Bad Boy Guarantees Strictly Construed in New Jersey

Posted by Michael Viscount on June 13, 2013

Real estate finance transactions typically involve non-recourse mortgage loans to single asset special purpose entities (“SPE’s”).  In these situations, upon non-payment of the loan, the lender’s recourse is limited to the mortgage property, and to the rents, deposits accounts and other assets affixed to or derived from the operation of the property.  The owners of the SPE/borrower are not personally liable for the non-recourse loan, unless the lender required the execution of a non-recourse carve-out guaranty.  Non-recourse carve-out guaranties are commonly referred to as “bad boy” guaranties, because the owners who sign them undertake to have repayment obligations in the event of certain specified acts or violations of the loan documents.

In New Jersey, as in many other states, courts strictly construe bad boy guaranties to impose liability for the entire loan balance irrespective of the nature of the damages to the lender arising from the breach at issue.  In this regard, the case of Princeton Park Corporate Center v. SB Rental I, 410 N.J. Super 114 (App. Div. 2009) is illustrative.  There, the mortgage loan documents executed in 2001 prohibited secondary financing without approval by the mortgage lender.  A subordinate loan was obtained in 2004 without the knowledge or approval of the lender, and it was paid off in just seven months.  Nonetheless, when the first mortgage loan went into default in 2006, the lender foreclosed, and immediately thereafter sued the signers of the bad boy guaranty for the full deficiency of $5 million.  The lender won at both the trial court and on appeal at the Appellate Division.  The appeals court held that even though the lender was not actually damaged by the second lien loan that had been paid off before the default, the absence of direct damages was not relevant.  In this regard, the court said “[h]aving freely and knowingly negotiated for the benefit of avoiding recourse liability generally, and agreeing to the burden of full recourse liability in certain specific circumstances, defendants may not now escape the benefit of their bargain.”  See also, Wells Fargo Bank v. Cherryland Mall, 812 N.W. 2d 799 (Mich.Ct.App. 2011), where trial and appellate courts of Michigan found the non-recourse carve-out guarantors liable for the full deficiency, because the SPE/borrower became insolvent and therefore in violation of the loan covenant requiring that the SPE remain able at all times to pay its debts and liabilities from its assets as the same became due.

The lesson here is that parties signing bad boy guaranties need to be very clear about the extent of the exposure they will undertake.  If the intent is to limit the lender’s recovery to the extent of damages actually realized, the documents need to be very specific in that regard.  In New Jersey and elsewhere, the courts will strictly construe unambiguous text making for a potentially unexpected and unsettling result for the non-recourse carve-out guarantor.

Is Federal Court Really a Better Place to Foreclose?

Posted by Michael Viscount on May 22, 2013

The common practice in New Jersey is to start a mortgage foreclosure action in the Chancery Division of the State Superior Court.  Many practitioners also promote the use of the federal court system as a forum that might short circuit use of questionable defense tactics and thereby expedite the process.  There are real questions on whether federal court is as effective as a forum as some might profess.

There is little controversy that federal judges have a tendency to move their cases faster than do state court judges.  Also, experience tells us that federal courts are less tolerant of unsubstantiated defenses and often more quickly get passed the frivolous to resolve cases expeditiously and without undue delay.  However, getting to judgment is just part of the problem in foreclosure cases.  After entry of judgment, there must be a judicial sale and getting to the sale is where the state court system might have the advantage.

In state court, the County Sheriff is the official who handles the judicial sale of the mortgaged property.  Sheriffs have been doing this for many years, are set up internally to process and complete the process in a routine way, and have the experience and knowledge to recognize and deal with out of the ordinary situations that often arise without warning as the sale process moves forward.  The same cannot be said for the federal system.

In federal court, the sale must be conducted by the U.S. Marshall Service or by another official such as a receiver or a special master appointed by the court for that purpose.  Certainly the Marshall Service can and will conduct the sale if so directed by the court.  But it is not something that is frequently done, and some say not something that the Marshall’s office want to be doing given the alternatives of providing protection and transportation services for the justice system and its buildings, personnel and persons in federal custody.

