Fairfax Savings, F.S.B. v. Kris Jen Ltd. Partnership

RODOWSKY, Judge. This case is an attempt to impose lender liability. Respondents are a limited partnership mortgagor and its general partner-loan guarantor. They sued the lender-petitioner after the mortgage had been foreclosed.

The Circuit Court for Harford County held that certain core allegations of the respondents’ complaint were precluded, under res judicata principles, by the judgment in the foreclosure action. The Court of Special Appeals reversed. Kris Jen Ltd. Partnership v. Fairfax Sav., F.S.B., 100 Md.App. 25 , 639 A.2d 206 (1994). We granted the lender’s petition for certiorari.

Our review of Maryland mortgage foreclosure law, in the light of contemporary claim and issue preclusion principles, supports the circuit court’s analysis. In January 1988 Kris Jen Limited Partnership (Kris Jen) borrowed $3,200,000 from Fairfax Savings, F.S.B. (Fairfax) in order to construct a development of eighteen luxury, single family townhouses in Bel Air. A loan agreement and a note evidenced the loan.

It was secured by a deed of trust on the Kris Jen property and by personal guaranties signed by John P. Seisman (Seisman), the general partner of Kris Jen, and by Seisman’s wife, Susan E. Seisman. .The loan was due January 22, 1989, but Kris Jen had the option of obtaining two extensions, each for a period of three months. Kris Jen avers that ⁵ as of December 1988 the loan had been extended for six months. On April 21, 1989, Fairfax notified Kris Jen that the loan was in default. The notice specified as events of default the maturity of the loan on January 22, 1989, Kris Jen’s failure to complete the project by that date, the filing of mechanic’s liens against the property, and Kris Jen’s failure to pay, as Fairfax had requested by letter of April 10, 1989, a refresher of $30,637.04 for the interest reserve account under the loan agreement and a refresher of $1,650,000 for the construction account under the loan agreement.

Fairfax instituted a foreclosure proceeding in the Circuit Court for Harford County on April 25, 1989. The property was sold on June 19, 1989, and the substituted trustees reported the sale to the court on June 22, 1989. An objection to ratification of the foreclosure sale was filed by Kris Jen on July 24, 1989. Thereafter, as reflected by docket entries from the mortgage foreclosure case filed as exhibits in the subject action, a considerable amount of discovery was undertaken.

In January 1990 Kris Jen advised the court that it had “no objection in [the foreclosure] proceedings” to ratification of the sale. Fairfax, however, opposed withdrawal of the objections and, alternatively, tendered a form of order of ratification that expressly would have adjudicated certain issues between Kris .Jen and Fairfax. The court permitted Kris Jen to withdraw its objections and ratified the sale on February 21, 1990, but without embellishing the order in the fashion urged by Fair-fax. The subject action, with a prayer for jury trial, had been instituted on January 31, 1990.

Prior to the entry of judgment in this action a final order of ratification of the auditor’s report was passed in the foreclosure action. A third action, brought by Fairfax on a confession of judgment given in connection with the construction loan guaranty, has been ⁶ stayed. 1 The circuit court decided the subject action at the stage of a second amended complaint to which Fairfax had filed a motion to dismiss. The second amended complaint by Kris Jen and Seisman (Plaintiffs) consists of ten counts, set forth in 110 paragraphs over thirty-one pages. Fundamentally, four groups of allegations are recycled through the complaint under the labels of various legal theories.

Our synthesis of the allegations in each group is presented below. At the inception of the project, Kris Jen offered prospective purchasers optional features in its townhouses. The form of contract between Kris Jen and a purchaser required the cost of the options to be paid by the purchaser before construction began, and the contract also referred to holding those payments for optional features in an escrow account “until settlement.” This contract was prepared by counsel for Kris Jen. As alleged in the complaint, Kris Jen intended to use these funds for construction, Fairfax knew that that was Kris Jen’s plan, and Fairfax expressly or impliedly approved use of those funds for construction.

The complaint further alleges that in July 1988 counsel for Fairfax insisted that the option feature payments be held in escrow with Fairfax until settlement. Compliance with this request created a shortfall in Kris Jen’s cash flow. We shall call this group of allegations the “options escrow” allegations. The options escrow allegations are the core of Counts VI and VII of the complaint, respectively alleging fraud and negligent misrepresentation as to both Plaintiffs, but options escrow allegations also appear throughout the complaint.

