Foreclosure and Receivers in the Current Liquidity Crisis

If a lender decides to pursue a deficiency judgment against the borrower after a non-judicial foreclosure sale, in Georgia, the lender must first obtain confirmation of the foreclosure sale. See O.C.G.A. ' 44-14-161; C.K.C., Inc. v. Free, 196 Ga. App. 280 (1990). At the confirmation hearing, the court will determine whether the property was sold to the auctioning lender for the fair market value, a prerequisite to the lender being permitted to pursue a deficiency judgment. Although title to the property will still pass, if the court decides that less than fair market value was paid for the property, the lender's right to pursue a deficiency judgment after the non-judicial foreclosure is eliminated unless the court orders a re-sale of the property.

Under Texas law, a lender may obtain a deficiency judgment after a non-judicial foreclosure, but the amount will be limited to the difference between the fair market value of the property (regardless of the purchase price at foreclosure) at the time of the foreclosure sale, and the balance of the defaulted loan. See e.g. Lester v. First American Bank, Bryan, Texas, 866 S.W.2d 361 (Tex. App. 1993). Fair market value is determined by an appraisal of the property, as of the date of the foreclosure. See generally Moore v. Bank Midwest, N.A., 39 S.W.3d 395, 400 (Tex. App. 2001). By statute, 'competent evidence' of the FMV of the property may include: 1) expert opinion testimony; 2) comparable sales; 3) anticipated marketing time and holding costs; 4) cost of sale; and 5) the necessity and amount of any discount to be applied to the future sales price or the cashflow generated by the property. Tex.Prop.Code.Ann. ' 51.003 (West. Supp.1992).

In bankruptcy, the process of non-judicial foreclosure can spell trouble for the secured lender, because such a sale will often result in the property being sold for the loan balance on the note as opposed to what would otherwise be the fair market value of the property. The sale is fraudulent if the seller received 'less than reasonably equivalent value' for the property. See 11 U.S.C. ' 548(a). The good news for secured lenders in the bankruptcy context is that the Supreme Court has held that the price received at a mortgage foreclosure sale will be deemed as reasonably equivalent value so long as the lender conducted the sale in compliance with the state's foreclosure laws. See BFP v. Resolution Trust Corp., 511 U.S. 531 (1994).

Judicial foreclosure is the most common form of foreclosure in the United States. In many states it is the only way to foreclose a secured real estate transaction. Judicial foreclosure is a foreclosure sale conducted with the assistance, involvement, and, ultimately, the blessing of the court. Judicial foreclosure sales involve significant time and are much more costly than non-judicial foreclosure sales.

In Georgia, for example, in order to initiate the judicial foreclosure process, the secured creditor has the option to either file a petition in equity or to obtain a statutory foreclosure at law, which requires the creditor to file a petition in the superior court in the county in which the property sits. The main difference between these two methods is that a petition in equity will allow the court to render a personal judgment against the debtor, while an action at law is essentially an in rem action that will result in a judgment in favor of the creditor that is then enforceable through execution and levy. In addition, if the security instrument is a deed to secure debt, the secured creditor can judicially foreclose on the deed to secure debt by initiating a suit on the note, which can then be reduced to a judgment for purposes of execution and levy. The fact that at deed to secure debt contains a power of sale clause does not preclude the secured creditor from proceeding with a suit on the note and foreclosure pursuant to statutory procedures. See Georgia Real Estate Finance and Foreclosure Law (F. Alexander), 4^th ed. (2004).

Receiverships

In response to defaults involving income-producing assets where the borrower has allowed property to fall into disrepair or where the property suffers from environmental contamination or regulatory noncompliance, many lenders pursue the appointment of a receiver in lieu of a judicial foreclosure process. The benefits of appointing a receiver in these circumstances include: 1) the lender does not enter the chain of title; 2) the lender is afforded an opportunity to improve the property by providing financing under a controlled environment; and 3) a neutral third party is appointed to operate and take custody of the property. The downside to receiverships include the costs associated with the receivers administration.

