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Lender Alternatives Upon Borrower's Default
(Foreclosure, Forbearance and/or Workout?)
Victor E. Carlin, Esq.
Moses, Dunn, Farmer & Tuthill, P.C.
Upon a borrower's default a real estate lender should not automatically send the borrower a demand letter and file a foreclosure action. Filing a foreclosure action without some communication between lender and borrower and without considering the alternatives to foreclosure will lead to one of several possible results: (1) judgment of foreclosure and a special master's sale; (2) litigation of a lender liability counterclaim and a resulting judgment for or against the lender; (3) bankruptcy of the borrower; or (4) settlement.
There are no hard and fast rules that will apply in every situation. However, prior to having counsel send a formal demand letter to a borrower, the real estate lender should communicate with the borrower and consider the alternatives available to the lender. Upon a borrower's default a real estate lender's objective should be to maximize its recovery of principal, interest, costs and attorney fees, and at the same time to avoid lender liability problems. However, that is easier said than done. In this day and age a lender can easily reduce its chances of recovery and incur significant lender liability exposure if the lender rushes to foreclosure without thoroughly analyzing the situation and considering the alternatives.
From a lender's perspective, where the debt is secured by real property, upon the borrower's default, the lender should consider and evaluate the following alternative courses of action:
1. Forbearance
2. Foreclosure
3. Deed in lieu of foreclosure
4. Workout
5. Involuntary petition in bankruptcy
At the same time as the lender is considering its alternatives the lender should understand that the borrower will be considering its own alternatives, as follows:
1. Bankruptcy
2. Filing suit against the lender (or filing a counterclaim if a foreclosure suit is filed)
3. Refinancing the debt elsewhere
4. Workout
5. Deed in lieu of foreclosure
6. Delay (requesting forbearance) in hopes that things will get better
7. Selling the property/project
The borrower's objective will be to realize the borrower's perceived equity in the property and/or to avoid owing a deficiency to the lender.
Choosing a Course of Action:
Upon the default of a loan secured by real property, prior to selecting a course of action in response to the borrower's default, the real estate lender needs to conduct an investigation of the pertinent facts and analyze the relevant legal issues, as follows:
1. First, the lender needs to make a realistic assessment as to why the loan is in default;
2. Second, the lender needs to find out the borrower's intentions (to sell, refinance and/or sue the lender, etc.);
3. Third, the lender needs to look at its collateral and determine the following:
a. Does the value of the collateral exceed the amount of debt?
b. How can the value of the collateral be maximized?
c. If the real estate collateral is a building, project, or development, does the lender's collateral have a going concern value that is greater than the collateral's value if the building, project or development is shut down?
d. Is the lender's security interest in its collateral properly documented and perfected?
4. Fourth, the lender needs to take a realistic look at lender liability issues.
Then, after analyzing the foregoing facts and legal issues, in response to a borrower's default the lender needs to focus on the alternative (or alternatives) that is (are) most reasonable both from the perspective of the lender and the borrower. From the lender's perspective a reasonable alternative response to default will minimize lender liability exposure and maximize recovery. From the borrower's perspective a reasonable alternative response to default will maximize the borrower's chances of realizing some of its perceived equity in the property/project. Borrowers that perceive that their lender is acting reasonably generally will not file lender liability lawsuits. On the other hand, even if the borrower ultimately does file a lender liability lawsuit (or counterclaim), when the case ultimately goes to the jury, having acted reasonably and being able to demonstrate the reasonableness of the lender's actions will maximize the lender's chances of a favorable outcome.
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Mr. Carlin has been an attorney with the Moses Law Firm in Albuquerque, New Mexico, since 1978. His practice includes litigation and problem resolution in the areas of creditors' rights, business, commercial, and real estate law. Phone: (505) 843-9440; e-mail: Vic@moseslaw.com
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