Lender Remedies After Default, Prior to Consummation of Foreclosure

1. Lender Remedies After Default, Prior to Consummation of Foreclosure • Lender’s basic choice is between; (1) accepting the proceeds of a sale to a third party in satisfaction of the mortgage; (2) accepting a deed from the borrower in lieu of foreclosure; (3) filing a foreclosure action; and, (4) in some states, foreclosing pursuant to state law that authorizes foreclosure by out-of-court sale. Donald J. Weidner

2. “Short Sales” • A “short sale” takes place when a lender accepts in satisfaction of a mortgage the net proceeds of a sale by the borrower to a third party, even though the proceeds are less than the amount due on the mortgage. • A lender is more likely to entertain a short sale if the property is worth less than the amount of the mortgage and a deficiency judgment against the borrower is either theoretically or practically improbable. Donald J. Weidner

3. “Short Sales” (cont’d) • The short sale route permits the lender to avoid: • The delays incident to foreclosure. • The costs of a foreclosure proceeding. • The carrying costs or management responsibilities incident to owning property upon consummation of foreclosure. • The resale costs of property acquired through foreclosure. • The appearance of too many “REO” properties (real estate owned as a result of foreclosure) on its books. Donald J. Weidner

4. Lender Remedies While Foreclosure is Pending • There are 3 remedies a lender might seek while a foreclosure action is pending: • 1. Physical possession of the mortgaged property. • 2. Assignment of rents from the mortgaged property. • 3. Appointment of a receiver to take charge of the mortgaged property. Donald J. Weidner

5. Lender Remedies After Default, Prior to Foreclosure (cont’d) • In the area of Lender remedies after default and prior to foreclosure, the theory of the mortgage has some, although limited, predictive value. Recall the three theories are: 1. Lien—A mortgage is only a lien, that is, a right to obtain title and possession by prosecuting a foreclosure action to completion. 2. Intermediate—A mortgage is initially only a lien, but title, and the right to possession, passes to the mortgagee when the mortgagor defaults 3. Title—A mortgage is a conveyance that passes title, and the right to possession, as soon as it is executed. Donald J. Weidner

6. Lender Remedy # 1: Physical Possession See Lifton article at text p. 870: • “Even in the title and intermediate states, modern courts are reluctant to grant a mortgagee physical possession of the property.” • Even if physical possession is possible, “restraints on the mortgagee and the risks of possession may dissuade lenders from seeking it.” Depending upon the jurisdiction a mortgagee in possession: • may have limited power over the property; • may not be compensated for its own management efforts and may not be able to recover money it spends to improve or to maintain the property; and • may risk having to account to the owner under stringent accounting rules for decisions on renting and operating the property if the owner later redeems. Donald J. Weidner

7. Lender Remedy # 2: Assignment of Rents Lifton article (cont’d): • Rather than seek physical possession, “the lender will usually look to the traditional remedies granting constructive possession. These are contained in standard mortgage provisions for • assignment of rents and for • appointment of a receiver in case of default.” • “Generally, an assignment of rents can be activated in title, intermediate and some lien states (such as Florida) by the mortgagee’s serving notice on the tenants . . . to pay their rents to the mortgagee.” • See the Florida assignment of rents Statute 697.07 • Most courts prefer to appoint an independent receiver. Donald J. Weidner

8. Florida Assignment of Rents Statute 697.07 • Purpose: to avoid the necessity of getting a receiver appointed to collect rents. • If a mortgage or separate instrument provides for an assignment of rents to secure repayment of an indebtedness, “the mortgagee shall hold a lien on the rents, and the lien created by the assignment shall be perfected and effective against third parties upon recordation of the mortgage or separate instrument with the public records of the county in which the real property is located . . . .” 690.07(1) and (2). • The assignment is enforceable “upon the mortgagor’s default and written demand for the rents made by the mortgagee . . . .” 690.07(3). • Therefore, on this issue, Florida is not the strictest of lien states Donald J. Weidner

