Views from the Footprint - Banking, Collateral, Default and Foreclosure Question
October 07, 2014
In this issue of Community Banking Excellence, we pose a question to Spilman’s banking law professionals throughout the firm’s geographical footprint, focusing on Virginia, Pennsylvania, North Carolina and West Virginia. The answers vary based on individual state laws.
Question: My bank has collateral in your state, specifically an office building. The loan is in default for failure to pay. I want to foreclose on it. What does this entail, what is the process, and what is the typical timeline?
Commercial foreclosures in Virginia are far more stream-lined than some of the surrounding states. In Virginia, foreclosure is a non-judicial process. Nonetheless, some very specific steps must be taken to ensure a foreclosure sale is not later set aside or questioned. The first step is to ensure proper demand and notice of acceleration have been made. This should be done even if the Note contains the standard waiver of presentment language often seen in Virginia form notes. Next, the foreclosing trustee's office should be asked to prepare a substitution of trustee document (substituting the foreclosing trustee or the foreclosing trustee’s office for the original trustee in the Deed of Trust). If the Grantor identified in the Deed of Trust is an individual, a service member affidavit must also be prepared. Note that, although the trustee need not necessarily be an attorney (though it is advisable to have an attorney perform this function), the trustee must be a Virginia resident or entity. More than one trustee may be named. Note also that, unlike other states, there is absolutely no prohibition on counsel for the lender also acting as trustee. The trustee, however, is prohibited from advising the lender on proper bid amount (though advice on consideration that can be made, i.e. payment of taxes, and considerations to be made if in the second lien position, should be acceptable).
Once the substitution of trustee document has been executed by the lender, the beneficiary of the Deed of Trust should confirm that it is the holder of the Note and let the Trustees know whether it still possesses the original note (as signed by the borrower). If the original note is in possession of the lender, it should be sent to the Trustee. If the lender does not have the original note, the Trustee will need to have an affidavit signed by the lender indicating that the original note has been lost or cannot be produced. This requires one additional 14-day notice to the borrower, during which time no steps should be taken to advance the sale. Not having the original note will not invalidate the sale, but not providing the lost note notice can cause significant issues later. After this has been completed, the Trustee should set a foreclosure date. Once the date has been selected, the trustee will want to ensure he receives a title update effective between 28 and 30 days prior to the sale. This will govern the persons to whom notice is required to be given. Virginia statute requires that the trustee give notice to certain subordinate lienholders whose liens are recorded more than 30 days prior to the sale. Federal statute requires that the IRS receive notice of the foreclosure sale of any property against which a Notice of Federal Tax Lien has been filed. Notice to the IRS must be given specifically as required by statute, and it must be postmarked no later than 25 days prior to the sale. Notice must be given to the owner of the property and to non-IRS subordinate lienholders 14 days in advance of the sale. The Trustee must also strictly comply with the advertising requirements in the Deed of Trust (and if there are none, then he must comply with the statutory requirements). A sale may be set aside if notice is not properly advertised. The first advertisement of a foreclosure sale must occur eight days or more prior to the sale; otherwise, the sale may be set aside. Once these requirements have been met, a Trustee can call the sale at the date and time advertised. Once the memorandum of sale setting forth the terms of the foreclosure sale is signed by the Trustee and the high bidder, the Grantor has no further interest in the property. There is no right of redemption for the Grantor under a Deed of Trust in Virginia. Finally, the Trustee then has six months from the date of sale to submit a Final Accounting of the Foreclosure Sale to the Commissioner of Accounts for the jurisdiction in which the property is located.
While challenges to the price obtained at foreclosure are sometimes made (primarily by the borrower), such challenges have limited merit. A foreclosure sale will not be set aside in Virginia unless the price obtained "shocks the conscious of the Court." Judges are extremely reluctant to grant such relief, and all that this author has encountered have understood the practical realities that a foreclosure sale is, by its nature, unlikely to obtain anything resembling "fair market value" for the property sold. Virginia has no anti-deficiency statutes, so challenges based on value in subsequent suits to collect the balance due under the Note are also met unfavorably in those jurisdictions with which this author has familiarity.
