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Chapter 10

Legal Aspects of Real Estate Finance

Objectives

• After reading this chapter, you should be able to– Prepare a promissory note.– Prepare a guaranty.– Understand the basic provisions contained in a

promissory note.– Understand the basic provisions contained in a

guaranty.

Objectives

• After reading this chapter, you should be able to– List the legal requirements for a mortgage, deed

of trust, or security deed.– Understand the risks inherent in a second

mortgage.– Identify the various legal remedies available to

both the borrower and the lender in the event of a default on a mortgage loan.

Promissory Note

• Promise made by one party (payor or maker) to pay money to another party (payee)

• Note may be negotiable or nonnegotiable– Negotiable• Note can be transferred from the original payee to a

third party (holder) who may become a holder in due course

Promissory Note

• Holder in due course (HDC) defeats any defenses to payment that the maker of note may have– Investors want HDC status• E.g., Fannie Mae, Freddie Mac, and other investors in

the secondary market

Promissory Note

• Exceptions to HDC rule– Incapacity of the maker– Illegality of the purpose of the note– Duress of the maker in signing the note– Discharge of the maker in bankruptcy– Forgery of the maker's signature– Fraud in factum– Material alteration of the note

Promissory Note

• Endorsement– Simply, a direction• Usually printed on the back of the note or attached to

the note

– Specifies that the money be paid to the order of the new owner of the note

– Notes are transferred and sold by endorsement

Promissory Note

• Endorsement– Certain contractual and warranty liabilities are

transferred to the new owner of the note– Endorser who sells the note by endorsement

warrants the following:• Endorser has good title to the note• All signatures are genuine and authorized

Promissory Note

• Endorsement– Endorser who sells the note by endorsement

warrants the following:• The note has not been materially altered• There are no defenses to payment of the note• Endorser has no knowledge of any bankruptcy

proceedings against the maker

Promissory Note

• Endorsement– Qualified endorsements– “Without recourse and warranty” • Negates contractual liability but still imposes warranty

liability on the endorser• Few investors purchase notes that contain a “without

recourse and warranty” endorsement

Promissory Note

• Payment– Maker's promise on a negotiable note is

unconditional– Maker is not released by the sale of the security

securing the note• Holder of the note is the only person entitled to

payment• To avoid multiple payments, makers of notes demand

that the original note be returned marked “paid” or “satisfied”

Promissory Note

• Prepayment– Note cannot be prepaid before the date

established in the note for payment– Right to prepayment must be provided for in the

note– Prepayment clause is used on commercial loans

held by life insurance companies and other commercial mortgage loan investors

Promissory Note

• Usury– Maximum interest rate

• Execution– Signed but witness or notary not needed– Usually not recorded

Promissory Note

• Practice tips for the paralegal– Original of the note is the best evidence of the

note at the time of collection– Corrections on the notes should be avoided– For notes that are more than one page in length,

the maker should initial each page of the note

Promissory Note

• Practice tips for the paralegal– Case• Acord v. Jones, 211 Ga. App. 682, 440 S.E.2d 679 (Ga.

1994)– Absent an express contractual provision to the contrary, the

maker may prepay the principal plus accrued interest without being required to tender unaccrued interest or pay any other penalty

Checklist: Preparation of a Note

• Parties– Maker• Borrower

– Payee or holder• Lender

• Amount of note


• Interest rate to be charged on note– Fixed– Adjustable

• Payments– Time and place of payments– Amount of payments


• Maker's right to prepay– May prepay in whole or in part at any time– May prepay in whole at any time after reasonable

notice– No prepayment allowed– No prepayment allowed for a certain period of

time


• Maker's right to prepay– Prepayment allowed on payment of prepayment

fee– No prepayment allowed for a certain period of

time, and after that period of time, prepayment allowed only on payment of prepayment fee


• Maker's failure to pay as required– Late charge for overdue payment– Amount of late charge– Default for failure to pay• Grace period• Notice of default and period of time to cure default• Acceleration of loan on default• Payment of holder's cost and expenses for collection of

note


• Identify security given for note– Mortgage or deed of trust– Assignment of leases and rents– Security agreement– Other documents

• Usury savings clause• Choice of applicable law


• Waiver of homestead exemption or other debtor's rights

• Joint and several liability• Waiver of notice of default, presentment of

notice of dishonor


• Signatures– Only maker signs note• Corporate maker• Partnership maker

– Names of all signers should be typed underneath the signature line

– Notes are not witnessed or notarized

Guaranty

• Mortgage lender may require a person other than the debtor to guarantee the payment of the debtor's note

• Gives mortgage lender the right to sue the guarantor for payment of the note and, if necessary, the right to recover debt from the personal assets of the guarantor (or corporation)

