Lenders Need to Consider Title Insurance Super Early in UCC Foreclosures

The reward for overcoming one obstacle is the opportunity to face another.

Amid the wave of Uniform Commercial Code (UCC) foreclosures in commercial real estate, title companies have shown a tendency to be meticulous in underwriting a new owner’s title insurance policies for lenders that are foreclosing. Obtaining an owner’s title insurance policy, whether at the time of the foreclosure or in connection with a subsequent sale of the real property, is one of many important aspects of a UCC foreclosure a lender must consider.

Many title companies in today’s market will open discussions with a lender’s counsel by telling them that issuing a new policy is not guaranteed, and that the title company will be scrupulous in reviewing the foreclosure process. The concerns of title companies vary, but the key priority is whether a UCC foreclosure was carried out properly in all respects or if the foreclosure could be challenged by the foreclosed-out borrower.  

The UCC only has a “commercially reasonable” standard for notices of sale, which is typically a minimum of 10 days, but a title company may now require a much longer process involving a brokered sale that could take up to 90 days. 

Additionally, the title company may require more “on the ground” updates, such as who is in possession of the property — even something as simple as who holds the keys — who is doing work at the property; who is paying for insurance; or have there been any rumblings of a bankruptcy. Some of these questions may only be possible to answer after the UCC foreclosure sale occurs. In certain instances, title companies will wait a particular period of time after the sale before issuing a policy, or they may issue a policy at the sale, but it will be rife with exceptions. Ultimately, the result is a protracted process burdened by additional uncertainty on whether a policy will actually be issued.

Once the gavel falls on a UCC foreclosure, lenders are left with the question of whether to obtain a new owner’s title insurance policy. Given the lender now controls the property owner (or ownership entity), the lender may choose not to purchase a new owner’s policy and instead rely on the existing owner’s policy or on the existing mortgage loan title policy, if the mortgage loan remains in place. 

Relying on the existing mortgage loan title policy would only apply for a mortgage loan that includes an equity pledge, as opposed to a lender holding only a mezzanine loan. More so now than in prior years, commercial mortgage lenders are requiring borrower equity pledges in addition to the property itself to collateralize mortgage loans; they do this to benefit from a possibly shorter foreclosure timeline, particularly in states with drawn-out judicial mortgage foreclosures, such as New York and Florida.

The lender that chooses to rely on an existing owner’s policy would save the expense of purchasing a new one — every dollar saved counts in a foreclosure scenario — but the lender would not have coverage through the date of the foreclosure, thus leaving them exposed via a gap in coverage between the date of the existing owner’s or lender’s policy and the date of the foreclosure. Depending on its circumstances, a lender may conclude that it is worth it to purchase a new owner’s policy. 

It’s important to remember that while a lender may or may not elect to purchase a new owner’s policy in connection with a UCC foreclosure, a subsequent purchaser of the property from the lender may not have that luxury and likely will require a new owner’s policy; and said purchaser’s lender will likely require the same as well. In that instance, the title company issuing the owner’s policy and/or new lender’s policy will likely have similar concerns as the title company that would have issued a new owner’s policy at the time of the foreclosure.

Given the possible end user implications for a subsequent sale of the real property, thought should be given to title insurance as early as possible when exercising remedies under the UCC. It is critical that lenders be diligent in foreclosing, even if they may not be thinking about a new owner’s policy at the time of the foreclosure. There are many aspects to a UCC foreclosure sale, and while the key is to conduct it in a reasonable manner to pass muster, it’s equally as important to keep in mind post-closing matters. 

In real estate, the details you overlook today may become the obstacles you pay for tomorrow. 

Scott Levine and Christine O’Connell are partners within the real estate and funds practice at global law firm King & Spalding.