It is common for banks to become the owners of properties that once secured their loans by virtue of making credit bids at foreclosure sales. These properties are commonly referred to as “OREO” (Other Real Estate Owned) in the banking industry. Dealing with OREO can be challenging, time-consuming and expensive for bankers who would rather spend their time making loans, opening new deposit accounts and otherwise servicing customers. This is the first article in a two-part series designed to provide practical suggestions for dealing with OREO properties. This first article will focus on pre-sale considerations. The second article, which will be published in the fall issue of the West Virginia Banker magazine, will address post-sale issues that may arise after the sale is completed.
Pre-Sale Due Diligence
In anticipation of foreclosure, it is important to plan for the possibility (and some would say probability) that your bank may become the owner of the property being foreclosed upon. The bank should put on its “owners hat” and undertake basic due diligence in advance of the sale. Although not an exhaustive list, some common due diligence steps that banks should consider in advance of foreclosure include:
- Updated Appraisal: Obtaining an updated appraisal is a must in order to develop a bidding strategy, mitigate challenges to the sales price and have an accurate value for booking and listing the property post-foreclosure. Relying on a dated appraisal based upon fair market value at the time the loan was made may not accurately reflect the true value of the property.
- Environmental Inspection: If you are dealing with a property that has been used for industrial purposes or there are other factors which suggest that there could be environmental issues, an environmental inspection such as a Phase I should be undertaken to identify any such issues which could impair the ability to resell the property and/or expose the bank to the liability down the road.
- Structural Inspection: Having a structural inspection performed may be prudent so that you can gain an understanding of any repair/maintenance issues that will need to be dealt with.
- Ascertain Taxes and Assessments: Often times, if your borrower is not making the loan payments, he/she is not paying the taxes, homeowners association fees, fire fees or other assessments either. These costs can mount up over time and in many cases are not discharged by the foreclosure sale. Banks should ascertain these costs up front so they can be factored into the bidding strategy and the post-foreclosure carrying costs can be determined.
- Consider a Comprehensive Title Exam/Title Insurance: In most instances, the trustee conducting the foreclosure sale will do a limited title search for foreclosure purposes, often going back to the date the deed of trust was recorded. Also, it is important to note that most lenders’ policies of title insurance do not provide coverage for the bank as an owner after the foreclosure sale. As a result, it may be a good idea to have a comprehensive title examination performed so that any title issues can be addressed and so that an owner’s policy of title insurance can be made available for the bank to purchase.
- Access/Utilities: Undeveloped properties may require additional due diligence especially with respect to making sure there is sufficient infrastructure, including roadways and utilities. The infrastructure costs associated installing roadways and utilities can be substantial and should be analyzed on the front-end.
- Occupants/Tenants: As will be discussed further in Part II of this article, there are certain laws which protect the rights of tenants who may reside at the property being foreclosed upon. Obtaining information on the tenants (as well as a copy of the lease) up front will be helpful for sending any required legal notices post-foreclosure. Further, if the deed of trust has an assignment of rents clause, information on the tenants may be useful in requesting that rental payments be made directly to the bank.
The type and scope of due diligence steps depends upon the circumstances of each specific property. This is certainly not an exhaustive list of due diligence items that should be considered and in some instances one or more of the items listed above may not be warranted. In sum, doing your homework up front can help avoid headaches and surprises down the road.
Consider Extra Marketing Prior to Sale
The official legal notices containing the metes and bounds description that get published in the legal section of the newspaper by the trustee are not often very enticing. In an effort to get third parties interested in the property (with the goal of not taking the property into OREO) consider placing a separate retail advertisement to draw more attention to the sale. In certain situations, it may be worth hiring an auctioneer to assist with the foreclosure process. While there are costs associated with running commercial ads and/or hiring an auctioneer, those investments may pay off if they produce a qualified third-party buyer.
Day of Sale Considerations
Bidder Sign-Up Sheet
On the date of the sale, it is prudent to have a bank representative present at the sale to not only make bidding decisions but to also meet other parties who may be interested in the property. Also, it is a good idea to have a bidder sign-up sheet at the foreclosure sale where the names and contact information for parties interested in the property can be obtained. Oftentimes potential buyers are not inclined to bid at the foreclosure sale but may be willing to discuss a purchase after the bank takes the property into OREO. Having the names and numbers of parties who showed interest may prove useful when you are trying to sell the property post-foreclosure.
Memorandum of Sale
You should make sure that your trustee intends to have the buyer execute a memorandum of sale (ie purchase agreement) immediately after the sale. This contract should set forth the basic terms of the sale including the buyer, property description, purchase price, deposit amount and deadline for closing. This memorandum not only confirms the buyer’s obligation to purchase the property but can also be beneficial in trying to help avoid a borrower’s attempt to have a foreclosure sale set aside in the event of a bankruptcy. In the case of In Re Bardell (Bk. Case No. 05-06808), a debtor asked the Bankruptcy Court for the Northern District of West Virginia to set aside a foreclosure sale where the debtor filed bankruptcy soon after the sale but before the trustee’s deed was executed. The Court denied the debtor’s request based, in part, upon the fact that a memorandum of sale had been executed between the buyer and the trustee following the foreclosure sale. Based upon the Bardell decision, a trustee should have the buyer execute a memorandum of sale immediately after the sale to avoid attempts to set the sale aside in a bankruptcy, including the bank if it is the purchaser at the foreclosure sale.
Hopefully this article has provided some practical tips that will assist banks in dealing with OREO properties up to the date of the sale. In part two of this article, which will be published in the fall edition of the West Virginia Banker magazine, we will address post-sale considerations, such as how to deal with tenants residing in the property, personal property left behind at the property and the like.