The complaint avers that Fairfax repeatedly delayed the payment of requisitions for construction loan draws and that ⁷ Fairfax improperly reduced the requisitions submitted. This is said to have caused Kris Jen’s initial construction manager/carpenter to terminate its contract and to have caused the successor carpentry subcontractor to request security for Kris Jen’s unpaid obligations, all of which delayed progress of the work. We shall call this group of allegations the “default inducing” allegations. They are the core of Count V of the complaint, claiming tortious interference with the contracts between Kris Jen and its purchasers, but default inducing allegations also appear in Counts I, II, and III, which are more particularly described, infra.

Plaintiffs further allege that, in December 1988, Fairfax agreed to modify the loan agreement. A principal feature of the modification extended the date for completion of construction and for maturity of the loan to July 1989. During the extension Fairfax was to receive all net proceeds from the sales of townhouses, “pay all outstanding invoices of subcontractors and materialmen so as to bring them current,” and “pay all future invoices received from subcontractors, materialmen and others directly and without hold-back.” It is averred that when the construction loan account was exhausted, Fairfax was to extend additional credit to Kris Jen, presumably until completion of the project. We shall call this group of allegations the “workout agreement” allegations.

They are the core of Count VIII of the complaint, in which Plaintiffs allege breach of the workout agreement with them. Workout agreement allegations are also integral to the first four counts. Count I avers breach of a duty to Kris Jen imposed by law on Fairfax and labels that duty “fiduciary.” Count II avers breach of a duty to Seisman imposed by law and labels it a duty of good faith and fair dealing. Count III avers breach of a duty to Plaintiffs implied in thé workout agreement that required Fairfax to act in good faith.

Count IV avers negligent performance by Fairfax of the workout agreement, to Plaintiffs’ damage. The remaining group of allegations deals with Fairfax’s conduct after entering into the alleged workout agreement. Plaintiffs aver that Fairfax, after having promised directly to ⁸ pay subcontractors and suppliers, not only failed to do so but denied to those persons that Fairfax had undertaken to do so. We shall call this group of allegations the “agreement denial” allegations.

Inasmuch as Seisman had told subcontractors and suppliers that Fairfax would pay them directly, Count IX of the complaint undertakes to use the agreement denial allegations to state a claim sounding in defamation on behalf of Seisman. The agreement denial allegations also appear in Counts I through IV. 2 The motion filed by Fairfax to dismiss the second amended complaint raised a number of defenses in addition to claim and issue preclusion. Fairfax also attached to its supporting memorandum documents and court papers that were not part of the complaint. In their response to the Fairfax motion, Plaintiffs attached additional documents and court papers that they had not incorporated into their complaint.

In a written opinion deciding the motion, the circuit court focused on the res judicata defense. The court identified five types of allegations that Plaintiffs were not permitted to aver in the complaint. The heart of the circuit court’s rationale is set forth below. “It is undisputed here that the foreclosure sale ... was ratified by the Court and that the auditor’s report of that sale was ratified by the Court. It is our conclusion that at a minimum Kris Jen and Seisman are not permitted in this action to assert [1] that there was no default in the loan from Fairfax to Kris Jen.

They are not permitted to assert in this action [2] that the default was induced or coerced by Fairfax or [3] that the foreclosure sale was illegal or fraudulent. Further, they are not permitted in this action to assert [4] that the price obtained at the foreclosure proceeding was inadequate. Further, they are not permitted to ⁹ assert [5] that Kris Jen and Seisman suffered damages as a result of the loss of the property by way of the foreclosure. “We conclude that the fact that there was a default, that Fairfax was entitled to act on the default, that the foreclosure sale was an appropriate response to the default, that the price obtained was appropriate under the circumstances of the sale, and that Kris Jen and Seisman have lost any right to redeem the property as a result of the foreclosure have all been adjudicated as a result of the ratification of the foreclosure sale and the ratification of the auditor’s report. Those determinations cannot now be attacked by the plaintiffs in this proceeding.” The circuit court gave Plaintiffs leave further to amend their complaint and, thus, the opportunity to state a legally cognizable claim without relying on the matters that were precluded by judgment in the foreclosure action. 3 Plaintiffs advised the court that they would not amend, and the court entered judgment in favor of Fairfax.

