Vanderbilt Law Review Volume 40 Issue 2 Issue 2 - March 1987 Article 2 3-1987 Freeing Mortgages of Merger Ann M. Burkhart Follow this and additional works at: https://scholarship.law.vanderbilt.edu/vlr Part of the Property Law and Real Estate Commons Recommended Citation Ann M. Burkhart, Freeing Mortgages of Merger, 40 Vanderbilt Law Review 283 (1987) Available at: https://scholarship.law.vanderbilt.edu/vlr/vol40/iss2/2 This Article is brought to you for free and open access by Scholarship@Vanderbilt Law. It has been accepted for inclusion in Vanderbilt Law Review by an authorized editor of Scholarship@Vanderbilt Law. For more information, please contact [email protected]. Freeing Mortgages of Merger Ann M. Burkhart* I. INTRODUCTION .................................. 284 II. HISTORICAL DEVELOPMENT ....................... 288 A. Doctrine of M erger ........................ 288 B. Mortgages ................................. 303 1. English Development .................. 303 2. American Development ................ 319 III. M ODERN CONTEXT .............................. 329 A. Merger and Mortgages ..................... 330 1. Mortgagee Acquires Title to the Encum- bered Property ........................ 331 a. Junior Liens .................... 332 b. Former Owner's Bankruptcy ...... 336 i. Fraudulent Transfer ......... 337 ii. Preference .................. 340 iii. Other Federal or State Laws . 341 c. Validity of the Deed-in-Lieu Transaction ..................... 342 2. Property Owner Acquires Lien .......... 362 B. Merger and Debts ......................... 369 1. Effect of Mortgagee's Property Acquisi- tion on Debt Enforceability ............ 373 a. Voluntary Conveyance ........... 373 b. Involuntary Conveyance ......... 377 2. Effect of Property Owner's Note and Mortgage Acquisition on Debt Enforce- ability ................................ 383 IV. CONCLUSION .................................... 386 *Associate Professor of Law, University of Minnesota. VANDERBILT LAW REVIEW [Vol. 40:283 I. INTRODUCTION Change in real property law often occurs with glacial speed. This rate of change in part reflects the normal inertia of estab- lished law. A more complete explanation, however, is the innate conservatism connected to a commodity that once was the primary source of wealth and power. That this conservatism is innate should not prevent application of Ockham's razor as needed. The relationship of the doctrine of merger to the burgeoning law of mortgages is one such area. "If the law has to bear these medieval shackles the time surely has come to examine them carefully. They may have rusted away."1 The modern doctrine of merger is easily stated: When a per- son holds two estates in property in the same right and without an intervening estate, the two estates will coalesce to one estate unless a beneficial reason exists for keeping them distinct.2 For example, a life tenant who acquires the reversion immediately following his life estate usually will be deemed to own the fee simple title rather than a separate life estate and reversion.3 Similarly, a tenant for years who acquires the landlord's interest in the leased property usually will be deemed to own the fee simple title.4 The doctrine of merger operates in these cases as a technical, nonsubstantive rule concerning property titles. If the holder of the interests is not ben- efited in any way by keeping the estates distinct, they will merge to simplify the state of title. Although the application of merger to separate estates in land is generally straightforward, the application of the doctrine to lesser property rights is far from clear. Indeed, with respect to questions involving title to property and a mortgage encumbering that property, merger has been described as "one of the most com- plex and confusing areas of the law of mortgages."5 Examination of 1. Industrial Properties (Barton Hill) Ltd. v. Associated Elec. Indus. Ltd., [1977] 1 Q.B. 580, 613. 2. 4 AMERICAN LAW OF PROPERTY § 16.142 (A. Casner ed. 1952) [hereinafter AM. L. PROP.]; 3 R. POWELL, THE LAW OF REAL PROPERTY %459 (P. Rohan rev. ed. 1984); 5 H. TIFFANY, REAL PROPERTY § 1479 (B. Jones 3d ed. 1939). 3. See, e.g., Citizens Bank & Trust Co. v. Watkins, 215 N.C. 292, 296, 1 S.E.2d 853, 856 (1939). Merger will not apply if the interests are held in different "rights." Therefore, if the trustee of a life estate acquires the reversion immediately following the life estate in his individual capacity, the life estate and reversion will not merge because the life estate is held in trust and the reversion is held in the owner's individual capacity. 4. See, e.g., Buell v. Simon Newman Co., 61 F. Supp. 157, 160 (N.D. Cal. 1945); Thomas v. Farr, 380 Ill. 429, 431, 44 N.E.2d 434, 435 (1942). 