ULC

Nonjudicial Foreclosure Act Summary

Traditionally, when a person’s home or other property is foreclosed by auction, the price is well below market value. The Uniform Nonjudicial Foreclosure Act ("UNFA") will provide two new methods of foreclosure designed to provide higher effective prices. If used, lenders should realize more of the indebtedness owed to them and borrowers will experience fewer deficiency claims and more surpluses. Additional protections are included in the Act, such as systems of notice, due process notice and hearing, judicial intervention where necessary, and redemption of the mortgaged property.

In the great majority of foreclosures, judicial involvement is unnecessary because there is no dispute between the debtor and creditor. Using the time of judges and the machinery of the courts to conduct routine foreclosures is often a misallocation of public funds as well as a waste of the secured creditor’s resources. The delays and inefficiency associated with foreclosure by judicial action are costly. They increase the rick of vandalism, fire loss, depreciation, damage, and waste. The resulting costs raise the prices of private mortgages and erodes the economic value of government subsidy program involving mortgages. The availability of a uniform, less expensive, and more expeditious foreclosure procedure will ameliorate these conditions, and will facilitate the secondary market sale and resale of real estate loans.

Purposes of Foreclosure

Foreclosure is intended to accomplish two distinct purposes: (1) to evaluate the collateral and (2) to liquidate it. Evaluation is necessary to determine whether the lender has a surplus (to be distributed to junior lienors and the debtor) or a deficiency (to be demanded from the debtor and others who are personally liable on the debt). Liquidation is necessary because the lender, in nearly all instances, is not in the business of owning real property and does not want to retain the collateral for the long term. However, there is no overarching principle that requires the evaluation and liquidation functions to be accomplished in a single process. Indeed, a persuasive case can be made that when both functions are done at once, as in the case of the traditional auction sale, both are likely to be done inefficiently. In recognition of these facts, the Act give lenders the opportunity (although not the obligation) to bifurcate the evaluation and liquidation functions.

Three Methods of Foreclosure under UNFA

The Uniform Nonjudicial Foreclosure Act provides for three methods of nonjudicial foreclosure and permits the secured creditor to elect the method to be used. The first is conventional foreclosure by means of an auction sale, in which both the evaluation of the collateral (by means of the high bid at the sale) and liquidation (by means of a foreclosure deed to the high bidder) are combined. The UNFA aims to improve prices at auction sales by requiring foreclosing lenders to disclose title information and to encourage disclosure of other information. Additionally, the Act encourages debtors to permit pre-foreclosure inspection of the security property by prospective buyers, a feature intended to foster higher price at sale.

The second method is foreclosure by negotiated sale, which is consummated similarly to other real property sales listed with a real estate broker and advertised extensively. The second method is effective in liquidating, but has not been used in this country because of concerns about collusive price-setting by the secured creditor and purchaser. That concern is eliminated in the Act because debtors and junior lien creditors holders can disapprove of the sale if they are dissatisfied with the "foreclosure amount" offered by the creditor. The Act provides the foreclosing creditor several options to employ if the sale is disapproved; however, if the amount is reasonable and more than the debtor and junior lienors could expect to recover from an auction sale, they have every reason to permit the sale to proceed.

The third method is foreclosure by appraisal, which accomplishes only the evaluation of the collateral. The third method leaves the secured creditor with the burden of liquidating it after the foreclosure is completed; however, more extensive safeguards are used to ensure the integrity of the appraisal’s result. With all three of these foreclosure methods, sufficient protections have been included to assure protection of the legitimate interests of debtors and subordinate interest holders. Although this method is similar to a "strict foreclosure," there are more extensive safeguards to protect the interests of the parties being foreclosed and to ensure the integrity of the appraisal’s result.

"Residential Debtor" Concept

The Act recognizes two classes of debtors: residential and everyone else. Residential debtors are presumed to need additional legal protections from foreclosing creditors that are not essential to other persons. Numerous protections for residential debtors within the Act include: standards of a security agreement may not be manifestly unreasonable; foreclosing creditors must send notices of default and foreclosure; creditors are required to make a reasonable effort to discover the correct address of the debtor; thirty days is the minium time for cure for residential debtors; and residential debtors who file an action to enjoin foreclosure on the ground that it is legally improper are not required to post bond in order to obtain a temporary restraining order.

