Evaluating the Options for Collecting the Debt
While this manual is devoted primarily to the enforcement of a loan through judicial or nonjudicial foreclosure of a deed of trust, the attorney should always keep in mind that a secured lender has a number of alternatives to foreclosure of the loan collateral and that in appropriate circumstances these alternatives may be of greater utility and value to the lender than foreclosure. The possible avenues for dealing with default on a secured loan include the following:
1.Negotiated Restructuring of the Debt. This entails accepting additional security for a reinstatement or modification of the debt; restructuring the debt payments, on either a temporary or permanent basis, and perhaps forgiving a portion of the debt; selling the loan (often at a discount) to a third party procured by the borrower; or for a residential loan, restructuring through a government-assistance-to-homeowner program. See section 3.3 below.
2.Negotiated Plans for Liquidation of the Collateral. This entails permitting a “short sale” of the mortgaged property, with or without compromise of payment of the shortfall; cooperating with the borrower in a voluntary plan to liquidate assets for application to the debt, either inside or outside of bankruptcy or receivership; or negotiating a deed in lieu of foreclosure. See section 3.4.
3.Unilateral Acts by Creditor to Take Control of All or Part of the Collateral. This entails taking control of rents under an assignment of rents; taking physical control of the mortgaged property as a mortgagee in possession; proceeding to nonjudicial foreclosure of the mortgaged property, with the option to thereafter pursue any deficiency against obligors on the debt; rescission of a vendor’s lien; involuntary bankruptcy filing against the obligor; or receivership proceedings. See section 3.5.
4.Judicial Action by Lender. This entails obtaining judgment on the debt, without seeking foreclosure of the mortgaged property; obtaining judgment on the debt, with judicial foreclosure of the mortgaged property; obtaining judgment on the debt and subsequently pursuing nonjudicial foreclosure of the mortgaged property; or filing suit on the debt and seeking judicial control of the mortgaged property during the interim (such as through receivership, injunction, or sequestration). See section 3.6.
The attorney must keep in mind that with some of these courses of action, the doctrine of election of remedies may be invoked to prevent the lender from simultaneously pursuing one or more other remedies. See section 3.6:1.
The attorney may also find it necessary to remind the lender that, unlike the self-help repossession of personal property allowed under section 9.609 of the Texas Business and Commerce Code, Texas law does not recognize self-help repossession of real estate. If the deed of trust contains no clause authorizing the lender to take possession of the mortgaged property before foreclosure, the only remedy afforded to the lender under a deed of trust is the right of nonjudicial foreclosure the lender bargained for. The lender who wrongfully exercises self-help repossession exposes itself to a variety of counterclaims. See, for example, Lighthouse Church of Cloverleaf v. Texas Bank, 889 S.W.2d 595 (Tex. App.—Houston [14th Dist.] 1994, writ denied), where the court (construing former section 9.503, now section 9.609) found that the repossessing lender had committed trespass by changing the locks on the doors of its borrower (a church) and posting guards to ensure that church members did not break back into the church for services. See section 3.5:2 for additional discussion.
Likewise, the lender is not entitled to collect the rents or profits of the mortgaged property before foreclosure except through a contractual agreement with the mortgagor. See chapter 9 concerning the collection of rents and profits before foreclosure.
§ 3.2Analyzing the Circumstances
To determine the most efficient way to resolve a default in payment of a debt or breach of security instrument, the lender must evaluate a significant number of circumstances pertaining to the situation of the lender, the borrower, and the mortgagor. The attorney can advise the lender of the legal implications of the facts and circumstances of the particular loan transaction, but ultimately it is the lender who must make the business decision (and accept the business risk) on how best to proceed with enforcement of the loan documents.
Common Factors: In making its decision on how best to proceed, the lender will invariably be influenced by any number of factors that may or may not be unique to the lender, which are not necessarily related to the ability to legally enforce the loan documents but which materially affect the relative value of the debt and the collateral to be realized by the lender in light of the estimated time and cost (both monetary and otherwise) of a particular course of action. Such factors might include—
1.the degree to which the lender is financially dependent on realizing immediate payment from the borrower;
2.the existence of other business relationships with the borrower that would be affected by the lender’s action on this particular debt;
3.the borrower’s availability and willingness to discuss an agreed resolution to the default;
4.casualty damage to the mortgaged property;
5.significant renovations to the mortgaged property that could be required under the Americans with Disabilities Act of 1990, 42 U.S.C. §§ 12101–12213, to facilitate a postforeclosure resale of the collateral;
6.suspected or known environmental problems with the mortgaged property that may affect the value of the collateral;
7.the lender’s ability to realize payment more easily through a guarantor than through pursuit of the borrower or foreclosure of the mortgaged property;
8.the availability of other borrower assets to bolster the existing credit relationship;
9.competition with other creditors of the borrower for access to the borrower’s assets (including the relative lien position of the lender in the lender’s existing collateral);
10.the nature of any defenses or counterclaims available to the borrower in light of the documentation or administration of the lender’s loan;
11.the likelihood of the borrower resisting collection efforts through bankruptcy or other court action; and
12.the likelihood that any arrangement with the borrower might be set aside as a preference by a third-party action, such as an involuntary bankruptcy filing against the borrower.
Bankruptcy Risk: In analyzing the best way to proceed with collection, the lender may also be faced with a number of factors that are beyond the lender’s control. The most commonly encountered of these factors is the unilateral right of the borrower and the mortgagor to file for bankruptcy and thereby stay all collection activities until the lender can obtain a lift of stay through bankruptcy proceedings. There are, however, many other borrower circumstances that can affect the lender’s decision as to how best to enforce a loan in default.
Military Service: The Servicemembers Civil Relief Act of 2003, codified at 50 U.S.C. §§ 3901–4043, protects military personnel from foreclosure actions arising out of loan defaults attributable to military service by suspending the lender’s collection rights while the servicemember is on active duty and for nine months after discharge from active duty. See chapter 33 for a discussion of the Act and related Texas statutes.
Divorce: The borrower or mortgagor may be involved in a divorce action. If so, the filing of a divorce action or the granting of a divorce after the execution of the mortgage and before the proposed deed-of-trust foreclosure sale does not suspend or prohibit a lender from nonjudicially foreclosing its lien. See Mussina v. Morton, 657 S.W.2d 871, 874 (Tex. App.—Houston [1st Dist.] 1983, no writ). However, the appointment of a receiver by a family law court does. Texas American Bank/West Side v. Haven, 728 S.W.2d 102, 104 (Tex. App.—Fort Worth 1987, writ. dism’d w.o.j.); see also Texas Trunk Railway Co. v. Lewis, 16 S.W. 647, 649 (Tex. 1891).
Guardianship: Similarly, a deed of trust executed by a guardian for a minor may not be foreclosed except pursuant to court order. Crowley v. Redmond, 41 S.W.2d 274, 278 (Tex. Civ. App.—Fort Worth 1931), aff’d, 70 S.W.2d 1113 (Tex. 1934).
Death of Mortgagor: The death of the mortgagor before foreclosure creates an enormous risk for the lender without first resolving the estate, as the foreclosure sale could be set aside by the subsequent opening of a dependent administration within four years of the mortgagor’s death. See chapter 26 for a discussion of the effect of probate law on the collection of the deceased’s debts through foreclosure.
Drug Enforcement Laws: The lender’s interest in the mortgaged property may be threatened or lost through illegal activities (of the borrower or others) on or related to the mortgaged property, as more than 140 different federal forfeiture statutes and several Texas statutes allow the government to seize a defendant’s interest in property. See sections 4.30 and 4.31.
Residential Lease: The lender’s freedom to deal with the mortgaged property postforeclosure may be restricted by residential leases granted by the mortgagor, as the Protecting Tenants at Foreclosure Act of 2009, which is title VII, sections 701–704 of the Helping Families Save Their Homes Act of 2009, requires that a lender who forecloses on a residence must honor any existing lease or, for tenants on month-to-month leases, provide tenants with a minimum of ninety-days’ notice to vacate. (Section 8 tenants are provided with parallel eviction protection.) See Pub. L. No. 111-22, § 702, 123 Stat. 1632, 1660–61; 12 U.S.C. § 5220 note; Fontaine v. Deutsche Bank National Trust Co., 372 S.W.3d 257, 260 (Tex. App.—Dallas 2012, pet. dism’d w.o.j.). See sections 15.9:1 and 15.9:4 concerning protections for residential tenants.
