At a foreclosure sale, the senior lien holder is only required to bid the lesser of the fair market value of the debtor's property and the senior's claim against he debtor. There is no requirement that a junior lien holder bid at the trustee's sale. Though the junior will lose its secured creditor status upon completion of the trustee's sale of the property.
Where the fair market value of the property is significantly higher than the amount owed to the senior, the junior would likely be motivated to bid at the trustee's sale to recoup as much of the amount owed to the junior as possible, but junior still has no obligation to bid at the sale. Also, if the fair market value of the property is significantly higher than the senior's debt, third party investor's may be motivated to bid up the purchase price at the sale.
It is concerning that there appears to be no rule protecting the debtor from the devaluation of the debtor's property through an underbid foreclosure sale when the junior pursues its unsecured claim after foreclosure. It seems only fair that if there is sufficient value in the debtor's property to pay off all of the senior's claim and a substantial amount of the junior's claim, the debtor should be relieved from paying the junior an amount equal to the difference between the final purchase price at the trustee's sale and the fair market value of the property.
The rule of the law in this area leans too heavily on the assumption that a trustee's sale is an efficient marketplace for fair market value transactions and the assumption that if there is value above the senior's claim the junior or a third party investor will bid up the purchase price out of self-interest. These assumptions, which serve as the foundation for foreclosure law, can have a dangerous effect on the outcome for the debtor.
Are there any protections afforded to the debtor in this scenario? Is this fair? Should the junior lien holder be required to bid at the trustee's sale if the fair market value exceeds the senior's claim and the junior is a not a sold-out junior liendholder? Should the junior's unsecured claim be reduced by the difference between the fair market value of the property and the amount bid by the senior lien holder at the sale?