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					     Lender Remedies After Default, Prior to
         Consummation of Foreclosure

• Lender’s basic choice is between a (1) deed in lieu of
  foreclosure, (2) filing a foreclosure action, and, (3) in
  some states, foreclosing pursuant to state law that
  authorizes foreclosure by out-of-court sale.
• There are 3 remedies a lender might seek while a
  foreclosure action is pending:
   – 1. Physical possession of the mortgaged
     property.
   – 2. Assignment of rents from the mortgaged
     property.
   – 3. Appointment of a receiver to take charge of the
     mortgaged property.
                                                        Donald J. Weidner

                             1
       Lender Remedies After Default, Prior to
               Foreclosure (cont’d)
• In the area of Lender remedies after default and prior to
  foreclosure, the theory of the mortgage has some, although
  limited, predictive value. Recall the three theories are:
1. Lien—A mortgage is only a lien, that is, a right to
  obtain title and possession by prosecuting a
  foreclosure action to completion.
2. Intermediate—A mortgage is initially only a lien,
  but title, and the right to possession, passes to the
  mortgagee when the mortgagor defaults
3. Title—A mortgage is a conveyance that passes
  title, and the right to possession, as soon as it is
  executed.
                                                      Donald J. Weidner

                              2
     Lender Remedy # 1: Physical Possession
See Lifton article at text p. 870:
• “Even in the title and intermediate states, modern
   courts are reluctant to grant a mortgagee physical
   possession of the property.”
• Even if physical possession is possible, “restraints on
   the mortgagee and the risks of possession may
   dissuade lenders from seeking it.” Depending upon
   the jurisdiction a mortgagee in possession:
   1. may have limited power over the property;
   2. may not be compensated for its own management
      efforts and may not be able to recover money it
      spends to improve or to maintain the property; and
   3. may risk having to account to the owner under
      stringent accounting rules for decisions on renting
      and operating the property if the owner later
      redeems.                                         Donald J. Weidner

                              3
   Lender Remedy # 2: Assignment of Rents
Lifton article (cont’d):
• Rather than seek physical possession, “the lender
   will usually look to the traditional remedies granting
   constructive possession. These are contained in
   standard mortgage provisions for
    – assignment of rents and for
    – appointment of a receiver in case of default.”
• “Generally, an assignment of rents can be activated
   in title, intermediate and some lien states (such as
   Florida) by the mortgagee’s serving notice on the
   tenants . . . to pay their rents to the mortgagee.”
    – Most courts prefer to appoint an independent
       receiver.

                                                       Donald J. Weidner

                             4
  Lender Remedy # 3: Appointment of Receiver

Lifton article (cont’d):
• States vary in their approach to appointment of a
   receiver:
1. At one extreme, an agreement to appoint a receiver is
   usually sufficient to support an appointment.
2. In the middle, some states will appoint a receiver if
   there is proof:
    – that the security is impaired (courts differ on what
       constitutes impairment) and/or
    – that the borrower is insolvent.
3. At the other extreme, it is almost impossible to obtain a
   receiver.
                                                       Donald J. Weidner

                             5
 Lender Remedy # 3: Appointment of Receiver
                  (cont’d)
• Drawbacks of the Remedy of Appointment of a
  Receiver:
    – It can take a long time to get a receiver appointed.
    – The receiver may not be a good manager.
    – The receiver’s fees may eat up a good portion of
      the income.
• Many lenders will simply choose to accept a deed in
  lieu of foreclosure.
    – Which can have risks.


                                                       Donald J. Weidner

                             6
  Florida Assignment of Rents Statute 697.07
• Purpose: to avoid the necessity of getting a receiver
  appointed to collect rents.
• If a mortgage or separate instrument provides for an
  assignment of rents to secure repayment of an
  indebtedness, “the mortgagee shall hold a lien on the
  rents, and the lien created by the assignment shall be
  perfected and effective against third parties upon
  recordation of the mortgage or separate instrument
  with the public records of the county in which the real
  property is located . . . .” 690.07(1) and (2).
• The assignment is enforceable “upon the mortgagor’s
  default and written demand for the rents made by the
  mortgagee . . . .” 690.07(3).
                                                      Donald J. Weidner

