The Deed-In-Lieu-of-Foreclosure: A Solution Whose Time Has Come

As we know, until recently, the vast majority of foreclosures in Oregon were conducted non-judicially, by advertisement and sale.  However, due to the McCoy and Hooker decisions,[1] the efficacy of this method of foreclosure has been placed in doubt. The proposal described below suggests that before filing judicial foreclosures, homeowners be offered an opportunity to convey the property back to the bank in lieu of foreclosure. This would avoid any McCoy/Hooker title problems, since the deed would come directly from the homeowner.  If there were subordinate liens on the property, the lender could either negotiate a voluntary removal of that lien, or could decide to foreclose judicially or non-judicially without the borrower’s involvement. This solution would provide significant benefits: (a) Lenders could avoid the costly filing fees, legal fees, and prolonged foreclosure process, compounded by the six month right of redemption; (b) Borrowers would be able to transition out of their distressed housing situation sooner, and would avoid having to hire an attorney to explain their rights; (c) The Oregon court system would avoid the time and cost of ramping up for hundreds or thousands of judicial foreclosures, saving significant money and administrative time.  – PCQ

Discussion. The impact of McCoy and Hooker continues to place the title to non-judicially foreclosed properties in doubt.  This is so, even though following the Beyer and James decision, some Oregon lenders are already declaring victory for the Big Banks.  But apparently, the title industry didn’t get the memo, as most companies continue to examine title to REOs on a case-by-case basis before insuring title out to purchasers. Although I do not know what possible legislation the lending/title industries have planned for the 2012 Session, it will likely be politically charged, as was the case in 2011. [Update 4-22-12:  SB 1552, the mandatory mediation law, was passed in the 2012 Legislative Session.  See discussion here.  It will become operative on July 12, 2012.  Among other “Foreclosure Avoidance Measures,” homeowners facing foreclosure will be able in mediation to try to negotiate a Deed-in-Lieu of Foreclosure solution with lenders. And on the judicial front, the original James decision, which issued from a Federal Magistrate, was reviewed and completely overturned in a well-reasoned opinion by Federal Judge Simon.  See discussion here and here. – PCQ]

Recently, we have seen several major lenders, such as Chase and Wells Fargo, begin filing their foreclosures in court, to avoid the recording difficulties imposed by ORS 86.735(1).  This decision has resulted in several predictable consequences for the banks, including: (a) Incurring significant court filing fees; (b) Requiring the use of lawyers to prepare and file legal pleadings, rather than using foreclosure trustees to handle the advertisement and sale process; (c) Involving the court system and judiciary in the foreclosure process; and (d) Triggering the automatic six month right of redemption to foreclosed borrowers.[2]

Impact of Judicial Foreclosures on Borrowers. The consequences were tangible and predictable for the banks and court system.  We knew this would occur at the outset.  But the consequences to affected homeowners were not a part of any analysis I am aware of.  However, in the course of my practice, I have seen the results.

Most borrowers are not used to being sued, and have no idea what to expect.  They are scared and fearful when they are served with a complaint seeking a judgment for thousands of dollars.  They fear garnishment of wages and bank accounts, and (incorrectly) execution on their retirement funds, IRSs, 529s, or social security.

In most cases, borrowers have absolutely no interest in fighting a foreclosure.  If given a choice, they would have preferred not to be publicly sued in a court of law, with the attendant stigmatization that goes beyond having one’s name appear in the Daily Journal of Commerce.  While homeowners usually know when foreclosure is imminent, most expect the process to follow the historical non-judicial format, i.e. the mailing of a notice to them that the property will be sold on a date certain a few months away.  However, to be personally served by a process server at a time not of their choosing, and to be informed in the paperwork that they have 30 days to respond or a default judgment will be taken against them for thousands of dollars, is a frightening experience.  In my opinion, there is a viable alternative.

A Lender DIL/F Program. I believe that prior to filing a lawsuit in court, lenders should uniformly make a good faith effort to contact defaulting borrowers and offer to take the property back using a deed-in-lieu-of-foreclosure (“DIL/F”).[3] Bank of America explains it on their website here.

The benefits to all affected parties, i.e. lenders, borrowers, and the judicial system, would be substantial: Lenders would save thousands, if not millions of dollars in attorney and filing fees, and borrowers would be able to transition out of their home in an orderly fashion – and avoid having to employ an attorney to inform them of their legal rights.[4] The overburdened and under-funded courts would be freed of having to deal with a majority of defaulted loans headed into judicial foreclosure.

