Is The Deed In Lieu Of Foreclosure Now Safe?

The answer to the question raised by the title is, legally, probably not, as a practical matter, probably yes.  What precisely that means is the point of this review.

In 2007, and responding to one of the perils to which defaulting residential borrowers were exposed, New York passed the Home Equity Theft Prevention Act (the “Act”).  The idea was to protect homeowners from scam artists who would convince them to convey the mortgaged property so that new financing could be obtained by a person with good credit, later to return the property to the borrower–former owner.  The problem was that the promise wasn’t kept and the borrower lost the property to the scammer.  One of the remedies of the statute (as is relevant to this discussion) was to require very strict obligations and a written contract when property was being purchased from a borrower in default or in foreclosure.  This included a contract rescission period and an ability to rescind the entire transaction within two years of recording the conveyance.

Because a deed in lieu of foreclosure is in actuality a conveyance from a borrower in default or in foreclosure, it certainly appears on the face of the act that it encompasses such a transaction.  But the deed in lieu does not so often elicit a contract, and if it did, the requirements are quite extensive.  If in addition there is a danger that the borrower could claim a violation of the statute – and thereby rescind the conveyance any time within the two years – a lender’s desire to accept a deed in lieu of foreclosure would be considerably reduced.

Although it would seem very unlikely that the Home Equity Theft Prevention Act was designed to cover the deed in lieu of foreclosure, there was no way to determine that from a reading of the statute.  Indeed, where the law provided for exceptions, it pointedly did not include among those exceptions the deed in lieu.  So the best conclusion had to be that the deed in lieu might actually be covered by the Act.

The net result of all this would be to impose upon the deed in lieu process extensive formal contractual obligations and the possibility of hitherto non-existent perils.  In turn, this could serve to discourage taking a deed in lieu.

But on May 10, 2011, an opinion of the State of New York Banking Department recited that the Act does not apply to a deed in lieu of foreclosure.  This certainly diminishes the dangers the Act presents, but the opinion is uncertain in two aspects.  First, it conditions its application on the concept that the market value of the home must be less than the sum due on the mortgage – perhaps sometimes a question of fact.  If the Act is not to encompass a deed in lieu, then the opinion should say that.  If there are prerequisites to non-application, then it is not so sure that the Act doesn’t apply; rather it suggests that it does apply in some instances.

Then there is the advise in the opinion that a deed in lieu to the foreclosing party (or its agent) is unaffected by the Act.  Servicers will recognize, though, that to avoid merger of the mortgage into the resultant deed, title is most often taken in the name of a nominee entity.  Unless there is assurance that the Banking Department meant that such a nominee is an agent, there is yet another (meaningful) exception to the opinion that a deed in lieu does not run afoul of the Act.

For these, and other reasons, the certainty that this opinion means that the deed in lieu of foreclosure is now free of any constraints of the Act remains open to question.

All that said, and it is important as a matter of law, in the end a lender would want title insurance for a deed in lieu of foreclosure.  If title companies are prepared to issue such insurance, for which they request certain affidavits from the parties, then the question of whether the act encompasses a deed in lieu becomes to a significant extent academic.  Title coverage, of course, is insurance and it is not free of all concerns, but it is a very good facsimile of assurance.  Because title companies generally will insure a deed in lieu of foreclosure under appropriate circumstances, whether the new opinion mentioned really helps very much or not is perhaps problematical.

The law remains unclear, but an insurable deed in lieu of foreclosure exists and certainly can be considered.

Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.