The Florida Bar

Florida Bar Journal

Disbursement of Surplus Proceeds from a Foreclosure Sale & The Urban Myth of the Race to the Courthouse

Real Property, Probate and Trust Law

An urban legend is usually a (good/captivating/titillating/engrossing/incredible/ worrying) story that has had a wide audience, is circulated spontaneously, has been told in several forms, and which many have chosen to believe (whether actively or passively) despite the lack of actual evidence to substantiate the story.1

They’re unlikely, bizarre, creepy, or funny stories, often involving some kind of corporate. . . or personal. . . conspiracy, payback, hoax, or intrigue.2

Examples of urban legends include:

• A borrower wipes out her debt by mailing in the last coupon in the payment book with her first payment.3

• “Enterprising crook scams money by leaving blank deposit slips imprinted with his account number in the bank.”4

• A debtor discharges his debt by sending the creditor a check for a fraction of the debt with the words “paid in full” written on the face of the check.5

These urban legends, also known as urban myths, are amusing because, despite being unlikely or bizarre, they are almost believable; and we can all imagine someone having the audacity to try to pull off one of these swindles. Also, in the particular examples cited above, it is not only conceivable that they would work, but the underlying “theory” of each scam seems viable. For example, by depositing the check for a fraction of the debt, isn’t the creditor accepting the partial payment as a full satisfaction?

Unfortunately, in our practice, we have repeatedly encountered another myth that has in fact “worked”—not only at first blush, but even through to final judgment—until reversed on appeal. As explained below, the result is bizarre; still, many have had the audacity to pull it off:

A debtor’s lawyer convinces the trial judge to disburse the surplus from a foreclosure sale to the debtor or the lawyer, despite the fact that outstanding claims of superior creditors remain unsatisfied.

The scenario works like this: A borrower defaults on a mortgage loan. The mortgagee files a foreclosure against the real property securing the loan and names inferior lienholders as defendants. Upon the completion of the foreclosure, the clerk of the court sells the property to satisfy the mortgagee’s judgment. The sale nets more money than the amount owed to the first mortgagee. This excess is called a “surplus.”

It has long been the law in Florida that any surplus remaining after a foreclosure sale should be paid to the junior lienholders in accordance with the priority of their liens on the property and that only after the liens have been satisfied may any surplus be disbursed to the owner of the equity of redemption.6

This rule seems elementary. Any surplus generated by the sale should be used to satisfy the debts owed to the junior secured creditors; and only if additional proceeds remain after these distributions should the borrower receive any share in the sale proceeds. However, mistaken, overzealous, and sometimes dishonest debtors’ lawyers frequently convince courts to distribute surplus proceeds to the mortgagors, leaving the junior secured creditors with no security and no means of enforcing their claims. Likewise, lawyers representing junior creditors will often improperly seek disbursement to their clients regardless of their lack of priority.

Like the myths mentioned above, the mistake is obvious, but only after some thought. Nonetheless, trial judges are frequently misled into ordering disbursement to junior interest holders, including junior creditors, debtors, or lawyers. This error would clearly be (and has consistently been) reversed upon appeal. However the reversals come at great expense to the parties and to the judicial system. More significantly, these wrongful distributions often go unchallenged because creditors know that any appellate victory will be pyrrhic. the time the order is reversed, the proceeds (and the security) are usually long-gone. This article aims to educate lawyers and judges alike regarding the correct priorities, rules, and procedures for distribution of foreclosure sale surplus when junior secured creditors and mortgagors compete for the funds.

Urban Myths That Lead to Wrongful Distributions
To understand how to avoid these wrongful distributions, we should explain how they occur in the first place.

a) The default myth and its variations.

When a borrower goes into default, the first mortgagee will often file a foreclosure complaint naming the mortgagor and all junior lienholders as defendants. Knowing that they have no defense against the senior lienholder’s claim to priority, junior lienholders sometimes ignore the complaint or fail to respond to subsequent pleadings. Lawyers and judges mistakenly view this failure to respond not only as implicitly conceding to the first mortgagor’s seniority but also as a default respect to the junior creditor’s own claim to the security and any surplus. This misunderstanding is neither consistent with the rules of civil procedure nor with substantive foreclosure law.

If a party defaults in an ordinary civil case, the failure to respond is deemed an admission of the allegations of the complaint. Fla. R. Civ. P. 1.500; Wiseman v. Stocks, 527 So. 2d 904 (Fla. 1st DCA 1988). In the foreclosure context, when a junior creditor fails to respond to a senior creditor’s complaint, all this means is that the junior creditor is admitting that the senior creditor’s claim is, in fact, senior to its own. It does not constitute an admission that the junior creditor has no claim to the property because the senior creditor would have no need to make such an allegation. In fact, the reason the junior creditor was named was because it does have a claim to the property, albeit inferior to that of the foreclosing party.