I Maryland Rule 2-322(c) in part provides: “If, on a motion to dismiss for failure of the pleading to state a claim upon which relief can be granted, matters outside the pleading are presented to and not excluded by the court, the motion shall be treated as one for summary judgment and disposed of as provided in Rule 2-501, and all parties shall be given reasonable opportunity to present all material made pertinent to such a motion by Rule 2-501.” Here Plaintiffs’ complaint alleged the advertising and sale at ■foreclosure of the deed of trust property, but the complaint does not aver what transpired thereafter. Exhibits to the parties’ legal memoranda presented the exceptions to ratification of sale filed by the Plaintiffs, the withdrawal of those ¹⁰ objections, the opposition of Fairfax to that withdrawal, and, more important, the ratification of the'sale and the ratification of the auditor’s report. Thus, although the order of the circuit court ruling on Fairfax’s motion gives leave to Plaintiffs to amend, the legal effect of the ruling was to grant a partial summary judgment. In the two paragraphs quoted above that are the heart of the circuit court’s opinion, the court first presents its preclusion ruling negatively, stating the facts that Plaintiffs will not be permitted to aver or prove.

The second paragraph states the consequence of the preclusion ruling affirmatively. In so doing the circuit court in effect applied Md.Rule 2 — 501(f), which reads: “When a ruling upon a motion for summary judgment does not dispose of the entire action ... the court, on the basis of the pleadings ..., may enter an order specifying the issues or facts that are not in genuine dispute. The order controls the subsequent course of the action but may be modified by the court to prevent manifest injustice.” Here the issues or facts that the circuit court determined were not in dispute, by virtue of its preclusion ruling, were that (1) there was a default, (2) on which Fairfax was entitled to act, and (3) did so appropriately by foreclosure sale, (4) at an appropriate price, with the result (5) that Plaintiffs lost any right to redeem the property. Given the choice either of pleading around facts that they would not be permitted to contradict or of suffering judgment and appealing, Plaintiffs chose the latter.

II On their appeal to the Court of Special Appeals, and in this Court, Plaintiffs submit that Rowland v. Harrison, 320 Md. 223 , 577 A.2d 51 (1990), controls the decision. In Rowland this Court adopted the position taken by Restatement (Second) of Judgments § 22 (1982). 320 Md. at 235 , 577 A.2d at 57 . Section 22 reads: ¹¹ “(1) Where the defendant may interpose a claim as a counterclaim but he fails to do so, he is not thereby precluded from subsequently maintaining an action on that claim, except as stated in Subsection (2).. “(2) A defendant who may interpose a claim as a counterclaim in an action but fails to do so is precluded, after the rendition of judgment in that action, from maintaining an action on the claim if: “(a) The counterclaim is required to be interposed by a compulsory counterclaim statute or rule of court, or “(b) The relationship between the counterclaim and the plaintiffs claim is such that successful prosecution of the second action would nullify the initial judgment or would impair rights established in the initial action.” Rowland involved an action in the District Court of Maryland by a veterinarian against a horse owner to collect for services rendered in boarding and treating the owner’s horse. The owner, by a prayer for jury trial, removed the contract claim to the circuit court where the owner counterclaimed, asserting malpractice in the care and treatment of the horse.

When the claim and counterclaim came on for trial, the owner was not prepared to try the malpractice case, and the court would neither postpone the case nor sever the counterclaim. Before the owner put on any evidence the court permitted the owner voluntarily to dismiss the counterclaim without prejudice. The veterinarian then obtained judgment on the contract claim. In a later, separate malpractice action by the owner, the circuit court granted summary judgment, based on res judicata, to the veterinarian.