Finally, it is absolutely essential that the lender be aware of any title issues surrounding its collateral. In many respects, the analysis of how to proceed with collection cannot begin until the lender understands whether title issues affect the value and marketability of the mortgaged property. See chapter 4 for a discussion of these title issues. For these and many other possible reasons, the lender must carefully evaluate all of the alternatives for collection and not merely proceed to foreclosure as a “knee-jerk” to a loan default.
§ 3.3Negotiated Agreements to Restructure the Debt
A negotiated restructuring of the existing credit relationship may provide a quicker resolution of a defaulted loan than a judicial or nonjudicial foreclosure actively resisted by the borrower or mortgagor, but to be successful the negotiated restructuring normally requires that the borrower (1) has access to material additional assets that can be pledged to secure the defaulted debt in consideration for a reinstatement, restructuring, or forbearance agreement, and/or (2) realistically can be expected to realize sufficient cash flow in the future to service a restructured debt payment plan. Even where the lender doubts that such is true, the lender may still wish to engage in negotiations with the borrower concerning the default, both to explore possible areas of agreement and to collect further information concerning the borrower’s circumstances.
Care must be exercised by the lender in workout discussions and communications to the obligors to avoid later claims of reliance on course of dealings, oral promises, and misrepresentation arising out of the discussions. Before starting such negotiations with the borrower, the lender should obtain a written agreement with the borrower concerning the terms of any workout negotiations, to avoid later claims that a borrower had relied on purported statements or agreements reached during the negotiations but never reduced to writing. See form 3-1 for a sample agreement concerning terms of workout negotiations. If necessary to facilitate negotiations, a foreclosure forbearance agreement may also be required. See form 3-2.
In Bluebonnet Savings Bank, F.S.B. v. Grayridge Apartment Homes, Inc., 907 S.W.2d 904, 909–10 (Tex. App.—Houston [1st Dist.] 1995, writ denied), the court found a borrower’s claim that the lender had agreed to refinance its delinquent loan to be unreasonable, partly on the basis that the parties had entered into a prenegotiation agreement. Also, in Commercial National Bank of Beeville v. Batchelor, 980 S.W.2d 750, 753–54 (Tex. App.—Corpus Christi 1998, no pet.), the court found that the lender’s previous acts of lenience with the borrower did not impose any obligation to continue such extra-contractual lenience in the future based on the UCC’s good-faith provision.
A key point to remember in connection with any material modification of a guaranteed loan is that the guarantor may be inadvertently released of liability for payment of the debt absent the guarantor’s consent to the modification. The guarantor’s consent for a material modification should be obtained either at the time of the modification or by prior agreement. See, for example, NCNB Texas National Bank v. Johnson, 11 F.3d 1260, 1266 (5th Cir. 1994), in which the court rejected the guarantor’s objection of no notice of debt restructure where the guaranty provided that the guarantor waived “notice of extensions, renewals or rearrangements of Debt, [notice] of release or substitution of collateral . . . and every other notice of every kind.” See also Wiman v. Tomaszewicz, 877 S.W.2d 1, 7 (Tex. App.—Dallas 1994, no writ); FDIC v. Attayi, 745 S.W.2d 939, 944 (Tex. App.—Houston [1st Dist.] 1988, no writ).
§ 3.3:1Loans to Financially Distressed Borrowers
A voluntary restructuring of the delinquent loan may involve the loan of additional cash to the borrower or the taking of new collateral, or both. A loan made to a borrower in financial distress that is secured by a lien on the borrower’s assets and subsequently foreclosed is not a fraudulent transfer if the lien granted was made for reasonably equivalent value. See Tex. Bus. & Com. Code §§ 24.005(a)(2), 24.009(a). In Yokogawa Corp. of America v. Skye International Holdings, Inc., 159 S.W.3d 266, 271 (Tex. App.—Dallas 2005, no pet.), the court noted that “[t]he value of the collateral is irrelevant because the excess over the debt is not lost to the debtor or other creditors” (citing First National Bank of Seminole v. Hooper, 104 S.W.3d 83, 86 (Tex. 2003)). The Yokogawa court also held that if this were not the case, “creditors would be reluctant to negotiate loan workouts with financially troubled debtors because taking collateral in excess of their loan would expose them to substantial risk over and above the amount of their debt.” Yokogawa, 159 S.W.3d at 271 (quoting First National Bank of Seminole, 104 S.W.3d at 86).
§ 3.3:2Statute of Frauds and Written Loan Agreements
All loan agreements with financial institutions involving amounts exceeding $50,000 must be in writing and signed by the party to be bound or by that party’s authorized representative. Tex. Bus. & Com. Code § 26.02(b). Likewise, agreements falling within the statute of frauds must be in writing. See Tex. Bus. & Com. Code § 26.01. In cases governed by section 26.01, “there must be a written memorandum which is complete within itself in every material detail and which contains all of the essential elements of the agreement so that the contract can be ascertained from the writings without resorting to oral testimony.” Cohen v. McCutchin, 565 S.W.2d 230, 232 (Tex. 1978).
The written memorandum must, within itself or by reference to other writings and without resort to parol evidence, contain all the elements of a valid contract, including an identification of both the subject matter of the contract and the parties to the contract. Dobson v. Metro Label Corp., 786 S.W.2d 63, 65 (Tex. App.—Dallas 1990, no writ). In a contract to loan money, the material terms include the amount to be loaned, the maturity date of the loan, the interest rate, and the repayment terms. T.O. Stanley Boot Co. v. Bank of El Paso, 847 S.W.2d 218, 221 (Tex. 1992). Parties to a written contract that is within the provisions of the statute of frauds—
may not by mere oral agreement alter one or more of the terms thereof and thus make a new contract resting partly in writing and partly in parol, the reason for the rule being that, when such alteration is made, part of the contract has to be proven by parol evidence, and the contract is thus exposed to all the evils which the statute was intended to remedy.
Dracopoulas v. Rachal, 411 S.W.2d 719, 721 (Tex. 1967) (quoting Robertson v. Melton, 115 S.W.2d 624 (Tex. 1938)). A modification to a contract need not restate all the essential terms of the original agreement. A modification alters only those terms of the original agreement to which it refers, leaving intact those unmentioned portions of the original agreement that are not inconsistent with the modification. Boudreaux Civic Ass’n v. Cox, 882 S.W.2d 543, 547–48 (Tex. App.—Houston [1st Dist.] 1994, no writ).
One Texas court has held that under Tex. Bus. & Com. Code § 26.02 (unlike the traditional statute of frauds language in section 26.01), the loan agreement itself must be in writing; a memorandum of agreement is not sufficient. Bank of Texas, N.A. v. Gaubert, 286 S.W.3d 546, 554 (Tex. App.—Dallas 2009, pet. dism’d w.o.j.). The court further noted that no Texas case has expressly held that the equitable exceptions to section 26.01 also apply to section 26.02 (and the court did not make any decision regarding such in reaching its verdict). Gaubert, 286 S.W.3d at 555. Finally, the court held that while equity will avoid the statute of frauds where application of the statute would itself work a fraud, there is no authority for avoiding the statute of frauds based on mere negligence. Gaubert, 286 S.W.3d at 556 (citing Nagle v. Nagle, 633 S.W.2d 796, 799 (Tex. 1982); Birenbaum v. Option Care, Inc., 971 S.W.2d 497, 503–04 (Tex. App.—Dallas 1997, pet. denied)).
In BACM 2001-1 San Felipe Road Ltd. Partnership v. Trafalgar Holdings I, Ltd., 218 S.W.3d 137 (Tex. App.—Houston [14th Dist.] 2007, pet. denied), the court found that the lender’s cashing of a $250,000 check tendered by the borrower bearing the notation “This payment on the captioned loans (see attachment) is in confirmation of your previous acceptance of the agreement contained in our letter of March 23, 2004 (attached)” coupled with a transmittal letter stating, “With further reference to my letter and proposal [20 percent discount on the loan’s principal, payment of discounted balance within four months, and immediately bringing loan current], I am enclosing our cashier’s check in the amount of $250,000 as was agreed upon during your telephone conference call to us yesterday . . . ,” were not sufficient to either establish a new contract meeting the requirements of Tex. Bus. & Com. Code § 26.02 or to be a contract modifying the existing loan. Without resorting to parol evidence, which is barred by Tex. Bus. & Com. Code § 26.02, the court could not establish several essential terms to the alleged new contract or a modification to the existing contract: identities of the parties, interest rate, treatment of late fees and default interest, and treatment of prepayment penalty. The court also found that if the proposal and good-faith payment made by the borrower and accepted by the lender were to be treated as a modification of the existing loan, the borrower breached the modified agreement by not immediately bringing the loan current, did not continue to make installment payments as they became due, did not pay late-payment charges, and did not pay the prepayment premium of $7,500,000 (i.e., terms that were not addressed in the proposal and thus were left intact as terms of the modified agreement).