In Schroth v. The Cape Coral Bank, 377 So. 2d 50 (Fla. 2d DCA 1979), the property owners failed to respond to the first mortgagee’s foreclosure complaint. The foreclosure sale proceeds exceeded the amount of the first mortgagor’s claim. The Schroths then appeared and sought to establish priority of their interest. The trial court held that they had waived their priority by failing to file an answer to the complaint. The Second District Court of Appeal reversed. It held that the court should have “conduct[ed] an evidentiary hearing to determine the rights to the excess proceeds of all claimants who were defendants in the foreclosure suit, irrespective of whether they filed responsive pleadings.”7

In D.A.D., Inc. v. Poole, 407 So. 2d 1072 (4th DCA 1981), the senior mortgagee foreclosed its mortgage. In addition to the mortgagor, it named as defendants, D.A.D., Inc., a junior mortgagee and four judgment creditors. D.A.D., Inc., had failed to file a cross claim of foreclosure, and the trial court therefore ruled that the judgment creditors had priority in the surplus from the foreclosure sale. Apparently, the trial court applied a theory that by failing to foreclose its junior mortgage, D.A.D., Inc., had waived its right to the surplus.

The Fourth DCA explained that the Florida Rules of Civil Procedure superseded prior case law by allowing a junior mortgagee to file a cross claim of foreclosure. Historically, under Florida case law, a junior creditor was not permitted to file a cross claim in response to the complaint of a senior creditor.8 The only remedy for the junior creditor was to wait for the foreclosure sale and have the trial court adjudicate its rights in any surplus.9 That apparently, was what D.A.D., Inc., did.

As the court explained, the Florida Rules of Civil Procedure superseded the prior case law:

Currently, Florida Rule of Civil Procedure 1.170(g) states:

“A pleading may state as a crossclaim any claim by one party against a co-party arising out of the transaction or occurrence that is the subject matter of either the original action or of a counterclaim therein or relating to any property that is the subject matter of the original action. . . . ”10 (emphasis added)

The court agreed with the creditor that this rule is permissive in nature; it does not create a new requirement that the junior creditor file a pleading to secure its claim to the surplus.11 Thus, the court of appeals affirmed the mortgagee’s priority over that of the judgment creditors, notwithstanding the mortgagee’s failure to file a cross claim foreclosing its mortgage. Still, in most cases, it will be wise for the junior creditor to file a cross claim of foreclosure to enforce its own mortgage or other security interest, or, at least, file an answer to the complaint.12

The D.A.D. court expressed doubt that it would go as far as the Second District Court went in Schroth.13 The D.A.D. court would apparently require some appearance by the junior creditor prior to moving for distribution of surplus. The court did not explain why it might require an earlier appearance. An explanation for its reservations would be in order not only because of the case law suggesting otherwise, but also because of the mechanics of a foreclosure. As one early case stated,

It seems to be the practice, on a bill to foreclose, to make all incumbrancers parties. And upon passing a decree of foreclosure, to ascertain and settle the rights of all parties, decree the payment of the mortgaged debt, and on default a sale of the premises, and the application of the proceeds in satisfaction of each incumbrance, according to priority, and a payment of any surplus to the mortgagor. This too whether junior mortgagees shall or shall not file cross-bills. The sale is as effectual, if made under the foreclosure of the first mortgage, to cut off all subsequent mortgages, as if upon a foreclosure of all the incumbrances. Where the sale is made under the foreclosure of one of several mortgages, the only question is as to the equitable distribution of the proceeds. And the surplus might be disposed of on application, to an incumbrancer not made a party to the suit, if it appeared that, in equity, he was entitled to receive the fund. If the defendants failed to file a cross-bill, they should establish their claims on the trial, or before the master on a reference.14

In other words, a default with respect to the first mortgagee’s complaint does not result in default, forfeiture, or waiver of the junior security interest in the underlying property.15 That said, it is usually recommended that a junior creditor respond to the complaint.16

Similarly, a failure of the junior creditor to participate in subsequent proceedings does not result in a waiver of its rights to the surplus. In Citibank, FSB v. PNC Mortgage Corp. of America, 718 So. 2d 300 (Fla. 2d DCA 1998), Citibank, a junior mortgagee, failed to attend a hearing at which the court disbursed surplus funds. The court divided the surplus among the remaining mortgagees, some of whom held interests junior to that of Citibank. The trial court denied Citibank’s motion for a rehearing on the disbursement of the surplus. On appeal the Second D.C.A. reversed. It held, “A claim is not lost by the mere failure to attend a disbursement hearing. Inferior junior lienholders have no equitable claim to the surplus proceeds until superior junior lienholders have had their claims satisfied.”17

The court explained, “After a foreclosure sale, the trial court is required to prioritize the interests of the competing junior lienholders and the amounts due each.”18 This obligation falls on the trial court regardless of whether the junior lienholders appear.

b) The delay myth.

