There are two primary methods of acquiring distressed real estate. The first and the most common is to purchase the property directly from the lender, or a receiver if one has been appointed after the foreclosure has been completed. The second and somewhat less common approach is to acquire the note prior to foreclosure. In the latter case, the note can be purchased either directly from the lender or from the receiver. But there are pitfalls that a buyer might encounter when purchasing the note directly from the receiver and representations that are needed in a loan sale agreement, regardless of whether the seller is the lender or the receiver.

There are any number of pitfalls when purchasing debt secured by distressed real estate, particularly if the property is a broken condo project under the control of a receiver. In such situations, many state laws assign strict liability to the builder, which could be the lender if it has taken steps to complete the project. However, the lender usually faces no such liability if it stays off of title and has the receiver complete construction and sell the property (either wholesale or retail), rather than the lender. To determine if the receiver has the required authority to build out and sell the project, a buyer needs to examine the court order appointing the receiver. Specifically, the court order should clearly grant authority to the receiver to not only sell the property, but also to hire contractors and subcontractors as needed to complete the project, hire a broker and attorney, negotiate a purchase and sale agreement and the like. Further, it is better for the buyer if the receiver is obligated to complete the foreclosure as a condition of the sale, in which case the property is typically transferred by a receiver's deed backed by title insurance.

Two problems arise when the receiver attempts to sell the property prior to foreclosure. First, this requires an effective waiver by the debtor of any borrower-protection laws, like those of reinstatement or redemption of the debt. In many states, waiving these laws is not allowed as a matter of public policy, while in others it may be permitted if the waiver is included in the terms of a restructure of the debt (but not when the loan was first made). The second problem is related to junior liens and other encumbrances. If there is no foreclosure, junior liens are not eliminated. As most of us know, waiting until foreclosure allows the buyer to acquire the property free of junior liens. Furthermore, if you're buying prior to foreclosure, no lender will warrant that there are no junior liens (as typically required of the borrower in any deed-in-lieu agreement).

If the purchase is to close after foreclosure, junior liens are removed and there are fewer issues. However, regardless of whether the property is sold before or after foreclosure, there are a number of representations, warranties and covenants that must be included in any loan purchase agreement. These include: (1) a representation that the lender (or receiver) is the legal holder of the note; (2) a representation that the seller has the requisite authority to sell the debt; (3) a representation and warranty stating the precise sum owed, including costs and expenses incurred by the lender (including legal fees); (4) a representation that the loan documents are duly enforceable in accordance with their terms; (5) a representation that the borrower is in default, specifying the exact nature thereof; (6) a representation that the borrower has no defenses to the foreclosure or claims against the seller; (7) a covenant that the lender or receiver, as the case may be, will not do or omit to do anything that would lead to a default; and (8) a covenant that the seller will maintain casualty and liability insurance on the project.

Of course there are additional reps and warranties that are desirable, but they are difficult to get. One approach is to ask the seller to represent that it has not received written notice of something (litigation, bankruptcy, condemnation, etc.) and that, to its best knowledge, none of these items have been threatened. The representation can be made even more acceptable to the seller if actual knowledge is defined as the "current actual knowledge" of a specifically named person. If due diligence is thorough and comprehensive and the right representations, warranties and covenants are included in the loan purchase agreement, a note can be purchased as easily as the property itself.

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