Mortgage Foreclosure: Familiarity Breeds Comfort

Although an expeditious method is available under New York law to foreclose a mortgage on commercial premises by non-judicial means, judicial foreclosure remains favored despite its time-consuming aspects.

Judicial foreclosure of a mortgage is governed by Article 13 of the New York Real Property Actions and Proceedings Law (the "RPAPL") and other related statutes. Although New York had, for some time, a non-judicial "foreclosure by advertisement" process governed by RPAPL Article 14, this process was not used because of concerns as to its constitutionality and difficulty in complying with some of its procedural requirements.

An uncontested judicial foreclosure action can take almost a year to move from commencement to foreclosure sale, and if contested, can take several years to complete, putting aside other delays posed by a possible bankruptcy stay and litigation in the bankruptcy courts.

Faced with these circumstances and in an effort to maintain New York's position as a domestic and international financial center that invites and encourages the extension of credit to spark its commerce, a new Article 14 of the RPAPL was enacted in 1998. This new article revamps the procedures governing non-judicial foreclosure in an effort to circumvent the delays inherent in the judicial foreclosure process (referred to herein as the "New Law").

The New Law tends to modify the traditional view of New York as a "lien" state, because it permits foreclosure of a mortgage via a "power of sale" more akin to "deed of trust" states. The New Law permits foreclosure of a commercial mortgage through the issuance of certain notices indicating that the mortgaged property will be sold at a foreclosure sale by an appropriate officer designated under the statute to conduct the sale. The New Law eliminates the need to obtain judicial appointment of that officer, and the time required to foreclose can thus shrink to, possibly, approximately two to three months.

Heralded as a much-needed remedy in the arena of commercial mortgage lending, the New Law, in practice, has been under-used. This is due, perhaps, to the lack of familiarity with its procedures, the recollection that its predecessor had a poor history, and the absence of recognized, if not standard, "forms" to implement its required steps. Furthermore, certain provisions of the New Law permit the borrower to litigate the propriety of foreclosure using the New Law's procedures, and litigation is also required to obtain a deficiency judgment. Primarily, however, it appears that the comfort level with the more well-understood and time-honored judicial foreclosure process, despite its drawbacks, continues to nourish its vitality.1 Since judicial foreclosure is governed not only by express statutory provisions contained in Article 13 (and elsewhere), but also by a number of customs and usages that cling to the process like barnacles, familiarity with the process remains worthwhile.

Like other actions, a judicial mortgage foreclosure action is commenced by the filing of the summons and complaint.2 At the time the foreclosure complaint is filed, a notice of pendency (previously known as a lis pendens) is also filed. The notice of pendency is an extremely useful device since those acquiring an interest in the mortgaged premises after the notice of pendency is filed are subject to the outcome of the foreclosure action and need not be named or served (i.e., their interests can be extinguished).

Assuming the defaulting borrower serves an answer, the lender will move for summary judgment, assuming that there is no issue, for example, as to the borrower's default and that the amount due under the mortgage loan has been properly accelerated.3 If the court grants summary judgment in favor of the lender dismissing the borrower's defenses to foreclosure, a final enforceable "judgment" (as that term is commonly understood) does not result because, among other things, the amount owed to the lender has not yet been determined by the court.

Instead, as a matter of custom, the court appoints a referee to compute the amount owed to the lender under the mortgage loan as accelerated. It is likely that approximately six months may elapse from the time the action is commenced to the date an order is signed granting summary judgment to the lender and appointing a referee.

Arrangements must then be made for the execution and filing of a referee's oath and the conduct of a referee's hearing. The referee's hearing is akin to a deposition at which the lender's officer testifies as to when the default occurred and the amounts due as a result of the default and acceleration including computation of unpaid principal, accumulated interest, default interest, and late charges to the extent provided for in the mortgage. Although the borrower can insist on a "live" referee hearing and contest the amount owed, in practice, borrowers often consent to waive the referee's hearing usually based on a written affidavit of the lender attesting to the amount owed and the manner of its computation.

