April, 2007

A Case Study in Ohio

by Nancy B. Young


The real estate market goes in cycles, and from all the evidence around us, this is a down cycle. Lower home mortgage interest rates have strained apartment occupancy rates. Many areas are suffering from a glut of office and retail space. New glitzy suburban malls are drawing shoppers away from the inner city shopping malls.

With higher vacancy rates come lower property values, and with lower income and values, come an interest in the borrower to “turn over the keys.” Although there are potentially adverse income tax consequences from deeding a property back to a lender, the benefits may far outweigh the downside. Many of the loans made during the past 15 or more years are non-recourse, that is the borrower is not liable for a deficiency after liquidation of the mortgage collateral, except in enumerated special areas of deliberate wrongdoing, called “carve-outs,” such as misapplication of insurance proceeds or security deposits. If there are guarantors, their liability is typically limited to the carve-outs and environmental issues. Also many if not most of the loans over the 15-year period were made to special purpose entities, formed solely to hold the mortgaged property with nothing else at risk. The borrower can stop the loss of operating expenses, avoid the adverse publicity, embarrassment and expense of a foreclosure trial, assure that the lender will pick up responsibility for landlord’s obligations under leases, and move on to develop yet more property.

If the title to the mortgaged property has no encumbrances other than those of the mortgagee that will itself, or far more commonly through a nominee, take fee title to the property, the issues become more simple. However, in many a deed in lieu situation, there are junior lienholders whose interests must be addressed.

It is still often more advantageous for a lender to accept the deed either itself or through a nominee. It removes the defaulting borrower from the picture. The lender now controls the property, can commence making any repairs or improvements that may improve the property’s value on the marketplace, can begin marketing the property on a limited basis and often has significant reporting and other regulatory gains by moving the property into the “real estate owned” category.

The lender’s chief concern is that the junior lienholder will argue that, by the doctrine of merger, the lesser mortgage interest merges into the fee simple interest that the lender holds and thereby ceases to exist, elevating their junior lien to a primary lien on the real estate. As the Supreme Court of Ohio stated in the seminal Ohio case on merger, Bell vs. Tenny, 29 Ohio St. Rep. 240, 242 (1876), “[a] merger is said to arise where a greater estate and a less coincide and meet in one and the same person, in one and the same right, without any intermediate estate.” This theory would have the mortgage interest, lesser than a fee simple, evaporate. The Court declined to apply that theory, stating that “…it is well settled in equity that the conveyance of the mortgaged premises, by the mortgagor to the mortgagee, does not necessarily merge the mortgage nor extinguish the mortgage debt. The question generally depends upon the intention of the person in whom the two estates unite.” The Court went on to say at page 243:

Where the intent to merge or not to merge, is, with knowledge of the facts, expressly or unequivocally fixed and declared, the question is settled by such determination. But where there is no expressed intent, or the party is incapable of expressing any, the court looks into the circumstances, and implies an intent upon the part of the owner of the two interests to keep the charge or incumbrance subsisting, where its subsistence is beneficial to him, and where there are no equitable circumstances which ought to require its extinguishment.

In the late 1970’s, my firm of Porter Wright Morris & Arthur, LLP (“Porter Wright”) was representing Aetna Life Insurance Company (“Aetna”), among other life insurance companies, in making agricultural loans to farmers as farm land prices soared. Within a very few years, the value dropped out of farmland, and the revenue from the farms declined, sending the industry into a wash of foreclosures. One of the foreclosures that we handled was Aetna life Insurance Company vs. Terry B. Hager, et al., Case No. 84-CI-41, Common Pleas Court of Ross County, Ohio (1984). Prior to the institution of the foreclosure action in January, 1984, on December 29, 1983, United Ag-Gro Enterprises, successor to Terry B. Hager and Vicki L. Hager (collectively the “Hagers”) and wholly owned by them, deeded the mortgaged property in Ross and Pickaway Counties, Ohio to Acme Holding Company, a subsidiary of Porter Wright, as the nominee of Aetna. The deeds both stated that the conveyance was “[s]ubject to covenants, conditions and restrictions of record, real estate taxes and assessments not yet due and payable, and to all existing mortgages, liens and encumbrances….” As the Court found in its Opinion and Judgment Entry filed on October 3, 1984:

