Courts: A Foreclosure Pandemic Pause? (Part 1)

As borrowers fall into financial distress as a result of the ongoing coronavirus pandemic, or otherwise, and loans default, some lenders look to foreclose their mortgage and mezzanine loans. While there is little judicial authority regarding the enforcement of such remedies in the midst of a global pandemic, some recent cases suggest that commencing, prosecuting, and completing a foreclosure sale during such time should be approached carefully.

In one recent decision by the United States District Court for the District of Hawaii (Mohr v. MLB Sub I, LLC (U.S. District Court, D. Hawai’i, April 13, 2020)) involving a decades-long battle over a residential mortgage foreclosure, the court held on April 13, 2020, after granting judgment in favor of the lender, that it would be inequitable to proceed with a foreclosure sale given existing conditions. In reaching its decision, the court stated “[i]n view of the on-going COVID-19 pandemic, the government shutdown and stay-at-home order, the common-law duty to obtain the best price for the property . . . and the fact that the real estate market is inactive and Hawai’i has temporarily halted evictions, the Court finds that it would be inequitable and not in the interest of either party to proceed with the foreclosure sale under the existing conditions.” The court noted the absence of potential bidders in its decision and held that the lender will be permitted to proceed with a foreclosure sale only after the court has issued an order recognizing that the threat of the virus has passed. Both parties will be allowed to petition the court in the future as to whether they believe this has (or has not) occurred.

Mezzanine lenders should be particularly mindful of foreclosing during the pandemic because mezzanine loans are governed by the Uniform Commercial Code (UCC), and the UCC requires that “[e]very aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.” This requirement of commercial reasonableness would apply to the method and efforts by the lender to locate potential buyers (through brokers, advertising, etc.), the content of published foreclosure notices, the location and method of bidding, the vetting of bidders, the amount of notice before the foreclosure sale, the availability of salient information relative to the interest being foreclosed, and the like.

In a New York Supreme Court case decided earlier this week (1248 Assoc. Mezz II LLC v. 12E48 Mezz II LLC (Supreme Court of State of NY, May 18, 2020)), a borrower sought a preliminary injunction to prevent the foreclosing mezzanine lender from conducting a UCC sale of its membership interests in a hotel property owner on the grounds that the (i) sale was prohibited under New York Governor Andrew Cuomo’s executive orders limiting foreclosures and (ii) established market procedures for conducting a UCC sale are not “commercially reasonable” in light of pandemic-related court closures, restrictions on public gatherings, and complications for bidders to conduct due diligence and obtain financing. The borrower also claimed that the lender shifted the auction in part to a poorly advertised virtual format. On May 18, 2020, the court lifted a temporary restraining order (TRO) and denied the borrower’s request to prevent the UCC sale, holding that a non-judicial UCC sale is not a mortgage foreclosure subject to Governor Cuomo’s Executive Orders, and permitted the foreclosing lender to proceed with its foreclosure sale. The court found that there was no proof of “irreparable harm” to the borrower and that the borrower did not show “a likelihood of success on the merits” (a requirement to obtain a preliminary injunction). The court found that the owner’s “anticipation of economic damage resulting from the noticing, the manner, or timing of the sale, particularly in light of the current economic shutdown and restrictions on travel as a result of the COVID-19 pandemic, is merely speculative,” and held that, if the owner did suffer harm, it can sue for money damages after the foreclosure.

So where does this leave us? New York state court Justice Frank Nervo did not agree that a commercially reasonable foreclosure sale could not be conducted during a pandemic, a decision that should cause New York mezzanine lenders to breathe a brief sigh of relief. Yet, the decision was silent as to what steps a foreclosing lender must take to satisfy the UCC’s requirement of commercial reasonableness and did not provide any guidance on what a borrower must prove, and what evidence it might proffer, to show that the foreclosure is not commercially reasonable and should, therefore, be “paused” as a result of the ongoing pandemic. Only time will tell whether the decision will be followed by other judges without analysis or whether it may be an outlier. It might also cause you to ask whether the Hawaii case is an outlier.

We are living in unprecedented times, and mezzanine (and mortgage) lenders would be well served by exercising additional caution in their foreclosures until further judicial guidance emerges. With foreclosures in the queue across the country, lenders should not be surprised if their borrowers fine‑tune their arguments seeking a “pandemic pause” until COVID-19 is under control. These New York and Hawaii cases are not likely to be the final chapter, and lenders should be prepared for pandemic arguments going forward.