Creating a Clear Path to the Deed

Many borrowers have found themselves in a situation where, after a series of loan extensions, their lenders refuse further extensions and demand full repayment. However, borrowers are unable to repay these loans for a variety of reasons. Compounding the issue for lenders is the length of time required to complete a foreclosure action and obtain the property from a sheriff’s sale (estimates range from two to three years). Thus, many lenders are seeking an alternative to foreclosure by either selling the note or facilitating the sale of the property with an appropriate debt cancellation.

A purchaser of distressed debt or property wants to avoid litigation with the borrower. Such investors seek a “clear path to the deed” and are looking for the borrower’s cooperation in the disposition of the property. In such a situation, a borrower may have an opportunity to address its financial situation.

When approached by a lender to cooperate in the sale of a note or property, a borrower should attempt to gain relief from certain provisions of a loan. If guaranties were provided, a borrower may attempt to have them cancelled in consideration for his cooperation. A monetary payment may also be requested as consideration for the borrower’s cooperation. Borrowers may also attempt to participate in a purchasing entity that may be formed to acquire a note or property. This may be particularly important where construction is unfinished because replacement builders are frequently reluctant to step into partially completed projects due to various construction liability issues.

Distressed condominium projects raise additional issues for consideration. In New Jersey, for example, if the project has been registered with the New Jersey Department of Community Affairs and is partially sold, a borrower must take care to address its obligations under the New Jersey Planned Real Estate Development and Full Disclosure Act. For example, a borrower may insist that a new purchaser be registered as sponsor for the project prior to a closing. The borrower should seek an indemnity from the purchaser and/or lender, particularly with respect to condominium association control, finances and turnover issues. This will eliminate the borrower’s responsibility for PREDFDA compliance. Frequently these issues may be overlooked in the haste to dispose of a distressed asset.

Likewise, it is incumbent upon a lender and an investor to have a clear understanding of the status of a condominium project. They should review the financial condition of the association and ensure compliance with all applicable PREDFDA regulations prior to assuming control of a project as a sponsor. They must also ensure that applicable offering documents have been properly amended to reflect the purchaser as the new sponsor because the NJDCA can impose stiff penalties for non-compliance. Thus, prior to the closing in a sale of a note or property affecting a condominium project, lenders and investors must investigate these issues.

Borrowers may consider potential lender liability issues in response to a foreclosure action. Such issues may affect the orderly disposition of an asset. Lenders will transfer a note without representations or warranties and this may subject the note’s purchaser to liability and defense of a lawsuit. Through loan extensions, lenders may have inadvertently impacted their rights under their loan documents. If a lender has acted outside the scope of ordinary lending practices, it could be liable for those actions. For example, if a lender directed that specific contractors be used in construction or directed sales of a project to the detriment of the property, these actions could subject the lender to claims by a borrower.

Tax considerations further complicate the matter. Borrowers must consult with their tax advisors to determine any potential tax liability which may result from a cancellation of any debt owed to a lender. Borrowers may spend months negotiating with a lender and/or investor to obtain the relief they sought only to incur significant tax liabilities as a result.

Entering into an agreement with an investor and/or lender may be an effective way for a borrower to address a default and resolve a difficult situation. Such a resolution removes the matter from the court system, places a property back into the market, removes a non-performing loan from a lender’s portfolio and offers investors an opportunity to earn a profit on their money.

Borrowers should identify their position and attempt to negotiate out the most detrimental provisions of the loan. Investors should seek the opportunity to earn the returns on their investment as quickly as possible. Lenders must decide whether the cost of carrying the distressed property through a contested foreclosure is worth more than a speedy disposition. Thus, all parties to the transaction share a common goal—the question is how much each is willing to forego to achieve it.

Khoren Bandazian is counsel in the real estate practice of Brach Eichler, based in Roseland, NJ. He may be contacted at kbandazian@bracheichler.com. The views expressed here are the author’s own.