Michael and Robert Schimmel
Real estate markets across the nation have come to a grinding halt, and foreclosure rates of properties have skyrocketed to unprecedented levels. Many developers, lenders and commercial investors are now in the process of analyzing loan documents to determine their respective rights and obligations. With partially-completed development projects on hold, tenants defaulting on leases and property values getting hit hard by the market correction, the cash flow necessary to support many of these commercial properties has disappeared. Borrowers are having a difficult time complying with obligations under their existing mortgages. Consequently, borrowers and lenders are evaluating the terms and provisions of these mortgages. This article explores mortgage and foreclosure law, specifically examining the appropriateness and effect of including provisions into the mortgage, addressing the appointment of a receiver in the event of a default, and the necessity of a foreclosure proceeding.
In most major real estate transactions, a mortgage is required to finance the deal. In the commercial context, many institutional lenders work from form documents containing multiple terms and provisions that are negotiated on a case-by-case basis. These terms depend on the lender’s relationship with the borrower and the asset’s property type.
The failure to make payments under a mortgage usually results in default of the mortgage. Default triggers the acceleration provision in the mortgage, which allows the lender to claim the entire debt immediately. To protect against foreclosure abuse, acceleration provisions are often regulated by state laws, which may permit late payments. Unfortunately, foreclosure is not a uniform process. There are a variety of methods depending on the terms of the mortgage and the laws of the state where the property is situated. Although several states permit grants of power to the lender to sell the property, the most common method used by states is a judicial foreclosure, which requires a court proceeding.
It is fairly common for a mortgage to contain a host of provisions imposing obligations on the borrower and giving rights to the lender to protect the property. A few noteworthy provisions include use and occupancy restrictions and minimum insurance obligations. A provision not always included but that should be considered is the appointment of a receiver in the event of default or foreclosure. The appointment of a receiver benefits both borrowers and lenders by helping to ensure the asset’s preservation during foreclosure proceedings. This provision should be narrowly tailored, outlining specific directives for the receiver and the requirement of court approval for all actions.
Any lender holding a mortgage aims to preserve the collateral and avoid waste, loss or destruction of the mortgaged property. When a borrower stops paying under the mortgage, it is highly likely that other management and/or maintenance fees have also stopped, along with payments of property taxes and possibly even the insurance premiums. To this end, there usually are specific provisions in the standard mortgage instrument prohibiting waste or destruction of the property. A specific provision allowing the appointment of a receiver would help guard against any actions or inactions that could damage the property. It is likely that the mortgage holder has also obtained a security interest in fixtures, equipment and other items as well as a conditional assignment of leases, rents and profits from the property. The key issue addressed by the addition of a provision appointing a receiver is that a receiver is immediately appointed before a mortgagor can begin to commit waste or destroy the collateral. There are potential monetary costs associated with this provision that must be considered and weighed by the parties, but on the surface, the cost of waste and potential for further diminution in value of the property is much greater. A provision appointing a receiver usually arises when the mortgagor has defaulted on the loan.
With the number of foreclosure and other litigation cases exponentially increasing, the time frame to complete a foreclosure case is increasing. As a result, often the mortgagee is forced to sit on the sidelines while the litigation process unfolds, sometimes watching the value of its collateral decrease due to waste. Although the potential receipt of rents and profits from the property from a conditional assignment may help to lessen the damages, the mortgagee should take all reasonable steps to ensure that its collateral is not wasted or diminished in value. Similarly, the borrower also has a vested interest in preserving the value of the property, which could ultimately lessen the borrower’s obligation upon the sale of the property through foreclosure. The parties can potentially remedy this situation, when appropriate, in the foreclosure litigation by seeking the appointment of a receiver to prevent the waste, loss or destruction of the property. However, in order to accomplish the appointment, the initial groundwork must be in place, starting with the proper language being included in the mortgage loan instruments. The request for the appointment should be made as soon as the mortgagee reasonably believes there is the potential for waste, loss or destruction. Although a request is made, in many jurisdictions, the appointment of a receiver remains the discretion of the court.
This article is merely a cursory review of certain provisions in mortgages and the foreclosure process. There are state statutory laws, numerous federal and state cases and countless secondary sources concerning this topic. Depending on the location of the property and the nature of the transaction, a more thorough review and analysis of the law should be conducted to ensure that a party’s rights are protected.
Michael S. Schimmel works in the Real Estate and Corporate Practice Group at Gunster Yoakley & Stewart. Robert Schimmel is a partner of Hessen, Schimmel & DeCastro.