Commercial Foreclosures- Judicial and Nonjudicial

Overview:  Differences Between Commercial and Residential Foreclosures

Commercial real estate, such as office buildings, apartment complexes, gas stations and other commercial properties, which are not single family owned residential properties, if encumbered by a mortgage or a deed of trust, can be foreclosed, similar to a residential property.  There are a few key differences with the processes used with each type and there are different strategies used with each type.

First, commercial real estate and foreclosures are not subject to state and federal consumer protection laws like Regulations X and Z, Fair Debt Collection Protection Act (FDCPA), and so on, like residential real estate and foreclosures are.  Second, residential property transactions receive oversight by the Consumer Financial Protection Bureau (CFPB), who has expanded Regulation X to provide foreclosure protections to residential homeowners like 120 day grace period prior to filing, regular statements, extensive loss mitigation options, and enforcement actions and consent orders for “wayward” servicers.

Unique Features 

While commercial real estate transactions and foreclosures receive none of these consumer protections, the players in this space are typically more sophisticated business people who in theory have incentive and bargaining power with lenders to maintain a liquid asset or to work out default situation.  Commercial mortgages usually contain personal guaranties, assignment of rents, agreement to a receiver, and agreement to provide ongoing financial documents and proof of insurance on a regular basis.   Commercial real estate owners often are in the business of owning, selling and developing commercial property, so they strive to be successful, or obtain a workout with their lender.

There are actions which a lender can take with commercial loans, whether in judicial or nonjudicial foreclosure states, that are inapplicable to or are not allowed with residential loans such as:

• Discontinuing advances on loan (if the loan has not been fully funded);
• Making demand upon the borrower and accelerating the loan;
• Making demand upon any or all of the guarantors;
• Exercising any self-help rights to other collateral if allowed, like repossession of vehicles;
• Drawing upon any pledged letters of credit;
• Exercising rights to set off against pledged deposits or reserve accounts.
• Pre-foreclosure alternatives (reinstatement, loan modification, liquidation, forbearance or repayment agreements, assignment for the benefit of creditors, assumption by qualified buyer, deed in lieu of foreclosure, short sale/pre-foreclosure sale, etc.).

Commercial Nonjudicial Foreclosure

Overview

While nonjudicial foreclosure process varies by state, the process proceeds outside of the court system and therefore are generally faster and easier than judicial foreclosures.  With both types, the loan documents and/or state requirements control what type of default notice, if any, must be sent upon default.  Even if a default notice is not required, it may be effective to send one in order to get the attention of the borrower and possibly work out the default.

Nonjudicial states usually use deeds of trust, similar to mortgages in judicial states, that secure payment of a loan, and the power of sale clause in the deed of trust permits the trustee to foreclose and sell the property for the benefit of the lender without filing a lawsuit.

Default, Notice of Default, Notice of Sale

After default and notice of default is sent or not, if not required, and after any applicable notice or waiting period, the lender or trustee may proceed with publishing a notice of sale.  Publication requirements vary from state to state, including how, where, and how many times the notice must publish prior to sale.  The notice of sale usually will have a prescheduled sale date and time when the sale will take place if the borrower does not cure or contest the sale by filing a court action.

Trustee Sale

After publication of the notice of sale, and any applicable waiting period, the trustee proceeds with the sale to public at large or sometimes to a private group of bidders.  The lender can receive a credit bid up to the amount owed on the loan and property is sold to the highest bidder.   If there is no bid higher than the lender’s, the property is sold to the lender and becomes “real estate owned”, or REO.  If there are excess funds after all liens are satisfied, the borrower receives those funds.  In many nonjudicial states, the borrower has a redemption right to buy back the property from the successful bidder within a certain period of time.

Commercial Judicial Foreclosure

Overview

While judicial foreclosure process varies by state, the process proceeds within the court system and therefore tends to be slower and lasts longer than nonjudicial.  Similar to nonjudicial, first step is to send notice of default to the borrower as required by the loan documents and/or state law.  The documents also may allow a demand for rents from tenants, so this can be sent.

Judicial states typically use mortgages and notes, along with assignments of rents, contracts and permits; personal guaranties; and UCC-1 filings and security agreements which may be recorded for personal property.  All of these documents provide causes of action which include:

• Foreclosing the mortgage
• Enforcing the note, possibly for a deficiency
• Filing replevin to recover personalty
• Appointing a receiver
• Filing motion for assignment of rents

Default and Notice of Default

After default and notice of default is sent or not, if not required, and after any applicable notice or waiting period, the lender may file a complaint which contains at a minimum a count for foreclosure, plus any other additional counts for causes of action as listed above.  Some judicial states require that the original note be available at the time of filing the action, or at least at the time of judgment, so arrangements for the collateral file to be sent to counsel should be made when appropriate.

Filing of Complaint and Service, Assignment of Rents, Appointment of Receiver

After any demand period expires, a title search is ordered, and reviewed.  A complaint is filed and served on the borrower, who has twenty days to file a responsive pleading or be defaulted.  The lender also file a motion for assignment of rents with a proposed order, or follow local requirements, in order to have any rental payments sent directly to the lender.  A motion to appoint a receiver can be filed and entered for this same reason, in addition to preserving the property.

Many commercial mortgages contain provisions allowing for the appointment of a receiver to Many take charge of the property during the course of the foreclosure proceeding. Additionally, common law grounds for appointing a receiver exist to prevent the wasting of the property. A foreclosing lender may request appointment of a receiver for income-earning property in connection with a foreclosure action or in an action filed separately.

Receivers may be funded through special court-approved loans made by the lender, which are secured by the property and are given a super-priority over all other liens, including the mortgage.

Filing of Responsive Pleading or Entry of Default, Judgment and Setting of Sale

After the borrower is served, they can file a responsive pleading and defend the action, or be defaulted.  Either way, the lender can attempt to proceed to judgment at which time a sale date will be set.  If the case becomes contested, the parties have an opportunity to set a mediation or to otherwise resolve the case through options previously outlined, to avoid costly and protracted litigation.