Deed in Lieu of Foreclosure

The “deed in lieu of foreclosure” is the foreclosure alternative in which the property owner turns over the property to the lender and avoids the formal foreclosure process. As in a true short sale, the borrower’s goal in a “deed in lieu” resolution is to avoid liability for the deficiency that results if the property is worth less than what the borrower owes on the debt. The general idea is that the borrower saves the lender the expense of foreclosing by giving the lender the deed to property. In exchange the lender waives the deficiency.

Most lenders in the states where I practice law, Connecticut and New York, require the borrower to list the property for sale for a certain time period (usually at least 90 days) before they will consider a taking a deed in lieu of foreclosing. Whether the lender actually accepts the deed, or waives the deficiency, after the time period expires is an open question. I have not been involved with any deed in lieu transaction in Connecticut or New York nor have I heard of any completed deed in lieu transaction in Connecticut or New York. I think this is largely for three reasons. First, the bank would much prefer that the borrower sell the property rather than the bank have to add the property to its inventory of unsold, “bank-owned” properties. The bank has carrying costs on the properties it owns and there is no reason to increase those costs in a terrible real estate market. Plus, real estate agents will tell you that it is generally easier to sell a property that is occupied than it is to sell a property that is vacant. If the bank takes the deed, the property will be vacant.

Second, Connecticut and New York are judicial foreclosure states. By the time the borrower starts considering a deed in lieu in transaction, the bank has already commenced the foreclosure lawsuit. For residential foreclosures, the parties will spend time in Connecticut’s Foreclosure Mediation program or New York’s Foreclosure Settlement Conference program trying to agree to a mortgage modification. If the programs fail to achieve a modification, most banks believe completing the foreclosure is a foregone conclusion. The bank has less incentive to consider a deed in lieu because it has already initiated and, in its view, can expeditiously complete, the foreclosure without having to waive the deficiency. Contrast this with a nonjudicial foreclosure state where a deed in lieu can avoid commencement of the foreclosure process.

Finally, banks don’t like to waive deficiencies. In a judicial foreclosure state, where the foreclosure lawsuit has already commenced, the borrower gets no real benefit from a deed in lieu if the bank will not waive the deficiency. This is essentially the flip-side of the bank’s viewpoint discussed above: the bank has little incentive to consider a deed in lieu when the foreclosure action is pending and neither does the borrower.

That being said, if a borrower is resigned to losing the property, it cannot hurt to explore the deed in lieu possibility with the bank. At the least, it might provide the borrower with some flexibility in vacating the property.

Connecticut’s Foreclosure Mediation Program

Connecticut’s Foreclosure Mediation Program provides court oversight to the mortgage modification process and can help borrowers obtain a mortgage modification that otherwise may have been beyond their reach.

The borrower must satisfy five criteria to be eligible for the program. First, the property must be the borrower’s primary residence. Second, the borrower must occupy the property. Third, the property must be a one to four family residence in Connecticut. Fourth, the person applying to the program must be the borrower. Fifth, the borrower must be the defendant in a mortgage foreclosure action.

If all five criteria are satisfied, the borrower completes and files with the court a Foreclosure Mediation Certificate together with an Appearance. Note that the “appearance” is a form; it does not require a physical appearance in court. A blank Foreclosure Mediation Certificate and Appearance form should be included with the summons and complaint. The borrower must file these forms with the court within 15 days of the return date listed on the summons but the borrower can move for permission to request mediation more than 15 days after the return date.

Shortly after the borrower files the Certificate and Appearance, the court will send the borrower a notice of the first mediation session. The mediations take place at the courthouse but not in a courtroom. They are informal. The only people present are the borrower (and if applicable the borrower’s lawyer), the bank’s lawyer and the mediator, who is a state employee but not a judge.

The program normally takes place over several mediation sessions. At the first session, the bank’s lawyer provides some information about the loan to the mediator, including the outstanding principal balance, whether there are escrows for taxes and insurance and the current payment. The mediator will discuss with the borrower the reasons why the borrower fell behind, the borrower’s employment or income situation and whether the borrower would like to stay in the home. If that is the case, the bank’s lawyer provides the borrower with some forms to complete and a list of documents to provide. The forms ask for information about the borrower’s income, expenses and assets. The documents requested usually include paystubs, bank statements and tax returns.

The court will send the borrower a notice of the next mediation session, which is usually 30-60 days after the first session. Subsequent sessions revolve around making sure the lender has all the documents and information it requested. Certain documents, like paystubs and bank statements, have to be updated as the mediation progresses.

A successful mediation results in a mortgage modification. The mediation process can be as exasperating as applying for a modification outside of the Foreclosure Mediation Program but in my experience the mediator’s oversight helps keep the lender on track.

Motion to Dismiss for Lack of Standing

Produce the Note, An Alternate View, Parts 1, 2 and 3 explained why borrowers might be better off asking the foreclosing party to prove ownership of the debt rather than asking it to produce the note. But how and when does the borrower go about asking the lender to do either of these things? In my view, the best way to do it is by a formal motion to dismiss for lack of standing. Part 1 of the Produce the Note series explained that standing is an aspect of subject matter jurisdiction and that if the foreclosing party lacks standing, the court lacks subject matter jurisdiction. If the court lacks subject matter jurisdiction, the case must be dismissed. When a borrower asks the foreclosing party to prove ownership of the debt (or to produce the note if the borrower goes that route), the borrower is really asking the court to dismiss the case because the foreclosing party can’t prove ownership of the debt (or produce the note). Whether the borrower does this informally, by making the request at a court appearance for example, or formally, by filing a written request with the court, the borrower’s request is a motion to dismiss for lack of subject matter jurisdiction. If the borrower chooses to ask the foreclosing party to prove it owns the debt, the borrower should make a formal written motion. The mortgage industry wants to prove standing merely by producing the note and that is all the courts have been requiring. The borrower needs to why producing the note is not sufficient and that requires a written explanation.

One of the best features of the lack of subject matter jurisdiction is that in some jurisdictions, like Connecticut, it cannot be waived or conferred by consent. This means that the borrower can raise it at any time. Other jurisdictions may require the borrower to do something, like raise it as a defense in the pleadings, to preserve the right to move to dismiss later. Assuming the borrower has properly preserved it, or doesn’t have to, the question of when to move to dismiss for lack of subject matter jurisdiction is really a question of strategy in a particular case. It may not be beneficial to do it early in the case when, for example, the borrower is participating in the Foreclosure Mediation Program (CT) or the Foreclosure Settlement Conference Program (NY). The goal of these programs is to modify the mortgage to keep the borrower in the property. They are essentially “court-annexed” programs, which means that if there is no case pending against the borrower, the borrower cannot participate in the program. A successful motion to dismiss will take the borrower out of the program because it results in there being no case. On the other hand, it may be beneficial to do it early in the case when no court-annexed program is available to the borrower as in the case of an investment property. In those circumstances, the borrower might get some leverage in negotiating a workout or modification if the foreclosing party is facing dismissal.