1. “Subject to” Conveyance
a. Grantee’s Rights and Obligations
If the grantee does not assume the mortgage debt, the conveyance is merely “subject to” the
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mortgage. Upon default, the mortgagee may foreclose and have the encumbered real estate sold, but as a general rule the mortgagee may not proceed against the “subject to” grantee personally.
Illustration: MR conveys mortgaged property to GE by deed that provides that the conveyance is “subject to” a prior recorded mortgage. This means that GE takes the property subject to the mortgage lien, but generally has no personal responsibility to pay the underlying obligation. The term “subject to” is not a promise from GE to pay the mortgage debt.
As indicated in the immediately preceding illustration, the deed from the mortgagor to the “subject to” grantee usually provides that the grantee takes title subject to the mortgage. Although a provision of this type is not necessary for the survival of a properly recorded mortgage, it is utilized by the mortgagor to limit the mortgagor’s liability on the deed’s covenants of title by excluding the mortgage from their coverage.
Illustration: MR conveys mortgaged property to GE by general warranty deed that does not mention a prior recorded mortgage. GE takes the property subject to the mortgage because GE is on constructive notice of the recorded instrument. GE,
however, may have a cause of action against MR for breach of the deed’s present covenant against encumbrances.
Although the “subject to” grantee is not personally liable on the mortgage debt, the grantee commonly
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pays the obligation to avoid losing the property by foreclosure.
b. Mortgagor’s Rights and Obligations
The mortgagor remains personally liable on the debt following a “subject to”
conveyance unless released by the mortgagee. When not released, the mortgagor becomes a surety, liable to the extent the land proves to be of insufficient value to satisfy the debt. As a surety, the mortgagor generally is still subject to suit by the mortgagee directly on the underlying obligation and is liable for any deficiency resulting from a foreclosure sale. See Ch. 8, pp. 184–185 (discussing recovery on note alone/“one action”
rule). If, however, the mortgagor is forced to pay the entire debt, the mortgagor typically is subrogated to the mortgagee’s rights and can foreclose in order to be reimbursed to the extent of the value of the land.
Illustration: MR executes a $10,000 promissory note and a mortgage to ME. MR then conveys the mortgaged property to GE by deed which provides that title is “subject to”
the mortgage. The parties make no agreement regarding payment of the note. GE fails to pay the note. ME generally may either (1) foreclose and seek a deficiency judgment against MR if the sale proceeds are insufficient to satisfy the debt or (2) bring suit against MR on the note without foreclosing. ME chooses the second alternative, which is normally available. MR pays ME $10,000 and is subrogated to ME’s right to foreclose.
MR forecloses; the property
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brings $8,000 at sale. MR is entitled to the $8,000, but MR ordinarily must absorb a
$2,000 loss because GE had no personal liability on the note.
2. “Assumption” Conveyance
a. Grantee’s Rights and Obligations
A grantee taking land encumbered by a mortgage may personally assume liability for the mortgage debt. When that occurs, the transaction is termed an “assumption”
conveyance. Although the assumption may be accomplished outside the conveyance, it is usually based on a clause in the deed to the effect that the grantee “assumes and agrees to pay” the mortgage debt. When the grantee accepts a deed containing a clause of this type, the grantee also accepts personal responsibility for the debt.
The mortgagor, as one of the contracting parties, of course may enforce the assumption contract. The mortgagee also may enforce the contract against the grantee under either
of two theories. (1) The generally accepted view is that the mortgagee is a third party beneficiary of the assumption contract. (2) Some courts consider the mortgagee’s rights against the grantee as “derived” under equitable principles from the mortgagor’s rights in the assumption contract. In either case, the consequence of an “assumption” conveyance is that, upon default, the mortgagee may foreclose and also obtain a deficiency judgment against the grantee. Furthermore, in most jurisdictions the mortgagee may obtain judgment
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against the grantee on the obligation without foreclosing the mortgage. Some derivative theory states, however, refuse the mortgagee this right on the ground that the grantee is not liable on the assumption contract until the mortgagor suffers actual loss.
See also Ch. 8, pp. 184–185 (discussing “one action” rule).
b. Mortgagor’s Rights and Obligations
The grantee’s assumption of personal responsibility for the mortgage debt does not relieve the mortgagor of liability. But see p. 130 (considering federal regulation that apparently requires the mortgagee to release the mortgagor in certain situations). Again the mortgagor becomes a surety, this time liable for any deficiency resulting from a foreclosure sale and in most jurisdictions, subject to direct suit on the debt. But see Ch. 8, pp. 184–185 (analyzing “one action” rule). The mortgagor is, however, in a much better position in an “assumption” conveyance than in a “subject to” transfer. First, because the assuming grantee is personally liable on the underlying obligation, the grantee has greater incentive to pay than when the grantee only risks loss of the land on default.
