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L.Keefer
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Hello, Need some advice. We have a rental property we can not sell. We also cannot afford to keep paying mortgage. Forclosure or bankruptcy? Which is better? HELP!!! Pennsylvania
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<BLOCKQUOTE><font size="1" face="Verdana, Arial">quote:</font><HR>Originally posted by L.Keefer:
Hello, Need some advice. We have a rental property we can not sell. We also cannot afford to keep paying mortgage. Forclosure or bankruptcy? Which is better? HELP!!! Pennsylvania<HR></BLOCKQUOTE>
My response:
How about neither ! Try talking to your mortgagor and arranging a deed in lieu of foreclosure. It's an attractive, but risky, alternative to foreclosure.
With the current real estate marketplace continuing to defy prediction, this may be an opportune time for real estate lenders to review their options when faced with the prospect of a defaulting or delinquent borrower.
In certain jurisdictions, one favored approach is for the defaulting borrower to grant the lender a deed in lieu of foreclosure. By deeding the secured property outright to the lender, the parties can avoid the often costly and time consuming process of judicial foreclosure. Although this consensual conveyance appears ideal compared to the contentious foreclosure process, any lender contemplating the deed in lieu approach must consider a number of significant risks.
Benefits of Deed in Lieu of Foreclosure
Besides the benefit to the lender of immediately obtaining marketable title and avoiding what may amount to years of litigious foreclosure proceedings, the deed in lieu option also carries several benefits to the borrower. For one, the borrower may obtain a tangible economic concession in exchange for the deed, such as the release of personal liability for a deficiency. A second benefit the deed in lieu may afford the borrower is the opportunity to avoid the negative publicity and notoriety often involved in foreclosure proceedings. Finally, the lender, in exchange for a deed in lieu of foreclosure, may agree to grant the borrower limited possessory rights in the property, including the right to lease or manage the property or an option to purchase.
The deed in lieu of foreclosure, however, is of limited utility to lenders in jurisdictions where a statutory power of sale or receivership option permits lenders to obtain title from a defaulting borrower simply and rapidly.
Before agreeing to accept a deed in lieu of foreclosure, lenders and their counsel should weigh the potential risks of such a transaction. As a general matter and as seen below, these risks are greatest if (1) the outstanding amount of the loan is less than the current fair market value of the property, and (2) junior creditors hold liens on the property. Another risk for the parties in a deed in lieu transaction is the possibility that subsequent to the deed in lieu transaction, borrowers or third parties could make a wide array of arguments to have a court set aside such a transaction, arguing, for example, that the deed was obtained for inadequate consideration or pursuant to a transfer that may be avoidable as the result of the subsequent commencement of a bankruptcy case with respect to the borrower.
Bankruptcy Concerns
Given the poor financial health of defaulting borrowers and the broad powers of bankruptcy trustees and courts, bankruptcy-related risks are paramount in deed in lieu transactions. The main bankruptcy issue involves a potential attack on the transaction as a fraudulent conveyance under either section 548 of the United States Bankruptcy Code (the "Code") or similar state fraudulent conveyance laws.
Fraudulent conveyance laws, generally speaking, allow a trustee to set aside a transfer made within one (1) year before a bankruptcy filing (or six (6) years under most state statutes) if made either with actual intent to hinder, delay or defraud a creditor or pursuant to a "constructively" fraudulent transfer. A transfer may be deemed "constructively" fraudulent if the borrower made the transfer while insolvent and received less than the reasonably equivalent value for the property transferred. Several courts hold that if a borrower’s equity in the property transferred exceeds thirty percent (30%) of the current property value, an outright transfer of the property to a creditor will be deemed constructively fraudulent. (By way of contrast, the Supreme Court has determined that, if the property is sold as a result of a judicial foreclosure, absent extenuating circumstances, the purchase price will per se constitute reasonably equivalent value.) Again, the key issue is valuation of the property, and a current appraisal is necessary to make the appropriate determination. Moreover, a lender may be well advised to obtain current financial statements from a borrower when contemplating a deed in lieu transaction in order to determine whether the borrower was insolvent at the time of the transfer.
Other protective measures a lender can insist on in a deed in lieu situation to lessen bankruptcy risks include obtaining an indemnity from the borrower against creditor liability claims and obtaining a pledge from the borrower not to file for bankruptcy within one (1) year of the deed transfer. The actual effects of these protective measures are questionable.
