Court Opinion

ID: 9760960
Source: CourtListenerOpinion
Date Created: 2023-08-29 01:26:18.80062+00
Date Added: 2024-06-11T07:29:19.193653
License: Public Domain

OPINION
PHILLIPS, Chief Justice.
The principal issue in this case is how to calculate the deficiency or surplus after foreclosure of a mortgage securing a “wraparound note.” The trial court held that the sale price should be credited against the outstanding balance of the note. The court of appeals held that the sale price should be credited against only that portion of the note which exceeds the *581outstanding balance of the underlying, or “non-wrapped,” debt. 737 S.W.2d 327. For the reasons discussed herein, we reverse the judgment of the court of appeals and affirm the judgment of the trial court.

Facts

Consolidated Capital Special Trust (Consolidated) acquired an apartment complex at a foreclosure sale in Harris County. The defaulting owner was Robert Sill, who had borrowed money from Consolidated and executed a note to it in the principal amount of $6,289,000. This note was secured by a deed of trust on the property. Sill had purchased the property from English Village Apartments, Ltd. (EVA), executing a so-called “wraparound note” to EVA for the principal sum of $4,700,000. Under wraparound financing, the purchaser makes an installment note which includes, or “wraps around,” the principal balance of an underlying indebtedness. The purchaser expressly does not assume responsibility for the underlying indebtedness, and he accepts title subject to the lien or liens which secure payment of that underlying indebtedness. While Consolidated’s eventual default gave rise to this suit, it is Sill’s note to EVA (Sill note) and the deed of trust securing it which we must interpret in this case.
In this case, the Sill note “wrapped” or included the unpaid principal balances of four pre-existing notes.1 To secure the Sill note, Sill executed a deed of trust in favor of James M. Summers, Trustee. That deed of trust was executed “for the purpose of securing the payment of that certain one note ... for the principal sum of Pour Million Seven Hundred Thousand and No/100 Dollars with interest on past due principal and interest at the rate provided therein....” Upon default, the trustee was empowered to sell the property secured by the deed of trust with the proceeds to be applied as follows:
[T]he Trustee shall first pay all expenses ..., and shall next apply such proceeds toward the payment of the indebtedness secured hereby (principal, interest [and] attorney’s fees, if any), and the remaining balance, if any, shall be paid to Grantors, their heirs and assigns.
The note, in turn, provided that the “indebtedness secured by this note is secured by,” among other items, the deed of trust.
On October 1, 1983, the Sill note became due and owing. Consolidated failed to pay, and the trustee proceeded to foreclose upon the underlying property. As required by the deed of trust securing the Sill note, the notice of sale expressly set forth that the sale would be “subject to” the prior notes and the prior liens. At the foreclosure sale on June 5, 1984, EVA bid $2,750,000. No other bids were received.
The question for our determination is whether EVA’s bid resulted in a deficiency against, or generated excess proceeds for the benefit of, Consolidated. EVA maintained that a deficiency was created because the amount bid ($2,750,000) was less than the “outstanding balance” of principal and interest owed by Consolidated on the Sill note ($6,206,952). Consolidated alleged that excess proceeds were generated because the amount bid at the foreclosure sale was greater than what it termed the “true debt”, or the amount by which the total outstanding balance due on the Sill note exceeded the balance due on the underlying obligations. Consolidated brought suit for this alleged surplus against EVA and the trustee, who in turn counterclaimed for a deficiency judgment and for post-foreclosure rents allegedly collected by Consolidated prior to foreclosure.
*582The trial court granted summary judgment for EVA and the trustee, awarding a deficiency judgment after the foreclosure sale together with rents. The court of appeals reversed and rendered judgment for Consolidated, holding that EVA’s bid resulted in a surplus for Consolidated and that EVA had not perfected its claim for rents. We reverse.

