Reprinted with permission from the June 9, 2016 issue of the New Jersey Law Journal.
Notwithstanding the reputation that arose from the robo-signing controversy several years ago, the process of initiating a foreclosure action requires careful, considered decision-making. This is especially true in the commercial foreclosure context, where the amounts at issue often exceed seven figures. Some of the critical threshold issues that are often overlooked in a foreclosure case are addressed here in turn.
The Standard for Standing to Foreclose
Oftentimes, there is no dispute as to the mortgagor's default under the loan documents. That does not mean, however, that the foreclosure will not be disputed. Because foreclosure actions are highly technical, there are myriad defenses available to a mortgagor having nothing to do with the actual payment or nonpayment of the loan. A mortgagee should anticipate as many of these potential defenses as possible and attempt to both plead around such defenses in the foreclosure complaint and have sufficient documentation available to quickly rebut such defenses, if raised.
One of the most commonly asserted defenses to a foreclosure action is that the plaintiff lacks standing to foreclose. Although recent case law is ambiguous as to the minimum requirements necessary to establish standing, as briefly outlined below, possession of the mortgage note and a recorded assignment of the mortgage will satisfy even the most stringent standard, thus allowing the plaintiff to avoid a protracted standing dispute.
To establish standing, it is generally accepted that a foreclosing plaintiff must own or control the underlying debt instrument. The showing necessary to demonstrate the plaintiff's control of the debt instrument, however, is not entirely clear. Without delving into the nuances of memorializing debt obligations, mortgage debt is typically evidenced by a promissory note that qualifies as a negotiable instrument under New Jersey's Uniform Commercial Code (UCC). Practically speaking, and with limited exceptions, if a plaintiff can establish: (i) that it has physical possession of the note; and (ii) that the note was delivered to the plaintiff for the purpose of giving the plaintiff the right to enforce the note, the plaintiff will have standing to enforce the note in a foreclosure action.
But what about if the plaintiff does not have physical possession of the note when the complaint is filed? Notwithstanding the UCC's requirements, the case law has not consistently required a foreclosing plaintiff to establish physical possession of the note. In fact, recent Appellate Division decisions have suggested (although not necessarily held) that the mere assignment of the note, without actual delivery, is sufficient to establish standing. See, e.g., Deutsche Bank Nat. Trust Co. v. Mitchell, 422 N.J. Super. 214 (App. Div. 2011), and Deutsche Bank Trust Co. Americas v. Angeles, 428 N.J. Super. 315 (App. Div. 2012). Notably, no published decision has addressed the inconsistency between this line of reasoning and the UCC. Despite these decisions, a prudent plaintiff should obtain possession of the note before commencing a foreclosure action so as to pre-empt a standing challenge.
The plaintiff's right to enforce the debt instrument should be a plaintiff's primary concern with respect to standing because, once established, the security for the debt instrument (the mortgage) will pass with the secured obligation. As a result, even if the plaintiff has not been assigned the mortgage (a necessary step to complete the chain of title and thus foreclose), if the plaintiff controls the note, it can seek to compel an assignment of the mortgage. That being said, possession of complete and recorded assignments of the mortgage, establishing the complete chain of title from the original mortgagee to the plaintiff, will significantly streamline the foreclosure process. Moreover, an assignment document may, depending on its terms, establish that the delivery of the note was for the purpose of giving the plaintiff the right to enforce the note, as required by the UCC. This will also ensure easy compliance with Rule 4:64(b)(10), which requires a recital in the complaint of all assignments in the property's chain of title.
After determining that it has standing to foreclose, the plaintiff should proceed carefully to draft the foreclosure complaint by strictly adhering to the requirements set forth in Rule 4:64. That section of the Rules of Court begins by requiring that a foreclosing plaintiff "receive and review a title search of the public record for the purpose of identifying any lienholder or other persons and entities with an interest in the property that is subject to foreclosure …." Indeed, it is of paramount importance that all subordinate lienholders and interested parties be named in the foreclosure complaint, the effect of which will be to allow the foreclosing plaintiff to obtain clean title (other than superior liens) upon the completion of a foreclosure sale. Not all subordinate lienholders are created equal under the law, however, and thus it is essential that a plaintiff understand the implications of adding each type of subordinate lienholder as a defendant.
