Opinion ID: 1352228
Heading Depth: 2
Heading Rank: 3

Heading: The Doctrine of Merger and Extinguishment

Text: Because we hold that the anti-deficiency statute does not apply, we must reach the merger and extinguishment issue that is the basis of the concurring opinion in the court of appeals. Dynamic listed that issue for our consideration under Rule 23(c), Ariz.R.Civ.App.P., 17B A.R.S., as an issue not decided by the court of appeals but that would need to be addressed if the court of appeals' opinion were reversed. [7]
As Dynamic has noted, the facts in this case provide the basis for two merger arguments. The first is the theory of merger of estates. Generally, when one person obtains both a greater and a lesser interest in the same property, and no intermediate interest exists in another person, a merger occurs and the lesser interest is extinguished. 3 R. POWELL, THE LAW OF REAL PROPERTY § 459 (1990 Rev.). Thus, merger may occur when a mortgagee's interest and the fee title are owned by the same person. Id. The potential for merger arises whenever a mortgagee acquires the mortgagor's equity of redemption. However, even if a merger would otherwise occur at law, contrary intent or equitable considerations may preclude this result under appropriate circumstances. 2 L. JONES, THE LAW OF MORTGAGES § 1080 (8th ed. 1928). This court has long recognized these general rules of merger of estates. Bowman v. Cook, 101 Ariz. 366, 419 P.2d 723 (1966); Hathaway v. Neal, 31 Ariz. 155, 251 P. 173 (1926). We assume, therefore, no one arguing to the contrary, that when Mid Kansas acquired title on the foreclosure of its second lien, its rights under that lien were merged in the title. See Bowman, 101 Ariz. at 367, 419 P.2d at 724. The question before us, however, is somewhat different. Today we must consider if Mid Kansas's rights under the first lien were affected when it acquired title by foreclosure on its second lien.
Where the same mortgagee holds both a first and second mortgage on the mortgagor's land, and becomes the purchaser at the foreclosure sale of one of the mortgages, the question of merger of rights  often called extinguishment  arises. The merger of rights doctrine addresses the narrow question of whether the mortgagor's personal liability on the senior debt has been discharged. Wright v. Anderson, 62 S.D. 444, 253 N.W. 484, 487 (1934). The primary issue in the doctrine of merger of rights is whether the lender would be unjustly enriched if he were permitted to enforce the debt. See generally Burkhart, Freeing Mortgages of Merger, 40 VAND.L.REV. 283, 382 (1987). Although the mortgagee's purchase of the property at the foreclosure of the senior mortgage will not extinguish the debt secured by a junior mortgage, the reverse is true where the junior mortgage is foreclosed. If one holding both junior and senior mortgages forecloses the junior and purchases the property at the foreclosure sale, the long-standing rule is that, absent a contrary agreement, the mortgagor's personal liability for the debt secured by the first mortgage is extinguished. G. NELSON & D. WHITMAN, REAL ESTATE FINANCE LAW § 6.16, at 467 (2d ed. 1985). The rule has been followed for generations. See Board of Trustees of the Gen. Retirement Sys. v. Ren-Cen Indoor Tennis & Racquet Club, 145 Mich. App. 318, 377 N.W.2d 432 (1985), appeal denied, 425 Mich. 875, 388 N.W.2d 680 (1986); Tri-County Bank & Trust Co. v. Watts, 234 Neb. 124, 449 N.W.2d 537 (1989); Annotation, Union of Title to Mortgage and Fee in Same Person as Affecting Right to Personal Judgment for Mortgage Debt, 95 A.L.R. 89, 104-105 (1935) (citing Belleville Sav. Bank v. Reis, 136 Ill. 242, 26 N.E. 646 (1891)); McDonald v. Magirl, 97 Iowa 677, 66 N.W. 904 (1896); Wright, 253 N.W. 484; see also 2 G. GLENN, MORTGAGES § 337, at 1408 (1943). The basis of the merger of rights doctrine is that the purchaser at a foreclosure sale of a junior lien takes subject to all senior liens. Ren-Cen Club, 377 N.W.2d at 434; Wright, 253 N.W. at 487; see also Burkhart, supra, 40 VAND.L. REV. at 377. Although the purchaser does not become personally liable on the senior debt (as does an assuming grantee), the purchaser must pay it to avoid the risk of losing his newly acquired land to foreclosure by the senior lienholder. Therefore, the land becomes the primary fund for the senior debt, and the purchaser is presumed to have deducted the amount of the senior liens from the amount he bids for the land. Tri-County Bank, 449 N.W.2d at 541. [8] As the court in Wright explained, when the same mortgagee holds both the junior and senior mortgages on the land and buys at the foreclosure sale of the junior mortgage: The mortgagor ... has an equitable right to have the land pay the mortgage before his personal liability is called upon and the purchaser will not be permitted to retain the land ... and enforce the same against the mortgagor personally. 253 N.W. at 487. Similarly, the court in Ren-Cen Club noted that [t]he indebtedness will be presumed to have been discharged so soon as the holder of it becomes invested with title to the land upon which it is charged, on the principle that a party may not sue himself at law or in equity. The purchaser is presumed to have bought the land at its value, less the amount of indebtedness secured thereon, and equity will not permit him to hold the land and still collect the debt from the mortgagor. 