DEEDS IN LIEU OF FORECLOSURE Colorado is a “lien theory” state, which means that regardless of language of conveyance that maybe contained in a deed of trust, mortgage or other instrument, a purported conveyance that is intended to secure an obligation creates a lien rather than transferring title to the beneficiary, mortgagee or other grantee. See Colo. Rev. Stat. § 38-35-117. Title does not pass to the beneficiary, mortgagee or other grantee except by foreclosure, and then only if the beneficiary, mortgagee or other grantee is the successful bidder at the foreclosure sale. Until January 1, 2008, Colorado statutes provided for the right of a property owner to redeem the property for a period of time following foreclosure sale, and court decisions routinely protected this right of redemption against attempted encroachments by mortgagees. Since 2008, the owner’s right of redemption has been replaced – with some exceptions for certain residential mortgages, provided for in Colo. Rev. Stat. § 38-39-901, et seq. – with an extended pre-foreclosure-sale right to cure. Language in pre-2008 cases, referring to the relative sanctity of the owner’s right to redeem, no longer applies literally. Still, deeds in lieu of foreclosure reflect a circumvention of the normal foreclosure process, and the spirit of older case law is likely to live on. In any event, structuring a deed in lieu of foreclosure requires attention both to legal/theoretical issues and to practical issues. This article will look at both. Legal/Theoretical Issues Although a deed in lieu of foreclosure is likely to foreshorten a borrower’s statutory cure rights, a debtor can, for valuable post-default consideration, validly convey the debtor’s interest in the mortgaged property to the mortgagee or the mortgagee’s designee. A waiver of cure rights, or an agreement to shorten the cure period, is unenforceable if made before default – see Colo. Rev. Stat. § 38-38-703 – but such waivers or agreements can be valid if they are made after default and if they are supported by consideration. In its simplest form, a deed in lieu of foreclosure is a deed given by the mortgagor directly to the mortgagee, in satisfaction of the secured debt, and the satisfaction of debt supplies the consideration. For reasons we will discuss, few though having the form of something other than a security device. to be returned to a debtor if he pays his debt when due or to be delivered to the creditor if the debt is not paid. 81 Colo. Ver Straten v. a deed deposited in escrow. 79 Colo. repurchase options and other devices that are intended to leave an obligor . 394 P. accompanied by a contemporaneous agreement that allowed the grantor to retain possession of the property so long as payments were made to the grantee.2d 129 (1964). 282. 393. is nonetheless intended to create a secured transaction. Pope v. but where the seller was purportedly entitled to terminate the contract and retake possession on default. 84 Colo. Worth. 1104 (1926). 155 Colo. if a debt owed by the grantor to the grantee is paid within a specified time. In structuring a deed in lieu of foreclosure transaction. Cheney. the key legal concerns are (1) to avoid having the transaction treated as an equitable mortgage as opposed to an absolute conveyance of the property. was in effect a mortgage and could only be enforced by foreclosure. For the present purpose. the term is used to describe an arrangement which. and (2) to avoid permitting the lien of the original security instrument to merge with fee title to the mortgaged property. may constitute an equitable mortgage if its execution is accompanied by the grantee’s agreement to return the deed. so consideration must be found elsewhere. A deed. Larson v. where the purchaser was entitled to possession so long as scheduled payments were made. however. A quitclaim deed. constituted an equitable mortgage. 987 (1927). 271 P. or reconvey the property.transactions are or should be structured in this form. 535. Equitable Mortgage Concerns The term “equitable mortgage” is sometimes used to refer to the result of an attempt – unsuccessful for some technical reason – to create a legal mortgage. 1118 (1928). Hinds. Parker. Leases. Morris v. purportedly absolute on its face. was likewise an equitable mortgage and could only be foreclosed as such. Similarly. typically in the form of a complete or partial exculpation of the borrower or others from personal liability for the secured debt. 243 P. 30. An installment contract for deed. which will nonetheless be enforced by a court of equity as though it were in fact a mortgage. 