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Obtaining Title Insurance for Deeds in Lieu
The recent increase in the number of mortgage defaults has led to renewed interest in alternatives to the traditional foreclosure process, including the deed in lieu of foreclosure [“DIL”]. It is well-settled that a mortgagor may give up his equity of redemption in a separate instrument which is supported by adequate consideration. (The mortgagee's forgiveness of the mortgage debt is generally deemed to satisfy this requirement.) However, an instrument of this nature presents two major problems: First, the mortgagee acquires title subject to junior (or intervening) liens, encumbrances, etc. Second, if the mortgagor files a bankruptcy petition, the DIL is vulnerable to attack as a preference or fraudulent conveyance. See 11 U.S.C. §§ 547 and 548.
Note that the mortgagor may not waive the equity of redemption in the mortgage instrument itself, or in a document executed contemporaneously there­with. Accordingly, requests to insure the validity of DILs delivered into escrow at the time of the mortgage closing are viewed with skepticism by title insurers. This is because the same may be attacked as a clog on the mortgagor's equity of redemption. Furthermore, if the mortgagor-grantor dies, is adjudicated incompetent or files a bankruptcy petition prior to its delivery out of escrow, questions may be raised about its effectiveness as a conveyance of title.
Sometimes a mortgagee will require a DIL to be delivered into escrow as part of a post-default "workout". In such cases it may be argued that because the mortgagor has already defaulted, allowing the mortgagee to commence a foreclosure suit, the mortgagee's forbearance is sufficient to justify the arrangement. Obviously, this is a sensitive matter in which the title company’s willingness to insure must be decided on a case-by-case basis.
The mortgagee may wish to have the DIL recite that the mortgage is not intended to merge with the fee, in order to facilitate a strict foreclosure suit (if the same should prove necessary), or in the event the transaction is subsequently attacked by the mortgagor's bankruptcy trustee. However, it should be noted that if a federal tax lien has been filed against the mortgagor, a strict foreclosure suit (which does not result in a judicial sale) cannot be relied upon to divest the interest of the United States. See 28 U.S.C. §2410.

Upon subsequent conveyance to a bona fide purchaser for value, the mortgage may be discharged in the conventional fashion, or by recital in the deed. However, most county recording officers now take the position that unless the mortgage is discharged before (or simultaneously with) the recording of the DIL, realty transfer tax [“RTF”] must be paid.

In cases where the mortgage is not merged with the DIL, title insurers may be requested to pro- vide so-called non-merger coverage in the owner’s policy insuring the DIL grantee. Although there is no standard form or endorsement for the same, title companies have occasionally agreed to do so in some instances. Nevertheless, such coverage is considered to be an extra-hazardous risk, for which an additional premium may be charged.

Where a DIL is delivered in connection with a mortgage which secures a lien on residential property, the lender may wish to take advantage of the remedy found in the Fair Foreclosure Act [“FFA”]. The FFA’s so-called “optional procedure” permits strict foreclosure under certain circumstances. See N.J.S.A. 2A:50-63. In such cases, the DIL is subject to a seven (7) day right of rescission, and proof must be obtained that the right has not been exercised.
Underwriting guidelines promulgated by the Fidelity National Title Group (and most title insurers) permit the insurance of DILs, but only if:
(a)        all liens or interests appearing of record, whether prior or subsequent to the recording of the mortgage, are set up as exceptions; and
(b)        an ALTA 2006 policy (containing a creditors’ rights exclusion) is issued; and
(c)        proof is obtained that the mortgagor has vacated the property (or the exception for rights of parties in possession is retained in the policy); and
(d)        the other guidelines set forth herein, as well as any additional requirements which may be imposed by the underwriter, are adhered to.
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