In Rowland this Court reversed, holding that a judgment for the owner in the malpractice action “would [not] nullify the initial judgment[, n]or would [it] impair rights established in the initial action.” Restatement § 22(2)(b). Plaintiffs correctly point out that Md.Rule 2-331(a) is a permissive counterclaim rule, 4 and that Maryland has no eom ¹² pulsory counterclaim rule comparable to Fed.R.Civ.P. Rule 13(a). 5 In the Court of Special Appeals Plaintiffs conceded “that there was a default under the original loan documents at issue in the foreclosure action, and that based on the terms of these loan documents, forfeiture was proper.” Brief of Appellant at 28 (emphasis added). Similarly in the Court of Special Appeals, Plaintiffs did “not challenge the purchase price obtained for the [deed of trust] property, or the propriety of the procedures employed to sell this property.” Id. Thus, Plaintiffs say that they do not seek to “nullify” the foreclosure judgment, with the result that the subject action may be maintained.

The Court of Special Appeals viewed Plaintiffs’ argument largely from the standpoint of its impact on that court’s decision in Klein v. Whitehead, 40 Md.App. 1 , 389 A.2d 374 (1978). There, after a foreclosure had gone to judgment, the trustee in bankruptcy of a borrower sued the lender alleging that the lender had defrauded the borrower and violated fiduciary duties, on the theory that lender and borrower were partners. The principal reason given by the Court of Special Appeals for holding that the suit was barred was that it was a collateral attack on the foreclosure judgment. Under this “collateral attack” rule, as then applied by the Court of Special Appeals, ¹³ “a party against whom judgment has been recovered [cannot] sustain an action against his adversary ... for damages occasioned by ... procuring a judgment by fraud, as long as the judgment remains in force unreversed, because the charges made in the second action are conclusively negatived by the former adjudication.” Id. at 22 , 389 A.2d at 386 (attribution and interior quotation marks omitted).

In its Kris Jen opinion, the Court of Special Appeals concluded that the above-quoted prohibition had been limited by Rowland. Kris Jen, 100 Md.App. at 36 , 639 A.2d at 211 . The court quoted the “relevant part” of comment f to § 22 reading as follows: “ ‘Normally, in the absence of a compulsory counterclaim statute or rule of court, the defendant has a choice as to whether or not he will pursue his counterclaim in the action brought against him by the plaintiff. There are occasions, however, when allowance of a subsequent action would so plainly operate to undermine the initial judgment that the principle of finality requires preclusion of such an action.

This need is recognized in Subsection (2)(b). “For such an occasion to arise, it is not sufficient that the counterclaim grow out of the same transaction or occurrence as the plaintiffs claim, nor is it sufficient that the facts constituting a defense also form the basis of the counterclaim. The counterclaim must be such that its successful prosecution in a subsequent action would nullify the judgment, for example, by allowing the defendant to enjoin enforcement of the judgment, or to recover on a restitution theory the amount paid pursuant to the judgment ..., or by depriving the plaintiff in the first action of property rights vested in him under the first judgment... (Emphasis added).” 100 Md.App. at 35-36 , 639 A.2d at 211 . Then, applying the “nullify” the judgment test, the Court of Special Appeals concluded, with respect to the Plaintiffs’ complaint, the following: ¹⁴ “[Plaintiffs] are not seeking to overturn the foreclosure or to escape from its effect, nor are they making any claim to the property itself.

Any recovery sought for an alleged unreasonableness in the sale price or for damages accruing from the loss of the property occasioned by the foreclosure would be barred ... for that would undermine the existing judgment, but compensatory damages for breach of duty, negligence, fraud, misrepresentation, or defamation (or, to the extent they otherwise may be allowed, punitive damages for those alleged transgressions) would not have that effect, and so are not barred by res judicata.” Id. at 41 , 639 A.2d at 213 . The holding by the Court of Special Appeals that recovery was precluded for unreasonableness in the foreclosure sale price is identical with one of the conclusions of the circuit court. The Court of Special Appeals also held that recovery was barred “for damages accruing from the loss of the property occasioned by the foreclosure.” Id. This holding is broader than the comparable, affirmative holding by the circuit court (foreclosure decree adjudicated Kris Jen’s loss of right to redeem), but this holding by the intermediate appellate court is consistent with the negative holding by the circuit court (Plaintiffs precluded from asserting that they “suffered damages as a result of the loss of the property by way of the foreclosure.”).

