What happens when a borrower defaults on a loan secured by commercial property? Lenders have a number of options for how to proceed, but that’s part of the problem – which course of action is the optimal strategy for protecting the lender and achieving maximum collections? There are way too many possibilities to discuss in one article, but here are a few examples to get you thinking.
The forbearance agreement is a short-term agreement between the lender and the borrower. In it, the lender agrees to delay enforcing their rights in exchange for the borrower agreeing to cure the default within a specified period of time. The only thing a forbearance agreement does is delay collection proceedings – it does nothing to the terms of the loan. If the borrower fails to pay what they owe by the new deadline, collections may move forward.
Whether the borrower is looking to refinance or sell the property, the lender must begin receiving payments. But it may not actually be the best thing to collect the rent if there’s already a property manager in place to maintain the property and take care of all other related management activities.
The next option is a loan modification. It shares a number of features with the forbearance agreement, but has a few key differences. For one thing, the loan modification does change the terms of the loan. Second, the loan modification results in the cure of the default, which means another default after modification will require the lender to start the foreclosure process over again. This won’t meet the lender’s goal of getting the full balance paid, but may still be preferable to immediate foreclosure.
Another option that helps avoid foreclosure is a deed in lieu of foreclosure. This essentially transfers the deed to the property to the lender in exchange for agreeing not to foreclose against the property. The borrower may pay a lump sum in order to get the lender to release the lien. Most of the time, the lender isn’t interested in owning the property, but if they’re going to own it at the end of a tedious and expensive foreclosure process anyway, the deed in lieu of foreclosure can be an enticing choice.
Lastly, you can opt to take the foreclosure route, probably the most familiar strategy for dealing with default. There’s both a judicial and nonjudicial method of foreclosure. The judicial involves filing a lawsuit for foreclosure, while the nonjudicial is a trustee sale. The lender’s fastest remedy is to file the judicial foreclosure in conjunction with an application for placement of a receiver on the property.
It’s the receiver’s job to manage the property under court authority, ensuring that the borrower won’t abscond with the collected rent, that the property is maintained and managed properly, and that the lender receives debt service to slow the increasing outstanding balance. While commencing the foreclosure lawsuit and seeking a receiver, it’s usually a good idea for the lender to simultaneously start the nonjudicial foreclosure process.
From forbearance agreements to foreclosure, lenders have plenty of options for dealing with a default situation. Which one is best for your unique circumstances? That’s a determination best made with the help of legal counsel and your accountant. How you respond to a default can make a substantial difference in how much money you reclaim.
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