Lender Considerations in the Event of Foreclosure Explained by Oliver Maner Partner Douglas Herman

Charlotte Nauert

Tuesday, March 3rd, 2015

When a residential or investment income mortgage borrower defaults on his or her mortgage loan, a lender naturally considers immediate acceleration of the debt and foreclosure proceedings.  Douglas E. Herman is a litigation partner at Oliver Maner LLP who regularly handles commercial and financial services litigation, in addition to insurance, real estate and professional liability matters.  He cautions that, while acceleration of the debt is often a sensible approach, there are a variety of factors that lenders should consider before doing so. 

One question Doug hears frequently is “What happens when the real property that serves as collateral for the loan is subject to fees assessed by a homeowners or condominium owners association?”

Doug explains that Georgia’s Legislature has adopted separate statutes governing property owners associations/homeowners associations (“POA” or “HOA”) and condominium owners associations (“COA”). The statutory sections that address what happens to accrued association fees and assessments as between POA/HOAs and COAs are essentially identical, although other provisions of the respective statutes vary greatly.

“In a nutshell,” Doug says, “a foreclosing lender is not directly liable for any fees and assessments incurred by the delinquent owner whose property is being foreclosed, nor is the real property subject to a lien in favor of the association following a foreclosure. However, the unpaid share of any delinquent fees and assessments, at the time of foreclosure, is deemed to be a ‘common expense,’ which can be collected from all of the property owner-members of the association, including the foreclosing lender, in their pro rata shares.” 

Georgia’s courts have held that, if an association already has obtained a judgment for association fees/assessments against the delinquent borrower, and that judgment includes late fees, penalties, and/or attorneys’ fees, then those amounts cannot be included in calculating the amount of the lender’s pro rata share of a common expense. Rather, the foreclosing lender is only responsible for its pro rata share of the delinquent owner’s amount due for the fees and assessments due.   

Doug offers an illustration. “Let us assume: (1) An association sues Mr. Jones for $25,000.00 in delinquent assessments, $5,000.00 in penalties and late fees, and $5,000.00 in attorneys’ fees, and it obtains a total judgment of $35,000.00; (2) There are 10 properties which belong to the association; and (3) Mr. Jones’ property is foreclosed by Bank as first mortgage holder after the association has obtained its judgment. In this example, the lender could be held liable for $2,500.00, or 10% (its pro rata share based on the number of owner-members of the association) of the actual fees/assessments incurred by Mr. Jones, and now treated as a “common expense” following the foreclosure. The bank would not be liable for any portion of the $10,000.00 awarded to the association for penalties and attorneys’ fees.” Accordingly, Doug says, lenders should pay attention to delinquent owners’ association fees and assessments of a borrower when considering whether to foreclose the property.  This is especially important when a builder owns numerous lots, which may have incurred substantial fees and assessments over a period of time. 

Doug’s clients also often ask what happens when a tenant still inhabits the foreclosed property following the foreclosure. He says that, “if a tenant of the foreclosed borrower/owner, or the owner himself, continues to inhabit real property collateral following foreclosure, a lender essentially steps into the shoes of a landlord, and has to follow certain statutory eviction procedures if it cannot amicably arrange with the tenant or foreclosed owner to vacate the premises.”

Doug adds that if the borrower himself continues to reside in the property following foreclosure, he may be treated as a “tenant at sufferance” who can be served with an immediate demand for possession. If the foreclosed owner does not respond to the demand for possession, the lender should file an action for eviction and follow the statutory dispossessory procedures provided for in the Georgia Landlord and Tenant Act. 

The same procedure may be followed for a commercial tenant if the lender elects to dispossess the commercial tenant rather than effectively assuming the lease and stepping into the shoes of the former owner/landlord. “Of course,” Doug clarifies, “a lender may believe that a foreclosed property will not prove to be suitable for a quick sale, in which case, it may wish to keep the tenant in the space and simply act as a landlord, while continuing to receive payments that will satisfy portions of the delinquent borrower’s outstanding debt.”

Until December of 2014, however, if a residential tenant continued to occupy the collateral property following foreclosure, attention had to be paid to the provisions of the Protecting Tenants at Foreclosure Act (“PTFA”), which protected the rights of residential tenants who resided in foreclosed properties that delinquent borrowers owned for investment. 