                            7
    Florida Assignment of Rents Statute 697.07
                     (cont’d)
• Upon application by either the mortgagor or the
  mortgagee, in a foreclosure action, a court “may require
  the mortgagor to deposit the collected rents into the
  registry of the court, or in such other depository as the
  court may designate.” 697.07(4).
• The court may authorize the use of the collected rents to
  pay “the reasonable expenses solely to protect, preserve,
  and operate the real property, including, without
  limitation, real estate taxes and insurance,” and to make
  payments to the mortgagee. 697.07(4)(a) and (c).
• “The court shall expedite the hearing on the application
  by the mortgagee or mortgagor to enforce the
  assignment of rents.” 697.07(6).
                                                      Donald J. Weidner

                             8
                  CUNA Mortgage v. Aafedt (Text p. 875)
                  3 notes to finance 3 townhouse purchases
1985   Borrower     3 Mortgages to secure notes              Credit Union

                                           HUD insured the
                                           Mortgages

                                                             Credit Union   Assign Ns & Ms CUNA
                                                                                           Assignee
1989   Borrower    Defaulted

                                                                     Commenced action to CUNA
                                                                     foreclose, stating it will Assignee
                                                                     not seek Deficiency
                                                                     .Judgment.


                       Offers Deeds in                           Rejects offer because       CUNA
       Borrower
                       Lieu of                                   CUNA’s mortgage insurer, Assignee
                       Foreclosure                               HUD, said it would not
                                                                 reimburse CUNA if all CUNA
                   Executed Quitclaim                            could assign to HUD was a
       Borrower                                                  title acquired by a Deed in
                   Deeds of 3 properties
                   and records w/out                             lieu of Foreclosure.
                   CUNA’s knowledge                              CUNA filed foreclosure action

       Borrower   Moved to dismiss foreclosure
                  action because it executed the
                                                                                               Donald J. Weidner
                  Deeds in lieu of foreclosure
                                                     9
      CUNA Mortgage v. Aafedt (cont’d)

• CUNA said its ability to receive the mortgage
  insurance proceeds from HUD would be
  impaired if it accepted a deed in lieu rather
  than title through foreclosure.
• Trial Court:
   – 1. Quitclaim deed was void [it was a
     unilateral act without CUNA’s consent,
     acquiescence, and hence there was no
     delivery]; and
   – 2. CUNA was entitled to bring the
     foreclosure proceeding.
                                             Donald J. Weidner

                       10
      CUNA Mortgage v. Aafedt (cont’d)

• Normally, recording a deed creates a
  rebuttable presumption of its delivery to, and
  its acceptance by, the grantee.
• However, the presumption of acceptance
  arises only if the deed is beneficial to the
  grantee, not when the deed places a burden
  on the grantee.
• Here, CUNA’s refusal to accept a deed in lieu
  was not in bad faith.

                                             Donald J. Weidner

                       11
        Lender Wariness of Deeds in Lieu of
                       Foreclosure
  Lenders are wary of “deeds in lieu” for a variety
  of reasons:
1. If bankruptcy is filed against the debtor within
  90 days of the conveyance, a deed in lieu may
  be set aside as a preference.
   – Many title companies won’t insure on a deed
      in lieu until the 90-day preference period has
      passed.
2. Another possibility, though less likely, is that, if
  bankruptcy is filed within a year of the
  conveyance, it may be deemed a fraudulent
  transfer.
                                                   Donald J. Weidner

                           12
         Lender Wariness of Deeds in Lieu of
                Foreclosure (cont’d)
3. A voluntary conveyance from the owner does not
   cut off junior mortgagees or mechanics lien
   claimants.
    – Therefore, a foreclosure action may still be
      necessary to wipe out those liens.
    – Also: a junior lienor may argue, under the
      merger doctrine, that it is now the senior lien.
    – In short, if intervening liens are discovered, “the
      only prudent alternative for the mortgagee is to
      foreclose.”
4. In some states, the tax on voluntary transfers may
   be very high—based on the total value of the
   property (unreduced by the mortgage).
                                                    Donald J. Weidner

                            13
Lender Wariness of Deeds in Lieu of Foreclosure
                   (cont’d)
 5. There is a difference between theory and
    practice as state courts consider deeds in
    lieu.
 • In theory:
     1. The rule against contemporaneous clogs
       on the equity of redemption does not apply
       to transactions subsequent to the original
       mortgage
     2. Most courts permit the mortgagee to
       purchase the mortgagor’s equity of
       redemption.
                                              Donald J. Weidner

                        14
     Lender Wariness of Deeds in Lieu of
            Foreclosure (cont’d)

• However, in practice, courts examine a deed
  in lieu to assure it is:
   1. Free from fraud.
   2. Based on an adequate consideration; and
   3. Is truly subsequent to the mortgage and
  not contemporaneous with it (not put in
  escrow when the mortgage was first
  executed).

