Does Foreclosure Terminate a Lease?

Carlton C. Casler

Carlton C. Casler

What are the landlord’s rights/obligations? What are the tenant’s rights/obligations?
These are the questions that many tenants and landlords are facing today. As in all cases, the answers depend on the facts and your point of view.
From the tenant’s perspective, they have signed a lease₁ and are current on the rent. So what happens if the property goes into foreclosure? The answer to that question is easy: a judicial foreclosure and a non-judicial foreclosure will both “foreclose” (i.e., wipe out) all liens and interests in the rental property that are subordinate to the lien being foreclosed, which in almost all cases, includes a residential rental agreement or lease.
When the landlord purchased the Property, s/he obtained a loan. When s/he obtained the loan, s/he signed a promissory note, which created the debt that is owed to the lender.
The landlord also signed either a “deed of trust” or a “mortgage.” Almost everyone refers to a house as having a “mortgage,” but the fact is that almost all loans in Arizona are secured by a deed of trust, rather than a mortgage.
Under a deed of trust, if the borrower commits a “default,” such as not making the payments, the lender may initiate a Trustee’s Sale, which is a non-judicial foreclosure of the Property. A non-judicial foreclosure means exactly that – the foreclosure may be conducted without going to court and/or getting a judgment. To initiate a non-judicial foreclosure (i.e., a Trustee’s Sale), the beneficiary (the lender) must instruct the trustee to record a Notice of Trustee’s sale with the county recorder and, after posting a notice on the property and sending the borrower various notices (whether actually received or not), the trustee may conduct a Trustee’s Sale of the Property.
Under a mortgage, if the borrower commits a default, the lender may commence foreclosure by filing a lawsuit in superior court and serving the borrower and all other parties with an interest in the property with a summons & Complaint. If the lender prevails at trial, the judge will issue a judgment of foreclosure and order that the sheriff seize the Property and sell it at auction.
A Trustee’s Sale, pursuant to a non-judicial foreclosure under a deed of trust, may be conducted ninety days after the Notice of Trustee’s Sale is recorded with the county recorder. A judicial foreclosure under a mortgage proceeds as any regular civil lawsuit. If none of the defendants oppose the foreclosure, the lender may receive a judgment by default in about the same time as conducting a Trustee’s Sale (i.e., ninety days). If, however, one or more defendants oppose the foreclosure action, it may take from four to twelve months to obtain a final judgment and the Sheriff’s sale of the property will occur sometime thereafter.
The reason that a deed of trust is more common than a mortgage is thus revealed. In almost all cases, the property can be sold at a foreclosure sale much sooner under a deed of trust than under a mortgage.
In addition, a deed of trust can be foreclosed as a mortgage (i.e., the borrower can elect to file a lawsuit in court rather than conducting a non-judicial sale), but a mortgage cannot be foreclosed as a deed of trust (i.e., a lender holding a mortgage must file a lawsuit and pursue a judicial foreclosure). For these reasons, almost all lenders prefer to use a deed of trust to secure real property.
The shortest time, then, from initial default until the foreclosure auction (either a Trustee’s Sale or a Sherriff’s Sale) is ninety days. But that presumes that the foreclosure process is commenced immediately upon the first default (i.e., failure to make a payment). Many lenders do not even begin foreclosure until a borrower is three or more payments behind. In today’s market, some lenders are waiting even longer (i.e., they already have enough foreclosures on their hands; no need to hurry to the next one). Sorry for the diversion, but an understanding of the process is important in order to understand the answers to our questions.Back to the tenant. When is the lease going to end?
If the lease is month-to-month, then there is no breach by the landlord. Either the landlord or the tenant may terminate a month-to-month tenancy for any reason (or no reason) by simply sending out a thirty-day notice of termination. (See A.R.S. §33-1375(B)). To avoid liability (discussed below), the landlord may simply send a notice of termination at the appropriate time before the foreclosure sale.
If the lease will terminate in less than ninety days, there is no possible way that the tenant will lose possession of the rental property before their lease expires. Again, there is no breach by the landlord. Whether or not a foreclosure is pending, a landlord has no obligation to renew or extend any lease, unless the lease expressly gives the tenant an option to extend or renew the lease, which is not common in residential leases.
If the lease termination date is somewhere between ninety days and six months away, then “potentially” there is a problem. And if the lease termination date is more than six months away and/or the lease gives the tenant the option to extend or renew the lease, then the landlord will be in breach of contract if the foreclosure sale occurs.
