Connecticut Deeds in Lieu of Foreclosure: Lender Concerns and Title Issues
| Publication year | 2021 |
| Pages | 433 |
64 CBJ 433. Connecticut Deeds in Lieu of Foreclosure: Lender Concerns and Title Issues
The depressed real estate economy of the last three years has manifested itself in crowded foreclosure calendars surpassing even those of the recession of the early seventies. What has come to distinguish the current experience from the former, however, has been the increased use of deeds being proffered by borrowers to lenders in lieu of foreclosure. Expectedly, the force compelling owners to offer such deeds - a marked decrease in real estate values - is the same force causing lenders to scrutinize the offers more critically than they would have in the past. But the question of the adequacy of the security only scratches the surface of the issues raised by such deeds; lenders need to address a number of concerns when reviewing a proffered deed, and they need to be certain that they have not unwittingly left themselves open to further problems down the line. A discussion of these concerns constitutes the first part of this article; the second part deals with the special concerns of title insurers who are asked to insure properties in which deeds-in-lieu are being contemplated.
A. Consideration.
Although consideration is not required for a deed to be effective as between parties, it is well established that a mortgage must give consideration for a deed in lieu of foreclosure. (fn1) Not so well established, however, is the amount of consideration necessary to support such a deed, so that it is safe from attack for want of adequate consideration. Historically, these types of conveyances have been viewed with suspicion. A typical expression of this philosophy is found in Villa v. Rodriguez, (fn2) in which the U.S. Supreme Court observed:
To give validity to such a sale by a mortgagor it must be shown that the conduct of the mortgage was, in all things, fair and frank, and that he paid for the property what it was worth. He must hold out no delusive hopes; he must exert no undue
influence; he must make no advantage of the fears or poverty of the other party. Any indirection or obliquity of conduct is fatal to his title. Every doubt will be resolved against him.
As evidenced by the frequent use of deeds in lieu of foreclosure, they are no longer viewed with the same degree of suspicion as in earlier times; but this is not to say that concerns about fair dealing, including the adequacy of consideration, can be tossed aside. Connecticut courts have been consistent in their requirement that a mortgagor's conveyance to his mortgage be supported by adequate consideration. In Cohn v. Bridgeport Plumbing Supply Co., Inc., (fn3) the Court noted the ruling of Batty V. Snook, to the effect that "the mortgagor may release the equity of redemption to the mortgage for a good and valuable consideration, when done voluntarily, and there is no fraud, and no undue influence brought to bear upon him for that purpose by the creditor." (fn4) Likewise, in Gavin v. Johnson, (fn5) the Court sanctioned agreements to convey a mortgagor's equity to the mortgage, after default,
if such an agreement is made upon a fair consideration, voluntarily and without fraud or imposition ... but equity will scan with care any transaction by which mortgagor surrenders his right of redemption, and if it finds that he has not received a substantial consideration or that unconscionable advantage has been taken of him or inequitable conduct practiced upon him, the transaction will be treated as null and void.
Having seen that Connecticut requires deeds in lieu of foreclosure to be made upon fair (fn6) or valuable (fn7) consideration, we must next proceed to the task of determining how much consideration will satisfy that rule. Some commentators suggest that something in excess of the mortgage debt ought to be paid, regardless of the sometimes inadequate value of the security. "Debt cancellation alone is not a sufficient consideration in many states to give the grantee the protection of the recording acts. Hence, money consideration is a practical necessity." (fn8)
In Connecticut, no statutory or case law requires, per se, additional consideration over debt cancellation to support a deed in lieu of foreclosure. As we shall see, however, there will be instances wherein such a payment is well advised.
