The lending world just got turned upside down. All strategies a mortgage lender used to rely upon to understand borrower defaults are no longer reliable.
In this new normal, a lender must be tactical when understanding what to do when a borrower defaults, because a one size fits all solution does not work in a post crisis world.
In this uncertain time, lenders want to know several things. First, what are a lender’s options when a borrower defaults? Second, what foreclosure restrictions are currently in place? Third, should a lender manage pre-crisis defaults differently than post-crisis defaults? Finally, what are the processes, timelines, and potential challenges that a lender faces when foreclosing?
Despite any confusion, lenders can still foreclose on business purpose loans in California during the COVID-19 crisis. Although lenders may struggle to complete a foreclosure sale at this time, lenders can still record Notices of Default to kickstart the foreclosure process.
Options Available to Lenders in the Event of a Borrower Default
Lenders have several options available when a borrower defaults. Foreclosure is one of them, but it is not necessarily always the most attractive option. Lenders can also offer borrowers a forbearance, modification, or deed in lieu. If a lender decides to move forward with a foreclosure, there are two primary types of foreclosure: judicial and trustee sale. Judicial foreclosures are not realistically available at this time due to the courts being closed for COVID-19 except for emergent matters, although a nonjudicial foreclosure is an available option even during this crisis.
When choosing between non-foreclosure options, it is helpful to understand what the options are. In effect, a forbearance allows the borrower to temporarily postpone payments or waive payments altogether, and otherwise gives the borrower some grace during a time of hardship. A modification of the loan can be just that – modifying the loan – including increasing the amount loaned to the borrower or a change to the interest rate. This may be a viable option if a larger restructure of the loan is necessary. A deed in lieu is where the borrower essentially just walks away from the loan, handing over to the lender their keys to the property used as collateral for the loan.
Note that best practices during this time for borrowers in need are to grant forbearances of payments or temporarily waive the maturity default for the loan. The recommended payment deferral time is around 60 to 90 days without charging default interest or other late charges.
Foreclosure Restrictions Currently in Place
In order to foreclose on a borrower, generally the borrower must monetarily default on the loan, and other loss mitigation options cannot or have not worked. At this time, judicial foreclosures in California are not available until at least 90 days after the State of Emergency declaration passes. Furthermore, the Federal Housing Finance Agency issued a 60-day moratorium on foreclosures starting from March 17, 2020 for all federally backed mortgage loans. California’s Department of Business Oversight has also requested that no foreclosures occur where the borrower has experienced a substantial decrease in household income due to COVID-19 or experienced substantial out-of-pocket medical expenses due to COVID-19.
For lenders, the bottom line is that in California, (i) there is no prohibition on starting a foreclosure on a business purpose loan, and (ii) since judicial foreclosures are generally unavailable, the only option is a nonjudicial foreclosure because it is done out of court. For lenders in other states, many have imposed moratoriums on foreclosures, so a state-by-state analysis is necessary to determine whether you can foreclosure in a particular state. Regardless, if it is possible to foreclosure, then lenders should consider foreclosing now, if they plan to do so, as states are imposing new restrictions almost on a daily basis.
The Foreclosure Process
If a lender chooses to proceed with a foreclosure, as already mentioned, the only type available right now is the nonjudicial foreclosure, or trustee sale. This also is the most common foreclosure process used for business purpose loans in California. There are four main steps in a trustee sale: (1) Issuing a Demand Letter; (2) Recording a Notice of Default; (3) Posting a Notice of Sale; and (4) Auctioning the Collateral Property.
1. Issue a Demand Letter
Although some loan documents do not require a demand letter, best practice is always to issue a demand letter to the borrower. Doing so sets the record for any potential litigation and allows the borrower a final opportunity before moving forward with formal proceedings. Typically, it is recommended that the lender does not record the Notice of Default until 10 days after the Demand Letter has been delivered to the borrower.
2. Record a Notice of Default
In California, no additional contact with the borrower is required before Recording a Notice of Default, where the loan is a business purpose loan. Consumer loans do require additional contacts, adding between 30 to 60 days to the process as well as a 120-day RESPA payment requirement time period. For a business purpose loan, the lender can then record a Notice of Default after the Demand Letter is delivered to the borrower.
3. Post a Notice of Sale
After ninety days from recording the Notice of Default, the lender may record a Notice of Sale. The Notice of Sale must be published in a public place, typically a newspaper within the city or possibly county where the collateral property is located. The auction must be at least 21 days out from the date of the posting. Right now, due to COVID-19, there are some issues related to posting in a public place, so be aware that you may not be able to complete the publishing requirement on the normal timeline.
4. Auction the Collateral Property
Once the auction is set, the lender should set a starting bid, maximum bid, and bid increments. Note that the starting bid should be lower than the loan amount in order to create leverage for a Breach of Guaranty suit. If someone bids an amount larger than the loan amount, the surplus is paid to junior lienholders and then to the borrower. After the sale, if a deficiency remains, the lender may seek a breach of guaranty against the guarantor. Similar to the publishing requirements, completing the actual sale is problematic at this time due to the requirement that there be a public auction. Since public gatherings are currently banned, even if a lender is able to complete all other steps in a nonjudicial foreclosure it is strongly recommended to postpone the actual sale date until restrictions on gatherings are lifted. Then, there is no argument by the borrower that the sale was improper or that bids were artificially low due to the lack of attendees at the sale.
Regarding the judicial foreclosure process, the lender should be aware of anti-deficiency rules and consider the implications of combining it with another action such a quiet title action. Judicial foreclosures are often pursued in conjunction with receivership and can run at the same time as a trustee sale. Typically, courts are reticent to provide receivership to lenders. Plus, with COVID-19, receivership may be altogether unavailable right now. Therefore, lenders should rule out all other options before pursuing receivership.
There are several key takeaways from this foreclosure discussion. First is for lenders to understand all of their options, because there is no one size fits all solution. If you as the lender choose to foreclose, act now rather than later before more executive orders with further restrictions are issued. And finally, as with any Trustee Sale, know your bidding strategy.
Although COVID-19 will likely continue to put pressure on not only borrowers but also lenders, staying abreast of temporary foreclosure restrictions as well as following the best practices suggested above put lenders in a stronger position to navigate these trying times.