Tough Times for Lenders : Financial Services Lawyer & Attorney : Winstead Law Firm : Finance, Banking, Bankruptcy

This is a series of blog entries in which we provide some quick answers to lenders' frequently asked questions (FAQ).

Two of my favorite little "sayings" about distressed commercial real estate are these:

• It's all about the lease (think money)
• Is there any collateral that is NOT real property?  Does the collateral include any personal property?

Before you foreclosure, it is crucial that you understand (i) how a foreclosure will effect existing commercial leases and (ii) what is the proper way to foreclosure upon the collateral that is personal property.

FAQ #40 - What does a real property foreclosure do to the commercial tenant leases?  Do they continue after the real property foreclosure?

• In some states (but not all states), if the mortgage or deed of trust was recorded PRIOR to the date of the lease, then the foreclosure will terminate the commercial lease.  (Yes, the end of the lease!)  On the other hand, if the date of the lease is PRIOR to the mortgage or deed of trust, then the foreclosure will not terminate the lease.
• If the property has performing leases that are dated AFTER the recording date of the mortgage or deed of trust, a lender might be able to foreclose “subject to” the existing leases which are providing cash flow to the property.  This approach will NOT terminate these leases.
• All of this changes if the lender and the tenant have entered into an agreement covering the continuation of the lease (or the continuation of tenant's right to remain in the leased premises) following a foreclosure.  Some times this agreement is contained in the lease itself, or it might be a separate agreement called a "subordination, non-disturbance and attornment agreement."  Do NOT overlook these agreements - review the lease and tear the file apart to determine if this agreement exists.
• WARNING: this topic should be reviewed and addressed by a lawyer since the laws on this topic vary (depending upon the state) and since the facts of each situation play an important role in answering this question.

FAQ #41 - How do I foreclose on the part of the collateral that is not land?

• Generally, foreclosing on collateral that is not land or “real property” is accomplished under the state’s requirements for a foreclosure sale of personal property under the state's version of the Uniform Commercial Code (UCC).  However, there are exceptions to this statement.
• The procedures, notices, and rules regarding a UCC sale differ from those used for a foreclosure sale of land
• One challenge in a UCC sale is that the sale itself must be undertaken pursuant to a standard of “commercial reasonableness” - which opens the door to litigation by the borrower that the sale was not correctly conducted.
• However, the UCC in many states allows for a concurrent sale of both personal property AND real property (so that the personal property can be foreclosed upon as part of the foreclosure of the real property).  This concurrent approach avoids the pitfalls inherent in a UCC sale.
• WARNING: this topic should be reviewed and addressed by a lawyer since the laws on this topic vary (depending upon the state) and since the facts of each situation play an important role in answering this question.
   

To read the entire Tough Times FAQ series, please click here.

Two things should be kept in mind. First, none of these questions can be answered in a vacuum. Questions should be considered with a thorough review of the file and an interview with appropriate loan officers. And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers.

If you have thoughts, suggestions or questions on this topic, please post a comment below.

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This is a series of blog entries in which we provide some quick answers to lenders' frequently asked questions (FAQ).  While I've covered this subject before [link], here's another overview of the advantages and disadvantages of taking title (to real property collateral) back from a borrower "in lieu of" doing a foreclosure.

FAQ# 16 - What are the advantages of a Deed in lieu of foreclosure (DIL)?

• A DIL should be used if it can be accomplished quickly (i.e., without extensive negotiation).  It allows the lender to obtain ownership of the property without the cost and time delay associated with judicial or non-judicial foreclosure.  This is very important in states where the foreclosure process is very lengthy (such as Florida [up to 2 years] and Ohio)
• Since a DIL is voluntary, the parties can agree upon the amount and related terms of any deficiency (and thereby avoid a dispute as to valuation), together with a release of any claims against the lender
• Since a DIL is voluntary, the lender can condition its acceptance of the DIL agreement upon receipt of such things as complete and accurate copies of the borrower's financial statements, tax records, leases, service contracts, construction plans, sale contracts, vendor payables, etc., which may result in a better "turn over" of the property to the lender (although a "friendly" non-judicial foreclosure can achieve the same result if the borrower cooperates with the lender and furnishes the information)
• The lender can condition its acceptance of the DIL agreement upon not being placed in a worse position than if it foreclosed (i.e., there is no reason to relinquish lender's rights to surviving indemnities under the loan documents, involving things such as keeping a continuing right to indemnity for environmental conditions or prior misrepresentations, and/or collections costs as set forth within the loan documents); and a DIL does NOT include the concept of a "right of redemption" (which is a right in some states giving the borrower the ability to pay the debt and "redeem" or get back title to the property after foreclosure) (In Texas, there is no right of redemption after a foreclosure - but this rule of law varies state to state)
• A DIL is a private transaction and avoids adverse publicity for the borrower (i.e., there is no publication or court filings like in a foreclosure), which may also minimize the impact upon property valuation
• A DIL avoids the problems with the foreclosure process, including the possibility of post-foreclosure attacks on the sale as a 'wrongful foreclosure'
• A DIL does not automatically release the lender's lien or space leases—these can be preserved by expressly making the deed in lieu subject to those interests, and permit the lender to foreclosure at a later date if necessary to extinguish a subordinate mechanic's lien