9. Florida Assignment of Rents Statute 697.07 (cont’d) • Upon application by either the mortgagor or the mortgagee, in a foreclosure action, a court “may require the mortgagor to deposit the collected rents into the registry of the court, or in such other depository as the court may designate.” 697.07(4). • The court may authorize the use of the collected rents to pay “the reasonable expenses solely to protect, preserve, and operate the real property, including, without limitation, real estate taxes and insurance,” and to make payments to the mortgagee. 697.07(4)(a) and (c). • “The court shall expedite the hearing on the application by the mortgagee or mortgagor to enforce the assignment of rents.” 697.07(6). Donald J. Weidner

10. Lender Remedy # 3: Appointment of Receiver Lifton article (cont’d): • States vary in their approach to appointment of a receiver: • At one extreme, an agreement to appoint a receiver is usually sufficient to support an appointment. • In the middle, some states will appoint a receiver if there is proof: • that the security is impaired (courts differ on what constitutes impairment) and/or • that the borrower is insolvent. • At the other extreme, it is almost impossible to obtain a receiver. Donald J. Weidner

11. Lender Remedy # 3: Appointment of Receiver (cont’d) • Drawbacks of the Remedy of Appointment of a Receiver: • It can take a long time to get a receiver appointed. • The receiver may not be a good manager. • The receiver’s fees may eat up a good portion of the income. • Many lenders will simply choose to accept a deed in lieu of foreclosure. • Which can have risks. Donald J. Weidner

12. 3 notes to finance 3 townhouse purchases CUNA Mortgage v. Aafedt (Text p. 875) 1985 Borrower Credit Union 3 Mortgages to secure notes HUD insured the Mortgages Credit Union Assign Ns & Ms CUNA Assignee Defaulted 1989 Borrower Commenced action to foreclose, stating it will not seek Deficiency .Judgment. CUNA Assignee CUNA Assignee Offers Deeds in Lieu of Foreclosure Rejects offer because CUNA’s mortgage insurer, HUD, said it would not reimburse CUNA if all CUNA could assign to HUD was a title acquired by a Deed in lieu of Foreclosure. CUNA filed foreclosure action Borrower Executed Quitclaim Deeds of 3 properties and records w/out CUNA’s knowledge Borrower Moved to dismiss foreclosure action because it executed the Deeds in lieu of foreclosure Borrower Donald J. Weidner

13. CUNA Mortgage v. Aafedt (cont’d) • CUNA said its ability to receive the mortgage insurance proceeds from HUD would be impaired if it accepted a deed in lieu rather than title through foreclosure. • Trial Court: • 1. Quitclaim deed was void [it was a unilateral act without CUNA’s consent, acquiescence, and hence there was no delivery]; and • 2. CUNA was entitled to bring the foreclosure proceeding. Donald J. Weidner

14. CUNA Mortgage v. Aafedt (cont’d) • Normally, recording a deed creates a rebuttable presumption of its delivery to, and its acceptance by, the grantee. • However, the presumption of acceptance arises only if the deed is beneficial to the grantee, not when the deed places a burden on the grantee. • Here, CUNA’s refusal to accept a deed in lieu was not in bad faith. Donald J. Weidner

15. Lender Wariness of Deeds in Lieu of Foreclosure Lenders are wary of “deeds in lieu” for a variety of reasons: 1. If bankruptcy is filed against the debtor within 90 days of the conveyance, a deed in lieu may be set aside as a preference. • Many title companies won’t insure on a deed in lieu until the 90-day preference period has passed. 2. Another possibility, though less likely, is that, if bankruptcy is filed within a year of the conveyance, it may be deemed a fraudulent transfer. Donald J. Weidner

16. Lender Wariness of Deeds in Lieu of Foreclosure (cont’d) 3. A voluntary conveyance from the owner does not cut off junior mortgagees or mechanics lien claimants. • Therefore, a foreclosure action may still be necessary to wipe out those liens. • Also: a junior lienor may argue, under the merger doctrine, that it is now the senior lien. • In short, if intervening liens are discovered, “the only prudent alternative for the mortgagee is to foreclose.” • In some states, the tax on voluntary transfers may be very high—based on the total value of the property (unreduced by the mortgage). Donald J. Weidner