Another problem is what to do if there is a delay in the sale process.  For example, in one case when the foreclosure case was completed with the entry of judgment and direction for a receiver to sell the property, the property owner filed bankruptcy and two more years of litigation followed before the United States Bankruptcy Court.  In the meantime, the federal district court judge ordered that the foreclosure case be closed, and the bankruptcy judge discharged the receiver.  Now, if the owner defaults under its bankruptcy plan of reorganization the lender will have the right to again have the property offered for sale.  But, who will sell it and where will the lender go to restart that process?  The federal district court judge does not want to hear about the case anymore and the receiver is no longer involved.  What to do is the question?

If this were in New Jersey Superior Court, the process would be simple.  The lender would have a writ of execution from the original foreclosure case which is a directive to the county sheriff to sell the property and the writ would be just as effective today as it was when originally issued by the Judge of the Chancery Court who issued the directive.  So, instead of having to move to reopen the federal case that has been closed, counsel for the lender would simply take the old writ to the sheriff and a sale would be scheduled under normal procedures.

So, while certain aspects of foreclosure in federal court might be beneficial to litigants, a view of the entire picture may tell a different story.  Certainly, if the lender expects a contested proceeding and can qualify for federal court jurisdiction, federal court should be considered.  But, if bankruptcy and associated delays are a real possibility, the alternative of state court foreclosure may prove to be more efficient in the long run.

Flood Maps and Increased Insurance Premiums Could Lead to Another Wave of Foreclosures

Posted by Christopher Fallon on March 12, 2013

On March 7, 2013, the New Jersey Department of Environmental Protection held a hearing on the Flood Hazard Emergency Amendments and Concurrent Proposed Amendments (the "Amendments") and FEMA's Advisory Base Flood Elevation ("ABFE") maps.  This hearing featured testimony from numerous interested citizens, including property owners, developers, planners and engineers.  Most of the testimony focused on the economic impact of the Amendments and ABFE maps.  Specifically, owners of commercial and residential properties that were substantially damaged now have to spend considerable sums of money to raise their properties to comply with the ABFE maps.  Additionally, many property owners will face increased premiums for flood insurance required by lenders.  The Amendments and ABFE maps could lead to a post-Sandy wave of defaults and additions to secured debt arising from forced-placed insurance obtained by lenders if property owners are unable to raise the elevation of their properties and afford increased flood insurance premiums.

Foreclosures Falling - What About New Jersey?

Posted by Brian Isen on February 18, 2013

RealtyTrac releases a monthly report which reviews foreclosure filings in all 50 states.  Overall, new foreclosures were down 11 percent nationwide, but what about in New Jersey?  RealtyTrac also releases a monthly report related to New Jersey foreclosures.  New Jersey has the 39th highest foreclosure rate in the country, and default notices, auctions and repossessions were up 63 percent from December!

It appears that the backlog in the foreclosure unit is finally freeing up.  Although many borrowers have been able to stay in their homes pending a foreclosure for several years, the tides may be turning.  If you are a borrower, and you receive a notice of intention to foreclose, you should consider consulting with an attorney who specializes in foreclosure law to consider your options, including a potential loan modification, short sale or deed in lieu of foreclosure.

FORECLOSURE DEFENSE LIMITS CLARIFIED

Posted by Michael Viscount on February 13, 2013

Trial judges in New Jersey are doing a much better job of late reducing the foreclosure back log in part by aggressively disposing of baseless defenses asserted solely for the purpose of delay. Such was the case just this week when a Bergen County judge denied a commercial loan guarantors motion to reconsider entry of summary judgment for the foreclosing bank mortgage holder.  The ruling lays out the limited scope of defenses that are germane in a mortgage foreclosure action.

To foreclose, the mortgage holder has to prove only three things: (1) the validity of the mortgage, (2) the amount of the indebtedness and (3) the right of the mortgagee to foreclose on the mortgaged property.  If the defendant’s answer in the action fails to challenge at least one of these essential elements, the case should be over.  Mere allegations will not suffice.  To be sufficient, defenses must be supported by specific facts.  General denials, or answering that the defendant is without knowledge of the allegations made by the plaintiff will no longer do the trick.

So remember that when seeking to foreclose, one must affirmatively set forth the three basic elements, and when looking to defend effectively one must assert specific facts that place one of these material elements into question. 

