Southeast Real Estate Advisor : Atlanta Real Estate Lawyer & Attorney : Kevin Caiaccio Law Firm : Commercial Development, Retail Leasing : Buckhead, Sandy Springs, Georgia

Given the dramatic rise in foreclosures over the past several years, the Georgia legislature has tackled foreclosure reform on several occasions.  However, this reform has largely been cosmetic and has not helped property owners or lenders.

The most recent attempts at reform are currently pending in the legislature and,  like other recent efforts, are mostly lacking in substance.  House Bill 1228  would provide the borrower with a statutory "right of redemption" for 90 days after the foreclosure sale.  The right would very rarely be exercised because it involves the full payoff of the debt plus penalties within 90 days.  House Bill 972 introduced by Rep. Billy Mitchell would provide a 90-day right-to-cure period after default which the debtor could exercise once every 24 months. 

In 2008, the last time foreclosure reform passed, the measures centered on the content of the notice to the borrower.  While somewhat helpful, many of the reforms do not include a  remedy for violating the provisions.

In my opinion, none of these reforms addresses the major problem with the current system and that is the obstacles to potential buyers bidding at the foreclosure sale.  Although the current system requires notice of the sale by publication for 4 weeks, potential bidders face several challenges:

• Little or no opportunity to perform due diligence
• No set time for the sale to occur (other than a 6-hour window on the first Tuesday of the month)
• No prior notice of when a sale is canceled or postponed

These problems are particularly acute in commercial foreclosures, and the result is that there is rarely competitive bidding.  The lenders are then forced to repossess the property and deal with the headaches of REO property rather than having the chance to mitigate their losses.  I have clients who are often interested in acquiring property at foreclosure but do not have an adequate opportunity to bid.

Any foreclosure reform should focus on improving the bidding procedures so that the sale functions more like a normal auction. 

I'm interested in hearing others' opinions concerning how best to reform our system.  Reform shouldn't be just about helping debtors keep over leveraged properties but also about helping lenders mitigate losses and having properties trade at appropriate values.

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As I wrote back in November, the dramatic fall in real estate values is leading to litigation  involving confirmation proceedings after a non-judicial foreclosure.  Under Ga. law, a creditor is allowed to foreclose on real property without a court hearing or other judicial action.  However, if the lender claims that the foreclosure sale did not fully satisfy the debt obligation and seeks to recover the deficiency, the lender must file a confirmation action which requires a court hearing and testimony as to the fair market value of the property.

The Ga. Court of Appeals issued an opinion earlier this month in Statesboro Blues Development, LLC v. Farmers and Merchants Bank (PDF) which reiterates the deference given to the trial court in determining fair market value.  The case involves a very typical scenario in Georgia:  the borrower purchased a large acreage tract with the intention of developing the property for single-family home lots.  After the residential  market collapsed, the borrower defaulted.  At the time of default, the outstanding loan balance was over $3.5MM.  The bank was the sole bidder at the foreclosure sale (as is usually the case) and bid $2.915MM.  After the foreclosure, the bank sought to recover the deficiency from the borrower and guarantors.

At the hearing, the borrower contested the bank's appraiser's use of comparable sales and his estimate of development costs.  The trial court accepted the appraiser's calculations and found for the bank.  On appeal, the court reiterated Ga. law:  “The trial court is the trier of fact in a confirmation proceeding, and an appellate court will not disturb its findings if there is any evidence to support them.”  Because the trial court found in favor of the bank, the court of appeals held:  "it appears that the opinion is not based on sheer speculation, then this court cannot second guess the methodology utilized to reach the opinion.”

The upshot for future litigation is that the ruling of a trial court will not often be overturned.  The trial court judges are relying on appraisers who are often guessing at fair market value.  The result will be inconsistent rulings based on the leanings of the appraisers and the judges.  In other words, borrowers can only hope for friendly judges.

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According to a recent article in the Atlanta Business Chronicle, "$3.7B in CMBS coming due from 2010 to 2012," approximately $3.7 billion in CMBS loans will mature in the Atlanta market alone between now and the end of 2012.  This provides a local perspective on a problem playing out nationwide.  The CMBS market is not functioning, and as the outstanding loans mature, financing is not currently available. 

The striking point about this problem is that there has been no concrete suggestions concerning where liquidity will be found.  According to William Boston's article in the Wall Street Journal, there is some indication that overseas investors will view depressed real estate prices and a weak dollar as an opportunity to purchase U.S. assets at bargain prices.  But so far, this hope seems to be based mostly on speculation and anecdotal evidence.  There has been much talk about the government’s proposed TALF program and whether it will help fill this void. Initial reports indicate that the program is off to slow start.

Unless liquidity returns to debt markets for CRE, it appears that many assets financed by CMBS loans will be turned over to special servicers.  And in fact, this is already occurring and accelerating at an alarming pace according to some reports.  (To see how this process plays out, see Joel Ross' article from hotelnewnow.com.)  What we will likely see is that special servicers will have to get creative in dealing with distressed assets.  Much remains unknown concerning how this process ultimately will play out . 

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Amongst the drumbeat of bad news and dire predictions, I enjoyed a recent article on Retail Traffic for its fresh perspective ("Commercial Real Estate Debt Won't Be the Next Shoe to Drop, Economists Say").  Many commentators have predicted that commercial real estate loan defaults will be the "next shoe to drop" on a economy struggling to find its footing in a fledgling recovery. 

The Retail Traffic article cites economists who predict that the impact of CRE loan defaults will not be as widespread as the fallout from residential mortgages.  Without a doubt, problems lie ahead in commercial real estate, principally from the lack of affordable debt financing at reasonable levels of leverage, but the fundamentals underlying CRE will ultimately be driven by the health of the economy.  As unemployment slowly moderates and consumer spending falls into a more normal and sustainable pattern, commercial properties, including multi-family and retail, as well as office, will gradually find their footing.

This report at least hold out some hope that the CRE issues should not have the same degree of impact as the residential crisis.

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Given the dramatic drop in commercial real estate values over the past two years, many borrowers are finding that their loan balances exceed the value of the property at the time of a default.  As a result, there has been an increase in litigation surrounding confirmation proceedings after a non-judicial foreclosure.

Under Georgia law, a creditor who forecloses on real property is barred from seeking a deficiency judgment against the borrower and guarantors unless the creditor files an application for confirmation within 30 days of the date of the foreclosure sale.  There are only two issues in a confirmation proceeding:  (1) whether the sale was properly conducted (i.e., in compliance with legal requirements concerning notice and conduct of sale), and (2) whether the property sold for fair market value.  Most of the cases which are litigated deal with the second issue.  Specifically,  the creditor must show in a confirmation proceeding that the property sold for fair market value.

Concerning the determination of fair market value, recent Georgia appellate cases have held as follows:

• The deduction of carrying costs and a bulk-sale valuation of multiple lots are permissible.  Trefren v. Freedom Bank of Ga (PDF)
  
• The deduction of completion costs and lost rents during construction are allowed.  Nash v. Compass Bank (PDF)
• A deduction due to the fact that the properties were in foreclosure is not permissible. Cartersville Developers, LLC v. Georgia Bank & Trust (PDF)

These recent cases reiterate that the appellate court will give great deference to the trial court in weighing the evidence of fair market value.  Borrowers defending a confirmation action must be prepared to submit evidence refuting the lender's calculation of fair market value.  The case law indicates that on appeal the court will not overrule the trial judge's ruling if decided on any rational basis. 

Because of the challenges in setting values and the broad discretion afforded to the trial courts, it will be interesting to follow the trends in the court rulings as more confirmation proceedings are contested in the current real estate market.

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