Second, if the mortgagor pays the debt, the mortgagor is subrogated to the mortgagee’s rights and may look to both the land and the grantee personally for reimbursement.
Third, it is commonly recognized that the mortgagor may sue the defaulting grantee for breach of the assumption contract without first having paid the
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mortgage debt and apply monies recovered toward satisfaction of the debt.
Illustration: MR executes a $30,000 promissory note and a mortgage to ME. MR then conveys the mortgaged property to GE by deed that provides that GE assumes and agrees to pay the mortgage debt. GE fails to pay. In most states, ME may either (1) foreclose and seek a deficiency judgment against MR and GE if the sale proceeds are insufficient to satisfy the note, (2) bring suit against MR on the note without foreclosing, or (3) bring suit against GE on the note without foreclosing. ME chooses the second alternative, which is widely available. MR pays ME $30,000 and is subrogated to ME’s rights against GE. MR may now either (1) foreclose and recover any deficiency from GE or (2) sue GE directly on the note and the assumption contract without foreclosing.
c. Successive “Assumption” Conveyances/Break in Chain of Assumptions
When successive “assumption” conveyances are made, each grantee is personally liable on the mortgage debt. The last assuming grantee, however, bears primary responsibility.
Illustration: MR executes a $20,000 note and a mortgage to ME. MR makes an
“assumption” conveyance to GE–1 who in turn makes an “assumption” conveyance to GE–2 who defaults. ME forecloses and receives $18,000 from the foreclosure sale. ME obtains a $2,000 deficiency judgment
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against GE–1. If GE–1 pays, GE–1 has the right to obtain reimbursement from GE–2.
If the chain of assumptions is broken by a “subject to” conveyance, authorities are divided on whether grantees who assume after the break are personally liable on the mortgage debt. In jurisdictions that view the mortgagee as a third party beneficiary of the assumption contract, a subsequent assuming grantee generally is liable. Some courts, however, have found the grantee free from liability on the ground that the parties did not intend the mortgagee to benefit from the assumption. In derivative theory states, a grantee who assumes after a break is not liable because the mortgagee has no claim against the “subject to” grantee and therefore, cannot derive rights from that individual’s assumption contract with a subsequent grantee.
d. Termination or Modification of Assumption Contract
Authorities also disagree as to whether the mortgagee’s rights against an assuming grantee are affected when the grantee is released from the assumption contract by the grantor. In most third party beneficiary theory states, the mortgagee’s rights survive the release if the mortgagee accepted or relied on the assumption agreement prior to the release. In a few third party beneficiary jurisdictions, the mortgagee’s rights survive the release in all cases on the theory that the mortgagee’s rights vested immediately upon the execution of the assumption
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contract. In derivative theory states, the mortgagee’s rights are destroyed by the release unless the mortgagee has previously filed a foreclosure suit or it would be inequitable to enforce the release.
A similar diversity of opinion exists on the question of whether the mortgagee’s rights are affected by modification of the assumption contract.
3. Extension Problem
The grantee normally pays the mortgage debt in both the “subject to” and the
“assumption” conveyance situations. If the grantee has difficulty doing so, the mortgagee may extend the time for payment. Serious collateral consequences may result. The extension may operate to discharge the mortgagor in whole or in part on the theory that it impairs the mortgagor’s right as a surety to pay the debt at maturity and to be
subrogated to the mortgagee’s position at that time.
An extension granted an assuming grantee typically operates to completely discharge the mortgagor. This is because the extension denies the mortgagor subrogation rights against the grantee for the entire debt. The rule, however, operates to discharge the mortgagor only if the mortgagee had knowledge of the assumption when it granted the extension.
Authorities differ as to the effect of an extension granted a “subject to” grantee. The generally accepted view is that the mortgagor is discharged to
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the extent of the value of the land at the time the extension was granted. This is because the extension costs the mortgagor the opportunity to be subrogated to the mortgagee’s right to foreclose. Some states go further and completely discharge the mortgagor in this situation. Other jurisdictions consider the mortgagor’s liability to be unaffected by the extension.
These rules on discharge are subject to two important qualifications. First, the mortgagor is discharged only by an extension agreement that is legally binding on the mortgagee. Mere inaction by the mortgagee after default does not constitute such an extension. Second, even when the grantee obtains a binding extension, the mortgagor is not discharged if the mortgagor consents to the arrangement. Consequently, mortgages commonly provide that the mortgagee may grant extensions to subsequent grantees without affecting the mortgagor’s liability.