§ 3.3:3Limitations and Reinstatement Agreements
The purpose of limitations statutes is to establish a point of repose for past actions and for “ensur[ing] that the search for truth is not impaired by stale evidence or the loss of evidence.” Childs v. Haussecker, 974 S.W.2d 31, 38–39 (Tex. 1998); accord Stewart Title Guaranty Co. v. Hadnot, 101 S.W.3d 642, 644 (Tex. App.—Houston [1st Dist.] 2003, pet. denied). If the lender accelerates the maturity of the indebtedness, the statute of limitations will begin to run from the date of acceleration. If the lender allows the borrower to cure the default and resume regular payments on the note, the statute of limitations will nevertheless continue to run unless the lender reinstates the loan or unaccelerates the note. If no reinstatement agreement is signed, the borrower may at a later date assert a statute of limitations defense to continued payment. See form 3-3 in this manual, Reinstatement, Modification, Renewal, and Extension Agreement. A general agreement in advance by the borrower to waive or not plead the defense of limitations on a particular obligation is void as against public policy. Duncan v. Lisenby, 912 S.W.2d 857, 858–59 (Tex. App.—Houston [14th Dist.] 1995, no writ).
See sections 5.12 and 10.26 for further discussion of limitations.
§ 3.3:4Renewal and Extension Agreements
Renewal and extension agreements pertaining to existing loans should be evidenced by a signed instrument recorded in the official records of the county in which the mortgaged property is located. Failure to do so creates the risk that the four-year limitations for enforcement of a deed of trust will run as to third-party lenders and purchasers relying on the public record. See sections 5.12 and 10.26 in this manual.
The mortgagee’s title insurance coverage will remain in effect for four years past the original maturity date of the note or a subsequently renewed and extended maturity date, whichever is later. Thus, the coverage provided by the mortgagee title insurance policy will be extended to the new maturity date of the note each time the note is renewed, provided, however, that the title insurance company will not be responsible for any loss incurred by the mortgagee as a result of the execution of an invalid renewal and extension agreement or the failure to record any renewal and extension agreement. See section 3.3:10 below.
§ 3.3:5Modification of Consumer Debt
The Truth in Lending Act is implemented by Regulation Z of the Federal Reserve Board, 12 C.F.R. pt. 226. If the workout agreement involves consumer credit governed by Regulation Z for which a truth-in-lending statement was originally required, a new truth-in-lending disclosure statement may need to be delivered to the borrower at the time the mortgage loan is reinstated. Regulation Z also provides that refinancing is a new transaction requiring new disclosures to the consumer, unless the refinancing falls within one of the exceptions. See 12 C.F.R. § 226.20(a). Section 226.20(a) provides for an exception for workout agreements if they involve a change in the payment schedule or collateral requirements as a result of the consumer’s default, unless the rate is increased or the new amount financed exceeds the unpaid balance plus earned finance charge and premiums for the continuation of certain types of insurance. See 12 C.F.R. § 226.20(a)(4).
§ 3.3:6Sale of Loan to Third Party
Even though a loan may never have been in default, there are times when, for any number of reasons, the relationship between the lender and the borrower has deteriorated to the point that one or both parties want to end it. Terminating the relationship is most commonly done through a loan sale or refinancing involving a third-party lender procured by the borrower. When the loan is in default, the lender may be willing to sell the loan at a discount, calculating that the reduction in recovery is more than offset by the uncertainties of the time, cost, and likely success in pursuing collection of the full loan balance.
See form 3-4, Loan Purchase Agreement; form 3-5, Assignment of Note and Lien; form 3-6, T-3 Endorsement Instructions for Use Upon Assignment of Lien; form 3-7, Estoppel Certificate from Note Seller; form 3-8, Estoppel Certificate from Obligors; and form 3-9, Letter to Maker.
§ 3.3:7Government Assistance to Homeowners
A number of federal programs exist to assist homeowners and creditors in the restructuring of delinquent residential home loans so as to avoid foreclosure of the residence. Depending on the particular circumstances of the loan and agreements between the creditor and the government, participation in some of these restructuring and assistance programs is mandatory. See chapter 36 in this manual for further discussion of these programs.
§ 3.3:8Release and Settlement of Claims
A relatively common lender practice is to require that, as a condition to a restructuring of the loan, the borrower and the mortgagor must release all known and unknown causes of action that arose under the loan transaction before the effective date of the restructuring agreement. The lender may also require that the borrower and mortgagor provide sworn affidavits as to their financial condition in connection with accepting a settlement and compromise plan. Both proposals obviously require careful consideration by the borrower, mortgagor, and their respective attorneys.
Assuming the loan is not part of one of the federal government’s homeowner assistance programs (and thus subject to the contractual/statutory requirements of the program), upon failure of a borrower to perform under an executory accord, the lender may treat the accord as repudiated and may choose to claim its rights under the original cause of action or the accord. Alexander v. Handley, 146 S.W.2d 740, 742–43 (Tex. 1941); BACM 2001-1 San Felipe Road Ltd. Partnership v. Trafalgar Holdings I, Ltd., 218 S.W.3d 137, 146 (Tex. App.—Houston [14th Dist.] 2007, pet. denied).
§ 3.3:10Mortgagee Title Insurance Concerns in a Restructuring
Procedural Rule P-9b(3), “Endorsement of Owner or Mortgagee Policies,” promulgated by the Texas Department of Insurance, provides:
Partial Release, Release of Additional Collateral, Modification Agreement, Reinstatement Agreement and/or Release from Personal Liability—When a Mortgagee Policy has been issued covering the lien securing an indebtedness, and the holder of such Mortgagee Policy desires to:
(a)release a part of the land described in Schedule A of said Policy; and/or
(b)release additional collateral securing indebtedness described in said Schedule A; and/or
(c)modify only one or more of the following items described in Schedule A of said policy: the mortgage, deed of trust, security instrument, guaranty or promissory note by entering into a Modification Agreement; and/or
(d)reinstate said mortgage or deed of trust by entering into a Reinstatement Agreement; and/or
(e)release the mortgagor(s) or other obligors from personal liability;
Upon payment of the premium prescribed by rate rule R-11.b, the Company which issued the original policy may issue a Form T-38 Endorsement thereto to show that policy coverage has not been reduced or terminated solely by virtue of the modification, reinstatement or release. An endorsement shall not be issued under this subparagraph (3) if:
(i)the modification agreement, reinstatement agreement or other instrument expressly creates or grants a lien or power of sale; or
(ii)the indebtedness secured by the lien of the insured mortgage or deed of trust is evidenced by a new promissory note; or
(iii)the insured mortgage or deed of trust is modified to secure additional principal indebtedness other than accrued or deferred interest on the specific indebtedness described on Schedule A of the policy or advances made pursuant to the terms of the original mortgage or deed of trust; or
(iv)the insured mortgage or deed of trust is cross-collateralized or otherwise modified to cover property not described on Schedule A of the policy.
28 Tex. Admin. Code § 9.1 (emphasis added) (adopting by reference The Basic Manual of Rules, Rates and Forms for the Writing of Title Insurance in the State of Texas, as amended (hereinafter Basic Manual), available from the Texas Department of Insurance, at https://www.tdi.texas.gov/title/titleman.html.
Anytime the lender reinstates or modifies the terms of payment of the secured debt, the mortgagee should consider obtaining a form T-38 endorsement for its mortgagee title insurance policy to reflect that its title insurance is still in effect and unaffected by the reinstatement or modification. A premium of $100 shall be charged for each endorsement within one year after the date of the original policy; if issued after the one-year period, an additional $10 shall be charged for each year thereafter, not to exceed 50 percent of the premiums applying to the original policy under Schedule of Basic Rates. See Basic Manual, rate rule R-11b.
The T-38 endorsement only confirms that the title company will not claim that its liability under the mortgagee title insurance policy has been terminated, waived, reduced, or otherwise impaired as a result of a release of collateral, modification, reinstatement agreement, or release of a mortgagor from personal liability. The T-38 endorsement expressly states that it does not (1) extend coverage on pre–March 1, 1983, policies past the statutory bar date as calculated from the original maturity date of the indebtedness; (2) extend coverage on post–February 28, 1983, mortgagee title insurance policies past the bar date as calculated from the extended maturity date unless there is a valid and recorded renewal and extension agreement; (3) change the original effective date of the mortgagee’s title insurance policy or the face amount of insurance stated on Schedule A of the policy; (4) alter or increase the coverage of the policy; (5) include within its scope any modification agreement, reinstatement, or other instrument not specifically set forth in the policy; or (6) cause the title company to have any liability by reason of the invalidity of the instruments described in the policy or the failure to record any renewal or extension agreement. See Basic Manual, form T-38. See also section 3.3:4 above.
