Written By: Eric D. Dean
Secured lenders must assess a number of concerns before concluding a non-judicial foreclosure by a trustees sale. If the secured lender fails to do so, it may be waiving valuable rights or exposing itself to unnecessary risks. Some of these concerns are addressed below in no particular order. This article is not meant to constitute a comprehensive discussion of all possible concerns or of any of the concerns referenced below but merely a checklist and brief description in order to heighten the lender awareness that further investigation and analysis may be warranted. The lender should consult counsel in the event any of the following concerns may exist.
Is There A Potential Deficiency: If a secured lender completes a non-judicial foreclosure it will under most circumstances be waiving its right to pursue claims for a deficiency. The secured lender may pursue a non judicial foreclosure and a judicial foreclosure concurrently until it either concludes the trustees sale or obtains judgment in the judicial foreclosure. In determining whether to pursue a judicial foreclosure the primary considerations of the lender are (1) Is there a potential significant deficiency (2) Does the Borrower have assets other than the loan collateral from which a deficiency can be collected and (3) Are there other sources of recovery for the deficiency besides the real property collateral and the borrower.
Are There Potential Environmental or Hazardous Waste Conditions. Depending on the nature and location of the loan collateral and the uses of the property made by the Borrower, before concluding a trustees sale, the lender should consider obtaining an update on its Phase 1 or Phase 2 Report or at least have an inspection of the property conducted as to potential environmental or hazardous waste conditions. Even in residential properties, mold conditions may be a significant problem depending on the nature of the property and whether it was abandoned by the borrower. If the lender completes a foreclose and such conditions exist, the lender may be required to clean up these conditions and also risks potential liability to third parties as to such conditions once it acquires title to the loan collateral. In the event such conditions exist and the property is still perceived by the lender to have value after considering the costs associated with the clean-up and risks, the safest course for the lender may be to have a receiver appointed by the Court to clean up the property before the trustees sale. The costs associated with the inspection, receivership and cleanup become part of the loan balance.
Are There Conditions On The Property That Constitute A Potential Nuisance. In addition to environmental conditions, there are numerous other potential conditions that might constitute a nuisance subjecting the lender to potential third party liability and costs to abate the nuisance once the lender acquires title to the loan collateral. In addition, many municipalities are imposing fines on lenders who acquire property in foreclosure and fail to abate untidy or dangerous conditions on the property. As with environmental concerns, the lender may want to have a receiver abate the nuisance before acquiring the collateral in foreclosure
Is there A Risk of the Borrower Diverting Rents, Removing Personal Property Collateral or Damaging the Collateral Pending the Foreclosure. If so, there are remedies the lender can seek through the Courts such as injunctive relief and the appointment of a receiver before the foreclosure and possibly damages after the foreclosure (see the next paragraph).
Has the Borrower Committed Waste (or Damage) on the Real Property, Diverted Rents or Converted Personal Property Collateral Most lenders in addition to the real property collateral also have a security interest in rents and some items of personal property such as fixtures. If the Borrower has without the lender’s permission diverted rents, removed personal property or committed waste to the real property, the lender may be entitled both to an award of actual damages as well as punitive damages against the Borrower and others who conspired with the Borrower to engage in such wrongful action. However, in order to preserve those claims the lender must not make a full credit bid at the trustees sale. The amount of the credit bid will cap the amount of recovery that the lender may recover in such a lawsuit. In the event the lender is able to prove its case, the punitive damage award may be as high a nine(9) times the actual damage award. A judgment obtained by the lender for these bad acts may also not be dischargeable in a bankruptcy.
Are There Guarantors A loan guaranty is typically a separate and unsecured obligation that the lender may pursue independent of the foreclosure either concurrent with the filing of the foreclosure or after its conclusion. However, to the extent that the lender makes a full credit bid at the trustees sale, the loan is deemed to have been satisfied and the guarantors have no further obligations to the lender under the guaranty. Therefore, the lender must carefully consider the potential of a deficiency and whether the guarantors have assets in determining its credit bid at the foreclosure sale.
