Possession of Property before Foreclosure - dummies

Possession of Property before Foreclosure

By Alan R. Romero

The mortgagor has the right to possess the property as long as she doesn’t default. The mortgage agreement specifies what constitutes default, but generally acts of default include failure to repay the debt as agreed and breach of other important obligations, such as paying property taxes.

The fundamental right of a mortgagee is to sell the property in foreclosure if the mortgagor defaults. But the lender/mortgagee may not want to foreclose immediately when the borrower/mortgagor first defaults.

And even if the mortgagee does want to foreclose immediately, the process of foreclosing can take a while. In the meantime, the mortgagee wants to make sure the property’s value doesn’t decline and thereby reduce the amount the mortgagee can recover if and when it ultimately forecloses.

The mortgagor who defaults may not have the money to manage the property well, and the mortgagor who expects to lose the property in foreclosure may stop taking care of the property. The mortgagee therefore may want to protect the property by having someone else possess and manage it. The mortgagee may do this in two ways:

  • It can take possession itself.

  • It can have a court appoint a receiver to take possession.

How the mortgagee takes possession of the property

If the mortgagor defaults, the mortgagee may have the right to take possession of the property. In a title theory state, the mortgagee can immediately take possession upon default. And in some lien theory states, the mortgagee can take possession upon default if the mortgage agreement gives the mortgagee the right to do so. In other lien theory states, however, the mortgagee has no right to take possession before foreclosure.

If the mortgagee does take possession, it doesn’t simply become the owner of the property with the right to do whatever it wants to do with the property. Rather, the mortgagee acts as a sort of trustee for the mortgagor. The mortgagee must manage the property prudently for the benefit of the mortgagor, including making repairs and paying essential expenses with the available income from the property.

The mortgagee in possession is also liable in tort to third parties, just as an owner would be. So taking possession has some benefits, allowing the mortgagee to protect the property and manage the rents or other income from the property, but it also has some risks of liability to the mortgagor or third parties.

How the mortgagee appoints a receiver

A receiver is a person appointed by a court to take possession of the property and manage it, such as maintaining it and collecting rents from tenants. As the preceding section explains, in some situations the lender itself can’t take possession, so a receiver is the only way to take possession from the mortgagor.

Even if the mortgagee could take possession itself, having a receiver appointed may be easier, and doing so avoids the duties and risks that come with taking possession.

The mortgage agreement may specify circumstances in which the mortgagee is entitled to have a receiver appointed. Some courts will enforce such agreements, but other courts reason that the appointment of a receiver is an exercise of the court’s equitable discretion, so they either disregard the mortgage clause entirely or apply their own criteria differently if the mortgage clause would authorize appointment of a receiver.

Even if the mortgage agreement doesn’t say anything about appointment of a receiver, a mortgagee may still ask the court to appoint a receiver. In that case, the court will of course apply its own criteria for deciding whether to appoint a receiver. And once again, even if the mortgage agreement does specify grounds for appointment of a receiver, some courts will still apply their own criteria.

Courts vary in the requirements for appointment of a receiver, but generally they consider the following:

  • Waste: Some courts appoint a receiver only if the mortgagor has committed waste or threatens to commit waste. Other courts simply consider waste as one factor in deciding whether to appoint a receiver. Waste essentially occurs when the present owner of the property acts in some way that impairs the value of the property in which another has a future interest.

    Damaging or neglecting the property in a way that reduces its value is waste. Failure to pay taxes, to pay mortgage interest, or to apply rents to the mortgage debt may also be waste, because doing so increases the debt secured by the mortgage and therefore reduces the extent to which the mortgagee’s debt is secured.

    If there’s no threat of waste, courts figure there’s no reason to think that a receiver is needed to protect and preserve the property — the mortgagor can do it herself.

  • Inadequate security: Some courts will appoint a receiver only if the security is inadequate; others consider inadequate security as a factor. The security is inadequate if the market value of the property isn’t enough to ensure that the mortgagee can get the debt fully repaid by foreclosing.

    If the property is worth well more than the outstanding debt, courts reason that a receiver isn’t needed because the mortgagee can simply proceed with foreclosure and thereby get its debt fully repaid.

  • Default and mortgagor’s financial ability: Some courts require that the mortgagor be in default before appointing a receiver. Others don’t require default, but they do consider the mortgagor’s financial circumstances that may make a default likely. If the mortgagor is in financial distress, that supports the mortgagee’s argument that a receiver is needed to ensure the property is well managed.

  • Other considerations: If the mortgagor has somehow committed fraud, the court may conclude that a receiver is needed to ensure the property is managed properly, even if the mortgagor hasn’t committed waste.

    A court also may consider what alternatives to a receiver are available to the mortgagee, wanting to avoid the harsh remedy of taking away possession from the mortgagor who, after all, owns the property. The court may compare the harms to the parties in deciding whether to appoint a receiver.

The receiver is an agent of the court, not of one of the parties. But she does have a duty to both parties to manage the property with reasonable care, skill, and loyalty. The mortgagee has no duty to fund the receiver’s activities, and the receiver has no duty to spend her own money to manage the property.

The receiver’s duty is just to use the money from the property itself or money that the interested parties give the receiver for that purpose.