Strategic Options for Overly Encumbered Real Property (Friendly Foreclosures), 0717 COBJ, Vol. 46, No. 7 Pg. 30
| Author | COREY T. ZURBUCH, J. |
COREY T. ZURBUCH, J.
This article discusses options for overly encumbered real property. It focuses on "friendly foreclosures" as a means to manage and restructure debt.
Foreclosure strategy may not be on everyone's mind in the middle of one of the longest-running economic expansions in history. However, what goes up must come down, and it is always a good idea to have a contingency plan in place. The particular plan discussed in this article is an asset protection maneuver that is often referred to as a "friendly foreclosure." Regardless of the name, the Colorado foreclosure process presents an efficient and effective way to manage and restructure debt and create an opportunity for both an investor and the current occupant.
Troubled Borrowers/Troubled Properties
In many instances, foreclosure is a sensible strategy for restructuring debt. In the typical scenario, a property owner either resides in or operates a business on the property. The occupant may have a stable income, but that income may be inadequate to service the debt on the property, and the value of the property may have decreased such that the debt exceeds the property's value. The fact that the troubled borrower either resides in or operates a business on the property gives her a strong interest in remaining in place and likely makes the property more valuable to the occupant than it is to other potential tenants or purchasers. The occupant can therefore be an attractive and readily available tenant or purchaser for a would-be investor.
What Is a Lender to Do?
In this circumstance, where the debt on real property exceeds the property's value and the borrower falls into arrears, any lender is at a considerable disadvantage because the foreclosure option is unlikely to recover the full amount of the loan and the lender risks holding title to a property that is declining in value. When faced with a loss in foreclosure or potentially holding an asset with declining value, lenders must look for strategies beyond foreclosure to clear at-risk and non-performing loans from their books. One strategy is to place these unwanted notes up for sale. Unless the terms of the note prohibit transfers or assignments (which is rarely the case), under Colorado law a note maybe freely transferred and a lender may market the note itself or through one of many available online clearinghouses. The Colorado foreclosure statute provides: "The holder of the evidence of debt may assign or transfer the secured indebtedness at any time during the pendency of a foreclosure action without affecting the validity of the secured indebtedness."[1] An investor may also contact local banks directly and ask about purchasing non-performing notes. Given the risk associated with non-performing loans, these notes are often sold at a steep discount. In Colorado, this option remains even if the lender or another lien holder has commenced foreclosure proceedings.
During the last recession, many non-performing notes sold for as little as half or even one-tenth the face value of the note. Such deep discounts create an opportunity for both potential investors and the distressed borrower. If the troubled borrower can locate a "White Knight" who is willing to purchase the note secured by his property and the White Knight can purchase the note at an attractive price to the parties, the White Knight can then use its financial position to renegotiate the terms of the loan with the borrower. If there is no other debt on the property, the amount the White Knight pays for the note may be less than the value of the property, resulting in the White Knight being adequately secured. If the borrower's financial position warrants it, the White Knight as the note holder can pass those savings on to the borrower, in whole or in part, byway of more favorable terms such as lower interest rates, lower principal payments, or an extended term. With such modifications, the non-performing, under-secured loan can be transformed into a performing, fully secured loan. In this instance, all parties benefit because the original lender removes a non-performing loan from its books without the cost and risk of foreclosure, the White Knight gains a performing and reasonably secured investment, and the borrower remains in possession of the property for its residence or business.
However, if there are junior liens such as mechanic's liens or second and third mortgages,2 the White Knight investor may not be adequately secured. There is also the risk that the borrower is not able to make payments on both the senior and junior liens, the risk of foreclosure by those junior lenders, and the risk of default on the note held by the White Knight based on the added financial pressure on the borrower. The White Knight would be in a better position if those additional obligations and liens were eliminated.
Assuming that the White Knight has acquired the note from the senior lender and that note remains in default, the White Knight can institute a foreclosure proceeding and wipe out the junior liens on the property. Provided no junior lienholder exercises its right to redeem, under CRS §...
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