By Alexander Berger, Rajinder Saini, and Charles Jacob
In this ongoing article series, the attorneys at Goulston & Storrs will keep you up to date on the current and emerging issues related to workouts and the Commercial Real Estate market.
You just finished the foreclosure process but the asset securing the loan was not worth enough to recover the entire amount of the debt. What happens now that there is a deficiency? Depending on the jurisdiction, a lender may be able to file for a deficiency judgment against the borrower or any guarantors. A deficiency judgment allows a lender (or mortgagee) to recover the remaining debt against the borrower and any guarantors following a foreclosure sale.
Many states restrict a lender’s ability to obtain a deficiency judgment, and some states do not allow a deficiency judgment following a non-judicial foreclosure. Because the procedure for computing the amount of deficiency judgments is state-specific, this article will focus solely on what you need to know about the deficiency computation process in Massachusetts and New York.
Massachusetts:
The Commonwealth of Massachusetts authorizes both judicial and non-judicial foreclosures. A deficiency judgment is permitted after a judicial foreclosure in Massachusetts. However, a lender is not automatically entitled to recover a deficiency after a non-judicial foreclosure. The lender must preserve its right to pursue a deficiency judgment through written notice delivered to the mortgagor at least 21 days before the foreclosure sale date that it intends to seek a deficiency judgment; and sign an affidavit of the notice’s mailing within 30 days after the foreclosure sale. The notice must declare the lender’s intent to foreclose by sale of the real property under a power of sale and seek recovery for any remaining deficiency after the foreclosure sale from the borrower.
This requirement of written notice cannot be waived, especially since oral notice of the lender’s intent to seek recovery is insufficient under Massachusetts law. However, the written notice requirement applies only to mortgagors, not to guarantors. The lender must bring an action for the deficiency judgment within two years after the sale.
A mortgagee exercising a power of sale must act in good faith and must use reasonable diligence to protect the interest of the mortgagor in the conduct of the sale. The duty of reasonable diligence requires that the mortgagee conduct the foreclosure sale fairly and in good faith by following the procedural requirements of the mortgage and applicable statutes. However, a mortgagee has no obligation to bid or realize the full fair market value of the property. Courts recognize that sale at a foreclosure auction rarely, if ever, realizes fair market value.
The burden is on the mortgagor to show that the mortgagee violated its duties in conducting the foreclosure sale in good faith and with reasonable diligence. The standard applied to determine whether the purchase price of the property sold at a foreclosure sale was so inadequate as to constitute a breach of the mortgagee’s duties is whether the purchase price as compared with the market value was “so grossly inadequate as to invalidate the sale.” While this formulation allows room for disagreement, review of Massachusetts case law indicates that the mortgagor’s burden is a substantial one.
It is also important to note that a mortgagor who is in possession of the property up to the time of a foreclosure sale is entitled to the rent and profits collected on such property. The same is also true if the mortgagee is in possession of the property before the foreclosure sale. In that case, the mortgagee collects the rent and profits as a trustee for the original mortgagor.
New York:
In New York, the approach to deficiency judgments is quite different than in Massachusetts, especially with respect to who has the burden of proof and to obtaining fair market value.
According to New York’s Real Property Actions & Proceedings Law, a mortgagee may be awarded an amount that a court determines “to be just and equitable, of the debt remaining unsatisfied, after a sale of the mortgaged property . . .” The mortgagee must make a motion in the action for leave to enter a deficiency judgment against the mortgagor simultaneously with the making of the motion for an order confirming the sale of the property securing the loan. Then the court will determine the fair and reasonable market value of the mortgaged property as of the foreclosure and make an order directing the entry of a deficiency judgment.
In New York, the lender bears the initial (prima facie) burden of demonstrating the fair market value of the mortgaged property as of the date of the foreclosure auction sale. A property’s fair market value is defined as “the amount which one desiring but not compelled to purchase will pay under ordinary conditions to a seller who desires but is not compelled to sell.” In essence, a deficiency judgment will be equal to the amount of the indebtedness, less the sale price of the property or its fair market value, whichever is higher. In this respect, a property’s fair market value is more important in determining a deficiency judgment in New York as compared to Massachusetts. In New York, a lender will not obtain a deficiency judgment without adequate proof of fair market value, while in Massachusetts the lender need only show that the property was sold in good faith and with reasonable diligence.
What if the property has generated rents and profits? Is the mortgagee entitled to such income in addition to the deficiency judgment? The answer is “no.” In a situation where the property has generated rental income and other profit while in the foreclosure process, the deficiency judgment will be accordingly reduced. The mortgagor must be given a credit for the rents and profits collected on the foreclosed property by a receiver.
The authors are attorneys at Goulston & Storrs where they are members of the firm’s Commercial Real Estate Workouts Group, which is a multi-disciplinary team of restructuring, real estate, litigation, and tax attorneys who guide clients through the complexities of commercial real estate loan workouts. In this ongoing article series, Goulston & Storrs will keep you up to date on the current and emerging issues related to workouts and the CRE market. For more information, email the team at DistressedREWorkingGroup@goulstonstorrs.com.
