When a borrower defaults on its mortgage, a lending institution has a number of remedies available to it. In the last few years, lenders as well as borrowers have actually significantly picked to pursue alternatives to the adversarial foreclosure procedure. Chief among these is the deed in lieu of foreclosure (described as a "deed in lieu" for brief) in which the lending institution forgives all or the majority of the borrower's commitments in return for the customer voluntarily handing over the deed to the residential or commercial property.

During these tough financial times, deeds in lieu offer loan providers and customers many advantages over a standard foreclosure. Lenders can reduce the unpredictabilities inherent in the foreclosure process, minimize the time and expenditure it takes to recuperate possession, and increase the likelihood of receiving the residential or commercial property in better condition and in a more smooth manner together with a proper accounting. Borrowers can prevent pricey and drawn-out foreclosure fights (which are generally unsuccessful in the long run), handle continuing liabilities and tax ramifications, and put a more positive spin on their credit and track record. Nevertheless, deeds in lieu can also present significant threats to the celebrations if the problems attendant to the process are not thoroughly considered and the documents are not correctly drafted.

A deed in lieu ought to not be thought about unless a professional appraisal values the residential or commercial property at less than the remaining mortgage commitment. Otherwise, there is the threat of another lender (or trustee in insolvency) declaring that the transfer is a deceptive conveyance and, in any case, the borrower would undoubtedly be unwilling to relinquish a residential or commercial property in which it might stand to recuperate some value following a foreclosure sale. Also, a deed in lieu transaction ought to not be forced upon a debtor; rather, it needs to be a complimentary and voluntary act, and a representation and service warranty showing this ought to be memorialized in the agreement. Otherwise, there is a risk that the deal might be vitiated by a court in a subsequent proceeding on the basis of undue impact or comparable theories. If a customer is resistant to finishing a deed in lieu transfer, then a loan provider intent on recovering the residential or commercial property needs to instead start 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 lending institution must avoid 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 unfavorable creditor. Therefore, before initiating, and again before consummating, the deed in lieu deal, the lender must do an adequate 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 quantity of any discovered liens. Often it will be prudent to try to negotiate for the purchase or complete satisfaction of fairly small third party liens. If the lending institution does decide to continue with the deal, it must assess the benefits of obtaining a new title insurance plan for the residential or commercial property and to have a non-merger recommendation included in it.1

For defense versus known or unknown subordinate liens, the loan provider will likewise desire to include anti-merger language in the contract with the borrower, or structure the deal so that the deed is provided to a loan provider affiliate, to make it possible for the loan provider to foreclose (or use take advantage of by factor of the capability to foreclose) such other liens after the delivery of the deed in lieu. Reliance on anti-merger arrangements, nevertheless, can be risky. Cancelling the original note can endanger the lending institution's security interest, so the lending institution ought to rather supply the borrower with a covenant not to sue. This also manages the lending institution versatility to keep any "bad young boy" carve-outs or any other continuing liabilities that are accepted by the celebrations, consisting of environmental matters. Depending on the jurisdiction or specific factual scenarios, nevertheless, another lender may effectively assault the validity of the effort 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 confidence in the residential or and the debtor, the lender requires to be especially vigilant in structuring the deal and establishing the proper contingencies.

One substantial advantage of a thoroughly structured deed-in-lieu procedure is that there will be a comprehensive agreement stating the conditions, representations and provisions that are contractually binding and which can endure the shipment of the deed and related releases. Thus, in addition to the typical pre-foreclosure due diligence that would be carried out by a lender, the agreement will provide a roadmap to the shift procedure along with important information and representations concerning operating accounts, accounting, turnover of leasing and agreement documents, liability and casualty insurance, and so on. Indeed, once the loan provider seizes the residential or commercial property through a voluntary deed process instead of foreclosure, it will likely (both as a legal and practical matter) have higher direct exposure to claims of renters, contractors and other 3rd parties, so a well-crafted deed-in-lieu agreement will go a long way toward enhancing the loan provider's convenience with the total procedure while at the exact same time supplying order and certainty to the customer.

Another significant concern for the loan provider is to make sure that the transfer of the residential or commercial property from the debtor to the lending institution fully and unquestionably snuffs out the debtor's interest in the residential or commercial property. Any staying interest that the customer preserves in the residential or commercial property may later on generate a claim that the transfer was not an absolute conveyance and was rather a fair mortgage. Therefore, a lender must highly resist any deal from the customer 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 concerns in a deed in lieu transfer. Other significant issues should likewise be thought about in order to safeguard the celebrations in this reasonably complicated process. Indeed, every transaction is special and can raise various concerns, and each state has its own guidelines and custom-mades associating with these plans, ranging from transfer tax issues 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 issues should not dissuade-and definitely have not dissuaded-lenders and debtors from increasingly utilizing deeds in lieu and therefore gaining the considerable benefits of structuring a transaction in this way.

1. For several years it was also possible-and extremely preferred-for the loan provider to have the title insurance coverage company consist of a creditors' rights recommendation in the title insurance plan. This protected the lending institution against having to safeguard a claim that the deed in lieu deal represented a deceptive or preferential transfer. However, in March of 2010, the American Land Title Association decertified the creditors' best endorsement and hence title business are no longer using this protection. It should be further kept in mind that if the deed in lieu were set aside by a court based on undue impact or other acts attributable to the loan provider, there would likely be no title protection because of the defense of "acts of the guaranteed".

Notice: The function of this newsletter is to determine select developments that may be of interest to readers. The information consisted of herein is abridged and summed up from different sources, the accuracy and efficiency of which can not be assured. The Advisory needs to not be construed as legal advice or viewpoint, and is not an alternative to the recommendations of counsel.