FAQ# - 17 What are the disadvantages of a DIL?

• The transferee takes the property subject to all existing liens (unlike a foreclosure sale which extinguishes junior or subordinate liens)
• Neither a deficiency amount nor property value is established unless expressly set forth in the DIL agreement (unlike a foreclosure sale which establishes any deficiency as the difference between the foreclosure sale price and balance due on the loan)
   

To read the entire Tough Times FAQ series, please click here.

Two things should be kept in mind.  First, none of these questions can be answered in a vacuum.  Questions should be considered with a thorough review of the file and an interview with appropriate loan officers.  And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers.

If you have thoughts, suggestions or questions on this topic, please post a comment below.

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This is a series of blog entries in which we provide some quick answers to lenders' frequently asked questions (FAQ).

FAQ # 14 -  What are the advantages of a real property foreclosure?

• Biggest advantage is that foreclosure extinguishes all liens that are subordinate or inferior to the lender's lien.  However, not all liens will be inferior.  State law differs and the facts surrounding the creation of each lien will differ.  For example, in some states, mechanics liens are NOT extinguished by a foreclosure; and property taxes typically are NOT extinguished.
• Sometimes the cost may be less than a deed in lieu transaction (which can involved title insurance premiums, and significant legal fees if negotiated)

FAQ #15 -  What are the disadvantages of a real property foreclosure?

• Receipt of a foreclosure notice by a borrower could encourage the borrower to file for bankruptcy—which will halt the foreclosure and impact the lender's chance of being fully repaid
• In a non-judicial foreclosure, the lender must strictly comply with all statutory legal requirements, or else the foreclosure can be overturned and the lender may be liable to the borrower for damages for wrongful foreclosure
• Depending on the law of the state where the property is located, non-judicial foreclosure may take more time than the lender is willing to accept.  So, in those states, taking the property back via a deed in lieu is a common strategy.
• While this probably shouldn't be called a "disadvantage," it is a practical problem: even though a foreclosure might legally extinguish a mechanics lien, the lender's motivation to quickly sell the property (after the foreclosure) might cause the lender to negotiate a settlement of the mechanics lien.  Sure, legally the lender could go to court for an order "removing" the lien from the real property records, or the lender could pursue a claim under the loan title policy, but both take time (and going to court results in legal fees).

To read the entire Tough Times FAQ series, please click here

Two things should be kept in mind.  First, none of these questions can be answered in a vacuum.  Questions should be considered with a thorough review of the file and an interview with appropriate loan officers.  And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers

If you have thoughts, suggestions or questions on this topic, please post a comment below.

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(More from our "Watch for Change" series . . . .)

As you know, the "new" economy is prompting a wide range of new laws and ordinances, all of which present opportunities for the unwary to trip up and mess up in the collection process.

This posting will interest you if any of your collateral involves residential real property.

While this posting is written from a Texas perspective, the concept applies to all states—because the new Federal law applies to all states.

Thanks to Vince Marino of Winstead PC for this information, which was published in the Houston Business Journal on July 17, 2009.

If you have any questions or comments, please post them.

New Federal Foreclosure Law Gives Residential Tenants 90 Days to Vacate

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Guest Writer: Brenda Brown, Winstead PC

More from ourTough Times FAQs series:

FAQ #4 -  Do I need to reduce the commitment amount after sending a Notice of Default?

• Typically, no – once the loan is declared to be in default, or once the maturity of the loan is accelerated, the lender has no on-going funding obligation – but confirm this in the documents.
• The lender typically is not required to fund current loan allocations or grant new loan allocations.
• Communicate clearly in writing to the Borrower that the lender has no further obligation to the fund and negotiations, inspections, administrations and even making future draws during a draw period (whether under a construction loan or a partial disbursed loan) do not amount to waivers of pre-existing defaults or can be considered obligations for future fundings.