The Specifics. I acknowledge that several conditions and exceptions are necessary to ease lender concerns.  I will address those that have occurred to me, and those that have been kindly suggested by title counsel.

  • It would only apply to the judicial foreclosure of 1 to 4 family dwellings.[5]
  • It would not apply to cases in which the lender needed to file judicially due to circumstances arising from a failure to probate or other title issues.
  • It would apply even though the property was encumbered by two or more subordinate lienholders.
    • If the subordinate lienholders refused to consent (or were unable to reach agreement with the borrower on payback of the deficiency), but the borrower was still willing to execute the DIL/F, the borrower could voluntarily do so, and the lender could decide whether to proceed judicially or non-judicially against those lienholders.  In order for the lender to preserve its right of foreclosure against subordinate lienholders, it uses “non-merger” language in the DIL/F, reserving its right to take the title from the borrower by not “merging” its lien with the recovered title.  That way, the lender may remain in a first lien position, and can deal with subordinate lienholders as necessary.  Certainly, however, no judicial foreclosures would be necessary against anyone.
    • Since McCoy and Hooker stem from borrower claims over the validity of non-judicial foreclosures, it would seem that once the borrower deeded the property back in lieu of foreclosure, the non-judicial process could be pursued against most subordinate lienholders, if necessary to remove the cloud of the lien.[6]
  • The parties would execute a mutual release of all claims, excepting only those resulting from a breach of some representation or warranty in the DIL/F documents.[7]
  • The DIL/F documents would be Oregon-specific (e.g. land use warning[8] and statement of consideration[9]), and thoroughly vetted in advance by Oregon title counsel, to assure future insurability. The forms would include an estoppel affidavit with all standard lender protections (e.g. (a) Making it clear that the DIL/F is a deed of conveyance of title – not a disguised mortgage; (b) Reciting that the loan is in default and subject to imminent foreclosure; and (c) Reciting that the borrower is not acting under any coercion or duress, etc.)[10]
  • Borrowers would release their right of redemption in consideration of which the lender seeking to foreclose would waive any claim for deficiency liability, together with all costs, disbursements and attorney fees.  Any deficiency owed to subordinate lienholders would be subject to lender-borrower negotiation for a specified period of time.
  • Similar to the short sale protocols: (a) All lender-held impounds or after-acquired refunds, etc., would belong to the lender; (b) Any intentional misrepresentations in the documents could invalidate the DIL/F and result in judicial action being filed; (c) A 1099-C would be issued for the year of transfer of the DIL/F.
  • The property would be delivered to the bank in broom clean condition, subject to reasonable wear and tear.
  • If a foreclosure suit had already been filed, the above protocol could apply, and if necessary, serve as an offer of judgment under ORCP 54E.

Conclusion. This DIL/F solution will result in a win-win solution for all parties and the already strapped Oregon court system.  In addition to the advantages discussed above, it will have two further significant benefits:

  • Since the DIL/F will come directly from the borrowers, and not a foreclosure trustee, it completely avoids the McCoy/Hooker problem, leaving title marketable and insurable, and;
  • It will substantially accelerate the movement of residential properties from a depressed foreclosure status to a condition of marketability, resale, and eventual price appreciation.  Under the non-judicial foreclosure process, we know there is a minimum period of at least 120 days, i.e. four months, from start to finish.[11] Judicially, the period from filing to entry of default judgment, sale, and a six month right of redemption, is hard to estimate.  Much depends on the court’s docketing ability to set protocols in place.  But I believe nine months would be a very fast track, and suspect it would take closer to a year from the filing and service of a foreclosure complaint, to recovery of marketable title (i.e. including the 6-month right of redemption). From REO listing to resale would extend the delay in getting homes into the marketplace. Due to the right of redemption, I suspect most investors, etc. would be less inclined to purchase at auction.

Currently, most observers agree that it will take several years before this country burns through its shadow inventory[12] of distressed housing.  The DIL/F option is one tool we can use to accelerate lender recovery and resale, free of the risk of the title problems that have forced some lenders into the high cost alternative of judicial foreclosure.

