When a debtor defaults on its mortgage, a lender has a number of solutions readily available to it. Over the last few years, loan providers as well as borrowers have increasingly chosen 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 lending institution forgives all or most of the debtor's obligations in return for the customer willingly handing over the deed to the residential or commercial property.

During these difficult economic times, deeds in lieu offer loan providers and debtors numerous benefits over a conventional foreclosure. Lenders can reduce the uncertainties fundamental in the foreclosure process, minimize the time and cost it takes to recover belongings, and increase the likelihood of receiving the residential or commercial property in better condition and in a more seamless way together with a correct accounting. Borrowers can avoid costly and drawn-out foreclosure battles (which are typically not successful in the long run), handle continuing liabilities and tax ramifications, and put a more positive spin on their credit and reputation. Even so, deeds in lieu can also posture considerable risks to the celebrations if the problems attendant to the procedure are not completely thought about and the files are not correctly drafted.

A deed in lieu should not be thought about unless a professional appraisal values the residential or commercial property at less than the remaining mortgage obligation. Otherwise, there is the hazard of another lender (or trustee in insolvency) declaring that the transfer is a fraudulent conveyance and, in any case, the customer would certainly be hesitant to relinquish a residential or commercial property in which it might stand to recover some value following a foreclosure sale. Also, a deed in lieu deal need to not be forced upon a debtor; rather, it needs to be a complimentary and voluntary act, and a representation and warranty reflecting this should be memorialized in the contract. Otherwise, there is a threat that the transaction might be vitiated by a court in a subsequent case on the basis of excessive influence or comparable theories. If a borrower is resistant to finishing a deed in lieu transfer, then a loan provider intent on recuperating the residential or commercial property needs to rather begin 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 delivery and recordation of the deed in lieu of foreclosure, is possibly 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 adverse creditor. Therefore, before starting, and again before consummating, the deed in lieu transaction, the lender needs to do a sufficient title check; after receiving the report, whether a loan provider will move forward will normally be a case-by-case decision based on the existence and amount of any found liens. Often it will be prudent to attempt to negotiate for the purchase or complete satisfaction of relatively minor 3rd party liens. If the lending institution does choose to proceed with the transaction, it ought to assess the advantages of obtaining a brand-new title insurance policy for the residential or commercial property and to have a non-merger recommendation consisted of in it.1

For defense versus understood or unknown subordinate liens, the loan provider will likewise desire to consist of anti-merger language in the agreement with the customer, or structure the transaction so that the deed is given to a lender affiliate, to make it possible for the loan provider to foreclose (or utilize take advantage of by reason 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 initial note can threaten the loan provider's security interest, so the lender should instead offer the customer with a covenant not to take legal action against. This also manages the loan provider flexibility to keep any "bad boy" carve-outs or any other continuing liabilities that are accepted by the celebrations, including environmental matters. Depending on the jurisdiction or specific accurate situations, nevertheless, another financial institution may 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 customer, the loan provider requires to be especially watchful in structuring the deal and establishing the appropriate contingencies.

One considerable benefit of a thoroughly structured deed-in-lieu procedure is that there will be a detailed agreement setting forth the conditions, representations and provisions that are contractually binding and which can make it through the shipment of the deed and associated releases. Thus, in addition to the regular pre-foreclosure due diligence that would be conducted by a lending institution, the arrangement will provide a roadmap to the shift process in addition to critical details and representations relating to operating accounts, accounting, turnover of leasing and contract files, liability and casualty insurance coverage, and so on. Indeed, once the loan provider acquires the residential or commercial property through a voluntary deed process instead of foreclosure, it will likely (both as a legal and useful matter) have higher direct exposure to claims of renters, contractors and other third celebrations, so a well-crafted deed-in-lieu arrangement will go a long way toward improving the lending institution's comfort with the general procedure while at the exact same time providing order and certainty to the borrower.

Another substantial concern for the loan provider is to make particular that the transfer of the residential or commercial property from the debtor to the lender completely and unquestionably extinguishes the borrower's interest in the residential or commercial property. Any remaining interest that the debtor preserves in the residential or commercial property might later on offer increase to a claim that the transfer was not an outright conveyance and was instead a fair mortgage. Therefore, a lender needs to highly resist any offer from the customer to rent, handle, or reserve an alternative to purchase any part of the residential or commercial property following the transaction.

These are just a few of the most important issues in a deed in lieu transfer. Other substantial concerns need to likewise be thought about in order to safeguard the parties in this fairly complicated procedure. Indeed, every deal is distinct and can raise various issues, and each state has its own guidelines and custom-mades connecting to these plans, varying from transfer tax issues 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 concerns need to not dissuade-and certainly have not dissuaded-lenders and customers from progressively using deeds in lieu and consequently enjoying the substantial benefits of structuring a deal in this way.

1. For lots of years it was also possible-and extremely preferred-for the lending institution to have the title insurance provider consist of a creditors' rights recommendation in the title insurance plan. This safeguarded the lending institution against 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 endorsement and thus title companies are no longer offering this defense. It ought to be additional 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 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 recognize select developments that may be of interest to readers. The information consisted of herein is abridged and summed up from various sources, the accuracy and efficiency of which can not be guaranteed. The Advisory needs to not be interpreted as legal recommendations or viewpoint, and is not a substitute for the suggestions of counsel.