…the facts show that plaintiff is the holder of two promissory notes. The first note was executed by Defendants Terry and Vicki Hager on July 25, 1978, and these defendants are in default of this note as of October 1, 1983. This note (hereinafter FIRST NOTE) is secured by a first FIRST MORTGAGE (emphasis in original) on real estate and a security interest in other collateral. The second note (hereinafter HAGER NOTE) was executed September 7, 1979, by Defendants Terry Hager, Umberto Del Rivo and James Hager. These defendants defaulted on this note October 1, 1983. The HAGER NOTE is secured by a mortgage (hereinafter HAGER MORTGAGE) on real property and a security interests in certain collateral. There are several other liens attached to the property securing these notes, but there is no dispute as to the plaintiff’s liens. ...

Defendants James Hager and Umberto Del Rivo oppose summary judgments on two basic grounds. First, both of these defendants are holders of secondary liens on the property which secures plaintiff’s FIRST MORTGAGE (emphasis in original) and therefore allege that summary judgment would be improper and highly prejudicial to their interests….Secondly, Defendant James Hager claims that summary judgment is improper because title to the real property subject to this action is held by the Acme Holding Company, for the benefit of the plaintiff. Defendant Hager argues that Acme is the alter ego of the plaintiff and consequently plaintiff has already received title and no longer has standing to foreclose.

Plaintiff has replied to this claim by stating that the conveyance to Acme did not result in a merger of the estates since the agreement between the plaintiff and the defendants clearly reflected an intention that no merger occur. A copy of this agreement, signed by Aetna and by Terry and Vicki Hager, as sole shareholders of United Ag-gro Enterprises, on December 29, 1983, clearly evidences an agreement between these parties that Acme will be a nominee for Aeta [sic]; that Aeta [sic] will foreclose on the mortgages held by it; that Aetna will direct Acme to lease the property to Frankfort Farms (another corporation owned solely by the Hagers); and that there is to be no merger of the two mortgages into the conveyance to Acme. Plaintiff argues that this agreement was merely a conveyance of Ag-gro’s equity of redemption in consideration for Aetna’s agreement to rent the farm to Frankfort Farms.

It is a general rule of law that a merger of estates occurs when a mortgagee acquires title to the mortgaged property from the mortgagor....However, equitable principles now govern the determination of merger and therefore, the intentions of all parties to such a transaction is the key to determining whether a merger took place....We hold that the agreement between Aetna, as mortgagee, and Defendants Hager and United Ag-gro, as mortgagors, clearly evidences an intent that the defendant’s mortgage debt not be extinguished nor the mortgages merged in the fee. Under this agreement, Aetna elected to keep the mortgages separate and distinct and such an election is clearly an available option....It should also be noted that the parties to this agreement are not the ones who are disputing or questioning the intentions as evidenced by this agreement. Hence, this Court can find no genuine issues regarding this agreement which would require further litigation. (Citations omitted)

Obviously the best protection for a lender in accepting a deed in lieu of foreclosure with the intention of reserving the right to foreclose its mortgage is appropriate documentation at the time of the deed in lieu transaction.

An extra thought. In Ohio a deed in lieu of foreclosure is exempt from the conveyance fee of $1.00/$1,000.00 to the County Auditor and up to an additional $3.00/$1,000.00 if voted in by the County Commissioners. Recording a deed from a sheriff’s sale is not exempt.


Nancy B. Young is a partner in the Columbus office of Porter Wright Morris & Arthur LLP. Porter Wright Morris & Arthur LLP is a nationally recognized law firm that traces its origins to 1846 in Ohio. With nearly 300 lawyers, the firm has offices in Cincinnati, Cleveland, Columbus, and Dayton, Ohio; Washington, D.C.; and Naples, Florida. Porter Wright provides counsel to a worldwide base of clients in a variety of areas of the law.