This article is written by Asha Kumari Manjhi .I from Bhadrak Law College 3rd year, during his internship with LeDroit India.
Abstract:
This paper provides empirical evidence that a strong statutory right of redemption leads to a statistically significant and an economically large impact in reducing bankruptcy filings. Under the statutory right of redemption, borrowers can repurchase the property after the foreclosure auction at a certain price. Implementations of the statutory right of redemption, however, vary substantially among states. When categorizing the redemption rights from an economic perspective, we find that a strong redemption right leads to a greater than 30% decrease in the odds that a borrower with a defaulted mortgage will file for bankruptcy.
Keywords:
Redemption right and its impact on defaulted mortgage outcomes,.
Empirical evidence, .
CLOG ON REDEMPTION – “ONCE A MORTGAGE, ALWAYS A MORTGAGE”.
INSTANCES DEPICTING CLOG ON REDEMPTION.
Stipulation barring mortgagor’s right of redemption after certain period.
Introduction:
The statutory right of redemption constitutes one of the most important mortgagor protection laws in the US (Schill, 1991), and represents one of the fundamental differences in foreclosure laws among the fifty states (Bauer, 1984). Under the statutory right of redemption, borrowers can repurchase the property after the foreclosure auction at a certain price. About half of the states allow post-foreclosure redemption.
Despite the prevalence of the statutory right of redemption, few empirical papers have investigated this important foreclosure law in-depth. The existing literature either treats the redemption right as a binary variable or uses the redemption period length to capture the strength of the redemption right. However, implementations of the statutory rights of redemption vary in several dimensions including accessibility to borrowers, redemption price, and transferability to third parties. For example, the redemption price could be based on either the foreclosure auction sale price or the outstanding debt, and these are associated with different utilities from redemption. As another example, a state might grant the redemption right only to borrowers following judicial foreclosures. If the majority of the foreclosures in the state follow a non-judicial procedure, then most borrowers would not be entitled to the redemption right. These legal variants of the statutory right of redemption have different economic implications. This paper comprehensively surveys redemption rights and empirically investigates the potential impact of the redemption right on defaulted mortgage outcomes (such as foreclosure or bankruptcy).
A mortgage in the foreclosure process could fall into four possible scenarios – continued default, bankruptcy filing, cure, or foreclosure sale. Both borrower and lender play a role in determining the outcome of a defaulted loan. The redemption right could change both borrowers’ and lenders’ mortgage decisions. For example, the redemption right could increase a borrower’s perceived utility from the foreclosure sale, especially when a state allows a borrower to repurchase the property based on the auction sale price. Previous literature has documented significant foreclosure price discounts.
For example, Campbell et al. (2011) document an average foreclosure discount of 28% which they attribute the discount to both the urgency of sale and vandalism. Mayer (1998) studies the foreclosure auction and documents a discount of up to 9% in Los Angeles during a housing boom and a 9% to 21% discount during a housing bust in Dallas. If the redemption right allows borrowers to repurchase the property at the lower auction price, then the redemption right could present a profitable opportunity for the borrower. Borrowers do exercise the option to redeem. For example, Bauer (1984) uses data from 1881 to 1980 from Johnson County and Iowa County in Iowa to show that 10.4% of borrowers redeemed the foreclosed properties after the foreclosure auctions. These studies provide evidence that mortgagors know about the redemption opportunity and also factor the redemption right into their mortgage decisions.
Another channel that could increase a borrower’s expected utility from foreclosure auction is through the deficiency judgment.4 The redemption right provides potential auction bidders with an incentive to place higher bids at the auction to reduce the likelihood of borrower redemption.5 For example, the bidding instructions from Fannie Mae specify that servicers should bid the full mortgage indebtedness in the foreclosure auction if the state allows a redemption right (Mae (2020), p. 465). This effectively eliminates the deficiency judgment. If a state has no redemption right, Fannie Mae instructs servicers to start from the minimum bid (Mae (2020), p. 466). The lower the bid, the greater the potential deficiency judgment. The reduced deficiency judgment benefits a borrower with a lower debt burden, but reduces a lender’s potential loss recovery from the deficiency judgment. Thus, ex ante, the redemption right with the above features could be perceived as carrying a positive option value associated with a foreclosure sale to the borrower, and a negative option value to the lender. Note, bankruptcy can serve as an alternative mechanism to eliminate deficiency judgments. In this sense, redemption and bankruptcy are competing choices for defaulted borrowers.