Application of Proceeds

In deciding how to apply the proceeds from the foreclosure sale, the.parties advocate two very different methods of calculation: the “true debt” method and the “outstanding balance” method.
The “true debt” approach argues that since the maker of a wraparound note did not accept responsibility for any underlying indebtedness when purchasing the property, he should not be responsible for that portion of the wraparound note which includes those debts. The underlying indebtedness remains the responsibility of those who incurred it and remain liable thereon; the maker of the wraparound note should be liable only for the actual amount of money advanced or credit extended to him by the holder of the note.
The facts of this case show the fallacy of this position. By contract, Consolidated promised to pay $4,700,000 plus accrued interest to EVA. Under the “true debt” approach, however, Consolidated would owe that purchase price only if it decided to make all payments in full on its installment note. If it ever decided to default on the contract, it would only owe the amount by which the outstanding balance on its contract exceeded the amount of the underlying notes. In applying the “true debt” analysis to this case, the court of appeals found that difference to be $2,212,686, so that EVA’s bid of $2,750,000 for the property resulted not in a deficiency for the additional amount owed under the contract, but in excess proceeds to Consolidated of more than $500,000. By defaulting on its agreement, Consolidated not only managed to avoid any further obligation to EVA, but obtained a windfall profit as a reward for its breach.
In adopting the “true debt” approach, the court of appeals confused the purchaser’s personal liability on the seller’s prior notes with the purchaser’s obligation to pay for the property pursuant to the express terms of its own agreement. It is true that Sill (and subsequently Consolidated) did not agree to assume liability for the balance of the underlying four prior mortgages. That is, they did not become guarantors of that debt, additional makers on those notes, or undertake any other obligation which would render them legally liable to the holders of those earlier obligations.2 The holders’ only legal recourse was to look to their respective makers who executed those notes, not to Sill or Consolidated. But this reservation in no way affects Sill’s (and subsequently Consolidated’s) obligation to EVA for the entire amount of the fifth note. This transaction was made “subject to” the prior notes and liens because the prior notes and liens would continue to encumber the property following a sale. See Taylor v. Brennan, 621 S.W.2d 592, 593 (Tex.1981). It was not made subject to the prior notes and liens because the prior lienholders were to share in the current purchase obligation.
Consolidated also points to the power of sale clause in the deed of trust, claiming it restricts the power of the trustee to pay off the prior senior liens. The clause provides:
With the proceeds arising from such sale or sales, the Trustee shall first pay all expenses of advertising, sale and conveyance, including a commission of 5% of the gross proceeds of such sale or sales to the Trustee acting, and shall next apply such proceeds toward the payment of the indebtedness secured hereby (principal, interest [and] attorney’s fees, if any), and *583the remaining balance, if any, shall be paid to Grantors, their heirs and assigns.
We see no such restriction in this clause. We recognize that if the foreclosing wrap note holder failed to apply excess proceeds to the pre-existing debt, a purchaser at foreclosure might have to pay twice to satisfy those upstream obligations and obtain clear title. Absent an express agreement between the purchaser and wrap note holder, the law should imply a covenant into the parties’ agreement requiring the trustee to apply the proceeds first to the satisfaction of pre-existing debt before making any distribution to the mortgagor. See J.M. Realty Inv. Cory. v. Stern, 296 So.2d 588, 589 (Fla.Dist.Ct.App.1974). Texas law permits the insertion of an implied covenant when necessary to effectuate the parties’ actual intent. As this court said in Danciger Oil & Ref. Co. v. Powell, 137 Tex. 484, 490, 154 S.W.2d 632, 635 (1941):
[Covenants will be implied in fact when necessary to give effect to the actual intention of the parties as reflected by the contract ... as construed in its entirety in the light of the circumstances under which it was made and the purposes sought to be accomplished thereby.
Henceforth, such a clause, if not expressly set forth, will be implied in every power of sale clause in a wraparound deed of trust in this state.
We therefore adopt the “outstanding balance” method of calculation, as have the other courts that have considered this question. See J.M. Realty Inv. Corp. v. Stern; Armsey v. Channel Asso., Inc., 184 Cal.App.3d 833, 229 Cal.Rptr. 509 (Cal.Ct.App.1986). Thus, when a deed of trust lien securing a wraparound note is foreclosed, the amount bid for the property at the sale, net of expenses, is to be credited to the entire outstanding balance, including wrapped indebtedness, due on that note. If the bid exceeds such balance, a surplus results; if the balance exceeds the bid, a deficiency results. The trustee acting for the note holder is obliged by implied covenant to apply the net sales proceeds to discharge the entire wrapped indebtedness reflected in the note to the fullest extent possible. The trustee’s breach of his obligation to so apply the net sales proceeds does not impair prior, undischarged liens.

Rents

Prior to the June 5, 1984 foreclosure, Consolidated collected rents for the entire month of June. On the day of foreclosure, EVA took possession of the property and purchased it at a foreclosure sale. EVA then brought an action seeking to collect the rent proceeds from Consolidated, claiming that the rentals had been assigned to EVA as security under the deed of trust. Consolidated asserted that EVA failed to take the necessary steps to collect the rents. The trial court granted summary judgment for EVA, awarding it $66,917.00 for both rents and security deposits.
Texas law addressing rentals assigned as security states that an assignment of rentals does not become operative until the mortgagee “obtains possession of the property, or impounds the rents, or secures the appointment of a receiver, or takes some other similar action” following a mortgagor’s default. See Taylor v. Brennan, 621 S.W.2d 592, 594 (Tex.1981). The court of appeals, holding that as a matter of law EVA was prohibited from collecting the disputed rents, stated that “EVA took no affirmative steps pursuant to its right of entry” following Consolidated’s default. 737 S.W.2d at 333.
As to rents, it is difficult to imagine what EVA could have done beyond foreclosing on the property, purchasing it at the sale and promptly taking possession of it. The trial court was correct in awarding EVA as a matter of law the rents collected prior to the foreclosure but attributable to a time after the foreclosure. We therefore reverse the judgment of the court of appeals. The cause is remanded to the trial court for a determination of the amount of rents to be awarded. Findings are necessary on this issue because EVA subsequently abandoned its claim for security deposits. The trial court is directed to render judgment in accordance with this opinion.
*584MAUZY, J., files a dissenting opinion in which SPEARS and RAY, JJ., join.
ON MOTION FOR REHEARING

. In order of priority, the liens encumbering the property were:
Original Principal Lien Mortgagee Sum
1 John Hancock $2,450,000
2 Gaslight Square 2,775,000 (Wrapped 1st lien)
Original Principal Lien Mortgagee Sum
3 Manchester Group 3,250,000 (Wrapped 1st and 2nd lien)
4 RAIA 500,000
5 EVA 4,700,000 (Wrapped 4 prior liens)

. The deed of trust executed by Consolidated provides in part as follows:
The Grantors have accepted the conveyance of the ... property subject to the Prior Notes and to the Prior Liens, to the extent and only to the extent set forth in the Deed, and Grantors have in no way assumed or agreed to pay or to become personally liable for any of the indebtedness evidenced by the Prior Notes.