Doug says that this legislation was passed in response to the rampant delinquencies and foreclosures that occurred in the latter portion of the last decade, and it essentially provided that, if a tenant in a foreclosed property had a written lease for a set term, the tenant could continue to reside at the subject property for the balance of that term so long as timely rental payments were made.  If a residential tenant did not have a written lease for a term, but was operating under a tenancy at will scenario, the lender had to provide ninety (90) days’ notice to the tenant to vacate the foreclosed property before it could take legal action to dispossess the tenant.  

However, the PTFA, was scheduled for “sunset” in December of 2014.  Doug explains that “sunset” is a way to put a time limit on the effect of certain legislation, and continuation of that legislation therefore requires renewal.  Although bills to extend the PTFA were introduced in Congress in 2014, none of those passed before the “sunset” date, Doug explains.  Accordingly, the federal PTFA is no longer operative, although certain lobbies are still pushing for its reinstatement.  To fill the gap, “several states have passed their own legislation to protect tenants,” Doug continues.  However, to date, Georgia has not passed any such legislation.  These developments are obviously good for lenders, Doug says, and “they reflect the steady recovery of the real estate debt market and the cycling through of many of the most problematic secured debts”.

Doug is also often asked:  “What happens when foreclosure occurs prior to a lender obtaining a judgment against the borrower and any guarantors?”

Because Georgia is a non-judicial foreclosure state, providing no redemption rights to a foreclosed property owner, Doug says lenders are often quick to request foreclosure against a delinquent borrower.

“With relatively modest acceleration and notice requirements, and the ease of conducting a non-judicial foreclosure sale, lenders know that they can obtain title to foreclosed properties in a few months post delinquency at most. However, if a lender moves to foreclose, but does not first obtain a money judgment against a borrower for amounts due pursuant to the applicable promissory note, then the lender must ‘confirm the sale’ in a hearing before a judge if it desires to proceed against the delinquent borrower for a deficiency judgment (i.e., the difference between what is owed by the borrower and the fair market value of the foreclosed property).” 

At a confirmation of sale hearing, the lender must establish that it bid on or sold the property at the foreclosure sale for fair market value and that the sale was properly conducted according to the statutory provisions. These requirements ensure that the lender is playing fairly with the delinquent borrower and that it will not receive a windfall with respect to any deficiency judgment. 

“However,” Doug adds, “a lender is not required to confirm the sale at a confirmation hearing if the lender first obtains a judgment against the delinquent borrower, for the amount still due pursuant to the promissory note. Thus, while obtaining a judgment before foreclosing requires a court proceeding and will take longer than simply foreclosing and seeking a judgment later, this approach eliminates any concern that the court will not confirm the sale and allow the lender to seek a deficiency judgment.” 

Therefore, if the deficiency is large because the debt is substantial and the value of the collateral is impaired or insufficient to cover the debt, a lender may want to take the time to obtain its judgment first before foreclosing the property. Conversely, if the collateral property is expected to deteriorate quickly – such as in the event of a hotel property that is shut down by the delinquent borrower and is no longer a going concern – foreclosing first might make the most sense to preserve the collateral, even if there is a risk that the court will not confirm the sale and allow the lender to proceed with a deficiency judgment. 

Doug adds that in most instances there will be little if anything a lender can hope to collect from a delinquent corporate borrower, following foreclosure of its commercial property; thus, lenders often require personal guaranties on debts to corporate borrowers in addition to the real property collateral. However, a recent Georgia Court of Appeals decision suggests that, if a personal guaranty is properly worded, the lender may be able to foreclose first and then proceed for a deficiency against a guarantor on the corporate debt without ever confirming the sale, even though the lender would be barred from collecting on a deficiency against the corporate debtor if it failed to confirm the sale prior to obtaining a money judgment. 

Doug sums up: “Simply put, lenders should not always assume the quick foreclosure paradigm is the best solution when they are facing delinquent secured real estate loans.  Other factors and considerations may affect the ability to the lender to use, control, market and dispose of the property, cause the lender to incur greater carrying expenses or even preclude the lender’s ability to recover certain portions of its debt.”