Foreclosures May Not Be Limited to Loan Payment Default

Mortgages play a central role in commercial real estate transactions, and the threat of foreclosure is a powerful incentive for borrowers to stay current on their loan payments.
Moreover, while the treatment of real property as collateral for a debt obligation is designed to protect lenders against defaults, pursuing a remedy in foreclosure is often an impractical or unappealing option for lenders as it can be time-consuming, expensive, and otherwise logistically burdensome.
Because of this, lenders typically will only pursue foreclosure as a remedy for default if a borrower has defaulted on a real, economic term of the deal — that is, when the borrower has failed to pay principal or interest.
However, a series of recent cases has illustrated that borrowers who default on terms of the loan which are unrelated to the debt itself may nonetheless face foreclosure. In other words, a lender’s ability to prevail in a foreclosure case is not limited to a situation in which a borrower fails to stay current on its loan payments.
For example, in Valley National Bank v. 325 Greenwich St., LLC, a recent decision from the Supreme Court, New York County, borrower was current on all debt obligations but failed to pay real estate taxes owed on the property “over a protracted period,” which constituted a default under the terms of the loan.
Lender initiated a foreclosure case based on borrower’s failure to pay real estate taxes and the court granted Valley National summary judgment and appointed a referee to proceed with the foreclosure, even in the face of the borrower having negotiated an installment payment plan with the taxing authority subsequent to the initiation of the foreclosure in an attempt to cure the default. While the court acknowledged the role of equity in foreclosure cases, it emphasized the importance of honoring a contract on its negotiated terms. 2024 NY Slip Op 33287(U) Index No. 850452/202.
This case highlights the importance of the agreed upon loan terms. Since the loan agreement is the instrument that governs the terms of default, this case is a reminder that it should be negotiated at length and carefully drafted by the parties.
The Second Department in 2020 in L&L Associates Holding Corp. v. Seventh Day Church of God of the Apostolic Faith reached the same conclusion. Lender in L&L Associates also initiated a foreclosure case on the grounds that the borrower failed to pay real estate taxes on the mortgaged property. Borrowers argued that foreclosure was an inappropriate remedy because the default was “merely technical.” However, the Second Department found for lender and affirmed the lower court’s decision to grant lender’s cross motion for summary judgment.
In its decision, the Second Department also discussed the role of equity in foreclosure cases but ultimately concluded that “[sympathy] for the defendants cannot be permitted to undermine the stability of contractual obligation.” 132 N.Y.S.3d 781, 2020 N.Y. Slip Op. 07047.
This case provides yet another example of the weight assigned to the language of the loan documents, which in this case, as in Valley National Bank (and in virtually all mortgage loans) required that borrower pay all real estate taxes for the property.
As a third example, in American Community Bank v. 419 County Road 39 Corp., lender brought a foreclosure case in Supreme Court in Suffolk County against borrower on the grounds that the borrower defaulted on its loan by “‘failing to complete all work associated with obtaining a certificate of occupancy pursuant to a commitment letter… which is incorporated by reference into the mortgage.” 889 N.Y.S.2d 881, 2009 N.Y. Slip Op. 51042(U). In contrast to Valley National Bank and L&L Associates, this court found in favor of borrower, however, in reaching this conclusion, the court again looked to the language of the loan documents, including, in this case, a lender commitment letter.
The decision is somewhat vague, but it appears that though the commitment letter (incorporated by reference into the mortgage) required funds be set aside to finish certain work, it did not explicitly require borrower to complete such work.
While borrower’s motion to dismiss was predicated upon the claim that lender was not entitled to a judgment of foreclosure and sale as there had been no default in payment or in any obligation imposed upon borrower under the terms of the loan documents or the mortgage, the court mostly ignored the lack of a payment default and focused instead on the missing covenant to complete the work.
The court reasoned that “neither the note nor the mortgage included a term which imposed upon the defendants any obligation to complete all work necessary to obtain certificates of occupancy. That the plaintiff may have expected this obligation would have been included as a material term of the mortgage, does not justify judicial insertion of such obligation as a contract term, the breach of which is now alleged to have put the defendants in default of the mortgage.
The plaintiff could have negotiated and included the defendants' procurement of certificates of occupancy as an express term of the subject mortgage or as a pre-closing condition, such as those set forth in the commitment letter.” 889 N.Y.S.2d 881.
Although the holding in American Community Bank is different from that of Valley National Bank and L&L Associates, the takeaway is similar: the terms of a loan will govern how a default is defined and may ultimately determine whether a foreclosure action by a lender will prevail, even where a borrower is not in default of its payment obligations, potentially even for defaults other than non-payment of real estate taxes.
While it may not always be in a lender’s best interest to initiate a foreclosure against a borrower in default for a non-monetary term of the loan, it is nonetheless an option which remains available to the lender and which New York courts have upheld.