FAQ #5 -  After a Default Notice, should I send statements showing Regular Monthly Interest or statements showing interest at the Default Rate?

• Statements to the borrower should reflect the Default Rate of interest (rather than the prior regular interest rate), late fees, and any other fees due the lender (such as legal fees) – all of which usually do not appear in the "standard" statement.
• So, typically it is best to STOP sending the regular monthly statements.

FAQ #6 -  What else should I put in writing?

• Agreements Regarding Interim or Protective Advances
• Forbearance Agreement

All of these first six questions underscore the fact that the status of the property and the loan must be looked at with current and fresh eyes so that the opportunities for solutions are enhanced, and the risks of encountering questions of waiver are avoided.

To read the entire Tough Times FAQ series, please click here.

Please post comments or questions below.
 

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More on our "Watch For Change (at the state house)" series (prior postings on new business tax; new foreclosure fee) . . . .

I suspect that many state and local authorities soon will be requiring lenders to register a loan BEFORE the loan is foreclosed.

Yes, another foreclosure trip wire.

Recently, a representative of MERS (the electronic note registry used extensively with residential mortgage note and to a lesser extent with commercial mortgage notes securitized in CMBS pools) told me that MERS is being used in new ways - most notably, several cities (such as Chula Vista, CA) are using the registry to "track down" and identify owners, servicers and managers of foreclosed single family houses.

He also tells me that several states (VA & CA, for example) have pending legislation requiring all foreclosed property to be registered in a database for use by governmental authorities (data points for the registry include ownership, servicer, property manager, etc.).  (I'm tracking down information on this.)

• Why? Thousands of homes have been foreclosed, and sit vacant and unattended.  And the public wants them to be kept secure, yards mowed, pools serviced, etc.  No one wants a meth lab, or a party house, as your newest next door neighbor.
• Why not?  Public officials want votes, so they're looking for ways to "please" the public without spending public funds.

However, since most commercial mortgage notes are NOT registered with MERS, it will NOT be a data-ready tool for use in tracking down commercial lenders after foreclosure (one caveat: some CMBS notes have been registered in MERS).

. . . yet. I predict that this will catch on in state legislatures across the nation - making registration a requirement before foreclosure.

If you can give us some information on this, or if you have any questions or comments, please post a contact.

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Here's another topic from our "ticking sound" series covering insurance issues and environmental issues:

The subject of insurance for foreclosed properties doesn't seem to come up very often, most likely because there are so many other more pressing problems to worry about. But failing to ensure that the property has adequate insurance – not just "trendy" coverage like environmental impairment insurance but also "old fashioned" property, liability and flood insurance – is absolutely vital to avoid problems that arise all too often.

A lender, servicer or foreclosure purchaser's analysis of insurance on foreclosed property should start with the working presumption that the borrower's insurance will not protect the lender, servicer or foreclosure purchaser after the property is transferred. This may no be so, particularly if care has been taken on the front end to ensure that the lender is included as a named insured on applicable policies, but it still is possible (if not quite likely) that the borrower quietly cancelled the policies to pick up any premium refunds that might be available. Even if the borrower did not resort to such a tactic, the transfer of title from borrower to lender may deprive the borrower of an insurable interest in the property, without which the policy may be void. Some policies also include exclusions or other provisions limiting or precluding coverage for abandoned property, and when the borrower walks away, these provisions may be triggered. The result can be a nasty surprise when a claim occurs later.

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As noted in our recent posting on this subject (The Very Dark Side), the Concurring Opinions Blog  addressed a volatile topic: evicting residential tenants after a real property foreclosure of a single-family residence.  In this posting, we suggest this topic has more relevance to commercial lenders and servicers than you might initially think; and we suggest some tips.

Clearly, most commercial mortgage lenders do not have this type of product (single-family) in the portfolio.  Or if they do, it is a million-dollar home occupied by an executive who is not a tenant, and definitely not a sympathetic figure in the new economy.

So, does a commercial mortgage lender or servicer care about this topic? Why should you care?

The prediction here is that the time will come when evicting a small business owner, or evicting families who occupy abandoned property (or a model home), or evicting laid-off workers occupying an abandoned warehouse or factory will gain the attention of the local media.

If this starts to sound like your portfolio, then here are a few tips:

• Realize that foreclosure and the process of taking possession will be much different than your typical commercial collateral foreclosure. For starters, you should notify a broader group of people in the foreclosure process. For example, contact your community relations or governmental relations group, and include them in decisions made during the foreclosure process. In turn, they will reach out to local community organizations and governmental agencies.
   