                                           Donald J. Weidner

                      15
       Lender Wariness of Deeds in Lieu (cont’d)
5. Theory versus practice and deeds in lieu (cont’d)
– Courts are concerned with the disparity in bargaining
   strength between a lender and a borrower in default.
– There are two situations in which the courts are more
   likely to be especially solicitous of the borrower:
1. If the transaction might be construed “as unfair and
   unconscionable,”
   – “especially if the consideration paid is
       disproportionately less than the value of the equity or if
       none is paid where the equity has value.”
2. Nonrecourse Debt. If “the deed is not by the mortgagor,
   but by a non-assuming grantee of the mortgagor, a
   release of the debt, since there was no personal liability,
   would be no consideration for the conveyance . . . and
   subject it to being set aside.”
                                                            Donald J. Weidner

                                 16
   Lender Wariness of Deeds in Lieu (cont’d)
5. Theory versus Practice (cont’d)
• “[T]here is always the possibility that a court will
   construe the [deed in lieu] as simply another
   mortgage transaction.”
   • “If the mortgagor is successful, he will be treated
      as a mortgagor under two mortgages—under the
      original mortgage which was not eliminated by the
      deed in lieu and under the deed in lieu treated as
      a second mortgage.”
• “[T]he possibility [also] exists that because of
   insolvency of the mortgagor or an actual intent on
   his part to defraud creditors the conveyance may be
   subject to avoidance at the suit of creditors outside
   of bankruptcy.”
                                                    Donald J. Weidner

                           17
                   “Short Sales”

• A “short sale” takes place when a lender
  accepts in satisfaction of a mortgage the net
  proceeds of a sale by the borrower to a third
  party, even though the proceeds are less than
  the amount due on the mortgage.
• A lender is more likely to entertain a short sale if
  the property is worth less than the amount of the
  mortgage and a deficiency judgment against the
  borrower is either theoretically or practically
  improbable.


                                                 Donald J. Weidner

                         18
               “Short Sales” (cont’d)

• The short sale route permits the lender to avoid:
   – The delays incident to foreclosure.
   – The costs of a foreclosure proceeding.
   – The carrying costs or management
     responsibilities incident to owning property
     upon consummation of foreclosure.
   – The resale costs of property acquired through
     foreclosure.
   – The appearance of too many “REO” properties
     (real estate owned as a result of foreclosure)
     on its books.
                                               Donald J. Weidner

                         19
                       Bankruptcy Review
•    A transfer by a debtor to a creditor prior to bankruptcy
     may be set aside as:
     – a preferential transfer that can be avoided or
     – a fraudulent conveyance
•    If bankruptcy occurs, arrangements between the debtor
     and creditors may be significantly altered:
1.   Section 365 permits the trustee or debtor in possession
     to assume or reject executory contracts and leases;
2.   The “cram down” provisions may force creditors to
     accept reorganization they do not like; and
3.   The Code’s automatic stay of proceedings against a
     debtor or the debtor’s property prevents a mortgagee
     from foreclosing unless an exception is granted;
4.   The automatic stay may also prevent a lender from self-
     help, such as collecting rents under an assignment of
     rents provision in a mortgage.
                                                           Donald J. Weidner

                                     20
Klee Article on Single Asset Real Estate Bankruptcy
 • Klee (p. 879) notes the change in 1994
   Bankruptcy law concerning single asset real
   estate (“SARE”) debtors.
    – Situations in which the debtor’s only asset
      was a single real estate property (not
      involving a residential property with fewer
      than 4 units)
 • The 1994 change added an additional
   procedure by which certain real property
   mortgage holders could obtain relief from the
   Bankruptcy Code’s “automatic stay” provisions.
                                               Donald J. Weidner

