Foreclosure Part 2: The Deed of Trust and Non-Judicial Foreclosure

The Deed of Trust; Avoiding Judicial Foreclosure.  When debtors default, creditors grow impatient, and their lawyers search for ways to circumvent lengthy and often expensive judicial processes. The Chancellor’s Court of Equity became wary of wily creditor schemes to cut off the equity of redemption swiftly and without intervention of pesky judges.  One such end run on the cumbersome process of judicial foreclosure was the deed of trust.  With a mortgage, the debtor transfers title to the creditor.  With a deed of trust, the debtor transfers title to a trustee, who holds that title as a fiduciary for both creditor and debtor in accordance with instructions set forth in the deed of trust.  If the deed of trust had been allowed to work as designed, the creditor would have regained what it had lost when the Chancellor gave debtors the equity of redemption.  If the debtor failed to make a payment on time, the trustee could transfer the title it held to the creditor, cutting off the debtor’s equity of redemption without a foreclosure.  Courts and legislatures, not to mention lawyers, were too invested in the notion of the equity of redemption to permit the deed of trust to operate in this fashion.  The deed of trust was too much like a mortgage.  The race was on to reign it in. 

Reigning in the Deed of Trust.  Most struggles end in compromises.  So too with the deed of trust.  Creditors retained the right to end the debtor’s equity of redemption without going into court, to foreclose non-judicially.  Debtors acquired the right, usually by statute, to be notified of their defaults and time in which to pay off their debts.  In states that permit deeds of trust, there are both judicial and non-judicial avenues for creditors to cut off a debtor’s equity of redemption.   

The Problems of Deficiency and Forfeiture: The Auction.  With the growth of the market economy, land prices began to fluctuate.  A creditor who thought he had land that was at least equal in value to the debt owed might find the debt was under water with the fall in land prices.  The debtor, on the other hand, had always run the risk of losing his equity to the foreclosing creditor when the land was worth more than the debt.  The creditor with an under-water debt wanted to go after the debtor’s other assets, and the debtor with plenty of equity in the property but little wherewithal to prevent its loss (or forfeiture) to the creditor, sought a means to recoup some of that excess value.  The problem for both creditor and debtor was how to determine the value of land so that the amount of the excess debt could be ascertained for the creditor and the amount of excess value in the land could be ascertained for the debtor.  The answer was the auction, imperfect as that may be.