Smith v. General Mortgage Corp. , 73 Mich. App. 720 ( 1977 )

Allen, P. J.

Where fire occurs before a mortgage foreclosure at which the mortgagee has bid in the property for the balance remaining due on the mortgage, who, as between mortgagor and mortgagee is entitled to the fire insurance proceeds? This question of apparent first impression in Michigan, though considered in other jurisdictions, comes to us following the trial court’s grant of summary judgment in favor of defendant mortgagees.

The mortgage in question was issued on January 4, 1969. The named mortgagee was defendant General Mortgage Corporation. That defendant is actually a servicing agent for defendant Federal National Mortgage Association (FNMA). Consequently, the mortgagee’s interest was immediately assigned by General Mortgage to FNMA. The mortgage contained a clause specifically designed to create an insurable interest in the mortgagee. Casualty insurance was to be paid for by the plaintiff mortgagors; but payment in the event of loss was to be sent to the mortgagee to be applied at its option either to reduce the mortgage debt or to repair the property.

The property was insured for $18,000. As of October, 1974, the balance due on the mortgage had been reduced to approximately $13,000. On October 17, 1974, the mortgaged house was totally destroyed by fire. At that time, plaintiffs were either already in default on their mortgage payments or went into default when they failed to make the November, 1974 payment on the mortgage.

In its capacity as a servicing agent for defendant FNMA, defendant General Mortgage began foreclosure proceedings on December 1, 1974. At a foreclosure sale held on January 7, 1975, defendant mortgagee FNMA bid in the property for $13,961, the amount of the then outstanding debt plus its foreclosure costs and attorneys’ fees. One of several mysteries raised by these facts is why the plaintiff mortgagors allowed their default to continue once it became clear that they could ultimately collect $18,000 from the insurance company. Their failure to clear the default or even to ask the defendants about the possibility of doing so has never been satisfactorily explained.

Six months after the foreclosure sale, the insurance company sent a check for $18,000 to defendant General Mortgage. The payees’ names on the check were General Mortgage and plaintiffs Charles Smith and Peggy Smith. The styling of the check meant that neither plaintiffs nor defendants could cash the check without the other’s cooperation. Since no agreement could be reached as to allocation of the proceeds, the check remains uncashed today. This lawsuit is an equity action by the plaintiffs to compel defendant General Mortgage to endorse the check or to obtain an exercise of the court’s equitable powers to prevent an "unjust enrichment” of the defendants. The plaintiffs’ position is that they are entitled to the full $18,-000 because the mortgage debt was extinguished when FNMA entered its bid at the foreclosure sale equal to the full amount of the debt. MCLA 600.3252; MSA 27A.3252. Defendants’ position is that the property is now practically worthless and that they should be entitled to retain a portion of the insurance proceeds equal to the amount of the former debt plus costs and attorneys’ fees. The trial judge granted the defendants’ motion for summary judgment on those terms. In effect, the judgment awards defendants approximately $14,-000 of the proceeds, with the remaining $4,000 going to the plaintiffs. The question presented¹ is whether the trial judge erred by allocating the proceeds of the insurance policy in the manner described.

We previously indicated our inability to understand why the plaintiffs allowed their default to continue when they could readily have cured the default by collecting the insurance proceeds. Equally puzzling was defendant FNMA’s decision to bid nearly $14,000 for property which is now described as practically worthless. In the more typical case where a fire occurs after the foreclosure sale, the mortgagee remains insured by the preexisting policy, at least until the mortgagor’s equity of redemption expires. That would mean that a mortgagee would be entitled to collect the full insurance proceeds if the fire occurred immediately after the foreclosure sale. FNMA v Ohio Casualty Insurance Co, 46 Mich App 587; 208 NW2d 573 (1973), Consolidated Mortgage Corp v American Security Insurance Co, 69 Mich App 251; 244 NW2d 434 (1976).

The trial judge relied upon FNMA v Ohio Casualty Insurance Co, supra, as authority for granting summary judgment for the defendants. It seems likely that defendant FNMA also relied upon the Ohio Casualty case and others like it from other jurisdictions when it decided to bid the full amount of the mortgage debt at the foreclosure sale. In other words, the bid of $14,000 for the worthless property made sense if FNMA believed that it would be entitled to collect at least $14,000, and perhaps $18,000, of insurance proceeds.

But both the trial judge and the defendants failed to note that there is one very important factual difference between this case and the more typical situation involved in the Ohio Casualty decision. That difference is that the fire in this case occurred before the foreclosure sale. This type of case should arise very infrequently since, as we have already noted, there should be no need for a foreclosure sale where the fire insurance proceeds are available to cure the default. Nevertheless, a few jurisdictions have dealt with this problem. Smith v Mutual Fire Insurance Co of Michigan, 234 Mich 119; 208 NW 145 (1926), involved a similar sequence of events (i.e., fire before foreclosure sale) and contains some statements supporting the plaintiffs’ position that the defendants cannot claim any of the insurance proceeds since they purchased the property at the foreclosure sale for the full amount of the mortgage debt. But Smith was a suit by the foreclosed mortgagor against the fire insurance company. The statements by the Court denying any possible claim by the mortgagee were intended only to defeat a defense raised by the insurance company in an effort to avoid making payment to the mortgagor.

