Foreclosing on a commercial mortgage is generally the lender's last resort when a borrower defaults. But when foreclosure is necessary, the lender will want to accomplish the task as quickly and cost-effectively as possible. Often, foreclosure can be accomplished without involving a court, such as through a deed of trust or pursuant to a mortgage with the power of sale provision. However, in some states, a court proceeding is the only method of foreclosure, and even in states in which out-of-court foreclosure is available, there are circumstances in which judicial foreclosure is necessary or advisable.
Fortunately, lenders can take some basic precautions to help ensure that if they must pursue a judicial foreclosure, they can complete the process with minimum complication.
One of the most potent borrower defenses to foreclosure is to allege that a loan officer, by words or conduct, modified the loan or waived the lender's right to foreclose. Such allegations are fairly easy to make, and they can significantly complicate foreclosure.
The first step lenders can take to protect against such allegations is to ensure during the origination process that loan documents are drafted with certain clauses and that those clauses are clear and comprehensive. At a minimum, the mortgage should contain an "integration" clause stating that the loan documents contain the entire agreement between the borrower and lender, and the borrower did not rely on any oral statements by the lender in agreeing to the loan terms. This ensures that foreclosure will be guided by the loan documents, not by some supposed side agreement or oral representation. The mortgage should also contain an "anti-waiver" clause stating that none of the lender's rights or remedies can be waived except by a formal written document signed by the appropriate bank officer. Such a clause protects against the possibility that an offhand remark by a loan officer can be later misconstrued as a promise to forebear from foreclosing.
Also essential is a "no oral modifications" clause stating that the terms of the loan can be modified only by a written agreement signed by the parties. The clause should include an acknowledgement by the borrower that it cannot rely on any oral or informal modifications made by a bank employee and that email communications do not qualify as a written agreement. Such a clause protects against a borrower who tries to bind the lender to an oral agreement or assert that the lender somehow misled the borrower as to the loan's terms.
These clauses are standard in commercial mortgages and, as a result, are often given little attention and forethought. Well-drafted mortgage documents will include more than mere "boilerplate" language and will anticipate typical borrower claims and defenses breach of contract, fraud, estoppel, and waiver. In addition, the lender should strive for additional protections in the loan documents whenever possible. Depending on circumstances and local law, the loan documents might include, for example, a waiver of certain borrower defenses or a personal guarantee from a principal of the borrower that would be triggered by certain post-default actions by the borrower. Precluding borrower claims and defenses through well-drafted provisions in the loan documents can save a lender from months, even years, of litigation.
The second step lenders can take to protect against typical borrower defenses is to use care in communicating with borrowers, especially borrowers who might be heading toward distress. Before discussing a potential modification of a loan, the lender and borrower should enter into a "pre-negotiation agreement" which makes clear that any proposed terms are not effective until the parties sign a written modification agreement. The pre-negotiation agreement should also include a "date down" of the essential clauses in the loan documents and, if possible, a waiver of claims and defenses by the borrower and an acknowledgment of all amounts due and owing.
But even with contractual protections in place, loan officers must use good judgment in discussions and email correspondence with borrowers. In litigation, the borrower's counsel will construe statements and written correspondence in a way most favorable to the borrower, regardless of what the loan officer might have meant. Ambiguous or sarcastic statements can be especially troublesome because they can be easily mischaracterized in court papers. Care should be taken in all email communications.
Judicial foreclosure is never the desired end of any lending relationship. However, it is sometimes unavoidable, and with basic precautions, lenders can normally avoid a litigation nightmare.
Y. David Scharf and Danielle C. Lesser are partners in the business litigation department of Morrison Cohen LLP. Brett Dockwell is a senior counsel in the same department.