• As soon as you have the legal right to directly communicate with the occupant, contact them to discuss the process and options available to them, including local community and governmental resources. In other words, be a resource of information for the occupant.
   
• Consider entering into a short-term lease arrangement (as a bridge to finding a replacement tenant) in order to give the occupant time to find new housing. (As to laid-off workers occupying the collateral - I'm still chewing on that one.)
   
• If the collateral is an affordable housing project, examine the title records to verify rental and other restrictions that burden the project.

Taking back the collateral is tough enough. And getting it back while managing media coverage only makes it worse.

If you have any other suggestions or questions, please post a comment.
 

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In two prior postings (Part 1) (Part 2), I briefly described each concept and the advantages of both. In this third and final posting, I'll briefly contrast the disadvantages of both.  So, here we go (with the expectation that you'll add to this listing):

Disadvantages of Foreclosure

Major disadvantages of a foreclosure include the following:

• Receipt of a foreclosure notice by a borrower could encourage the borrower to file for bankruptcy. Filing for bankruptcy halts all foreclosure proceedings and could impact the likelihood that the lender will be fully repaid for the money it loaned to borrower.
• Most notably in the case of a non-judicial foreclosure, strict compliance with all statutory requirements is required or else the borrower may have the foreclosure overturned, and the lender may then become liable to the borrower for damages associated with wrongful foreclosure. Lender's liability may extend to junior lien holders if they were not properly notified of the foreclosure sale.
• Depending upon the law of the relevant state, a non-judicial foreclosure may take more time than a creditor is willing to accept.

Disadvantages of a Deed-in-Lieu

Deeds-in-lieu have a few serious disadvantages, some of which can be contracted around, however:

• Unlike with foreclosures, a deed-in-lieu does not alter or affect other lien holders to the property. The lender takes the property, along with all encumbrances. If there are senior lien holders with "due-on-transfer" rights, the lender would immediately become liable for paying off those claims. If the borrower is the senior lien holder, the borrower takes the property subject to all, if any, junior liens. At least in foreclosure, the liens junior to the those of the foreclosing party are cleaned-up.
• At a foreclosure sale, if there is a deficiency between the sale price of the property and the balance due on the loan, the lender can go after the borrower for the deficit (subject, however, to applicable state law limitations). With a deed-in-lieu, no market-value is set for the property, unless it is expressly set forth in the terms of the agreement. The need to agree upon value points leads to the next subject.
• Negotiations of the terms of the deed-in-lieu agreement (such as the valuation of the property if a deficiency will be agreed upon) may take more time than initially anticipated. Some of this might be mitigated by the use of a non-binding term sheet covering the terms of the deed-in-lieu agreement; however, there is no assurance that the existence of a term sheet in fact will "speed" the negotiations of the deed-in-lieu agreement (in that some parties simply insist upon negotiating).

If you have any suggestions or questions, please post your comments.

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2nd in a series of 3 postings

In a prior posting, I briefly described each concept.  The more difficult task is contrasting and comparing them.  So, here we go (with the expectation that you'll add to this listing):

Advantages of Real Property Foreclosure

Major advantages of a foreclosure include the following:

• The one overwhelming advantage of foreclosure (whether judicial or non-judicial), when compared to a deed-in-lieu of foreclosure (to be discussed in more detail below), is that a foreclosure proceeding clears or extinguishes all liens that are subordinate or inferior to the lien held by the foreclosing lender.
• Sometimes the cost to undertake a non-judicial foreclosure may be less than the costs of a deed-in-lieu transaction (in that a deed-in-lieu can include title insurance premiums, significant legal fees if the agreement is negotiated, etc. – although some of this may be mitigated by the use of a term sheet in the deed-in-lieu process).

Advantages of a Deed-in-Lieu

Deeds-in-lieu have several advantages over foreclosure proceedings as a means of obtaining some measure of repayment for a lender from a defaulting borrower:

