Banks typically follow two paths at the same time, one leads to foreclosure and one leads to the short sale. It looks like the foreclosure path came to an end first. Are you using an attorney for the closing? There may be a redemption period during which you could complete the short sale or some other legal remedy. I would highly recommend talking to an attorney familiar with the foreclosure laws in Tennessee.
I have a Bank of America right now on the same situaiton. Short Sale was approved for both 1st & 2nd in early August. In late August, BOA notified the Lisitng Agent the 2nd was being transferred on August 31st. The Listing Agent is now working on getting a new approval for the 2nd.
You also can see if the new mortgage company will honor the exisitng Short Sale approval letter. It is worth asking.