7. Are There Senior Liens, Including Such Things As Senior Deeds of Trust, Liens as to Unpaid Taxes or Mechanics Liens and If So What Is Their Status. It can be assumed until investigation proves otherwise, that if the lender’s junior lien is in foreclosure any senior liens are also in default and real property taxes are unpaid. The lender will typically obtain a trustees sale guaranty when commencing a foreclosure which will disclose the existence and status of senior liens as of the date of the report. However, since completion of the a foreclosure takes months, the lender should stay in contact with senior lien holders and requests periodic updates of the TSG to prevent the senior lien from completing a foreclosure or taking other action such as the appointment of a receiver that may impact the lender’s position and the amount of the secured obligations senior to the lender’s deed of trust.
Are There Potential Clouds On Title Including Issues Such As Leases, Licenses, Prescriptive easements, Setbacks. Mechanics liens etc. If there are potential clouds on title this may have a dramatic impact on both the marketability and value of the real property collateral as well as subjecting the lender to potential liability once it concludes a trustees sale and therefore must be considered before conducting a trustees sale. In many cases, the lender by correspondence or being named in a lawsuit will be made aware of the title issues. However this is not always the case. The lender therefore must both inspect the property and review the Trustees Sale Guaranty before for potential title issues at the early stages of the foreclosure analysis. If such issues exist the lender needs to make a claim on its ALTA Title Policy and if it turns out that there is not coverage consider either a direct action or action through a receiver to resolve the title concern.
Are There Potential Structural Compliance, Permit or ADA Concerns on the Real Property Loan Collateral. If these types of concerns exist once the lender acquires the property in foreclosure the lender may be subjected to the costs of repairing these conditions. The existence of these conditions may dramatically reduce the value of the loan collateral may need to be disclosed to potential buyers of the property especially if known by the lender. If the property is not in compliance with ADA requirements, the lender who acquires title to the property at a trustees sale will also be subject to liability under Federal Law and the California Unruh Act. Depending upon such factors as the nature and age of the property, the foreclosing lender may want to want to have an inspection of the loan collateral done before completing its foreclosure and seek the appointment of a receiver to make repairs to any discovered defect before completing a foreclosure.
Is There Possible Fraud. To the extent “red flags” as to potential fraud exist and the lender is facing a potential material deficiency, the lender should consider having the file audited by a competent attorney or fraud analyst or underwriter to determine if there are potential fraud claims and if so whether those claims are worth pursuing. If the lender makes a full credit bid at the trustees sale fraud claims are waived under California law and the amount of the credit bid caps the amount of the recovery the lender may obtain should it pursue the fraud claim.
Is there Other Collateral and If So Is It Valuable. UnderCalifornia law, a secured lender who has multiple items of collateral may proceed to foreclose concurrently or it may proceed to foreclose on the collateral in such order as it sees fit. However, if the lender completes a non-judicial foreclosure of one item of collateral and makes a full credit bid at the trustees sale, the loan is deemed satisfied and the lender is required to release its lien against any other item of collateral regardless of the whether or not the foreclosed property is of sufficient value to satisfy the loan balance. Even if the lender does not make a full credit bid at the trustees sale, the amount of the credit bid will be reduced from the outstanding debt and therefore reduce the credit bids the lenders may make on the balance of its collateral when it proceeds to conclude the foreclosure of the additional collateral. The lender must therefore be careful to consider all its collateral before completing the foreclosure of any part of the collateral interests.
Is There a Claim of Lender Liability. A lender faced with a potential lender liability claim needs to be very careful before proceeding with a foreclosure and seek the advice of counsel. Pursuing a foreclosure in the face of a good faith and plausible lender liability claim will most certainly be viewed as inflammatory by the borrower and depending on the facts and circumstances may also be viewed as a being in bad faith by a judge or jury resulting in an injunction being entered against the foreclosure proceeding and an enhanced risk of a punitive damage award being entered against the lender in a substantial amount. This is not to say that a foreclosure should not be pursued even if a claim has been asserted by the borrower. However, before doing so, evaluating risk and developing a strategy if risk exists are essential if the lender is faced with a potential lender liability claim.