Mitigating Risks Associated with Hotel, Restaurant and Entertainment Industry Economic Challenges: Part 5 – Commercial Foreclosures 101

Sometimes, foreclosure of a commercial property is the only option available to lenders and servicers to limit losses as a result of defaults on hotel and restaurant mortgages.  Parts 1-4 of this series discussed pre-foreclosure options available to lenders dealing with hotel/restaurant mortgage defaults.  This article provides a high-level overview of the commercial foreclosure process and practical considerations for lenders and servicers.

Practically speaking, a commercial foreclosure action proceeds much the same as other civil actions. A complaint is filed, then the borrower has the ability to respond to the complaint and assert defenses.  Then, if necessary, the parties will conduct discovery and the plaintiff will seek to end the lawsuit by filing a motion for summary judgment or setting the case for trial in the event there are factual issues in dispute.

The Complaint to Foreclose the Mortgage

Before filing a complaint for commercial foreclosure, the lender/servicer must first determine whether the lender/servicer is in possession of the original promissory note.  The pleading requirements are different depending on whether the lender/servicer is in possession of the original promissory note.  Specifically, if the lender/servicer is in possession of the original promissory note, the lender/servicer must file a certification contemporaneously with the foreclosure complaint. The certification must set forth the location of the promissory note, the name and title of the person giving the certification, the name of the person who personally verified such possession, and the time and date on which the possession was verified. § 702.015(4), Fla. Stat. (2019).  The lender/servicer must also attach to the certification a correct copy of the note and all allonges to the note.

On the other hand, if the original promissory note was lost, destroyed or stolen, the lender/servicer must attach a lost note affidavit to the complaint. The affidavit must:

1. Include a clear chain of all endorsements, transfers or assignments of the note;
2. Set forth facts showing that the plaintiff is entitled to enforce a lost, destroyed or stolen instrument as required by Section3091(1), Florida Statutes; and
3. Include evidence demonstrating the acquisition, ownership and possession of the note, such as copies of the note, allonges and/or audit reports.

702.015(5), Fla. Stat. (2019).

Further, senior lienholders need to name junior lienholders as parties to the foreclosure complaint in order to extinguish the junior lienholder’s interest in the real property. Specifically, if a junior lienholder is named in the lawsuit, the junior lien will be extinguished after the foreclosure sale whether or not there were any excess proceeds to repay the junior lienholder.  However, and critically, a junior lien is not extinguished if the junior lienholder was omitted from the foreclosure action.  Abdoney v. York, 903 So. 2d 981, 983-84 (Fla. 2d DCA 2005).  As such, prior to foreclosing on the real property, lenders/servicers should perform a title search to ensure that all junior lienholders are properly named in the complaint.

Finally, lenders/servicers who may want to seek a deficiency judgment from the borrower need to request a deficiency judgment in the complaint.

The Borrower’s Answer and Affirmative Defenses

Once the foreclosure complaint is served on the borrower, the borrower will have 20 days to file an answer and assert affirmative defenses (if any).  Some of the most common defenses raised by a borrower include:

1. Lack of notice,
2. Estoppel and waiver,
3. Lack of standing,
4. Payment,
5. Statute of limitations and repose,
6. Unclean hands, and
7. Usury.

While the parol evidence rule typically precludes a party from raising extrinsic evidence (e.g., oral agreements) between the parties to a written contract made before or at the time of execution of the contract, it is important for lenders/servicers to recognize that the parol evidence rule does not prohibit the use of extrinsic evidence arising after the parties executed the contract. See The Race, Inc. v. Lake & River Recreational Props., Inc., 573 So. 2d 409, 410-11 (Fla. 1st DCA 1991) (explaining the parol evidence rule and holding that the trial court erred in granting summary judgment against a borrower who raised affirmative defenses of failure of consideration and oral modification).  Thus, sometimes borrowers will assert affirmative defenses that involve factual issues, which will preclude quick resolution of the foreclosure action on summary judgment.

Interim Relief

Assignment of Rents

During the foreclosure action, and prior to entry of a final judgment, lenders/servicers have many options available to help mitigate their damages or attempt to expedite the foreclosure process.  For example, as discussed in Part 4 of this series, Florida’s assignment of rents statute allows lenders to perfect a lien on the rents derived from a mortgaged property by recording the assignment of rents agreement.  More importantly, it allows courts to sequester the rents into the court registry pending the outcome of the foreclosure action.