255 P. conventional lien rights (for example. if the secured party had other. with its attendant delays. and reject title as unmarketable . as may any of the covenants contained in the deed of trust. it is unwise for the lender to demand possession. At a minimum. if a defaulted loan is to be reinstated or the term of the loan is to be extended. no option to repurchase. may be held to constitute equitable mortgages. those rights may be determined to have been waived or superseded by the equitable mortgage. The time within which the debtor may attack an ostensibly completed transaction is probably limited only by the doctrine of laches. Instead. of a deed that is to be recorded in the event of a subsequent default or returned to the borrower if no default occurs. Since the existence of a previous debtor/creditor relationship is one of the “badges” which frequently accompanies a determination that a given transaction was intended as a security arrangement. so the secured party can never be certain as to when “enough” time has passed to validate the secured party’s apparent title. The power of sale contained in a pre-existing deed of trust may be unenforceable.with ongoing property rights so long as the obligation is not delinquent. the secured party’s equitable lien will have to be foreclosed by judicial action. Moreover. future title examiners may well notice that the chain of title depends on a deed from mortgagor to mortgagee. dated or acknowledged well before the date of recording. the borrower should have no ongoing rights with respect to the property – no right to possession or income. a lender contemplating workout terms must be especially careful. Even if the borrower never attacks the arrangement. the arrangement will not be enforced in accordance with its purported terms. no right to object to the lender’s sale of the property to a third party and no right to an accounting for any proceeds of sale. The consequences of a determination that an arrangement amounts to an equitable mortgage are potentially severe. Conversely. or escrowing. If a deed in lieu of foreclosure is to be taken. but to deprive the obligor of those rights upon the occurrence of a default. a deed of trust to the Public Trustee). two devices are typically used. 764 P. the mortgage lien ceases to exist and can no longer operate as a means to extinguish junior liens and other interests in the property. the conveyance should run to an entity other than the lender – ideally an entity .” Goldblatt v. in tandem. First. to have occurred.2d 514 (Colo. App. unless a contrary intent appears. 95 Colo. 1934). the court found that merger was intended. will attack the lender’s title. Lien Merger Concerns The Colorado Supreme Court has held that “[i]n law a merger always takes place when a greater estate and less coincide and meet in one and the same person. 1989). Cannon. in one and the same right. Colorado National Bank of Denver. or someone claiming under him. and the courts held that merger had not been intended and so had not occurred. 1988). Hammar. Merger is not the inevitable result of a deed in lieu of foreclosure. If a mortgage lien is merged with a “greater estate” such as fee title.2d 359 (Colo. unless for some reason the holders of those liens and interests also participate in transferring the liens and interests to the owner of the “greater estate” as well.2d 524 (Colo. and cannot demonstrate that the intention of both parties to the transfer of fee title was to avoid merger of the mortgage lien. supra. 419. 37 P. but whether it is deemed to have occurred depends on what characterization a court chooses to place on facts that have already occurred. or even alleged. Second. App. Thus. 786 P. For an example of how detrimental this can be to a mortgagee. In Federal Land Bank of Wichita v.in view of the ongoing possibility that the borrower. the lien ceases to exist and related covenants are no longer enforceable – but liens and interests that were junior to the merged lien are not affected. the senior lienholder was more fortunate. in lieu of foreclosure of a senior lien. if the holder of a mortgage lien acquires fee title. In both Goldblatt and Hammar. see Colorado National Bank – Exchange v. the documents governing the deed in lieu transaction should state unequivocally that neither party intends a merger to occur. without any intermediate estate. To minimize the risk that merger will be held. numerous efforts were made to circumvent debtors’ equitable redemption rights. If the condition failed to occur. As with any title insurance transaction.5 (1952). for the mortgagee to take possession of the mortgaged property prior to default. Early English common law mortgages operated in fact much the way a literal reading of the language of a modern mortgage would suggest – as absolute conveyances of title (including the incidents thereof. See generally. it is essential that the title company be informed in writing of all off-record circumstances that may affect its risk in issuing or updating insurance coverage. the conveyance became absolute. however. 