Deeds in Lieu of Foreclosure

Publication year1986
Pages394
CitationVol. 15 No. 3 Pg. 394
15 Colo.Law. 394
Colorado Lawyer
1986.

1986, March, Pg. 394. Deeds in Lieu of Foreclosure




394


Vol. 15, No. 3, Pg. 394

Deeds in Lieu of Foreclosure

by Robert A. Holmes

As real estate values remain unstable and office vacancies remain high, an increasing number of borrowers are unable to comply with loan repayment schedules to which they agreed in more optimistic times. When these problems arise, both the borrowers and their lenders may conclude that foreclosing the lenders' deed of trust (or similar enforcement of the lenders' remedies) is not in the best interests of the parties. Instead, the parties may decide to have the owner execute a deed to the property (which was used as security for the loan) in lieu of foreclosure by the lender (referred to here as a "deed-in-lieu").

For the lender, there are many risks inherent in such a procedure. This article examines some of those risks and discusses protections which can be incorporated into the deed-in-lieu transaction. Much of the material contained in this article assumes a commercial lending situation, but the principles are generally valid for a residential loan.


Reasons for Using a Deed-in-Lieu

Speed and cost are two incentives for lenders to agree to a deed-in-lieu, as opposed to other available workout strategies. A deed-in-lieu is much faster than many other remedies since the deed can be recorded and ownership transferred immediately---there is no need to wait for notices, publications or redemption periods required in every foreclosure, even if uncontested. Immediate ownership and right to possession can be very important to a lender since, especially with income-producing property, immediate action may be required to protect the property and preserve or increase its income and marketability.

A deed-in-lieu can be much less expensive to a lender than a foreclosure or other available remedies since the parties are cooperating and there are no detailed statutory requirements with which the lender must comply. However, the lender still needs protection from risks inherent in a deed-in-lieu, some of which are discussed below. Protection from these risks requires time to document and negotiate; however, in most situations, properly documenting a deed-in-lieu transaction still is much faster and less expensive than a foreclosure.

If a deed-in-lieu is not used, it may be difficult to assure recovery of funds advanced for improvements or repairs. Once a foreclosure sale has occurred, Colorado's redemption statutes do not specifically authorize recovery of such advances.(fn1) Even though a lender's deed of trust may specifically authorize expenditures benefiting the property to be included in the amounts secured by the deed of trust, the priority of the lien for such expenditures may be different than the lien of the lender's deed of trust.

The general rule is that where a lender is obligated to make future advances, those advances will be secured by the deed of trust in the same priority as were the initial advances. However, where the future advances are optional with the lender, the subsequent advances will be subject to any intervening liens.(fn2) If the lender instead takes title through a deed-in-lieu, the lender immediately becomes the owner and can include any advances in the sale price.

With regard to funds advanced by a lender, even appointment of a receiver for the property will not provide the same assurances as will a deed-in-lieu. Some protection can be obtained if the order appointing the receiver specifically grants the receiver the authority to reimburse a lender for funds advanced for the property or the authority to use the receiver's funds for such improvements and repairs. However, such an order will be subject to challenge by other interested parties and assumes that the property will generate enough income to cover these expenses. Additionally, the disbursement of all rents and other income collected by a receiver will be subject to court supervision, whereas if the lender takes a deed-in-lieu, it can apply all income however it chooses.

A recent Colorado case has raised some questions about the ease with which a receiver can be appointed.(fn4) In general, obtaining the appointment of a receiver is more expensive and time-consuming than a deed-in-lieu and gives the lender less control than outright ownership.

Other recent developments may adversely affect the certainty of the foreclosure process and cause lenders to look more favorably on deeds-in-lieu. Courts have generally been reluctant to set aside foreclosure sales in the absence of fraud or collusion where the foreclosing creditor bid in either the full amount of its indebtedness or the fair market value of the property.(fn5)

However, in Moreland v. Marwich, Ltd.,(fn6) the court set aside a foreclosure sale and extended the owner's redemption period after all statutory redemption periods had expired and after a Public Trustee's deed had been issued, even though the creditor had bid in the full amount of its indebtedness and there was no fraud or collusion. The court cited various factors for reaching its decision, including the fact that the creditor's bid at the foreclosure sale was significantly less than the fair market value of the property. This holding could cause lenders to look more favorably on deeds-in-lieu whenever the fair market value exceeds the amount the lender is willing to bid at the foreclosure sale.

By using a deed-in-lieu, the lender has the cooperation of the borrower, since existing defaults are being forgiven and the borrower's debts are reduced or forgiven entirely. This cooperation can be valuable in dealing with existing tenants, finding new tenants, negotiating with existing lienholders, and in achieving an orderly succession of management from borrower to lender.

If a deed-in-lieu is used, the lender will avoid the stigma of a foreclosure. Avoiding the negative image of a foreclosure can make it easier to market the property to prospective tenants and purchasers. If the lender decides instead to...

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