor did those notices describe the amount of the superpriority. Instead, the majority shifted the burden to the lender to pay what was demanded by the HOA by stating that “nothing appears to have stopped U.S. Bank from determining the precise superpriority amount in advance of the sale or paying the entire amount and requesting a refund of the balance.”

The majority stated that it was premature to rule on U.S. Bank’s arguments that the foreclosure by the HOA deprived it of due process of law and declined to address U.S. Bank’s argument that the foreclosure by the HOA was commercially unreasonable.

The three dissenting justices would have affirmed the trial court. They interpreted the Act to require an HOA to judicially foreclose upon a unit in order to extinguish a first priority lien. The dissent also noted that a nonjudicial foreclosure deprived the mortgage holder of the opportunity to “determine whether an association is even foreclosing on superpriority portions of its lien such as to prompt it to purchase the property at the association’s sale.” It also noted that the majority’s holding may leave the former owner of the property liable for the entire amount of the first priority mortgage or deed of trust without any “mechanism by which to obtain the property’s value as an offset against the amount still owed.”

It is important to note that the appeal was from an order dismissing SFR Investment’s complaint for failing to state a claim for relief. Thus, the Nevada Supreme Court did not hold that the real estate speculator obtained title to the property free and clear of U.S. Bank’s loan, nor did it hold that the foreclosure sale conducted by the HOA could not be set aside by the trial court. Instead, it remanded the matter for further proceedings. The Nevada Supreme Court also noted on several occasions that the record had not been adequately developed. Thus, SFR Investments is far from the last word on priority disputes.

There are a number of unresolved issues related to the Statute and the Court’s ruling in SFR Investments. Those issues include, but are not limited to, the following:

  1. What happens if the mortgage holder tenders payment of the superpriority portion of the lien and the tender is rejected? In our experience, many of the collection agencies that HOAs employ to foreclose on HOA liens refuse to accept a tender unless the mortgage holder pays everything that the HOA alleges it is owed regardless of whether it is the superpriority piece or the subpriority piece of the lien.
  2. Does the purchase of the property at the HOA foreclosure sale have priority over the mortgage holder if the HOA simultaneously forecloses on the subpriority piece of the lien? HOAs typically foreclose on the HOA’s entire lien, not just the superpriority piece of those liens. The appeals court in the District of Columbia, which has a similar statute, recently upheld the priority of nonjudicial HOA foreclosure sale but in that case, unlike the Nevada case, the HOA only foreclosed on the superpriority piece of the HOA’s lien. Chase Plaza Condominium Association, Inc. v. JP Morgan Chase Bank, N.A., 2014 WL 4250949 (D.C. App. August 28, 2014) (unpublished).
  3. Is a foreclosure sale conducted by an HOA that is not strictly in compliance with the Act void or voidable?
  4. Is the purchaser of property at an HOA sale, which likely paid a small fraction of the value of the property, a bona-fide purchaser for value?
  5. Can the sale of property by an HOA be avoided by a court because it was commercially unreasonable, a fraudulent conveyance or for inadequate consideration?
  6. Can the sale of property by an HOA be avoided by the holder of a first priority lien because it was not given adequate notice or due process of law?
  7. Does the Nevada Supreme Court’s construction of the Act in SFR Investments conflict with the duties and obligations of lenders, Nevada’s public policy to keep homeowners in their homes, and the legislative intent set forth in Nevada’s foreclosure mediation statute and the Homeowner’s Bill of Rights.