REQUIRED READING: Amidst the unprecedented number of foreclosure sales taking place across the country, servicers and their investors are increasingly faced with properties that violate local housing codes because of borrower neglect. When the loan is still pre-foreclosure, servicers are caught in a precarious position: The property must be brought into compliance, but servicers are unlikely to make the necessary repairs because the property is pre-foreclosure and is, therefore, still owned by the borrower.
Indeed, many servicers do not see pre-foreclosure property preservation as part of their job description, because they don't own the property, and a third-party bidder could acquire title at the foreclosure sale, thereby making the code violations somebody else's problem.
This article serves to debunk that strategy and encourage servicers to work proactively with borrowers and code enforcement to ensure that the properties are adequately maintained during the pre-foreclosure stage. Ensuring proper maintenance during the pre-foreclosure stage is more than a courtesy to the neighborhood in which the property is located – it often makes financial sense.Â
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Servicers often first learn that a property is being neglected by receiving a formal notice from code enforcement directly, when the problem has already escalated. As a preliminary matter, rather than simply waiting for the bad news to arrive, servicers should consider trying to anticipate the problem whenever a loan goes into default or a borrower reaches out for loss mitigation assistance. Statistically, those are the properties that are higher-risk.
By obtaining regular broker price opinions and inspections on those properties, the servicer can notify the borrowers that action needs to be taken before the neighbors lodge a complaint with code enforcement. In short, if code enforcement officials aren't given a reason to knock, then they won't knock.Â
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The importance of good communication with borrowers cannot be over-emphasized. Communicating with borrowers has proven to be a challenge in the loss mitigation context, so it should be no surprise that it is difficult in the property preservation context, as well. Indeed, if borrowers are current on their monthly payments, it may be even more difficult to communicate with them, because they are not attempting to get something from the servicer in return, such as a loan modification or some other form of loss mitigation.
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Nonetheless, servicers need to acquire good contact information for the borrowers before the default occurs, including cell phone numbers and e-mail addresses. Borrowers need to be made aware of their obligation to adequately maintain their properties and the consequences of failing to adhere to this responsibility.
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More importantly, communicating with borrowers about code violations is more than just a good business practice – the language in many deeds of trust frequently requires such notification before the servicer can take any action to protect its interest in the property (such as advancing abatement costs, paying liens or pursuing the appointment of a receiver). If a borrower's contact information is stale or incomplete, the servicer's first contact letter will be nothing more than a legal formality, with no hope of actually curing the violations.
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The first contact letter should do more than simply comply with a rigid notice requirement set forth in the deed of trust. Rather, it should notify the borrower of the consequences of failing to maintain the property, and seek to prevent further costs and fees from escalating.
A borrower who occupies a neglected property and seeks approval for a loan modification could be a huge liability for a servicer. Rather than risking more fines from code enforcement or redefault on a modified loan, a deed-in-lieu of foreclosure could be a potential cost-saving alternative to immediately acquire title to the property so that the repairs can be made.
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The servicer's first contact letter to the borrower can serve to open a dialogue with the borrower about other nontraditional options that are available to resolve the violations, apart from merely demanding that the borrower cure the violations as soon as possible. Depending on whether or not any confidential account information is revealed in the letter, servicers' outside counsel might also consider sending a copy of the letter to the code-enforcement officer in charge of the property so he or she is aware of what action the servicer is taking to resolve the situation.
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Additionally, servicers' property preservation companies need to coordinate with the loss mitigation team. If loss mitigation discussions are ongoing with the borrowers, servicers might consider having a property inspection completed prior to entering any formal agreement. Servicers should consider making loss mitigation contingent on the borrowers' resolving any outstanding code violations by a specified date.
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Unfortunately, many borrowers fail to respond to the servicer's first contact letter. Under those circumstances, if the loan is already in default, it may be possible for the servicer to reach an agreement with officials to delay enforcement and have certain repairs completed within a specified period of time. Communication with code-enforcement officials is critical. However, the viability of this strategy will depend on when the foreclosure sale is scheduled to occur.
