Does A Deed-In-Lieu Of Foreclosure Automatically Release A Borrower From Personal Liability?
June 19, 2013
A deed-in-lieu of foreclosure (DIL) is one of many alternatives to foreclosure. For background, review my post Deeds In Lieu Of Foreclosure: Who, What, When, Where, Why And How. Today I discuss the Indiana Court of Appeals’ opinion in GMAC Mortgage v. Dyer, 965 N.E.2d 762 (Ind. Ct. App. 2012), which explored whether a DIL in a residential mortgage foreclosure case released the defendant borrower from personal liability.
Deficiency. In GMAC Mortgage, the borrower sought to be released from any deficiency. The term “deficiency” typically refers to the difference between the fair market value of the mortgaged real estate and the debt, assuming a negative equity situation. Exposure to personal liability arises out of the potential for a “deficiency judgment,” which refers to the money still owed by the borrower following a sheriff’s sale. The amount is the result of subtracting the price paid at the sheriff’s sale from the judgment amount. (For more on this topic, please review my August 1, 2008, June 29, 2009 and March 9, 2012 posts.)
DIL, explained. GMAC Mortgage includes really good background information on the nature of a DIL, particularly in the context of residential/consumer mortgages. According to the U.S. Department of Housing and Urban Development (HUD), a DIL “allows a mortgagor in default, who does not qualify for any other HUD Loss Mitigation option, to sign the house back over to the mortgage company.” A letter issued by HUD in 2000 further provides:
[d]eed-in-lieu of foreclosure (DIL) is a disposition option in which a borrower voluntarily deeds collateral property to HUD in exchange for a release from all obligations under the mortgage. Though this option results in the borrower losing the property, it is usually preferable to foreclosure because the borrower mitigates the cost and emotional trauma of foreclosure . . .. Also, a DIL is generally less damaging than foreclosure to a borrower’s ability to obtain credit in the future. DIL is preferred by HUD because it avoids the time and expense of a legal foreclosure action, and due to the cooperative nature of the transaction, the property is generally in better physical condition at acquisition.
Release of liability in FHA/HUD residential cases. The borrower in GMAC Mortgage had defaulted on an FHA-insured loan. The parties tentatively settled the case and entered into a DIL agreement providing language required by HUD that neither the lender nor HUD would pursue a deficiency judgment. The borrower wanted a stronger resolution stating that he was released from all personal liability. The issue in GMAC Mortgage was whether the executed DIL agreement precluded personal liability of the borrower under federal law and HUD regulations. The Court discussed various federal protections afforded to defaulting borrowers with FHA-insured loans, including DILs. In the final analysis, the Court held that HUD’s regulations are clear: “A [DIL] releases the borrower from all obligations under the mortgage, and the [DIL agreement] must contain an acknowledgement that the borrower shall not be pursued for deficiency judgments.” In short, the Court concluded that a DIL releases a borrower from personal liability as a matter of law.
Commercial cases. In commercial mortgage foreclosure cases, however, a lender/mortgagee may preserve the right to pursue a deficiency, because the federal rules and regulations outlined in GMAC Mortgage do not apply to business loans or commercial property. The parties to the DIL agreement can agree to virtually any terms, including whether, or to what extent, personal liability for any deficiency is being released. The point is that the issue of a full release (versus the right to pursue a deficiency) should be negotiated in advance and then clearly articulated in any settlement documents. A release is not automatic.
GMAC Mortgage is a residential, not a commercial, case. The opinion does not provide that all DILs release a borrower from personal liability, and the precedent does not directly apply to an Indiana commercial mortgage foreclosure case.