Even absent a bankruptcy filing, a borrower or a third party, following a deed in lieu of foreclosure, may seek to have the transfer voided or set aside for inadequate consideration. Courts will scrutinize such transactions carefully to determine if they were entered into through coercion or undue influence on the part of the lender. To protect themselves, lenders should recite, in any settlement agreement entered into in connection with the deed in lieu, a full list of the consideration received by the borrower, including the amount of the debt and any release of liability or obligation. Obtaining an independent appraisal would be helpful here as well.
Merger
Another risk for a lender in a deed in lieu of foreclosure transaction involves the common law doctrine of merger. Under this doctrine, if both title to property and title to a mortgage on the property are held under the same name, the mortgage, as a lesser interest, merges into the greater fee interest. As a result, the mortgage becomes extinguished, and any junior lienors are elevated to a higher priority security interest in the property. Unlike in a foreclosure proceeding, junior liens remain intact following a deed in lieu of foreclosure. Thus, if a merger occurs subsequent to a deed in lieu, a lender will lose its first priority lien status and will be unable to foreclose if the deed in lieu is set aside. To prevent this loss of priority, a lender should conduct a thorough title search to determine if junior liens exist. In addition, all of the conveyance documents should indicate that the intent is not to merge the mortgage into the fee and that the debt remains unsatisfied. Such an expression of intent is usually effective in averting merger. Finally, a lender may want to consider having the deed conveyed to a subsidiary or nominee in order to prevent a merger.
Environmental Concerns
No deed in lieu of foreclosure should proceed without the lender conducting a comprehensive environmental assessment of the property. This assessment is crucial because of a lender’s increased liability as owner of the property under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") and other environmental statutes. Accordingly, prior to the acceptance of a deed in lieu, a lender should order an up-to-date environmental assessment and proceed with caution if any environmental cleanup issues are indicated. A limited exception to CERCLA liability exists for an owner who holds an ownership interest in the property to protect a security interest but participates to only a limited degree in the management and operation of the property. While courts are divided as to what degree of management constitutes minimum participation, a lender should not accept a deed in lieu of foreclosure and undertake any management responsibility to manage the property without performing an environmental study.
Title Insurance
Before accepting a deed in lieu of foreclosure, the lender sh
Hello, Need some advice. We have a rental property we can not sell. We also cannot afford to keep paying mortgage. Forclosure or bankruptcy? Which is better? HELP!!! Pennsylvania<HR></BLOCKQUOTE>
My response:
How about neither ! Try talking to your mortgagor and arranging a deed in lieu of foreclosure. It's an attractive, but risky, alternative to foreclosure.
With the current real estate marketplace continuing to defy prediction, this may be an opportune time for real estate lenders to review their options when faced with the prospect of a defaulting or delinquent borrower.
In certain jurisdictions, one favored approach is for the defaulting borrower to grant the lender a deed in lieu of foreclosure. By deeding the secured property outright to the lender, the parties can avoid the often costly and time consuming process of judicial foreclosure. Although this consensual conveyance appears ideal compared to the contentious foreclosure process, any lender contemplating the deed in lieu approach must consider a number of significant risks.
Benefits of Deed in Lieu of Foreclosure
Besides the benefit to the lender of immediately obtaining marketable title and avoiding what may amount to years of litigious foreclosure proceedings, the deed in lieu option also carries several benefits to the borrower. For one, the borrower may obtain a tangible economic concession in exchange for the deed, such as the release of personal liability for a deficiency. A second benefit the deed in lieu may afford the borrower is the opportunity to avoid the negative publicity and notoriety often involved in foreclosure proceedings. Finally, the lender, in exchange for a deed in lieu of foreclosure, may agree to grant the borrower limited possessory rights in the property, including the right to lease or manage the property or an option to purchase.
The deed in lieu of foreclosure, however, is of limited utility to lenders in jurisdictions where a statutory power of sale or receivership option permits lenders to obtain title from a defaulting borrower simply and rapidly.