Appointment of a Receiver

Additionally, lenders/servicers can request the court to appoint a receiver.  Barnett Bank of Alachua Cty., N.A. v. Steinberg, 632 So. 2d 233, 234 (Fla. 1st DCA 1994) (discussing the appointment of receivers); Colley v. First Fed. Savs. & Loan Ass’n of Panama City, 516 So. 2d 344, 345 (Fla. 1st DCA 1987) (identifying guidelines for a court to consider when determining whether to appoint a receiver). The appointment of a receiver can be a powerful remedy for lenders/servicers because the receiver has the power to, inter alia, manage the property to preserve the collateral, assume or reject executory contracts of the estate (during the receivership), settle claims with the approval of the court, and sell property free and clear of existing liens. The receiver can stop the bleeding and perhaps even right the ship during the pendency of the foreclosure action—when the lender would otherwise be helpless to do so.  Part 6 of this series provides a more in-depth analysis on the appointment of receivers.

Order to Show Cause (Section 702.10, Florida Statutes)

Moreover, lenders/servicers can request that the court enter an order to show cause under Section 702.10, Florida Statutes.  If the foreclosure complaint states a cause of action and complies with the requirements for a foreclosure complaint as set forth in Section 702.015, Florida Statutes (as discussed above), the court must promptly issue an order to show cause.  The order to show cause directs the borrower to appear before the court and show cause why a judgment of foreclosure should not be entered.  In other words, the borrower must raise a genuine issue of material fact that would preclude entry of a foreclosure judgment. If the borrower fails to demonstrate a genuine issue of material fact, the court must promptly enter a judgment of foreclosure. § 702.10(1)(d), Fla. Stat. (2019). If the borrower raises a genuine issue of material fact, but the court finds that the lender/servicer is “likely to prevail in the foreclosure action,” the court must enter an order requiring the borrower to make the mortgage payments to the lender during the pendency of the lawsuit.  § 702.10(2)(d)&(e). If the borrower fails to comply with this order, the lender/servicer is generally entitled to possession of the premises.  Fla. Stat. § 702.10(2)(f).  Part 7 of this series provides a more in-depth analysis on Section 702.10, Florida Statutes.

Issuance of a Final Judgment of Foreclosure

If there are not any factual issues in dispute that preclude entry of summary judgment, the court will likely grant a summary final judgment in favor of the lender/servicer.  Otherwise, a trial will be required.  Once the court finds that a judgment should be entered, the court will enter a final judgment, which will set forth the total amount determined to be due to the lender and will also schedule a date upon which the real property shall be sold.

Pursuant to Section 45.031, Florida Statutes, the judgment of foreclosure must schedule the foreclosure sale to take place 35 days or less after the entry of the judgment, unless the parties consent otherwise.  § 45.031(1)(a), Fla. Stat (2019). The foreclosure sale is conducted at public auction, and the winner is issued a certificate of sale. If there are no objections within 10 days, the clerk will record a certificate of title, which identifies the new owner of the property.  Upon issuance of the certificate of title, the purchaser is entitled to possession of the property. If the foreclosed owner remains in possession, the purchaser may obtain a writ of possession or other relief from the court.

The proceeds from the sale are distributed to the lienholders according the lien priorities. If there are any junior lienholders named in the lawsuit, their liens will be extinguished regardless of whether there are any funds distributed to them. Most of the time, the sales proceeds will be insufficient to satisfy even the most senior lien.  Therefore, junior liens are generally extinguished without any compensation to the junior lienholder.

Deficiency Judgments

Once the foreclosure sale occurs, the lender/servicer will know whether there were sufficient funds to make the lender whole.  If there was not, the lender/servicer has the ability to seek a deficiency judgment, which is a personal money judgment against the borrower for the difference between the judgment amount and the fair market value of the property on the day of the foreclosure sale. The fair market value is usually determined by an appraisal of the property close to the date of the foreclosure sale and typically requires an evidentiary hearing.

While the entry of a deficiency judgment is the rule rather than the exception, the court has discretion to enter a deficiency judgment and may rely upon equitable considerations for denying entry of a deficiency judgment.  Lloyd v. Cannon, 399 So. 2d 1095, 1096 (Fla. 1st DCA 1981).

Conclusion

The purpose of this article is to provide a general overview of the commercial foreclosure process.  However, as with all litigation, commercial foreclosures can become complex and the unique facts of each case should be thoroughly considered.

The next parts of this series will explore some of these concepts in more detail.  Specifically, Part 6 will analyze the considerations to give for appointment of a receiver and Part 7 will discuss how to expedite the commercial foreclosure process by requesting an order to show cause under Section 702.10, Florida Statutes.

Continued Reading in this Mitigating Risks Associated with Hotel, Restaurant and Entertainment Industry Economic Challenge Series:

• Part 1: Introduction and Considerations When Hotels and Restaurants Default on Their Mortgages
• Part 2: Pre-Foreclosure Loss Mitigation Options
• Part 3: Commercial Mortgage Default Options Including Acceleration and Enforcement of Personal Guaranties
• Part 4: Assignment of Rents Under Section 697.07, Florida Statutes