Deed in Escrow

Is a “deed in escrow,” sometimes referred to as a “deed in a box,” enforceable in New York? While many real estate attorneys believe that it is not, a recent court ruling illustrates that the answer may not be as straightforward as once believed.[1]

A “deed in escrow” transaction affords a lender a seemingly quick and easy avenue towards taking title to a mortgaged property following a loan default without having to obtain a foreclosure judgment. Typically, the lender will agree to forbear from exercising its rights and remedies under the loan documents after a default (including foreclosing on the mortgaged property), in exchange for the borrower’s agreement to, among other things, voluntarily place a deed to the mortgaged property in escrow for the benefit of the lender. In the event of a termination of the forbearance under the terms of the forbearance agreement, the lender then has the right to take the deed out of escrow and record it, thereby taking title to the mortgaged property.

A number of New York courts have found that “deed in escrow” transactions are unenforceable on the grounds that they are violative of the equitable right of redemption and N.Y. Real Prop L §320 (“RPL §320”). Under the equitable right of redemption, a borrower retains the absolute right to redeem its property by repaying a mortgage debt at any time prior to the actual conclusion of a foreclosure. The equitable right of redemption serves to protect a borrower from an overreaching creditor, particularly in workout negotiations when a lender has leverage over a borrower due to the borrower being in default under its loan. RPL §320 states, “A deed conveying real property, which, by any other written instrument, appears to be intended only as a security in the nature of a mortgage, although an absolute conveyance in terms, must be considered a mortgage. . . .” Therefore, the courts reason that, if a “deed in escrow” is considered a type of mortgage under RPL §320, then the lender “must proceed in the same manner as any other mortgagee—by foreclosure and sale—to extinguish the mortgagor’s interest” (See First Union Baptist Church of the Bronx (“Borrower”) v. TD Capital Grp. LLC (“Lender”) (In re First Union Baptist Church of the Bronx, 572 B.R. 79 (Bankr. S.D.N.Y. 2017)) (the “First Union Case”). Said differently, New York courts have viewed a “deed in escrow” as impeding a borrower’s equitable right of redemption by allowing it to take title to mortgaged property without foreclosing on it.

But are there circumstances where a “deed in escrow” might not implicate RPL §320 or the concerns that the equitable right of redemption seeks to address? In the First Union Case, Borrower was in default under a mortgage loan made by Lender, which was secured by a property owned by Borrower in the Bronx, New York. As a result of the default, Lender obtained a foreclosure judgment. The foreclosure sale was scheduled for October 1, 2012, but before it could be held, Borrower filed for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code, thereby staying the foreclosure sale.

On May 16, 2014, after months of settlement negotiations, Borrower and Lender obtained the bankruptcy court’s approval to a stipulation. The stipulation provided that Borrower would continue to own and have the right to refinance or sell the mortgaged property until June 15, 2015, at which time the $1,500,000 balance of the loan would be due to Lender. Until such date, Borrower would make monthly use and occupancy payments to Lender.

The stipulation afforded Lender varying remedies following an uncured default depending on the date of such default. If a default occurred and was not cured during the first 180 days of the stipulation, Lender would be permitted to a foreclosure sale of the mortgaged property under the prior foreclosure judgment. If a default occurred and was not cured during the following 180 days, however, then Lender had the option of either proceeding with the foreclosure sale or recording the “deed in escrow” (which was delivered to Lender by Borrower in conjunction with the stipulation). Borrower defaulted, which default remained uncured, during the second 180-day period. As a result, on June 8, 2015, Lender recorded the “deed in escrow.” Six months later, Borrower sought to void the recording as a violation of RPL §320.

The United States Bankruptcy Court, Southern District of New York, ruled in favor of Borrower, holding that the “deed in escrow” constituted a mortgage, and therefore Lender’s right to record the “deed in escrow” was unenforceable and should be voided. In so ruling, the bankruptcy court found that the parties intended that the “deed in escrow” constitute security for the loan at the time the deed was delivered, and therefore the recordation of the “deed in escrow” was violative of RPL §320 and subject to the equitable right of redemption.

On appeal (In Re: The First Union Baptist Church of The Bronx, No. 1:2017cv07184—Document 15 (S.D.N.Y. 2018)), the United States District Court, Southern District of New York, reversed the bankruptcy court’s ruling, finding that the parties intended that the “deed in escrow” constitute something far more than a mortgage. In support, the district court pointed to the fact that “deed in escrow” formed part of a heavily negotiated court approved stipulation, the purpose of which was to extend the time in which Borrower might be able to retain the mortgaged property despite the fact that a foreclosure judgment had already been obtained. Moreover, it alluded to the fact that the payments under the stipulation were termed as “use and occupancy payments,” rather than mortgage or debt service payments.

But the foregoing alone likely would not have been enough to reverse the bankruptcy court’s ruling. The district court also relied on other precedent and analyzed public policy concerns related to the equitable right of redemption. Citing Meyerson v. Werner, 683 F.2d 723 (1982) (the “Meyerson Case”)—a case where the United States Court of Appeals, Second Circuit affirmed the conveyance of mortgaged property pursuant to a court-administered settlement agreement was not violative of RPL §320—the district court found that, as in the Meyerson Case, the court approved stipulation increased, rather than reduced, protection against overreaching creditors, which is a key concern the equitable right of redemption seeks to protect debtors from. So, in the end, the district court upheld the “deed in escrow” and its ultimate recordation.

The First Union Case involved a unique set of facts that essentially enabled the district court to affirm Lender’s “deed in escrow” by ruling that it did not fall within the purview of RPL §320, while at the same time maintaining the integrity of the equitable right of redemption by finding that the stipulation and process by which it was approved afforded Borrower adequate protection from overreaching by Lender. While the First Union Case is undoubtedly favorable to lenders, lenders should not overestimate its impact. Its holding was extremely narrow and dependent on a multitude of interdependent factors relating to both the terms of the stipulation and processes by which it was approved. Also impactful to the district court’s decision was the First Union Case’s similarity to the Meyerson Case and the fact that it involved a debtor “whose rights were plainly and unambiguously at an end.”

MoFo’s Real Estate and Distressed Real Estate Groups routinely monitor the case-law surrounding “deeds in escrow,” and, should you have any questions, please do not hesitate to reach out to us.

[1] Note, that certain other issues surrounding the enforcement of “deeds in escrow”—such as those that might arise in a bankruptcy proceeding and those relating to whether a local recorder will accept the deed for recording upon its release from escrow—are not covered in this client alert.