§ 3.4Negotiated Plans for Liquidation of Collateral
For various reasons, the lender and borrower may find it mutually advantageous to enter into a negotiated plan for liquidation of the loan and the loan collateral, rather than seek to restructure and continue the loan. From the lender’s perspective, the agreed liquidation avoids the threat of bankruptcy by the borrower and many of the uncertainties of repossessing and reselling the collateral against opposition by the borrower. As an incentive to the borrower to participate in the liquidation, the lender may offer to reduce the loan balance or deficiency amount in exchange for the borrower’s cooperation. (In some situations, the lender will make such reduction conditional on the borrower realizing a stipulated sum from liquidation of the collateral within a specified period, as a further incentive for the borrower’s cooperation.) Another typical settlement agreement strategy contemplates a deed in lieu of foreclosure (see section 3.4:3 below) being held in escrow while the debtor is permitted a marketing period to avoid losing the mortgaged property and equity. See Kent v. Citizens State Bank, 99 S.W.3d 870 (Tex. App.—Beaumont 2003, pet. denied), in which the mortgagor unsuccessfully challenged the bank’s filing of an escrowed deed. In any event, the basic calculation is that cooperation will lead to a better result for both sides of the loan relationship.
A short sale occurs when the mortgage holder agrees to allow mortgaged property to be sold through the normal real estate market rather than foreclosure, even if the proceeds of the sale will not cover the amount due on the mortgage. Because of this shortfall, if there are junior liens on the collateral, the junior lienholders must approve the sale and release their liens; otherwise, the continued existence of junior liens securing any significant debt against the property will normally discourage any prospective purchaser from closing the short sale.
The advantage of a short sale to the lender is that a sale through the normal real estate market with the cooperation of the property owner may help the mortgage holder realize a greater net return than trying to market the property after foreclosure. In cases where foreclosure of the mortgage makes little sense (because, e.g., the resale will be time consuming and expensive), the lender may provide incentives for the obligor to arrange a short sale. For example, the U.S. Housing and Urban Development’s short sale program for residential homeowners provides latitude for the mortgage holder to make payments (up to $1000) to the homeowner in order to encourage a short sale. (Lenders typically do not volunteer this information, so it is a good idea to ask about this point when representing the homeowner in a short sale situation.)
From the borrower’s perspective, the short sale will avoid a foreclosure notation on the borrower’s credit report and usually results in a greater loan pay-down than if the property went to foreclosure. In addition, under Fannie Mae’s short sale option for qualified homeowners, homeowners are eligible for cash relocation assistance.
Because a short sale does not necessarily discharge the borrower’s debt (it merely results in the release of lien), the borrower may resist closing a short sale unless the lender agrees to waive or reduce the resulting deficiency (notwithstanding that in practice, a short sale will usually result in a greater pay-down of the obligor’s debt than the foreclosure process). However, in some federal homeowner assistance programs, the lender is required to waive the deficiency. If the borrower has other assets at risk and the lender is not required to waive any deficiency, the borrower may want to offer a cash contribution in addition to the sale price in exchange for a waiver of the balance of the deficiency. Any agreement between the lender and the borrower for a short sale should be reduced to writing and expressly set out how the deficiency will be handled.
If any whole or part of the deficiency remaining after a short sale is forgiven by the lender, the amount of the deficiency forgiven may be imputable as taxable income to the borrower, depending on whether the borrower is solvent at the time the deficiency is forgiven. See chapter 23 in this manual for further discussion and IRS Topic 431 and IRS Publication 4681.
§ 3.4:2Agreed Bankruptcy or Receivership to Liquidate Assets
While outside the scope of this manual, agreed bankruptcies (such as the 2009 Chapter 11 bankruptcy filing of General Motors where, with federal assistance, General Motors negotiated agreements with many of its creditors before entering bankruptcy that were ratified by the bankruptcy court against the opposition of other creditors) and receiverships are ways that borrowers and lenders may freeze collection activities by third parties, arrange for an orderly disposition of claims against the debtor’s property, and (in bankruptcy) even discharge claims against the debtor and/or obtain time for implementation of a reorganization of the debtor’s business affairs.
The Bankruptcy Code provides an automatic stay on all actions or proceedings, including nonjudicial foreclosure sales, against the debtor in bankruptcy or his mortgaged property. See 11 U.S.C. § 362. The stay of action also includes a stay of demanding payments, accelerating the debt, posting for or proceeding with foreclosure, filing suit against the debtor, repossessing or otherwise obtaining or perfecting liens against the property of the debtor, exercising any right of offset, and most other collection efforts. 11 U.S.C. § 362(a)(4). A foreclosure sale knowingly made in violation of the automatic stay can expose the lender to liability for actual and punitive damages. 11 U.S.C. § 362(k)(1). It is very important to run a bankruptcy check on a borrower before proceeding with a foreclosure action so as not to be exposed to liability for violating the automatic stay.
In a receivership, the court appoints a receiver over the debtor’s or mortgagor’s property, which is held in custodia legis. The effect is that any action related to the property must be approved by the court that appointed the receiver. In Pratt v. Amrex, Inc., 354 S.W.3d 502 (Tex. App.—San Antonio 2011, pet. denied), the court held that the first lien mortgagee had no authority to foreclose its deed of trust against real property held in custodia legis by a receiver without the permission of the court that appointed the receiver. Pratt, 354 S.W.3d at 506 (citing First Southern Properties, Inc. v. Vallone, 533 S.W.2d 339, 341 (Tex. 1976)).
A voluntary receivership is accordingly a means by which the lender and borrower may stop action against the mortgaged property by third parties and arrange for an orderly disposition of the mortgaged property without going through a bankruptcy proceeding. See generally, Donna Brown, Post Judgment Remedies: Judgment Liens, Garnishment, Execution, Turnover Proceedings, Receiverships under the DTPA, Charging Orders, and “Other Stuff,” in Collections & Creditors’ Rights Course, State Bar of Texas (2019); Randolph L. Burns, Looking at a Receivership Issue? Here’s What You Need to Know, in Advanced Real Estate Drafting Course, State Bar of Texas (2012). See sections 4.18 and 6.7:10 in this manual for additional discussion.
It is strongly recommended that attorneys considering bankruptcies or receiverships prenegotiated by the lender and borrower should consult with attorneys specializing in those areas of law before implementing any such actions.
§ 3.4:3Deed in Lieu of Foreclosure
The deed in lieu of foreclosure is a conveyance of the mortgaged property by the mortgagor to the lender (or to a person designated by the lender) in full or partial satisfaction of the debt owing on the secured promissory note, outside of a nonjudicial foreclosure sale.
See form 3-10 in this manual, Warranty Deed in Lieu of Foreclosure, and form 3-11, Agreement for Deed in Lieu of Foreclosure.
The court in Morrison v. Christie, 266 S.W.3d 89 (Tex. App.—Fort Worth 2008, no pet.), described this practice as follows: “No specific statutory scheme governs the format of this type of transaction, although the Texas Legislature provides some protections against undisclosed liens or encumbrances on the property to a holder of a debt secured by a deed of trust who accepts such a conveyance as payment.” Morrison, 266 S.W.3d at 93 (citing Tex. Prop. Code § 51.006). Texas common law concerning deeds in lieu of foreclosure has been significantly affected by the adoption of Texas Property Code section 51.006 in 1995, which reads:
(a)This section 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.
(b)The holder of a debt may void a deed conveying real property in satisfaction of the debt before the fourth anniversary of the date the deed is executed and foreclosed under the original deed of trust if:
(1)the debtor fails to disclose to the holder of the debt a lien or other encumbrance on the property before executing the deed conveying the property to the holder of the debt in satisfaction of the debt; and
(2)the holder of the debt has no personal knowledge of the undisclosed lien or encumbrance on the property.
(c)A third party may conclusively rely upon the affidavit of the holder of a debt stating that the holder has voided the deed as provided in this section.
(d)If the holder elects to void a deed in lieu of foreclosure as provided in this section, the priority of its deed of trust shall not be affected or impaired by the execution of the deed in lieu of foreclosure.
(e)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. The priority of such deed of trust shall not be affected or impaired by the deed in lieu of foreclosure.
