I'm sorry, this sounds like a mess. I think you're going to need to get a legal opinion on this one. It sounds like the tenant did what they were told by the bank, but the question is did the bank have the right to tell them? There are attorney's who deal with issues like this who may be able to give some free consultation advice.
You may want to ask about the benefits of doing a short sale while you are there. Each situation is different and there could be some advantages over letting the home go through foreclosure.