Regardless of whether a referee's hearing is actually held or the referee accepts the lender's testimony as to the amount owed in affidavit form, the referee must formally determine the amount owed under the mortgage loan pursuant to the "referee's report of amount due." This report to the appointing court recites/summarizes the testimony/evidence submitted to the referee as well as the referee's computation of the amounts due based thereon. The referee's report of amount due is generally prepared by the lender's counsel for the referee's review and signature.

After the referee's report of amount due is filed with the court, the lender will make a motion for judgment of foreclosure and sale asking the court to confirm/approve the referee's report of amount due and to appoint a referee (usually the same referee who computed the amount due) to sell the mortgaged property pursuant to a judgment of foreclosure and sale, the provisions of which tend to a follow a generally accepted form that usually accompanies the motion. Motion practice associated with this phase of the action usually takes approximately two to three months to complete to the point of obtaining a judgment of foreclosure and sale signed by the court (which form usually receives prior scrutiny by court clerks experienced in reviewing this document).

Once the judgment of foreclosure and sale is entered, lender's counsel is free to schedule a foreclosure sale with the referee without further judicial involvement. Section 231 of the Real Property Law requires that the foreclosure sale be advertised in a newspaper (designated by the court in the judgment of foreclosure and sale), once a week for four weeks or twice a week for three weeks, prior to the sale. The place of the foreclosure sale is specified in the judgment of foreclosure and sale and is also a product of custom. Thus, for example, foreclosure sales in actions commenced in the Supreme Court, New York County, are held at the first floor rotunda of the courthouse building located at 60 Centre Street in Manhattan. Similar customary locations exist in other counties.

The foreclosure sale is conducted like an auction with the referee reading a "terms of sale" prior to conducting the auction. The terms of sale are prepared by lender's counsel and contain customary provisions concerning, for example, the amount of the required down payment, closing date, and consequences of default in the event of a failure of the successful bidder to close. Generally, these provisions are not fixed by statute and also tend to be the product of custom and usage. Usually, the successful bidder is required to pay a 10 percent down payment at the conclusion of the auction in the form of a certified or official bank check and to sign a memorandum of sale agreeing to the terms of sale.

Prior to the premises being "struck down" at the foreclosure sale auction, the borrower (or other defendant having an interest in the premises such as a tenant) has the right to tender all that is due to the lender under the judgment of foreclosure and sale, including the unpaid principal balance, accrued interest, attorneys fees, and court costs; if so tendered, the foreclosure action is rendered a nullity (the so-called "equity of redemption"). However, once the premises are "struck down" at the auction, the borrower's and other defendants' rights in the premises are extinguished, even though the actual closing takes place later.

The closing generally occurs 30 to 60 days after the foreclosure sale at which time appropriate real estate transfer tax and other forms are delivered by the referee along with a referee's deed to the mortgaged premises. These documents are also customarily prepared by lender's counsel.

It is easy to understand then that the judicial foreclosure process in New York can be a fairly laborious and time-consuming affair. The current real estate marketplace is characterized by record-setting prices supported by substantial mortgage loans made at record-low interest rates. Counterpoised are the voices, including Alan Greenspan's veiled intimations, that the "irrational exuberance" that was the hallmark of the dot-com inspired stock markets of the 1990s has been replaced by the real estate "bubble" of the early years of the new millennium. How current market forces play out remains to be seen. It seems, however, that the lethargic and somewhat complex New York judicial foreclosure process may continue to provide the chosen remedy for lenders whose angst leads them to jettison jumbo low interest, defaulted and under-performing mortgage loans in the face of declining real estate values and rents.

gt;1 A thorough discussion of the foreclosure process in New York, including the provisions of the New Law are set forth in considerable annotated detail in the multi-volume treatise Bergman on New York Foreclosures (Matthew Bender: 2005), a seminal guide to this area of the law.

2 Certain other matters also precede the filing of the complaint including, primarily, establishing a default under the mortgage by appropriate notices as and if required by the mortgage documents, acceleration, and the ordering and review of a foreclosure search/title report for purposes of determining who will be named and served as defendants in the action.

3 If the lender's motion for summary judgment is denied, discovery and trial will follow. The lender may also seek the appointment of a receiver, usually at the time the action is commenced, to operate the mortgaged premises and collect the rent and other income generated therefrom pendente lite.

Published October 1, 2005.