17. Lender Wariness of Deeds in Lieu of Foreclosure (cont’d) • There is a difference between theory and practice as state courts consider deeds in lieu. • In theory: • The rule against contemporaneous clogs on the equity of redemption does not apply to transactions subsequent to the original mortgage • Most courts permit the mortgagee to purchase the mortgagor’s equity of redemption. Donald J. Weidner

18. Lender Wariness of Deeds in Lieu of Foreclosure (cont’d) • However, in practice, courts examine a deed in lieu to assure it is: 1. Free from fraud. 2. Based on an adequate consideration; and 3. Is truly subsequent to the mortgage and not contemporaneous with it (not put in escrow when the mortgage was first executed). Donald J. Weidner

19. Lender Wariness of Deeds in Lieu (cont’d) 5. Theory versus practice and deeds in lieu (cont’d) • Courts are concerned with the disparity in bargaining strength between a lender and a borrower in default. • There are two situations in which the courts are more likely to be especially solicitous of the borrower: 1. If the transaction might be construed “as unfair and unconscionable,” • “especially if the consideration paid is disproportionately less than the value of the equity or if none is paid where the equity has value.” 2. Nonrecourse Debt. If “the deed is not by the mortgagor, but by a non-assuming grantee of the mortgagor, a release of the debt, since there was no personal liability, would be no consideration for the conveyance . . . and subject it to being set aside.” Donald J. Weidner

20. Lender Wariness of Deeds in Lieu (cont’d) 5. Theory versus Practice (cont’d) • “[T]here is always the possibility that a court will construe the [deed in lieu] as simply another mortgage transaction.” • “If the mortgagor is successful, he will be treated as a mortgagor under two mortgages—under the original mortgage which was not eliminated by the deed in lieu and under the deed in lieu treated as a second mortgage.” • “[T]he possibility [also] exists that because of insolvency of the mortgagor or an actual intent on his part to defraud creditors the conveyance may be subject to avoidance at the suit of creditors outside of bankruptcy.” Donald J. Weidner

21. Bankruptcy Review • A transfer by a debtor to a creditor prior to bankruptcy may be set aside as: • a preferential transfer that can be avoided or • a fraudulent conveyance • If bankruptcy occurs, arrangements between the debtor and creditors may be significantly altered: • Section 365 permits the trustee or debtor in possession to assume or reject executory contracts and leases; • The “cram down” provisions may force creditors to accept reorganization they do not like; and • The Code’s automatic stay of proceedings against a debtor or the debtor’s property prevents a mortgagee from foreclosing unless an exception is granted; • The automatic stay may also prevent a lender from self-help, such as collecting rents under an assignment of rents provision in a mortgage. Donald J. Weidner

22. Klee Article on Single Asset Real Estate Bankruptcy • Klee (p. 879) notes the change in 1994 Bankruptcy law concerning single asset real estate (“SARE”) debtors. • Situations in which the debtor’s only asset was a single real estate property (not involving a residential property with fewer than 4 units) • The 1994 change added an additional procedure by which certain real property mortgage holders could obtain relief from the Bankruptcy Code’s “automatic stay” provisions. Donald J. Weidner

23. Klee Article on Single Asset Real Estate Bankruptcy (cont’d) • A SARE mortgage holder may get relief from the automatic stay to foreclose unless, within 90-days after the order for relief, the debtor has a confirmable plan or begins making monthly payments to the mortgage holder. • This shortens the Chapter 11 process for the lender or forces the debtor to “pay to play” by making cash payments to the lender. • After 2001, there is no $4 million debt cap on this provision. Donald J. Weidner

24. BFP v. Resolution Trust Corp. (Text p. 883) BFP is a PP to buy a home. Ps: Pedersens & Barton Foremans Sellers Contract to sell and buy $356,250 Cash to purchase S & L PP 1 $356,250 Purchase Money Note and Deed of Trust 2. $200,000 Sellers Purchase Money Note and 2nd Deed of Trust Noticed the partnership and the sellers of a non-judicial foreclosure sale in accordance with state law PP S & L Paid $433,000 at F/C sale Buyer at FC Sale Allegation: Fair Market Value was $725,000 Deed Shortly thereafter, the PP filed under Chapter 11 and sought to set aside the F/C sale conveyance to Buyer on the ground that it constituted a fraudulent transfer. Donald J. Weidner