Advantages of Deed in Lieu: A deed in lieu of foreclosure attempts to satisfy the following desires of the borrower, the mortgagor, and the lender: (1) the lender obtains immediate control and use of the mortgaged property, (2) the parties are permitted to choose the tax year in which the transfer will occur, (3) the expenses incident to a foreclosure may be reduced, (4) the stigma to the borrower of having lost property through a foreclosure sale is eliminated, (5) the lender avoids the possibility of competitive bidding by third parties at the foreclosure sale, (6) future attacks by the borrower against a nonjudicial sale as a wrongful foreclosure are avoided, (7) the risk of the borrower’s filing bankruptcy may be limited, and (8) the lender may recover the collateral when foreclosure is precluded because of (a) the death of a mortgagor whose estate is not in independent administration or (b) the mortgagor and the mortgaged property are subject to the Servicemembers Civil Relief Act (see generally 50 U.S.C. §§ 3901–4026). See chapter 33 in this manual.
Section 51.003 of the Property Code may also make the use of deeds in lieu of foreclosure an attractive alternative. See Tex. Prop. Code § 51.003. If the lender expects the debtor to contest the issue of fair market value and if the potential deficiency judgment does not justify the costs and uncertainty of a jury trial, the lender may want to accept a deed in lieu of foreclosure rather than go through the delay and expense of a trial. See the discussion of deficiencies at sections 13.7:2, 15.3, and 15.5, and the discussion of section 51.003 at sections 13.2:1, 13.7:2, 14.8:1 and 17.5 in this manual. The court in Morrison interpreted a deed in lieu of foreclosure coupled with an agreement by the lender-grantee to apply the net proceeds to be later derived from its subsequent sale of the property against the borrower’s note. The court rejected the borrower’s argument that it was entitled to a determination of the fair market value of the property under section 51.003 of the Texas Property Code to reduce the deficiency. The court also rejected the argument that the deed in lieu was a disguised mortgage with a power of sale. The court stated that adequate consideration existed for the deed in lieu of foreclosure sale, even though no credit was given at the time of the deed in lieu, as the mortgagor avoided the negative effect on its credit that a foreclosure would have had. Morrison, 266 S.W.3d at 94.
Adoption of section 51.006 of the Property Code has given additional comfort to lenders because it allows the lender to void the deed in lieu of foreclosure and proceed with foreclosure if undisclosed liens and encumbrances are subsequently discovered. See Tex. Prop. Code § 51.006(b). The statute further provides that the priority of the lender’s deed of trust is not affected or impaired by the acceptance of the deed in lieu of foreclosure. Tex. Prop. Code § 51.006(d).
Disadvantages of Deed in Lieu: The deed in lieu of foreclosure is not free from problems. Unless voluntarily agreed to between the borrower and the lender, the transfer of the mortgaged property from the mortgagor to the lender, without a foreclosure sale, does not establish a value or determine the amount of the deficiency on the promissory note. Without an agreement about deficiency, the deed in lieu of foreclosure will probably be deemed an extinguishment of the debt. Before the revisions of the Uniform Commercial Code as adopted in the Texas Business and Commerce Code, Texas courts treated the retention by a secured party of personal property collateral without a foreclosure sale as an election to accept the collateral in full satisfaction of the debt. See Tanenbaum v. Economics Laboratory, 628 S.W.2d 769 (Tex. 1982). However, Texas Business and Commerce Code section 9.620 effectively supersedes the Tanenbaum decision. A secured party may accept the collateral in full or partial satisfaction only if the conditions of section 9.620(a) are met. See Tex. Bus. & Com. Code § 9.620(a). Likewise, a “purported or apparent acceptance of collateral” is ineffective unless the conditions of section 9.620(a) are met and the secured party consents to the acceptance in an authenticated record or sends the proposal to the debtor. Tex. Bus. & Com. Code § 9.620(b). Comment 5 to Texas Business and Commerce Code section 9.620 expressly provides that mere delay in collection or disposition of collateral does not constitute a “constructive” strict foreclosure. See Tex. Bus. & Com. Code § 9.620 cmt. 5. The State Bar committee comment to section 9.620 expressly states this “will change the result” in cases like Tanenbaum. See the State Bar committee comment to Texas Business and Commerce Code section 9.620.
In at least two cases, mortgagors have executed and recorded deeds without the consent of the lenders, apparently attempting to avoid foreclosures and deficiency judgments. The courts in both cases found the lenders’ lack of acceptance of the deeds prevented the conveyances from being effective and allowed deficiency judgments against the borrowers. See Martin v. Uvalde Savings & Loan Ass’n, 773 S.W.2d 808 (Tex. App.—San Antonio 1989, no writ); Hennessey v. Bell, 775 S.W.2d 650 (Tex. App.—Corpus Christi 1988, writ denied).
Problem of Junior Lienholders and Other Junior Encumbrances: A deed in lieu of foreclosure is basically a sales transaction as of the date of the deed. A junior lienholder’s right of redemption is not automatically extinguished as in the case of a foreclosure sale. See Whiteside v. Bell, 347 S.W.2d 568, 570 (Tex. 1961) (citing R.B. Spencer & Co. v. May, 78 S.W.2d 665 (Tex. Civ. App.—Waco 1935, writ ref’d)); see also Jones v. Ford, 583 S.W.2d 821, 823 (Tex. Civ. App.—El Paso 1979, writ ref’d n.r.e.) (citing North Texas Building & Loan Ass’n v. Overton, 86 S.W.2d 738, 741 (Tex. 1935)).
In Flag-Redfern Oil Co. v. Humble Exploration Co., 744 S.W.2d 6 (Tex. 1987), after the date of the deed of trust, the mortgagor conveyed an undivided one-half interest in the minerals to Flag-Redfern’s predecessor in title. After the mineral conveyance, the mortgagor conveyed the mortgaged property, including all the mineral estate, to the lender for the stated consideration of the satisfaction of the original debt. After Humble acquired the property from the successors in interest of the lender, Humble discovered the prior mineral conveyance and brought suit to determine ownership of the interest. The Texas Supreme Court held that the deed in lieu of foreclosure did not cut off the conveyance of the one-half interest in the mineral estate. Additionally, the court stated, “There is no such deed as a deed in lieu of foreclosure.” Flag-Redfern, 744 S.W.2d at 8.
The court noted that “it would be unfair to allow parties to make private conveyances, although judicially efficient, to the detriment of unknowing parties by foreclosing their right to bid at a trustee sale; to redeem their interests; to insist on the marshalling of assets.” The court also noted that notice is an integral part of judicial and nonjudicial foreclosure of a deed of trust. Flag-Redfern, 744 S.W.2d at 9.
The court further drew a distinction between cases involving a vendor’s lien and those involving solely a deed-of-trust lien. The court concluded that deed-in-lieu transactions involving a vendor’s lien include the right of rescission with the implied right to cut off the interests of intervening purchasers, whereas deed-of-trust transactions do not. Flag-Redfern, 744 S.W.2d at 9. (See also section 3.5:4 below, concerning vendor’s liens.)
The court noted that the cases cited by Humble (Jones, 583 S.W.2d 821; North Texas Building & Loan Ass’n, 86 S.W.2d 738; and Yett v. Houston Farms Development Co., 41 S.W.2d 305 (Tex. Civ. App.—Galveston 1931, writ ref’d)) would have supported a different result in Flag-Redfern had the “deed in lieu” been in satisfaction of a vendor’s lien mortgage. The court stated that in such cases—
[a] deed conveying land but coupled with a lien for the unpaid purchase money equates [to] an executory contract that will ripen into a title in the purchaser when the obligation to pay the purchase money is met. Whiteside v. Bell, 347 S.W.2d 568 (Tex. 1961). Default can lead to recission [sic] of the contract. This can be accomplished through foreclosure, or privately when the vendee executes a deed reconveying the property.
Flag-Redfern, 744 S.W.2d at 9.
But having accepted a deed in lieu of foreclosure, the lender/deed-in-lieu grantee in a deed-of-trust transaction may face an unpleasant choice, as it did in Flag-Redfern. Assuming the lender’s right to foreclose is still legally available (as the court noted was the case in Flag-Redfern), to cut off the intervening interests, the lender would have to foreclose its lien and subject the property to public bidding. If the debt is not significant compared with the then-current market value of the mortgaged property, the lender may not be the high bidder, and significant surplus sales proceeds may remain that would have to be distributed to all successors to the borrower (in Flag-Redfern, for example, to both Humble and Flag-Redfern).
