When a debtor defaults on its mortgage, a lender has a number of remedies available to it. In the last few years, lenders in addition to customers have progressively picked to pursue options to the adversarial foreclosure procedure. Chief among these is the deed in lieu of foreclosure (referred to as a "deed in lieu" for brief) in which the lending institution forgives all or the majority of the customer's commitments in return for the debtor willingly turning over the deed to the residential or commercial property.

During these hard economic times, deeds in lieu offer lending institutions and borrowers many benefits over a standard foreclosure. Lenders can reduce the uncertainties inherent in the foreclosure procedure, reduce the time and expense it requires to recuperate belongings, and increase the possibility of getting the residential or commercial property in much better condition and in a more smooth manner together with a proper accounting. Borrowers can avoid pricey and lengthy foreclosure fights (which are normally unsuccessful in the long run), handle continuing liabilities and tax ramifications, and put a more favorable spin on their credit and reputation. However, deeds in lieu can also position significant threats to the parties if the issues attendant to the process are not completely thought about and the files are not appropriately drafted.

A deed in lieu ought to not be considered unless a professional appraisal values the residential or commercial property at less than the remaining mortgage commitment. Otherwise, there is the risk of another creditor (or trustee in bankruptcy) claiming that the transfer is a fraudulent conveyance and, in any case, the debtor would clearly be hesitant to relinquish a residential or commercial property in which it may stand to recover some value following a foreclosure sale. Also, a deed in lieu transaction need to not be required upon a debtor; rather, it must be a totally free and voluntary act, and a representation and warranty reflecting this must be memorialized in the agreement. Otherwise, there is a risk that the deal could be vitiated by a court in a subsequent proceeding on the basis of undue influence or similar theories. If a borrower is resistant to finishing a deed in lieu transfer, then a lender intent on recovering the residential or commercial property ought to rather begin a standard foreclosure.

Ensuring that there are no other negative 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 risk a lender need to avoid in structuring the deal. Subordinate liens on the residential or commercial property can just be discharged through a foreclosure process or by arrangement of the adverse lender. Therefore, before starting, and once again before consummating, the deed in lieu transaction, the lender needs to do an enough title check; after getting the report, whether a loan provider will move forward will normally be a case-by-case decision based on the existence and quantity of any found liens. Often it will be prudent to try to work out for the purchase or satisfaction of relatively minor 3rd party liens. If the loan provider does decide to proceed with the transaction, it must evaluate the benefits of obtaining a brand-new title insurance coverage for the residential or commercial property and to have a non-merger endorsement consisted of in it.1

For protection against understood or unknown secondary liens, the lending institution will also wish to consist of anti-merger language in the arrangement with the borrower, or structure the transaction so that the deed is provided to a loan provider affiliate, to allow the lender to foreclose (or utilize leverage by factor of the ability to foreclose) such other liens after the shipment of the deed in lieu. Reliance on anti-merger provisions, however, can be dangerous. Cancelling the initial note can endanger the lender's security interest, so the lender must rather provide the borrower with a covenant not to sue. This also pays for the lender flexibility to keep any "bad boy" carve-outs or any other continuing liabilities that are concurred to by the celebrations, consisting of ecological matters. Depending upon the jurisdiction or particular factual situations, however, another financial institution might effectively assault the credibility of the attempt 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 confidence in the residential or commercial property and the customer, the loan provider requires to be especially alert in structuring the deal and establishing the proper contingencies.

One substantial advantage of a carefully structured deed-in-lieu process is that there will be an in-depth arrangement setting forth the conditions, representations and provisions that are contractually binding and which can endure the delivery of the deed and related releases. Thus, in addition to the regular pre-foreclosure due diligence that would be conducted by a lending institution, the arrangement will supply a roadmap to the shift procedure along with vital info and representations relating to operating accounts, accounting, turnover of leasing and agreement documents, liability and casualty insurance coverage, and so forth. Indeed, once the lender 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 greater exposure to claims of occupants, contractors and other 3rd parties, so a well-crafted deed-in-lieu contract will go a long way towards enhancing the loan provider's comfort with the total process while at the same time offering 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 lender completely and unquestionably snuffs out the customer's interest in the residential or commercial property. Any remaining interest that the customer preserves in the residential or commercial property might later trigger a claim that the transfer was not an outright conveyance and was rather an equitable mortgage. Therefore, a loan provider ought to strongly resist any offer from the customer to rent, manage, or reserve an option to acquire any part of the residential or commercial property following the deal.

These are just a few of the most essential concerns in a deed in lieu transfer. Other significant issues need to likewise be considered in order to safeguard the celebrations in this reasonably complex procedure. Indeed, every deal is unique and can raise various issues, and each state has its own guidelines and custom-mades relating to these plans, ranging from transfer tax concerns to the reality that, for example, in New Jersey, deed in lieu transactions likely fall under the state's Bulk Sales Act and its requirements. However, these concerns ought to not dissuade-and certainly have not dissuaded-lenders and debtors from significantly utilizing deeds in lieu and consequently enjoying the considerable benefits of structuring a deal in this way.

1. For several years it was also possible-and extremely preferred-for the lender to have the title insurer include a creditors' rights recommendation in the title insurance plan. This safeguarded the lending institution versus needing to protect 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 creditors' best endorsement and hence title business are no longer offering this defense. It ought to be further kept in mind that if the deed in lieu were set aside by a court based on unnecessary 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 might be of interest to readers. The information included herein is abridged and summed up from different sources, the accuracy and completeness of which can not be guaranteed. The Advisory must not be construed as legal suggestions or viewpoint, and is not an alternative to the advice of counsel.