Collateral Damage: What Lenders and Servicers Need to Know About Indiana Code Enforcement and Demolition Orders

Vacant and distressed properties frequently become the subject of municipal code enforcement proceedings. What may begin as a grass-cutting violation, nuisance complaint, or repair order can ultimately result in an unsafe building determination, demolition order, substantial municipal liens, and the destruction of the lender’s collateral.  

Indiana law grants municipalities broad authority to address unsafe structures through the Indiana Unsafe Building Law, Indiana Code Chapter 36-7-9. At the same time, mortgagees often possess significant statutory, constitutional, and contractual rights that allow them to protect their security interest before a demolition occurs.  

Understanding these rights – and acting quickly when a code enforcement matter arises – can significantly reduce losses and preserve collateral value. This article will address three main questions that lenders and servicers should ask themselves:

1. How do we identify a code enforcement problem early?  

2. What rights do we have before demolition occurs?  

3. What are the financial consequences if we do nothing?

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Notice

Indiana’s Unsafe Building Law contains provisions specifically recognizing the interests of mortgage holders, including the right to receive notice of code enforcement proceedings. Specifically, municipalities are required to provide notice to any party with a “substantial property interest” that is properly recorded in the office of the county recorder or is the subject of written information that is received by the division of development services and includes the name and address of the holder of the interest described.

The best way for a lender or servicer to receive timely notice of any code enforcement proceeding is to ensure that county records are properly updated to reflect the current holder of the mortgage document. This is typically accomplished through the timely recording of assignments of mortgage after a loan is sold or servicing rights have been transferred. Upon receipt of notice, lenders and servicers should reach out to trusted counsel immediately to obtain the status of code enforcement proceedings and to discuss available options.

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Authority

Although municipalities often focus enforcement efforts on the property owner, mortgagees possess an independent property interest that may be substantially impaired if protective actions are not taken. For this reason, lenders and servicers should not assume the code enforcement proceedings are solely the borrower’s problem and should utilize any authority provided in the loan documents to protect their interests.

Modern mortgage instruments almost always contain “protection of lender’s interest” provisions that allow the lender or servicer to act when the collateral is threatened by waste, code violations, tax delinquencies, environmental hazards, or demolition proceedings. These provisions are particularly important in unsafe building and demolition order situations because they often give lenders and servicers contractual authority to preserve the collateral and then add those expenditures to the secured debt. Here are a few examples of the types of provisions lenders and servicers may rely on:

1. Right to Cure Violations – this provision usually provides that the borrower shall maintain the property in a condition that does not impair the lender’s security and, if the borrower fails to do so, the lender may make repairs or take other action reasonably necessary to protect its interest in the property.

2. Right to Advance Funds – this provision provides that a lender or servicer may do or pay for whatever is reasonable or appropriate to protect the collateral. This would include paying for repairs identified in the code violation notice or demolition order.

3. Right of Entry – this provision provides that a lender or servicer may enter upon the property if it is vacant, abandoned, or the security is impaired.

4. Waste and Impairment Clauses – this provision states that a borrower shall not commit waste or permit impairment of the property or the lender’s interest.  

These provisions, commonly found in most mortgage documents, provide lenders and servicers with the legal authority to take appropriate actions to cure code violations and demolition orders upon timely receipt of notice. In the event timely notice is not received, one of the strongest arguments a mortgagee can make is that it was willing and able to cure the violations under its mortgage documents but was denied adequate notice or opportunity to do so before demolition occurred. That argument combines both contractual rights under the mortgage and procedural due-process protections under Indiana law.

Despite what seems like clear authority to take immediate action, servicers often take a conservative approach to these situations. This is often a result of several factors, including various restrictions set in place by loan investors, trustees, government-sponsored enterprises, mortgage insurers, or guarantors whose requirements govern the administration of the loan. As such, servicers may lack the unilateral authority to commit substantial funds toward repairs, remediation, or demolition-related expenses. This is especially true if there is any concern over the eventual recoverability of the costs, whether as a result of the value of the property or due to the terms of the loan documents. Code enforcement actions often have short timelines, which also makes it difficult for servicers to properly evaluate the situations, obtain any necessary approvals, and decide to take action.  

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Risk

Although lenders and servicers may have legitimate reasons for delaying or declining intervention, the financial consequences of inaction can be substantial. The most immediate consequence is the accumulation of municipal fines, penalties, and enforcement costs that, in some jurisdictions, can become special tax assessments. If not paid, the property could be added to the list of properties eligible for tax sale, which would result in the loss of the mortgage lien.

Equally concerning is the high potential for continued deterioration of the collateral. Buildings subject to serious code violations often continue to deteriorate while enforcement proceedings are underway. Deferred maintenance, vandalism, weather damage, and unauthorized occupancy can accelerate the decline in value, resulting in lower foreclosure sale proceeds and diminished recovery upon liquidation of the collateral.

Although not as immediately concerning given the additional steps required in the process, demolition orders present the greatest overall risk due to the potential removal of all improved structures on the property resulting in a vacant lot. The reduction in value from an improved parcel to a vacant lot can be extreme, leaving lenders and servicers with no practical way to recover amounts due on the loan.

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Conclusion

Code violations and demolition proceedings present unique challenges for lenders and loan servicers, particularly when they arise during the foreclosure process. Each situation requires a careful evaluation of the property's condition, the status of the foreclosure, applicable municipal ordinances, investor guidelines, and the potential costs and benefits of available response options. Because code enforcement and demolition matters frequently involve complex and rapidly evolving legal issues, lenders and servicers should consult with experienced foreclosure and creditors' rights counsel as soon as these issues arise. MDK can help assess available options, coordinate with local authorities, navigate procedural requirements, and develop a strategy that protects the lender's interests while minimizing legal and financial risk.