Being in the business of lending is quite risky these days, and you never
know when the borrower will default on the loan despite you having conducted
a thorough investigation and analysis of the borrower’s financials.
The whole loan process may pass through three stages – the good,
the bad, and the ugly - and the lender should be proactive through all
the steps. Every bank, lender, and loan servicer should follow the rules
and regulations to manage the risks of the loan portfolio and ensure compliance
with the legal process so that the lender’s rights and remedies
under the loan documents are protected. In this article, we will provide
a few valuable tips that will not only secure your investment but will
also help in any future judicial proceedings.
PHASE ONE – The Honeymoon Stage
The first stage begins after the loan has closed and the borrower commences
making monthly payments. At this time, everything appears to be running
smoothly. Nevertheless, lenders and loan servicers should remain vigilant
and alert to avoid potential litigation risks, and can do so by following
a couple of simple steps.
The first thing a lender and its agents must keep in mind is to send monthly
statements to the borrower even if the loan documents have a waiver of
presentment. The monthly statements will serve as a notice to the borrower
as to what is owed and how previous payments have been applied. This transparency
is recommended because it will benefit the lender in the event there is
a monetary default and the lender chooses to initiate foreclosure proceedings.
Many times, in order to stop a foreclosure, borrowers allege that they
were not provided with the amounts due under the loan, or that they were
not aware that one of the monthly payments was considered late or that
the loan is now accruing at the default interest rate. Monthly statements,
therefore, eliminate the ambiguity as to what is owed, why it is owed,
and when the payments are due. Therefore, the monthly statements will
help lenders combat any potential argument a borrower may assert in a
wrongful foreclosure action that it was never provided any notice of what
was owed. In addition, lenders are statutorily obligated to notify the
borrower of what is owed under the terms of the loan documents if requested.
Before a lender or loan servicer decides to send the monthly statements
to the borrower, however, the lender and/or its loan servicer must ensure
that it has a proper accounting system in place in order to keep accurate
records; otherwise a lender may be at risk of returning money to a borrower
or having waived its right to collect certain amounts that may have been due.
In addition to a careful record of amounts due and payments made, lenders
and their agents must be careful as to how internal documents such as
write-ups, e-mails, or inter-office memorandums are written. In the event
there is a lawsuit, whether it is filed by the lender or the borrower,
a lender and/or its loan servicer’s loan file may be discoverable.
Therefore, a lender and its agents must be careful when documenting the
loan file. For instance, if you have a guarantor that is a principal of
the borrowing entity, do not reference the guarantor as the borrower.
While it is easy to reference the principal of the borrower entity as
the borrower instead of as a guarantor, such reference could be used by
a guarantor in support of a sham guaranty defense to invalidate a guaranty.
PHASE TWO - What Are the Options If the Borrower Defaults?
During the life of a loan, a lender will likely encounter issues such as,
among other things, missed payments, late payments, and failure to pay
real property taxes or maintain the property. All of the aforementioned
examples, are most likely considered an event of default under the terms
of the loan documents.
- Notice of Default and Reservation of Rights Letter
In the event there is a default, a lender should send a default letter
with rights of reservations to the borrower. A notice of default and reservation
of rights letter not only documents the default, but it also places the
borrower on notice that the lender is reserving all of its rights and
remedies until the default is cured. In addition, such a letter to the
borrower will pre-empt any argument a borrower may raise in a future lawsuit
that it was not aware there was an event of default.
- Loan Modification or Forbearance
The lender and borrower may also enter into negotiations to modify the
terms of the loan or have the lender temporarily forbear from exercising
its rights and remedies (i.e. invoke the default interest rate or foreclosure
proceedings) pending the borrower curing the default by a certain agreed
upon date. Before entering into such negotiations with a borrower, a lender
should understand the difference between a loan modification and a forbearance.
A forbearance agreement is when a lender agrees to forbear from exercising
its rights and remedies under the terms of the loan documents and at law
until the borrower is able to cure the event of default by an agreed upon
time. Therefore, the event of default has not been waived. A loan modification
is when a lender agrees to waive the event of default and modify certain
terms of the loan documents for the duration of a loan.
In the event a lender and borrower agree to a loan modification or forbearance,
the agreement should properly identify the event(s) of default and should
include a release provision that releases the lender and its agents, successors,
and assigns of all claims relating to the loan.
- Do Not Violate the Automatic Stay
Many times, despite having entered into a modification of the loan or a
forbearance, borrowers may cease making payments and communicating with
lender and/or its agents, and may even file for bankruptcy. In the event
the borrower files for bankruptcy, all collection activities must cease;
including sending a notice of default. A bankruptcy filing automatically
creates a stay on all collection activities by the lender, and if a lender
violates the automatic stay, even if by accident, said violation of the
stay could cause the lender to lose its security interest. As soon as
you receive a notice of bankruptcy filing, a lender and/or its loan servicer
should notify their legal representative, whether it is their in-house
counsel or outside legal counsel.
PHASE THREE – Exercising a Lender’s Rights and Remedies
Many times there is no other solution but to initiate foreclosure proceedings.
In California, a lender can simultaneously pursue judicial and non-judicial
foreclosure. The are several reasons for why a lender would dual track
a judicial and non-judicial foreclosure. The most common reason is the
preservation of a deficiency judgment against the borrower. Following
a completed non-judicial foreclosure sale, there is no way to seek a deficiency
judgment in most cases. However, by filing a judicial foreclosure lawsuit,
the lender may be able to keep the borrower sweating with the threat of
a deficiency judgment.
In addition to foreclosing on the property, lenders can initiate a breach
of guaranty lawsuit against a guarantor for the deficiency balance. Also,
lenders can further ensure a full recovery of the amounts due under a
commercial loan by pursuing pre-judgment remedies, such as writs of attachment
or writs of possession, against the guarantor and borrower so long as
the note or guaranty are not secured by real property.
Hopefully, by having read this article you realize there are many ways
to protect your rights and remedies. While the article provides a general
overview of how lenders and its agents may protect themselves from a litigious
borrower or how to maximize recovery, a lender and/or its agents should
also consult with a qualified legal expert to consider all of its options
when faced with seeking or defending against legal actions.
If you have any questions contact Jenny Park or call our main office at