Written By: Eric D. Dean
On May 20, 2009, President Obama signed into law a bill which requires consideration of new systems and procedures to respond to the mandates and unintended consequences of the Act and creates further risks and duties in those instances where the Act applies. This Act entitled, “Protecting Tenants at Foreclosure Act of 2009” (PTFA), was passed as a reaction to the victimization of good faith tenants who in many instances had paid advanced rent and security deposits to landlord/borrowers and were then evicted summarily after a foreclosure.
In an effort to address these concerns, as will be discussed below, PTAFA created a federal requirement that unless an exemption applies, a tenant must be given a minimum of 90 days notice of an eviction before an eviction action can be commenced and that if there is a “bona fide” lease that extends beyond the 90 day period, the lease must be honored by the lender and servicer. In this Article, we will examine the Act, its application, potential unintended consequences of the Act and possible responses to the Act. Moreover, we will explore the way the new Law will be applied in conjunction with State laws in the context of both Judicial and Non-Judicial foreclosures.
Because the Law is in its infancy and was in many respects extremely general, both servicers and attorneys representing the default servicing industry are scrambling to determine the full implications of the Act and potential responses to the Act. Until clarification is provided by case decisions, there remains some uncertainty as to exactly how the Act will be applied in various jurisdictions. It also should be noted that the Act, if applicable to a particular property, only provides a minimum standard of protection afforded tenants and that more restrictive state statutes or local ordinances restricting eviction after foreclosure continue to apply.
A Brief Summary of the Act and its Ramifications
THE LEGISLATION
Notice Requirements under the Act
Under the Act, a lender or servicer that forecloses on residential property that is occupied by a “bona fide” tenant must give no less than 90 days notice of an eviction to a tenant or, if the lease has more than 90 days to run, honor the terms of the lease. If the legislation does not apply, then individual State laws or local ordinances continue to control the notice that is required to proceed with evictions after foreclosure.
Exemptions under the Act
The law only applies to leases that are “bona fide”. Under the legislation, there are five (5) criteria as to whether a lease is exempt from the legislation:
When Was Lease Entered Into?
The lease must have been entered into before foreclosure was commenced to be subject to the Act. In many jurisdictions legal aid societies and plaintiff’s counsel are already arguing over when a foreclosure is “commenced”;
- Who Is the Lessee? The legislation does not apply where the lessee is a mortgagor/trustor or a child, spouse or parent of a mortgagor/trustor. However, as hereinafter discussed, it does arguably apply where the “tenant” is a best friend, cousin, sibling etc opening up the door for claims that leases exist that are complete shams;
- Is the Lease Arms Length? The lease must be a result of a good faith, arms length transaction and not a contrived or sham lease. The problem is that the burden of proof is likely to be placed on the lender servicer to establish that the “lease” is, in fact, a sham;
- Is the Rent Fair? Under the new law, leases that are substantially below fair market rent are exempt from the federal notice requirements. However, it is likely that the burden will fall on the lender/servicer to establish that the rent is not at market. This again opens up the door for sham leases at below market rents; and,
- Does a New Owner Intend to Occupy the Property As a Principal Residence? If so, only the 90 day notice is required and a longer lease term need not be honored. However, it is not currently clear whether this provision applies only to the successful bidder at the foreclosure sale or also applies if the lender takes title to the property at foreclosure and thereafter markets and sells the property to a third party buyer who intends to occupy the property as his or her principal residence. The prevailing opinion appears to be that in the later circumstance, once the buyer who intends to occupy the property has acquired title, but not before, the buyer may terminate the tenant’s lease on 90 days notice to the tenant. It remains to be seen as a matter of practicality how marketable foreclosed dwellings will be to buyers who intend to occupy the property but must go through a 90 day notice period followed by a lawsuit in order to obtain possession of the property.
Treatment of Section 8 Housing under the Act
Where the bona fide tenant is a Section 8 voucher holder receiving government-sponsored assistance, the purchaser at foreclosure sale is bound by the terms of the lease between the prior owner and the tenant, as well as the housing assistance payment contract between the prior owner and the public housing agency. So long as funding of the rent continues, only a new owner intending to occupy the premises as his or her primary residence can terminate the lease following a 90-day notice to vacate to the tenant.
Sunset Provision: The Act contains a sunset provision in 2012 assuming it is not otherwise extended.
EVICTIONS BEFORE THE ACT
Prior to PTAFA, unless otherwise restricted by local laws, lenders and servicers acquiring properties at foreclosure sales could simply record the deed and then be in a position to evict either the owner or tenant by filing an action for forcible entry and detainer. Depending on the State law this was typically done by service of a notice to leave the premises which might be require anywhere from three to sixty or more days followed by the filing of the complaint. Many tenants would learn of the foreclosure only when they were served with this notice. Moreover, it was very common for tenants to pay rent to the borrower/landlord throughout the entire foreclosure proceeding, unaware they were soon to be evicted and unable to recover their security deposits.
In the past, in most instances, lenders and servicers ignored rents and simply focused on gaining possession of the property after foreclosure. As hereinafter discussed, the Act will by necessity require reconsideration of how lenders and services will approach tenant occupied properties both pre and post foreclosure.