                         21
    Klee Article on Single Asset Real Estate
               Bankruptcy (cont’d)
• A SARE mortgage holder may get relief from
  the automatic stay to foreclose unless, within
  90-days after the order for relief, the debtor
  has a confirmable plan or begins making
  monthly payments to the mortgage holder.
   – This shortens the Chapter 11 process for
     the lender or forces the debtor to “pay to
     play” by making cash payments to the
     lender.
• After 2001, there is no $4 million debt cap on
  this provision.
                                               Donald J. Weidner

                        22
              BFP v. Resolution Trust Corp.                                  (Text p. 883)

BFP is a PP to buy a   Contract to sell    Foremans
home. Ps:              and buy             Sellers
Pedersens & Barton



                        $356,250 Cash to purchase                                            S&L
        PP
                         1 $356,250 Purchase Money Note and Deed of Trust
                         2. $200,000
                         Purchase Money Sellers
                         Note and 2nd Deed of
                         Trust


                              Noticed the partnership and the sellers of a non-
        PP                    judicial foreclosure sale in accordance with state             S&L
                              law       Paid $433,000 at F/C sale            Buyer at
                                               Allegation: Fair Market Value FC Sale
                                               was $725,000
                              Deed



Shortly thereafter, the PP filed under Chapter 11 and sought to set aside the F/C sale
conveyance to Buyer on the ground that it constituted a fraudulent transfer.

                                                                                              Donald J. Weidner

                                                     23
     BFP v. Resolution Trust Corp. (cont’d)

• Unlike the vulnerability of a deed in lieu, a
  foreclosure that is properly conducted under
  state law receives great deference
   – Even if it is conducted outside of court.
• BFP v. Resolution Trust involves a non-judicial
  foreclosure of a partnership’s equity of
  redemption in a property allegedly worth
  $725,000.
   – The puchaser at the foreclosure sale paid
     only $433,000.

                                              Donald J. Weidner

                        24
     BFP v. Resolution Trust Corp. (cont’d)

• The partnership subsequently filed under
  Chapter 11 and asserted that the foreclosure
  of its equity of redemption in the year prior to
  the filing constituted a fraudulent transfer.
• A trustee in bankruptcy, or a debtor in
  possession under Chapter 11, has the power
  to set aside fraudulent transfers of two types:
   – Those infected by actual fraud; and
   – Those involving constructive fraud.

                                                Donald J. Weidner

                         25
              BFP v. Resolution Trust (cont’d)
•    The rule in question permits the trustee to avoid
     the sale if the trustee can establish:
1.   that the debtor had an interest in the property
     (clearly here);
2.   that a transfer of that interest occurred within one
     year of the filing of the bankruptcy petition (clearly
     here);
3.   that the debtor was insolvent at the time of the
     transfer (or became insolvent because of it)
     (clearly here); and
4.   that the debtor received “less than a reasonably
     equivalent value in exchange” for the transfer.
     That is the question in BFP.
                              26
                                                      Donald J. Weidner
           BFP: Justice Scalia’s Response
•  The Circuits had 3 different approaches to determine
   whether “reasonably equivalent value” had been given:
1. The 5th Circuit in Durrett had said that any foreclosure
   sale for less than 70% of fair market value failed to
   qualify as “reasonably equivalent value” and should be
   invalidated;
2. The 7th Circuit adopted an “all facts and circumstances”
   approach to determine whether “reasonably equivalent
   value” is received; and
3. The 9th Circuit in this case held that a “non-collusive and
   regularly conducted nonjudicial foreclosure sale . . .
   cannot be challenged as a fraudulent conveyance
   because the consideration received in such a sale
   establishes ‘reasonably equivalent value’ as a matter of
   law.”
                                                        Donald J. Weidner

                              27
         BFP: Scalia’s Response (cont’d)
• Justice Scalia said that both the 5th Circuit and the 7th
  Circuit “refer to fair market value as the benchmark
  against which determination of reasonably equivalent
  value is to be measured.”
• Fair market value is used elsewhere in the Bankruptcy
  Code, but not “in the context of an otherwise lawful
  mortgage foreclosure sale.”
• “One must suspect [the use of the term “reasonably
  equivalent value”] means that fair market value
  cannot—or at least cannot always—be the benchmark.”
• “The suspicion becomes a certitude when one considers
  that market value, as it is commonly understood, has
  no applicability in the forced-sale context; indeed, it is
  the very antithesis of forced-sale value.”
                                                      Donald J. Weidner

