Commercial foreclosures are, in most cases, very similar to residential foreclosures. The foreclosure may be nonjudicial or judicial depending on the state where the property is located and what the loan documents dictate.
With both nonjudicial and judicial commercial foreclosures, the process starts when the borrower defaults on the mortgage. A default occurs when the borrower falls behind in payments or fails to do something that the loan documents require, such as maintaining hazard insurance on the property. After the default, the lender may accelerate, or call due, the outstanding balance on the loan. Typically, the lender must first send a breach letter to the borrower that outlines the reason for default and gives a time frame during which the borrower may cure the default and avoid acceleration. Usually, the amount of time given to cure a default is thirty days, but this can vary depending on the terms of the mortgage. Once the time period expires, if the borrower has not cured the default, then the lender may commence foreclosure proceedings.
A nonjudicial foreclosure, or power of sale foreclosure, is an out-of-court process. With a commercial foreclosure, just like a residential foreclosure, the lender may proceed nonjudicially if the loan documents contain a power of sale clause and if allowed by state foreclosure law.
The power of sale clause is located in the deed of trust or mortgage and empowers a trustee sell the property without court supervision. This process typically involves recording a notice of default (or similar document) in the county records, mailing a copy of that notice to the borrower and other interested parties, as well as publishing the notice of default or notice of sale, though nonjudicial procedures vary from state to state.
Judicial foreclosures are processed through the court system and are initiated when the lender files a lawsuit—usually in the form of a complaint for foreclosure or petition for foreclosure—against the borrower seeking a judgment of foreclosure and order for sale.
First, a title report will be ordered so that the lender’s attorney can determine all interested parties that must be named as defendants in the lawsuit. The defendants might include lienholders (like junior mortgage holders) or the U.S. Internal Revenue Service, if there is a federal tax lien on the property. The attorney will also receive copies of all underlying commercial mortgage documents, including the mortgage, the security agreement, the assignment of leases (if any), the assignment of rents (if any), any UCC filings, and any guaranties.
Because commercial loans are often taken out in the name of the business, in many cases the business owner will have provided a personal guaranty pledging payment of the loan. The business owner as guarantor will also be included as a defendant in the foreclosure suit, along with the business itself. Each defendant must be served with a copy of the complaint for foreclosure, either personally or by publication if a particular defendant can't be found. Defendants are given a certain amount of time, often 20 or 30 days, to file an answer to the complaint.
In an uncontested foreclosure, the lender’s attorney will file a motion to obtain a judgment. In a contested case, the matter will typically proceed to trial. Once the judgment and order of sale have been entered, notice of the sale date will be given to the defendants and might be published, depending on state requirements. The foreclosure sale will be held, and the property will be deeded to the new owner after any applicable redemption period has expired. (Learn about Foreclosure Alternatives for Commercial Properties.)
In a commercial foreclosure, just like with residential foreclosures, many potential defenses are available to a property owner to fight the action. Possible defenses include:
The rights of any tenants in a foreclosed commercial property will depend on the terms of the lease and the date on which the lease was signed. The tenant’s interest could potentially be terminated by a foreclosure due to the legal concept referred to as “first in time, first in right,” which allows the purchaser of a foreclosed property to void a lease if the mortgage was executed before the execution of the lease. (See our article on The First in Time, First in Right Rule.)
Many commercial leases contain a subordination, non-disturbance, and attornment agreement, or SNDA. Under the terms of an SNDA, the tenant agrees to subordinate, or make junior, its interest in the lease to any lender making a loan secured by the commercial property; the tenant agrees to attorn to, or recognize, any new owner of the commercial property as its landlord; and any new owner of the commercial property agrees not to disturb the tenant’s possession of the property as long as the tenant pays rent and complies with the terms of the lease. For tenants, an SNDA provides some assurance that their rights to their premises will be preserved even if the property is foreclosed.
If you are a commercial property owner facing foreclosure, or a commercial tenant with a landlord in foreclosure, it's important to keep in mind that there are many legal intricacies involved with foreclosures. It might be beneficial to employ the services of a qualified attorney to help you through the process and ensure that you fully understand your rights under the law.