When a customer defaults on its mortgage, a lending institution has a number of remedies readily available to it. In the last few years, lending institutions as well as borrowers 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 loan provider forgives all or most of the customer's obligations in return for the borrower willingly turning over the deed to the residential or commercial property.

During these challenging economic times, deeds in lieu deal lending institutions and borrowers many benefits over a standard foreclosure. Lenders can reduce the uncertainties intrinsic in the foreclosure process, decrease the time and expenditure it requires to recover ownership, and increase the likelihood of receiving the residential or commercial property in better condition and in a more seamless manner together with a correct accounting. Borrowers can prevent costly and drawn-out foreclosure fights (which are usually unsuccessful in the long run), handle continuing liabilities and tax implications, and put a more positive spin on their credit and reputation. Even so, deeds in lieu can likewise present considerable risks to the parties if the issues attendant to the procedure are not thoroughly considered and the files are not correctly prepared.

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 risk of another financial institution (or trustee in insolvency) claiming that the transfer is a deceptive conveyance and, in any case, the customer would undoubtedly hesitate to give up a residential or commercial property in which it may stand to recover some value following a foreclosure sale. Also, a deed in lieu deal must not be required upon a borrower; rather, it should be a free and voluntary act, and a representation and service warranty reflecting this should 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 excessive influence or similar theories. If a customer is resistant to finishing a deed in lieu transfer, then a lender intent on recuperating the residential or commercial property ought to rather commence a conventional 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 biggest pitfall a loan provider must prevent in structuring the transaction. Subordinate liens on the residential or commercial property can only be released through a foreclosure procedure or by contract of the negative creditor. Therefore, before starting, and again before consummating, the deed in lieu transaction, the lender should do an adequate title check; after receiving the report, whether a lending institution will move on will typically be a case-by-case decision based upon the presence and quantity of any found liens. Often it will be prudent to try to work out for the purchase or satisfaction of fairly small 3rd party liens. If the loan provider does choose to proceed with the deal, it needs to examine the benefits of getting a new title insurance coverage for the residential or commercial property and to have a non-merger endorsement consisted of in it.1

For defense against understood or unidentified secondary liens, the lender will likewise want to consist of anti-merger language in the arrangement with the customer, or structure the transaction so that the deed is offered to a lending institution affiliate, to enable the loan provider to foreclose (or use leverage by factor of the ability to foreclose) such other liens after the delivery of the deed in lieu. Reliance on anti-merger provisions, nevertheless, can be dangerous. Cancelling the original note can threaten the lending institution's security interest, so the lending institution should rather offer the borrower with a covenant not to sue. This also manages the lender flexibility to keep any "bad kid" carve-outs or any other continuing liabilities that are agreed to by the parties, consisting of environmental matters. Depending on the jurisdiction or specific accurate circumstances, nevertheless, another lender might successfully assault the validity 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 confidence in the residential or commercial property and the customer, the loan provider requires to be particularly alert in structuring the transaction and setting up the suitable contingencies.

One considerable advantage of a thoroughly structured deed-in-lieu procedure is that there will be an in-depth contract stating the conditions, representations and arrangements that are contractually binding and which can make it through the shipment of the deed and related releases. Thus, in addition to the typical pre-foreclosure due diligence that would be conducted by a loan provider, the contract will provide a roadmap to the transition process along with important info and representations relating to operating accounts, accounting, turnover of leasing and contract documents, liability and casualty insurance, and the like. Indeed, once the loan provider acquires the residential or commercial property through a voluntary deed procedure rather than foreclosure, it will likely (both as a legal and practical matter) have higher direct exposure to claims of tenants, contractors and other 3rd parties, so a well-crafted deed-in-lieu agreement will go a long way toward enhancing the loan provider's comfort with the general process while at the exact same time supplying order and certainty to the borrower.

Another significant issue for the lending institution is to make sure that the transfer of the residential or commercial property from the customer to the loan provider completely and unquestionably extinguishes the debtor's interest in the residential or commercial property. Any staying interest that the customer keeps in the residential or commercial property might later on offer rise to a claim that the transfer was not an absolute conveyance and was rather a fair mortgage. Therefore, a loan provider needs to strongly resist any deal from the borrower to rent, handle, or reserve a choice to buy any part of the residential or commercial property following the transaction.

These are simply a few of the most crucial problems in a deed in lieu transfer. Other considerable issues must also be thought about in order to secure the celebrations in this reasonably intricate process. Indeed, every deal is distinct and can raise various problems, and each state has its own rules and custom-mades relating to these arrangements, ranging from transfer tax issues to the fact that, for instance, in New Jersey, deed in lieu deals most likely fall under the state's Bulk Sales Act and its requirements. However, these concerns should not dissuade-and certainly have not dissuaded-lenders and borrowers from progressively utilizing deeds in lieu and thus reaping the significant benefits of structuring a deal in this method.

1. For several years it was also possible-and highly preferred-for the loan provider to have the title insurer include a creditors' rights endorsement in the title insurance coverage. This safeguarded the lender against having to protect a claim that the deed in lieu deal represented a deceitful or preferential transfer. However, in March of 2010, the American Land Title Association decertified the creditors' ideal recommendation and hence title companies are no longer providing this protection. It needs to be further noted that if the deed in lieu were set aside by a court based upon undue influence or other acts attributable to the lending institution, there would likely be no title coverage because of the defense of "acts of the guaranteed".

Notice: The purpose of this newsletter is to recognize select developments that might be of interest to readers. The info included herein is abridged and summarized from various sources, the accuracy and efficiency of which can not be ensured. The Advisory should not be construed as legal advice or viewpoint, and is not an alternative to the recommendations of counsel.