FIRST FEDERAL SAVINGS BANK v. HARTLEY

OPINION

BROOK, Chief Judge.

Case Summary

Appellant-plaintiff First Federal Savings Bank ("the Bank") appeals a judgment in favor of appellees-defendants Donald and Joyce Hartley. We reverse.

Issue

In this foreclosure action, the trial court subordinated the Bank's mortgage lien to the Hartleys' claim for money they spent improving a parcel of real estate on which the Bank has a mortgage. The Bank challenges this priority determination.

Facts and Procedural History

The facts most favorable to the judgment reveal that on October 23, 1996, Gregory Blatz1 executed a promissory note ("Note") with the Bank for $200,000 to establish a line of credit, which he planned to use to purchase investment real estate. On April 7, 1997, the Bank, pursuant to the note, advanced to Blatz $32,000 to purchase a parcel of real estate located at 8861 Jannie Lane, Silver Lake, Indiana. Blatz signed a mortgage on the Jannie Lane property with the Bank, which in turn properly recorded it on April 22, 1997.

From October 23, 1996 through the date of trial, the balance due on the Note was refinanced into subsequent promissory notes. During that time, Blatz made only interest payments to the Bank except when a particular property was sold, in which case Blatz would deliver the net proceeds to the Bank for release of its mortgage with regard to that particular property. Blatz made no principal payments toward the $32,000 loaned by the Bank for his purchase of the Jannie Lane property. By the time of trial, the Bank's mortgage on the Jannie Lane property remained of record and unsatisfied.

On September 1, 1997, Blatz entered into a land contract to sell the Jannie Lane property to the Hartleys. The land contract, which was recorded on September 5, 1997, states that the property "is presently subject to a mortgage." Appellant-plaintiff's Ex. 8. Indeed, the Hartleys understood that the Jannie Lane property was subject to a mortgage, but did not know which financial institution held the mortgage. Immediately after signing the land contract, the Hartleys moved into the Jannie Lane property. From 1997 until 2001, they made monthly payments under the land contract and spent $6,142.87 on improvements to the property. During that time, the Hartleys did not inquire as to the mortgage's status or attempt to secure a release. On May 15, 2001, the Hartleys delivered to Blatz the $30,0237.13 balance then due and obtained deeds from Blatz for the Jannie Lane property. However, rather than paying the proceeds to the Bank and securing a release of the Bank's mortgage on the Jannie Lane property, Blatz deposited the $30,237.13 into an account at the Bank in the name of Empire Home Buyers.

The Bank was unaware that the Hartleys had any interest in the Jannie Lane property until mid-2001 when it reviewed the results of a title search obtained in anticipation of filing a foreclosure complaint against Blatz. Blatz had defaulted on his payments due under the Note. By October 2002, the balance due thereon was $1,007,796.73, plus interest accruing after October 4, 2002 and attorney's fees. The Bank named the Hartleys as parties to the complaint against Blatz because of their interest in the Jannie Lane property. At the November 14, 2002 trial, the Hartleys asserted a claim seeking reimbursement of the monies they spent on improvements. In its "Findings of Fact, Conclusions of Law and Judgment on Claim Against the Hartleys and on Hartley Counterclaim," the trial court recognized the validity of the Bank's mortgage and foreclosed that mortgage, but held that the first $6,142.87 from the sale of the Jannie Lane property should be paid to the Hartleys. In pertinent part, the judgment reads:

THE COURT NOW CONCLUDES:

Appellant's App. at 24-26 (emphasis added) (footnote omitted). The Bank appeals.

Discussion and Decision

Our standard of review provides that we "shall not set aside the findings or judgment unless clearly erroneous, and due regard shall be given to the opportunity of the trial court to judge the credibility of the witnesses." See Ind. Trial Rule 52(A). In applying this rule, we employ a two-tiered standard of review. OVRS Acquisition Corp. v. Community Health Servs., Inc., 657 N.E.2d 117, 123-24 (Ind.Ct.App. 1995), trans. denied. First, we consider whether the evidence supports the findings, construing the findings liberally in support of the judgment. Id. at 124. The findings are clearly erroneous only when a review of the record leaves us firmly convinced a mistake has been made. Id.

Wagner v. Estate of Fox, 717 N.E.2d 195, 200 (Ind.Ct.App.1999) (citations omitted).

Neither party disputes the findings of facts. Hence, we focus our review upon the latter tier of the analysis, whether the findings support the judgment. Specifically, we concentrate upon conclusion number 22, in which the court stated: "However, the Hartleys' improvements to and maintenance of the real estate were of benefit to the Bank, and it would be inequitable not to reimburse [the] Hartleys for those improvements under the circumstances presented to the Court by this case."

