When a borrower defaults on a commercial loan by failing to make the mortgage payments, a foreclosure doesn't have to be inevitable. Keep reading to learn about several alternatives to foreclosure that are generally available for commercial loans.
One workout option for commercial loans—as well as residential loans—is a forbearance. A forbearance is when the lender agrees to reduce or suspend mortgage payments for a certain period of time and not to initiate a foreclosure during the forbearance period. Sometimes the lender will also agree to waive or modify a mortgage requirement that the borrower is unable to meet.
In a forbearance, the lender retains the right to resume the foreclosure once the forbearance period expires if the agreed-upon conditions are not met.
A commercial loan workout could also consist of a loan restructuring by means of a loan modification. With a modification, the lender might agree to:
Another possible commercial loan workout option is a short sale. In a commercial short sale, as with a residential short sale, the borrower sells the property for a price that is less than the total debt. The lender agrees to release its lien on the property and to accept the proceeds of the sale in full or partial satisfaction of the outstanding indebtedness. (Learn some of the risks of using a short sale to avoid foreclosure.)
Depending on the terms of the short sale agreement, the lender might be able to get a deficiency judgment by filing a lawsuit following the short sale. Lenders are, in general, more likely to seek a deficiency judgment after the short sale of a commercial property than a residential property.
A deed in lieu of foreclosure is also sometimes an option for commercial borrowers who are facing foreclosure. A deed in lieu of foreclosure is a transaction in which the borrower voluntarily transfers title to the commercial property to the lender in exchange for the lender releasing the mortgage lien in full or partial satisfaction of the outstanding indebtedness.
Borrowers are commonly given a release of all liability with deeds in lieu of foreclosure. But if the property is severely underwater (where the value of the property is significantly less than the total debt), the lender might require an additional payment or insist it retain the right to seek a deficiency judgment. (To learn more about how a deed in lieu works, and how it can help prevent a foreclosure, see Basics of a Deed in Lieu of Foreclosure.)
A key benefit to a commercial deed in lieu of foreclosure transaction is that it generally provides a smoother transition of the commercial property than a foreclosure. Usually, there is a mutual cooperation clause in the agreement so that files, leases, and other records are easily transferred, and other issues that might come up are addressed. For this reason, lenders are sometimes more willing to consider a deed in lieu of foreclosure as an alternative to foreclosure for commercial properties than they are for residential properties.
Workouts that are available for commercial properties are generally very similar to those that are available for residential properties. But one significant difference in the process of negotiating a workout involves the pre-negotiation letter. Whether a commercial property owner is seeking a forbearance, loan modification, short sale, or deed in lieu of foreclosure, the commercial workout process often starts with the pre-negotiation letter, which provides an outline for the preliminary discussions about the workout.
The purpose of the pre-negotiation letter is to avoid any misunderstandings during the workout negotiations. The letter will set the ground rules for the workout discussions, preserve the lender’s rights regarding the existing default, and might eliminate the ability of the borrower to later claim that the lender made verbal promises or otherwise acted improperly regarding the workout. The letter will typically require the borrower to acknowledge that a workout agreement is not binding until and unless it is formalized in writing and has been signed by all parties.
If you're facing a commercial property foreclosure, you might have a defense to the foreclosure that could buy you some time or leverage in your dealings with the lender. Because raising a foreclosure defense and negotiating a commercial loan workout can be complicated, consider hiring a qualified attorney to represent you through the process. You might also want to talk to a lawyer about bankruptcy options.