Possible Alternative to State Court Foreclosure
Thomas A. Gugliotti, Esq.
May 11, 2021
Substitute Bill No. 6356, “An Act Adopting the Uniform Commercial Real Estate Receivership Act” (the “Bill”), now pending in the Connecticut Legislature, if passed and signed into law, would provide an alternative (but not a replacement) to the present usual remedy of a judicial foreclosure upon default in a real estate mortgage. Under current Connecticut law (and as has been the case for decades – even safe to say, centuries), upon a default in a real estate mortgage, the lender’s remedy is to initiate a litigation case generically known as a “foreclosure”. The result of such foreclosure would be either a foreclosure by sale involving a forced sale by way of public auction, or the unique remedy of “strict foreclosure”, by which there is no sale but title to the property vests either in a redeeming defendant, or failing that, in the plaintiff.
A Connecticut foreclosure is a form of “litigation”, a “lawsuit”, much the same as for example, a suit for damages, negligence or to enforce some contract right. It requires commencement of a lawsuit, followed by all of the usual and required pleading, discovery and trial requirements as found in just about all other litigation cases. While a foreclosure of a mortgage is designated as a “privileged case”, which supposedly moves the case up the trial calendar ladder more quickly than other cases, it is still not unheard of for a Connecticut foreclosure to take upwards of a year, two years or longer to complete. It is not apocryphal to say that there are some foreclosures that are still pending after ten years.
Substitute Bill No. 6356 would create an alternative path for the exercise of remedies after a mortgage goes into default, excluding a mortgage that covers four or less “dwelling units”. There are some exceptions to this exclusion such as for example, if the dwelling units are used for agricultural purposes. Among the apparent intentions and goals of the Bill are to allow for a more expeditious and presumably less expensive means to foreclose a defaulted mortgage, through the Court appointment of a Receiver, whose purpose would be, among other things, to sell the subject property and return the proceeds to the lienors of the property, in their order of priority. All under the supervision and oversight of the Court. Much the same as would occur in the present “foreclosure by sale” procedure.
Upon a default in a mortgage, rather than the mortgagee commencing a lawsuit in the nature of a foreclosure, the mortgagee would have the option to initiate a case seeking the appointment of a Receiver. Generally, such appointment of a Receiver by the Court would be after notice and an opportunity to be heard by the parties in interest, including of course the mortgagor. In some instances, if the Court were to find that circumstances required it, the Receiver could be appointed without prior notice to the owner. The Court may also consider appointing a Receiver after notice to the owner but without a hearing. These later two circumstances would seem to be intended to prevent some extraordinary loss that might result if prior notice were given and if a hearing were scheduled. The general course however, would be the giving of prior notice to the owner and a hearing prior to the Court appointing the Receiver.
The Court which appoints the Receiver would then have exclusive jurisdiction to determine any controversy relating to the receivership or the receivership property. This would appear to be the place where disputes over the mortgage, liens, debt and priorities would be considered.
The Bill contains extensive provisions regarding the qualifications and powers of the Receiver, and the process of the Court’s oversight over the Receiver’s activities. Much like the current “foreclosure by sale” procedures, the Receiver would have the ability to sell the property, free and clear of liens at and below the mortgage which precipitated the receivership, with the proceeds then being distributed to lienholders in accordance with their priorities, as supervised by the Court. If the party initiating the receivership is for example, a “second mortgagee”, the sale by the Receiver would be subject to the lien interest of the senior lienor. Such sale however, would have the effect of “foreclosing out” any subordinate liens and the lien from which the receivership case was initiated. Same as in the current “foreclosure by sale” regimen.
