When a debtor defaults on its mortgage, a lender has a variety of solutions offered to it. In current years, lending institutions in addition to debtors have progressively chosen to pursue alternatives to the adversarial foreclosure process. Chief among these is the deed in lieu of foreclosure (described as a "deed in lieu" for short) in which the loan provider forgives all or many of the borrower's responsibilities in return for the customer voluntarily turning over the deed to the residential or commercial property.

During these tough financial times, deeds in lieu deal loan providers and customers various advantages over a conventional foreclosure. Lenders can diminish the unpredictabilities inherent in the foreclosure process, reduce the time and expense it takes to recuperate possession, and increase the possibility of getting the residential or commercial property in better condition and in a more smooth way together with a proper accounting. Borrowers can prevent pricey and lengthy foreclosure fights (which are normally unsuccessful in the long run), manage continuing liabilities and tax ramifications, and put a more positive spin on their credit and credibility. Even so, deeds in lieu can also present considerable dangers to the parties if the concerns attendant to the procedure are not completely considered and the documents are not appropriately prepared.

A deed in lieu need to not be considered unless a professional appraisal values the residential or commercial property at less than the remaining mortgage responsibility. Otherwise, there is the hazard of another creditor (or trustee in bankruptcy) claiming that the transfer is a deceitful conveyance and, in any case, the borrower would clearly be hesitant to relinquish a residential or commercial property in which it might stand to recuperate some worth following a foreclosure sale. Also, a deed in lieu deal should not be forced upon a debtor; rather, it must be a complimentary and voluntary act, and a representation and warranty reflecting this ought to be memorialized in the agreement. Otherwise, there is a threat that the deal might be vitiated by a court in a subsequent proceeding on the basis of excessive influence or comparable theories. If a customer is resistant to finishing a deed in lieu transfer, then a lending institution intent on recuperating the residential or commercial property needs to instead start 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 perhaps the most significant risk a lender should prevent in structuring the transaction. Subordinate liens on the residential or commercial property can just be discharged through a foreclosure process or by agreement of the unfavorable financial institution. Therefore, before initiating, and again before consummating, the deed in lieu transaction, the lender needs to do a sufficient title check; after getting the report, whether a lender will move on will typically be a case-by-case decision based on the existence and quantity of any discovered liens. Often it will be sensible to try to work out for the purchase or fulfillment of relatively minor 3rd party liens. If the lending institution does decide to proceed with the deal, it must assess the advantages of getting a new title insurance policy for the residential or commercial property and to have a non-merger endorsement included in it.1

For protection versus known or unknown secondary liens, the loan provider will also wish to consist of anti-merger language in the arrangement with the debtor, or structure the deal so that the deed is provided to a lending institution affiliate, to make it possible for the lending institution to foreclose (or use leverage by reason of the ability to foreclose) such other liens after the shipment of the deed in lieu. Reliance on anti-merger arrangements, nevertheless, can be dangerous. Cancelling the original note can endanger the loan provider's security interest, so the lending institution needs to rather offer the borrower with a covenant not to take legal action against. This likewise pays for the lender flexibility to maintain any "bad kid" carve-outs or any other continuing liabilities that are accepted by the celebrations, consisting of environmental matters. Depending upon the jurisdiction or specific accurate scenarios, however, another creditor may 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 customer, the loan provider needs to be particularly vigilant in structuring the transaction and establishing the appropriate contingencies.

One considerable benefit of a thoroughly structured deed-in-lieu procedure is that there will be a comprehensive arrangement stating the conditions, representations and provisions 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 conducted by a lending institution, the agreement will supply a roadmap to the transition procedure along with crucial details and representations concerning operating accounts, accounting, turnover of leasing and agreement files, liability and casualty insurance, and so forth. Indeed, once the lender 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 exposure to claims of occupants, professionals and other 3rd parties, so a well-crafted deed-in-lieu arrangement will go a long method toward improving the lending institution's comfort with the general process while at the same time offering order and certainty to the debtor.

Another significant 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 snuffs out the debtor's interest in the residential or commercial property. Any remaining interest that the debtor maintains in the residential or commercial property may later on offer increase to a claim that the transfer was not an outright conveyance and was instead an equitable mortgage. Therefore, a lending institution should highly resist any deal from the borrower to lease, manage, or reserve an alternative to acquire any part of the residential or commercial property following the transaction.

These are just a few of the most crucial problems in a deed in lieu transfer. Other substantial concerns must also be considered in order to safeguard the celebrations in this fairly intricate procedure. Indeed, every deal is special and can raise different concerns, and each state has its own rules and custom-mades connecting to these plans, varying from transfer tax problems to the fact that, for example, in New Jersey, deed in lieu deals most likely fall under the state's Bulk Sales Act and its requirements. However, these issues ought to not dissuade-and definitely have not dissuaded-lenders and borrowers from progressively using deeds in lieu and thereby enjoying the significant advantages of structuring a transaction in this method.

1. For several years it was also possible-and extremely preferred-for the loan provider to have the title insurance provider include a financial institutions' rights recommendation in the title insurance coverage. This protected the lender against needing to safeguard a claim that the deed in lieu transaction represented a fraudulent or preferential transfer. However, in March of 2010, the American Land Title Association decertified the lenders' ideal endorsement and thus title business are no longer offering this protection. It ought to be more noted that if the deed in lieu were set aside by a court based on excessive impact or other acts attributable to the lending institution, there would likely be no title coverage because of the defense of "acts of the insured".

Notice: The purpose of this newsletter is to identify choose advancements that might be of interest to readers. The details included herein is abridged and summed up from various sources, the accuracy and completeness of which can not be guaranteed. The Advisory should not be interpreted as legal suggestions or opinion, and is not a substitute for the advice of counsel.