Guaranty

• Must be written• May either be payment or collection guaranty– Payment• Unconditionally guarantees to pay the note when due

without resort to any other party– Collection• Promises to pay the note only after the holder of the

note has sued the original maker of the note, has reduced claim to judgment, and has attempted to collect against the assets of the maker

Mortgages, Deeds of Trust, andSecurity Deeds

• Three basic types of security instruments1. Mortgage2. Deed of trust3. Deed to secure debt

Mortgages, Deeds of Trust, and Security Deeds

• Mortgage– Pledge of land as security for a debt


• Deed of trust– Debtor conveys title of land to the trustee who

holds the title in trust for benefit of the lender– When the debt is repaid, the title is transferred to

the debtor– If the debt is not paid, the trustee has the power

to sell the property and pay the debt


• Deed to secure debt– Owner of the real property conveys legal title

directly to the lender as security for the repayment of the debt

– Lender is given the power to sell the real property if the debt is not paid


• Requirements of a mortgage– Names of parties– Words of conveyance or grant– Valid description of the property conveyed– Proper execution and attestation– Effective delivery to the lender


• Parties to mortgage– Mortgagor• Owner of property

– Debtor

– Mortgagee• Lender

– Creditor


• Secured debt– Open-end (dragnet) mortgage• Can be a problem for the borrower

• Secured property• Assignment of a mortgage– Conveys real property and secured debt


• Transfer of property encumbered by a mortgage– Due on sale clause• Prohibits the sale of real property without the

mortgagee's consent• Violation of this provision is a default under the

mortgage• Could result in a foreclosure of the real property


“Subject to”• Purchaser does not have

personal liability for payment of the debt

• Lender can foreclose and sell the real property and sue the original mortgagor for payment of the debt

“Assumption”• Purchaser is personally

liable• Lender can foreclose and

sue the owner and original mortgagor


• Cancellation or satisfaction of mortgage– Mortgage is automatically released by full

payment of the debt, but mortgagee (lender) must file a cancellation or satisfaction of mortgage in deed records where the mortgage has been recorded


• Second mortgage loans– Risky for lenders– Must use estoppel certificate

Foreclosure and Other Mortgage Remedies

• Foreclosure– Foreclosure by sale• Current method

– Property is sold to the highest bidder at a public sale

– Mortgagee has the first claim to the proceeds received from the sale

– Excess proceeds are given to debtor-mortgagor


• Foreclosure– Grounds for foreclosure– Types of foreclosure• Power of sale

– Nonjudicial but public sale of the real property

• Judicial– Lawsuit


• Foreclosure– Effect of a valid foreclosure sale• Extinguishes all the debtor's ownership rights in the

property– But the debtor may have right of redemption

– Distribution of money in a foreclosure sale• Interpleader proceeding


• Foreclosure– Antideficiency laws• Post-foreclosure judicial confirmation proceeding

– Remedies other than foreclosure• Taking possession of the mortgaged real property• Having a receiver appointed to take possession of the

property


• Foreclosure– Mortgagee (lender) in possession• Agent of the mortgagor• All income collected from the real property must be

used to pay the debt– With deductions for reasonable expenses of management and

maintenance


• Foreclosure– Appointment of a receiver• Third party appointed by the court to take possession

of the real property in the event of a mortgage default– Maintains property– Collects rent

• Makes sure all proceeds are applied to the debt


• Waiver of default– If the mortgagee, on notice that there has been a

default under the mortgage, does not act promptly to exercise its remedies, the mortgage holder may waive the default and not be entitled to exercise its remedies

– Acceptance of late payments estops the mortgage lender from declaring a default


• Federal and state limits on foreclosure– New laws generally impose upon lenders a waiting

period of somewhere between 60 and 120 days before foreclosure can take place

– Federal Homeowner Affordability and Stability Plan allows access to low-cost financing for certain homeowners

Debtor's Remedies and Defenses to Foreclosure

• Injunction– Grounds• Invalidity of debt• Absence of default• Payment of debt• Improperly conducted sale

Debtor's Remedies and Defenses to Foreclosure

• Suit for conversion or wrongful foreclosure• Bankruptcy– Debtor's main defense to foreclosure– Automatic stay

Ethics: Confidentiality of Client Information

• Attorney and paralegal must keep all client information and correspondence confidential– Without trust the client would be unwilling to

disclose to his or her attorney all the facts necessary for legal representation

• Only the client can give permission for the release or disclosure of confidential information

Summary

• Basic loan documents used to secure a real estate loan– Note– Security instrument• Generally referred to as a mortgage

Summary

• Note– Promise to pay– Sets forth• Amount of debt• Interest rate• Payment terms

– On some notes payment may be secured by guaranty

Summary

• Security instrument– Conveys interest in the real property to secure the

payment of the note– Forms of security instrument• Mortgage• Deed of trust• Deed to secure debt

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