In many cases, a borrower will offer a deed to his lender because be realizes that there is no equity in the property over the mortgage, and he wants to avoid exposure on a possible deficiency judgment. The lender may be in accord with this proposal, not wanting to incur the expense and delay of foreclosure. But even the most knowledgeable bank officer should not rely on his own estimation of value. Rather, be should retain a competent independent appraiser to perform the task of determining the value of the proffered realty. In-house appraisals should be avoided, since they are arguably biased. When the day comes, as it surely will, that the economy reverses its downward trend, the borrower who so eagerly deeded his $175,000 house to avoid a foreclosure of his $200,000 mortgage may come knocking at the lender's door seeking compensation for the extra equity now existing in the house, whose value may have increased to $250,000. Happy then will be the lender who can produce a contemporaneous and disinterested appraisal, showing that there was no excess value in the property and that the transaction was fair and equitable.
In a reverse situation, where the value of the property clearly exceeds the mortgage debt, the question of adequate consideration can become more difficult. Recalling the criteria of good faith and fair dealing established in such cases as Cohn and Gavin, we can be certain that equity will not permit a lender to gain a windfall at the expense of a disadvantaged borrower. But does this mean that a lender must contribute additional consideration up to the full market value of the property? Probably not, but a number of factors will come into play in resolving the question. For instance, if the property has been on the market for a prolonged period, it would probably be acceptable for the additional consideration to represent a price the owner would have been willing to accept, in view of the extended period the property has remained unsold and taking into consideration a real estate commission that would
have been paid in a private sale. (fn9) A second factor in the equation lies in the bankruptcy concerns discussed below (Section E) whereby the lender must deal with the possibility that the transaction might be set aside in the bankruptcy court as a fraudulent transfer.
This fact pattern occurs with some frequency: Owner's ("O's") property is valued at $200,000 (well below its original value). Lender ("L") holds a mortgage for $400,000. 0 would like to give a deed in lieu of foreclosure, but L does not want to forgive the entire debt. The parties ultimately agree that 0 will deed the property to L, but L will covenant not to sue 0 for any amount in excess of $100,000. Will this work?
From a consideration point of view, the answer is: Yes. There is no question that 0 is receiving a benefit by being absolved from $100,000 of exposure on a deficiency. Likewise, L is suffering a detriment of equal measure. There can be no mortgage without a debt; thus as will be discussed in Section C, relating to issues of merger, it is sometimes important that the debt not be extinguished in these cases. Additionally, our example is squarely in accord with Connecticut case law holding that, after default, the parties are free to enter into fair agreements resolving the issues confronting them.
In Phipps v. Munson, (fn10) the lender had already begun a foreclosure. During the pendency of the action, the parties agreed that the owner would convey the premises to the lender, who agreed to reconvey the property to the owner if payment of the debt was tendered within six months. The tender was made, but some days after the six months had expired. The owner asserted that the agreement was a new mortgage and sought a right to redeem. In disallowing this claim the Court observed:
The object of the settlement, so far as the object can be gathered from its terms and the attending circumstances, was to effect a foreclosure by the action of the parties instead of the court. The very purpose of the deed was to destroy and not to create an equity of redemption; and of the agreement to reconvey, to give the plaintiff, in lieu of art equity of redemption, a right to purchase for a given price within a
limited time ....
The parties resorted to an agreement doubtless for the purpose of saving expense. In it we see nothing oppressive, and nothing that contravenes any principle of law or equity.
B. "Clogging" the Equity of Redemption
Deeds, given either simultaneously with a mortgage or prior to default as additional security for the debt, seeking to avoid the necessity of foreclosure in the event of default, must be carefully distinguished from deeds in lieu of foreclosure. Although the parties are free to negotiate for a deed in lieu of foreclosure after a default, equity prohibits such arrangements prior to default. Such schemes are commonly characterized as "clogging" the equity of redemption, and have consistently been condemned. The rule, 11 once a mortgage always a mortgage", has been held to apply in such instances, and "its purpose is to protect the debtor who, under circumstances of hardship or necessity, might be an easy prey to those who sought to exact inequitable conditions." (fn11)
The leading Connecticut case on "clogging" is Cohn v. Bridgeport...
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