4 American Law of Property § 16. the English Chancery. but the lender will at least be able to look to the title insurer for the defense of any attack on the continuing validity of the lien. that no such scheme would be enforced. then the lender should also consider obtaining an update of the original mortgagee’s title insurance policy concurrently with the recording of the deed in lieu of foreclosure. to discourage any claim that the grantee was a mere alter ego of the mortgagee. courts developed the practice of permitting mortgagors to redeem their property from strict enforcement of their mortgages by paying the mortgage debt following default – hence the term “equity of redemption”.that existed before the deed in lieu transaction and that has an operating history and other assets. namely the payment of a defined debt by a specified date. and eventually legally forbidden. or equity. . subject to defeasance upon the occurrence of a condition subsequent. As one American court described the doctrine. As it became accepted that the mortgagor retained most of the practical attributes of ownership until default. the merger issue will not disappear entirely. Over time it became less customary. The equity courts were adamant. Creditors being creditors. If the title insurer is willing to update the loan policy without exception for possible consequences of the deed in lieu. A Note About Equity Clogging Equity-clogging is an arcane concept with real-world implications of significant but largely undefined scope. Assuming it is important to the lender to preserve the existing lien. such as the right of possession and the right to receive income). scheme or contrivance” is that by which the mortgagee acquires. The doctrine would prevent the mortgagee from taking through any trick.). scheme or contrivance the equity of redemption from the borrower. the borrower is divested absolutely of all interest in the mortgaged property. which contains by far the best discussion of cases which have applied or considered the rule. English and American courts have almost uniformly refused to enforce such options. Sup. Super. or both.2d 705 (1949). . the lender may seek to capture some “up-side” potential benefits by insisting on an option to convert all or part of the loan at some future time to an equity interest in the mortgaged property.The doctrine against clogging the equity of redemption of a mortgage estate is an old English doctrine brought forward in this Country to prevent lenders taking an inequitable advantage of distraught borrowers. MacArthur v. 255 Wis. . Practical Considerations A deed in lieu of foreclosure transaction differs from a transaction involving a purchase of the collateral in one crucial respect – the decision to invest has already been made and executed. . Granahan. Perhaps the most widely denounced “trick. North Palm Beach Utilities. Vol. simultaneously with its mortgage. Ct. an option to purchase the mortgaged property from the mortgagor at any time while the debt remains unpaid. the possibility of an equity-clogging claim may arise. however. Nonetheless.W. where a lender agrees to accept a substantial reduction in the recoverable amount of interest... Inc.61 (1952). and the mortgagee and its lawyer need to weigh the risks and benefits. 185 (Fla.. principal. Real Property § 4668 (1958 Repl. a mortgagee should approach a deed in lieu transaction . In a workout situation. MacArthur v. 38 N.2d 898 (1973). v. North Palm Beach Utilities. Cf. 4 American Law of Property §§ 16. supra. 530.J. Inc. 303 A.58-16. Out of the doctrine developed the proposition that when the borrower repays his loan he is entitled to a return of that which was mortgaged as security for the loan . 1967). Doerr. 192.2d 181. See Humble Oil & Refining Co. Equity clogging is unlikely to occur in a deed in lieu of foreclosure transaction where. But see. and Barr v. 9 Thompson. as recommended. At that point. 202 So. 123 N. Accounting for and requiring turnover of tenant security deposits previously collected by the borrower. and will be bound by. whether or not they are technically secured by liens on the property. . metropolitan districts and similar bodies. These include. Rev. the rights of parties in possession. by resignation of declarant appointees from the board of directors. homeowners’ associations or other members of the local community. the assignment of declarant rights should contain the provisions contemplated by Colo. Obtaining a current environmental assessment with regard to the property. Investigating the status of the borrower’s obligations to third parties.3-304(5)(d). Identifying and requiring assignment of any rights the borrower may have to receive reimbursements for infrastructure costs from utility companies. Relinquishment by the borrower of control of any homeowners’ or condominium unit owners’ association. § 38-33. As a prospective grantee. If there are serious contamination issues. Stat. Identifying and requiring assignment of the borrower’s rights as declarant with respect to a planned community or condominium project. the mortgagee may be better off abandoning the collateral instead of taking title and attempting to resell it. Note that if the mortgagee or designee intends to resell the property rather