This Update discusses the analysis that a Wisconsin lender should undertake to determine if it should take an assignment of a developer's agreement as part of a deed-in-lieu of foreclosure transaction.
Deeds-In-Lieu of Foreclosure Generally
Taking back a deed to a property is an alternative to the sometimes lengthy and costly judicial process of foreclosing on a delinquent loan. In a "deed-in-lieu" transaction, the parties agree that the lender will take title to the real property securing the borrower's defaulted note in exchange for the lender releasing the borrower (in full or partially) of its liability under the defaulted note.
Although the lender is both the property owner and lienholder after the deed-in-lieu transaction is completed, the documents (the deed, deed-in-lieu agreement and estoppel affidavit) typically provide that the parties intend not to merge the mortgage into the ownership of the property (the "fee" interest). A non-merger endorsement should be obtained from the title company to insure that the deed and mortgage remain separate.
The debt must be preserved if the lender needs to commence a foreclosure to wipe out junior liens and encumbrances after it becomes the fee owner. This can be done by making the debt non-recourse as to the borrower in the deed-in-lieu agreement. (Note that some courts outside of Wisconsin have held that merger of the mortgage and fee interest does occur if the lender takes title with knowledge of one or more junior liens, meaning that the obligations evidenced by the junior liens cannot be extinguished).
Due Diligence
Before agreeing to take a deed-in-lieu, a lender must undertake significant due diligence because it will be taking the real estate subject to all of its risks and potential liabilities – i.e., environmental issues, delinquent taxes, judgments, and other liens and encumbrances. The lender should make sure that it has reviewed all documents affecting the mortgaged property, including easements, plats, encumbrances on the title, the closing book from the borrower's acquisition of the property, all plans prepared in connection with developing the project, and documents evidencing a trademark or trade name for the project.
The lender should also undertake a thorough analysis of any developer's agreement relating to the property before it decides to take an assignment. A developer's agreement is a contract between a municipality and a real estate developer that specifies the municipality's requirements for a development. It could include, for example, provisions requiring that public improvements and infrastructure (such as streets, water, sanitary sewer, storm water drainage) be constructed, requiring that only a certain type of development can be constructed, dictating the maximum number of residential or commercial units, requiring that payments (such as connection fees) must be made to the municipality, requiring that a certain amount of green space must be preserved, or requiring that streets or land must be dedicated to the municipality. Among other things, the lender will want to understand the obligations under the developer's agreement that have been completed, those that remain to be done and the cost of satisfying the remaining obligations.
Lender's Options For Dealing With Developers' Agreements
The lender has different options depending on whether the developer's agreement is subordinate to the lender's mortgage. If the developer's agreement is subordinate to the mortgage, the lender may treat it the same as other junior liens on the property and foreclose out the developer's agreement (if the mortgage and the fee interest do not merge and the debt has been preserved). On the other hand, this may not be the best course of action if future dealings with the municipality are necessary.
If the lender is not going to foreclose out the developer's agreement (or if the developer's agreement is not subordinate to the lender's mortgage), the lender must decide whether to take an assignment of the agreement. The first issue is whether it is assignable. The municipality may have required its prior consent to any assignment. When a developer's agreement does not state whether or not it may be assigned, the general law of assignability controls and, like other contracts that do not expressly permit or prohibit assignment, it would be assignable.
The more difficult question is not whether the lender can take assignment, but whether it should . There is no one factor that drives this decision – rather, the lender needs to weigh the impact of multiple factors to determine what option will best serve its interests. Principle factors include:
Pros and cons associated with taking an assignment of a developer's agreement as part of a deed-in-lieu transaction also include:
Understand the Fundamentals of Each Unique Situation
Ultimately, a lender's decision whether to take an assignment of a developer's agreement as part of a deed-in-lieu transaction will involve analysis of all of the factors described in this Update. This analysis will enable the lender to develop a more complete picture of the merits and risks of taking an assignment before making this important decision.
von Briesen & Roper Legal Update is a periodic publication of von Briesen & Roper, s.c. It is intended for general information purposes for the community and highlights recent changes and developments in the legal area. This publication does not constitute legal advice, and the reader should consult legal counsel to determine how this information applies to any specific situation.