Deed in Lieu of Foreclosure Agreement
(Commercial) (Pro-Lender) (NJ)

Summary

This template for a deed in lieu of foreclosure agreement is used in connection with a New Jersey commercial real estate loan, where the borrower has defaulted on the loan and the lender takes ownership of the property. This template contains practical guidance, drafting notes, and optional clauses. This template is suggested for use in New Jersey; however, local counsel should be engaged to ensure that all state-specific requirements are met, and that the agreement and ancillary documents comply with New Jersey law in all respects. For a detailed discussion of deed in lieu of foreclosure agreements in commercial real estate loans, see Foreclosure of Real Property. After a loan is in default, including a failure to pay at maturity, the lender must determine what remedies are available to collect on its debt. If the value of the property is less than the loan balance, the borrower might agree to transfer the property to the lender or an entity designated by the lender in return for releases of any guaranties or existing recourse liability. This type of transaction is called a deed in lieu of foreclosure transaction. Advantages to the lender in a deed in lieu of foreclosure transaction include obtaining title to the property quickly and avoiding the costs and delays of a potentially lengthy foreclosure process. Advantages to the borrower and guarantors in a deed in lieu of foreclosure transaction include avoiding deficiency claims and the reputational hit of a foreclosure. While accepting a deed in lieu of foreclosure may save the lender time and money, there are pitfalls associated with these types of transactions, and lenders need to exercise caution when considering accepting a deed in lieu of foreclosure. Unlike a foreclosure, delivery of a deed in lieu of foreclosure does not extinguish any junior liens or encumbrances on the property. The lender's counsel should ensure that the deed in lieu of foreclosure includes non-merger language stipulating that (1) the mortgage lien is not extinguished, (2) the transfer is subject to the mortgage, and (3) the lender reserves the right to foreclose the mortgage after delivery of the deed to eliminate any junior liens or encumbrances. This language will preclude an inferior lienholder from successfully arguing that the mortgage lien was extinguished upon acceptance of the deed in lieu of foreclosure. Counsel should note that part of the underlying mortgage debt must remain alive in order for the non-merger language to be effective so that the lender's mortgage lien can be foreclosed upon. This may be accomplished by providing the consideration for the transfer as a release from personal liability for the underlying mortgage debt or by providing a covenant not to sue upon the mortgage debt. As long as the mortgage debt and mortgage lien include the foregoing protective measures, a lender that takes the conveyance by deed in lieu of foreclosure subject to inferior liens may foreclose its superior mortgage lien and extinguish any inferior liens upon the real property. A lender will also want to consider forming a single purpose entity for the purpose of taking title to the real property to be conveyed by a deed in lieu of foreclosure. The first advantage to this structure is that the mortgage lien and the fee ownership interests are held by two separate entities, which helps to ensure that the merger doctrine does not apply (although, it is still advisable to include language the non-merger language discussed above in the deed in lieu of foreclosure agreement). The second advantage to conveying the property to an entity other than the lender is that the lender avoids becoming an owner or operator that may be subject to strict liability for the costs associated with the cleanup and restoration of environmental contamination problems related to the real property. For a detailed discussion of single purpose entities, see Borrower as a Single Purpose Entity. For a more thorough discussion of deeds in lieu of foreclosure and other foreclosure options, see Foreclosure of Real Property. To the extent that these pitfalls are avoided, a deed in lieu of foreclosure transaction can be an effective means for a lender of a nonperforming mortgage loan to save time and expense, especially if the property is worth less than the mortgage debt. Deeds in lieu of foreclosure can also be placed in escrow pursuant to a forbearance agreement in a loan workout scenario. In the event that the mortgagor defaults under the terms of the forbearance agreement, the deed in lieu of foreclosure may be released to the lender. Even if there are subordinate liens upon the real property, the lender, provided that it takes the steps set forth above to protect its ability to foreclose, may still want to accept the deed in lieu of foreclosure upon default. The lender then, by essentially foreclosing against itself, avoids the delay that may be caused by a borrower asserting frivolous defenses or otherwise interfering with the prosecution of a foreclosure action. For a full listing of key content regarding commercial mortgage foreclosures, see Commercial Foreclosure Resource Kit (National and Select States). For a detailed discussion of workouts of commercial real estate loans, see Workouts of Commercial Real Estate Loans. For a template of a New Jersey forbearance agreement, see Forbearance Agreement (Commercial Real Estate Loan) (NJ).