I agree with Reevee… However, if you are a principal in the transaction, then you can sell it as you described without too much problem. Do do that, you have to control the property with a purchase contract or an option to purchase or something. Then, go find the highest bidder.
If you do a Sub2, you will need to somehow cure the loan, otherwise, it will still foreclose.
Seems like you need to figure out your exit strategy, then you can figure out what is the best way to structure the transaction. For example, if you are just going get out as quick as you can with a decent pay day for yourself (hence, your suggested auction), then Sub2 is not what I would choose. A simple option or contract should suffice.
A final note… if the Medicaid lien is actually a judgment, then I assume that will also need to be cured somehow before a warrantable sale can take place. If that debt is attached to the house in the form of a judgment, there is a good possibility that you could negotiate that $95k down substantially. Depending on how old the debts are, it is conceivable to reduce that debt 50%. You create more equity in the house by doing so.
It sounds like your heart is in the right place by trying to help your friend. But I see a problem with the equity spread and your ROI on this. $257K + $95K = $352K (total pay off of mortgage and liens). This does not include repairs, closing costs and holding costs. Lets assume your ARV is acurate and there is NO repairs needed you would have a $48K spread. Now if you calculate normal closing costs to sell the home at full retail value using a realtor (avg 6% of sale price = 3% listing agent and 3% buyers agent) (1% of sale price for title/escrow fees) which is approximately $28K. Then you need to add average holding time carrying costs and back payments to bring the mortgage current. Example, 3 months holding time plus the 3 months of behind payment at 7% int using $257k original purchase price would be approximately $1800 monthly payment = 6 months by $1800 = $10,800. $48k - $28k (realtor fees) - $11k (holding costs and arrears) = $9k (without repairs) profit.
With that much work and risk involved I would not recommend doing this deal. Instead you could offer assistance in the form of marketing and repairs of the home with an agreement that you would get 50% of the profit as your payment for “sweat equity”. You could also bring his/her mortgage current to further secure your position and make sure you record your interest in the property in the form of a memorandom and/or a notorized agreement that is enforceable in a court of law. But if this is your friend he/she shouldn’t try to screw you but never take it for granted.