Dealing with a financial crisis during uncertain times creates significant challenges for many lenders and borrowers.
During the current COVID-19 crisis, a significant number of borrowers are having difficulty making their mortgage payments, leaving lenders with no choice but to move forward with foreclosure. However, there may be an alternative to foreclosure that offer advantages to both the lender and borrower.
What is a Deed in Lieu of Foreclosure?
A deed in lieu of foreclosure (“DIL”) is a deed instrument in which the borrower conveys all interest in the secured property to the lender. This is done to satisfy a loan that is in default, and to avoid foreclosure proceedings.
Advantages to a Deed in Lieu of Foreclosure
Advantages to the Borrower
The DIL offers several advantages to both the borrower and the lender. The main advantage to the borrower is that it immediately releases them from all the indebtedness associated with the loan that is in default. The borrower avoids the having the public be aware of a foreclosure proceeding on their record. Furthermore, the borrower’s credit hurts less with a deed in lieu than with a foreclosure.
Advantages to the Lender
Advantages to the lender include a reduction in time and cost to repossess the property, ownership of property with direct control of its operation, and lower risk of borrower damaging the property to exact revenge against the lender.
It should be noted that lenders will need to evaluate a borrower’s facts and circumstances to decide whether to proceed with a DIL instead of a foreclosure. It is important to consult with your counsel whether a DIL is the best option, and if it is, to properly document the DIL agreements and any ancillary documents.
Preliminary Steps by Lender
Here is a simplified checklist to consider as a lender if you are considering a DIL:
- Confirm that the proposed terms of the offer from the borrower are in writing. If the proposed offer is not in writing, require a written offer from the borrower.
- Confirm the following:
- Nature and extent of all existing borrower defaults;
- Accrued and unpaid interest, default interest, and late fees, if any;
- Prepayment fees applicable to the transaction; and,
- The outstanding amount of the debt under the loan.
- Review the loan documents to make sure you have a complete loan file, that the loan documents are enforceable, and that there are no deficiencies in the loan documentation that require amendments before closing.
- Obtain and review a current title search to determine status of title and whether there are any tax liens or judgments.
- Inspect the property and applicable public records.
- Order and review an independent appraisal.
Remember, it is important that you consult with your counsel at every step to make sure you are on track.
Draft and Negotiate the Deed in Lieu
The lender’s counsel typically drafts and sends the DIL to the borrower’s counsel for review and negotiation. Lender’s counsel also typically drafts and sends to borrower’s counsel for review and negotiation the following documents:
- DIL
- Covenant not to sue
- Release of claims
- Escrow agreement
- Bill of sale
- Assignment of leases, rents and security deposits
- Assignment of contracts, warranties, permits, and licenses
- A non-foreign status certificate
- Tenant estoppel certificate
- SNDA, if required by the lender
- Tenant notice letter advising the tenants of the change in ownership
- List of permitted exceptions
- Itemized list of amounts to be paid by the lender to the borrower or borrower’s creditors
Pre-Closing Matters
During the pre-closing period, the lender and borrower should communicate frequently so any problems can be resolved quickly. Also, it is important to determine the party signing the closing documents and ensuring they are available for the closing. This will provide for a smoother transaction between the lender and the borrower.
Prepare a Closing Checklist
The lender’s counsel should prepare a closing checklist to keep organized and know the current status of the due diligence process and the deliverables needed to close the transaction. It is important that the lender’s counsel review the entity DIL agreement for all actions and items needed to close, calendar important dates and actions, set alerts or reminders leading up to each date and action, and include a working parties list with all of the parties involved in the transaction.
Handle Ownership Matters
If the lender is taking title to the property in its own name, the title company typically requires the lender to produce an incumbency certificate to issue a new owner’s title insurance policy.
If the lender’s nominee is taking title to the property, the lender’s counsel should ensure that the entity has properly been formed and has the requisite authority to own and operate the property.
Prepare the Closing Statement
The initial draft of the closing statement is typically prepared by the title company and then reviewed by counsel for the borrower and lender, but counsel may prepare the initial draft of the closing statement.
Closing Statement Tips
The closing statement should:
- Account for security deposits under the property leases delivered by the borrower
- Include disbursements that are paid at the closing (i.e. title costs, escrow fees, etc.)
- Account for payment of counsel fees
- Account for additional sums that lender agrees to pay
- Credit for outstanding loan escrow balances
Conclusion
A DIL can be beneficial for both a lender and a borrower. This will help avoid expensive foreclosure costs and negative consequences of a foreclosure. It is important to keep in mind that lenders must maintain proper documentation and provide for sufficient consideration to protect the DIL against claims of duress from the borrower.
The lender must make sure that a DIL is the good choice for the particular circumstance, and must evaluate all the facts of the situation. The lender must also be sure to make a decision after consulting with an attorney. The borrower must verify that all required documentation is fully executed and all consideration is fully paid so that they are released from personal liability on the mortgage. If the above are taken into consideration, a DIL transaction may be the best choice for both lender and borrower.
