Deeding Property to the Lender
by David J. Willis J.D., LL.M.
Foreclosure is the involuntary transfer of property from a borrower, usually to the lender. But what about relinquishing property voluntarily and unilaterally? Since a lender cannot be forced to foreclose (and some lenders drag their feet) an option may be for the owner to unilaterally deed the property to the lender and walk away. It may be more cost-effective to let an underwater or underperforming property go and instead direct resources to profitable investments, a cheaper housing alternative, or toward paying off homestead-exempt assets.
Effects of Foreclosure
So what are the potential benefits of a unilateral DIL? To answer, one must consider the alternative and examine the negative after-effects of foreclosure. These include adverse credit impact for seven or more years; the potential for a deficiency lawsuit by the lender; and the prospect that the IRS will deem the deficiency amount to be ordinary income taxable to the borrower. That could be a whopping number (deficiencies in the $100,000 range are not uncommon) and the borrower must take that amount as ordinary income all in one year. For an investor, the IRS consequences may be the worst aspect of the foreclosure process.
In 2008 Congress made homestead deficiencies exempt from the IRS deemed-income problem, but that does not help investors who may be looking at numerous underwater investment properties.
Effects of Non-foreclosure: Zombie Titles
Surprisingly, a significant percentage of banks are choosing not to foreclose after borrowers default. Why? These lenders have considered the negative factors involved in taking foreclosed properties into inventory (maintenance and insurance costs, carry time, etc.) and decided that it is more financially favorable to sell the defaulted note to a collector and write off the loss. These lenders walk away, effectively dumping the abandoned property onto the local municipality. The nightmare result for the homeowner (who was under the impression from lender notices that a foreclosure was imminent) is that he or she is relentlessly pursued by a third-party collector who now owns the note, by local taxing authorities seeking unpaid ad valorem taxes, and by cities and homeowners associations who either sue or impose liens for trash removal, health and safety code violations, and demolition. After all, since the lender decided not to go through with the foreclosure sale, the homeowner still owns title and is therefore responsible for the property. In this scenario, the best option may be a unilateral DIL to the lender enabling the borrower to assert non-ownership of the property as a defense against circling vultures.
What is a deed in lieu of foreclosure?
Executing and delivering a deed from the owner of real property to the lender-lienholder has traditionally occurred in the context of a bilateral DIL, which is designed to transfer property to the lender in satisfaction of the debt and in exchange for a release of lien. The customary DIL occurs when both parties expressly consent to the mutual benefits of this arrangement. Morission v. Christie, 266 S.W.3d 89 Tex. App.—Ft. Worth 2008, no pet.). The problem is that few lenders nowadays will agree to accept a DIL and give a release in exchange. They would rather use the foreclosure process to wipe out junior liens and acquire a deficiency judgment, which then appears as an asset on the lender’s books. So a traditional, bilateral DIL is often not an available option.
This article examines the benefit to deeding property to the lender anyway—even if the lender has not expressly agreed to discharge and release the debt in exchange. What happens if a borrower executes a unilateral DIL, records it, and then sends a copy to the lender saying “Here, the property is yours now, and by the way, I consider the debt paid in full?
Conveyance to the Noteholder
A DIL should convey the property to the current owner and holder of the note. This can be confusing, since ownership of the note is often split from the servicing function. In order to maximize the unilateral DIL strategy, the homeowner should deed the property to the actual holder of the note, not the servicer.
The 80-20 Problem
What if there are two liens against the property and two different lienholders? There is no perfect solution in such a case, but the most effective strategy is to give a DIL to the senior lienholder since it likely holds the largest debt. If one must choose, it makes sense to defend against the more significant threat, especially the possibility of IRS deemed income on a large deficiency.
Presumption of Acceptance
When a grantor transfers property, title to the property vests in the grantee upon execution and delivery of the deed. The grantee’s acceptance is not usually indicated anywhere on the document. Acceptance is generally presumed. A showing that a deed was executed and delivered with an intent to convey the property is sufficient to establish that the deed vested title in the grantee. Stephens County Museum, Inc. v. Swenson, 17 S.W.2d 257, 261-62 (Tex. 1975). Proof that a deed was recorded creates a presumption of and establishes a prima facie case of delivery and intent by the grantor to convey the land. Troxel v. Bishop, 201 S.W.3d 290, 297 (Tex. App.—Dallas 2006, no pet.). Both cases are cited with approval in , 274 S.W.3d 791 (Tex. App.—Fort Worth 2008, pet. denied).