When a landlord and tenant sign a lease, the tenant agrees (among other things) to pay a specified amount of rent each month (or some other specified period) and to stay for a certain length of time (i.e., no rent increases during the term of the lease) and for a certain length of time. The landlord’s failure to make the loan payments on the rental property is not a breach of contract, at least not to the tenant; it is a breach of contract under the promissory note and deed of trust or mortgage that the landlord signed with the lender. Rarely, if ever, is there a provision in the lease that requires the landlord to keep the loan payments on the rental property current during the term of the lease. If there was, then the landlord would be in breach of contract as soon as the landlord failed to make a required payment. Likewise, there is no statute that requires the landlord to keep loan payments current on the rental property during the lease term. If there was, then the landlord would be in violation of the law as soon as the landlord failed to make a payment. Consequently, the landlord will only be in breach of contract if the rental property is foreclosed during the rental term and the tenant is forced to move out before the end of the lease term. In that instance, the landlord has failed to provide the tenant with the subject property for the agreed upon period. This, by definition, is a breach of contract by the landlord. The tenant may then sue the landlord for all damages that result from the breach of contract, which may also include the tenant’s moving expenses.
If, however, the lender begins the foreclosure process on the subject property, but the landlord makes up the back payments and averts the foreclosure, then there has been no breach of contract by the landlord. Likewise, if the landlord’s solution to avert the foreclosure is to sell the property is averted for any reason (i.e., the sale paid off the foreclosing lender, the new buyer assumed the existing loan and brought it current, the lender extended the foreclosure sale date, etc.), then the landlord has not breached the lease contract. Keep in mind, however, that when someone buys real property that is subject to an existing lease, the buyer takes the property subject to the existing lease, which means that the new buyer is bound by the terms of the existing lease and must allow the tenant to remain in the property until the end of the lease term.
But, we are not done yet. What if the landlord “knew” the property was going into foreclosure when he signed the lease? What if it is his intent to keep all the money that the tenants pay to him and not make any loan payments to the lender until the lender forecloses on the property? Again, the specific facts will determine the answer. The extremes will be easy, so let’s start there. If the lease is month-to-month and the landlord provides adequate advance notice to the tenant before the foreclosure sale, then there is no breach by the landlord. On the other hand, if the landlord signed a ten-year lease, then it would be clear that the landlord intended to defraud the tenant. In that case, the tenant would be able to sue the landlord for breach of contract and fraud. The grey area in the middle is less clear. If the landlord signed a six-month, one-year, or other specified length lease with a tenant, knowing that he never intended to make a payment during the term of the lease, but with the expectation that the lender would not foreclose before the end of the lease term, then answer is less clear. Intent is not an element in a breach of contract claim. Therefore, if the tenant is forced to move before the end of the lease term, then the landlord is in breach of contract. Whether the landlord is also liable for fraud will turn on whether his expectation that the lender would not foreclose before the end of the lease term was “reasonable.”
Can I stop making the rent payments? That is a question I hear frequently. Many lawyers are telling tenants to stop making the rent payments when a property goes into foreclosure. I believe that to be bad advice. Yes, I recognize that the tenant may argue that the landlord’s failure to make the payments and the impending foreclosure is an “anticipatory breach of contract” by the landlord. But I also know that every landlord will argue that they are experiencing some “financial difficulties,” which are not being compounded by the tenant’s actual breach (not anticipatory breach) of failing to pay the rent. My opinion is that most judges will find the “actual breach” to be more compelling than the “anticipatory breach.” Which means that the tenant will be in breach of contract, will be evicted and may be liable for rent until the end of the lease term. And this may be true even if the rental property is actually foreclosed because the landlord will claim that the tenant’s failure to pay the rent was the reason the landlord could not pull the rental property out of foreclosure. Bottom line for the tenants is you are better off paying rent. If the foreclosure sale actually takes place, then the landlord is in breach of contract if you are forced to leave the rental property before the end of your lease term. You can sue the landlord for breach of contract and, under appropriate facts, for fraud, but keep in mind that if the landlord lost the property to foreclosure, s/he may have other financial problems and may be on the verge of bankruptcy.
Tenants should also know that there is a process that follows any foreclosure sale. Whether by Trustee’s Sale or by Sheriff’s Sale, the successful bidder (or the bank, if no one bids) is not immediately entitled to possession. The new owner must first serve the occupant(s) with a five day demand for possession. If the occupant does not move, then the new owner must file a forcible detainer action (i.e., an eviction action) to remove the occupants. The hearing will be set approximately five days after the lawsuit is filed. If the occupants do not appear at the hearing (and even if they do), the court will enter a judgment in favor of the new owner and a “writ of restitution” can be issued five days later. That is the date that the Sheriff or constable will show up at the door and escort all occupants out of the property and deliver possession of the property to the new owner. So, from the foreclosure sale to the date the Sheriff shows up is about fifteen days. Not a lot of time, but certainly “some” amount of time to find substitute housing.

