On the heels of a recent D.C. Court of Appeals ruling, the Nevada Supreme Court issued an opinion yesterday holding that a homeowners association (HOA) lien is a true super-priority lien that, if foreclosed upon, extinguishes a first deed of trust. This ruling will affect how residential lenders underwrite and structure their loans going forward, and it will affect the long-term servicing of residential loans.

As noted in our March 19, 2013, e-alert, HOAs were foreclosing on liens for assessments, and third parties were buying homes at the resulting foreclosure sales. Although it was generally accepted that the HOA's foreclosure extinguished the homeowner's title and interest in the home, the question of whether such foreclosure also extinguished a first deed of trust was up in the air.

In SFR Investments Pool 1, LLC. v. U.S. Bank, N.A., the Nevada Supreme Court noted that the Nevada HOA lien statute is based on the Uniform Common Interest Ownership Act of 1982, and that the court could look to the drafters' comments and the laws of other states to explain the Act. The court ultimately reasoned that a portion of an HOA lien was superior to a first deed of trust, and it rejected the first deed holder's arguments that the HOA statute only provided a payment priority.

To support its analysis, the court found that notice of an HOA foreclosure sale must be given to junior lienholders, and to senior lienholders who ask for notice. The court reasoned that a junior lienholder can simply pay off an HOA lien or establish an escrow account to pay HOA dues. These two actions, if not provided for by the lender, result in an inequity of the lender's own doing when the lender loses its first deed of trust.

In addition, the court rejected the first deed holder's other arguments, including:

• That any super-priority HOA lien must be judicially foreclosed upon, as opposed to non-judicially foreclosed upon
• That non-judicial foreclosure of an HOA lien violates due process
• That a lender-savings clause in the HOA's conditions, covenants, and restrictions—which explicitly subordinates an HOA lien to that of a first deed of trust—is ineffective, given that the statute does not allow the HOA lien scheme to be varied

Although the opinion holds that a non-judicial foreclosure by an HOA generally extinguishes a first mortgage interest, it leaves several other issues unanswered. For example, it does not address whether an HOA foreclosure is invalid if a first deed holder attempts to pay off the underlying lien, but the HOA refuses either to provide the amount of the lien or to allow the lender to tender payment. This is a common occurrence in Nevada, with some HOAs arguing that they are either prohibited or not obligated to provide the amount of the lien. The opinion also declines to address whether an HOA foreclosure is invalid if the sale is not properly noticed by the HOA.

Finally, another unanswered question is whether an HOA foreclosure is void as commercially unreasonable if the sale price is unreasonably low. Houses sold as HOA foreclosures typically sell for a tiny fraction of the market value of the property—usually $5,000 to $10,000. If such a sale can extinguish a first deed of trust, the lender is left with an enormous unsecured debt and the homeowner is left with an enormous deficiency judgment to the lender.