A commercial foreclosure is very similar to a residential foreclosure. A commercial foreclosure may be a judicial foreclosure or a nonjudicial foreclosure. This depends on the state and the provisions of the loan documents of the particular mortgage.
In both a judicial and a nonjudicial foreclosure, the process begins when the borrower defaults on their mortgage. A default occurs when a borrower falls behind on their payments or fails to satisfy a requirement in the loan documents, which may include things such as maintaining hazard insurance on the property.
Following a default by a borrower, a lender may accelerate, or call due, any outstanding balance on the loan. Usually, a lender is required to first send the borrower a breach letter which outlines the reason for the default and provides a time frame in which the borrower may cure the default and avoid acceleration.
In most cases, the time provided to cure the default is 30 days. However, this may vary depending on the mortgage terms. Once this time period expires, if the default is not cured by the borrower, the lender is permitted to commence foreclosure proceedings.
A judicial foreclosure is processed through the court system and is initiated when a lender files a lawsuit, typically in the form of a complaint for a foreclosure or a petition for foreclosure against the borrower which seeks a judgment of foreclosure and order of sale.
Typically, a title report is ordered, which allows the lender’s attorney to determine the interested parties that must be named as defendants in the lawsuit. This may include lienholders, such as junior mortgage holders. The attorney will also receive copies of all related mortgage documents.
In many cases, commercial loans are taken out in the name of the business and the business owner provides a personal guaranty pledging payment of the loan. The business itself and the business owner will be named as defendants in the foreclosure suit. Defendants are provided with a time period, often 20 to 30 days to file an answer to the complaint.
A nonjudicial foreclosure, also called a power of sale foreclosure, is a process that does not require court intervention. In a commercial foreclosure, a lender may proceed non-judicially if the loan documents include a power of sale clause and if it is permitted by the state foreclosure law.
What is the Commercial Foreclosure Process?
When a commercial property owner defaults on their mortgage, the lender will make every effort to ensure that the borrower does the following:
- Maintains the property in good condition;
- Continues to carry the required insurance on the property; and
- Does not continue to collect rent payments or other profits from the priority without putting the amount toward the outstanding debt first.
Typically, a commercial property mortgage contains a clause for the assignment of profits to the lending institution in the event a foreclosure occurs. The lender will request the court to appoint a receiver, who takes over the management of the commercial property until the foreclosure is complete. In some cases, the receiver will also be responsible for the sale of the property.
The commercial property is typically sold at auction to the highest bidder. Any sale proceeds are applied to the mortgage debt.
If there are no bidders at the auction, the lender bids. This is known as a credit bid because the lender may bid for any amount up to what is currently owed but does not pay anything because that amount is already owed to the lender.
In some cases, a foreclosure auction sale may not occur. A receiver may get permission and sell the commercial property outside of the foreclosure proceedings.
What Types of Legal Issues may be Involved in Commercial Foreclosures?
One of the biggest legal issues involved in a commercial foreclosure is the rights of the tenant. These rights will depend on the terms of the lease and the date on which it was signed.
In some cases, a tenant’s interests may be terminated if there is a foreclosure based on the legal concept of first in time, first in right. This concept permits the purchaser of a foreclosed property to void a lease if the mortgage was executed prior to the execution of the lease.
In many commercial leases, there is a subordination, non-disturbance, and attornment agreement, SNDA. Pursuant to the SNDA, the tenant agreed to:
- Subordinate its interests in the lease to any lender that is making a loan secured by the commercial property;
- Attorn to, or recognize, a new owner of the property as its landlord; and
- A new owner of the property agreed not to disturb the tenant’s possession of that property so long as they pay rent and comply with the lease.
For tenants, these provisions provide assurance that their rights will be preserved even if the property is foreclosed upon.
What are Some Legal Remedies for Commercial Foreclosure Violations?
In many cases, mortgage loan documents provide the process upon a borrower’s default. This may include the delivery of a default notice as well as a time period during which the borrower may cure the default.
The majority of loan documents identify the conditions which give rise to a default. If the loan documents provide a cure period, the lender must provide the borrower that time period to cure the default prior to pursuing any relief.
If a borrower does not timely cure a default, the lender may then proceed pursuing available remedies. At this time, a lender is permitted to accept a late cure by the borrower at its discretion and should evidence this acceptance with new documents.
Some remedies for commercial foreclosure violations may include:
- Acceleration of the loan;
- A set-off clause, which gives a lender authority to seize the borrower’s deposits when they default on their loan;
- A lawsuit on the loan agreement;
- Foreclosure on the mortgage;
- Receivership; and
- A settlement of the debt and a transfer of the collateral to the lender by a deed in lieu of a foreclosure proceeding.
How Has COVID-19 Affected Commercial Foreclosure Proceedings?
COVID-19 has had a profound effect on almost everything, including commercial foreclosure proceedings. In anticipation of many commercial real estate borrowers having difficulty making mortgage payments as a result of a reduction in income, many states and municipalities have temporarily suspended foreclosures and are encouraging lenders to work with borrowers on forbearance programs and other relief options.
There are also federal relief programs that were in place, however, many are coming to an end. The Coronavirus Aid, Relief, and Economic Security Act (CARES) provided assistance to commercial real estate borrowers as well as landlords and tenants who have been affected by COVID-19.
The CARES Act provides loans to small businesses to assist with certain mortgage obligations as well as other issues. The programs provided under the CARES Act include:
- The Paycheck Protection Program (PPP);
- The Economic Injury Disaster Loans (EIDL); and
- The Coronavirus Economic Stabilization Act of 2020 (CESA).
It is important to consult with a local attorney to determine what protections are still available through the federal government and what the state is currently providing. These laws and protections are changing daily and an attorney is best equipped to provide advice and analysis.
Do I Need a Lawyer for Help with a Commercial Foreclosure?
Yes, it is essential to have the assistance of a foreclosure lawyer if you are having any issues related to a commercial foreclosure. It is important to consult with an attorney as soon as possible, especially if your goal is to avoid the foreclosure process. Your attorney can examine your situation, provide you with your options, and fight to protect your rights.