Ratification of Intervening Encumbrances: In Kimsey v. Burgin, 806 S.W.2d 571 (Tex. App.—San Antonio 1991, writ denied), the court held that the interest of a purchaser under a contract for deed survived a deed in lieu of foreclosure by its seller back to the seller’s purchase-money lender. Even though Kimsey involved a vendor’s lien with rights of rescission, the court found that the original landowner that reacquired the land by deed in lieu of foreclosure had ratified the contract. Kimsey, 806 S.W.2d at 574–75. Under the later adopted Texas Property Code section 51.006, the lender could arguably overturn this result by reinstating its lien and conducting a nonjudicial foreclosure.
Loans Secured by Debtor’s Residence: It is unclear whether section 51.002 of the Texas Property Code requires that a certified mail notice of default be sent to the debtor on a loan secured by the debtor’s residence if a deed in lieu is being proposed. Section 51.002(d) provides for such notice “[n]otwithstanding any agreement to the contrary.” Tex. Prop. Code § 51.002(d).
Federal Tax Liens: A deed in lieu will be subject to any federal tax lien filed at least thirty days before the deed-in-lieu-of-foreclosure transaction. See 26 C.F.R. § 301.7425–2(a).
Tenants’ Security Deposits: A deed in lieu of foreclosure may make the lender accountable for tenants’ security deposits. Section 92.105(a) of the Texas Property Code provides that if there is a change in ownership, “the new owner is liable for the return of security deposits.” Tex. Prop. Code § 92.105(a). However, section 92.105(c) provides, “Subsection (a) does not apply to a real estate mortgage lienholder who acquires title by foreclosure.” Tex. Prop. Code § 92.105(c). Subsection (c) does not exempt deeds in lieu of foreclosure. See Tex. Prop. Code § 92.105(c). See section 4.15.
Other Problems: The lender accepting a deed in lieu of foreclosure may find itself subject to claims of fraud, duress, undue influence, misrepresentation, lack of consideration, preferential transfers by an insolvent debtor, and other attacks for which a nonjudicial foreclosure sale could also be set aside. See Ulmer v. Ulmer, 162 S.W.2d 944 (Tex. 1942).
Conducting Nonjudicial Foreclosure after Accepting Deed in Lieu of Foreclosure: Texas Property Code section 51.006 provides that the holder of a debt that accepts a deed in lieu of foreclosure in satisfaction of the debt may void the deed in lieu before the fourth anniversary of the date the deed in lieu is executed and foreclose under the original deed of trust if (1) the debtor failed to disclose to the holder a lien or other encumbrance on the property before executing the deed conveying the property to the holder of the debt in satisfaction of the debt and (2) the holder had no personal knowledge of the undisclosed lien or encumbrance. Tex. Prop. Code § 51.006(a), (b). Third parties may conclusively rely on an affidavit of the holder stating that the holder has voided the deed as provided under Property Code section 51.006. See Tex. Prop. Code § 51.006(c). If the holder voids the deed in lieu of foreclosure, the priority of the holder’s deed of trust is not affected or impaired by the execution of the deed in lieu of foreclosure. Tex. Prop. Code § 51.006(d). The holder may both accept a deed in lieu of foreclosure and proceed with foreclosure under its deed of trust without electing to void the deed. The priority of the deed of trust is not affected or impaired by the deed in lieu of foreclosure. Tex. Prop. Code § 51.006(e).
The issues of what constitutes “disclosure” and “personal knowledge” and the relative priority of a judgment lien over the lien of a mortgagee, the security interest of a collateral assignee of the mortgagee, and title acquired by deed in lieu by the mortgagee are the subjects of the court’s holding in two companion cases. Joiner v. Pactiv Corp., No. 13-04-580-CV, 2005 WL 1907780 (Tex. App.—Corpus Christi Aug. 11, 2005, pet. denied) (mem. op.) (Joiner, mortgagee of DRC Distributors, accepted deed in lieu of foreclosure under deed of trust recorded before recording of abstract of judgment by Pactiv and without actual knowledge of filing of abstract of judgment at time of acceptance of deed in lieu and filing of release of its mortgage lien); Cameron Life Insurance Co. v. Pactiv Corp., No. 13-05-760-CV, 2007 WL 2388906 (Tex. App.—Corpus Christi Aug. 23, 2007, pet. denied) (mem. op.) (Cameron Life, collateral assignee of Joiner, became subsequent mortgagee of Joiner after Joiner accepted deed in lieu from DRC). The court in these cases held that recording of the abstract of judgment imputed personal notice to the mortgagee.
Additionally, the mortgagee’s execution of its release of the mortgagee’s lien prevented it from establishing its lien as superior to the subsequently filed abstract of judgment.
Use of Undated Quitclaims and Deeds in Lieu of Deed of Trust: In the past, some Texas lenders have attempted to circumvent the time delays and procedures involved in foreclosing a deed of trust by requiring that at closing of the loan the borrower deliver a signed but undated quitclaim or deed conveying the mortgaged property to the lender. In the event of a subsequent default by the borrower, the lender would then date and file the instrument in the public records and thus acquire record title to the mortgaged property. The practitioner should review Texas Business and Commerce Code chapter 21, which regulates residential foreclosure consulting services, and chapter 21A, which regulates the execution of deeds in transactions involving residential real estate, such as expressly prohibiting a seller or lender in a residential real estate transaction from requiring that the purchaser or borrower execute a deed or quitclaim conveying the real estate back to the seller or lender as security. See Tex. Bus. & Com. Code § 21A.002(a), (c). Such instruments can be voided on an action brought within four years of the date the deed was recorded. See Tex. Bus. & Com. Code § 21A.002(c). The only statutory protections for third parties when such a deed is voided are for (1) successors in title to the purchaser who acquired the property without notice of the violation and (2) lenders who without notice of the violation extended credit based on a deed executed in violation of the statute. See Tex. Bus. & Com. Code § 21A.002(b). The statute also authorizes the attorney general to bring an action for civil penalties or injunctive relief against parties who procure such quitclaims and deeds. See Tex. Bus. & Com. Code § 21.003. Because of the four-year period in which to bring an action to void such instruments, if a deed or quitclaim to a lender is found in the chain of title to property, further investigation into the circumstances of that instrument is necessary to determine if the prior conveyance to the lender is subject to revocation.
Statute of Limitations: In the absence of acceleration of an installment note, a deed in lieu of foreclosure executed more than four years after the borrower stops installment payments is not barred under Tex. Civ. Prac. & Rem. Code § 16.035. McCright v. Rodriguez, No. 01-07-00480-CV, 2008 WL 2548814, at *2 (Tex. App.—Houston [1st Dist.] June 26, 2008, no pet.) (mem. op.).
§ 3.5Unilateral Acts by Creditor to Take Control of All or Part of Mortgaged Property
If the parties are unable to reach an agreement for resolution of default, or if the lender believes the particular facts of the situation require immediate action, there are several unilateral actions the lender can take to seek either physical control or ownership of the mortgaged property.
§ 3.5:1Enforcement of Assignment of Rents
The right to collect the rents and profits derived from the mortgaged property is potentially a very valuable right, and lenders routinely required that the rents and profits be pledged to the lender as collateral securing the loan. See chapter 9 in this manual for a discussion of the recent significant changes to Texas law concerning assignments of rent and the enforcement of such assignments.
§ 3.5:2Mortgagee in Possession
A lender may take peaceable possession of mortgaged property before foreclosure only pursuant to an agreement with the mortgagor to such effect. Wilhite v. Yount-Lee Oil Co., 140 S.W.2d 293, 296 (Tex. Civ. App.—Texarkana 1940, writ ref’d). In order for a lender’s possession to be lawful, it must be peaceably and legally acquired; taken in good faith; free from deceit, fraud, or wrong; and without violation of any contract with the vendee. Robinson v. Smith, 128 S.W.2d 27, 30–31 (Tex. 1939).
The agreement to allow peaceable possession of the mortgaged property by the lender and the conditions for exercise of the right are typically set out in the deed of trust, but the agreement can be pursuant to a subsequent agreement with the mortgagor. Pioneer Building & Loan Ass’n v. Cowan, 123 S.W.2d 726, 730 (Tex. Civ. App.—Waco 1938, writ dism’d judgm’t cor.); see also Diversified, Inc. v. Walker, 702 S.W.2d 717, 720 (Tex. App.—Houston [1st Dist.] 1985, writ ref’d n.r.e.); Wilhite, 140 S.W.2d at 296. In the absence of an agreement with the mortgagor, a mortgagee has no right to possession. See Robinson, 128 S.W.2d at 33.