Pennsylvania is a mortgage state, so the owner of a property retains title and the lender acquires a lien on the property by recording a mortgage against it. If the mortgage grants the lender a right to foreclose against the property in the event of default, then the lender must follow the judicial foreclosure process set forth in the Pennsylvania statutes and regulations in order to realize on its collateral and acquire title to the property. Strict compliance with the statutes and regulations is required, as fundamental due process is necessary in order to take an owner’s property, even after default and failure to cure. Compared to the trustee sale or non-judicial process under deed of trust states elsewhere, there is nothing quick or simple about the Pennsylvania process. If all goes smoothly and there are no objections, answers, counterclaims or new matters raised, then a lender should expect the process to take upwards of six to nine months, at a minimum, to complete, even in a commercial setting where additional notices are required before and during the process.
After default, a lender may initiate the foreclosure process by filing the Complaint in the county where the property is located. If there is an IRS tax lien, the plaintiff lender must include the United States as a defendant on the Complaint, but that is not particular to Pennsylvania. Notice on defendants within Pennsylvania must be served by a Sheriff, but alternative service may be obtained, with Court approval, for those who are or have become unavailable. General state rules apply, but local rules in each county apply, as well. The defendant may then file preliminary objections or an answer, and the answer may include new matter and counterclaims, but this author’s personal and anecdotal experience indicates that most foreclosure complaints go unanswered, and the process proceeds.
Presuming either the defendant defaults by not responding or the plaintiff lender succeeds in Court against the preliminary objections, answer, new matter and/or counterclaims, a Judgment in foreclosure is entered in favor of the plaintiff lender. At this point, the lender’s counsel prepares the foreclosure package, which includes the Notice of Sheriff’s Sale, the Writ of Execution and the 3129 Affidavit. The 3129 Affidavit lists, among other things, any other party that may have an interest in the property – including other lien holders, along with those junior in priority to the mortgage that will lose their lien in the foreclosure – and must be served to all of those parties in advance of the Sheriff’s Sale. Public notice of the date, place and time of the Sheriff’s Sale must also be published once a week for three successive weeks in a newspaper of general circulation in the county where the property is located, as well as in the local legal journal, if any, per local rules.
If the Sheriff’s Sale is not stayed or discontinued, it proceeds under bidding processes that vary from county to county throughout the Commonwealth. Taxes and governmental liens are only discharged to the extent paid. If there is a winning bidder, the Sheriff publishes a Schedule of Distribution within 30 days. Assuming no Petition to Set Aside the Sale is filed and prosecuted, then within 10 days thereafter the Sheriff is to prepare and deliver to the Recorder of Deeds the Sheriff’s Deed, which completes the conveyance of the property and also distribute the proceeds pursuant to the Schedule. There is no right of redemption after this point, other than the 120-day redemption period in favor of the United States, if applicable.
Any good title professional will scour the foreclosure procedure and paperwork to make sure that the process was followed strictly before issuing title work anew after the plaintiff lender or any other successful bidder acquires title through the process.
North Carolina is a title theory state, which means that deeds of trust are used instead of a mortgage. A deed of trust, like a mortgage, pledges real property to secure a loan; however, instead of creating a non-possessory lien to a lender, the deed of trust conveys the property to a third-party trustee to hold in trust with a power of sale to be exercised if there is a default under the loan. Because of the power of sale clause contained most deeds of trust, lenders in North Carolina may foreclose on deeds of trust using either a judicial or non-judicial foreclosure process. Of course, the most common foreclosure process is the non-judicial foreclosure, which allows the trustee to sell the property pursuant to the terms of the deed of trust without filing a lawsuit.
The first step in a power of sale foreclosure on a commercial property is to send a default notice to the debtor’s last known address stating the amount due, including the amount of principal, interest, and any other fees, expenses or disbursements the lender is claiming to be due as of the date of the notice. A title search and/or update will need to be ordered to (i) confirm there are no issues with the title, especially in the event the lender takes title to the property following the foreclosure, and (ii) identify and confirm all record owners of the property who will need to be served with Notice of the Foreclosure Hearing (“Notice of Hearing”). Upon completion of the title search or update, the Notice of Hearing will be filed with the clerk of court in the county where the property is located and served on (i) any person directed under the security instrument (i.e., those persons identified on the deed of trust), (ii) any person obligated to repay the indebtedness and who the lender intends to hold liable for any deficiency after foreclosure, and (iii) every record owner of the property subject to the foreclosure.
