A Lender s Guide to Massachusetts Foreclosures By Francesco A. De Vito and Jonathan C. Hayden
Table of Contents Introduction 3 What to Do After Default 4 Foreclosing on Residential Property 6 Prior to the Foreclosure Auction 8 The Foreclosure Auction 10 After the Foreclosure Auction 13 2
Introduction The purpose of this guide is to provide lenders with a roadmap to understanding how foreclosures work in Massachusetts. In our experience representing lenders confronting a troubled loan, we have found that our clients make the best decisions if they have a thorough understanding of the foreclosure process. In Massachusetts, foreclosures are usually conducted by sale pursuant to the power of sale in a mortgage. The sale is a public auction without court supervision. Foreclosure procedure in Massachusetts is governed by statute and requires lenders to strictly comply with notice requirements and conduct the foreclosure in good faith and with reasonable diligence. If there are no challenges or delays, a commercial foreclosure could be completed in a matter of weeks, while a residential foreclosure would likely take many months. 3
What to Do After Default The promissory note and related loan documents describe the defaults that entitle the lender to exercise remedies and foreclose, and the lender s obligations to notify the borrower of a default. Lenders should pay careful attention to all notice requirements because a failure to provide proper notice may invalidate a foreclosure and require a lender to restart the entire process. The notice of default should cite specific clauses from the loan documents and describe the circumstances of the default. When drafting the notice, lenders should consider whether it will implicate the Fair Debt Collection Practices Act and, if necessary, ensure compliance. After the lender sends a notice of default and the expiration of any applicable cure period under the loan documents, then a lender can accelerate the loan and declare the outstanding amount of the loan due (subject to compliance with any other statutory cure periods). 4
What to Do After Default (continued) It is an important consideration for the foreclosing lender to understand that, under Massachusetts law, the lender must be the record holder of the mortgage and the underlying promissory note. If the lender has continuously held the mortgage and note since making the loan, this requirement is easily satisfied. However, if the loan has been sold, the foreclosing lender must confirm that the note and the mortgage have been properly assigned, and that all required assignment documents have been recorded with the applicable Registry of Deeds. Some Massachusetts municipalities have adopted ordinances requiring foreclosing lenders to notify the municipality of pending foreclosures and inspect and maintain the property during the foreclosure process. Determining early in the foreclosure process whether such ordinances exist avoids compliance problems later. 5
Foreclosing on Residential Property Everything necessary to foreclose on a commercial property must also be performed to foreclose on a residential property. However, Massachusetts law imposes additional requirements prior to commencing any foreclosure of a one- to four-family residence occupied at least partially by the borrower as its principal residence. 1) Notice of 90 Day Right to Cure For most residential loans, the lender must give the borrower 90 days to cure any default and may not accelerate the debt or require the borrower to pay any charge or penalty during that time. 2) Notice of Right to Mortgage Modification For some residential loans, such as those that start with a low introductory rate or an interest only period, or those that have an excessive debt to value ratio, the lender must notify the borrower of its statutory right to request a mortgage modification. The notice of right to a mortgage modification informs the borrower that he or she has 30 days to provide the lender with the borrower s financial information and request that the lender modify the mortgage by reducing the borrower s monthly payments, reducing the principal of the loan, lowering the interest 6
Foreclosing on Residential Property (continued) rate, or increasing the amortization period. Upon the lender s receipt of the borrower s financial information and request for a modified mortgage loan, the lender calculates a suitable monthly payment for the borrower and determines whether it would receive a better return from that newly-calculated affordable monthly payment or by foreclosing on the property. The borrower and lender can negotiate a mortgage modification for as long as both parties desire. The notice of right to a mortgage modification is sent separately from, but simultaneously with, the notice of 90 day right to cure. The lender must notify the borrower of these rights with letters that should be identical to the forms provided by the Massachusetts Division of Banks. The lender also must provide evidence of its compliance with the notice requirements to the Massachusetts Attorney General and the Massachusetts Division of Banks. After the 90-day cure period has passed and the parties complete any applicable mortgage modification negotiation without a modified mortgage, then the lender can proceed with accelerating the debt and foreclosing on the property. 7
Prior to the Foreclosure Auction The remaining steps leading to a foreclosure auction are dictated principally by statute, and are typically coordinated by lender s counsel. They can be completed in as little as five to six weeks, unless an action to determine military status is required. The federal Servicemembers Civil Relief Act prohibits a foreclosure against a service member during his or her active military service. The lender should obtain a court judgment stating that the borrower is not entitled to the protections of the Act. The judgment is needed to prevent the borrower from attempting to invalidate the foreclosure based on the Act s protections, and to avoid a cloud on the title. Obtaining the judgment is routine, but time consuming. As of the date of this writing, the process takes approximately eight months because of the court s backlog. Fortunately for many foreclosures, particularly foreclosures of commercial properties, this procedure is not required. The Act does not apply if the property is owned by a corporation, limited partnership, limited liability company, limited liability partnership, business trust with transferable shares, or a general partnership whose members are those types of entities. 8
