Understanding Lender Options upon Real Estate Loan Default, Part 2 of 2

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This article was first published on March 26, 2013 in The Profit published by the Atlanta Real Estate Investor Alliance.

Last month I began this two-part article on the options and procedures that lenders may take when a borrower defaults on their real estate loan.  Understanding this process is important to real estate professionals whether they are lenders, borrowers, agents or investors attempting to buy or manage property during the default process.

When a borrower defaults on his loan, most often by failing to make the monthly payments, the lender has several options.  Although not exhaustive nor mutually exclusive, these options include foreclosure, filing suit, self-help repossession or requesting that the court appoint a receiver to manage the property.

The two most popular options differ in their order: lenders can foreclose first or file a lawsuit first.  Therefore, the lender gets to choose its starting point: (1) foreclose first and then sue, or (2) sue first and then foreclose.  The order is important and it is significant to remember that the second step in either option is at the lender’s discretion.  Last month I addressed the first and most popular option for residential loans.  In this article, I will discuss the second option.

2. Sue First and Then Foreclose (if you want)

The second most popular option by lenders is what I have entitled the “sue first and then foreclose (if you want)” process.  This process is very popular in commercial loan defaults.  Some may even argue that this is the lender’s first choice in a commercial context.  An example is the best way to illustrate this.

Rob borrows $5,000,000 to buy a small commercial property.  After his purchase, the market declines leaving his commercial property valued at $3,000,000.  Rob’s best tenant, who was occupying 60% of the space, goes out of business.  Therefore, Rob is unable to make his mortgage payments. Predictably, the bank sends a demand for payment.  When Rob fails to pay, instead of foreclosing, the bank files a lawsuit.

In a lawsuit like the example above, a bank will easily prevail.  After winning the lawsuit, the court will enter a judgment for $5,000,000+ against Rob.  If Rob does not pay the judgment, the bank has collection options like any other judgment holder.  It can, among other things, garnish wages, garnish bank accounts, seize Rob’s business holdings, take his personal property or seize any of Rob’s real estate holdings, including the property in our example.  The bank does not have to pursue the property that the loan was borrowed against, but it may.

The “sue first and then foreclose (if you want)” option gives banks more options and, in turn, generally applies more pressure to their borrowers.  This option also does not require the bank to go through the costly and unpredictable confirmation process that was discussed in last month’s article.  In today’s market, many banks are selecting this option when their borrowers default.  For banks and borrowers, these disputes often wind up as a complex game of negotiating.  Any bank or borrower in this situation should hire an attorney with experience to help them navigate these tumultuous waters.

Disclaimer: The information contained in this article is for informational purposes only and is not legal advice or a substitute for legal counsel.  It does not constitute advertising or solicitation. The information in this article may or may not reflect the most current legal developments; accordingly, this article is not guaranteed to be complete, and should not be considered an indication of future results.