When a lender seeks to foreclose under a deed of trust, often a borrower who does not have the resources or incentive to resist the foreclosure will offer the lender a deed in lieu of foreclosure. This can be an attractive alternative to a lender in that it holds out the prospect of skipping the delay and expense of foreclosure. It has two principle disadvantages, however. One of these is that borrowers often have success in challenging the deed after the fact, by claiming that the deed was really a form of disguised mortgage. Careful documentation can reduce this risk, though it cannot be entirely eliminated.
The other well-known disadvantage to accepting a deed in lieu is that, unlike a foreclosure, a deed in lieu does not eliminate any junior liens against the property. This can be a big problem if there is a merger of the foreclosing lender’s interest under the deed of trust and its title to the property, upon acceptance of the deed in lieu. Fortunately for lenders, however, merger is a matter of intent, and unless there is evidence that the lender intended such a merger of interests to occur, the lender should still be able to foreclose its deed of trust after acceptance of a deed in lieu if it needs to do so because of a junior lien.
This was illustrated recently in the case of Decon Group, Inc. v. Prudential Mortgage Capital Company, LLC (June 30, 2014) 14 Cal. Daily Op. Serv. 7453, WL 2927406. In that case, a lender accepted a deed in lieu of foreclosure from a borrower where there was a substantial mechanic’s lien junior to the lender’s deed of trust. After accepting the deed in lieu, the lender completed a foreclosure, eliminating the mechanic’s lien. The mechanic’s lien claimant brought a lawsuit alleging that the lender’s acceptance of the deed in lieu resulted in a merger of the interests of the lender as beneficiary of the deed of trust and as owner, essentially eliminating the deed of trust and leaving the mechanic’s lien in place.
The trial court agreed, but on appeal the Court held that there was no such merger, and that the foreclosure validly eliminated the mechanic’s lien. The court cited prior case law which established that there is no automatic merger when junior liens are present, and also discussed the fact that the deed in lieu expressly provided that the debt would remain in place and not be merged out of existence.
To ensure that in accepting a deed in lieu a lender is not agreeing to a merger, it is prudent to include language in the deed in lieu clarifying that no merger is intended. This should preserve the lender’s right to pursue foreclosure of the deed of trust if necessary to eliminate any junior liens present when the deed in lieu is given.