When a borrower defaults on its mortgage, a loan provider has a variety of remedies available to it. In recent years, lending institutions in addition to borrowers have actually significantly selected to pursue alternatives to the adversarial foreclosure process. Chief among these is the deed in lieu of foreclosure (referred to as a "deed in lieu" for short) in which the loan provider forgives all or many of the borrower's commitments 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 lenders and borrowers various benefits over a traditional foreclosure. Lenders can diminish the uncertainties intrinsic in the foreclosure procedure, reduce the time and expense it requires to recuperate possession, and increase the likelihood of getting the residential or commercial property in better condition and in a more seamless way together with an appropriate accounting. Borrowers can prevent costly and protracted foreclosure fights (which are normally not successful in the long run), handle continuing liabilities and tax ramifications, and put a more favorable spin on their credit and reputation. Even so, deeds in lieu can also posture substantial risks to the celebrations if the issues attendant to the process are not completely thought about and the documents are not appropriately drafted.

A deed in lieu must not be thought about unless an expert appraisal values the residential or commercial property at less than the staying mortgage commitment. Otherwise, there is the risk of another creditor (or trustee in personal bankruptcy) claiming that the transfer is a deceptive conveyance and, in any case, the borrower would clearly be unwilling 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 transaction should not be required upon a customer; rather, it must be a free and voluntary act, and a representation and service 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 case on the basis of excessive influence or comparable theories. If a borrower is resistant to completing a deed in lieu transfer, then a lender intent on recovering the residential or commercial property should instead begin a standard 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 delivery and recordation of the deed in lieu of foreclosure, is possibly the most significant mistake a lending institution need to avoid in structuring the transaction. Subordinate liens on the residential or commercial property can only be discharged through a foreclosure procedure or by contract of the adverse creditor. Therefore, before initiating, and again before consummating, the deed in lieu deal, the lending institution must do an enough title check; after receiving the report, whether a lending institution will move on will normally be a case-by-case choice based on the existence and amount of any found liens. Often it will be sensible to attempt to work out for the purchase or complete satisfaction of fairly minor 3rd celebration liens. If the lending institution does decide to proceed with the transaction, it must examine the benefits of obtaining a new title insurance coverage for the residential or commercial property and to have a non-merger endorsement consisted of in it.1

For security against known or unidentified subordinate liens, the loan provider will likewise wish to include anti-merger language in the agreement with the debtor, or structure the transaction so that the deed is offered to a loan provider affiliate, to enable the lending institution to foreclose (or utilize leverage by factor of the ability to foreclose) such other liens after the delivery of the deed in lieu. Reliance on anti-merger provisions, however, can be risky. Cancelling the initial note can threaten the lending institution's security interest, so the lender should rather provide the customer with a covenant not to sue. This likewise manages the lender flexibility to maintain any "bad young boy" carve-outs or any other continuing liabilities that are accepted by the parties, including environmental matters. Depending upon the jurisdiction or specific factual circumstances, nevertheless, another creditor might effectively assault the validity of the effort to prevent merger. Moreover, a non-merger structure may, 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 debtor, the lender requires to be especially alert in structuring the deal and setting up the suitable contingencies.

One considerable benefit of a carefully structured deed-in-lieu procedure is that there will be a detailed contract setting forth 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 regular pre-foreclosure due diligence that would be performed by a lending institution, the agreement will provide a roadmap to the transition process as well as vital information and representations regarding operating accounts, accounting, turnover of leasing and contract documents, liability and casualty insurance coverage, and the like. Indeed, once the lender takes possession of the residential or commercial property through a voluntary deed procedure rather than foreclosure, it will likely (both as a legal and useful matter) have greater exposure to claims of renters, specialists and other 3rd parties, so a well-crafted deed-in-lieu arrangement will go a long way towards enhancing the lending institution's comfort with the general process while at the very same time supplying order and certainty to the borrower.

Another substantial issue for the loan provider is to ensure that the transfer of the residential or commercial property from the customer to the loan provider completely and unquestionably extinguishes the borrower's interest in the residential or commercial property. Any remaining interest that the borrower keeps in the residential or commercial property may later on trigger a claim that the transfer was not an absolute conveyance and was rather an equitable mortgage. Therefore, a lender ought to highly resist any offer from the debtor to rent, 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 essential problems in a deed in lieu transfer. Other significant concerns should likewise be thought about in order to secure the parties in this relatively complicated process. Indeed, every transaction is unique and can raise different 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 likely fall under the state's Bulk Sales Act and its requirements. However, these concerns need to not dissuade-and definitely have not dissuaded-lenders and borrowers from significantly utilizing deeds in lieu and consequently enjoying the considerable benefits of structuring a deal in this way.

1. For lots of years it was likewise possible-and extremely preferred-for the loan provider to have the title insurance provider consist of a financial institutions' rights recommendation in the title insurance coverage. This secured the lending institution versus needing to safeguard a claim that the deed in lieu deal represented a fraudulent or preferential transfer. However, in March of 2010, the American Land Title Association decertified the lenders' right endorsement and therefore title companies are no longer providing this protection. It should be further noted that if the deed in lieu were set aside by a court based upon excessive influence or other acts attributable to the lender, there would likely be no title protection because of the defense of "acts of the insured".

Notice: The function of this newsletter is to identify select advancements that may be of interest to readers. The info contained herein is abridged and summed up from different sources, the precision and completeness of which can not be guaranteed. The Advisory must not be interpreted as legal advice or opinion, and is not a replacement for the suggestions of counsel.