If, for example, the United States has liens against the property, it can be named as a defendant to extinguish the liens. The United States, however, is subject to different rules for service of process and has an extended time to answer a foreclosure complaint. Moreover, the United States has a unique set of redemption rights that differ significantly from any other lienholder. Specifically, under 28 U.S.C. §2410(c), if the United States has a subordinate tax lien that is foreclosed, the United States is provided four months to redeem the property after the sheriff's sale. Additionally, if the United States has any other type of lien foreclosed, it is provided one year from the date of the sheriff's sale within which to redeem. Notably, in order to redeem, the United States need only pay the amount paid for the property at the foreclosure sale, rather than the entire amount of the underlying debt. Thus, while a credit-bidding plaintiff might ordinarily seek to keep the auction price low so as to avoid paying high sheriff's fees and transfer taxes, such a strategy may no longer be prudent if liens held by the United States have been foreclosed. A commercial plaintiff investing significant resources into property subject to a foreclosure should therefore be advised as early as possible of the implications of a lien held by the United States.
Tenants are another category of persons/entities with an interest in the property that must be given careful consideration before being named as defendants in a foreclosure action. Note that the analysis of tenant issues in this article is specific to commercial tenancies. Residential tenancies, which are subject to the protections of the Anti-Eviction Act, N.J.S.A. 2A:18–61.1 to –61.12, as interpreted by Chase Manhattan Bank v. Josephson, 135 N.J. 209 (1994), are not addressed.
If the property has a lease subordinate to the mortgage, naming the tenant as a defendant will extinguish the tenant's lease and right of possession upon entry of the foreclosure judgment. If, however, the mortgagee wishes to preserve the lease, the tenant should not be joined in the foreclosure. In such a case, the tenancy will continue and the purchaser at the sheriff's sale will step into the shoes of the landlord and be bound by the terms of the lease. Note that if a tenant is not named in the foreclosure action, a writ of possession, which is necessary to evict a foreclosed tenant, will not issue against that tenant.
Because the presence or absence of a lease can have a dramatic impact on the value of commercial property, the plaintiff should carefully evaluate each lease, and the implications of retaining or foreclosing the tenancy. Addressing tenancy issues at the outset of a foreclosure action can help the plaintiff plan for its future use or sale of the property after the completion of the foreclosure process.
Update the Title Report!
After reviewing a title report and determining the parties to name as defendants, the foreclosure complaint should be finalized and filed. Immediately thereafter, the plaintiff should file a notice of lis pendens with the county clerk's office. Any lien placed against the property after the notice of lis pendens is filed will be foreclosed by the ultimate foreclosure judgment, and abdicate the need to include the subsequent lienholder as a party in the foreclosure action.
A plaintiff must be careful, however, during the time period between issuance of the title report and the filing of the notice of lis pendens. Any liens placed against the property during that interim time period will not be automatically foreclosed out unless the lienholder is named as a defendant in the foreclosure action. Thus, to ensure that the foreclosure judgment results in clean title, a plaintiff should update its title report after the filing of the notice of lis pendens and amend its complaint to include any intervening lienholders. If this process is undertaken quickly, the amended complaint can be sent out with the initial service of process.
In summary, before commencing a commercial foreclosure action, counsel should ensure that the client can and has taken the necessary steps to establish standing to foreclose, as well as identified all interested parties and considered the implication of naming (or not naming) those parties in the foreclosure complaint. Careful planning at the outset of a commercial foreclosure action can streamline the foreclosure process and assist the client in maintaining an orderly transition of the ownership of the property.