What's In Your Condemnation Clause?

Article by

George J. Kroculick* and

Michael J. McCalley**

What does the "condemnation clause" in your mortgage

say? If you do not know, you are not alone. After all, the chances

of a property being condemned and the condemnation clause coming

into effect are slim. Nevertheless, there are several issues to

consider when drafting a condemnation clause or entering a mortgage

agreement.

1. The Sovereign Power Of Eminent Domain

   Eminent domain is the power of the sovereign to take property

   for "public use" without the owner's consent. The

   power of eminent domain does not require recognition by

   constitutional provision, but exists in absolute and unlimited

   form.1 The power of eminent domain is described as an

   inherent attribute of the sovereign. Thus, there is no stated

   constitutional source of such power. Rather, only the limitations

   on such power must be stated positively by state law. The most

   fundamental limitation is met by the provisions found in most of

   the state constitutions relating to the taking of property by

   eminent domain requiring that the condemning agency pay "just

   compensation." The legislature, of course, may prescribe more

   than the minimum requirement of the payment of just compensation.

   Such constitutional provisions, however, neither directly nor

   impliedly grant the power of eminent domain, but are simply

   limitations upon a power already in existence that would otherwise

   be unlimited.2

2. Notice Of The Taking And Rights Of Mortgagees To

   Participate In Condemnation Cases

   Whether a mortgagee is named a party in a condemnation case will

   likely depend on state law and how the term "condemnee"

   or "owner" is defined in a jurisdiction's relevant

   statute. In some jurisdictions, the relevant statute requires that

   owners and any persons having an interest in the property being

   condemned shall be joined as parties. In others, absent an express

   statutory requirement, mortgagees with a mere security interest in

   the property condemned need not be made a party to the action.

   For example, New Jersey law requires that mortgagees be listed

   as potential condemnees in the complaint. However, across the

   Delaware River, Pennsylvania law provides only that such mortgagees

   receive notice of the condemnation. Moreover, the notice provision

   under Pennsylvania law was only added in September 2006. Prior to

   that date, the condemning agency was not required even to provide

   the mortgagee notice, potentially leaving that mortgagee in the

   dark about the impact that a taking could have on the property

   securing the mortgage. Based on the varied treatment of mortgagees

   in condemnations throughout the country, it is best for the

   mortgagee to have its condemnation clause include a provision that

   the condemnee provide it with written notice of any attempts by

   governmental agencies or other entities embodied with the power of

   eminent domain to acquire the subject property.

   The right of mortgagees and lienholders to participate in a

   condemnation may depend on the mortgage language itself as well as

   state law. That is, some courts will allow the mortgage language to

   govern the mortgagee's right to participate in the

   condemnation. In other instances, the right of the mortgagee to

   participate may depend upon how that particular jurisdiction treats

   the mortgagee's interest. Many jurisdictions observe that the

   mortgage does not pass title to the mortgaged land, but only

   creates a security interest in the nature of a lien upon the land.

   Thus, because the mortgagee does not have an ownership interest in

   the land, certain jurisdictions may limit the mortgagee's

   participation. Yet, other jurisdictions may still follow common law

   where a mortgage is treated as conveying a defeasible title to the

   land mortgaged. In these situations, the mortgagee is most likely

   to be considered a condemnee with a right to seek compensation from

   the condemnor.

   Due to the varied treatment of mortgages and the rights they

   convey, the method of participation by a mortgagee will vary from

   state to state. Some jurisdictions allow the mortgagee to

   participate fully in an action against the condemnor. Others allow

   the mortgagee to participate only to the extent necessary to claim

   its portion or allocation of the condemnation proceeds. Yet, a few

   jurisdictions only provide that the mortgagee maintains a remedy

   against the mortgagor. Consequently, mortgagees should seek to

   reserve the fullest protections and rights of participation as

   granted under the controlling law when drafting a condemnation

   clause.

3. Rights Of Parties To The Proceeds/Impact Where Rights Are

   Assigned To Mortgagee

   Most standard condemnation clauses address the mortgagee's

   right to the condemnation proceeds, and may go so far as to

   establish the distribution as between mortgagor and mortgagee.

   Typically, the clause includes a provision whereby the proceeds of

   any award or claim for damages in connection with any condemnation

   or conveyance in lieu of condemnation is assigned to the

   mortgagee. Such a clause is intended to give the mortgagee the

   unfettered right to the condemnation proceeds.3 While

   this language protects the mortgagee's interest and gives the

   mortgagee a right to as much of the condemnation proceeds needed to

   satisfy the outstanding mortgage obligation, it may have unintended

   consequences.

   1. Condemnor Takes Title Free And Clear Of All Liens And

      Encumbrances

      In most cases, upon notice of the filing of a declaration of

      taking or similar document and the offer/deposit of estimated just

      compensation, the...