Practical And Legal Perspectives On Deed In Lieu Transactions

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When a customer defaults on its mortgage, a lending institution has a number of treatments available to it. Over the last few years, loan providers as well as customers have progressively chosen to pursue options to the adversarial foreclosure procedure. Chief among these is the deed in lieu of foreclosure (described as a "deed in lieu" for short) in which the lender forgives all or the majority of the customer's responsibilities in return for the customer willingly handing over the deed to the residential or commercial property.


During these hard economic times, deeds in loan providers and borrowers various benefits over a traditional foreclosure. Lenders can reduce the uncertainties inherent in the foreclosure procedure, decrease the time and expense it takes to recuperate ownership, and increase the probability of receiving the residential or commercial property in better condition and in a more seamless way together with an appropriate accounting. Borrowers can prevent costly and drawn-out foreclosure fights (which are generally not successful in the long run), handle continuing liabilities and tax implications, and put a more positive spin on their credit and reputation. Nevertheless, deeds in lieu can likewise present substantial risks to the parties if the issues attendant to the procedure are not thoroughly thought about and the documents are not effectively drafted.


A deed in lieu should not be thought about unless an expert appraisal values the residential or commercial property at less than the staying mortgage responsibility. Otherwise, there is the hazard of another financial institution (or trustee in bankruptcy) claiming that the transfer is a deceitful conveyance and, in any case, the debtor would certainly hesitate to give up a residential or commercial property in which it might stand to recuperate some worth following a foreclosure sale. Also, a deed in lieu deal ought to not be forced upon a debtor; rather, it must be a free and voluntary act, and a representation and warranty reflecting this must be memorialized in the contract. Otherwise, there is a threat that the deal might be vitiated by a court in a subsequent proceeding on the basis of undue impact or comparable theories. If a debtor is resistant to completing a deed in lieu transfer, then a lender intent on recuperating the residential or commercial property should rather commence a traditional foreclosure.


Ensuring that there are no other adverse liens on the residential or commercial property, and that there will be no such liens pending the shipment and recordation of the deed in lieu of foreclosure, is perhaps the biggest mistake a lender need to avoid in structuring the deal. Subordinate liens on the residential or commercial property can only be released through a foreclosure process or by arrangement of the adverse financial institution. Therefore, before initiating, and once again before consummating, the deed in lieu deal, the lender must do a sufficient title check; after receiving the report, whether a lender will move on will generally be a case-by-case decision based upon the existence and quantity of any discovered liens. Often it will be prudent to try to work out for the purchase or complete satisfaction of reasonably minor third party liens. If the loan provider does choose to proceed with the transaction, it ought to assess the advantages of acquiring a brand-new title insurance coverage for the residential or commercial property and to have a non-merger recommendation consisted of in it.1


For protection versus known or unknown subordinate liens, the loan provider will also desire to consist of anti-merger language in the arrangement with the customer, or structure the transaction so that the deed is provided to a lending institution affiliate, to enable the lending institution to foreclose (or utilize leverage by factor of the capability to foreclose) such other liens after the delivery of the deed in lieu. Reliance on anti-merger provisions, nevertheless, can be risky. Cancelling the original note can endanger the loan provider's security interest, so the loan provider needs to instead offer the customer with a covenant not to sue. This also affords the lender flexibility to retain any "bad boy" carve-outs or any other continuing liabilities that are consented to by the parties, consisting of ecological matters. Depending on the jurisdiction or specific factual scenarios, nevertheless, another lender might effectively attack the credibility of the attempt to prevent merger. Moreover, a non-merger structure might, 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 borrower, the loan provider needs to be specifically watchful in structuring the transaction and establishing the appropriate contingencies.


One considerable advantage of a carefully structured deed-in-lieu process is that there will be an in-depth agreement setting forth the conditions, representations and arrangements 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 carried out by a lender, the contract will offer a roadmap to the shift process as well as crucial info and representations regarding operating accounts, accounting, turnover of leasing and agreement files, liability and casualty insurance, and so forth. Indeed, once the loan provider seizes the residential or commercial property through a voluntary deed procedure instead of foreclosure, it will likely (both as a legal and useful matter) have higher exposure to claims of renters, contractors and other third parties, so a well-crafted deed-in-lieu arrangement will go a long method toward enhancing the loan provider's convenience with the overall procedure while at the same time offering order and certainty to the borrower.


Another substantial issue for the lending institution is to make particular that the transfer of the residential or commercial property from the debtor to the lending institution totally and unquestionably extinguishes the customer's interest in the residential or commercial property. Any remaining interest that the borrower preserves in the residential or commercial property might later on generate a claim that the transfer was not an outright conveyance and was rather an equitable mortgage. Therefore, a lender needs to strongly withstand any deal from the debtor to rent, manage, or reserve an option to purchase any part of the residential or commercial property following the deal.


These are simply a few of the most essential problems in a deed in lieu transfer. Other substantial concerns must also be considered in order to safeguard the parties in this fairly complex process. Indeed, every transaction is special and can raise different issues, and each state has its own rules and custom-mades connecting to these plans, varying from transfer tax concerns to the truth that, for instance, 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 borrowers from increasingly using deeds in lieu and thus reaping the significant benefits of structuring a transaction in this way.
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1. For several years it was also possible-and highly preferred-for the lending institution to have the title insurance provider consist of a creditors' rights endorsement in the title insurance coverage. This secured the loan provider versus needing to defend a claim that the deed in lieu transaction represented a deceptive or preferential transfer. However, in March of 2010, the American Land Title Association decertified the financial institutions' ideal recommendation and therefore title business are no longer using this protection. It needs to be more kept in mind that if the deed in lieu were set aside by a court based upon undue influence or other acts attributable to the loan provider, there would likely be no title coverage because of the defense of "acts of the insured".


Notice: The function of this newsletter is to recognize choose developments that may be of interest to readers. The info included herein is abridged and summarized from various sources, the precision and efficiency of which can not be ensured. The Advisory must not be interpreted as legal guidance or opinion, and is not an alternative to the recommendations of counsel.