A related argument that courts have rejected is based on a mortgagor’s delay in moving for the surplus. In U.S. v. Sneed, 620 So. 2d 1093 (Fla. 1st DCA 1993), the United States was the holder of several junior mortgages all of which were foreclosed by the first mortgagee. The United States purchased the property at the foreclosure sale, paying nearly $40,000 more than was owed under the first mortgage, and later resold the property.

Nine years passed while the surplus proceeds sat unclaimed in the court registry. Finally, the mortgagors moved for the surplus. The United States offered no excuse for the delay, admitted its neglect, but opposed the motion, claiming that it was entitled to the surplus. The trial court awarded the surplus to the mortgagors. The court of appeals reversed. It held, “The failure to schedule a hearing on the disbursement of such proceeds, while neglectful and even dilatory, has not divested the United States of its right.”19 The court explained, “The rights of the United States arose at the time of the foreclosure and have not been extinguished. Mrs. Sneed has no equitable claim to the surplus because the junior lienholder’s claim has not been satisfied.”20

c) The equitable exception myth.

Another argument that mortgagors tend to mistakenly put forward in an attempt to obtain the surplus is the equitable exception. Citing the equitable exception, mortgagors will argue that they, and not the mortgagee, should receive the surplus based upon equitable considerations. This argument, alluded to in the Sneed opinion, above, is based on the fact that a foreclosure is an action in equity.21

[A] court of equity sitting to distribute an excess brought into the custody of the court, such as proceeds from a foreclosure sale, has full and complete jurisdiction to determine all justiciable rights made necessary to be determined, in order to fix the priorities of claimants. . . . ”22

This characterization of foreclosure proceedings is accurate. There are limits, however, to the courts’ discretion in applying it.

In General Bank, F.S.B. v. Westbrooke Point Inc., 548 So. 2d 736 (Fla. 3d DCA 1989), a second mortgagee foreclosed against the mortgagor and the third mortgagee. The third mortgagee bought the property at the foreclosure sale subject to a first mortgage. The sale generated a surplus. After the second mortgagor was paid, both the third mortgagee and the mortgagor moved for distribution of the surplus. The trial court awarded the money to the mortgagor and the third mortgagee appealed.

The mortgagor argued that the distribution was correct based upon equitable principles. The court of appeals found it unnecessary to even specify the equitable principles cited. It ruled in favor of the third mortgagee:

The equitable exception was articulated by the Supreme Court of Florida in Tucker v. Crown Corp., 136 Fla. 517, 527, 183 So. 740, 745 (1938): “In determining who is entitled to surplus proceeds arising in a foreclosure sale, it is the general rule that all incumbrances on mortgaged premises inferior to the mortgage on which sale is based, must be paid in order of time in which they respectively become liens, except as some equitable right demands a different order of payment.”

See also Waybright v. Turner, 129 Fla. 310, 176 So. 424 (1937). In plain language Tucker holds that the equitable exception applies to competing “encumbrances.” Westbrooke, as the mortgagor, clearly is not a lienholder; its equity interest does not “encumber” the property.23

d) The myth that the security was extinguished by foreclosure.

One of the features of a foreclosure is that it forecloses or extinguishes all junior interests in the property. This enables the purchaser to take a property with good title. An argument that is often misapplied to the detriment of junior lienholders is that because their interests were extinguished by the foreclosure, they have no claim to the proceeds. This argument is raised in many contexts, including litigation over surplus proceeds from a foreclosure sale.