Before agreeing to accept a deed in lieu of foreclosure, lenders and their counsel should weigh the potential risks of such a transaction. As a general matter and as seen below, these risks are greatest if (1) the outstanding amount of the loan is less than the current fair market value of the property, and (2) junior creditors hold liens on the property. Another risk for the parties in a deed in lieu transaction is the possibility that subsequent to the deed in lieu transaction, borrowers or third parties could make a wide array of arguments to have a court set aside such a transaction, arguing, for example, that the deed was obtained for inadequate consideration or pursuant to a transfer that may be avoidable as the result of the subsequent commencement of a bankruptcy case with respect to the borrower.
Bankruptcy Concerns
Given the poor financial health of defaulting borrowers and the broad powers of bankruptcy trustees and courts, bankruptcy-related risks are paramount in deed in lieu transactions. The main bankruptcy issue involves a potential attack on the transaction as a fraudulent conveyance under either section 548 of the United States Bankruptcy Code (the "Code") or similar state fraudulent conveyance laws.
Fraudulent conveyance laws, generally speaking, allow a trustee to set aside a transfer made within one (1) year before a bankruptcy filing (or six (6) years under most state statutes) if made either with actual intent to hinder, delay or defraud a creditor or pursuant to a "constructively" fraudulent transfer. A transfer may be deemed "constructively" fraudulent if the borrower made the transfer while insolvent and received less than the reasonably equivalent value for the property transferred. Several courts hold that if a borrower’s equity in the property transferred exceeds thirty percent (30%) of the current property value, an outright transfer of the property to a creditor will be deemed constructively fraudulent. (By way of contrast, the Supreme Court has determined that, if the property is sold as a result of a judicial foreclosure, absent extenuating circumstances, the purchase price will per se constitute reasonably equivalent value.) Again, the key issue is valuation of the property, and a current appraisal is necessary to make the appropriate determination. Moreover, a lender may be well advised to obtain current financial statements from a borrower when contemplating a deed in lieu transaction in order to determine whether the borrower was insolvent at the time of the transfer.
Other protective measures a lender can insist on in a deed in lieu situation to lessen bankruptcy risks include obtaining an indemnity from the borrower against creditor liability claims and obtaining a pledge from the borrower not to file for bankruptcy within one (1) year of the deed transfer. The actual effects of these protective measures are questionable.
Even absent a bankruptcy filing, a borrower or a third party, following a deed in lieu of foreclosure, may seek to have the transfer voided or set aside for inadequate consideration. Courts will scrutinize such transactions carefully to determine if they were entered into through coercion or undue influence on the part of the lender. To protect themselves, lenders should recite, in any settlement agreement entered into in connection with the deed in lieu, a full list of the consideration received by the borrower, including the amount of the debt and any release of liability or obligation. Obtaining an independent appraisal would be helpful here as well.
Merger
Another risk for a lender in a deed in lieu of foreclosure transaction involves the common law doctrine of merger. Under this doctrine, if both title to property and title to a mortgage on the property are held under the same name, the mortgage, as a lesser interest, merges into the greater fee interest. As a result, the mortgage becomes extinguished, and any junior lienors are elevated to a higher priority security interest in the property. Unlike in a foreclosure proceeding, junior liens remain intact following a deed in lieu of foreclosure. Thus, if a merger occurs subsequent to a deed in lieu, a lender will lose its first priority lien status and will be unable to foreclose if the deed in lieu is set aside. To prevent this loss of priority, a lender should conduct a thorough title search to determine if junior liens exist. In addition, all of the conveyance documents should indicate that the intent is not to merge the mortgage into the fee and that the debt remains unsatisfied. Such an expression of intent is usually effective in averting merger. Finally, a lender may want to consider having the deed conveyed to a subsidiary or nominee in order to prevent a merger.
Environmental Concerns
No deed in lieu of foreclosure should proceed without the lender conducting a comprehensive environmental assessment of the property. This assessment is crucial because of a lender’s increased liability as owner of the property under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") and other environmental statutes. Accordingly, prior to the acceptance of a deed in lieu, a lender should order an up-to-date environmental assessment and proceed with caution if any environmental cleanup issues are indicated. A limited exception to CERCLA liability exists for an owner who holds an ownership interest in the property to protect a security interest but participates to only a limited degree in the management and operation of the property. While courts are divided as to what degree of management constitutes minimum participation, a lender should not accept a deed in lieu of foreclosure and undertake any management responsibility to manage the property without performing an environmental study.
Title Insurance
Before accepting a deed in lieu of foreclosure, the lender sh
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