¹ Many people refer to a “lease” as a document that commits the landlord and tenant to a specific lease term, whereas a “rental agreement” refers to either an oral or written document for a month-to-month tenancy. For purposes of this article, the term “lease” shall refer to both.

Carlton C. Casler is an Attorney at Law licensed to practice law in the state courts of Arizona and in federal court.  He is the Owner of the CASLER LAW OFFICE and Owner of the CASLER SCHOOL of REAL ESTATE.  He is a Licensed Arizona Real Estate Broker and Author of real estate books and reference guides and one of the leading authorities on Landlord/Tenant law in Arizona.  Mr. Casler’s books are available at the Hogan School bookstore.

This entry was posted on Monday, January 26th, 2009 at 8:10 pm and is filed under Landlord/Tenant. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.

  • My owner is in default of loan as of MAY 29. We signed lease on Jan 9 for 2 years. The realestate company said that they can’t collect funds when owner is in default. Is this a law or just there rules. How do we still pay rent and stay legal if they wont collect them?

    Comment | Greg Mobley , July 8, 2012
  • I purchased property in July and found out right after there was a tenant. The tenant signed a lease with the LL in Feb. The LL was given notice of Foreclosure Sale in March, approx 5 weeks later. The LL did not provide the tenant with any heads up on the possible sale of property and even took and kept the rent from the month after the sale before the new owner could speak to tenant. The new owner stated to tenant lease is no longer valid and willing to work with tenant. Tenant is angry with new owner and states lease is valid and new owner has no rights. Tenant insists they have right to stay til next year? Current tenant staying for free this month as former LL took her rent and new owner understanding.

    Is lease valid under Arizona law? Is there a federal law that does not allow lease to be terminated even in event of trustee sale? I really need help! Want to be fair but cannot wait till next year.

    Michele

    Comment | Michele , August 10, 2012
  • Federal law enacted in 2009 states that if a valid lease was entered into prior to the foreclosure action being started the new owner (the bank or other successful bidder) must honor the lease. If there was no lease the new owner must give the tenant 90 days notice to vacate.
    Here is the info: http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/ptfa.pdf

    I hope that helps,

    Comment | Jim Hogan , August 13, 2012
  • Great info. What about a lease term starting after the auction sale date? Tenant did not receive notice of foreclosure.

    Comment | Edie , August 31, 2012
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