Analogous to the filing of a bankruptcy case in which real property is an “asset of the estate”, upon the appointment of a Receiver there would be a stay of any other action against the subject receivership property. There are numerous other aspects of the Bill that look much like a page out of the Bankruptcy Code:
- The Receiver must be free of any actual or potential conflict of interest;
- The Receiver may deal with “executory contracts”;
- Without Court approval, the Receiver can operate the business “in the ordinary course”, if the property subject to the receivership is a business;
- To the extent applicable and without prior Court approval, the Receiver can incur unsecured debt in the ordinary course of business;
- With Court approval, the Receiver may incur debt that is not in the ordinary course of business;
- The Receiver may pay expenses incurred in the ordinary course;
- The Receiver may, with Court approval, engage necessary professionals;
- A party in interest may seek “relief from the stay” imposed by the receivership by petitioning the Court;
- A claims process is provided for;
- The sale of property covered by the receivership may be by public or private sale.
The most essential element of the Bill is the ability of the Receiver to sell receivership property. Sale of receivership property which would be part of the “ordinary course” of the receivership entity’s business may be conducted without prior Court approval. Sale of receivership property which is not in the ordinary course requires Court approval. No doubt this is the lynchpin of the Bill, that is, providing a mechanism for the sale of receivership property, especially real property with much the same consequences as would be the case in a foreclosure by sale. The Bill allows however, for a sale by either public auction – or by private sale. The implication here is that the Receiver will have the opportunity to maximize on the receivership assets by proceeding other than by a “forced sale” – public auction. Instead, the Receiver can engage in marketing the property in order to obtain a sale in an arms-length transaction, presumably maximizing the recovery on the property.
Which leads to two basic questions: (1) why is this Bill useful? and (2) what if anything would be “lost” if the mortgagee elected to use the receivership procedures rather than our existing foreclosure litigation process?
The answer to the first question may be that this proposed receivership procedure would present a more expeditious process to pursue a foreclosure of a defaulted mortgage – while still retaining the judicial oversight that our 200 or so years of jurisprudence provides. The intention seems to be to streamline the foreclosure process, while interjecting perhaps a new feature, which would be the Receiver’s ability to market a property for sale and negotiate a favorable price in an arm’s length transaction, rather than subject the property to a distressed public auction sale.
It may be the intention of the Bill to allow a court to more expeditiously deal with issues that come up in the context of a typical “contested foreclosure” – though the manifestation of that intention may not be readily apparent. Parties in interest would still have the opportunity to raise issues as to the enforcement of the mortgage or to question priorities. The Bill contains the provision that the Court would have “exclusive jurisdiction to . . . determine any controversy related to the receivership or receivership property.” The Bill also states that unless specifically “displaced” by some provision in the Bill, “. . . the principles of law and equity supplement . . .” the provisions in the Bill.
As to what may be “lost” under this Bill if a mortgagee exercised the opportunity to seek a Receiver, absent is any reference to what we now know as the “strict foreclosure” remedy. Connecticut and Vermont are the only states in this country that have the remedy of “strict foreclosure”. For a property owner, the possible advantage of a strict foreclosure is that the fair market value of the property is applied to the debt when calculating a deficiency – not the diminished “forced sale” which results from a typical foreclosure by sale. But, this Bill provides that the Receiver does not have her hands tied to a “forced sale” at all. In fact, a significant feature of the Bill is that it allows the Receiver to “market” the property, and presumably get a better return on the property than any forced sale. That result would seem to benefit both mortgagor (owner) and mortgagee (lender).
In fact however, nothing is “lost” in terms of available remedies: a mortgagee can still elect to pursue a foreclosure in the traditional way. If this Bill is adopted and becomes law, there will be two paths for a mortgagee to choose from with respect to enforcing lien rights against real property – the traditional foreclosure suit, or seeking a Receiver.
While this Bill has passed through several preliminary steps in the Connecticut legislative process at this point, it of course remains to be seen if it will be adopted in both the Connecticut Senate and House of Representatives, and then be signed into law by the Governor.
Thomas Gugliotti is the Chair of the Firm’s “Creditor’s Rights Practice Group”, having practiced in this area, including foreclosures, for over 40 years. He has been a contributing author to the leading treatise on foreclosures in Connecticut, Connecticut Foreclosures, An Attorney’s Manual of Practice and Procedure. Attorney Gugliotti can be reached at 860.548.2661 or at firstname.lastname@example.org.