                            28
                      Scalia (cont’d)
• Market value is the “price as would be fixed by
  negotiation and mutual agreement, after ample
  time to find a purchaser, as between a vendor who
  is willing (but not compelled) to sell and a
  purchaser who desires to buy but is not compelled
  to take the particular . . . piece of property.” (citing
  Black’s)
   – These market conditions, by definition, do not
     exist in a forced-sale context.
• “Market value cannot be the criterion of
  equivalence in the foreclosure-sale context.”
• Property that must be sold within the strictures “of
  state-prescribed foreclosure” “is simply worth less.”
                                                    Donald J. Weidner

                             29
                         Scalia (cont’d)

• One might ask whether there is a “reasonable” or “fair”
  forced-sale price, but these are policy judgments courts have
  no authority to make under the Bankruptcy Code.
• The price realized in a foreclosure sale “depends upon the
  terms of the forced sale,” which vary among the states.
• When the state procedures have been followed, it is “black
  letter” law “that the mere inadequacy of the foreclosure sale
  price is no basis for setting the sale aside,
   – though it may be set aside (under state foreclosure law,
      rather than fraudulent transfer law) if the price is so low as
      to “shock the conscience, or raise a presumption of fraud
      or unfairness.”



                                                             Donald J. Weidner

                                 30
                    Scalia (cont’d)
• Foreclosure law and fraudulent transfer law “enjoyed
  over 400 years of peaceful coexistence” until the 5th
  Circuit’s unprecedented decision in Durrett.
• “To our knowledge no prior decision had ever applied
  the ‘grossly inadequate price’ badge of fraud under
  fraudulent transfer law to set aside a foreclosure
  sale.”
• “We deem . . . that a fair and proper price, or a
  ‘reasonably equivalent value,’ for foreclosed property,
  is the price in fact received at the foreclosure sale, so
  long as all the requirements of the State’s foreclosure
  law have been complied with.”

                                                       Donald J. Weidner

                             31
     A Florida Note to B.F.P. v. Resolution Trust
• The type of out-of-court foreclosure procedure used
  in B.F.P. v. Resolution Trust is not available under
  Florida law.
• Florida Statute 702.01 provides:
  “All mortgages shall be foreclosed in equity. In a
  mortgage foreclosure action, the court shall sever
  for separate trial all counterclaims against the
  foreclosing mortgagee. The foreclosure claim shall,
  if tried, be tried to a court without a jury.”



                                                Donald J. Weidner

                          32
 Skylake Insurance Agency, Inc. v. NMB Plaza, LLC
                             (Supp. p. 34)
• Landlord LLC executed a 10-year lease of commercial
  property in Florida to Tenant corporation.
• Only one party executed the lease on behalf of the
  Landlord.
• Under the Florida law of LLCs, a lease is effective if it is
  signed by any member of a member-managed LLC or by
  any manager of a manager-managed LLC.
• However, FSA 689.01, “How real estate conveyed,” states
  that no estate “for a term of more than 1 year” shall be
  created or transferred “in any other manner than by
  instrument in writing, signed in the presence of two
  subscribing witnesses . . . .”
   – With a specific exception for conveyances by corporations that
     comply with the requirements of with corporate law.
                                                                 Donald J. Weidner

                                   33
   Skylake Insurance Agency, Inc. v. NMB Plaza,
                   LLC (cont’d)
• The landlord repudiated the lease on the ground that there
  were not two witnesses to its signature.
• Judge Cope said the “corporate” exception does not apply
  to LLCs.
• Therefore, Judge Cope concluded that the 10-year written
  lease did not satisfy the requirement of the Florida statute
  on real estate conveyances.
• Therefore, it was not an effective conveyance of an estate
  in real property enforceable by specific performance.
• However, it did satisfy the Florida Statute of Frauds.
• Therefore, it was a valid contract enforceable by damage
  remedy.
                                                        Donald J. Weidner

                              34

				
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