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When a customer defaults on its mortgage, a lending institution has a variety of treatments offered to it. Recently, lending institutions in addition to debtors have progressively chosen 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 short) in which the lending institution forgives all or many of the debtor's responsibilities in return for the customer willingly turning over the deed to the residential or commercial property.

During these hard financial times, deeds in lieu offer lenders and customers numerous advantages over a standard foreclosure. Lenders can diminish the unpredictabilities intrinsic in the foreclosure procedure, reduce the time and expense it takes to recover belongings, and increase the probability of receiving the residential or commercial property in better condition and in a more smooth manner together with a correct accounting. Borrowers can avoid pricey and lengthy foreclosure battles (which are usually unsuccessful in the long run), handle continuing liabilities and tax implications, and put a more positive spin on their credit and track record. Nevertheless, deeds in lieu can likewise posture significant dangers to the celebrations if the concerns attendant to the procedure are not thoroughly thought about and the documents are not properly prepared.

A deed in lieu should not be considered unless an expert appraisal values the residential or commercial property at less than the remaining mortgage responsibility. Otherwise, there is the risk of another lender (or trustee in bankruptcy) claiming that the transfer is a deceptive conveyance and, in any case, the borrower would undoubtedly be reluctant to give up a residential or commercial property in which it may stand to recover some worth following a foreclosure sale. Also, a deed in lieu transaction need to not be forced upon a customer; rather, it must be a free and voluntary act, and a representation and guarantee showing this ought to be memorialized in the agreement. Otherwise, there is a threat that the deal could be vitiated by a court in a subsequent proceeding on the basis of undue impact or similar theories. If a borrower is resistant to completing a deed in lieu transfer, then a lender intent on recuperating the residential or commercial property ought to rather start a conventional 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 maybe the biggest pitfall a lending institution should prevent in structuring the deal. Subordinate liens on the residential or commercial property can only be released through a foreclosure procedure or by contract of the adverse financial institution. Therefore, before starting, and once again before consummating, the deed in lieu transaction, the lending institution needs to do an adequate title check; after receiving the report, whether a loan provider will move on will typically be a case-by-case choice based upon the presence and quantity of any found liens. Often it will be prudent to attempt to work out for the purchase or satisfaction of reasonably minor 3rd party liens. If the lender does decide to continue with the deal, it ought to assess the benefits of acquiring a new title insurance plan for the residential or commercial property and to have a non-merger recommendation consisted of in it.1

For security versus understood or unidentified secondary liens, the loan provider will also desire to include anti-merger language in the agreement with the borrower, or structure the transaction so that the deed is offered to a loan provider affiliate, to make it possible for the loan provider to foreclose (or use take advantage of by reason of the capability to foreclose) such other liens after the shipment of the deed in lieu. Reliance on anti-merger arrangements, however, can be dangerous. Cancelling the original note can endanger the lender's security interest, so the lender must rather offer the borrower with a covenant not to sue. This also affords the loan provider versatility to retain any "bad kid" carve-outs or any other continuing liabilities that are accepted by the parties, including environmental matters. Depending upon the jurisdiction or specific accurate scenarios, nevertheless, another financial institution may effectively 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 debtor, the lender requires to be particularly alert in structuring the deal and establishing the suitable contingencies.

One significant advantage of a thoroughly structured deed-in-lieu procedure is that there will be an in-depth contract setting forth 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 carried out by a lender, the arrangement will offer a roadmap to the shift process as well as crucial information and representations concerning running accounts, accounting, turnover of leasing and agreement documents, liability and casualty insurance, and the like. Indeed, once the lending institution acquires the residential or commercial property through a voluntary deed process rather than foreclosure, it will likely (both as a legal and practical matter) have greater direct exposure to claims of renters, professionals and other 3rd parties, so a well-crafted deed-in-lieu contract will go a long method toward enhancing the lender's comfort with the overall process while at the very same time providing order and certainty to the customer.

Another substantial issue for the lending institution is to make sure that the transfer of the residential or commercial property from the debtor to the loan provider completely and unquestionably snuffs out the borrower's interest in the residential or commercial property. Any staying interest that the customer preserves in the residential or commercial property may later generate a claim that the transfer was not an absolute conveyance and was instead an equitable mortgage. Therefore, a lender should strongly withstand 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 simply a few of the most important issues in a deed in lieu transfer. Other must likewise be thought about in order to safeguard the celebrations in this fairly intricate procedure. Indeed, every deal is unique and can raise various issues, and each state has its own rules and customs relating to these plans, ranging from transfer tax concerns to the fact that, for example, in New Jersey, deed in lieu deals likely fall under the state's Bulk Sales Act and its requirements. However, these issues must not dissuade-and certainly have not dissuaded-lenders and customers from progressively using deeds in lieu and therefore enjoying the substantial advantages of structuring a transaction in this way.

1. For numerous years it was also possible-and highly preferred-for the lending institution to have the title insurer include a creditors' rights endorsement in the title insurance policy. This protected the loan provider versus having to protect a claim that the deed in lieu deal represented a deceitful or preferential transfer. However, in March of 2010, the American Land Title Association decertified the lenders' best recommendation and hence title companies are no longer using this security. It must be further kept in mind that if the deed in lieu were set aside by a court based upon unnecessary impact or other acts attributable to the lender, there would likely be no title protection due to the fact that of the defense of "acts of the insured".

Notice: The function of this newsletter is to identify select developments that might be of interest to readers. The information contained herein is abridged and summarized from various sources, the precision and efficiency of which can not be assured. The Advisory should not be construed as legal advice or opinion, and is not an alternative to the guidance of counsel.