December 18, 2008

With delinquency rates rising and property values falling, many owners of commercial real estate are wondering whether to give their properties to the lender to avoid foreclosure. From a borrower's perspective, this workout strategy—known as a deed in lieu of foreclosure—offers several advantages:

  1. The debt is forgiven (if not specifically reserved by the creditor);

  2. The borrower or principal participants of the borrower are released from all or some portion of personal liability;

  3. The borrower avoids the time and expense of litigating a mortgage foreclosure case; and

  4. The lender may be willing to pay the taxes, title charges and other expenses of the transfer.

From a lender's standpoint, a deed in lieu of foreclosure is also advantageous, as it may be completed quickly without court intervention, resulting in a property that is immediately marketable once the deed is recorded. Furthermore, the lender controls the outcome of the process and can operate the property without a receiver, retain valuable tenants and collect all of the income from the project.

Not without Pitfalls

The process, however, has its pitfalls. Unless the offer of conveyance is truly voluntary—with no pressure, duress or undue influence by the lender—there is a risk that the borrower may later challenge the transaction. For this reason, the offer to "give back" the property should originate with the borrower in the form of a written offer submitted to the lender by the borrower or the borrower's attorney. After receiving an offer, the lender should reply to the borrower with a written acknowledgement. A lender is not under any duty to accept a deed from a borrower and thus it should carefully state the conditions, if any, under which it would consummate the transaction.

As a means of protecting themselves, most lenders will not accept a deed in lieu of foreclosure unless there are no other mortgages or subsequent liens on the property and there is no equity above the amount of the outstanding debt. Of particular concern is the prospect that a bankruptcy court might set the transaction aside in a subsequently filed bankruptcy.

While a deed in lieu of foreclosure is not a cure for every type of delinquency, borrowers, lenders and their counsel should consider this strategy as part of a responsible workout plan for distressed real estate loans.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.