Generally, a receiver is appointed by the commencement of a lawsuit by the lender against borrower. In Texas and in Georgia, the appointment of a receiver can be accomplished ex parte in many circumstances. Once the court enters an order appointing the receiver, the borrower no longer controls its business and property. This allows the lender to assert control indirectly through the receiver to maximize the value of its collateral without exposing the lender to mortgagee in possession liability. Moreover, where the assets are specialized, a receiver with experience in the borrower's industry can be selected. In real estate cases, receivers with property management experience can be selected by the lender and recommended to the judge hearing the receivership case. In most cases, the receivership choice recommended by lender's counsel will be accepted by the judge unless the selection is glaringly unfair. Good judgment from local receivership counsel is essential to make sure appointments are approved timely. From a practical perspective, the most important point associated with the appointment of a receiver is adequately setting out the receiver's duties and powers in the receivership order. Most receivership statutes allow the receiver to take all actions necessary to administer and sell property so long as adequate reporting is provided to the Court and interested creditors. In many cases, the receiver may borrow money, hire professionals, sue and be sued, and act in place of the borrower's former management. For those instances where the costs of administering a receivership is not prohibitive, it can be an attractive remedy for lenders that do not want to own real estate that secures their loans.

As the subprime market crisis continues with little indication that the housing market is stabilizing, the value of many mortgages may end up being worth more than the underlying asset, thereby increasing defaults and then foreclosures. As secured lenders face the prospect of foreclosing on an increasing number of properties, they will need to make an informed decision as to which method of foreclosure is best. Going forward, the costs involved and the ability to seek recovery of any deficiency following the sale of the property will be key considerations to take into account as part of the debt recovery and/or asset realization process.

Keith Miles Aurzada is a partner with Powell Goldstein LLP, Dallas. He can be reached at [email protected] or 214-721-8041. Gwendolyn J. Godfrey is an associate in the Atlanta office of Powell Goldstein. She can be reached at 404-572-4536 or [email protected].

Given the instability in the current real estate market and the significant rise in the number of borrowers defaulting on their mortgages, the topic of foreclosures, regardless of the type, will be the subject of many future discussions and articles. Just a quick review of popular business periodicals reveals the many forces working together to both increase the number of foreclosures and decrease property values. In this climate, many lenders will be assessing their options when it comes to foreclosing on delinquent borrowers. Where foreclosure is not an option due to environmental concerns or properties that are not in compliance with regulatory restrictions, receiverships may become a more attractive remedy even where nonjudicial foreclosure is available to the lender.

Foreclosure

Many states, including Georgia and Texas, have statues that authorize a lender to foreclose when a borrower has defaulted on a loan. Generally, there are two types of foreclosure: judicial and non-judicial.. A non-judicial foreclosure, or power of sale foreclosure, does not involve court action other than certain notice provisions and is the most common form of foreclosure in those states that allow them. In the majority of non-judicial foreclosures sales, the bidding process is not competitive and the secured creditor is typically the party both conducting the sale and purchasing the property. See Georgia Real Estate Finance and Foreclosure Law (F. Alexander), 4^th ed. (2004). In those states that do not have a statutory right of redemption post-foreclosure, such as Georgia and Texas, the process of non-judicial foreclosure can be a quick and inexpensive remedy for a secured creditor. However, because the non-judicial foreclosure process does not involve any court oversight, there is a risk the lender will forfeit the right to pursue a deficiency judgment against the borrower later. This is important to consider when choosing a non-judicial foreclosure.

If a lender decides to pursue a deficiency judgment against the borrower after a non-judicial foreclosure sale, in Georgia, the lender must first obtain confirmation of the foreclosure sale. See O.C.G.A. ' 44-14-161; C.K.C., Inc. v. Free , 196 Ga. App. 280 (1990). At the confirmation hearing, the court will determine whether the property was sold to the auctioning lender for the fair market value, a prerequisite to the lender being permitted to pursue a deficiency judgment. Although title to the property will still pass, if the court decides that less than fair market value was paid for the property, the lender's right to pursue a deficiency judgment after the non-judicial foreclosure is eliminated unless the court orders a re-sale of the property.

Under Texas law, a lender may obtain a deficiency judgment after a non-judicial foreclosure, but the amount will be limited to the difference between the fair market value of the property (regardless of the purchase price at foreclosure) at the time of the foreclosure sale, and the balance of the defaulted loan. See e.g. Lester v. First American Bank, Bryan, Texas , 866 S.W.2d 361 (Tex. App. 1993). Fair market value is determined by an appraisal of the property, as of the date of the foreclosure. See generally Moore v. Bank Midwest, N.A ., 39 S.W.3d 395, 400 (Tex. App. 2001). By statute, 'competent evidence' of the FMV of the property may include: 1) expert opinion testimony; 2) comparable sales; 3) anticipated marketing time and holding costs; 4) cost of sale; and 5) the necessity and amount of any discount to be applied to the future sales price or the cashflow generated by the property. Tex.Prop.Code.Ann. ' 51.003 (West. Supp.1992).