25. BFP v. Resolution Trust Corp. (cont’d) • Unlike the vulnerability of a deed in lieu, a foreclosure that is properly conducted under state law receives great deference • Even if it is conducted outside of court. • BFP v. Resolution Trust involves a non-judicial foreclosure of a partnership’s equity of redemption in a property allegedly worth $725,000. • The puchaser at the foreclosure sale paid only $433,000. Donald J. Weidner

26. BFP v. Resolution Trust Corp. (cont’d) • The partnership subsequently filed under Chapter 11 and asserted that the foreclosure of its equity of redemption in the year prior to the filing constituted a fraudulent transfer. • A trustee in bankruptcy, or a debtor in possession under Chapter 11, has the power to set aside fraudulent transfers of two types: • Those infected by actual fraud; and • Those involving constructive fraud. Donald J. Weidner

27. BFP v. Resolution Trust (cont’d) • The rule in question permits the trustee to avoid the sale if the trustee can establish: • that the debtor had an interest in the property (clearly here); • that a transfer of that interest occurred within one year of the filing of the bankruptcy petition (clearly here); • that the debtor was insolvent at the time of the transfer (or became insolvent because of it) (clearly here); and • that the debtor received “less than a reasonably equivalent value in exchange” for the transfer. That is the question in BFP. Donald J. Weidner

28. BFP: Justice Scalia’s Response • The Circuits had 3 different approaches to determine whether “reasonably equivalent value” had been given: • The 5th Circuit in Durrett had said that any foreclosure sale for less than 70% of fair market value failed to qualify as “reasonably equivalent value” and should be invalidated; • The 7th Circuit adopted an “all facts and circumstances” approach to determine whether “reasonably equivalent value” is received; and • The 9th Circuit in this case held that a “non-collusive and regularly conducted nonjudicial foreclosure sale . . . cannot be challenged as a fraudulent conveyance because the consideration received in such a sale establishes ‘reasonably equivalent value’ as a matter of law.” Donald J. Weidner

29. BFP: Scalia’s Response (cont’d) • Justice Scalia said that both the 5th Circuit and the 7th Circuit “refer to fair market valueas the benchmark against which determination of reasonably equivalent value is to be measured.” • Fair market value is used elsewhere in the Bankruptcy Code, but not “in the context of an otherwise lawful mortgage foreclosure sale.” • “One must suspect [the use of the term “reasonably equivalent value”] means that fair market value cannot—or at least cannot always—be the benchmark.” • “The suspicion becomes a certitude when one considers that market value, as it is commonly understood, has no applicability in the forced-sale context; indeed, it is the very antithesis of forced-sale value.” Donald J. Weidner

30. Scalia (cont’d) • Market value is the “price as would be fixed by negotiation and mutual agreement, after ample time to find a purchaser, as between a vendor who is willing (but not compelled) to sell and a purchaser who desires to buy but is not compelled to take the particular . . . piece of property.” (citing Black’s) • These market conditions, by definition, do not exist in a forced-sale context. • “Market value cannot be the criterion of equivalence in the foreclosure-sale context.” • Property that must be sold within the strictures “of state-prescribed foreclosure” “is simply worth less.” Donald J. Weidner

31. Scalia (cont’d) • One might ask whether there is a “reasonable” or “fair” forced-sale price, but these are policy judgments courts have no authority to make under the Bankruptcy Code. • The price realized in a foreclosure sale “depends upon the terms of the forced sale,” which vary among the states. • When the state procedures have been followed, it is “black letter” law “that the mere inadequacy of the foreclosure sale price is no basis for setting the sale aside, • though it may be set aside (under state foreclosure law, rather than fraudulent transfer law) if the price is so low as to “shock the conscience, or raise a presumption of fraud or unfairness.” Donald J. Weidner

