Businesses can get into financial trouble and fall behind on mortgage payments. Failing to make the payments or violating the loan contract in some other way is called "defaulting" on the loan. After a default, the lender typically begins foreclosure proceedings to sell the property to recoup the loaned money.
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: judicial or nonjudicial. Whether a particular foreclosure will be handled through a judicial or nonjudicial process depends on the law of the state where the property is located (some states allow only judicial foreclosures) and the language and terms of the mortgage contract.
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 type of foreclosure is called an "uncontested" foreclosure. On the other hand, if the foreclosure is validly contested, a trial will probably take place. If the borrower loses at trial, the court will enter a judgment in favor of the lender.
The foreclosure sale date will be set after the court enters a judgment and orders the property sold to satisfy the mortgage debt.
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 publish notice in a newspaper. Each state’s laws are different.
The 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:
- doesn't allow the property to deteriorate
- continues to maintain, secure, and insure the commercial property, and
- doesn't 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 request 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 generally 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 type of bid is called a "credit bid."
However, when a receiver is appointed, a foreclosure sale might not happen. Instead, in some cases, the receiver can sell the property to a new owner outside of the foreclosure with the court’s permission and the consent of the lender, borrower, and any junior lienholders.
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 repayment plan, allowing the borrower to catch up on the overdue mortgage payments over time. Or, the lender might agree to a mortgage modification, 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. Speaking with a lawyer is also typically a good idea.