Old Second Nat’l Bank v. Jafry, 57 N.E.3d 1251 (Ill. Ct. App. 2016)
The Appellate Court of Illinois, Second District (the “Appellate Court” or the “Court”) held that when a mortgagee obtains a deficiency judgment against the mortgagor in a foreclosure action, purchases the property at a judicial sale, and then resells it to a third party for an amount that exceeds the price paid for at the judicial sale, the mortgagor is not entitled to a setoff in the mortgagee’s enforcement proceedings to recover the deficiency judgment because the foreclosure terminates the mortgagor‑mortgagee relationship. The Court further held that if the mortgagor fears that the mortgagee will obtain a windfall in purchasing the property at a judicial sale, the mortgagor may attempt to sell the property himself before foreclosure or challenge the confirmation of sale under the Mortgage Foreclosure Law.
Syed and Asmat Jafry (“Defendants”) were guarantors on a real estate loan extended by plaintiff, Old Second National Bank (the “Bank”). After a loan default, the Bank obtained a judgment on June 19, 2013, to foreclose on the real property. The judgment reflected an outstanding loan balance of $1,362,329. The Bank purchased the property for $900,000 at the sheriff’s sale on June 19, 2014. Defendants contested confirmation of the judicial sale on the basis that the Bank’s bid was unconscionably low. Defendants submitted an appraisal which valued the property at $1,280,000. The Bank submitted two appraisals that valued the property between $1,000,000 and $1,060,000. On August 26, 2014, the trial court approved the sale and entered a deficiency judgment of $577,876 against Defendants. Defendants did not appeal from that order. Four months later, the Bank sold the property to a third party for $1,320,000. On February 17, 2015, the Bank initiated enforcement proceedings against Defendants, seeking the full deficiency judgment of $577,876, plus interest. Defendants responded on April 15, 2015, with a petition for equitable setoff, arguing that allowing the Bank to obtain a substantial profit from the resale of the property as well as the full deficiency judgment would constitute an improper double recovery. Defendants requested a $420,000 reduction in the deficiency judgment, reflecting the difference between the Bank’s winning bid at the judicial sale and the resale price.
The Trial Court:
On May 19, 2015, the Bank moved to dismiss Defendants’ petition pursuant to section 2‑615 of the Code of Civil Procedure (the “Code”) (735 ILCS 5/2‑615 (West 2014)). The trial court dismissed Defendants’ petition on July 15, 2015, explaining that, in the foreclosure context, a claim for setoff is unavailable because it could cause foreclosure proceedings to drag on indefinitely and in some cases it would be impossible for the trial court to determine the setoff amount. Defendants then appealed to the Appellate Court.
The Court of Appeals:
On appeal, Defendants contended that the trial court erred in denying them setoff. They argued that (i) Illinois has a long-standing policy against double recoveries which should apply to all enforcement actions, including foreclosure and (ii) a judgment debtor should be allowed to seek a setoff when the judgment creditor has recovered all or part of the loan deficiency before the creditor initiates proceedings to enforce a deficiency judgment. Although an issue of first impression, the Court was guided by principles that a purchaser at a foreclosure sale takes under the decree and not the mortgage or trust deed, and therefore the purchaser’s rights are not dependent on any privity of contract between the purchaser and the mortgagor. Essentially, the Court explained, the foreclosure ends the mortgagor‑mortgagee relationship and vests in the purchaser at foreclosure sale all the right, title, and interest of both the mortgagor and the mortgagee.
The Court rejected Defendants’ argument that they retained any post-foreclosure right of setoff or equitable setoff. The Court explained that the right to setoff is derived from either a contractual right or equity. Without a contractual right, there is no inherent right to setoff in equity; rather, the Court explained, equitable setoff was conceived as a limited remedy. Thus, a right to setoff in equity arises only if the indebtedness is certain and already reduced to a precise figure without a need for the intervention of a court or jury to estimate it. The Court noted that it could not find a case where a defendant had been entitled to a setoff or equitable setoff because a third party, who had no relationship with the defendant, made a payment to the plaintiff.
The Court noted that Defendants’ position essentially asked the Court to create a new type of setoff based on the Court’s inherent equitable powers, one that would be a broad and flawed expansion of the setoff doctrine that would not be equitable. As an example, the Court noted that if a third party had purchased the property at the sheriff’s sale, Defendants would have no recourse against that third party to reduce the deficiency judgment held by the Bank. Yet, Defendants insisted that, since it was the Bank holding their mortgage that also bought the property, the Bank should be held to a different standard. In rejecting the Defendants’ argument, the Court noted that other than having sympathy for the judgment debtor, there was no reason to treat a bank differently than a third party who purchases the property at a court‑ordered sale. To hold otherwise, the Court concluded, would contravene the long‑recognized principles that a purchaser at a foreclosure sale obtains all rights to the property and that the foreclosure sale terminates the relationship between the mortgagor and the mortgagee. In sum, the Court held that it is not appropriate to treat lenders and third parties differently in the context of the judicial sale of real estate.
The Court further explained that Defendants’ breach of contract was unrelated to the compensation the Bank received from the third‑party purchaser of the property. The foreclosure action terminated the mortgagor‑mortgagee relationship, and the Bank obtained an unencumbered right of ownership which conferred the right to sell the property to a third party. The Bank was not receiving an improper double recovery for the same injury, the Court determined, and the deficiency judgment represented a single satisfaction of Defendants’ debt regardless of how the value of the property changed between the dates of the two sales. The Court further noted that a truly equitable solution to Defendants’ perceived problem would run both ways in that when the mortgagor‑mortgagee relationship ends with the judicial sale, the debtor loses any input over how the property will be maintained, and thus he faces no liability for potential losses incurred by the lender. The debtor is neither liable for future losses nor entitled to future gains. Certainly, the Court concluded, Defendants were not advocating for a rule whereby a judgment creditor could recover in enforcement proceedings an amount exceeding the deficiency judgment.
The Court concluded by noting two steps future defendants can take to prevent this type of perceived profiteering by mortgagees. First, defendants can attempt to sell the property themselves before the foreclosure proceedings deprive them of the opportunity to do so. In this case, the Court found, Defendants did not take advantage of this ability. And because the Bank’s transactions were independent of one another, they did not constitute a double recovery. Second, section 15‑1508(b) of the Mortgage Foreclosure Law safeguards debtors by stating that the judicial sale shall be confirmed unless the Court finds that a required notice was not given, the terms of the sale were unconscionable, the sale was conducted fraudulently, or justice was otherwise not done. While Defendants’ availed themselves of the opportunity to challenge the sale on the grounds that the Bank’s bid was unconscionable, the Court found that Defendants did not appeal the trial court’s order that confirmed the sale and thus Defendants’ failure to appeal precluded the Court from granting Defendants equitable relief. Thus, the Court found, the trial court did not err in granting the Bank’s motion to dismiss Defendants’ petition for setoff.