Prior to the Foreclosure Auction (continued) After the lender obtains a judgment on the complaint to determine military status, the remaining steps to prepare for the foreclosure auction consist of: updating title; sending certain required notices to the borrower, guarantors and junior lienholders; publishing notices of the foreclosure in the local newspaper and, in some cases, advertisements with other media outlets; engaging an experienced auctioneer; and scheduling the auction. 9
The Foreclosure Auction The auction is held at or near the property. The auctioneer will register bidders and conduct the auction. Bidders must qualify by showing they have the required deposit in acceptable form, which is described in the notice of sale. The amount of the required deposit varies depending on the type and value of the property. Before the auction, the lender should decide on its bidding strategy. While there typically is no reserve price (i.e., required minimum bid), the lender can effectively create a reserve price by bidding up to a certain amount. However, if the lender bids in this manner, the lender must be prepared to win the auction and take title to the property. If the lender takes title, it can always sell the property to a third party later, but it will have to hold the property until then. The lender should consider two important factors when calculating its bid. First, if a lender wins an uncontested auction with a low bid, and the borrower claims the foreclosure was done improperly, then a court could determine that the auction was not conducted fairly and invalidate the sale. Second, if the winning bid is higher than the sum of the lender s costs and the borrower s outstanding debt, then the junior lienholders and the borrower are entitled to receive the excess. Therefore, the lender will need to know its maximum bid. 10
The Foreclosure Auction (continued) If only one or two bidders attend the auction and the lender does not intend to bid, the lender should be prepared to delay the auction and attempt to generate additional interest. At the auction, the lender will also conduct a foreclosure by entry. This is an alternative means of foreclosure where the foreclosing lender simply walks onto the property and later records a document attesting to the entry with the Registry of Deeds. Three years later, the foreclosure is complete, and the lender takes title to the property. Since few lenders would be content to wait three years to complete a foreclosure, this procedure is rarely used as the chief means to foreclose. However, foreclosure by entry remains useful to buttress a foreclosure by sale if there were any defects with respect to the foreclosure sale. 11
The Foreclosure Auction (continued) Immediately at the conclusion of the auction, the winning bidder and the lender will execute a memorandum of sale, which is the contract detailing the terms of the closing under the foreclosure sale. The timing of the execution of the memorandum of sale is critical because once the parties sign it, the borrower s right to redeem the property by paying off the debt is terminated and the borrower is no longer able to delay or prevent the foreclosure by filing for bankruptcy. Any bankruptcy filing prior to executing the memorandum of sale will result in an automatic stay of the foreclosure unless and until the lender obtains relief from the stay from the bankruptcy court. 12
After the Foreclosure Auction Under the standard terms of a Memorandum of Sale, the winning bidder has 30 days to complete the transaction and close on the sale. When the winning bidder pays the balance of the winning bid, the lender will deliver the foreclosure deed and other necessary documents to the winning bidder, who will record those documents as appropriate. The winning bidder is typically responsible for paying the applicable recording fees and deed stamps. The lender is responsible for notifying the municipality s tax assessor of the foreclosure, and the municipal entity providing water and sewer services. Additionally, if there are tenants at the property, the lender must notify the tenants of the sale within 30 days of the auction. The status of a commercial lease after the foreclosure will vary depending on the date of the lease and the subordination language of the lease or the provisions of any applicable subordination, nondisturbance, and attornment agreements. Any residential leases remain effective pursuant to Massachusetts law. 13
After the Foreclosure Auction (continued) Finally, within 60 days of lender s receipt of the sale proceeds, the lender must provide the borrower with an itemized accounting of the proceeds from the foreclosure. The accounting must show how the proceeds were used to pay legal fees, auctioneer fees, publication and advertising costs, other costs of the foreclosure, the borrower s outstanding debt, and any junior liens on the property. If sale proceeds remain after paying in full all expenses, the mortgage loan and any junior liens, then the borrower is entitled to the remaining funds. If the borrower or other property owner at the time of foreclosure refuses to vacate the property after the foreclosure, then the winning bidder must file an eviction action in the appropriate court to evict the holdover owner. In the eviction action, the court will determine whether the lender properly foreclosed on the property. If the foreclosure was done properly, then the winning bidder will have superior title to the property and can evict the holdover owner. If the foreclosure was not done properly, then the holdover owner will retain title and the foreclosure will be void. With this kind of risk, it is important for foreclosing lenders to engage knowledgeable counsel to conduct the foreclosure to ensure the eviction action affirms the winning bidder s superior title. 14
About the Authors Frank De Vito is an experienced real estate and finance attorney, serving as counsel to lenders, borrowers, developers, landlords and tenants in a broad range of commercial transactions. He chairs the firm s Finance and Workout Group and is a member of the firm s Executive Committee. fdevito@rackemann.com 617.951.1112 Jon Hayden concentrates his practice in the area of real estate law representing commercial mortgage lenders in connection with loans for properties located throughout the United States. He is an associate in the firm s Real Estate Department and Finance and Workout Group. jhayden@rackemann.com 617.951.1104 This publication is for informational purposes only and does not constitute legal advice. The reader should consult with knowledgeable legal counsel regarding any specific facts and legal questions. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. 15