If the owner of a commercial property, like an office building, apartment complex, or retail center, doesn't make mortgage payments, the lender can foreclose. In a commercial foreclosure, the lender goes through a legal process to sell the property and uses the proceeds to pay off the loan.
While each state has specific laws covering foreclosures, including business foreclosures, here's what you can generally expect to happen in a commercial foreclosure.
Business foreclosures go through the same basic process as home foreclosures. The process will be judicial or nonjudicial, depending on state law and what the loan contract says.
A judicial or nonjudicial commercial foreclosure starts after the business owner (the borrower) defaults on the mortgage, such as by failing to make the payments or violating the terms of the loan documents, like not having hazard insurance covering the property.
Following a mortgage default, the lender will usually send a notice to the borrower before accelerating the loan. This notice describes the default and gives the borrower some time, say 30 days, to "cure" the default and avoid acceleration. "Curing" the default means fixing the issue, like by getting caught up on past-due payments.
If the business owner doesn't cure the default by the notice's deadline, then the lender may accelerate the loan. After acceleration, the commercial foreclosure begins.
In some cases, the foreclosure is judicial. Other times, the process is nonjudicial.
A "judicial" commercial foreclosure goes through the court system. This kind of foreclosure officially begins when the lender files a complaint for foreclosure or a petition for foreclosure (a lawsuit) in court.
In the suit, the lender asks the court for a judgment of foreclosure and order for sale (permission to sell the property at a foreclosure sale).
The defendants in the lawsuit will be the business and any other parties with a lien on the commercial property. These defendants could potentially include junior mortgage holders or possibly the U.S. Internal Revenue Service if the property is subject to a federal tax lien.
All defendants get a copy of the lawsuit, either by personal service or publication if a particular defendant isn't available. The defendants then get time to prepare an answer to the suit, often 20 or 30 days.
If the business doesn't file an answer, the lender's attorney will probably file a motion with the court asking for a default judgment (an automatic win for the lender). But if the business owner responds to the suit and raises valid issues for the court to decide, the case will go through the typical litigation process, including discovery and trial.
The court enters a judgment and orders a sale if the lender prevails in the lawsuit. Then, the defendants get a notice of the sale date. This notice might also be published in a newspaper.
The foreclosure sale then happens, and the commercial property is deeded to the new owner after the redemption period (if there is one) has expired.
Nonjudicial commercial foreclosures, or "power of sale" foreclosures, generally happen without court oversight. (Although, in some states, a court plays a minor role in the process.)
A nonjudicial foreclosure is allowed if state law permits this procedure and if the loan documents have a power of sale clause. A "power of sale" clause is a provision in the mortgage or deed of trust. This provision gives a trustee the right to sell the property after following specific out-of-court procedures described in the state's laws.
Nonjudicial foreclosure procedures vary widely from state to state. The process sometimes involves recording a notice of default or another document in the county's land records, mailing a notice to the borrower and other interested parties, plus publishing a notice of default or notice of sale. But, again, procedures are different in different states.
One significant difference between commercial foreclosures and residential foreclosures is that if the business owner isn't tending to the business, the lender might ask the court to appoint a receiver.
A "receiver" is a third party assigned to protect the lender's interest in the commercial real estate. The receiver manages the property during the foreclosure process. Among other duties, the receiver will make sure the property doesn't deteriorate and collect rent from tenants.
The receiver is sometimes allowed to sell the commercial property before a foreclosure sale happens. But the court, lender, borrower, and any junior lienholders must agree to the sale.
The property is sold to the highest bidder at a commercial foreclosure sale, just as in a foreclosure sale for a residential home. The sale proceeds are used to repay the lender.
At the sale, the lender bids on the property using a "credit bid." With a credit bid, the lender gets a credit at the sale up to the amount of the borrower's debt, including principal, interest, fees, and costs. If no one else makes a higher bid on the property, the lender becomes the new owner of the foreclosed commercial property.
If you want to avoid the foreclosure of your commercial property, you can try to work out an alternative with your lender.
Your lender might agree to a repayment plan so you can get current on past-due amounts. In a repayment plan, you bring a loan current by paying the past-due amount over time, paying a portion of the delinquent amount with each of your upcoming regular mortgage payments.
You and the lender will agree on a payment schedule without changing the loan terms.
In a modification, the lender changes the terms of your loan, say to lower the interest rate or add the overdue amounts to the loan balance and reamortize the loan. Potential changes to the loan terms could also include canceling a receivership or extending the repayment term, for example.
The lender might allow a "short sale." In a short sale, you sell the property for less than you owe on the mortgage loan. But if you signed a personal guarantee, the lender might be able to get a personal judgment, called a "deficiency judgment," against you for the difference between the outstanding mortgage debt and the sale price.
Generally, lenders are more likely to go after deficiency judgments following foreclosures of commercial properties than residential properties. (The debt could be dischargeable in bankruptcy so consider talking to a bankruptcy attorney before the lender gets a deficiency judgment or as soon after as possible.)
With a deed in lieu of foreclosure, you give the commercial property's title to the lender. Typically, lenders don't seek deficiency judgments after a deed in lieu of foreclosure. (The deficiency amount would be the difference between the debt and the commercial property's fair market value.)
Still, read the deed in lieu of foreclosure documents carefully to be sure that the transaction fully satisfies the debt.
Depending on what your loan documents say, you could lose more than your business real estate if you fail to make mortgage payments. You could face additional losses if you cross-collateralized the loan by pledging another property to secure the loan or if your loan paperwork has a provision allowing the lender to repossess fixtures and goods your business owns. And, again, if you signed a personal guarantee, the lender might be able to go after your personal assets, like your home, bank accounts, and other belongings.
To learn the extent of your lender's rights, consider talking to a foreclosure lawyer who can analyze your situation and review your loan documents to advise you of your options.