§ 3.5:3Nonjudicial Foreclosure
This entire manual is, of course, primarily concerned with nonjudicial foreclosure, which is the most common form of unilateral action by a lender to collect payment on a delinquent debt. The powers granted in a deed of trust to seek judicial or nonjudicial foreclosure in an event of default, and the right to commence with one remedy and before completion change to the other remedy, are extraordinarily valuable contract rights, and Texas courts do not readily let the borrower or mortgagor interfere with such rights. See for example, Kasper v. Keller, 466 S.W.2d 326 (Tex. Civ. App.—Waco 1971, writ ref’d n.r.e.), where the court stated:
[T]he mortgagor should not be permitted to destroy or impair the mortgagee’s contractual right to foreclosure under the power of sale by the simple expedient of instituting a suit, whether groundless or meritorious, thereby compelling the mortgagee to abandon the extra-judicial foreclosure which he had a right to elect, nullifying his election, and permitting the mortgagor to control the option as to remedies.
Kasper, 466 S.W.2d at 329. See also Stille v. Colborn, 740 S.W.2d 42, 44 (Tex. App.—San Antonio 1987, writ denied), where the court held that the lender’s failure to file a counterclaim seeking foreclosure of the deed of trust securing the note in a prior suit by the borrower/mortgagor did not preclude the lender from later seeking collection of the note and foreclosure of the liens securing the note.
§ 3.5:4Rescission of Vendor’s Lien
When an express vendor’s lien is retained to secure unpaid purchase money, the vendor holds superior title and lien against the property conveyed and the vendee has a mere equitable right to acquire title by carrying out the agreement. State v. Forest Lawn Lot Owners Ass’n, 254 S.W.2d 87, 91 (Tex. 1953); Lusk v. Mintz, 625 S.W.2d 774, 776 (Tex. App.—Houston [14th Dist.] 1981, no writ). As a purchase money lien, under Texas law the vendor’s lien has a priority position over and against any encumbrances created by or through the grantee under the deed. A vendor’s lien retained in a deed is even superior to a previously recorded judgment lien against the purchaser. Donie State Bank v. Parker, 554 S.W.2d 858 (Tex. Civ. App.—Waco 1977, writ ref’d n.r.e.).
On default by the vendee, the vendor has a choice of remedies: the vendor may sue for payment of the purchase price, rescind the contract and take possession, or sue to recover title and possession. Whiteside v. Bell, 347 S.W.2d 568, 570 (Tex. 1961); Lusk, 625 S.W.2d at 775–76. The remedy of rescission of the vendor’s lien is separate and distinct from and wholly independent of the other remedies available to the lender to enforce payment. Lusk, 625 S.W.2d at 776; Bunn v. City of Laredo, 245 S.W. 426, 429 (Tex. Comm’n App. 1922, judgm’t adopted). Rescission can be a valuable alternative to a creditor administration if a loan enters into default. Even if there is a fatal defect with the deed of trust, the lender may still use the vendor’s lien to take title to that portion of the property conveyed in the deed where the vendor’s lien was retained (which may or may not be the same as the mortgaged property pledged under the deed of trust). In practice, most purchase money lenders require that they be assigned the vendor’s lien at closing, to have a “fail-safe” remedy in the event that the deed of trust proves unenforceable for any reason.
A mortgagee in lawful possession can assert title to the mortgaged property against the vendee even though the vendor’s lien is barred by limitations. See, e.g., Murphy v. Sills, 268 S.W.2d 296, 311 (Tex. Civ. App.—Beaumont 1953, writ dism’d); Myricks v. Heilbron, 170 S.W.2d 827, 829 (Tex. Civ. App.—Texarkana 1943, no writ). However, see Dominey v. Unknown Heirs & Legal Representatives of Lokomski, 172 S.W.3d 67, 74 (Tex. App.—Fort Worth 2005, no pet.), where the court held that the holder of the vendor’s lien was barred by the statute of limitations from seeking rescission as the statute had not been tolled because the assignee of the vendor was not a lawful mortgagee in possession.
The process for an involuntary bankruptcy, whereby creditors force an eligible debtor into bankruptcy proceedings, is set out at section 303 of the Bankruptcy Code and is commenced by the filing of a petition under chapter 7 or 11. See 11 U.S.C. § 303. (Note, however, that involuntary petitions are not allowed against farmers, banks, nonprofit groups, insurance companies, credit unions, and savings and loans; railroads are not subject to an involuntary chapter 7 filing; and stock and commodity brokers are not subject to chapter 11 filings.) If the debtor has twelve or more creditors, an involuntary petition requires the joinder of any three or more creditors whose claims (1) are not contingent as to liability or bona fide dispute as to either liability or amount and (2) total at least $15,325 if unsecured or $15,325 more than the value of any liens securing the claims if any of the claims are secured. See 11 U.S.C. § 303(b)(1). (Note that this dollar amount is subject to periodic adjustment.) If the debtor has fewer than twelve creditors, any one qualifying creditor can file the petition. See 11 U.S.C. § 303(b)(2). To support the petition, the creditors must also show that the debtor is generally not paying its debts. See 11 U.S.C. § 303(h)(1). Creditors can also file if a custodian or receiver took possession of the debtor’s business within 120 days of the filing date. See 11 U.S.C. § 303(h)(2).
Unlike in a voluntary bankruptcy, the debtor is not immediately placed into bankruptcy and may continue to operate and use, acquire, or dispose of its property until the court rules on the merit of the petition filed by the creditors. See 11 U.S.C. § 303(f). The debtor will have twenty days to respond to the filing. See Fed. R. Bankr. P. 1011. If the petition is not timely controverted, the court will enter an order of relief, officially placing the debtor in bankruptcy. See 11 U.S.C. § 303(h). Once filed, an involuntary petition cannot be dismissed without notice and opportunity for hearing, even if the creditors and the debtor agree to dismissal. See 11 U.S.C. § 303(j). There are, of course, serious ramifications to the petitioning creditors if the involuntary bankruptcy filing fails—the creditors can be liable for the debtor’s costs and attorney’s fees and the bankruptcy court may award both actual and punitive damages if it finds the petition was filed in bad faith. See 11 U.S.C. § 303(i). Because of the complexity of the bankruptcy process and the possible penalties, it is strongly recommended that the attorney consult with a bankruptcy specialist before initiating an involuntary bankruptcy petition on behalf of a lender client.
§ 3.5:6Receivership Proceedings
Receivership is a process by which the control of property is taken from its owner and such property is placed under the control and supervision of a court. Typically, receivership is used for the purpose of installing a neutral third party to operate a business or supervise an asset while the parties in dispute litigate ownership or control of the property subject to the receivership. Texas recognizes both equitable receiverships under the common law (where receivership is normally an ancillary proceeding to a lawsuit) and statutory receiverships under both chapter 11 of the Texas Business Organizations Code and chapter 64 of the Texas Civil Practice and Remedies Code. Texas courts have traditionally disfavored receiverships (even statutory receiverships), as taking away a person’s control of his property before the outcome of a dispute involving the property is seen as one of the most radical remedies available through the judicial process. Because of the complexity of the receivership process and the possible penalties for losing such an action, it is strongly recommended that the attorney consult with a specialist in the field before initiating receivership proceedings on behalf of a lender client. See sections 3.4:2 above and 6.7:10 in this manual for additional discussion.
§ 3.6Judicial Action by Lender
Most deeds of trust are written to provide the lender with maximum flexibility in deciding whether to pursue collection of a debt through nonjudicial foreclosure, judicial foreclosure, or a combination of the two. See, for example, the current version of the Texas Real Estate Forms Manual’s form for deed of trust, which provides:
Proceeding under this deed of trust, filing suit for foreclosure, or pursuing any other remedy will not constitute an election of remedies.
2 State Bar of Tex., Texas Real Estate Forms Manual ch. 8, form 8-1 (3d ed. 2017).
A prior version of the Texas Real Estate Forms Manual’s form for deed of trust provided:
It is agreed that in the event a foreclosure hereunder should be commenced by the Trustee, or his substitute or successor, Beneficiary may at any time before the sale of said property direct the said Trustee to abandon the sale, and may then institute suit for the collection of said note, and for the foreclosure of this Deed of Trust lien; it is further agreed that if Beneficiary should institute a suit for the collection thereof, and for a foreclosure of this Deed of Trust lien, that he may at any time before the entry of a final judgment in said suit dismiss the same, and require the Trustee, his substitute or successor to sell the property in accordance with the provisions of this Deed of Trust.
State Bar of Tex., Legal Form Manual for Real Estate Transactions form 7C (1973, rev. 1982).