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If the servicer does not anticipate completing the foreclosure sale for six months, or if the servicer is encountering difficulty in obtaining relief from a bankruptcy stay, the servicer may find it difficult to persuade code enforcement to delay enforcement.
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Nonetheless, pursuing a written timetable for curing the violations is frequently a cost-effective strategy that gives servicers time to acquire title to the property but still provide assurance to code enforcement that the violations will be resolved in the near future.Â
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Cities are increasingly enforcing their nuisance-abatement ordinances by issuing administrative citations and imposing fines of up to $1,000 per day for continuing violations. Notice of the fines can be placed on the title, making it more difficult for servicers to sell the property post-foreclosure. In some cases, the fines can be assessed against the property and collected with the property taxes. Working with code enforcement in developing an agreed-upon timetable for curing the violations may also help to avoid such hefty fines from accumulating against the property.Â
Contemplating receivership
In extreme cases, where there are numerous violations that present a danger to the public, a written timetable for curing the code violations may not be sufficient to persuade code enforcement to delay enforcement. Several states have statutes that specifically provide for the appointment of a receiver over property that is considered substandard in the event the owners, or other responsible parties, refuse to correct substandard conditions. Many cities are seeking this relief from the court, and servicers may be held liable for the city's litigation costs if a receiver is appointed.
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If the foreclosure sale is many months away, it may be necessary for the servicer to seek the appointment of a receiver by the court to manage the property until the violations have been cured or until the borrowers no longer own the property, as opposed to the city seeking such relief. This is particularly true in circumstances where the borrower has abandoned the property, and the property has become a crime magnet or serious nuisance to neighboring properties.
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Abandoned properties are particularly troublesome for cities and should be of great concern to servicers due to the high likelihood of vandalism, increasing both the number of violations and the cost of repair. Similarly, if the borrowers are current on their payments but are neglecting the property, a receivership may be required, as it typically takes a longer period of time to foreclose under those circumstances.
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A receiver is a neutral third party appointed by the court that is given certain powers to take control, manage, lease, repair and even sell a property. If code violations exist, a receiver can act to retain contractors and abate the violations. A receivership is a powerful tool, but it can be a costly one. The hourly rates charged by receivers can vary from the low $200s to upwards of $600.
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Theoretically, the receiver can be paid from the equity in the property at issue. However, because the current market has created a glut of properties that have no positive equity, servicers should anticipate the possibility of the receiver being compensated by liening the property with receiver "certificates" that occupy a priority position over any pre-existing liens.
If the property is generating rental income, then that stream of income could be tapped to finance the receivership. Indeed, because the Helping Families Save Their Homes Act potentially requires servicers to honor leases that pre-date the completion of the property's foreclosure sale, using rental income to finance receiverships may become increasingly popular.Â
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Receiverships are an extremely effective tool to cure code violations during the pre-foreclosure stages, but in light of the cost of appointing receivers and the complexity of ascertaining how they will be paid, servicers and their counsel should give careful consideration to the receiver's fees and the equity position of the property before pursuing this strategy. In particular, special attention should be placed on estimating what the cost of noncompliance will be if the servicer simply waits to act until the foreclosure sale is completed.
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Although receiverships can be expensive, the cost is often less than the total sum of the costs that would accrue if the servicer were to fail to act until the sale is completed – the fines, liens, administrative fees and litigation costs that may accrue during the pre-foreclosure stages are usually substantial. Appointing a receiver to maintain the property early may actually improve the servicer's balance sheet once the asset is disposed of through an REO sale, because the improved property will have a higher market value, and substantial code enforcement-related costs will be avoided.
Kerry W. Franich is the principal of The Law Office of Kerry W. Franich, a real estate law firm with an emphasis in representing servicers, REO professionals and developers in litigation matters and other contract-related disputes. His office is located in Mission Viejo, Calif., and he can be reached at kerry@franichlaw.com. Charisse Smith is an attorney specializing in code enforcement litigation and receiverships at Best Best & Krieger LLP, a corporate and municipal agency law firm with offices throughout California. She can be contacted at charisse.smith@bbklaw.com.