This paper uses a nationwide mortgage dataset to study the potential effects of redemption right on defaulted mortgage outcomes. To control for the heterogeneity across multiple real estate markets, we limit our sample to the forty-three cross-border MSAs. The impact of social/economic and housing market conditions on mortgage performances should be comparable within the same MSA. When other factors remain constant throughout the same MSA and state foreclosure laws change discretely across the state boundary, it helps identify the effect of redemption rights. We classify the states into: accessible redemption states, where borrowers are likely to have access to the redemption right; restricted redemption states, where borrowers are unlikely to have access to the redemption right despite residing in a redemption state; and no redemption states. For states with accessible redemption, we further classify the redemption right according to its option value depending on whether the redemption price is based on the outstanding debt or the auction sale price. The accessible redemption right, which allows borrowers to redeem the property at the auction price, represents a strong right and is likely to carry a positive value to the borrower and thus potentially impacts mortgage outcomes. When taking the different implementations of redemption rights into consideration and categorizing the statutory rights of redemption from an economic perspective, we find that a strong redemption right leads to a large impact on mortgage outcomes. Specifically, the results reveal that a strong redemption right leads to an over 30% decrease in the odds of a bankruptcy filing.
Previous literature uses the redemption time period as a proxy for the strength of the redemption right. However, the redemption price increases at a state specified rate over time (interest rate). Longer redemption times, on the one hand, grant borrowers extra time to locate a funding source to redeem the property. On the other hand, the longer borrowers wait to redeem the property, the higher the redemption price. Since borrowers have the opportunity to redeem early without incurring interest payments, borrowers might be better off with a longer redemption time. However, whether a longer redemption time has any material impact on mortgage outcomes remains an empirical question. When including redemption time in the analysis, the results show that redemption time period does not have any significant impact on mortgage outcomes.
The contributions of this paper are threefold. First, we conduct a comprehensive survey and introduce a fuller picture of the redemption right. Second, the empirical results show that redemption time period does not have a significant impact on mortgage outcomes. This has implications for possible credit law reforms. The statutory right of redemption benefits borrowers but has been unpopular with lenders. Our results suggest that the redemption time might be shortened to benefit lenders, without affecting its economic benefits for borrowers. Our findings therefore support the movement of redemption right reform in recent years by various states.7 Third, the empirical results show that a strong redemption right leads to a decrease in bankruptcy filings. This indicates that foreclosure law reforms might have unexpected effects on bankruptcy filings and vice versa. Thus redemption and bankruptcy need to be jointly considered when drafting consumer protection law reforms.
Statutory right of redemption and defaulted loan outcomes:
Section 2.1 first briefly discusses the historical context of the statutory right of redemption, then introduces the various features of the redemption rights, as well as how we classify the various redemption rights. Section 2.2 discusses the possible channels through which redemption rights could influence mortgage outcomes.
Empirical evidence:
This section investigates the empirical impact of redemption right on defaulted mortgage outcomes. Section 3.1 discusses the data sources and the sample, and defines the variables. Section 3.2 presents the empirical results using different proxies for redemption rights.
Right of Mortgagor to Redeem Meaning Of Redemption :
The primary and significant entitlement held by the mortgagor is the right to redeem the mortgage. The term ‘redemption’ refers to the act of repaying the mortgage amount and reclaiming full ownership of the mortgaged property. The mortgagor possesses the ‘right of redemption,’ which guarantees the return of their property upon fulfilling their obligation. According to Section 60 of the Transfer of Property Act, once the principal amount becomes due, the mortgagor has the privilege of reclaiming the property by paying or tendering the mortgage amount. This provision ensures that the mortgagor maintains the right to regain full ownership of the property. Additionally, it is required that the mortgage instrument, along with all the title deeds, be returned. If the mortgagee is currently in possession of the property, they must deliver possession to the mortgagor.
Furthermore, in cases where the mortgage was created through a registered instrument, the mortgagor is responsible for either retransferring the property at their own expense or providing a written acknowledgment confirming the mortgagee’s right has been extinguished. It is important to note that the right granted by this section can be extinguished either by the actions of the involved parties or by a court decree.