In bankruptcy, the process of non-judicial foreclosure can spell trouble for the secured lender, because such a sale will often result in the property being sold for the loan balance on the note as opposed to what would otherwise be the fair market value of the property. The sale is fraudulent if the seller received 'less than reasonably equivalent value' for the property. See 11 U.S.C. ' 548(a). The good news for secured lenders in the bankruptcy context is that the Supreme Court has held that the price received at a mortgage foreclosure sale will be deemed as reasonably equivalent value so long as the lender conducted the sale in compliance with the state's foreclosure laws. See BFP v. Resolution Trust Corp ., 511 U.S. 531 (1994).

Judicial foreclosure is the most common form of foreclosure in the United States. In many states it is the only way to foreclose a secured real estate transaction. Judicial foreclosure is a foreclosure sale conducted with the assistance, involvement, and, ultimately, the blessing of the court. Judicial foreclosure sales involve significant time and are much more costly than non-judicial foreclosure sales.

In Georgia, for example, in order to initiate the judicial foreclosure process, the secured creditor has the option to either file a petition in equity or to obtain a statutory foreclosure at law, which requires the creditor to file a petition in the superior court in the county in which the property sits. The main difference between these two methods is that a petition in equity will allow the court to render a personal judgment against the debtor, while an action at law is essentially an in rem action that will result in a judgment in favor of the creditor that is then enforceable through execution and levy. In addition, if the security instrument is a deed to secure debt, the secured creditor can judicially foreclose on the deed to secure debt by initiating a suit on the note, which can then be reduced to a judgment for purposes of execution and levy. The fact that at deed to secure debt contains a power of sale clause does not preclude the secured creditor from proceeding with a suit on the note and foreclosure pursuant to statutory procedures. See Georgia Real Estate Finance and Foreclosure Law (F. Alexander), 4^th ed. (2004).

Receiverships

In response to defaults involving income-producing assets where the borrower has allowed property to fall into disrepair or where the property suffers from environmental contamination or regulatory noncompliance, many lenders pursue the appointment of a receiver in lieu of a judicial foreclosure process. The benefits of appointing a receiver in these circumstances include: 1) the lender does not enter the chain of title; 2) the lender is afforded an opportunity to improve the property by providing financing under a controlled environment; and 3) a neutral third party is appointed to operate and take custody of the property. The downside to receiverships include the costs associated with the receivers administration.

Generally, a receiver is appointed by the commencement of a lawsuit by the lender against borrower. In Texas and in Georgia, the appointment of a receiver can be accomplished ex parte in many circumstances. Once the court enters an order appointing the receiver, the borrower no longer controls its business and property. This allows the lender to assert control indirectly through the receiver to maximize the value of its collateral without exposing the lender to mortgagee in possession liability. Moreover, where the assets are specialized, a receiver with experience in the borrower's industry can be selected. In real estate cases, receivers with property management experience can be selected by the lender and recommended to the judge hearing the receivership case. In most cases, the receivership choice recommended by lender's counsel will be accepted by the judge unless the selection is glaringly unfair. Good judgment from local receivership counsel is essential to make sure appointments are approved timely. From a practical perspective, the most important point associated with the appointment of a receiver is adequately setting out the receiver's duties and powers in the receivership order. Most receivership statutes allow the receiver to take all actions necessary to administer and sell property so long as adequate reporting is provided to the Court and interested creditors. In many cases, the receiver may borrow money, hire professionals, sue and be sued, and act in place of the borrower's former management. For those instances where the costs of administering a receivership is not prohibitive, it can be an attractive remedy for lenders that do not want to own real estate that secures their loans.

As the subprime market crisis continues with little indication that the housing market is stabilizing, the value of many mortgages may end up being worth more than the underlying asset, thereby increasing defaults and then foreclosures. As secured lenders face the prospect of foreclosing on an increasing number of properties, they will need to make an informed decision as to which method of foreclosure is best. Going forward, the costs involved and the ability to seek recovery of any deficiency following the sale of the property will be key considerations to take into account as part of the debt recovery and/or asset realization process.

Keith Miles Aurzada is a partner with Powell Goldstein LLP, Dallas. He can be reached at [email protected] or 214-721-8041. Gwendolyn J. Godfrey is an associate in the Atlanta office of Powell Goldstein. She can be reached at 404-572-4536 or [email protected].