When a borrower defaults on its mortgage, a lending institution has a number of solutions readily available to it. In the last few years, lenders along with customers have actually increasingly chosen to pursue options to the adversarial foreclosure procedure. Chief amongst these is the deed in lieu of foreclosure (referred to as a "deed in lieu" for brief) in which the lending institution forgives all or many of the customer's obligations in return for the borrower voluntarily handing over the deed to the residential or commercial property.

During these difficult financial times, deeds in lieu deal lenders and borrowers numerous advantages over a conventional foreclosure. Lenders can decrease the uncertainties inherent in the foreclosure procedure, reduce the time and expense it takes to recover belongings, and increase the probability of getting the residential or commercial property in much better condition and in a more smooth way together with a correct accounting. Borrowers can avoid expensive and protracted foreclosure battles (which are typically not successful in the long run), manage continuing liabilities and tax ramifications, and put a more positive spin on their credit and reputation. Even so, deeds in lieu can also pose significant risks to the parties if the concerns attendant to the process are not completely considered and the documents are not properly prepared.

A deed in lieu ought to not be considered unless a professional appraisal values the residential or commercial property at less than the staying mortgage responsibility. Otherwise, there is the danger of another financial institution (or trustee in insolvency) claiming that the transfer is a deceptive conveyance and, in any case, the borrower would obviously be hesitant to give up a residential or commercial property in which it may stand to recuperate some value following a foreclosure sale. Also, a deed in lieu deal need to not be forced upon a customer; rather, it must be a totally free and voluntary act, and a representation and guarantee reflecting this must be memorialized in the arrangement. Otherwise, there is a danger that the transaction might be vitiated by a court in a subsequent case on the basis of undue impact or comparable theories. If a customer is resistant to completing a deed in lieu transfer, then a lending institution intent on recovering the residential or commercial property needs to instead start a traditional foreclosure.

Ensuring that there are no other unfavorable liens on the residential or commercial property, which there will be no such liens pending the shipment and recordation of the deed in lieu of foreclosure, is possibly the most significant pitfall a lender need to avoid in structuring the deal. Subordinate liens on the residential or commercial property can just be released through a foreclosure process or by arrangement of the adverse lender. Therefore, before initiating, and again before consummating, the deed in lieu deal, the lender should do a sufficient title check; after receiving the report, whether a lender will progress will typically be a case-by-case choice based on the existence and quantity of any discovered liens. Often it will be sensible to try to work out for the purchase or satisfaction of relatively minor third celebration liens. If the lending institution does choose to proceed with the deal, it should assess the benefits of getting a brand-new title insurance coverage policy for the residential or commercial property and to have a non-merger recommendation included in it.1

For security against understood or unidentified secondary liens, the loan provider will likewise want to consist of anti-merger language in the arrangement with the debtor, or structure the transaction so that the deed is offered to a lending institution affiliate, to make it possible for the loan provider to foreclose (or utilize leverage by factor of the capability to foreclose) such other liens after the shipment of the deed in lieu. Reliance on anti-merger arrangements, nevertheless, can be dangerous. Cancelling the initial note can threaten the lending institution's security interest, so the lending institution must rather offer the customer with a covenant not to sue. This also manages the loan provider flexibility to keep any "bad kid" carve-outs or any other continuing liabilities that are consented to by the parties, consisting of environmental matters. Depending on the jurisdiction or particular factual scenarios, however, another creditor might successfully attack the credibility of the effort to preclude merger. Moreover, a non-merger structure might, in some jurisdictions, have a transfer tax repercussion. 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 requires to be specifically watchful in structuring the deal and setting up the appropriate contingencies.

One substantial advantage of a carefully structured deed-in-lieu process is that there will be a comprehensive agreement setting forth the conditions, representations and provisions that are contractually binding and which can survive the delivery of the deed and associated releases. Thus, in addition to the regular pre-foreclosure due diligence that would be performed by a loan provider, the arrangement will provide a roadmap to the transition procedure as well as vital details and representations concerning running accounts, accounting, turnover of leasing and agreement files, liability and casualty insurance coverage, and so on. Indeed, once the lending institution seizes the residential or commercial property through a voluntary deed process as opposed to foreclosure, it will likely (both as a legal and practical matter) have greater direct exposure to claims of tenants, specialists and other third celebrations, so a well-crafted deed-in-lieu arrangement will go a long way toward boosting the lending institution's convenience with the total process while at the exact same time providing order and certainty to the debtor.

Another substantial concern for the lender is to ensure that the transfer of the residential or commercial property from the customer to the loan provider totally and unquestionably extinguishes the borrower's interest in the residential or commercial property. Any remaining interest that the debtor maintains in the residential or commercial property may later on give rise to a claim that the transfer was not an outright conveyance and was rather an equitable mortgage. Therefore, a lending institution must highly resist any offer from the borrower to lease, handle, or reserve an alternative to purchase any part of the residential or commercial property following the deal.

These are simply a few of the most essential issues in a deed in lieu transfer. Other significant problems need to likewise be thought about in order to protect the celebrations in this relatively complicated procedure. Indeed, every deal is special and can raise various concerns, and each state has its own guidelines and custom-mades relating to these plans, varying from transfer tax problems to the reality that, for example, in New Jersey, deed in lieu deals 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 increasingly utilizing deeds in lieu and consequently enjoying the significant benefits of structuring a deal in this method.

1. For lots of years it was likewise possible-and extremely preferred-for the lender to have the title insurance company consist of a financial institutions' rights endorsement in the title insurance coverage. This safeguarded the loan provider versus having to defend a claim that the deed in lieu deal represented a fraudulent or preferential transfer. However, in March of 2010, the American Land Title Association decertified the creditors' ideal endorsement and thus title companies are no longer using this protection. It needs to be additional kept in mind that if the deed in lieu were set aside by a court based on excessive impact or other acts attributable to the lending institution, there would likely be no title coverage due to the fact that of the defense of "acts of the guaranteed".

Notice: The function of this newsletter is to identify choose developments that may be of interest to readers. The info contained herein is abridged and summed up from various sources, the precision and completeness of which can not be guaranteed. The Advisory ought to not be interpreted as legal suggestions or opinion, and is not an alternative to the recommendations of counsel.