than continuing with development and marketing efforts. water or sanitation districts.with substantially all of the questions and concerns that an arms’ length buyer would have. in order to minimize the risk of liability as a successor declarant. the mortgagee or its designee has constructive notice of. to the extent performance of those obligations would be required to maintain essential services or to establish good relationships with tenants. Relinquishment by the borrower of control of any special district serving the mortgaged property. without limitation: A physical inspection of the property and inquiries of those found to be in possession. architectural control committees and similar bodies. brokers. plans and specifications. Obtaining a transfer of the borrower’s rights with respect to contracts. . On the other hand. leases. Obtaining assurances of future cooperation by the borrower with respect to issues and problems relating to the property. Depending on the borrower’s financial and organizational condition. taxes and other items of income and expense. proration of rents. the lender may find it impossible to obtain satisfaction with respect to many of these items. construction warranties. utilities. Proceeding with the transaction may still appear more attractive than the alternatives. If the borrower has any available cash. governmental permits and licenses (including liquor licenses) and other intangible assets. the lender will not get anything for which it fails to ask. Colorado (referred to. any act or omission of Grantor or any other declarant under the Declaration that occurred before the execution and delivery of this deed. Colorado. as it may have been amended or supplemented to date.] . Grantee shall not be deemed to assume. subject to (1) the lien of general taxes for 200 . dated as of . before the execution and delivery of this deed. . payable in the following year. a [State of Formation] [Type of Entity] whose street address is (“Grantee”). in the real property records of County. through. dated [date of deed of trust] recorded [date of recording] at Reception No. (2) the Deed of Trust from Grantor to the Public Trustee of County for the use and benefit of [Grantee or. without limitation. [The interest conveyed by this deed includes. name of original lender]. that by accepting this deed. to wit: [insert legal description] with all its appurtenances.Appendix A [Sample Deed in Lieu of Foreclosure] SPECIAL WARRANTY DEED [NAME OF GRANTOR]. for the consideration of TEN DOLLARS and other good and valuable consideration. through or under Grantor that are to be excepted from Grantor’s warranty of title]. (3) [list any other encumbrances created by Grantor or persons claiming by. in the real property records of County. provided. and recorded . and shall have no liability for. the following real property in the County of and State of Colorado. or any supplement to. the Declaration that has not been recorded in the real property records of County. all of Grantor’s right. as the “Declaration”). . hereby sells and conveys to [NAME OF GRANTEE]. Colorado. nor shall Grantee have any liability or responsibility of any kind under any amendment or modification of. title and interest as declarant (including but not limited to any special declarant rights) under the Declaration . if different. at Reception No. and warrants the title against all persons claiming by. in hand paid. or under Grantor. a [State of Formation] [Type of Entity] whose address is (“Grantor”). Appendix A. an interest in one or more liens or encumbrances affecting title to the property conveyed herein. ) The foregoing instrument was acknowledged before me this ____ day of . My commission expires:____________________________ Witness my hand and official seal. and (B) this deed shall not result in the merger of any such lien or encumbrance with the title conveyed hereby. or that Grantee or an affiliate of Grantee may have or acquire. directly or indirectly. 200 . Page 2 Notwithstanding the fact that Grantor may be indebted to Grantee or an affiliate of Grantee. equitable or other right to redeem any interest in the property conveyed herein. a [State of Formation] [Type of Entity]. Notary Public . by as of [Name of Grantor]. 200 . (A) this deed is intended as an absolute conveyance rather than as security for any obligation. a [State of Formation] [Type of Entity] By Secretary Name: Title: STATE OF COLORADO CITY AND COUNTY OF DENVER ) ) ss. [NAME OF GRANTOR]. Signed and delivered as of the ____ day of ATTEST: . or in the subordination or extinguishment of any such lien or encumbrance in favor of any other lien or encumbrance. and Grantor expressly waives any statutory. .. B. dated as of . in Book at Page (Reception No. a Colorado limited liability company (“Borrower”) whose address is 1099 Ski Time Square Drive. Connecticut 06510. Major Financial Corporation. capitalized terms used herein without definition have the meaning given such terms in the Declaration. a Colorado nonprofit corporation. Steamboat Springs. 