By Jones Osborn II

Most states have deed of trust statutes that provide for the quick and inexpensive foreclosure of liens against real estate. Under these statutes, certain notices are given, and after a specified period of time, generally about 90 days, the property may be sold at auction. Often the lienholder purchases the property with a "credit bid," which means that he pays for the property with the cancellation of all or a portion of his secured debt. He then has title to the property and can dispose of it at his leisure, or can retain it indefinitely if he so desires. No court proceedings are necessary, and the process normally moves very quickly and inexpensively.

This is not always the case, however. There are a number of things that can happen to slow the process down and increase the expense. It is essential to consider these potential problems if you are (a) lending money on property as an investment, or (b) taking back a deed of trust on property you are selling.

Bankruptcy. The most common problem is that the debtor files bankruptcy. Upon the filing of bankruptcy, any further foreclosure proceedings are immediately halted. This is known as the "automatic stay." At this point, the lienholder should seriously consider hiring bankruptcy counsel to review the situation and protect his interests.

Delay and expense are not the only adverse things that can result from a bankruptcy. Depending on the type of property and the type of bankruptcy, there is also the risk that the lien could be reduced in amount or even entirely released, or that the interest rate or other terms of payment could be modified. Normally, the lien is not released except to the extent that the value of the property at the time of filing bankruptcy is less than the amount of the debt. If the lien is reduced, the lienholder becomes an unsecured creditor for the amount by which the lien is reduced, which often means that little or nothing is paid with respect to this portion of the debt. Because value is a matter of opinion, a lienholder may be unhappy with the amount by which his lien has been reduced by the bankruptcy court, feeling that he could have done better had he been allowed to foreclose.

Even if the amount or terms of the secured obligation are not changed by the bankruptcy court, there is certain to be delay and expense while the bankruptcy case proceeds, or at least until the court can be persuaded to lift the automatic stay so that the lienholder can proceed with his foreclosure.

Litigation. Any debtor who wants to stop a non-judicial foreclosure can file an action with the court to enjoin the foreclosure. Of course, the debtor is supposed to have good grounds to file such an action, but in the desperation created by a pending foreclosure many debtors are able to come up with some sort of basis for seeking an injunction. For example, the debtor might claim that the foreclosure was not conducted strictly in accordance with the law or that there was an agreement that the debtor was to be granted an extension of time, that the debtor has an offsetting claim, or that the creditor defrauded the debtor in some way or otherwise engaged in inequitable conduct. The kinds of claims that may be made are limited only by one's imagination, and depend largely on the facts of the individual case. Whatever they are, however, they slow down the foreclosure and increase its expense, even if ultimately resolved in favor of the lienholder.

Tax Liens. Federal tax liens recorded subsequent to a deed of trust are subordinate to the deed of trust. Not even the I.R.S. can step in ahead of a properly perfected deed of trust. On the other hand, even though tax liens are subordinate, they have special privileges that can cause delay and expense to the lienholder.

Any federal tax lien that is filed at least 30 days before a scheduled trustee's sale can cause a problem. In this situation, the District Director of the I.R.S. must be given notice of the sale at least 25 days before it occurs. If this notice is not properly and timely given, the tax lien survives the foreclosure and moves up in priority because the foreclosing party's lien and any other junior liens have been wiped out by the foreclosure. Even if the notice is properly given, however, that's not the end of the problem. The I.R.S. has 120 days from the date of the trustee's sale to redeem the property from the purchaser for the sales price plus interest at 6%. Because of this 120-day right of redemption, the sale of the property becomes more difficult. Usually, the lienholder purchases the property by a credit bid and then waits 120 days to resell it. Thus, a 90-day foreclosure can turn into a 210-day wait.

It is possible to seek a waiver of the I.R.S.'s redemption rights by submitting certain information. This information is intended to show that the redemption right is of no value. However, even the seeking of the waiver can involve additional time and expense, and there is no assurance it will be granted. Many lienholders find it better just to wait the 120 days.

Conclusion. To be sure, modern deed of trust statutes are a vast improvement over the old procedure which required judicial foreclosure (which is in essence a lawsuit). In most cases, the deed of trust procedure works exactly as intended. However, anyone contemplating the acceptance of an obligation secured by a deed of trust on real estate should be aware that a simple and inexpensive foreclosure is not guaranteed. It is a good idea to make sure your debtor is financially sound before accepting any obligation secured by a deed of trust, even if the value of the security is adequate. It is usually the debtor in financial straits that goes into default, files bankruptcy, commences litigation, or becomes subject to tax liens. If any of these things occurs, delay and expense are certain to follow.