Approximately 25-30 days after the Notice of Hearing is filed, a hearing will be held before the clerk of court to determine whether a foreclosure sale may take place. To authorize the sale, the clerk must find (i) the existence of a valid debt held by the lender seeking foreclosure, (ii) the existence of a default, (iii) the right to foreclose under the security instrument, (iv) proper service of the Notice of Hearing, (v) that the underlying debt is not a “home loan” (or if it is, the home loan requirements have been met), and (vi) that the sale is not barred by the debtor’s military service, if any. These findings are usually made based on the clerk’s review of written testimony in the form of affidavits from the lender and trustee. However, oral testimony may also be heard at the hearing. If the clerk makes all of the above findings, he or she will grant the proposed order for sale. It should be noted that a clerk may grant continuances of the hearing upon finding “good cause.” Because “good cause” is not defined, the clerk is given broad discretion to grant a continuance to debtors. These continuances are typically between 30 and 60 days. Once the clerk enters an order for sale, a notice of sale is (i) sent to those entitled to notice under the foreclosure statutes via regular mail, (ii) posted at the courthouse, and (iii) published in a newspaper of general circulation in that particular county for two consecutive weeks.
The sale date is set approximately 25-30 days from the date of the order to allow time for publication. Following the sale of the property at the courthouse, there is a 10-day upset bid period. If there are any bidders during the upset bid period, the upset bid period is extended for another 10 days. At the conclusion of the upset bid period(s), the high bidder is contacted to coordinate closing on the property. The high bidder is usually given 30 days to close on the property or risk being held in default of bid. If the lender is taking the property after the sale, the Trustee’s Deed and final accounting can be filed immediately. However, if there is a third-party taking title to the property, the final accounting cannot be filed until the closing has occurred. The total estimated time for a commercial power of sale foreclosure in North Carolina with no continuances and no additional upset bid periods is two to four months.
In West Virginia, commercial foreclosure is a non-judicial process. The first step in the process is to ensure that a notice of default is sent to the borrower and guarantors, along with a demand and notice that the terms of the Note have been accelerated. This should be done even where the language in the Note provides a waiver of presentment. If necessary, the foreclosing trustee should then prepare an appointment of successor trustee or trustees (there can be more than one trustee) that substitutes the foreclosing trustee for the original trustee identified in the Deed of Trust. The lender must execute the appointment of successor trustee, which is then recorded in the County in which the property is located. In West Virginia, the trustee may act as counsel for the lender entity; however, the trustee may not provide advice about the proper bid amount.
Once the appointment of successor trustee document is recorded, a foreclosure sale date may be set. Usually a foreclosure sale date is set approximately six weeks after the recordation of the appointment of successor trustee document. Notice of the foreclosure sale should be provided to the borrower and guarantors 30 days prior to the foreclosure sale date. Additionally, an updated title search should be performed within 28 and 30 days prior to the foreclosure sale date to ascertain any subordinate lienholders. If the IRS has a lien on the property, notice of the foreclosure sale must be sent to the IRS and must be postmarked no later than 25 days and no more than 30 days prior to the foreclosure sale. If the West Virginia State Tax Department has a lien on the property, notice to it must be postmarked no later than 15 days prior to the foreclosure sale. Notice must be sent to other subordinate lienholders and the notice must be postmarked no later than 20 days prior to the foreclosure sale.
Notice of the foreclosure sale must also be made in accordance with the Deed of Trust. If there is no language in the Deed of Trust regarding notice of the sale, then pursuant to state law, notice must be published at least one week in advance of the sale, and for two consecutive weeks (meaning that the first publication should be published at least three weeks before the foreclosure sale). If publication is not properly completed, a foreclosure sale may be set aside.
Generally speaking, a foreclosure sale very rarely is set aside if the proper procedure is followed and notices given. However, there can be challenges to the value received at foreclosure sale. There is no requirement that property sold at a foreclosure sale be sold for the appraised value. West Virginia case law provides that the property should be sold for an amount that would not “shock the conscience of the Court.” However, West Virginia case law implies that amount is approximately 75 percent of the appraised value of the property. There is no right to redemption after the foreclosure sale (excepting those foreclosures that are subject to the Farm Credit Act).
If you have any questions regarding foreclosures, please contact Spilman.