Commercial foreclosures are, for the most part, 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 say.
With both nonjudicial and judicial commercial foreclosures, the process starts when the borrower defaults on the mortgage. A "default" happens 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 30 days, but this time frame can vary depending on the terms of the mortgage.
Once the time period given in the breach letter expires and if the borrower hasn't cured the default, then the lender may start 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 to sell the property without court supervision.
This process typically involves:
Once all requirements under state law are met, a foreclosure sale is held. Nonjudicial procedures vary from state to state.
Judicial foreclosures are processed through the court system and begin 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, the lender will order a title report so that its attorney can determine all interested parties that must be named as defendants in the lawsuit.
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 get 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 get a judgment. In a contested case, the matter will typically proceed to trial.
If the lender wins the suit and after a judgment and order of sale have been entered, a notice of the sale date is given to the defendants. The notice might also 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.
Once a commercial property goes into foreclosure, the lender will want to ensure that:
To ensure that these objectives are met, a lender might seek the appointment of a "receiver" as soon as a commercial mortgage loan goes into default.
A "receiver" is an unbiased third party that the court appoints to protect the property from damage or lost rental income. Typically, the receiver is an individual person, though it could be a company.
The receivership process ordinarily begins when a commercial property owner goes into default. The lender submits a petition to the court to appoint a receiver either before an action to foreclose or concurrently with the foreclosure.
The court-appointed receiver is then responsible for managing the property until the foreclosure is complete. Once appointed, the receiver is generally able to:
Furthermore, the duties of the receiver include:
The main reason a lender might want a receiver is because, once appointed, the receiver (rather than the borrower) manages the income-producing commercial property. Having a receiver reduces the risks of "rent skimming" and "waste."
Hiring a receiver can be costly for the lender. Generally, receivers are paid on an hourly basis, with rates typically being several hundred dollars per hour. Though, rates vary quite a bit based on the geographic location of the property. The lender has to cover the cost of a court-appointed receiver.
Moreover, a court-appointed receiver answers to the court, not the lender. So, the lender must give up some control. This lack of control is of particular concern to lenders when it comes to selling the commercial property, setting a minimum sale price, and distributing the proceeds.
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." This general rule allows the purchaser of a foreclosed property to void a lease if the mortgage was executed before the execution of the lease.
Many commercial leases contain a subordination, non-disturbance, and attornment agreement (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're a commercial property owner facing foreclosure, or a commercial tenant with a landlord in foreclosure, it's important to keep in mind that many legal intricacies are 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.