When a borrower defaults on its mortgage, a loan provider has a number of solutions offered to it. Over the last few years, lenders in addition to customers have progressively selected to pursue options to the adversarial foreclosure process. Chief amongst these is the deed in lieu of foreclosure (referred to as a "deed in lieu" for short) in which the lender forgives all or the majority of the customer's commitments in return for the customer voluntarily turning over the deed to the residential or commercial property.

During these hard economic times, deeds in lieu offer lending institutions and customers various advantages over a traditional foreclosure. Lenders can lessen the uncertainties fundamental in the foreclosure process, minimize the time and cost it requires to recover belongings, and increase the possibility of receiving the residential or commercial property in much better condition and in a more seamless manner together with a correct accounting. Borrowers can prevent costly and drawn-out foreclosure fights (which are normally not successful in the long run), handle continuing liabilities and tax ramifications, and put a more positive spin on their credit and reputation. Nevertheless, deeds in lieu can also position substantial dangers to the celebrations if the issues attendant to the process are not completely considered and the files are not effectively prepared.

A deed in lieu must not be thought about unless a professional 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 customer would obviously hesitate to relinquish a residential or commercial property in which it might stand to recover some worth following a foreclosure sale. Also, a deed in lieu deal must not be required upon a borrower; rather, it needs to be a totally free and voluntary act, and a representation and guarantee reflecting this need to be memorialized in the agreement. Otherwise, there is a danger that the deal might be vitiated by a court in a subsequent case on the basis of unnecessary 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 rather start a traditional foreclosure.

Ensuring that there are no other negative 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 perhaps the most significant pitfall a loan provider must 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 adverse financial institution. Therefore, before starting, and once again before consummating, the deed in lieu deal, the loan provider should do a sufficient title check; after getting the report, whether a loan provider will move forward will normally be a case-by-case decision based upon the presence and amount of any found liens. Often it will be sensible to attempt to negotiate for the purchase or complete satisfaction of fairly small 3rd party liens. If the lender does decide to proceed with the deal, it should evaluate the advantages of getting a new title insurance coverage for the residential or commercial property and to have a non-merger endorsement included in it.1

For defense against known or unknown subordinate liens, the lending institution will likewise wish to include anti-merger language in the contract with the customer, or structure the transaction so that the deed is provided to a lending institution affiliate, to allow the lender to foreclose (or utilize utilize by factor of the capability to foreclose) such other liens after the delivery of the deed in lieu. on anti-merger arrangements, however, can be dangerous. Cancelling the initial note can endanger the lender's security interest, so the lending institution ought to rather supply the customer with a covenant not to sue. This likewise affords the loan provider versatility to retain any "bad young boy" carve-outs or any other continuing liabilities that are consented to by the parties, including environmental matters. Depending on the jurisdiction or specific accurate situations, nevertheless, another lender might successfully attack the credibility of the attempt to prevent merger. Moreover, a non-merger structure might, in some jurisdictions, have a transfer tax effect. The bottom line is that if there is not a high degree of self-confidence in the residential or commercial property and the customer, the loan provider requires to be specifically watchful in structuring the deal and setting up the suitable contingencies.
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One substantial benefit of a thoroughly structured deed-in-lieu process is that there will be an in-depth contract stating the conditions, representations and arrangements that are contractually binding and which can survive the delivery of the deed and related releases. Thus, in addition to the normal pre-foreclosure due diligence that would be performed by a lender, the arrangement will offer a roadmap to the transition process in addition to crucial details and representations concerning operating accounts, accounting, turnover of leasing and contract documents, liability and casualty insurance coverage, and the like. Indeed, once the lender acquires the residential or commercial property through a voluntary deed procedure as opposed to foreclosure, it will likely (both as a legal and practical matter) have higher exposure to claims of tenants, specialists and other third parties, so a well-crafted deed-in-lieu contract will go a long method towards boosting the lender's convenience with the general procedure while at the exact same time offering order and certainty to the debtor.
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Another substantial issue for the loan provider is to make sure that the transfer of the residential or commercial property from the borrower to the lender totally and unequivocally extinguishes the customer's interest in the residential or commercial property. Any remaining interest that the customer preserves in the residential or commercial property might later trigger a claim that the transfer was not an outright conveyance and was instead an equitable mortgage. Therefore, a loan provider needs to highly resist any deal from the customer to lease, handle, or reserve a choice to acquire any part of the residential or commercial property following the transaction.

These are simply a few of the most important issues in a deed in lieu transfer. Other significant issues should also be considered in order to protect the parties in this relatively complex process. Indeed, every deal is distinct and can raise different concerns, and each state has its own guidelines and customs connecting to these arrangements, ranging from transfer tax problems to the fact that, for example, in New Jersey, deed in lieu deals likely fall under the state's Bulk Sales Act and its requirements. However, these issues should not dissuade-and definitely have not dissuaded-lenders and debtors from increasingly using deeds in lieu and thus gaining the substantial benefits of structuring a deal in this way.

1. For several years it was also possible-and extremely preferred-for the lender to have the title insurance business include a creditors' rights recommendation in the title insurance policy. This protected the lending institution versus having to defend a claim that the deed in lieu transaction represented a deceitful or preferential transfer. However, in March of 2010, the American Land Title Association decertified the financial institutions' best recommendation and therefore title business are no longer providing this security. It should be more kept in mind that if the deed in lieu were reserved by a court based on excessive impact or other acts attributable to the lending institution, there would likely be no title protection due to the fact that of the defense of "acts of the insured".

Notice: The purpose of this newsletter is to identify select advancements that might be of interest to readers. The information contained herein is abridged and summarized from numerous sources, the accuracy and efficiency of which can not be ensured. The Advisory should not be construed as legal guidance or opinion, and is not an alternative for the guidance of counsel.