The deed in lieu of foreclosure has always been an important settlement or loss mitigation device in the mortgage foreclosure equation. Because it is so well known, perhaps we need not outline its use here.
What does merit attention, though, is the not uncommon creative approach to pursue a deed in lieu to hold as a sword to insure that the borrower keeps some promises as part of a settlement or forbearance – payments, placing insurance, selling another parcel, etc. This seems to make sense because what occurs when a foreclosure action ends is that the foreclosing lender either becomes the owner of the property (presumably to sell it for a sum sufficient to satisfy the mortgage obligation) or is paid sums up to the full amount due. (Nowadays there may be some compromise with a lesser sum paid, but the concept is the same.) Therefore, having the “end result” already in hand – a deed – seems to offer considerable comfort, savings and security.
However, the conspicuous flaw in such an apparently seductive scenario (from a mortgage holder’s vantage point) is a legal concept that prevails in many states, New York chief among them. A deed, although absolute on its face, when given as security for payment of a debt, is in actuality a mortgage – quite an ironic twist.
Dating back to 1909, this is even a matter of statute in New York, RPL §320:
“§320. Certain deeds deemed mortgages
“A deed conveying real property, which, by any other written instrument, appears to be intended only as a security in the nature of a mortgage, although an absolute conveyance in terms, must be considered a mortgage; and the person for whose benefit such deed is made, derives no advantage from the recording thereof, unless every writing, operating as a defeasance of the same, or explanatory of its being desired to have the effect only of a mortgage, or conditional deed, is also recorded therewith, and at the same time.”
As a practical matter, this legal rule thwarts the lender’s or servicer’s intention to effortlessly become the owner of the property should a default upon the settlement ensue. The reason is because the mortgage holder would be constrained to foreclose upon the deed as a mortgage, which is pointedly incongruous since the mortgage holder already holds a mortgage.
A sobering example which highlights the practical danger of this concept emerges from a New York matrimonial case settled by a stipulation entered into in open court, an agreement which would otherwise typically be inviolate. (See Gioia v. Gioia, 234 A.D.2d 588, 652 N.Y.S.2d 63 (2d Dept. 1996).
The terms of the stipulation were that the husband was to pay a certain sum in installments to the wife, who was to convey her interest in the marital residence to the husband in escrow, pending receipt of all sums due. In turn, the husband secured the obligation with a mortgage to the wife, together with a deed conveying his interest in the property to the wife, likewise to be held in escrow. In the event of default, the parties agreed that the wife could either foreclose the mortgage or simply record the deed. Lenders and servicers can readily see how this might match up to a typical thought about how to use a deed in lieu in a pure mortgage foreclosure matter.
The case did end up in default, and the wife moved in the resultant litigation for a declaration that she was the owner of the property, having chosen (perhaps, not surprisingly) to refrain from slogging through an onerous foreclosure action. But, the court declined to so declare. Because the deed was a mortgage, the wife was obliged to foreclose, notwithstanding what the stipulation stated.
This principle, and the consequences, can readily translate to circumstances involving settlement of a mortgage foreclosure case. In his or her zeal to obtain a forbearance, a borrower might say to a servicer: “Hold a deed to the property, so if I don’t keep my promises, you own it.” And, the servicer might just view this as a good way to assure a quick and favorable settlement route. But, if a servicer holds a deed to the mortgaged premises to secure performance of a stipulation or forbearance agreement, the deed is not likely to provide title in the event of default. Rather, it will have given the servicer yet another mortgage to foreclose, which is hardly an advantage.
In summary, the role of a deed as security in the foreclosure process is limited at best. Because, however, the legal consequences can vary from state to state, familiarity with the nuances in the jurisdiction where the question arises is essential – as is knowing in advance that a potential problem is lurking, as it does in New York.
Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.