§ 3.6:1Election of Remedies Doctrine
Notwithstanding the flexible language of most deeds of trust, the attorney and lender must be careful not to run afoul of the “election of remedies” doctrine under Texas law. Filing suit to collect the debt coupled with a request for foreclosure constitutes an election by the mortgagee to foreclose on the mortgaged property by legal process and constitutes an abandonment of nonjudicial foreclosure of the real property. Coffman v. Brannen, 50 S.W.2d 913, 914–15 (Tex. Civ. App.—Amarillo 1932, no writ). A trustee’s sale conducted pending a judicial foreclosure suit is void. Jackson v. The Praetorians, 83 S.W.2d 740, 741 (Tex. Civ. App.—Dallas 1935, no writ); City National Bank v. Morgan, 29 S.W.2d 923, 927 (Tex. Civ. App.—San Antonio 1929, writ dism’d w.o.j.). A lender is, however, entitled to conduct a nonjudicial foreclosure sale while concurrently prosecuting a suit merely to collect the debt. See French v. May, 484 S.W.2d 420, 428 (Tex. Civ. App.—Corpus Christi 1972, writ ref’d n.r.e.); see also Tex. Bus. & Com. Code § 9.601. Also, as discussed below in section 3.6:4, the lender may also first obtain judgment on the debt and then commence nonjudicial foreclosure of the collateral.
Suit on the debt does not require a concurrent request for judicial foreclosure of the mortgaged property or collateral. There is no legal requirement that all collateral be liquidated before entry of judgment on the debt. Garza v. Allied Finance Co., 566 S.W.2d 57, 62 (Tex. Civ. App.—Corpus Christi 1978, no writ); Melcer v. Warren, 550 S.W.2d 760, 763 (Tex. Civ. App.—Austin 1977, writ ref’d n.r.e.). If a portion of the collateral is liquidated during the pendency of the suit on the debt, the liquidation proceeds are credited to the debt to reduce the amount of the final judgment.
A lender may decide to file suit on the promissory note and not seek foreclosure of the mortgaged property for a number of reasons. For example, the mortgaged property may have casualty damage or suffer from Americans With Disabilities Act deficiencies or environmental pollution problems with remediation and cleanup costs greater than the value of the property after restoration. In such a case, the creditor may decide to seek to reduce the indebtedness to judgment and abstract it as soon as possible in order to attach its lien to other unencumbered assets of the borrower.
Suits on the debt may lead to surprising results. In Keenan v. Gibraltar Savings Ass’n, 754 S.W.2d 392, 395 (Tex. App.—Houston [14th Dist.] 1988, no writ), the court was called on to construe a guaranty that provided the guarantor’s guaranty would cease when the principal of the note was reduced to $1,648,750. The note had an original principal balance of $2,148,750 and a principal balance of $1,680,807 at the time of suit. The court held the guaranty was unambiguous and the guarantor was liable for the full principal balance plus accrued interest and attorney’s fees. Keenan, 754 S.W.2d at 395; see also Western Bank—Downtown v. Carline, 757 S.W.2d 111, 113 (Tex. App.—Houston [1st Dist.] 1988, writ denied) (holding that limited guarantors not liable to lender for postpetition interest and attorney’s fees).
§ 3.6:3Judicial Foreclosure of Deed of Trust
Judicial foreclosure of deed-of-trust liens are quite rare in Texas because the nonjudicial foreclosure procedure is generally much quicker and less expensive than a court proceeding. However, judicial foreclosure is an available remedy to the lender in situations where there are defects or other uncertainties concerning the power of nonjudicial sale in the lender’s deed of trust. See chapter 20 in this manual for a general discussion of judicial foreclosure.
Even though the lender may have initially filed suit on the note with a request for judicial foreclosure of the mortgaged property, the lender is permitted to terminate the judicial foreclosure in favor of commencing a nonjudicial foreclosure sale as long as no judgment has been taken for judicial foreclosure. An order of dismissal may be required, since commencing a private sale alone is not deemed tantamount to abandonment of the judicial action. See Patterson v. Shell Petroleum Corp., 143 S.W.2d 208, 213–14 (Tex. Civ. App.—Amarillo 1940, writ dism’d judgm’t cor.); Gandy v. Cameron State Bank, 2 S.W.2d 971, 973 (Tex. Civ. App.—Austin 1927, writ ref’d). One advantage of judicial foreclosure is that section 51.003 of the Texas Property Code applies only to deficiency actions after nonjudicial foreclosure sales under section 51.002, and not to judicial foreclosures. See Tex. Prop. Code § 51.003.
§ 3.6:4Pursuing Judgment on Debt with Subsequent Nonjudicial Foreclosure
Neither the doctrine of election of remedies nor Texas Property Code section 51.003 preclude the lender from first obtaining judgment on the note and subsequently seeking judicial or nonjudicial foreclosure of the deed-of-trust lien. The proceeds of a subsequent nonjudicial foreclosure sale are credited to the judgment in the same manner as any other payment on the judgment. Carter v. Gray, 81 S.W.2d 647, 648 (Tex. 1935); Kempner v. Comer, 11 S.W. 194, 196 (Tex. 1889); Stephens v. LPP Mortgage, Ltd., 316 S.W.3d 742, 746 (Tex. App.—Austin 2010, pet. denied); Lodal & Bain Engineers, Inc. v. Bayfield Public Utility District, 583 S.W.2d 653, 654–55 (Tex. Civ. App.—Houston [1st Dist.] 1979, rev’d on other grounds, 602 S.W.2d 262 (Tex. 1980)); see Tex. Prop. Code § 51.003; see also Tex. Prop. Code § 52.005. The court of appeals in Stephens rejected the mortgagor’s argument that res judicata precluded the lender from bringing an action to foreclose on the deed-of-trust lien after first securing a judgment on the note in a separate, previously filed suit. Stephens, 316 S.W.3d at 747. The court held that the claims in the two suits were different, the remedies sought were different, and the parties were different. Stephens, 316 S.W.3d at 747. The court further held that until the debt is actually satisfied, the recovery of a judgment on the note secured by the deed-of-trust lien, when foreclosure has not been sought in that suit, does not merge the deed of trust in the judgment and does not preclude foreclosure on the lien in a subsequent suit instituted for the purpose. Stephens, 316 S.W.3d at 748.
If the borrower has other unencumbered assets or under-encumbered assets, the lender may wish to proceed to seek a judgment on the note as quickly as possible so that the mortgagee can abstract its judgment to create a general lien on real property and to levy as to personal property.
§ 3.6:5Suit for Judicial Sequestration of Collateral
A writ of sequestration is a judicial remedy in which the court takes control of real or personal property pending the outcome of the suit on the note. Tex. Civ. Prac. & Rem. Code §§ 62.001–.063. A writ of sequestration can be issued in a suit for judicial foreclosure of the deed of trust or security agreement if there is immediate danger that the defendant or party in possession will conceal, dispose of, ill-treat, waste, or destroy the property or remove the property from the county during pendency of the suit. The lender will, however, be liable for a wrongful sequestration. Dismissal of suit after service of a writ of sequestration may render the plaintiff liable for wrongful sequestration. See Burnett Trailers, Inc. v. Polson, 387 S.W.2d 692, 694–95 (Tex. Civ. App.—San Antonio 1965, writ ref’d n.r.e.).
Even though the secured creditor may have obtained a writ of sequestration in connection with a suit on the note and request for judicial foreclosure of its security interest, the secured creditor may subsequently abandon seeking a judicial foreclosure and conduct a nonjudicial foreclosure sale of the collateral. Unicut, Inc. v. Texas Commerce Bank—Chemical, 704 S.W.2d 442, 445 (Tex. App.—Houston [14th Dist.] 1986, writ ref’d n.r.e.). But see American Lease Plan v. Ben-Kro Corp., 508 S.W.2d 937, 943–44 (Tex. Civ. App.—Houston [1st Dist.] 1974, writ ref’d n.r.e.); Moszkowicz v. A.B. Lewis Co., 268 S.W.2d 548, 551 (Tex. Civ. App.—Waco 1954, writ ref’d n.r.e.).
Baucum, Michael. “Alternatives to Foreclosure—Ideas and Forms.” In Advanced Real Estate Drafting Course, 2015. Austin: State Bar of Texas, 2015.
Bernstein, Mike. “Nuts and Bolts of Turnover Receiverships.” In Collections & Creditors’ Rights Course, 2019. Austin: State Bar of Texas, 2019.
Brown, Donna. “Post Judgment Remedies: Judgment Liens, Garnishment, Execution, Turnover Proceedings, Receiverships under the DTPA, Charging Orders, and ‘Other Stuff.’” In Collections & Creditors’ Rights Course, 2019. Austin: State Bar of Texas, 2019.
Cassella, Stefan D. Asset Forfeiture Law in the United States, 2nd ed. New York: JURIS Publishing, 2013, Supplement 2016.