5. G. NELSON & D. WHITMAN, REAL ESTATE FINANCE LAW § 6.15 (2d ed. 1985). Other 1987] FREEING MORTGAGES OF MERGER the historical developments of merger and of mortgages reveals why their union has created theoretical and practical problems: the modern mortgage does not create an interest in land to which merger should apply.' Furthermore, modern title and finance prac- tices have obviated the need for merger. The doctrine of merger and the practice of using land as security for the repayment of loans, integral parts of English land law since the feudal period, originated when the common law of property was in its infancy. The advantages of the abstract concept of title had not been discovered; recognized interests in land con- sisted primarily of the right to possess or to receive feudal inci- dents as an overlord. With the increase in property transactions, merger and mortgages developed as transactional devices. Despite substantial alterations in title forms and practices since the incep- tions of merger and of mortgages approximately seven hundred years ago, courts continue to apply merger largely unchanged to the modern mortgage, a property interest that bears only one fea- ture in common with its feudal counterpart-the existence of a debt. If the continued application of merger to mortgages created no problem other than a problem of theory, even such a thoroughgo- ing theorist as a legal scholar might be willing to ignore the prob- lem as a harmless anachronism. Continued application of merger to mortgages, however, often has adverse and occasionally devas- tating economic effects without serving any beneficial purpose. Courts' rote applications of merger to mortgage interests have unnecessarily destroyed valuable property rights and have wrong- fully created others. Additionally, as bad law begets worse, mis- perceptions concerning the doctrine have caused many courts to apply the doctrine not only to interests in property, but also to debts secured by property as if debt were a new variety of real commentators have described the topic as "[o]ne of the most perplexing incidents of title," G. WARVELLE, ABSTRACTS AND EXAMINATIONS OF TITLE § 347 (4th ed. 1921); and as "a fear- some title, because it invokes the fine points that attend the law of real property." 1 G. GLENN, MORTGAGES § 45.2 (1943). 6. Throughout this Article, the term "mortgage" will be used to refer to all types of real property security instruments, including deeds of trust and deeds to secure debt. Although the various types of real property security instruments differ in some respects, the issues raised in this Article concerning the applicability of merger apply with equal force to each type of instrument. See generally 1 G. GLENN, supra note 5, § 1. Similarly, although this Article focuses on real property security interests, merger applies with equal force to personal property security interests. See, e.g., Wilhelmi v. Leo- nard, 13 Iowa 330 (1862); Food City, Inc. v. Fleming Cos, Inc., 590 S.W.2d 754 (Tex. 1979). VANDERBILT LAW REVIEW [Vol. 40:283 property interest. With respect to mortgages, the merger issue typically arises when a secured lender agrees to accept title to the encumbered property from the defaulting debtor in lieu of foreclosing its mort- gage on the property. In this way, the borrower and lender avoid the time and expense of a foreclosure action. As described in this Article, if a court holds that the lender's mortgage lien thereby merged into its fee title, the lender usually will be an unsecured, rather than a secured, creditor if the debtor's conveyance to it is voided, such as in connection with the debtor's subsequent bank- ruptcy. Furthermore, the lender will be unable to clear the title of junior liens although the law is well established that the lender could have done so if its lien did not merge. These merger-related problems are not outweighed by any beneficial effect of merger. As the number of loan defaults and foreclosures occurring nationwide has increased to the greatest level since the Great De- pression of the 1930s,7 the problems created by the misapplication 7. During 1985, delinquencies on debts secured by one to four unit residential proper- ties ranged from 6.19% during the first quarter to 5.72% during the fourth quarter, which is more than double the rate during the 1950s. Foreclosure actions were commenced during 1985 against .92% of all one to four unit residential properties encumbered by mortgages, as contrasted with .59% just five years earlier. See MORTGAGE BANKERS ASSOCIATION OF AMERICA, ECONOMICS DEP'T, JUNE 1985 REPORT. See also STATISTICS AND ANALYSIS DIVISION, OFFICE OF POLICY AND ECONOMIC RESEARCH, FED. HOME LOAN BANK BD., REPORT ON MORT- GAGE FORECLOSURES BY FSLIC-INSURED SAVINGS AND LOAN ASSOCIATIONS (1984). During fiscal year 1985, the Department of Housing and Urban Development (HUD) acquired approximately 38,000 houses through foreclosure and, after selling all but 16,700 properties, estimated the value of its holdings to be $627,500,000. The agency's deputy assis- tant secretary for single family housing estimates that HUD may acquire more than 40,000 additional properties during 1986. At the end of January 1986, the Veterans Administration owned 18,783 properties as a result of loan defaults, with an estimated aggregate value of $787,000,000, and acquisition procedures had been commenced for an additional 14,809 properties as a result of loan defaults.