Furthermore, this section does not invalidate any provision that requires the mortgagee to receive reasonable notice before the payment of the principal money, especially in cases where the time for payment has lapsed or was not explicitly fixed. Under Indian law, the terms “right to redeem” and “equity of redemption” (as per English Law) are considered synonymous. The mortgagor’s right to redeem, even after the expiration of the specified payment date, is not an equity but a statutory right protected by Section 60 of the Transfer of Property Act. However, it’s essential to understand that this remedy is only available to the mortgagor before the mortgagee initiates legal action to enforce the mortgage, as established in the case of Poulose v. State Bank of Travancore. It should be noted that the mortgagor does not possess the right to redeem the mortgage before the mortgage-money becomes due, which is the time fixed for the payment of the mortgage amount.
CLOG ON REDEMPTION – “ONCE A MORTGAGE, ALWAYS A MORTGAGE”:
The right to redeem is an inherent aspect of a mortgage. Regardless of any contrary agreement, the mortgagor retains the right to reclaim their property, free from any conditions or liens, by paying off their debt. This right remains intact until the mortgagor’s equity of redemption is officially foreclosed, which occurs when a foreclosure suit results in a court decree. It is important to note that no law or contract can deprive the mortgagor of this right to redemption, as it is an inseparable element of the mortgage itself. This principle is succinctly expressed by the maxim “once a mortgage, always a mortgage.” The true object of a mortgage being to give the lender security for repayment of his loan, the lender ought not to be able in any case to claim to retain the security if his money is forthcoming from the borrower within a reasonable time of his demanding it. It would be inequitable if the property were forfeited for non-payment on the fixed day. For instance, the lender might intentionally evade payment by hiding or some unexpected accident might prevent the borrower from having the money ready. The right of redemption is a statutory right that is extremely strong, to the point that even the parties involved cannot override or invalidate it. No condition can restrict or impede this right. It is worth noting that Section 60 does not include any provision stating, “in the absence of a contract to the contrary.” When viewed from a legal perspective, any provision discovered within a mortgage deed that hinders the right of redemption will be regarded as an impediment or constraint on redemption and will be considered invalid and ineffective. Pollock has described this doctrine as “an anachronism” and has suggested that it should be limited to cases of oppressive or unconscionable bargains. However, both in England and in India, it is now well settled that a mortgage cannot be made irredeemable (except as regards companies, which may issue secured irredeemable debentures); nor can the right to redemption be made illusory or superfluous. The doctrine of “clog on the equity of redemption” is based on principles of equity, fairness, and good conscience. It is important to note that this doctrine applies specifically to transactions that occur between the parties involved at the time of entering into the mortgage contract. It does not apply when the parties later decide to modify the terms under which the mortgage can be redeemed. Additionally, the application of this doctrine is subject to any rights held by the mortgagee prior to the mortgage agreement. The doctrine is similar to the ‘rule against perpetuity’. The principle is that no one can take away the right which the law vests in him. What is a clog on equity of redemption is, however, a matter of fact in each case (depending upon the nature of transaction, the time the condition, the price spiral, the term of bargain and the other obligations in the background of the financial conditions of the parties). A condition or stipulation is considered a “clog” and is therefore void.
The key elements of a clog are as follows: . The condition or stipulation must be imposed by the mortgagee and cannot be introduced by any other person or outsider to the transaction. . The condition or stipulation should be included in the mortgage deed itself, although the parties are free to stipulate through a separate contract outside of the mortgage deed. The condition or stipulation included in the deed must be unreasonable, against public policy, and demonstrate malicious intent. . The nature of the condition or stipulation should impose an absolute restraint on the mortgagor’s right of redemption, preventing them from redeeming the property for an unreasonably extended period. . The determination of whether a condition or stipulation meets these criteria is a matter of fact and may vary from case to case based on the specific circumstances involved.