ENHANCED PRE-FORECLOSURE DUE DILIGENCE AND RISK OF FRAUD
As noted above, where bona-fide tenants occupy the property, unless an exemption applies, under this legislation the foreclosing lender may not evict the tenant until the expiration of the lease or 90 days, whichever is later. No distinction is made in the legislation between oral and written leases. However, it should be noted that under many state laws a lease for a period in excess of one year, must be in writing to be enforceable.
The breath and vagueness of the legislation unfortunately creates the likely prospect of schemes between unscrupulous lawyers, brokers and borrowers to create sham leases so that the borrower can either continue to occupy the foreclosed property under the guise that it is occupied by a bona fide tenant or extort a payment out of the foreclosing lender as an inducement to vacate the property.
Based on the new legislation, it would appear that servicers will now have to be far more diligent in determining pre-foreclosure if the property is owner or tenant occupied and if tenant occupied whether the purported lease is bona fide and the terms of any leases on non-owner occupied properties. At the same time, servicers will need to remain mindful of avoiding claims such as trespass and wrongful interference with the contract between the borrower and tenant pre-foreclosure.
THE LENDER OR SERVICER AS A LANDLORD OR MORTGAGEE IN POSSESSION
Most forms of mortgages and deeds of trust include an assignment of rents provision under which the lender and its successors and assigns are granted a security interest in rents which may be exercised upon a loan default. Many lenders and servicers have been reluctant to exercise the assignment of rents out of a variety of potential legal concerns including becoming what is called a “mortgagee in possession”.
As a mortgagee in possession, a lender or servicer in essence may be held to assume responsibility for the habitability of the property and be held liable to the tenant if the property is found not to be habitable or if injury results from an unsafe condition on the property. Based on these concerns, most lenders and servicers have avoided collecting rents during the foreclosure process. However, under the new Federal Legislation, lenders are now forced to become landlords of tenant occupied properties and be subject to the duties, risks and responsibilities of a landlord if a decision is made to complete the foreclosure for at least a 90 day period and if a longer term lease is in effect possibly for the term of the lease.
Lenders and servicers may, therefore, desire to reconsider the assertion of claims to rents pre-foreclosure since the issue may otherwise be unavoidable post-foreclosure. In analyzing the issue of whether the lender should exercise the assignment of rents pre-foreclosure, it may also be considered that allowing the borrower to continue to collect rents acts as an incentive to the borrower to engage in stall tactics to delay the foreclosure so that further rents are collected while property related expenses go unpaid.
POSSIBLE RESPONSES TO THE ACT
It is, therefore, critical for the lender to adopt policies and procedures to determine if the property is tenant occupied and if so, how the lender will proceed as to the collateral. If the lender proceeds with concluding the foreclosure of a tenant occupied residence, it needs to establish procedures to determine if the property is, in fact, claimed to be tenant occupied and , if so, to determine if the claimed tenants are “bona fide”. If it is determined that the occupied is protected by the Act (1) establish a procedure to manage the property and collect rents for the required period (2) expedite the sale of the property to a third party who is prepared to take title to the property with the tenant in place or intends to occupy the property as a principal residence or (3) establish systems and procedures to negotiate a termination of the lease and turnover of possession with the tenant. While some lenders or servicers may simply choose to complete the foreclosure and simply give 90 days on a universal basis, the risks of tenant and third party liability for conditions on the property as well as the potential of a longer term bona fide lease existing make the adoption of this policy appear potentially problematic.
THE USE OF RECEIVERS AS A POSSIBLE ALTERNATIVE
Under virtually all state laws, Landlord’s have duties to maintain residential tenant occupied property in a habitable condition that cannot as a general rule be waived. Failure to do so can, depending on the jurisdiction in which the property is located subject the landlord to draconian civil damages and even criminal prosecution. Since lenders and servicers are already target defendants adding further risks of liability and damage claims would appear imprudent.
Many lenders do not want to take ownership of tenant occupied property and then be held responsible as a landlord or exercise the right to collect rents pre-foreclosure and run the risk of being deemed a mortgagee in possession. Additionally, as noted above, a borrower who is collecting rents may also desire to stall the foreclosure so that rents and deposits can continue to be collected for an extended period without payment of offsetting expenses. Rather than immediately complete a foreclosure in a tenant occupied property, lenders may desire to appoint a receiver to manage and control the property during the term of the lease or until a third party purchases the asset.
The receiver is not technically an agent of the lender so that the lender does not bear responsibilities for the management of the property during the term of the receivership. In addition to being authorized to collect rents, in some jurisdictions the receiver may also be authorized by the court to sell the property so that the lender never goes into title to or management of the property. Utilization of the receiver as an alternative to immediate foreclosure does not make economic sense unless costs are contained by the adoption of special fee programs by attorneys and property managers qualified to be appointed receivers. However, based on the significance of the concern and volume of properties impacted by the new legislation it would appear that the opportunities for cost effective fee programs to service this heightened concern certainly exist.
Conclusion
PTAFA has created on a national basis a whole new set of concerns and issues that lenders and servicers had previously not been required to consider. It is essential that lenders, servicers and their counsel engage in a dialogue as to how these issues and concerns will be addressed and responded to maintain collateral value, limit expenses and avoid unintended risks.