Editor’s note: With foreclosures on the rise in many parts of the country, Inman News examines the legal risks of investing in foreclosed properties at auction, describing the most common legal problems that arise and explaining how two investors had to fight in court to keep the property they purchased at auction after the former owner raised legal challenges. (See Part 1 and Part 3.)

“One risk in investing in properties at a foreclosure sale is not doing an appropriate title search and knowing what that property is encumbered with,” said Marvin E. Katz, an attorney with Ben-Ezra & Katz, P.A. in Fort Lauderdale, Fla., which represents lenders in foreclosure proceedings. “If you think there’s a lot of equity there, it could be that the second mortgage was foreclosed, and you’re taking the property subject to the first mortgage.”

Colorado purchasers are warned of just such a possibility because an influential Colorado resident was burned in a foreclosure sale, said Jon Goodman, an attorney with Frascona, Joiner, Goodman and Greenstein, P.C. in Boulder, Colo., who represents both mortgage holders and foreclosure investors. Under Colorado law, he said, public notices for foreclosures must give buyers a heads up that the lien being foreclosed may not be a first mortgage.

“This was driven by a legislator who thought he was getting a steal buying a property in a foreclosure sale,” Goodman said. “Only after the fact did he learn that he bought the property subject to a large first mortgage.”

Even if it’s the first mortgage that’s being foreclosed, you’ll probably end up paying other liens, including mechanics or judgment liens, Goodman said. Also, you’ll always take subject to an IRS lien and past-due property taxes. In our case, Herman hadn’t paid about $10,000 in property taxes, but we’d done our research and had factored that amount into our investment calculations.

Though you may know the amount of past-due taxes, you can still end up being surprised by the taxes, said Bruce Bronster, a lawyer with Dreier LLP in New York City, who represents institutional clients such as lenders in foreclosure sales. “You buy thinking the house is taxed at a certain level,” he said, “but you really need to understand what the taxes are because you may lose some exemptions. For instance, a veteran’s or a senior citizen’s exemption can be lost in a foreclosure sale, and you could get hit with higher taxes.”

Katz said that in Florida, homeowners’ association dues and fees typically fall in a foreclosure sale, but not always. “You have to check the homeowners’ association documents,” he said. Condo associations are better protected under Florida law, he said, and you may be forced to pay back the full amount of past-due assessments if you buy at foreclosure sale.

Even if you’ve done a title search, you can encounter non-lien issues, such as easements or zoning violations. “There can also be encroachment issues,” said Goodman. “For instance, the house you bought might encroach onto the neighboring property.”

Goodman said he ran into a situation where a lender foreclosed and discovered the house on the property encroached onto the property next door. “The neighbor was waiting, loaded for bear, for a deep pocket to go after,” he said, and when the bank foreclosed, he got just that. An unwitting investor might have just as easily been tagged with the headache of an encroaching property.

The problem with an encroachment, Goodman said, is that you wouldn’t necessarily learn of it by doing a title search. “It would show up on a survey,” he said, “but foreclosure investors generally don’t ante up for a survey before they buy.”

Investors can also make huge mistakes by not reading the property’s legal description or checking it against an actual address. “In one case, a purchaser bought a dwelling unit that turned out to be a windowless basement unit with no kitchen or bathroom,” said Bronster. “He was pretty unhappy and sued to undo the sale. He was successful because the court bent over backwards to help him out, but I think the court was wrong because it really is caveat emptor.”

In another case, the purchaser looked up the owner’s address and drove by it. “He saw a nice property in a nice part of town and bought it,” said Bronster. When the investor went to look at the property again after the sale, he realized the property he bought was at a different address than the owner’s address he’d looked up. “He’d bought a run-down single-family house on a different street that was a disaster,” Bronster said.

The lesson is to read the legal description. “Drive by the property to get a visual,” said Bronster. “Look at the street address and make sure it matches the legal description.”

Though my friend and I had done solid research on liens, and we were sure of the property address, we weren’t prepared for the legal buzz saw we ran into after we purchased.

In Illinois, a foreclosure sale must be confirmed by the judge overseeing the foreclosure lawsuit, which is usually a technicality. The attorney for the party seeking foreclosure will appear in court shortly after the sale is held and report the results to the judge, who enters an order finalizing the sale. (Each state has slightly different procedures for a foreclosure sale, so be sure to know your state’s legal process before you buy.)

In our case, we purchased in late November, and the confirmation hearing was scheduled for late December. Much to our surprise, Herman finally got off his duff and challenged the foreclosure before the confirmation hearing, claiming he’d never been properly served with the foreclosure action.

Never properly served? The court file showed 20-something attempts to serve Herman with the lawsuit. Service was attempted at all hours of the day and evening, and the process server had dutifully recorded each effort. The notes indicated such things as lights that were on in the unit had been suddenly turned off when the process server buzzed the intercom to deliver the legal documents.

“Under New York law,” Bronster said, “for almost five years after you purchase, you suffer a danger that service was bad in the underlying foreclosure action and that somebody’s going to wake up one day and challenge service or claim that there was some irregularity in the sale and be successful. Those are tricky things you can’t protect yourself against.”

“The funniest example of somebody challenging service,” Bronster said, “and it’s only funny in hindsight, involved a woman who was incapacitated and not living at the property. We attempted service and couldn’t find her, so we had a guardian appointed for service and then sold the property.” After the sale, the new buyer tore down the house and was in the middle of building a new multifamily home on the property when somebody came to the woman’s aid and helped her sue for improper service.

“The court vacated the judgment of foreclosure and sale,” Bronster said, “and the guardian for the incapacitated woman sold the property to another person. The foreclosure buyer ended up paying the second buyer to go away…He was a sophisticated buyer at foreclosure auctions, and he got burned.”

In states like Colorado, the primary method of foreclosure is non-judicial foreclosure, which doesn’t require personal service of the foreclosure action. “Service is a question of whether the notice was mailed out, and that’s verified out by checking the mailing list of the public trustee,” says Goodman, “So challenges to service aren’t very common in Colorado.”

Though Florida owners can redeem their property by paying the full judgment amount only before the foreclosure sale is conducted, they can assert legal challenges, such as improper service, even after the foreclosure sale. “The owner could dispute service of process or make other objections to the sale,” said Mark Ben-Ezra, also of Ben-Ezra & Katz, P.A. in Fort Lauderdale, Fla., “such as the sale wasn’t advertised properly or the clerk of the court didn’t conduct the sale properly. Those objections are rarely upheld by courts, but the investor’s money is tied up for the whole period.”

That’s exactly what happened to us.

Next: What we had to do to protect ourselves while the original owner made the unbelievable argument that he never knew his property was slipping from his grasp. Plus, another legal hurdle: getting the previous owner out of the property.

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