Thought Leadership on Banking and Commercial Transactions presented by Weinstock, Friedman & Friedman P.A.
This article is the second of a two-part series serving as an introduction to the basic legal issues lenders face in handling defaulted commercial loans.
Although bankruptcy is fairly prevalent in the world of commercial loan workouts, it is outside the scope of this article. This series will focus on two aspects: (1) transactional workouts via documentation and (2) court-related intervention via obtaining judgment or liquidating collateral. Please also note that this article is not jurisdiction-specific or detailed, but rather generic and basic. Each state will have specific practices and procedures that should be researched and reviewed before taking any action.
If you have determined that transactional work-out documentation is not a viable or desired alternative, the court system gives you another avenue to handle your defaulted commercial loan. Depending on how your loan is written and collateralized, several options are available within the court system.
The first option is the most general, and most widely used. That is the judgment.
There are two basic ways to obtain judgment: (1) by breach of contract action, and (2) by cognovit or confession. Use of the breach of contract lawsuit is the most basic and straightforward way to obtain judgment. However, a suit for judgment can be both time-consuming and expensive, so it is important to know your loan documents and the laws in your state to determine if a judgment by confession (also known as a cognovit judgment in some states) is available to you. If your documents allow for a judgment by confession, and you are able to comply with your state’s laws to make it happen procedurally, a judgment by confession may be a quicker and more cost-effective option to obtain judgment.
The next option to consider applies in cases where you have real property collateral. That option is foreclosure. The foreclosure process can vary greatly from state to state, but the general categories are judicial or non-judicial.
The general steps for a judicial foreclosure sale begin with a review of the title work and verification that the ownership on deed matches the Deed of Trust. Next, the attorney will order an appraisal and possibly an environmental study. If a property is residential, the attorney may be required to send a notice letter with loss mitigation information. Next, the attorney prepares a Deed of Appointment, assigning a trustee to control the foreclosure sale process. Once executed, that Deed of Appointment is recorded in Land Records. This document authorizes the appointed trustees to handle the foreclosure.
Next, the attorney will draft other necessary documents required by the jurisdiction (for example, an order to docket foreclosure, statement of debt, lender’s affidavit, military affidavit), get any required signatures, and send them for filing with the court, along with required exhibits. Some generally needed types of exhibits include the deed of trust (generally a certified copy), a copy of note or debt instrument, a copy of the deed of appointment, an affidavit regarding military service of the borrower/owner, and an affidavit regarding the right to foreclose.
If the property in question is residential, some jurisdictions are now requiring you to include a loss-mitigation affidavit detailing what programs are available for the borrower to mitigate the loss, and whether the borrower qualified for those programs. Some jurisdictions also require the lender and borrower to undergo mediation.
After filing, the attorney will order a bond (generally controlled by local statute or rule) and work with the auctioneer to schedule the sale. The attorney will serve a court filing and send notices to all interested parties and municipalities. Prior to the auction, the attorney should discuss with the client and advise the trustee on the minimum bid that is acceptable, and whether the client will attend auction. Also, the attorney should advise the Trustee whether the client wishes to buy-in the property if it does not sell to a third party, and under what terms.
At the auction, the trustee generally must be present. A client/lender representative generally may be present, or may be available by telephone. Following the sale, the attorney generally has a specific number of days to file certain sale-related documents with the court, and some jurisdictions require the results of the sale to be advertised for a period of time in a local paper. Once all post-sale requirements are completed, the court will review the sale for ratification. Once ratified, settlement will be scheduled and property sold. The attorney then files a proposed audit with court auditor, showing the details of the sale. The file cannot be closed until audit is completed.
As you can see, the judicial foreclosure process can be quite involved. However, some states do not require judicial intervention for the foreclosure process, making it less complicated and less expensive. These states use a non-judicial foreclosure process, which begins similarly to commencement of the judicial sale: with a review of the file, title work and ownership information. The attorney similarly prepares a Deed of Appointment of the trustee, which is recorded in Land Records once signed.
Next, the attorney sets a sale date with the auctioneer. The attorney and/or auctioneer send required notices regarding the foreclosure date to all interested parties. Prior to the auction, the attorney should discuss with the client and advise thetrustee of the minimum bid that is acceptable, the lender buy-in, if different, and whether the client will attend auction. At the auction, the process is much the same as the judicial foreclosure. Thereafter, the trustee files an accounting of the sale with an auditor or commissioner, who must then follow local procedures (such as posting the account for objection/exception) and then approve the accounting if appropriate.
In the event foreclosure is not a desired or available option, there are others, such as a sheriff’s sale, a short sale or a deed in lieu of foreclosure. A sheriff’s sale (also called a judgment creditor’s suit) can be an alternative to foreclosure if the foreclosure procedures are burdensome in your jurisdiction. But if you do that, you must be aware of the lien priorities that apply to the properties in question. A judgment creditor will not have the same lien priority as secured lien holder.
A short sale is a type of sale releasing the property for less than the amount that is borrowed for. If you elect a short sale, you should make certain that you are aware whether your jurisdiction will allow you to proceed against the borrowers for the deficiency following the short sale. Some do not. A Deed in Lieu of Foreclosure is basically the borrower transferring title of the collateral to the lender instead of going through a foreclosure. As a lender, you should be careful taking title to the property, and make sure that there are no environmental issues that will impair your ability to subsequently transfer the property. Also, the lender in such a situation should make sure to account for the costs it will incur in maintaining the property, until which time it can be re-transferred.
If there is no real property collateral, but rather the loan is collateralized with personal property, you have the option of a Uniform Commercial Code (UCC) sale. That process is governed by Article 9 of the UCC and provides several remedies. For example, you can require the borrower to collect and turn over the collateral, obtain possession of the collateral yourself (as long as you can do so without breaching the peace), or institute a judicial action to obtain possession (generally used where you cannot obtain possession without breaching the peace). Once the collateral is obtained, you can liquidate it through private or public sale.
These are just a few examples of the most common strategies used by attorneys to obtain judgment or liquidate collateral on defaulted commercial lending facilities. The use and effectiveness of each can vary from state to state, and lenders should consult with local counsel to discuss which strategies are best for each specific circumstance.