Junior Lienholders Beware of the Deed in Lieu

A grant deed in lieu of foreclosure (“deed in lieu”) given by a beneficiary to a foreclosing lender does not merge with the foreclosing lender’s deed of trust. For creditors with junior liens secured by real property, including contractors who file a mechanic’s lien claim that is recorded after a deed of trust, a recent court ruling on this issue confirms an often misunderstood area of the law.

In the case, decided on June 30, 2014 (Decon Group, Inc. v. Prudential Mortgage Capital Company, LLC, et al.), the appellate court ruled that a mechanic’s lien recorded later in time to a foreclosing deed of trust could be extinguished in a later foreclosure proceeding filed by the senior deed of trust holder, despite the beneficiary handing over a “deed of lieu” to the foreclosing lender. The court held that the act of the landowners/beneficiary handing over a “deed of lieu” to the foreclosing lender did not create a merger with the lender’s deed of trust, and the lender was free to continue with its foreclosure proceeding. Upon completion of the foreclosure proceeding, the foreclosure sale has the effect of extinguishing all junior, or later recorded, encumbrances. In the decided case, the sole junior encumbrance was a mechanic’s lien recorded by a contractor who was not paid by the landowner/beneficiary.

The ruling is important as it affirms a long precedent of law on this issue. It is also a reminder that there is always risk to a mechanic’s lien claimant when the landowner fails to keep current all prior recorded deeds of trust, and that a “deed in lieu” does not stop a foreclosure process commenced by the lender who accepts the deed from the beneficiary.

Michael Friedrichs is a partner at White and Bright specializing in real estate and business litigation and creditors in debt collection matters. For questions relating to this article or for assistance with debt collection issues, please contact Mr. Friedrichs at White and Bright (760-747-3200).

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