Relating to Real Estate
Consider Becoming a Mortgagee-in-Possession When Your Borrower with Income-Producing Property Defaults
A version of this article was published in The Daily Record on July 7, 2014.
Lenders’ counsel typically take steps to prevent their clients from being deemed to be mortgagees-in-possession of distressed real property. However, under some circumstances it may be advantageous for a lender to become a mortgagee-in-possession.
In a recent action in Baltimore City, on behalf of the holder of a loan that was in default, we obtained a court order in a foreclosure case that gave the lender the right to collect the rents from the tenants of a multi-family project and to take over the operation of the property prior to the foreclosure sale. PP Baltimore 3 LLC v. Quantum Leap Investments LLC, in the Circuit Court for Baltimore City, number 24-O-12-002132.
Typically, when a lender wants to capture the rents and provide for the operation of income-producing property, it petitions a court to obtain the appointment of a receiver. In this case, however, we considered the benefits of the lender being a mortgagee-in-possession and pursued that course.
What is a mortgagee-in-possession? Maryland is a “title theory” state, meaning that a mortgage or deed of trust constitutes an actual conveyance of title to the property by the borrower, rather than the mere grant of a lien in the property. While this would ordinarily seem to allow the lender to take possession of the secured property whenever it wants, a typical mortgage or deed of trust provides that the borrower is entitled to retain possession of the property until the occurrence of a default. Upon a default, however, the lender becomes entitled to possession of the property, Windsor Const. Corp. v. Kolker, 180 Md. 113, 23 A.2d 29 (1941), and, upon exercise of that right, it is a mortgagee-in-possession.
Upon taking possession of the property, a lender, as a mortgagee-in-possession, is subject to certain duties, which have been enunciated in a progression of judicial decisions. Generally, a mortgagee-in-possession is charged with treating the property “as a provident owner would do.” Booth v. Baltimore Steam Packet Co., 63 Md. 39, 44 (1885). A mortgagee-in-possession must account for the proceeds generated by the operation of the property, id., must maintain the property in ordinary repair, id., and must pay taxes assessed against the property, Barron v. Whiteside, 89 Md. 448, 458-59 (1899). If the borrower’s estate in the property is a leasehold, such as pursuant to a ground lease, the lender will be obligated to pay the ground rent. Williams v. Safe Deposit & Trust Co. of Baltimore, 167 Md. 499, 504-05 (1934). Additionally, the right of a mortgagee-in-possession to make improvements to the property is very limited because the concomitant increase in the property’s value will render it more difficult for the borrower to redeem the property through payment of the secured debt. Dougherty v. McColgan, 6 Gill & J. 275, 285-86 (1834).
While there are certain advantages to a lender taking possession of property as a mortgagee-in-possession, there are also risks. If a lender taking possession of property is considered to be possessing the property to the exclusion of the mortgagor’s rights, such as by denying the mortgagor the right to redeem the property from the mortgage, then the lender could be deemed a wrongdoer and have liability to the borrower under Booth.
Taking control of a property as a mortgagee-in-possession, however, offers a lender considerable benefits over seeking the appointment of a receiver. Typically, a court will require that a receiver be a disinterested third party, which will necessitate the hiring of an independent receiver by the lender and the payment of the receiver’s fees. As a mortgagee-in-possession, the lender is able to avoid these fees. (The requirement that a receiver be disinterested is under Title 13 of the Maryland Rules, which governs receiverships. Even though these Rules specifically provide that they do not apply to receivers appointed under mortgages or deeds of trust, courts will often look to these Rules in receivership cases.)
A receiver will often be required to make periodic reports to the court about the operation of the property, but this requirement can generally be relaxed or avoided in a mortgagee-in-possession situation, especially if a lender becomes a mortgagee-in-possession in the context of a foreclosure. The lender should account for the finances regarding the property from the time it took control as part of the post-foreclosure-sale audit process.
In PP Baltimore 3 LLC v. Quantum Leap Investments LLC, our goal was to enable the lender to control the property prior to a foreclosure sale without having a receiver appointed. Additionally, the lender wanted the benefits of the rights as a mortgagee-in-possession, while minimizing both the uncertainty of its obligations (which, as an outgrowth of judicial decisions, were subject to some degree of interpretation) and the possibility of claims by the borrower that the lender was improperly possessing the property. Thus, our goal was to have the lender exercise the rights of a mortgagee-in-possession pursuant to a court order, which would specify the extent of the lender’s obligations.
To do this, we instituted the foreclosure process by filing a Petition to Foreclose under the “assent to decree” clause of the deed of trust, rather than the more common method of filing an Order to Docket under the “power of sale” clause. In the Decree for Sale that we submitted to the Court, we provided for the lender to take possession of the property, and we explicitly set forth the rights and obligations of the lender in this context. While the Court required that the Petition to Foreclosure be served on the defendant (a requirement not usually imposed in a foreclosure action that does not involve single-family residential property because it is ex parte), the lender was able to take possession of the property essentially as a mortgagee-in-possession, but with the specificity of a court order that circumscribed its rights and duties.
As the case worked out, the lender took possession of the property, collected the rents, paid the expenses, and controlled the operation and management of the property. Then it conducted a foreclosure sale on the property. After the sale, it accounted to the court auditor for the income and expenses for the period of time when it acted as mortgagee-in-possession.
Lenders often avoid becoming mortgagees-in-possession, but under the right set of facts, it is a path worth pursuing.