Businesses can get into financial trouble and fall behind on mortgage payments. This is called “defaulting” on the mortgage. When this happens, the lender will typically begin foreclosure proceedings in order to sell the property and claim repayment of the loan.
A commercial foreclosure is, ordinarily, very similar to a residential foreclosure, with one main difference: the appointment of a receiver.
Understanding Commercial Foreclosures
Commercial foreclosures, like residential foreclosures, are conducted using one of two procedures; either judicial or nonjudicial. Whether a particular foreclosure will be handled through a judicial or nonjudicial procedure depends on the law of the state where the property is located (some states allow only judicial foreclosures) and what the language and terms of the mortgage say.
How Judicial Foreclosures Work
With a judicial foreclosure, the lender must file a lawsuit against the borrower asking the court for a judgment of foreclosure and order of sale. The defendants (the borrower and any other parties with an interest in the property) get a certain amount of time—typically 20 or 30 days—to respond to the suit by filing an answer with the court.
If no one files an answer, the lender’s attorney will ask the court for a foreclosure judgment. This is called an “uncontested” foreclosure. On the other hand, if the foreclosure is contested, there will probably be a trial. If the borrower loses at trial, the court will enter a judgment in favor of the lender.
After the court enters a judgment and orders the property sold to satisfy the mortgage debt, the foreclosure sale date will be set.
Foreclosures in the following states are typically judicial: Connecticut, Delaware, Florida, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Vermont, and Wisconsin.
How Nonjudicial Foreclosures Work
If the loan documents contain a power of sale clause and state law allows it, the lender can foreclose on a commercial property nonjudicially.
With a nonjudicial foreclosure, the lender forecloses by taking a series of out-of-court steps as set out by state law. For example, the lender might mail the borrower a written notice of default or sale, post notice about the foreclosure on the property, and/or publish notice in a newspaper. Each state’s laws are different.
Foreclosures can be nonjudicial in: Alabama, Alaska, Arizona, Arkansas, California, Colorado, District of Columbia, Georgia, Idaho, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, North Carolina, Oregon, Rhode Island, Tennessee, Texas, Utah, Virginia, Washington, West Virginia, and Wyoming.
Lender Might Ask a Court to Appoint a Receiver During the Foreclosure
After the owner of a commercial property (the borrower) defaults on the mortgage, the lender will want to ensure that the borrower:
- does not allow the property to deteriorate
- continues to maintain, secure, and insure the commercial property, and
- does not collect rent and profits from the property without putting them towards the outstanding mortgage debt. (Often, a mortgage for a commercial property will contain an assignment of rents and profits clause, which gives the lender the right to these amounts.)
So, the lender may ask a court to appoint what's known as a "receiver." This can happen as part of a judicial or nonjudicial foreclosure. The receiver’s job is to manage the property until the foreclosure is complete (or, in some cases, to sell the property.)
What Happens at a Commercial Foreclosure Sale
To complete a judicial or nonjudicial foreclosure, the property will be sold at a foreclosure sale to the highest bidder. The proceeds from the sale go to pay off the mortgage debt.
If no one bids on the property at the sale, the lender will make a bid, up to the amount owed (including all principal, interest, late charges, attorneys’ fees, trustees’ fees, and costs). Because the lender is already owed this amount, it doesn’t actually have to pay anything. This is called a credit bid.
However, when a receiver is appointed, there might not be a foreclosure sale. In some cases, the receiver can (with the court’s permission and the consent of the lender, borrower, and any junior lienholders) sell the property to a new owner outside of the foreclosure.
Options to Avoid Foreclosure
Commercial borrowers who have defaulted on a mortgage, or are in danger of defaulting, can try to work out a deal with the lender to avoid a foreclosure.
For example, the lender might agree to a forbearance plan that allows the borrower to catch up on the overdue mortgage payments over a certain period of time. Or, the lender might agree to a mortgage modification, which could reduce the interest rate (therefore lowering the payments), cancel a receivership, or extend the repayment term.
It’s best to ask the lender about ways to avoid foreclosure as soon as possible, before the process has gone too far. It is also typically a good idea to speak with a lawyer about the possibility of filing for bankruptcy.
Questions to Ask Your Real Estate Lawyer
- How do I get my lender to pay attention to my request for a modification of my business's mortgage loan?
- Will filing for business bankruptcy help me avoid a foreclosure?
- If my business property is being foreclosed on, is it possible for me to continue running my business at another location?