32. Scalia (cont’d) • Foreclosure law and fraudulent transfer law “enjoyed over 400 years of peaceful coexistence” until the 5th Circuit’s unprecedented decision in Durrett. • “To our knowledge no prior decision had ever applied the ‘grossly inadequate price’ badge of fraud under fraudulent transfer law to set aside a foreclosure sale.” • “We deem . . . that a fair and proper price, or a ‘reasonably equivalent value,’ for foreclosed property, is the price in fact received at the foreclosure sale, so long as all the requirements of the State’s foreclosure law have been complied with.” Donald J. Weidner

33. A Florida Note to B.F.P. v. Resolution Trust • The type of out-of-court foreclosure procedure used in B.F.P. v. Resolution Trust is not available under Florida law. • Florida Statute 702.01 provides: “All mortgages shall be foreclosed in equity. In a mortgage foreclosure action, the court shall sever for separate trial all counterclaims against the foreclosing mortgagee. The foreclosure claim shall, if tried, be tried to a court without a jury.” Donald J. Weidner

34. Skylake Insurance Agency, Inc. v. NMB Plaza, LLC (Supp. p. 41) • Landlord LLC executed a 10-year lease of commercial property in Florida to Tenant corporation. • Only one party executed the lease on behalf of the Landlord. • Under the Florida law of LLCs, a lease is effective if it is signed by any member of a member-managed LLC or by any manager of a manager-managed LLC. • However, FSA 689.01, “How real estate conveyed,” states that no estate “for a term of more than 1 year” shall be created or transferred “in any other manner than by instrument in writing, signed in the presence of two subscribing witnesses . . . .” • With a specific exception for conveyances by corporations that comply with the requirements of with corporate law. Donald J. Weidner

35. Skylake Insurance Agency, Inc. v. NMB Plaza, LLC (cont’d) • The landlord repudiated the lease on the ground that there were not two witnesses to its signature. • Judge Cope said the “corporate” exception does not apply to LLCs. • Therefore, Judge Cope concluded that the 10-year written lease did not satisfy the requirement of the Florida statute on real estate conveyances. • Therefore, it was not an effective conveyance of an estate in real property enforceable by specific performance. • However, it did satisfy the Florida Statute of Frauds. • Therefore, it was a valid contract enforceable by damage remedy. Donald J. Weidner

36. Representations and Warranties by Mortgage Sellers • “When banks sell mortgages to investors or bundle them into securities, they typically offer ‘representations and warranties,’ in which they guarantee that information backing the loans is accurate. Examples include borrowers’ income and the appraised worth of the home. If the data is proven wrong, the bank may buy back the loan or reimburse investors for the lost value.” • Hugh Son and Dawn Kopecki, Bank of America Sees $2 Billion Charge on Home Loans, Bloomberg, 1/3/11. Donald J. Weidner

37. Representations and Warranties by Mortgage Sellers (cont’d) • On January 3, 2011, Bank of America Corp. agreed to pay $2.8 billion to Freddie Mac and Fannie May after Fannie and Freddie demanded the Bank buy back mortgages they said were based on faulty data. • Largely traced to its acquisition of Countrywide. • Some analysts said BOA got off easy. • The Bank exited the TARP program in December of 2009. Donald J. Weidner

38. Representations and Warranties by Mortgage Sellers (cont’d) • In January of 2013, Bank of America announced roughly $11.6 billion of settlements with Fannie Mae. • B of A is paying $3.6 billion to Fannie Mae and buying back $6.75 billion of bad loans from the mortgage company to clear up all claims Fannie Mae had against B of A. • Under a separate settlement, B of A will pay Fannie Mae because of foreclousure delays. Donald J. Weidner

39. “Robo-Signing” Settlement • In January of 2013, ten banks agreed with federal regulators to pay $8.5 billion to borrowers for so-called “robo signing,” which involved fraudulent mortgage foreclosure proceedings. • Part of the money will go to direct payments to parties who have been foreclosed upon, part to forgiveness of deficiencies and part to loan modifications. • This follows a $25 billion settlement in 2012 with many state attorneys general. Donald J. Weidner