Asset Protection and The Rise of New Legal Strategies

Many of our clients have questions about strategic default and the consequences that can follow from defaulting on a mortgage that is “underwater.”  When the value of the real estate that is security for a loan falls below the amount due on the loan, the mortgage is said to be underwater.  Many of the concerns about strategically defaulting revolve around deficiency judgments.  A deficiency judgment occurs when a lender forecloses on real estate and then seeks to collect the difference between the value of the real estate and the amount due on the loan.  The fact is that many, many banks just aren’t pursuing deficiency judgments these days.  Some are even prohibited by state law from suing borrowers for deficiencies.

Novel Legal Theories: Protecting Assets in Foreclosure

In addition to laws in certain states that prohibit deficiency judgments, attorneys are getting creative in an effort to help protect assets and preserve wealth for people who have chosen the path of strategic default.  As an example, consider a new strategy being employed by some foreclosure defense attorneys that tries to draw a distinction between mortgages held directly by sellers and those held by third-party lenders, such as banks and credit unions.

In the Same or Better Position

The distinction that some foreclosure defense attorneys are trying to assert is that sellers are not injured or “damaged” when they finance a buyer who later defaults and a foreclosure occurs.  The argument, in its most basic sense, is that because the seller receives title to the exact same piece of real property that was previously owned and he or she gets to keep the mortgage principal payments made up until the time of default, the seller is already in a better position than he or she would have been.  In such a scenario, the argument goes, it would be patently unfair for the buyer to be saddled with a deficiency judgment, which would have the effect of giving the seller ownership of the original piece of property and the full selling price.  Essentially, foreclosure defense attorneys are making an appeal to fairness, which courts can consider when exercising their equitable powers.

It remains to be seen whether courts will adopt this argument, since a sale of real property effectively transfers both upside and downside economic risk to the buyer . . . in theory at least.  This is true whether the buyer obtains financing directly from the seller or a third-party financial institution.  Only time will tell which position prevails, but if you live in a state where deficiency judgments are permitted, if you don’t know whether they are permitted in your state, or if you have questions about strategic default or asset protection, we are always here to answer your questions.