Plaintiffs have not sought certiorari review of these holdings by the Court of Special Appeals. Thus, the only issue before this Court is whether the circuit court erred in holding that, as a result of claim or issue preclusion, Plaintiffs may not controvert that there was a loan default on which Fairfax acted appropriately by foreclosure sale. Phrased another way, the circuit court did not hold that Plaintiffs were barred from seeking damages for “breach of duty, negligence, fraud, misrepresentation, or defamation.... ” Id. The circuit court merely held that in seeking damages for those alleged wrongs, Plaintiffs could not aver or prove that there was no default justifying foreclosure. ¹⁵ Ill Despite the relatively narrow holding by the circuit court, the Court of Special Appeals and the parties in their arguments to us have devoted principal attention to whether all of the claims in Plaintiffs’ complaint are barred under the rule in § 22.

In addition, Plaintiffs note that “the foreclosure case initiated by Fairfax is an ex parte, in rem proceeding.” Brief of Appellee at 12. This raises the threshold question of whether the preclusion issue in the instant matter is correctly analyzed under the law relating to in rem judgments, including those rendered in quasi in rem proceedings, or under the law relating to in personam judgments. The foreclosure sale in the matter before us was conducted pursuant to a power of sale in the deed of trust under the summary procedure authorized by Md.Code (1974, 1988 Repl.Vol.), § 7-105(a) of the Real Property Article. 6 The conditions precedent to commencing an action to foreclose a mortgage are that “(1) [t]he mortgage has been filed to be recorded, and (2) [tjhere has been a default in a condition upon which the mortgage provides that a sale may be made.” Md.Rule W72.a. In these summary proceedings “it shall not be necessary ... that process issue or be served upon the opposite party, or that the opposite party file an answer, or that a hearing be held.” Rule W72.e.

Prior to sale of the mortgaged property, the person authorized to make' the sale gives notice by publication in a newspaper and by certified mail to certain persons, including the mortgagor. Rule W74.a.2(b) and (c). ¹⁶ Following the sale at foreclosure, the person making the sale reports it to the court. Rules W74.e and BR6.a. Notice by publication is then given “stating that the sale will be ratified thirty days from the date of the notice unless cause to the contrary be shown.” Rule BR6.b.2.

If “exceptions are not filed to the report of sale, or if exceptions are filed but overruled,” a final order of ratification of the sale is passed by the court. Rule BR6.b.4. Upon final ratification of a report of sale in a mortgage foreclosure, it is mandatory that “the papers in the proceeding ... be referred to [an] auditor to state an account,” directing the distribution of the proceeds of sale. Rules BR6.b.5 and W74.e.

A party or claimant may file exceptions to an auditor’s account or report and obtain a decision by the court. Rule 2-543(g) and (h). . “If, after a sale of the whole mortgaged property, the net' proceeds of sale ... are insufficient to pay the mortgage debt and accrued interest, as found by the court upon the report of the auditor, a motion for a deficiency decree may be made.” Rule W75.b.l. Notice that a deficiency judgment is sought is to be given “by summons or otherwise, as the court may direct.” Rule W75.b.4. A deficiency judgment is an in personam judgment.

Id. Restatement (Second) Chapter 3 deals with “Former Adjudication: The Effects of a Judicial Judgment.” Chapter 3 is divided into topics. Topic two deals with “Personal Judgments” while topic three deals with “Judgments Based on Jurisdiction over Things or over Status.” Section 22 is part of the “Personal Judgments” topic. Restatement (Second) § 30 comment a treats a judgment in an action to foreclose a mortgage as a judgment based on jurisdiction to determine interests in “things.” Thus, it is possible for a mortgage foreclosure proceeding in Maryland in which no deficiency decree is sought to be purely in rem. .

It is also possible, if the mortgagor voluntarily appears, for the proceeding to include judgments ¹⁷ in the form of rulings on exceptions to the sale and to the auditor’s report, respectively, that have in personam collateral estoppel effect. In the instant matter, Kris Jen personally appeared in the foreclosure action and filed exceptions to the report of sale. Those exceptions, however, were never adjudicated, so that we are not concerned in this case with collateral estoppel or issue preclusion against the Plaintiffs, but with res judicata. Consequently, any preclusive effect that the order of ratification in this matter may have, greater than the preclusive effect that a foreclosure judgment would have if entered without any exceptions having been filed, is necessarily dependent on Plaintiffs’ voluntary appearance in the foreclosure proceeding.