"[T]he vast weight of authority holds that foreclosure actions are essentially equitable." Songer v. Civitas Bank, 771 N.E.2d 61, 69 (Ind.2002); see also Smith v. Federal Land Bank of Louisville, 472 N.E.2d 1298, 1302 (Ind.Ct.App. 1985) ("In Indiana, `there is no doubt' that an action to foreclose a mortgage or lien is essentially equitable."). Notwithstanding equity's influence, rules of law obviously guide the foreclosure process. See, e.g., Ind.Code §§ 32-30-10-1 through -14 (setting out procedures for mortgage foreclosure actions). Moreover, "where substantial justice can be accomplished by following the law, and the parties' actions are clearly governed by rules of law, equity follows the law." Lake County Auditor v. Bank Calumet, 785 N.E.2d 279, 281 (Ind.Ct.App.2003).

Here, by requiring that "the payment of costs of the action, together with the costs and expenses of the Sheriff's sale of the property" be paid before either the Bank or the Hartleys, the trial court followed the first part of the statutorily mandated disposition for foreclosure. See Ind.Code § 32-30-10-14(1). However, in thereafter prioritizing the Hartleys' claim for improvements over the Bank's mortgage the trial court seems to have deviated from the law's requirements.

In Skendzel v. Marshall, 261 Ind. 226, 301 N.E.2d 641 (1973), cert. denied, 415 U.S. 921, 94 S.Ct. 1421, 39 L.Ed.2d 476 (1974), our supreme court stated:

Regarding priority of mortgages and similar interests, our legislature has provided:

Ind.Code § 32-21-4-1(b). "Generally, where there are two competing mortgages claiming priority in a foreclosure setting, application of the recording statute would resolve the dispute." Bank of New York v. Nally, 790 N.E.2d 1071, 1074 (Ind.Ct.App. 2003).

The Bank properly recorded its mortgage on the Jannie Lane property on April 22, 1997. The land contract between Blatz and the Hartleys was recorded on September 5, 1997. Having recorded its interest first, the Bank should have priority over the land contract according to the recording statute. See Ind.Code § 32-21-4-1(b). Thus, to the extent the Hartleys' claim for improvements is attached2 to their land contract, the Bank's mortgage should trump the subsequent claim for improvements.

We note that a bona fide purchaser for value without notice may seek equitable protection from application of the recording statute. Bank of New York, 790 N.E.2d at 1074. However, the trial court, if it relied on such a theory, did not mention it. Moreover, the Hartleys wisely do not attempt to circumvent the recording statute by claiming bona fide purchasers for value without notice status. Indeed, the Hartleys admitted that they knew the Jannie Lane property was subject to a mortgage (as it was written into the land contract). While the Hartleys may not have known which lending institution held the mortgage, a quick check of the recorder's office would have revealed such information. Hence, they do not meet the "without notice" requirement. Unfortunately for the Hartleys, one who fails to search property records acts at his own peril, jeopardizing his interest against prior interest holders of record. See Wienke v. Lynch, 407 N.E.2d 280, 286 (Ind.Ct.App. 1980).

It is possible that the trial court viewed the Hartleys' $6,142.87 improvements claim as akin to a mechanic's lien. However, even ignoring the fact that the Hartleys did not comply with the statutory requirements necessary to create a valid lien, see Ind.Code § 32-28-3-3, mechanics liens take priority only over interests subsequently created. Ind.Code § 32-28-3-5(b). Moreover, mechanics' liens are not rendered superior to the lien of a prior recorded mortgage by the fact that the security of the latter is increased by the improvement. See Thorpe Block Sav. & Loan Ass'n v. James, 41 N.E. 978, 978,13 Ind.App. 522, 522 (1895). Applied here, while the Jannie Lane property may have been improved by the Hartleys' work and may eventually sell for a higher price than it would have had they not done the work, their improvements claim cannot take priority over the Bank's prior recorded mortgage.

In summary, the Hartleys stand to lose the lakehouse for which they paid all money due under the land contract, as well as additional money for improvements, because Blatz failed to pay off the mortgage. However, the Hartleys knew that the Jannie Lane property was subject to a recorded mortgage when they made payments to Blatz and voluntarily undertook the improvements. On the other hand, the Bank properly recorded its mortgage, had no obligation to separately notify the Hartleys of the mortgage or its status, did not preclude the Hartleys from making payments directly to the Bank, and did not interfere with the land contract. Given these facts and the law as stated above, we cannot affirm the trial court's conclusion that the Hartleys' improvements claim on the land contract should be paid before the Bank's properly recorded mortgage. While we sympathize with the Hartleys' situation, we note that their remedies, if any, lie in (1) an action against Blatz, and (2) the possibility that the improved property will sell for a price high enough to pay off the Bank first and still leave sufficient funds to reimburse them.

Reversed.

BAKER, J., and SHARPNACK, J., concur.