And Protecting Owners and Personal Guarantors
Most commercial property owners are family-owned affairs. Many owners have most of their net worth tied-up in their properties. Consequently, when rent rolls or business revenue dwindles, losing one or more properties can be catastrophic to the owners and their families.
This article discusses foreclosure proceedings, common defenses, and strategies. If a property has equity, the goal of litigation is generally to save it. If the property has no equity, the objective is to avoid personal liability for owners under their guaranties or “Bad Boy” provisions.
1. Discussion of defenses in commercial mortgage foreclosure cases
Commercial foreclosure proceedings are somewhat different from residential foreclosure actions. Homeowners have an arsenal of defenses which are rooted in consumer-protection legislation. Yet these laws do not apply to commercial transactions. By contrast, the commercial owner’s battery of defenses is unique. Let’s discuss:
The defenses to a commercial mortgage foreclosure fall into three categories: (i) contractual defenses, (ii) procedural defenses, and (iii) equitable defenses.
* Contractual defenses, if available, are often the strongest. Examples include a lender’s breach of its promises to: (a) forebear from foreclosing if the owner catches up on one or more payments; (b) modify the terms of the loan; or (c) reinstate the loan. Reinstatement also may occur automatically by operation of law. Another common contractual defense is the lender’s failure to properly credit a borrower’s catch-up payments. And another frequently asserted defense is breach by the lender of the duty of good faith and fair dealing.
Other popular contractual defenses require the presence of special facts. These include lack of consideration, defective acceleration, and accord and satisfaction.
* Procedural defenses, if available, also offer opportunities. The most compelling example relates to the recording of the mortgage with the county clerk. It may be fatal to the lender’s security interest (and thus their foreclosure) if the lender made errors or omissions in its recorded documents. In some cases I have seen, the lender or title company failed to record the mortgage at all.
Another procedural defense is failure by the lender to pay Florida documentary stamp tax. See Florida Statute § 201.08. I can be up to $2,450 per mortgage. While the lender’s failure to pay over the tax is not a permanent bar to foreclosure or receivership, it is a prerequisite. See,One 79th St. Estates v. Am. Inv. Servs., 47 So. 3d 886 (Fla. 3d DCA 2010). The same holds true for Florida’s intangible tax.
The last variety among the procedural defenses is rooted in misconduct by bank’s attorneys and employees. Various courts have held that fraud by bank personnel or counsel can defeat or delay a foreclosure. The most prominent example is the “robo-signing” epidemic, in which mortgages, assignments, even court affidavits were never reviewed, approved, and properly executed.
* Some other defenses, equitable in nature, may also apply. Yet they will be unavailing unless they have clear factual support. These include equitable estoppel, waiver, merger, laches, and unclean hands.
Likewise, it is best to avoid the “blame the bank” lender-liability defenses unless there is good cause. These defenses go to the conduct of the lender in making and servicing the loan. Examples include fraudulently inducing a borrower to pursue the loan and unconscionability of loan terms and conditions. When these issues are asserted without factual support, the bank will focus on vindication, not settlement.
2. Strategies and tactics in battling commercial lenders
Before you can understand strategy, let’s review history. During the mid-2000s, the landscape was different. When property values were climbing, lenders were eager to foreclose quickly on defaulted loans. They would often have a buyer lined up even before the ink dried on the judge’s final order of foreclosure.
Today, the opposite is sometimes true. Many lenders do not want title. Title is a risk. It imparts liability to the lender for payments to vendors, premises liabilities, and even environmental hazards.
Whatever the circumstances, banks have found a way to cope. It is through receivership. They seek to have the court appoint a receiver who will take control of the asset, manage the property, and (most importantly for the lender) ensure that the mortgage is paid first from the property’s gross operating income, if there is any. This is appealing for the lender. If the process works, the lender may continue to mark the loan as performing.
Accordingly, more than half the time, we are not fighting foreclosure. Instead, we are battling the lender’s efforts to appoint (or renew the term of) a court-supervised receiver. Given this situation, we as counsel for the owner have many more options and pressure points above and beyond court-ordered mediation.
Another common strategy is strategic use of the bankruptcy court. In high-stakes, a well-timed bankruptcy is generally helpful. The bankruptcy will not prevent foreclosure, given the lender’s secured position.Yet a Chapter 11 proceeding can be used to prevent a lender from appointing a receivership or can remove a receiver.
Generally, on the filing of a bankruptcy petition, a receiver must cease all actions impacting property of the bankruptcy estate under section 543(a). Section 543(b)(1) generally requires a receiver to turn over commercial property owned by the bankruptcy estate to the bankruptcy trustee. Receivers are classified as “custodians” under Section 101(11).
The “turnover provisions of §543 are part of the statutory expression of the Congressional preference that a Chapter 11 debtor be permitted to operate and control its business during the reorganization process.” See, In re Northgate Terrace Apartments, Ltd, 117 BR 328, 332-33 (Bankr. S.D. Ohio 1990). Accordingly, the bank’s receivership attempt can be thwarted. The owner can be put back in possession and control.
There are also ways to combat a lender’s state court receivership petition outside of the bankruptcy court. These are not always as reliable. State court judges are often quick to enforce the receivership provisions spelled out in the loan documents.
All of these devices, and many more, are designed to achieve one outcome. It is the same outcome that the court desires. And it is the same outcome that most banks fundamentally want: settlement. Lenders are sometimes as eager as owners to delay or avoid foreclosure.
Yet every case is unique. Every property is different. Every loan is different. The debt-to-equity ratio is different for every asset. Lendersare influenced by different factors, too, including the philosophies of bank officers and employees, their in-house and outside attorneys, their history of prosecuting foreclosures and receivership actions, “bad-boy” provisions, and pressures from regulators.This is therefore a fact-driven process. There is no such thing as a “standard” commercial foreclosure.
3. Protecting personal guarantors from deficiency judgments
If foreclosure is inevitable, the next challenge is defending personal guarantors against deficiency judgments. There are a variety of tools available to do this. Moreover, we have seen a number of favorable court decisions relating to this issue. See, e.g., Farah v. Iberia Bank, 47 So.3d 850, 851 (Fla. 3d DCA 2010).
4. “Bad Boy” clauses
Lenders also may attempt to reach the principals by way of “Bad-Boy” clauses. These are carve-outs to otherwise non-recourse loans. They are triggered by action by the owner that the lender classifies as misconduct. When triggered, the owner becomes personally liable for all or part of the note.
Common triggers include: (a) selling or transferring the property or interests without prior consent of the lender; (b) failure to get the lender’s prior consent to subordinate financing; (c) failure to pay, when due, the first full monthly payment of principal and interest under the note; (d) resisting foreclosure or other contested enforcement proceedings; (e) filing for bankruptcy; and, (f) not paying or bonding off liens.
Regrettably, many of these issues arise when properties are in trouble or facing death spirals. The good news for owners is that Bad Boy actions can often be avoided, postponed, or mitigated.
See, the Truth-in-Lending Act, the Residential Settlement Procedures Act, the Homeowner Equity Protection Act, and the F.D.C.P.A.
By Carlos J. Bonilla, Esq