When a debtor defaults on its mortgage, a lender has a number of solutions offered to it. In current years, lending institutions as well as borrowers have progressively picked to pursue options to the adversarial foreclosure process. Chief among these is the deed in lieu of foreclosure (referred to as a "deed in lieu" for brief) in which the lender forgives all or many of the customer's obligations in return for the customer voluntarily turning over the deed to the residential or commercial property.

During these tough economic times, deeds in lieu offer loan providers and debtors numerous advantages over a conventional foreclosure. Lenders can reduce the uncertainties intrinsic in the foreclosure process, decrease the time and expenditure it takes to recuperate belongings, and increase the likelihood 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 expensive and lengthy foreclosure battles (which are generally not successful in the long run), manage continuing liabilities and tax ramifications, and put a more positive spin on their credit and track record. However, deeds in lieu can likewise posture substantial threats to the parties if the problems attendant to the procedure are not thoroughly considered and the documents are not effectively drafted.

A deed in lieu should not be considered unless an expert appraisal values the residential or commercial property at less than the staying mortgage responsibility. Otherwise, there is the danger of another financial institution (or trustee in personal bankruptcy) claiming that the transfer is a deceptive conveyance and, in any case, the debtor would clearly be unwilling to give up a residential or commercial property in which it might stand to recuperate some value following a foreclosure sale. Also, a deed in lieu deal need to not be forced upon a borrower; rather, it needs to be a complimentary and voluntary act, and a representation and guarantee reflecting this must be memorialized in the contract. Otherwise, there is a risk that the transaction might be vitiated by a court in a subsequent case on the basis of undue influence or similar theories. If a debtor is resistant to finishing a deed in lieu transfer, then a loan provider intent on recovering the residential or commercial property ought to rather start a traditional foreclosure.

Ensuring that there are no other negative liens on the residential or commercial property, which there will be no such liens pending the shipment and recordation of the deed in lieu of foreclosure, is possibly the biggest risk a loan provider should avoid in structuring the transaction. Subordinate liens on the residential or commercial property can just be discharged through a foreclosure process or by arrangement of the negative lender. Therefore, before starting, and again before consummating, the deed in lieu transaction, the loan provider needs to do an adequate title check; after receiving the report, whether a loan provider will move on will normally be a case-by-case decision based upon the presence and amount of any discovered liens. Often it will be prudent to try to negotiate for the purchase or complete satisfaction of relatively minor third party liens. If the lending institution does choose to proceed with the transaction, it should evaluate the benefits of acquiring a brand-new title insurance coverage policy for the residential or commercial property and to have a non-merger endorsement included in it.1

For security versus known or unidentified secondary liens, the lender will likewise desire to include anti-merger language in the arrangement with the borrower, or structure the transaction so that the deed is offered to a lending institution affiliate, to allow the loan provider to foreclose (or utilize take advantage of by factor of the ability to foreclose) such other liens after the shipment of the deed in lieu. Reliance on anti-merger arrangements, however, can be risky. Cancelling the initial note can threaten the lending institution's security interest, so the loan provider ought to instead offer the borrower with a covenant not to sue. This also pays for the lending institution flexibility to retain any "bad young boy" carve-outs or any other continuing liabilities that are concurred to by the parties, including environmental matters. Depending upon the jurisdiction or particular accurate circumstances, however, another financial institution might successfully assault the credibility of the effort to preclude 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 debtor, the lending institution needs to be specifically watchful 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 a detailed contract setting forth the conditions, representations and arrangements that are contractually binding and which can endure the shipment of the deed and related releases. Thus, in addition to the normal pre-foreclosure due diligence that would be conducted by a lending institution, the contract will offer a roadmap to the shift procedure in addition to important info and representations concerning running accounts, accounting, turnover of leasing and agreement documents, liability and casualty insurance coverage, and the like. Indeed, once the lending institution takes ownership of 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 exposure to claims of occupants, specialists and other 3rd parties, so a well-crafted deed-in-lieu arrangement will go a long way toward improving the loan provider's convenience with the overall process while at the exact same time supplying order and certainty to the borrower.

Another considerable concern for the lender is to ensure that the transfer of the residential or commercial property from the customer to the lender fully and unquestionably extinguishes the customer's interest in the residential or commercial property. Any staying interest that the customer preserves in the residential or commercial property might later on generate a claim that the transfer was not an outright conveyance and was rather an equitable mortgage. Therefore, a lending institution should strongly resist any deal from the debtor to lease, handle, or reserve an option to acquire any part of the residential or commercial property following the deal.

These are simply a few of the most essential issues in a deed in lieu transfer. Other considerable problems must also be considered in order to secure the parties in this relatively complex procedure. Indeed, every deal is distinct and can raise various concerns, and each state has its own rules and customizeds connecting 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 debtors from significantly utilizing deeds in lieu and thus reaping the considerable advantages of structuring a deal in this way.

1. For several years it was likewise possible-and extremely preferred-for the lending institution to have the title insurer include a financial institutions' rights endorsement in the title insurance coverage. This safeguarded the lender versus having to defend 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 creditors' best recommendation and hence title companies are no longer using this security. It needs to be additional kept in mind that if the deed in lieu were reserved by a court based upon undue influence 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 recognize choose advancements that might be of interest to readers. The info included herein is abridged and summed up from different sources, the precision and completeness of which can not be guaranteed. The Advisory needs to not be construed as legal recommendations or opinion, and is not an alternative to the advice of counsel.