Two-notice System

Nonjudicial foreclosure statutes presently in effect are typically either one-notice or two-notice systems. The two-notice system requires the secured creditor to send a notice of default and, after the passage of some time period, a second notice of foreclosure. The UNFA requires a two-notice system and debtors are given a 30-day period of cure before a notice of foreclosure may be issued to them. After the cure period expires an original notice of foreclosure must be given to all parties whose interests will be extinguished by the foreclosure, rather than, as currently practiced, only to the debtor. This prevents the unfair result of junior mortgage holders being unaware of a termination.

Due Process, Notice and Hearing

UNFA provides for notice to all those whose property rights are put at risk by foreclosure. There is also an opportunity for any other person who wishes to receive notice of the foreclosure to file a request for such notice in the public records. Furthermore, residential debtors have the right to an informal meeting with a responsible representative of the secured creditor to present reasons why the foreclosure should not go forward. It is believed that the right to a meeting will satisfy the hearing element of the constitutional due process requirement if a government agency is foreclosing under the Act. While the Act does not obligate creditors to hold a meeting with nonresidential debtors or with subordinate lienholders, neither does it preclude such a meeting.

Judicial Intervention

In a great majority of cases, foreclosures under the Act are expected to proceed without judicial involvement. However, there are a number of situations in which a party may seek and obtain the intervention of a court. Debtors who believe there has been no default under the security agreement can seek judicial intervention. Courts may also postpone a foreclosure to determine the competing priority interests, to direct foreclosure in bulk or by parcels, or to direct the order of distribution of the proceeds of a foreclosure. In these and other situations, the court serves as a "safety valve," guarding against improper or overreaching actions by the foreclosing creditor.

Redemption and Title from Foreclosures

The Act recognizes the fundamental right to equitable redemption until the date of foreclosure, but does not permit post-foreclosure redemption. While post-foreclosure redemption occasionally benefits a debtor or junior lienor, it is believed that in the aggregate such parties are disadvantaged by the depression bid prices that result from the uncertain status of title by statutory redemption.

No matter what method of foreclosure is employed, the Act provides that if a notice of foreclosure has been recorded, completion of the foreclosure process by an appropriate deed and affidavit conclusively establishes compliance with the Act in favor of good faith purchasers for value of the collateral. If a creditor fails to comply with the Act in conducting a foreclosure, a court may assess damages against the creditor. In addition, a serious failure of compliance may warrant a court in setting aside the foreclosure if no bona fide purchaser’s rights have intervened.

Deficiency Liability

In general, no matter which of the three foreclosure methods is employed, the UNFA permits recovery of a deficiency by the foreclosing creditor if the obligation is a recourse debt. However, a residential debtor who acts in good faith is exempt from deficiency liability. In addition, deficiency liability is limited by the "fair market value" concept: a debtor may present proof of the property’s fair market value, and may have the amount of the deficiency limited as though the foreclosure amount was at least 90 percent of fair market value. This limitation is available to all debtors if the foreclosure was by auction, but is available only to residential debtors in the case of a foreclosure by negotiated sale or by appraisal.

Predatory Lending

There has been a good deal of legislative activity attempting to ban or control "predatory lending" - a term that generally refers to activity by mortgage lenders that is unfair or deceptive to consumer borrowers. The UNFA does not stand in the way of enforcement of such legislation, whether now in effect or adopted in the future. Under Section 105, a court may enjoin or otherwise take control of a foreclosure that would otherwise proceed nonjudicially under the Act.

UNIFORMITY

The feasibility of nonjudicial foreclosure is demonstrated by the fact that about half of the American jurisdictions use it routinely, and by the implementation of two federal statutes that permit the U.S. Department of Housing and Urban Development to foreclose the mortgage loans it holds by power of sale. A few states have adopted power of sale foreclosure statutes in recent years, but there are still nearly twenty states that have no practical form of nonjudicial foreclosure. The Uniform Nonjudicial Foreclosure Act is offered in the belief that non-judicial foreclosure can be both fair to borrowers and efficient from the viewpoint of lenders, and will often be the preferable form of foreclosure for all of the affected parties.