200 . Concurrently with the execution and delivery of this Assignment. irrevocably and without any reservation of rights. LLC. Ritzy Club Association. Colorado 80487. the meaning given such terms in the Colorado Common Interest Ownership Act. Security Agreement and Fixture Financing Statement given by Borrower. INC. to DESIGNEE. Colorado (the “Land Records”). ) (the “Deed of Trust”). a Delaware corporation (“Lender”) is the beneficiary and holder of the Combination Deed of Trust. Borrower wishes and intends to transfer to Assignee . or any successor thereto as provided in the Declaration. Borrower is conveying to Assignee. title and interest in and to the Project. Inc. as such Act exists on the date of this Assignment (“CCIOA”). absolutely. Borrower is the declarant (the “Declarant”) under the Condominium Declaration for Ritzy Club Condominiums (the “Project”) as more particularly described on Schedule 1 attached hereto (as amended from time to time in accordance with the terms and provisions thereof and hereof the “Declaration”). By this Assignment. 200 and recorded in the Office of the Clerk and Recorder of Routt County. a Washington corporation (“Assignee”) whose address is 123 East Drive. is the unit owners’ association formed pursuant to the Declaration (the “Association”). or if not defined therein. East Haven. Except as otherwise specifically stated herein. by RITZY CLUB.Appendix B [Sample Assignment of Special Declarant Rights] ABSOLUTE ASSIGNMENT OF SPECIAL DECLARANT RIGHTS THIS ABSOLUTE ASSIGNMENT OF SPECIAL DECLARANT RIGHTS (this “Assignment”) is made as of . all of Borrower’s right. C. RECITALS A. Borrower has done nothing to alienate. Page 2 all Special Declarant Rights provided for in the Declaration or available to Borrower under the provisions of CCIOA. Assignee may exercise the right to control the executive board of the Association. it shall not affect the validity or enforcement of the remaining obligations or portions hereof. Notwithstanding the foregoing. Stat. (c) This Assignment is to be construed and enforced in accordance with the substantive laws of the State of Colorado. Miscellaneous. 2. Designee wishes to acquire all such Special Declarant Rights. Assignment. . representations and warranties contained in it. Stat. Statement of Intention. as provided in Colo. but to hold all such Special Declarant Rights solely for transfer to another person. Borrower assigns and transfers to Designee. § 38-33.3-303(5). dated the date of the Deed of Trust. (d) If any provision of this Assignment is determined to be invalid or unenforceable under Colorado law. transfer or encumber any of such Special Declarant Rights. conditions. Warranty. shall bind and benefit the successors and assigns of Borrower and Assignee. 3. Pursuant to Colo. all Special Declarant Rights provided for in the Declaration and by CCIOA. ASSIGNMENT NOW.Appendix B. Assignee declares Assignee’s intention not to exercise such Special Declarant Rights itself. the singular number shall include the plural. and the use of any gender shall be applicable to all genders. and intends to hold such rights solely for transfer to another person. THEREFORE. (b) Wherever used. D. Borrower warrants that except for a Collateral Assignment of Declarant’s Rights in favor of Lender. absolutely and without any reservation of rights. Rev. in consideration of the foregoing and the mutual provisions of this Assignment. Borrower and Designee agree as follows: 1. and the covenants. (a) This Assignment. § 38-33. Rev.3-304(5)(d). to the extent permitted by the Declaration and CCIOA. powers or remedies hereunder shall operate as a waiver of such rights. by as of Ritzy Club. and shall take such other actions. 200 . powers and remedies herein provided for are cumulative and none are exclusive. Notary Public . LLC. each of which shall. This Assignment may be executed in two or more counterparts. day of The foregoing instrument was acknowledged before me this . LLC. constitute a single Assignment. powers or remedies. a Colorado limited liability company By Name: Title: STATE OF COLORADO COUNTY OF ) ) ) ss. as may be requested by Assignee or Lender in order to carry out the purposes of this Assignment. Counterparts. RITZY CLUB. My commission expires Witness my hand and official seal.Appendix B. Page 3 (e) No failure or delay by Assignee to exercise or enforce any rights. All rights. Signed and delivered as of the date first mentioned above. 4. upon execution and delivery of counterparts by each party. (f) Borrower shall execute upon request such additional documents. a Colorado limited liability company. . day of The foregoing instrument was acknowledged before me this . INC. a Washington corporation By Name: Title: STATE OF COUNTY OF ) ) ) ss. by as of Designee.Appendix B. Page 4 ACCEPTED: DESIGNEE. 200 . a Washington corporation. My commission expires Witness my hand and official seal. Notary Public . Inc. ...