In a New York case, Adirondack Trust Co. v. Snyder, 136 Misc. 2d 159, 518 N.Y.S.2d 337, the mortgagor observed that foreclosure extinguishes all liens on the security. She argued that once the property was sold, the proceeds became the personal property of the holder of the right of redemption, which, not coincidentally, happened to be her. The court rejected this argument, stating:

It has been established that surplus money resulting from the foreclosure of real property held by mortgagors as tenants by the entirety is considered personal property. However, it is equally established that such surplus money is not “a general asset of the owner of the equity of redemption but stands in place of the land for all purposes of distribution among persons having vested interests or liens upon the land.” A lien existing against the real property at the time of the sale is transferred to the surplus money.24

Florida law likewise recognizes that liens on the property are transferred to the proceeds of the foreclosure sale: “Surplus money arising from a sale of land under a decree of foreclosure stands in the place of the land itself in respect to liens thereon or vested rights therein.”25

Distribution of Surplus Follows Prescribed Procedures
It is clear, then, that mortgagees or other lienors will have priority over defaulting mortgagors when it comes to distribution of the surplus. While statistics are unavailable, anecdotal evidence and our own experience indicates that mistakes in distributions occur far too frequently. The mortgagees themselves should take steps to protect their interests. Furthermore, the law imposes certain obligations upon judges to ensure proper distributions of surpluses.

a) Mortgagees should protect themselves.

The court in D.A.D., 407 So. 2d 1072,26 discussed above, indicated that pursuant to Fla. R. Civ. P. 1.170(g), junior lienholders may now file cross claims in the foreclosure action. Indeed, this is usually a wise course of action. It notifies the court and the other parties that the lienholder intends to enforce its interest against the property or the proceeds of the sale.

Practically speaking, many junior lienholders forego filing a cross claim, and instead file a simpler answer and petition to participate in distribution of surplus. Whether or not the junior lienholder files a cross claim or answer during the foreclosure, the junior lienholders should also file a motion for disbursement of surplus (with accompanying affidavits or other evidence) as soon after the foreclosure sale as possible.27 Again, such a motion alerts the judge to the party’s interest and puts others on notice of the lienor’s intent to enforce that interest.

b) Judges are obligated to ensure proper distributions.

As noted above, the court too bears responsibility for ensuring the proper distribution of the surplus proceeds. The court is obligated to determine the relative priorities of the interested parties. As numerous courts have held, the favored method of making this determination is by conducting an evidentiary hearing.28 Moreover, a party’s failure to participate in the disbursement hearing does not relieve the court of its duty to independently evaluate the priorities and to distribute the proceeds accordingly.

This case that best illustrates this point is Citibank, FSB v. PNC Mortgage Corp. of America, 718 So. 2d 300 (Fla. 2d DCA 1998). Citibank, a junior lienholder, had asserted, prior to the foreclosure, its interest in any surplus proceeds that would be generated by the sale.29 After the sale, the court held an evidentiary hearing to determine the respective priorities of the remaining lienholders.30 Citibank had received notice of the hearing. But, for some reason, did not attend. The court distributed the surplus to other more junior lienholders. Citibank moved for a rehearing. The trial court denied the motion and Citibank appealed. The Second District Court of Appeal reversed, holding:

[Citibank is] entitled to relief because the trial court erred by failing to entertain Citibank’s claim on rehearing and by disbursing the surplus funds without first determining the priorities and amounts due to the remaining junior lienholders. After a foreclosure sale, the trial court is required to prioritize the interests of the competing junior lienholders and the amounts due each. The rights of Citibank arose at the time of foreclosure. A claim is not lost by the mere failure to attend a disbursement hearing. Id. Inferior junior lienholders have no equitable claim to the surplus proceeds until superior junior lienholders have had their claims satisfied. Here, the orders disbursing the surplus funds failed to determine the legal priorities of the junior lienholders. This was error.31

Thus, despite Citibank’s unexcused failure to attend the hearing, the court erred by failing to evaluate the interests of all parties, even those not presently asserting their interests.

The Third-party Purchaser Myth
A related situation arises when someone other than the mortgagor or mortgagee purchases the property at foreclosure sale. Foreclosure does not necessarily extinguish all debts attached to the property. For example, property taxes, some code enforcement fines, and certain other debts will usually not be foreclosable. When someone purchases the property at the foreclosure sale, unless the court has ordered some other payment of outstanding property taxes, the buyer will usually be required to pay. Thus, the buyer takes title subject to the tax lien or fine.

In several cases the third-party purchaser has moved for a share of the surplus as compensation for payment of these taxes or other debts. The law, however, provides that only lienors or the holder or the right of redemption (usually the mortgagor) are entitled to the surplus. Any other distribution of surplus is unlawful.

