DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
DEEDING PROPERTY TO THE LENDER
The Merits of Strategic Default
IN ANTICIPATION OF FORECLOSURE
by David J. Willis Attorney
Much has been made in the media of the explosion in foreclosures – meaning the involuntary loss of property as a consequence of a lender exercising its default remedies. But there is a strong case to be made that the voluntary relinquishment of property can be rationally justified on strategic grounds. It may be far more cost effective to let an "underwater" property go and instead direct one´s resources either to a cheaper housing alternative or toward paying off homestead-exempt assets. Since one cannot force a lender to foreclose – and many lenders are dragging their collective feet in commencing foreclosure and some are choosing not to foreclose at all – the best option may be for the owner to unilaterally deed the property to the lender ("DIL"). This is possible because only the grantor, not the grantee, is required to sign and acknowledge a deed.
Effects of Foreclosure
So what are the potential benefits of a unilateral DIL? To answer this question, one must examine (and weigh) the negative after-effects of foreclosure: adverse credit impact for seven years; the potential for a deficiency lawsuit by the lender ("deficiency" being defined as the difference between the unpaid note amount and the amount the lender receives at the foreclosure sale); and, often worst of all, the prospect that the IRS will deem the deficiency amount to be ordinary income that is taxable to the borrower. That could be a whopping amount (deficiencies in the $100,000 range are not uncommon now) and the borrower would have to take that amount as ordinary income all in one year. The IRS consequences may be the worst aspect of the foreclosure process.
Note that in 2008, Congress made homestead deficiencies exempt from the deemed income problem. But that does not help investors who may be looking at numerous underwater investment properties.
Effects of Non-Foreclosure: Zombie Titles
Surprisingly, a significant percentage of banks are choosing not to foreclose after the borrower defaults. Why? These lenders have considered the negative factors involved in taking foreclosed properties into inventory (maintenance and insurance costs, carry time, etc.) and decided that it is more financially favorable to sell the defaulted note to a collector and write off the loss. These lenders walk away, effectively dumping the abandoned property onto the local municipality. The nightmare result for the homeowner (who was under the impression from notices from the lender that a foreclosure was imminent) may be that he or she is relentlessly pursued by the collector who now owns the note, by local taxing authorities seeking unpaid ad valorem taxes, and by cities and homeowners associations who either sue or impose liens for trash removal, health and safety code violations, and demolition. After all, since the lender decided not to go through with the foreclosure sale, the homeowner still owns title and is therefore responsible for the property. In this scenario, the best option is a unilateral DIL to the lender, enabling the borrower to assert non-ownership of the property as a defense against circling vultures.
What is a "deed in lieu of foreclosure?"
Executing and delivering a deed from the owner of real property to the lender/lienholder has traditionally occurred in the context of a bilateral "deed in lieu of foreclosure," a specialized instrument designed to transfer property to the lender in satisfaction of a debt and in exchange for a full and complete release. This occurs when both parties expressly consent to the mutual benefits of this arrangement (Morission v. Christie, 266 S.W. 3d 89 Tex.App.-Ft. Worth 2008, no pet.).
The problem is that few lenders nowdays will agree to voluntarily accept a deed in lieu of foreclosure and give a release in exchange. They would rather use the foreclosure process to unquestioned title by wiping out any junior liens. So a traditional, bilateral DIL is not an available option.
This article addresses the question: what benefit might there be in deeding property to the lender anyway – i.e., even if the lender has not expressly agreed to discharge and release the debt? What if a borrower just executes a deed containing appropriate language, records it, and then sends a copy to the lender saying "Here, the property is yours now, and by the way, I consider the debt paid in full?"
Conveyance to the Noteholder
Note that when preparing the deed in lieu of foreclosure, the property needs to be conveyed to the current owner and holder of the note. This can be confusing, since ownership of the note is often split from servicing functions (i.e., collecting monthly payments). In order to maximize the unilateral DIL strategy, the homeowner should deed the property to the actual holder of the note, not the servicer.
Presumption of Acceptance
A deed need only be signed and acknowledged by the grantor before it is recorded. The recipient of the property (the "grantee") need not sign it. In fact, the grantee´s acceptance of the conveyance is not usually indicated anywhere on the document – acceptance is presumed. When a grantor transfers property, title to the property vests in the grantee upon execution and delivery of the deed conveying the property. A showing that a deed was executed and delivered with an intent to convey the property is sufficient to establish that the deed vested title in the grantee Stephens County Museum, Inc. v. Swenson, 17 S.W.2d 257, 261-62 (Tex. 1975). Proof that a deed was recorded creates a presumption of and establishes a prima facie case of delivery and intent by the grantor to convey the land Troxel v. Bishop, 201 S.W.3rd 290, 297 (Tex.App.-Dallas 2006, no pet.). Both cases are cited with approval in Watson v. Tipton, 2008 WL 1323 (Tex.App.-Fort Worth 2008).
However, there is a case that says acceptance of a deed by a lender in consideration for cancellation of a note will be not be presumed (Martin v. Uvalde Sav. and Loan Ass'n, 772 S.W.2d 808 Tex. App – San Antonio, 1989, no writ). This nonetheless leaves a lender who receives a deed in an ambiguous and possibly hazardous position. If enough time goes by without action by the lender, is this still true? What if the lender, after receiving such a deed, refrains from filing a foreclosure or a deficiency suit – might not this inaction be construed as implied agreement with the stated terms of the deed (i.e., discharge of the debt)? After all, courts widely recognize the concept of an implied agreement based on the conduct of the parties.