Standing to Commence Foreclosure

Posted by Michael Viscount on February 06, 2013

For mortgage loans that have been bundled into mortgaged backed securities and other collateralized debt obligations (“collectively, “CDO’s”), the most common defense raised by the property owner is that the party instituting foreclosure does not have standing to sue.  The prime example where this comes about is when a servicing agent for a CDO trustee brings a foreclosure action, and simple alleges the right to foreclose without laying out the facts.  If the agent does not have ownership and possession of the debt instruments, it can have a problem where the defendant property owner challenges the right to sue.  The proper procedure would be for the CDO trustee to assign the debt instruments to the agent before the complaint is filed and for the agent to allege ownership and possession. 

Best practices would also dictate that the instrument assignment be recorded in the mortgage records of the county in question.  However, failure to record does not result in a sustainable defense.  A New Jersey appellate court recently confirmed this point in an unpublished opinion which confirmed that recording is not essential, but ownership and control of the debt instruments must be established to successfully foreclose.

Congratulations Michael!

Posted by Brian Isen on January 22, 2013

I am happy to report my colleague and co-contributor Michael J. Viscount, Jr. was recently appointed by Chief Judge of the United States Bankruptcy Courts in New Jersey to serve as a member of the Lawyers Advisory Committee for which he will also serve as Chair of the Chapter 11 Subcommittee.

The Lawyers Advisory Committee serves as liaison between the bankruptcy bar and the bankruptcy judges and court administrators in the district working on projects to promote the effective administration of the bankruptcy process throughout the state. 

Exempt Property Sales in Bankruptcy

Posted by Michael Viscount on January 14, 2013

I just had an interesting discussion with a partner on the subject of the sale of exempt property in bankruptcy.  We concluded that even though tenant by the entireties real estate might be exempt from creditor claims in some states, nonetheless in bankruptcy it is still property of the estate under Bankruptcy Code section 541 and subject to the bankruptcy trustee’s general powers of sale under Code section 363(b).  The analysis goes like this:  section 541 creates a bankruptcy estate that includes all interests of the debtor in property without mention of exemptions, and sections 522(b) exempts certain of the debtor’s property either under state law or under federal law depending upon the exemption scheme elected by the debtor.  But exempt property is still property of the estate under section 541 and the significance of exemption is, as we are told by section 522(c) is simply that the exempt property is not liable for debts that are resolved in the bankruptcy. So, we concluded that the trustee can sell the debtor’s interest in exempt property as along as the proceeds are not used to resolve the debts that arise as of the date of the filing of bankruptcy.  The only glitch is that the trustee would have to pay to the debtor/property owner the value of the property that is exempt.  So why sell? Well, often, selling exempt property along with non-exempt property might make the entire bundle more valuable and generate a greater return for all involved.

Court's Consider Pro-longed Period of Non-payment in Receivership Analysis

Posted by Michael Viscount on January 14, 2013

I use to think that non-payment of installments was not a proper subject for consideration by the court when weighing the factors considered for appointment of a receiver.  It now appears more and more that the tide is turning on this.  Lenders always cite chronic delinquency when moving for a receiver in a foreclosure matter.  For the debtor, I would always respond that we are paying the insurance, taxes and upkeep, thus preserving the value of the secured lenders lien and maintaining the status quo.  I still think that standing alone, non-payment is not enough for the lender to carry the day, but am now seeing cases where the courts are saying non-payment is a factor.  It is particularly true when the period of non-payment is prolonged and when the lender is seeking a receiver after the entry of final judgment pending completion of the sheriff’s sale.  New Jersey’s intermediate appellate court just ruled as much in an unpublished opinion we were able to see through a service available to us here in the state.  The over all facts do matter, but the period of non-payment is now one that may be given more weight depending on the balance of the considerations offered by the lender.

NJ Adopts Summary Foreclosure Procedure for Abandoned Residential Property

Posted by Michael Viscount on January 14, 2013

New Jersey has taken a huge step in steam lining the process for mortgage holders to foreclosure on residential properties that are found to be vacant and abandoned.  The lender may now proceed in a summary action including by order to show cause served as the original process.  The measure was signed into law by Governor Christie on December 6 and takes effect immediately.  There are certainly conditions that must be satisfied, and the fact of vacancy and abandonment must be established by clear and convincing evidence.  However, if the lender proceeds properly and can make out the case for relief, it will now be possible to obtain a judgment from the court and actually get to a sheriffs sale of an abandon residential property in roughly 115 to 120 days.  That is a far cry from the time it has been taking lenders to get title to a property and should be welcome relief to the lending industry and the communities hardest hit by the lending crisis.  A copy of the legislation can be found at this link.