When a debtor defaults on its mortgage, a loan provider has a number of solutions available to it. Over the last few years, loan providers in addition to customers have actually increasingly chosen to pursue options to the adversarial foreclosure process. Chief among these is the deed in lieu of foreclosure (referred to as a "deed in lieu" for short) in which the lending institution forgives all or the majority of the debtor's responsibilities in return for the borrower willingly turning over the deed to the residential or commercial property.

During these tough economic times, deeds in lieu deal loan providers and debtors numerous advantages over a standard foreclosure. Lenders can reduce the uncertainties inherent in the foreclosure process, decrease the time and cost it takes to recover possession, and increase the probability of receiving the residential or commercial property in better condition and in a more smooth manner together with a correct accounting. Borrowers can avoid pricey and protracted foreclosure fights (which are typically unsuccessful in the long run), manage continuing liabilities and tax ramifications, and put a more positive spin on their credit and reputation. Nevertheless, deeds in lieu can likewise pose substantial dangers to the celebrations if the concerns attendant to the process are not thoroughly thought about and the documents are not appropriately drafted.

A deed in lieu must not be thought about unless an expert appraisal values the residential or commercial property at less than the staying mortgage commitment. Otherwise, there is the hazard of another lender (or trustee in personal bankruptcy) claiming that the transfer is a deceptive conveyance and, in any case, the borrower would clearly be hesitant to give up a residential or commercial property in which it might stand to recover some value following a foreclosure sale. Also, a deed in lieu transaction ought to not be forced upon a borrower; rather, it should be a free and voluntary act, and a representation and service warranty reflecting this must be memorialized in the contract. Otherwise, there is a risk that the deal could be vitiated by a court in a subsequent case on the basis of undue impact or similar theories. If a debtor is resistant to finishing a deed in lieu transfer, then a loan provider intent on recovering the residential or commercial property should instead begin a standard foreclosure.

Ensuring that there are no other unfavorable liens on the residential or commercial property, and that there will be no such liens pending the delivery and recordation of the deed in lieu of foreclosure, is maybe the biggest pitfall a lender need to prevent in structuring the deal. Subordinate liens on the residential or commercial property can just be discharged through a foreclosure process or by agreement of the negative lender. Therefore, before starting, and once again before consummating, the deed in lieu deal, the lender needs to do an adequate title check; after receiving the report, whether a lender will progress will typically be a case-by-case decision based upon the existence and quantity of any discovered liens. Often it will be sensible to attempt to negotiate for the purchase or complete satisfaction of reasonably minor 3rd party liens. If the lending institution does choose to proceed with the deal, it should assess the advantages of acquiring a new title insurance plan for the residential or commercial property and to have a non-merger recommendation included in it.1

For protection versus understood or unknown subordinate liens, the lender will also want to consist of anti-merger language in the contract with the borrower, or structure the transaction so that the deed is offered to a loan provider affiliate, to allow the loan provider to foreclose (or use utilize by reason of the ability to foreclose) such other liens after the shipment of the deed in lieu. Reliance on anti-merger provisions, however, can be dangerous. Cancelling the initial note can endanger the lending institution's security interest, so the lender ought to rather provide the customer with a covenant not to sue. This likewise manages the lending institution versatility to retain any "bad boy" carve-outs or any other continuing liabilities that are concurred to by the parties, including ecological matters. Depending on the jurisdiction or particular factual scenarios, nevertheless, another financial institution may effectively attack the credibility of the attempt to preclude merger. Moreover, a non-merger structure may, in some jurisdictions, have a transfer tax consequence. The bottom line is that if there is not a high degree of self-confidence in the residential or commercial property and the debtor, the lending institution needs to be especially watchful in structuring the transaction and setting up the proper contingencies.

One substantial advantage of a carefully structured deed-in-lieu process is that there will be a detailed arrangement stating the conditions, representations and provisions that are contractually binding and which can endure the shipment of the deed and associated releases. Thus, in addition to the normal pre-foreclosure due diligence that would be performed by a lending institution, the agreement will supply a roadmap to the shift process in addition to important details and representations regarding running accounts, accounting, turnover of leasing and contract documents, liability and casualty insurance, and so on. Indeed, once the lender seizes the residential or commercial property through a voluntary deed process rather than foreclosure, it will likely (both as a legal and useful matter) have higher direct exposure to claims of occupants, contractors and other 3rd parties, so a well-crafted deed-in-lieu agreement will go a long method toward improving the loan provider's convenience with the general process while at the exact same time offering order and certainty to the debtor.

Another significant concern for the lending institution is to ensure that the transfer of the residential or commercial property from the borrower to the lending institution fully and unquestionably extinguishes the customer's interest in the residential or commercial property. Any staying interest that the debtor maintains in the residential or commercial property might later give rise to a claim that the transfer was not an absolute conveyance and was rather an equitable mortgage. Therefore, a lending institution should strongly withstand any deal from the debtor to lease, manage, or reserve an option to acquire any part of the residential or commercial property following the transaction.

These are simply a few of the most crucial issues in a deed in lieu transfer. Other considerable problems should likewise be considered in order to safeguard the parties in this fairly complex process. Indeed, every deal is unique and can raise various concerns, and each state has its own rules and custom-mades relating to these arrangements, varying from transfer tax concerns to the truth that, for example, in New Jersey, deed in lieu transactions likely fall under the state's Bulk Sales Act and its requirements. However, these problems ought to not dissuade-and certainly have not dissuaded-lenders and debtors from significantly using deeds in lieu and consequently gaining the substantial benefits of structuring a deal in this way.

1. For many years it was likewise possible-and extremely preferred-for the loan provider to have the title insurance provider consist of a financial institutions' rights endorsement in the title insurance coverage. This protected the loan provider versus needing to safeguard a claim that the deed in lieu transaction represented a fraudulent or preferential transfer. However, in March of 2010, the American Land Title Association decertified the lenders' ideal endorsement and hence title companies are no longer providing this security. It should be further kept in mind that if the deed in lieu were reserved by a court based on unnecessary impact or other acts attributable to the lending institution, there would likely be no title protection since of the defense of "acts of the guaranteed".

Notice: The purpose of this newsletter is to determine select advancements that may be of interest to readers. The information included herein is abridged and summarized from numerous sources, the precision and completeness of which can not be ensured. The Advisory needs to not be construed as legal guidance or viewpoint, and is not a replacement for the recommendations of counsel.