377 N.W.2d at 435 (quoting Belleville Savings Bank v. Reis, 136 Ill. 242, 26 N.E. 646, 647 (1891) (citations omitted)). Thus, the merger of rights doctrine holds that the senior lien is merged into  or extinguished by  the title acquired by the lienholder when he acquires the mortgagor's equity of redemption under a sale on the junior lien. Of course, this rule comes into play only when the equity of redemption is extinguished. See Wright, 253 N.W. at 487; 2 JONES, supra, § 1080, at 514. Although the deed of trust is a relatively new instrument that post-dates cases such as Wright and Belleville, we find the doctrine of merger and extinguishment even more compelling under a modern deed of trust statute, which cuts off the borrower's equity of redemption at the time of the trustee's sale. See A.R.S. § 33-811(B). In Patton v. First Federal Savings & Loan Ass'n, we commented on the unique features of the deed of trust that required a strict construction in favor of the borrower: Compared to mortgage requirements, the Deed of Trust procedures authorized by statute make it far easier for lenders to forfeit the borrower's interest in the real estate securing a loan, and also abrogate the right of redemption after sale guaranteed under a mortgage foreclosure.... [U]nder a Deed of Trust, the trustee holds a power of sale permitting him to sell the property out of court with no necessity of judicial action. The Deed of Trust statutes thus strip borrowers of many of the protections available under a mortgage. Therefore, lenders must strictly comply with the Deed of Trust statutes, and the statutes and Deeds of Trust must be strictly construed in favor of the borrower. 118 Ariz. 473, 477, 578 P.2d 152, 156 (1978). As we have previously noted, even where a merger would otherwise occur at law, an express agreement between the parties that no merger shall occur often precludes such a finding by the court. NELSON & WHITMAN, supra, § 6.16, at 467 (citing Toston v. Utah Mortgage Loan Co., 115 F.2d 560 (C.C.A.Idaho 1940); Continental Title & Trust Co. v. Devlin, 209 Pa. 380, 58 A. 843 (1904); Van Woerden v. Union Improvement Co., 156 Wash. 555, 287 P. 870 (1930)). Of course, where the mortgagee acquires title to the property through an involuntary conveyance, such as foreclosure, the parties obviously will not have formed a mutual intent concerning the continued enforceability of the debt. Burkhart, supra, 40 VAND.L.REV. at 377. However, such an intent may be implied under circumstances that would make a finding of merger inequitable to the parties. The dissent in Wright, for instance, argued that where the mortgagee paid the full value of the property without deducting the amount of the prior lien, the rule of merger should not apply. 253 N.W. at 489 (Polley, J., dissenting). This argument was adopted by a recent decision that allowed a bank to retain its claim for the unsecured deficiency remaining on the first mortgage even though the bank purchased the property at the foreclosure sale on the second mortgage. In re Richardson, 48 B.R. 141 (Bkrtcy, E.D.Tenn. 1985). The court found that the bank had not tried to take unfair advantage of the debtor because its bid had reflected the value of the property and the bank had, in addition, credited the debtors with the amount beyond the bid it received on reselling the property. Id. at 142. A different result would obtain where the mortgagee is permitted to keep land that is worth as much as the two mortgage debts and also allowed to collect on the senior debt. In the latter situation, the mortgagee would be unjustly enriched, and the merger doctrine is appropriately applied to destroy the senior debt. NELSON & WHITMAN, supra, § 6.16, at 467-68. The facts in this case clearly illustrate and require application of the doctrine of merger and extinguishment; they also demonstrate that no equitable exception is appropriate here. Mid Kansas held the four first deeds of trust and the second blanket deed of trust on the four lots. Mid Kansas purchased all four pieces of property with a credit bid of the amount due on the second lien, $101,986.67. Mid Kansas thus acquired free and clear title to improved property apparently worth between $555,750 and $608,000. [9] Even accepting the lower figure, it is apparent that the sum of the junior and senior liens ($527,236.67  exclusive of interest and costs) on the property at the relevant time  the date of the foreclosure sale  was probably less than the value of the property. Mid Kansas obviously tendered a credit bid that was discounted by the amount of the senior liens. Therefore, Mid Kansas would be unjustly enriched were we to allow it to acquire, for $100,000, property worth over $500,000 and also sue Dynamic for another $400,000 under the first notes. Mid Kansas does not contend that the property it acquired was worth less than the total owed on the first and second liens. On these facts, we hold that the doctrine of merger and extinguishment applies. See Ren-Cen Club, 377 N.W.2d at 436 (equity will not assist plaintiff in obtaining the price advantage of purchasing at a second mortgage sale without the disadvantage of having to satisfy the debt secured by the first mortgage). Because the holder of the senior lien acquired title, free from any equity of redemption, on the foreclosure of the junior lien, the doctrine of merger extinguishes the maker's liability on the senior notes. [10] This result is supported by other courts that have applied the doctrine of merger and extinguishment and held that the debt secured by the first mortgage is discharged when the senior mortgagee acquires the property at a sale on the second mortgage and the price at foreclosure sale is depressed to reflect the outstanding first mortgage. See, e.g., Ren-Cen Club, 377 N.W.2d 432; Tri-County Bank, 449 N.W.2d 537; see also authorities cited in Annot., supra, 95 A.L.R. at 104-105.