In Part IV, infra, we consider whether the foreclosure decree in the instant matter, viewed as an in rem judgment exclusively, precludes litigation of the mortgage default issue. Plaintiffs injected the in rem nature of Maryland mortgage foreclosure into this case by arguing that an alternative reason why their complaint is not precluded is because their claims procedurally could not have been asserted in the mortgage foreclosure proceeding. We consider a^l reject that argument in Part V, infra. Finally, because we hold in Part V that Kris Jen had the opportunity to assert the no default defense in the mortgage foreclosure action, the res judicata effect of the ratification of the sale on the Plaintiffs’ claims should be analyzed under the rules in § 22.

We present that analysis in Parts VI and VII. IV Bainder v. Sound Bldg. & Loan Ass’n, 161 Md. 597 , 158 A. 2 (1932), illustrates the in rem effect of foreclosure sale ratification under facts that are somewhat analogous to those in the instant matter. Bainder and his co-mortgagor, Levey, after having executed a mortgage in June 1923, conveyed the mortgaged property in August of that year. Thereafter, the ¹⁸ new owner paid the mortgage.

In 1926 Levey died, and the mortgagee made no claim against Levey’s estate. In 1931 the lender foreclosed, no exceptions were taken to the report of sale, and the sale was ratified. Bainder thereafter unsuccessfully excepted to the auditor’s report, and he appealed from its ratification. This Court assumed that Bainder’s exceptions and his proffer of proof were directed to showing that the mortgagee had released the mortgage debt against Levey’s estate, and, further, that the legal effect of that release was to discharge Bainder from further liability on the mortgage.

On those assumptions, this Court nevertheless held as follows: “[I]n such a proceeding as this, which is against the mortgaged property alone, such an objection could only be made by the mortgagors ... in a direct attack on the right of the mortgagee to foreclose the mortgage, and not collaterally in a proceeding relating exclusively to the distribution of the proceeds of a foreclosure sale, since the right of the mortgagee to subject the mortgaged property to the payment of the mortgage debt was conclusively fixed by the final ratification of the mortgage sale (Albert v. Hamilton, 76 Md. 304 , 25 A. 341 [ (1892) ]), for there can be no real doubt that, if Bainder as mortgagor personally was liable for any deficiency, he would have been interested in having the property sold for enough to discharge his liability, and he would have been entitled to protect that interest by objecting to the ratification of a' sale unfairly or improperly made.... And since he could have excepted to the ratification of the foreclosure sale, but failed to do so, he is bound by it as completely as if he had objected to it. The effect of that decree was to establish the mortgage debt as a valid and subsisting debt enforceable against the mortgaged property, but not to establish the personal liability of Bainder for the payment of that debt. That question cannot arise unless and until the mortgagee, by a petition or motion for a decree in personam or other appropriate proceeding attempts to establish that liability, and while the fact, if it is a fact, that the mortgagee discharged Bainder from any per ¹⁹ sonal liability for the debt would be relevant in such a proceeding, it is not relevant in a proceeding to distribute the proceeds of a sale of the mortgaged property after the sale has been finally ratified.

For the mortgage debt and the personal liability of the mortgagors for the payment of that debt are different things ... not relevant except in a proceeding to enforce that liability.” Id. at 603-04, 158 A. at 5 (emphasis added; citations omitted). 7 Bainder would be more analogous to the instant matter if Bainder had contended that the exculpation of the mortgagors from personal liability was part of a release of the property from the lien of the mortgage. That would have presented a direct conflict between ratification of the sale, with its implicit determination that the property was subject to the mortgage, and a defense, raised against a deficiency but not asserted by exceptions to the report of sale, that the mortgage debt and ²⁰ lien were released. Nevertheless, under the rule adopted by the original Restatement of Judgments concerning judgments in rem, the defense to the deficiency claim in our hypothetical would not be precluded. Restatement of Judgments § 73 (1942), “Proceedings with Respect to Property,” states the following: “(1) In a proceeding in rem with respect to a thing the judgment is conclusive upon all persons as to interests in the thing. “(2) A judgment in such a proceeding will not bind anyone personally unless the court has jurisdiction over him, and it is not conclusive as to a fact upon which the judgment is based except between persons who have actually litigated the question of the existence of the fact.” The comparable section in