[1] In re McCoy, 446 BR 453 (Bankr. D. Or. Feb. 7, 2011) (MERS could not be beneficiary; all assignments of beneficial interests required to be recorded); Hooker v. Nw. Tr. Servs., Inc., Civil No. 10-3111-PA, 2011 U.S. Dist. LEXIS 57005, 2011 WL 2119103 (D. Or. May 25, 2011), appeal docketed sub nom. Hooker v. Bank of America, N.A., No. 11-35534 (9th Cir. June 24, 2011) (MERS not a valid beneficiary, all assignments of beneficial interest in trust deed must be recorded).

[2] See, ORS 18.964.  This right of redemption is, in most cases, a useless form of protection to borrowers, since the home likely had negative equity at the time of foreclosure.  Thus, the cost to redeem would exceed the value of the property redeemed.

[3] This is not to suggest that in the early stages of default, borrowers should not first try to short sell the home.  But in the latter stages, when curing is impossible and foreclosure imminent – say, 30 days away –  the DIL/F alternative should be pursued before filing in court.

[4] Most attorneys are unfamiliar with the judicial foreclosure process, since it has not been a significant part of our legal landscape since the Oregon Trust Deed act was passed in 1959.  The result could be that borrowers may end up paying their own lawyers to learn (or re-learn) laws they are unfamiliar with themselves.

[5] I do not recommend using the “residential trust deed” definition found in ORS 86.705(3), which focuses on the date the foreclosure is “commenced.”   Instead, I suggest that the DIL/F approach be followed in all cases in which it reasonably appears from the lenders’ files that the purpose of the loan was to fund the purchase of a primary residence.  In those cases in which the lender: (a) believes it is legally entitled to recover a deficiency; (b) intends to recover a deficiency; and (c) reasonably believes from its files that the borrower is financially capable of responding to a deficiency judgment, it may proceed judicially after the DIL/F process has failed (i.e. the bank cannot reach agreement with the borrower on payback of all or a portion of the deficiency).

[6] Interestingly, it appears that some lienholders, e.g. HOAs, are now taking the position that under McCoy and Hooker, their subordinate position cannot be legally extinguished by a non-judicial foreclosure.  However, the cost of this gambit to a HOA would seem daunting, given the poor financial condition that most are in today.

[7] I anticipate that such a release might include provisions designed to eliminate benefits under any future class action settlements or the 50 (now 48?) state attorneys general probe, etc.

[8] See, ORS 93.040.

[9] See, ORS 93.030.

[10] If there would be any way to concisely put this approach into statutory form, I would suggest that: (a) the recitals in the estoppel deeds and affidavits contain similar protections found in ORS 86.780 (“Recitals in trustee’s deed and certain affidavits as prima facie or conclusive evidence”); and (b) at the time of filing a judicial foreclosure of a trust deed on a 1-4 family residence, the plaintiff’s attorney would be required to certify that he/she made a good faith effort to secure a DIL/F from the borrower(s).  This certification should be based upon the attorney’s actual knowledge, not just belief.  Actual knowledge could be based upon telephonic or personal contact with the borrower prior to filing, or review of a signed receipt for delivery of a certified letter offering the DIL/F option over 30-days prior to filing, etc.

[11] Of course, this does not include the time it takes from the first payment default to the filing of the foreclosure, which can be 9+ months.

[12] This shadow inventory consists of: (a) Homes not yet in foreclosure, but in some stage of impending default; (b) Homes in actual default that are queued up, but the foreclosure has not yet been filed; (c) Homes in formal foreclosure, prior to the actual sale date; (d) Homes in some stage of loan modification or abatement (which historically has had very high failure rates) that may eventually end up in default;.  Of course, HARP 2.0 will do little to eliminate this problem, since it merely refinances negative equity, rather than liquidating it through short sale, DIL/F, or foreclosure. Until this shadow inventory of distressed housing is significantly reduced or eliminated, the price of homes with equity will continue to drop, in lock-step those without equity.  According to the RMLS™, average sale prices for the Portland-Metro area in June, July, August, and September, 2011, dropped 7.8%, 7.4%, 9.2% and 4.2%, respectively, from the same period in 2010.  Buyers dictate housing prices because of the availability of lower priced comps, and every short sale, foreclosure sale, and REO sale today, becomes tomorrow’s comp for Realtors® and appraisers. This disequilibrium will not abate until the shadow inventory of distressed housing clears out, thus shifting some bargaining power to sellers, as prices begin to rise.  Rising prices incentivize buyers to buy sooner rather than later.  But in a market with falling prices, such as Oregon, not even historically low interest rates can move buyers off the sidelines.