Although Smith could be distinguished on that basis, it so happens that it has properly anticipated the ruling of courts in other states which have considered precisely the problem raised by the present appeal. In both Whitestone Savings & Loan Ass’n v Allstate Insurance Co, 28 NY2d 332; 321 NYS2d 862; 270 NE2d 694 (1971), and Northwestern National Insurance Co v Mildenberger, 359 SW2d 380 (Mo App 1962), the courts concluded that mortgagees in the position of the present defendants were not entitled to any of the insurance proceeds. We are persuaded by Judge Breitel’s reasoning in the Whitestone case:

"What seems to have caused confusion is the equally well-settled rule that the rights under a fire insurance policy are fixed both as to amount and standing to recover at the time of the fire loss. From this rule it has been further and improperly deduced that the mortgagee could do nothing to impair his rights thus fixed at the time of loss.

* * *

"The theory of recovery by a mortgagee is indemnity. The risk insured against is an impairment of the mortgaged property which adversely affects the mortgagee’s ability to resort to the property as a source for repayment. Where the debt has been satisfied in full subsequent to the fire, neither reason nor precedent suggest recovery on the policy by the mortgagee.

"The rule is not harsh and it is eminently practical. None disputes that the mortgagee is entitled to recover only his debt. Any surplus value belongs to others, namely, the mortgagor or subsequent lienors. Indeed, it is not conceivable that the mortgagee could recover a deficiency judgment against the mortgagor if it had bid in the full amount of the debt at foreclosure sale. To allow the mortgagee, añer effectively cutting off or discouraging lower bidders, to take the property—and then establish that it was worth less than the bid— encourages fraud, creates uncertainty as to the mortgagor’s rights, and most unfairly deprives the sale of whatever leaven comes from other bidders.”321 NYS2d at 863, 866. (Emphasis supplied.)

See also Nationwide Mutual Fire Insurance Co v Wilborn, 291 Ala 193; 279 So 2d 460 (1973), Insurance Co of North America v Citizens' Insurance Co of New Jersey, 425 F2d 1180 (CA 7, 1970), and Rosenbaum v Funcannon, 308 F2d 680 (CA 9, 1962).

From all of the preceding cases, we draw the following rules to be applied in situations where the mortgagee purchases the mortgaged premises at a foreclosure sale for a bid which is sufficient to completely extinguish the mortgage debt:

(1) Where the sequence of events is fire after foreclosure sale, the mortgagee is entitled to receive all of the insurance proceeds if the fire occurs before the equity of redemption expires. FNMA v Ohio Casualty Insurance Co, supra, Consolidated Mortgage Corp v American Security Insurance Co, supra.

(2) If the sequence of events is fire before foreclosure sale, the mortgagor is entitled to all of the insurance proceeds. Whitestone Savings & Loan Ass’n v Allstate Insurance Co, supra.

A strict application of the second rule would mandate reversal of judgment in the present case and entry of summary judgment awarding plaintiffs the full amount of the check for $18,000. But we decline to do so because that result would be contrary to the very equitable principle, viz., prevention of unjust enrichment, which the plaintiffs have invoked. The rule announced in Whitestone Savings & Loan Ass’n v Allstate Insurance Co, supra, and the other foreign jurisdiction cases has never previously been recognized in Michigan.² We recognize that litigants are often made to suffer because they fail to properly anticipate legal developments. Such a failure is a mistake of law which, unlike a mistake of fact, may ordinarily not be forgiven. Still, we are conscious of the fact that strict enforcement of a previously unannounced rule in this case would impose an undeserved loss upon the defendants while simultaneously conferring an unearned benefit upon the plaintiffs. In Moritz v Horsman, 305 Mich 627; 9 NW2d 868 (1943), the Court quoted with approval the following language from Reggio v Warren, 207 Mass 525; 93 NE 805 (1911):

"The important question was not whether the mistake was one of law or fact, but whether the particular mistake was such as a court of equity will correct, and this depends upon whether the case falls within the fundamental principle of equity that no one shall be allowed to enrich himself unjustly at the expense of another by reason of an innocent mistake of law or of fact entertained by both parties. ” (Emphasis supplied.) 305 Mich at 634.

We assume that the mistake was mutual. If the plaintiffs have deliberately created this rather unusual set of circumstances, that would only reinforce our conclusion that strict enforcement of the new rule would be unjust.

In Michigan, appellate courts review equity actions de novo. Stachnik v Winkel, 394 Mich 375; 230 NW2d 529 (1975). We have done so and now remand this case for entry of an order embodying the following provisions:

(1) Plaintiffs shall endorse the check from the insurance company now held by defendant General Mortgage.

(2) From the proceeds of that check, defendant General Mortgage shall pay $13,961 to defendant FNMA and pay the remaining $4,039 jointly to plaintiffs Charles and Peggy Smith.

(3) If the plaintiffs so request in the trial court, the judgment entered pursuant to this opinion shall require defendant FNMA to give the plaintiffs a deed conveying fee title to the property from defendant FNMA to plaintiffs Charles and Peggy Smith as tenants by the entireties. If the plaintiffs make no such request prior to the entry of judgment, title to the property shall remain in defendant FNMA.

In all cases involving foreclosure sales occurring after the release date of this opinion, this case should be cited only for the general rules announced herein, not the specific equitable exception created for these unique facts.

Judgment vacated; cause remanded for entry of a judgment in accord with this opinion.

D. C. Riley, J., concurred.

1 Plaintiffs also challenge the trial judge’s decision to allow defendant FNMA to intervene in an action brought only against defendant General Mortgage. Although styled as an action to prevent unjust enrichment, the present suit has many of the characteristics of interpleader actions. GCR 1963, 210. We believe that the intervention of FNMA was authorized by GCR 1963, 209.1(4). At the very least, the trial judge did not abuse his discretion to allow intervention pursuant to GCR 1963, 209.2(2).

2 But see the discussion of Smith v Mutual Fire Insurance Co of Michigan, supra.