Deeds in lieu of foreclosure are often heavily negotiated. However, in many instances the lender is actually doing the borrower a favor by agreeing to accept a deed-in-lieu. The lender rarely is actively seeking to acquire a property with a value less than the outstanding debt, which may require major repairs, renovation and rehabilitation. Lenders may even refuse to accept a deed-in-lieu, for reasons including environmental contamination, the belief that there is equity in the property, and the existence of excessive or monetarily significant subordinate liens.
On the other hand, the lender may agree to accommodate a cooperative borrower by delaying the timing of delivery of the conveyance to postpone the tax consequences to the borrower. There is certainly a benefit to taking title immediately and avoiding the foreclosure process, but it also may be costly to structure a deed-in-lieu transaction, as the lender customarily will bear most or all of the transactional expenses, including title and recording costs, and environmental inspections. Case law generally supports the ability of a mortgagee to foreclose its mortgage after acceptance of a deed in lieu of foreclosure, at least where the deed contains an anti-merger provision.In any event, a deed in lieu of foreclosure does not eliminate any subordinate liens, and the grantee-mortgagee takes subject to all existing liens, whether known or unknown. To eliminate these liens, the lender still must still foreclose the mortgage or otherwise deal with each of the existing liens and encumbrances. The lender actually may have an incentive to pay certain minor lien claims to avoid a contested foreclosure proceeding; after all, the primary purpose of a deed-in-lieu transaction usually is to avoid foreclosure and the time and costs involved.
The section of the Illinois mortgage foreclosure statute that deals specifically with deeds in lieu of foreclosure, 735 ILCS 5/15-1401, states (with respect to the issue of merger) that:
A deed in lieu of foreclosure, whether to the mortgagee or mortgagee’s nominee, shall not effect a merger of the mortgagee’s interest as mortgagee and the mortgagee’s interest derived from the deed in lieu of foreclosure.
Most other states rely (at least in part) on the intention of the parties, either express or implied, to determine whether a merger occurred as the result of a deed-in-lieu transaction. For example, in Tidwell v. Dasher, 152 Mich. App. 379, 393 N.W.2d 644 (1986), the court dealt with the issue of whether a deed in lieu of foreclosure created a merger that would affect the priority of an intervening lien. The court stated that “[t]he question of intention of a mortgagee or vendor is a question of fact which must be developed from evidence produced to show what the intention was at the time the acts were done.” Id. at 647. In Weitzki v. Weitzki, 437 N.W.2d 449 (Neb. 1989), the court noted that the intention of the mortgagee is controlling as to whether the mortgage is kept alive. The court held that when the mortgagee becomes the owner of the fee, and there is no expression of intention as to whether the mortgagee wished to keep the mortgage alive, it will be presumed that the mortgagee intended to do what would prove most advantageous to himself in the absence of circumstances indicating a contrary purpose. The court then found that in this case no merger of title and lien occurred in light of the mortgagee’s intention to retain the priority of his lien against the subordinate lien.
The validity of an attempted preservation of the mortgage lien may depend on whether other creditors would be prohibited from having available to them the normal methods of collection that they would have if the lien were extinguished. Courts generally will not enforce a non-merger provision in a deed in lieu of foreclosure where the rights of innocent third parties may be affected – or even lost – because of fraud or inequitable conduct by the parties to the deed. For example, in United States Leather, Inc. v. Mitchell Mfg. Group, Inc., 276 F.3d 782 (6th Cir. 2002), the Sixth Circuit held that under the facts of the case, allowing an exception to the merger rule (based on the intention of the parties stated in the quitclaim deed in lieu of foreclosure that no merger of the mortgage and fee would occur) would not be enforced because it would inequitably permit the mortgagor to void its obligations to an intervening judgment creditor to the sole advantage of the mortgagor’s corporate parent. The court found that this case was distinguishable from other Michigan cases where non-merger language contained in a deed in lieu of foreclosure had been enforced, as this was not a situation where the mortgagee was trying to protect itself from the claims of junior lienholders of the mortgagor.
The author has been informed that in New York a title insurer may not issue a non-merger endorsement. The author also has been informed that the (unwritten) position of the New York State Tax Commission is that the mortgage can be foreclosed (if there is non-merger language in the deed from the mortgagor to the mortgagee-grantee), but it cannot thereafter be kept alive for the purpose of a future transaction; e.g., the mortgagee-grantee cannot re-sell the property and modify the mortgage with its purchaser and retain a valid mortgage lien.
In Texas, tex. prop. code § 51.006 permits the mortgagee to void a previously accepted deed in lieu of foreclosure in certain circumstances and foreclose the deed of trust. Also, the statute authorizes the mortgagee to foreclose its deed of trust after accepting the deed in lieu of foreclosure. In both cases the statute provides that the priority of the deed of trust is not affected or impaired by the deed in lieu of foreclosure.