It appears to be settled beyond all question that one claiming a surplus or the right to share in a surplus resulting from a sale under foreclosure must either own the equity of redemption at the time of the sale or must be one then holding a lien or vested right in the property.32

Thus, once the lienors have been paid from the surplus, any remaining proceeds should be distributed to the holder of the right of redemption. If third-party purchasers do not want to pay outstanding taxes or other remaining debts, their only option is to reduce their bids accordingly. They will not be otherwise compensated. Where, however, the mortgagee purchases the property after the foreclosure sale, it has an alternative remedy. A mortgagee may usually pay the outstanding taxes and other nonforeclosable debts. If it does so prior to the foreclosure sale, the mortgagee may then add the amount paid to the principal balance due on the mortgage and move for an amended judgment incorporating the sum paid.33 But, other than the scenarios discussed above, a third party purchaser cannot expect compensation from any surplus.

Financial industries have a way of generating urban myths that lead people to believe that they can manipulate the system to obtain wholly unjustified windfalls. Despite the fact that very clear and specific rules govern the distribution of foreclosure sale surpluses, many still believe or act as if they believe that these sums are available to the first taker. These surplus myths come in many forms, but at the end of the day, they are just myths. The rules are simple: 1) surplus funds take the place of the property sold; 2) surplus is distributed in order of lien priority on the property; and 3) the only parties entitled to a share in the surplus are the holder of the right of redemption and the holder of a lien or other vested right. Anything else you hear is just a myth. q

1 Murray Wells, Urban Legends Research Center, FAQ page,
FAQRefNum=FAQ0001 as of Dec. 16, 2003.
2 Duncan O’Neill and Carl Wyant, The Urban Legend Magazine, as of Dec. 15, 2003.
3 Mikkelson at, as of Dec. 12, 2003, citing Thomas Whiteside, Computer Capers 26–27 (Mentor 1978), ISBN 0-451-62173-5).
4 Mikkelson at, as of December 12, 2003, citing Computer Capers 28–30.
5 Mikkelson at, citing Liz Pulliam Weston, Money Talk, Los Angeles Times, March 3, 2002, at p. C3.
6 General Bank, F.S.B. v. Westbrooke Pointe, Inc., 548 So. 2d 736 (Fla. 3d D.C.A. 1989).
7 Schroth, 377 So. 2d at 51.
8 D.A.D., Inc., 407 So. 2dat 1073.
9 Id.
10 Id.
11 Id.
12 Id.
13 Id. at n.1 and accompanying text.
14 Ellis v. Southwell (1863), 29 Ill. 549, 552 (as quoted by Kankakee Federal Savings & Loan Assoc. v. Mueller, 481 N.E.2d 332 (Ill. App. 3d 1985)) (emphasis added).
15 Schroth, 377 So. 2d 50, but see D.A.D., Inc., 407 So. 2d 1072, 1073 n.1.
16 D.A.D., Inc., 407 So. 2d 1072.
17 PNC Mortgage, 718 So. 2dat 302 (citations omitted).
18 Id.
19 Sneed, 620 So. 2dat 1094.
20 Id.
21 Sens v. Slavia, 304 So. 2d 438 (Fla. 1974).
22 Id., quoting Tuttle v. Ehrehart, 102 Fla. 1129, 137 So. 245, 246 (1931).
23 Westbrooke Point, 548 So. 736–37.
24 Adirondack Trust Co. v. Snyder, 136 Misc. 2d 159, 161–62; 518 N.Y.S.2d 337, 339 (1987).
25 Rosen v. Dorn-Kothe, Inc., 126 Fla. 717, 171 So. 646, 648 (Fla. 1936)
26 See note 4 and text beginning at note 4.
27 Schroth, 377 So. 2d at 51.
28 General Bank, 548 So. 2d at 736; Schroth, 377 So. 2d at 51.
29 PNC Mortgage, 718 So. 2dat 301.
30 Id.
31 Id. at 302 (citations omitted).
32 Jelic v. Sears Mortgage Corp., 614 So. 2d 1149, 1150 (Fla. 4th D.C.A. 1993), quoting Rosen, 126 Fla. 717, 171 So. 646.
33 Patron v. American National Bank of Jacksonville, 382 So. 2d 156, 158 (Fla. 5th D.C.A. 1980).

Sandra Hankin and Marc A. Ben-Ezra are attorneys with Marc A. Ben-Ezra, P.A. The firm’s practice is limited to foreclosures including related bankruptcies and evictions and real estate transactions including REO and relocation closings, commercial transactions, loan originations, and real estate litigation. Asher Perlin provides all types of outsourced legal research and writing services and consults on litigation matters.

This column is submitted on behalf of the Real Property, Probate and Trust Law Section, Laird Andrew Lile, chair, and William P. Sklar and Richard R. Gans, editors.

Real Property, Probate and Trust Law