Is a Bank Required to Take a Deed in Lieu?

New York Real Estate Journal recently published an article authored by Co-Chair of Olshan’s Real Estate Law practice Thomas Kearns entitled “Is a Bank Required to Take a Deed in Lieu?” In the article, Tom explains that non-recourse loans are the market standard in sophisticated New York real estate deals. These loans allow the lender to recover only from the property itself, not from the borrower or their principals, except in cases of "bad acts" such as fraud, bankruptcy or environmental violations, which are covered by carve-outs. Lenders typically cap the loan at a percent of the appraised value to protect against potential drops in property value, and if property value falls below the loan amount, the lender absorbs the loss after borrower equity is depleted. “The theory is that by limiting the loan to value ratio at the time of the making of the loan the lender eliminates or limits the loss if the value of the property diminishes,” Tom writes. Once equity is lost, borrowers often have no incentive to manage the property. Lenders’ main option, although costly, is foreclosure. Tom cites a recently filed action in New York (New West Harlem Owner LLC v. SIG RCRS A/B MF 2023 Venture LLC) as an example, wherein the borrower seeks to hand over the property via deed-in-lieu of foreclosure, but the lender refuses, asserting that it has the right to elect its remedies, even though it hasn't chosen to foreclose. “As a policy matter,” Tom asks, “should New York law require the lender to accept a deed in lieu in these circumstances? Logic would indicate that it should since there is no other remedy that the lender has.” This case raises significant questions about borrower and lender rights in non-recourse loan situations, and its outcome could influence future policy or contract drafting. Tom concludes: “If a non-recourse lender won’t take a deed in lieu, won’t agree to a short sale and won’t foreclose, what is a borrower to do?”