Because of these risks and ambiguities, the only safe and prudent course for a lender who truly does not want to accept title to the property in exchange for discharge of the debt is to take the affirmative step of filing an instrument in the real property records rejecting the deed. However, in filing dozens of deeds of this nature, this author has yet to see a lender take such action – even though they may not like the fact that the borrower has deeded the property to them. Wells Fargo is such a lender. It sends a letter saying "We find your correspondence to be incomprehensible and completely without merit . . . We view the document provided as fraudulent and it provides no basis for debt relief." These protestations notwithstanding, title to the property has still been conveyed back to the lender as a matter of record – their nasty letter does not reverse that; and as to the "fraudulent" aspect of the deed, that is nonsense. Fraud is intentional concealment. Conveying property to the lender cannot by any reasonable standard be construed as fraud.
Property Code Sec. 51.006
What sort of instrument must the lender file to reject a deed? Tex. Prop. Code Sec. 51.006 may offer guidance. It "applies to a holder of a debt under a deed of trust who accepts from the debtor a deed conveying real property subject to the deed of trust in satisfaction of the debt." It expressly provides that a lender may record an affidavit voiding such a deed within 4 years if the grantor/debtor did not disclose liens of which the lender hand no personal knowledge. But this is a narrow case. It applies only to this specific non-disclosure scenario.
The practical question is, if a lender already has deed in hand, will it expend the time and money to formally reject the deed and then proceed with a foreclosure? Perhaps, perhaps not. Lenders are likely to vary in their response to this – some may simply send the deed to their loss mitigation or REO ("real estate owned") department with instructions to list the property for sale and not bother with the foreclosure; others may decide to continue with the foreclosure process in spite of having been given a deed. Tex. Prop. Code Sec. 51.006 expressly permits this: "If a holder accepts a deed in lieu of foreclosure, the holder may foreclose its deed of trust as provided in said deed of trust without electing to void the deed."
Potential Benefits Even if there is a Foreclosure
It is of course not guaranteed that deeding property to an unwilling lender will result in avoidance of foreclosure. It could; but even if foreclosure occurs, might there be other benefits to executing such a deed? Given the potentially severe effects of both foreclosure and non-foreclosure, does the borrower have anything to lose by giving this method a try?
The first effect – the effect on credit – is not likely to be changed by executing a deed in lieu of foreclosure if the lender chooses to go ahead and conduct a foreclosure sale anyway.
The second effect – avoiding or defending against a deficiency suit – presents more interesting possibilities. Let´s say that the deed contained language reciting that it was being executed and delivered in satisfaction of the debt. If the lender sues on the deficiency, but has never filed anything of record rejecting the deed, might not the borrower be able to assert the deed as a defense (the legal term for such a defense is "accord and satisfaction")? Essentially, the borrower could argue that no deficiency exists. There is no case on this of which I am aware, but it would is a creative and powerful argument.
Similarly, if the IRS declares that the deficiency amount is ordinary income to the borrower, and then demands that tax be paid, the borrower could then hold up the deed and declare that since the lender accepted it (or, more precisely, never rejected it) that there is no deficiency and therefore no taxable income. Would this argument prevail? It certainly has a fighting chance, which is a good deal more than most taxpayers have in this circumstance.
Lastly, in a non-foreclosure scenario (where the lender threatens to foreclose but then does not), the former homeowner can use the DIL to defend against suits from third-parties who are trying to collect taxes or liens that have accumulated against the property.
It goes without saying that a unilateral DIL must contain certain specific statements and recitals if it is to be an effective defense. This is where an expert attorney´s drafting skills come into play. Executing a simple warranty deed to the lender will not do the job.
This is not your Parents´ Default
As a rule, Texans are inclined to honor their word and are reluctant to default on any obligation. However, consider that the world has changed; the top 1% of Americans now control 80% of the wealth. The CEO of the bank holding that note you can no longer afford to pay may well be sitting on his yacht in the Bahamas, toasting his fellow Wall Street friends on their massive new wealth – unprecedented in human history – and laughing at the poor souls who continue to make payments on their underwater notes.
Executing a unilateral DIL is not a "magic bullet" but it has interesting and potentially rewarding benefits, especially if the borrower is subsequently sued for a deficiency, receives an unwelcome IRS tax bill for deemed income, or is pursued for ad valorem taxes. In such event a skillfully drafted DIL may be the borrower´s only defense. However, this course of action should be taken only after thorough consultations with both legal and tax advisors.
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.
THIS DOCUMENT IS NOT INTENDED TO BE USED, NOR CAN IT BE RELIED UPON, BY ANY TAXPAYER FOR THE PURPOSE OF AVOIDING PENALTIES IMPOSED UNDER UNITED STATE FEDERAL TAX LAWS. THIS DOCUMENT DOES NOT CONSTITUTE DOES NOT CONSTITUTE A TAX OPINION OR OTHER ADVICE TO WHICH CIRCULAR 230 IS RELATED.
David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his web site, http://www.LoneStarLandLaw.com. Copyright © 2013 by David J. Willis. All rights reserved worldwide.