By Jonathan Mehl, Esq.
Many real estate investors have recently been purchasing notes from lenders where the current borrowers are in default. While such an investment can be lucrative, there are potential legal pitfalls. An investor should beware and take proper precautions.
While many people refer to the process as purchasing a note, an investor is really purchasing the entire loan assets. This would include the mortgage, assignment of leases and rents, guarantee, and any other document signed by the borrower at the loan closing.
The closing of the purchase of loan assets is a relatively simple procedure. Generally, it involves a wire transfer of funds to the lender, and then the lender forwarding the documents. The original assignment of the mortgage must then be recorded with the County Register or Clerk of the county in which the property is located.
Recording the assignment of mortgage does several things. First, it puts the world on notice that there is a new lender. Second, it is a transfer of the lien upon the property. Third, it gives the investor the right to foreclose upon the mortgage.
When negotiating for the purchase of the loan assets, an investor must make sure that all of the proper documents are obtained. Often, only copies of certain documents are available. Inquiry should be made of the lender as to which original documents will be turned over, and which documents there are only copies of.
It is important that the purchaser of the loan assets obtain, at a minimum, the following original documents: note, mortgage, assignment of leases and rents, and an assignment of the mortgage in recordable form. If the borrower signed a personal guarantee, then the original of that should be obtained as well. An investor should inquire with the lender whether the following documents were obtained in the loan process or signed at closing, and obtain copies of these as well: environmental reports, survey, mortgage loan title policy, environmental indemnity agreements, indemnification agreement, security agreement, and estoppel certificates (if there are commercial tenants).
Going through the legal process of purchasing the loan assets is only the first step. An investor then has several other choices on how to proceed. Most likely, unless an arrangement can be reached with the defaulting borrower, then the purchaser of the loan assets will have to go through the foreclosure process. Based upon the current backlog in the foreclosure process at this time, depending upon the county in which the property is located, this could easily take one (1) year or more until a Sheriff’s Sale is conducted, and eventually a Sheriff’s deed is issued.
There are various other legal steps to be followed. If a foreclosure action was filed by the lender’s attorney, the foreclosure file must be reviewed to make sure that everything was done properly. Sometimes mistakes are discovered. It is better to find out sooner rather than waiting until the final judgment is applied for. Otherwise, it could be costly and time consuming to correct.
Applications will have to be made to the court to substitute the Plaintiff in the action, and to substitute the attorney for the Plaintiff. If there was a rent receiver already appointed, and the investor wants to appoint a different receiver, an application will have to be made to the court to relieve the current rent receiver and to appoint a new one
If the loan was for a multi-family building, then an application can be made to the court for the appointment of a rent receiver, or potentially the changing of the rent receiver if one is in place. A rent receiver is one who collects the rents and manages the property.
Based upon all that is involved, an investor would be best to see if an arrangement can be reached with the former borrower to transfer title to the property to the investor. This is done by what is called a deed in lieu of foreclosure. The proper form of deed, with all attachments, as well as various other documents must be properly signed. Otherwise, there are certain legal ramifications which could arise.
The next big issue that can arise based upon the attempt to record the deed, is the payment of a realty transfer fee. Many investors have typed into the deed that the consideration is less than $100.00. This if often done in an attempt to avoid a realty transfer fee. In order to do this, the deed must actually be deed in lieu of foreclosure, and a discharge of the mortgage must be recorded simultaneously with the deed in lieu of foreclosure.
Otherwise, the Register will view the value of the property to be in a minimum amount of the amount of the mortgage upon the property. Then, a realty transfer fee will have to be paid based upon the principal balance of the mortgage.
If there are junior mortgages upon the property, the realty transfer fee will have to be paid based upon the value of these junior mortgages. This is regardless of whether the first mortgage is discharged at the same time as recording the deed in lieu of foreclosure.
The affidavit of consideration must be truthful, and consider all consideration, and take into account any consideration paid for the deed in lieu of foreclosure. According to the affidavit of consideration form, this means “the actual amount of money and the monetary value of any other things of value constituting the entire compensation paid or to be paid for the transfer of title to the lands, tenements or other realty, including the remaining amount of any prior mortgage to which the transfer is subject or which is assumed and agreed to be paid by the grantee and any other lien or encumbrance not paid, satisfied or removed in connection with the transfer of title.”
Based upon this language, if there are other liens such as judgments, tax sale certificates, or municipal liens, then these could also be taken into account by the Register and a realty transfer fee will have to be paid based upon the value of these liens.
Therefore, it is important to have a full title search conducted, and to be aware of any liens which are upon the property. Not only will the realty transfer fee have to be paid, but unless the investor goes through the full foreclosure process to close out any liens, then the property will be purchased subject to these liens, which will need to be paid off and satisfied. One cannot foreclose out municipal liens such as taxes, water and sewer. These will need to be paid in full with any interest and penalties.
You must do your homework. While a deal may seem very good, if there are other liens out there which need to be paid off, then the discounted loan purchase amount may not be worth it.
Overall, in these troubling economic times, purchasing loan assets can be a good investment. Still, an investor should know exactly what is being purchased, what the costs will be, and what can be done with the loan assets after purchase.
An investor should have a good attorney who not only knows the legal issues which can arise, but knows the steps to take to address any problems. If you have any questions regarding the purchase of a note and loan assets, deeds in lieu of foreclosure, the foreclosure process, or any other real estate related legal matter, please feel free to contact me.
Jonathan R. Mehl, Esq. concentrates on representing real estate investors. This includes: the transactions of buying and selling commercial properties; refinances; evictions and landlord – tenant issues; formation of business entities and corresponding drafting of agreements between the owners; contract negotiation; drafting and negotiating leases; and real estate related litigation. Jonathan R. Mehl, Esq. has maintained own law firm since April 1, 1996, and is admitted to practice law in New Jersey, New York and Washington, D.C.
Since 2008, Jonathan R. Mehl, Esq. has been on the New Jersey Supreme Court Rules Committee for the Special Civil Part. This includes the Court Rules pertaining to landlord – tenant court. Jonathan R. Mehl, Esq. recently completed a four year appointment to a New Jersey legal District Ethics Committee.