One of the key questions I’m often asked is whether a seller/borrower should sign the consent agreements that the lender provides as part of their short sale. These agreements typically provide that the lender is only releasing its lien on the property but not the remaining debt. Depending upon the actual language used, the effect could be: 1) that the lender is only reserving its right, if any, to come after the borrower to collect the deficiency between what the lender receives from the short sale and what the borrower actually owes; or 2) that the borrower agrees that the debt continues and they will pay the deficiency.  While one can understand lenders seeking to protect their interests, it is legally unclear how enforceable such agreements will be if the lender actually seeks to collect.

Some lenders, such as Bank of America, have until very recently demanded that recourse language be in every Short Sale consent letter. Few if any lenders have written loans with non-recourse language for many years. During the past month, we know that BofA has dropped the recourse language from short sale consents in at least two short sales we assisted in.  The legal issue is whether the language in a short sale consent can alter the recourse or non-recourse nature of the original loan. We do not believe that it can. 

For example, in California where we practice law, if the loan in question is a purchase-money acquisition loan for a 1-4 unit property in which the borrower lived, that loan is non-recourse as a matter of law. For any lender to try to get around this with a short-sale consent is likely unenforceable. But we cannot know how the courts will ultimately rule on these if the lender subsequently tries to collect the deficiency. In a different situation, if the original loan was recourse, ie: not an acquisition loan, then the lender has a better chance at collecting on a deficiency because they had that right in the original loan. However, if there is only one loan on the home and it is a recourse loan, it is still highly unlikely that a lender would ever realistically pursue a judicial foreclosure in order to get a deficiency judgment. It costs too much and takes too long compared with a Trustee Sale which is relatively quick and cheap but bars them from a deficiency. These are the issues we look for in our consultations and it provieds the basis for the strategies in short sale negotiation.

Obviously, we always recommend seeking to strike recourse language from short sale consents. If the lender refuses, then it is a weighing of the risks vs rewards of signing anyway:

1. The Short Sale is better for the borrower because the credit damage is less and it doesn’t trigger the FHA and FNMA foreclosure blocks on further loans;

2. The Short Sale generally produces a higher price than a foreclosure so it reduces potential debt forgiveness taxes.

3. Even if the borrower signs the consent, it still may be unenforceable since arguably the borrower received no real benefit from the deal;

4. Even if the borrower signs the consent, it still may be unenforceable since arguably the lender has no right to waive taking the security and then suing the borrower.

Points 3 and 4 are the critical issues that the courts will likely deal with in the next 2-3 years if any such lender recovery suits get filed.

So, there is no one right answer to this question. The above examples are based upon California law. The law in other states may lead to different conclusions, especially in states that do not allow for Trustee Sales. Signing may make sense but I would always make sure that the seller/borrower understands the risks and rewards before making any recommendation.

I also appreciate that real estate agents are placed in a difficult conflicted position with shorts sales. If the seller signs the consent, the agent gets paid. If they don’t sign, the agent doesn’t get paid. While of course agents always look out for their client’s best interest and have a fiduciary duty to do so, the risk-reward equation is different for the agent than it is for the seller, especially when there would be no recourse (and no commission paid) if the property were foreclosed because the short sale failed.

So, if you are faced with the situation of deciding whether or not to sign the lender consent agreement in a Short Sale, be sure to get competent legal advice first from a real estate attorney in your state and be sure that they can advice you as well on the impact of debt forgiveness tax even if there is no recourse.

If you have specific questions about your California loans, liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or call us at (916) 966-2260 for a phone or personal appointment.  We offer a $200 flat fee attorney consultation to enable you to evaluate your judgment and tax risks and to plan a strategy to minimize or even avoid them.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.