Notwithstanding the foregoing, the weight of authority is that the presumption of acceptance does not apply if a title transfer is accomplished without the knowledge or agreement of the grantee. Aguilar v. Sinton, 501 S.W.3d 730 (Tex.App.—El Paso, 2016, pet. denied). This nonetheless leaves a lender who receives a unilateral DIL in a possibly hazardous position. If enough time goes by without action by the lender, is this still true? What if the lender, after receiving such a deed, takes possession or refrains from filing a foreclosure or a deficiency suit—might not this inaction be construed as implied agreement with the stated terms of the deed (i.e., discharge of the debt)? After all, courts widely recognize the concept of an implied agreement based on conduct of the parties.
Property Code Section 51.006
What sort of instrument must the lender file if it wishes to reject a deed? Property Code Section 51.006 may offer guidance. This statute “applies to a holder of a debt under a deed of trust who accepts from the debtor a deed conveying real property subject to the deed of trust in satisfaction of the debt.” It expressly provides that a lender may record an affidavit voiding such a deed within four years if the grantor-debtor did not disclose liens of which the lender hand no personal knowledge. But this is narrowly focused. It applies only to this specific non-disclosure scenario.
The practical question is, if a lender already has a DIL in hand, will it expend time and money to formally reject it and proceed with foreclosure? Perhaps, perhaps not. Lenders vary in their response to this. Some (the minority) simply send the deed to their loss mitigation or REO department with instructions to list the property for sale and not bother with foreclosure. Others (the majority) continue with foreclosure in spite of having been given a DIL. Property Code Section 51.006 expressly permits that “[i]f a holder accepts a deed in lieu of foreclosure, the holder may foreclose its deed of trust as provided in said deed of trust without electing to void the deed.”
Potential Benefits Even if There Is a Foreclosure
Accordingly, it is unlikely that deeding property to an unwilling lender will result in avoidance of foreclosure. But even if foreclosure occurs, might there be other significant benefits to executing a DIL? Given the potentially severe effects of both foreclosure and non-foreclosure, does the borrower have anything to lose by giving this method a try?
The first effect—the effect on credit—will not be avoided by executing a unilateral DIL if the lender chooses to go ahead and conduct a foreclosure sale anyway. That much is clear.
The second effect—avoiding or defending against a deficiency suit—presents more interesting possibilities. Say that the DIL contains language reciting that it was being executed and delivered in satisfaction of the debt. If the lender sues for the deficiency but has never filed anything of record rejecting the deed, might not the borrower be able to assert the deed as a defense (an “accord and satisfaction”)? Essentially, the borrower could argue that no deficiency exists. It would be a creative argument.
Similarly, if the IRS declares that the deficiency amount is ordinary income and then demands that tax be paid, the borrower could produce the DIL and declare that since the lender accepted it (or, more precisely, never rejected it) there is no deficiency and therefore no taxable income. Would this argument prevail? No cases yet. However, it certainly has a fighting chance, which is a good deal more than most taxpayers have in this circumstance.
Lastly, in a non-foreclosure scenario (where the lender threatens to foreclose but then does not), the former homeowner can use the DIL to defend against suits from third parties who are trying to collect taxes or enforce liens that have accumulated against a neglected property.
It goes without saying that a unilateral DIL must contain specific statements and recitals if it is to have any effect. A simple warranty deed to the lender will not do the job.
This Is Not Your Parents’ Default
Texans are inclined by nature to honor their word and are reluctant to default on any obligation. However, consider that the world has changed; the top 1% of Americans now control 80% of the wealth. The CEO of the bank holding the note you can no longer afford may be sitting on his yacht in the Bahamas, toasting his fellow Wall Streeters on their obscene new wealth—unprecedented in human history—and laughing at poor souls who continue to make payments on their underperforming properties.
Executing a unilateral DIL is not a perfect technique but it may have interesting and potentially rewarding benefits in certain limited cases. Even so, this strategy remains in the experimental category.
Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. No attorney-client relationship is created by the offering of this article. This firm does not represent you unless and until it is expressly retained in writing to do so. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well, since we do not give tax advice.
Copyright © 2019 by David J. Willis. All rights reserved. Mr. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.