• Accepting a deed-in-lieu allows the lender to obtain ownership of the property without the costs and delays associated with judicial and non-judicial foreclosure. (Note: in a future posting we'll discuss other agreements that allow the lender access to the property WITHOUT obtaining the title.)
• Since a deed-in-lieu is a voluntary conveyance by the borrower, the parties can agree upon the amount and related terms of any deficiency (and thus avoid a dispute as to the valuation of the property), together with a full release of any claims against lender.
• Again, since a deed-in-lieu is a voluntary conveyance by the borrower, the lender has a great deal of leverage in terms of conditioning its acceptance. The lender can condition acceptance of the deed-in-lieu upon such things as receiving a complete and accurate copy of the borrower's financial statements, tax records, leases, service contracts; construction plans and contracts, sales contracts, etc. In other words, this may be a better "turnover" of the property to the lender. (However, a "friendly" non-judicial foreclosure can achieve the same result.)
• Unlike a foreclosure, a deed-in-lieu is a private transaction that does not involve publication or court filings. Thus, with a deed-in-lieu, the borrower can avoid adverse publicity, which may also minimize the impact on property valuation.
• Accepting a deed-in-lieu of foreclosure avoids all the problems with the foreclosure process, such as the possibility of post-foreclosure attacks on the sale as a wrongful foreclosure.
• Note that accepting a deed-in-lieu structure does NOT mean that the lender's lien (or space leases) will be released or extinguished. Indeed, the lien (and space leases) may be "preserved" or "kept alive" by expressly making the deed-in-lieu subject to those interests (so that such interests will expressly continue). This will permit the lender to foreclose at a later date if, for example, there are mechanics' liens that need to be extinguished (which are subordinate to the lien). Note that use of this structure depends upon this important consideration: is the lien absolutely superior to other objectionable or problematic title matters (such as M&M liens)?

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1st in a series of 3 postings

This is a first of three postings on these two (2) concepts. The first posting will briefly describe each, the second posting will list some of the advantages of each, and the third posting will cover some of the disadvantages of each.  Note that this series is not intended as a comprehensive discussion of these topics. (For example, this series will not address related topics such as trapping rents, redemption periods, legal limitations on deficiencies, the use of deficiency agreements, laws that limit or prevent a creditor from ignoring its security, laws that prohibit a creditor from bringing more than one action to exhaust its security, nor laws that limit recourse against a guarantor – look for other postings on these topics.)

The following is a brief description of a foreclosure and a deed-in-lieu of foreclosure:

Real Property Foreclosure
Foreclosure is the legal proceeding whereby a defaulting borrower is stripped of its interest in real property in order to satisfy debts owed to a lender. These are debts that were originally secured by the real property. In a judicial foreclosure proceeding, the lender files a motion in state court seeking a foreclosure decree. The lender must prove that the borrower is in default on a valid note. Generally, the court will then appoint a trustee to notify all interested parties of the pending foreclosure sale. The trustee will carry out the sale and disburse the proceeds under strict court supervision. In many states, judicial foreclosure is the only means of foreclosing on real property. Because judicial foreclosure is a court proceeding, it can take months if not years to complete.

A limited number of states permit a non-judicial foreclosure (such as California and Texas). A non-judicial foreclosure is one where the foreclosure is conducted with little to no court supervision. Meaning, the interested parties are notified, the sale is conducted, and the proceeds disbursed without court supervision. Typically, the ability to conduct a non-judicial foreclosure is not a statutory or constitutional right; it is a contractual right that must be specifically granted by the borrower to the lender in the loan documents. Because a non-judicial foreclosure does not involve a court proceeding, the process is easier and faster to complete than a judicial foreclosure.

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Mortgagor's Interest: No Right of Redemption
Before the sale is actually consummated, the mortgagor is entitled to pay the amount of indebtedness at any time, and, if there is a dispute concerning the amount, he or she may pay into the registry of the court the amount alleged due and halt the sale. Once a valid sale is consummated, however, the mortgagor has no right of redemption. The mere fact that negotiations between the mortgagor and the mortgagee were pending while the sale was held does not constitute an irregularity sufficient to set aside the sale. After the foreclosure sale, the mortgagor's ownership of the property has been transferred to the successful bidder, and the mortgagor may face a deficiency suit from the mortgagee.

Junior Lienholders
Following the valid foreclosure of a senior lien, junior lienholders do not have a right of redemption, and their liens, if not satisfied from the proceeds of the sale, are extinguished. There is an exception to this rule in the case of property which may be removed form the real property without material damage to the land, the improvements themselves, and surrounding improvements.

Purchase at Foreclosure of Inferior Lien
If a lien inferior to the first lien is being foreclosed, the trustee distributes proceeds to the inferior lienholder and executes a trustee's deed in favor of the successful bidder. If there are excess proceeds available, they will be distributed to inferior liens or, alternatively, if there are no inferior lienholders, to the mortgagor of the foreclosed inferior lien. Of course, the successful bidder at a junior lien foreclosure takes title subject to prior liens and must service the prior liens in order to prevent loss of the property by foreclosure of the prior liens.

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