30 Nov Is a deed in lieu of foreclosure right for me?
The rocky landscape for commercial real estate has pushed many owners to the brink of foreclosure. For those who’ve fallen behind on their mortgage payments, though, a deed in lieu of foreclosure (DILF) may be a less cumbersome process.
What are the advantages?
A DILF offers several benefits to owners. The debt is generally forgiven completely, and a recourse borrower is released from all or part of its personal liability. Borrowers can preempt drawn-out and costly foreclosure litigation, and might be able to negotiate for the lender to cover certain expenses associated with transferring the property.
What can I expect from lenders?
DILFs hold some appeal for lenders, too — especially those wanting to take immediate possession. Most lenders, however, will make some demands — for example, they will typically require clear title, free of any liens, taxes or other claims or encumbrances. They generally aren’t open to DILF arrangements unless the current owner lacks the financial strength to continue making payments, the owner has attempted to sell the property for a reasonable period of time, and the current fair market value is greater than the outstanding debt.
Most lenders also shy away from DILF arrangements on property with multiple liens, which foreclosure would simply eliminate. If the lender is willing to proceed despite possible lien issues, the borrower might need to provide warranties and representations that no lien claims will come against the lender based on the period the borrower owned the property. The lender might also require a new owner’s title policy.
On recourse loans, lenders may require a cash payment in satisfaction of a portion of the debt. The lender, however, may wish to retain the ability to pursue the borrower and its guarantors for part of the debt.
The lender may require an environmental assessment report. Depending on the findings, the borrower might have to accept continued responsibility for future environmental liability. Finally, the lender will want to address issues related to the borrower’s existing tenants.
How is the borrower protected?
Borrowers should secure a release of any personal or guarantor liability, along with a covenant to protect the borrower and its guarantors from deficiency judgments and lawsuits. Moreover, the borrower should include a provision prohibiting the lender from filing negative reports with credit agencies and requiring it to return the original promissory note.
Tax caveats
A DILF can produce unexpected tax consequences. A borrower could, for example, end up with taxable “cancellation of debt” income. So it’s critical for borrowers to consult their tax advisors before making any decisions on foreclosures and DILFs.