Instances Depicting Clog On Redemption:
Case Study:
In the case of Gangadhar v. Shankar Lal, it was established that the principle of the “clog on the equity of redemption” applies. This principle states that a provision in a mortgage agreement, which declares that the mortgagor forfeits all rights to the mortgaged property and the mortgage-deed is treated as a deed of sale in favor of the mortgagee if the mortgagor fails to redeem the mortgage within a specified period, cannot be enforced. Such a term is considered a restriction on the mortgagor’s right to redeem and is deemed invalid. The court ruled that such a provision constitutes a “clog” on the mortgagor’s equity of redemption and cannot be legally enforced. Long term redemption A long term is not necessarily a clog on redemption. A leading case on the point is discussed hereunder. In the case of Gangadhar v. Shankar Lal10, the mortgage instrument in question contained these terms: “l or my heirs will not be entitled to redeem the property for a period of 85 years. After the expiry of 85 years, we shall redeem it within a period of six months, otherwise we shall have no claim over the mortgaged property, and the mortgagee shall have no claim to get the mortgage-money. In such a case, this very deed will be deemed to be a saledeed”. The appellant argued that the covenant which established a long term of 85 years for the mortgage, coupled with the provision that required the mortgagor to redeem the mortgage within a six-month period or lose the right to redeem entirely, constituted a restriction on the mortgagor’s equity of redemption. The appellant contended that this arrangement amounted to a “clog on the equity of redemption” and therefore should be considered invalid. The respondents argued that, in the absence of a special condition allowing the mortgagor to redeem the mortgage during the specified term, the right of redemption can only be exercised upon the expiration of that specific period.
They referred to the case of Bakhtawar Begum v. Husaini Khanam, to support their contention. In the present case, the mortgage term is stated to be 85 years, and there is no provision in the agreement that grants the mortgagor the right to redeem the mortgage before the completion of that term. As the term has not yet expired, the respondents argue that the lawsuit filed after 46 years since the creation of the mortgage is premature.
The Supreme Court (Sarkar, J.) observed: “The rule against clogs on the equity of redemption no doubt involves that the Courts have the power to relieve a party from his bargain. lf he has agreed to forfeit wholly his right to redeem in certain circumstances, that agreement will be avoided. But the Courts have gone beyond this. They have also relieved mortgagors from bargains whereby the right to redeem has not been taken away but restricted. The Court’s jurisdiction to relieve a mortgagor from his bargain depends on whether it was obtained by taking advantage of any difficulty or embarrassment that he might have been in when he borrowed the money on the mortgage. Was the mortgagor oppressed? If he was’ then he may be entitled to relief. We then have to see if there was anything Unconscionable in the agreement that the mortgage would not be redeemed for 85 years. Is it oppressive? Was he forced to agree to it because of his difficulties? Now this question is essentially one of fact and has to be decided on the circumstances of each case.” The Court further observed: “The Court’s power against clogs on the equity of redemption evolved in the early English Courts of Equity for a special reason. All through the ages the reason has remained constant, and the Court’s power is therefore limited by the reason.
In Vernon v. Bethell, (1762) 28 ER 838, Lord Chancellor said that “this Court of conscience is very jealous of persons taking securities for a loan and converting such securities into purchases. A mortgagee can never provide at the time of making the loan for any event or condition on which the equity of redemption shall be discharged, and the Conveyance absolute. And there is great reason and justice in this rule, for necessitous men are not, truly speaking, free men, but to answer a present exigency, will submit to any terms that the crafty may impose upon them”. In Kreglinger’s case12, it was observed that this jurisdiction was merely a special application of a more general power to relieve against penalties and to mould them into mere securities.
In the case of Fateh Mohammad v. Ram Dayal13 , the court deemed a period of 200 years as oppressive and unreasonable, constituting a restriction on the equity of redemption. On the other hand, in the case of Pomal Govindji v. Vrajlal Purohit, the Supreme Court ruled that a long redemption period, on its own, does not amount to a clog on the equity of redemption. However, when coupled with other relevant factors such as inflation and price increases, a very long redemption period (99 years in this instance) may give rise to a presumption that it is a restriction on the equity of redemption. The Apex Court, in the Pomal’s case observed: “In the Context of fast changing circumstances and economic instability, long term for redemption makes a mortgagee an illusory mortgage, though not decisive. It should prima facie be an indication as to how clogs on equity of redemption should be judged.”
Stipulation barring mortgagor’s right of redemption after certain period
Stipulation barring mortgagor’s right of redemption after certain period In the case of Murarilal v. Deo Karan ,, a mortgage deed contained a provision stating that if the mortgagor failed to make payment within 15 years, the mortgagee would become the absolute owner of the property. The court held that the mortgagor’s obligation to repay the loan within 15 years did not prevent them from filing a suit for redemption. This is because the provision in the mortgage deed was considered a clog on the equity of redemption.
