Pre-Default Deed in Lieu of Foreclosure Held Ineffective

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03/14/2011 9:19 AM

The Maryland Court of Appeals recently held that lenders can’t skirt foreclosure requirements by making borrowers sign a deed in lieu of foreclosure at the closing, before the borrower has even defaulted. In that case the lender required the borrower to execute both a deed of trust and a deed in lieu of foreclosure as security for the loan at closing. The deed in lieu of foreclosure stated that if the borrower defaulted, the lender could immediately take title without a foreclosure proceeding. After the borrower defaulted, the lender recorded the deed in lieu of foreclosure to take title to the property without a foreclosure proceeding.

The Court of Appeals called it a "‘heads I win, tails you lose’" arrangement, requiring the borrower to give up its right to a foreclosure proceeding at the outset, before the borrower had even defaulted. The Court held that the deed in lieu of foreclosure did not convey the title to the lenders – rather, the Court treated it as a mere mortgage, which requires the lender to file a foreclosure action.

At a time when the foreclosure practices are under close scrutiny, it’s important for lenders to follow the rules to the letter. While it’s tempting to be creative to avoid the costly and time-consuming process of foreclosure, the Court of Appeals decision makes it clear that corner-cutting will not be tolerated, much less rewarded. It is important to note, however, that the Court’s decision does not render all deeds in lieu of foreclosure invalid. A borrower can still validly give up his or her right to a foreclosure proceeding by negotiating a deed in lieu of foreclosure with the lender after the borrower has defaulted.

The full-text of the opinion, C. Phillip Johnson Full Gospel Ministries, Inc. v. Investors Fin. Servs., Inc., is here.

If you have any questions regarding this topic, please contact Catherine Hopkin at chopkin@tydingslaw.com or 410.752.9768.

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