Similarly, in the case of Vadiparthi v. Appalanarasimhalu, a mortgagor (A) mortgaged his land to a mortgagee (B) for a period of 5 years, with a provision that rents and profits would be offset against interest. The deed also stated that if the mortgage was not redeemed within 20 years, the mortgagee would treat the land as sold to him unconditionally. The court ruled that this provision constituted a clog on redemption, and the mortgage remained redeemable even after the expiration of 20 years. In the case of Shankar v. Yeshwant17, the mortgagor (X) mortgaged his land to the mortgagee (Y) with possession. The mortgage agreement stated that if redemption was not exercised within 20 years, Y would become the owner of half the land. The court determined that this provision amounted to a clog on the equity of redemption. However, four years after the expiration of the 20-year period, while Y was still in possession, X executed a deed transferring half of the land to Y, and Y released the other half from the mortgage. The court held that this arrangement was a valid means of discharging the mortgage.
Condition postponing redemption in case of default :
In the case of Mohammad Sher Khan v. Seth Swami Dayal, a mortgage agreement was made for a term of 5 years. The agreement included a provision stating that if the money was not paid, the mortgagee had the right to take possession of the property for a period of 12 years, during which the mortgagor could not redeem the property. The court held that this condition constituted a clog on the mortgagor’s right to redeem because it obstructed an existing right.
Restraint of alienation :
A provision in a mortgage deed that prohibits the mortgagor from selling or obtaining a loan on the mortgaged property has been considered a clog.
Redemption restricted to mortgagor :
An agreement that limits the right of redemption solely to the mortgagor and excludes their heirs has been deemed as a clog.
In the case of Suraj Lamp & Industries Pvt. Ltd. v. State of Haryana and Anr..
In this case, the Supreme Court of India held that any agreement that bars the right of redemption of the mortgagor is void and unenforceable. The court also held that the right of redemption is an important right of the mortgagor and cannot be taken away by any agreement. The court further stated that any agreement that is against public policy or is unconscionable will be considered as a clog on the equity of redemption.
Penalty in case of default :
An agreement that imposes additional burdens on the mortgagor, such as penalties or collateral advantages for the mortgagee, beyond the return of the principal amount with interest, may be valid or invalid based on the terms and circumstances. These contracts are valid if they are not oppressive, do not function as penalties, and do not contradict the principles of equity or redemption.
Stipulation to charge an increased rate of interest in case of default :
A provision that stipulates a higher rate of interest from the date of the mortgage in the event of payment default has been regarded as a clog. However, if there is no undue influence, a high rate of interest alone does not necessarily constitute a clog. It should be noted that the Kreglinger’s case has been held to be not applicable in India. A collateral benefit, whether it affects the land or not, cannot extend beyond the period of redemption.
Partial Redemption :
Partial redemption is not permitted. Generally, partial redemption is not permitted. Partial redemption means redemption of only a part of the mortgage. This situation may arise where a co-owned property is mortgaged jointly. For instance, A, B and C are the co-owners of land. The land is mortgaged jointly to X who advances a loan of Rs. 40,000/- to them jointly. A has half share in the land and B and C have one-fourth each. Now, the question is, whether A by making payment of Rs. 20,000/- (which is proportionate to his half-share in mortgaged land) can redeem the mortgage to the extent of his share? According to the last paragraph of Section 60, a person having a share in the mortgaged property has no right to redeem only his own share of the property. In a transaction of mortgage, the creditor values his security as one and indivisible. If the mortgagor is allowed to redeem the property in part, the mortgagee’s interest in getting back the whole amount including interest thereon, would be jeopardized. Partial redemption results in splitting of mortgagee’s security. Therefore, this is disfavored under English law and also under the Transfer of Property Act. The mortgagee cannot be compelled to permit redemption of part of the mortgaged property. The reason behind the rule that a share or portion of the mortgage property cannot be redeemed is that mortgagee (creditor) values his security as one and e. If the mortgagor is permitted to redeem the property in fragments, then, “different proportions of value might be stuck in different suits
