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Protecting Tenants in Foreclosure Act

A New Amendment to the “Protecting Tenants in Foreclosure Act”

As described in a previous article, Changes for Some Post-Foreclosure Evictions, subsequent to May of 2009, tenants occupying foreclosed properties with a bona fide lease were not subject to immediate eviction. One of the issues discussed in the prior article was the many ambiguities contained in the Protecting Tenants in Foreclosure Act (the “Act”). In an apparent attempt to overcome one such problem, Congress amended the Act in 2010.

Specifically, under the initial version of the Act, to be a bona fide tenant, the lease had to have been entered “before the notice of foreclosure.” While the term “notice” had no definition, in Colorado, a strong argument could be made that any lease entered subsequent to the recording of the Notice of Election and Demand (the “NED”) was, by definition, not bona fide. While there is no reported case in Colorado on this point, two New York cases came to this very conclusion.

Despite the fact that the NED is recorded to provide notice to the world that a property is in foreclosure, the 2010 amendment to the Act provides a new definition for the term “notice.” Specifically, the Act now provides:

    The Date of a Notice of Foreclosure Shall Be Deemed to Be the Date on Which Complete Title to a Property Is Transferred to a Successor Entity or Person as a Result of an Order of a Court or Pursuant to Provisions in a Mortgage, Deed of Trust, or Security Deed

So, under the current version of the Act, an individual can become a “bona fide tenant” up until the point that title vests following the foreclosure sale. In Colorado, title does not vest until the expiration of all redemption periods. Therefore, in certain circumstances, an owner in foreclosure could enter a lease after the Public Trustee foreclosure auction where the tenant would have all of the protections of the Act (and the owner likely keeps the first month’s rent). While I noted in my initial article on the Act that it could be difficult for a foreclosure investor to determine whether there was a bona fide tenant in a property pre-sale, the new amendment creates additional uncertainty.

The new definition of “notice” was undoubtedly added to try to give additional protection to tenants, but it is likely to have a negative effect on both lenders and owners in foreclosure. That is, it is best for the principals involved in foreclosure to have active third party bidding at Public Trustee auctions. The 2010 amendment of the Act will have a chilling effect on foreclosure investors as there is now another source of uncertainty. This effect is likely to be most pronounced in areas where even fair market rental values do not provide adequate cash flow on leveraged properties. It is also extremely problematic for those investors who do not want to have their funds tied up in any one particular property for a long period of time.

The only other change to the Act in the 2010 amendment is an extension of its duration. Initially, the Act was to remain in effect through December 31, 2012. It has now been extended through December 31, 2014.

In addition to the 2010 amendment, the handful of newly reported cases around the country involving the Act provide insight into its interpretation. In one such case, the winner of the foreclosure auction demanded that the occupants of a property provide information about their purported lease within a five day time frame. When the tenants refused, the owner moved to evict them. The New York court hearing the matter determined that the “successor owner that carries the burden of demonstrating that a resident of a foreclosed property is not a bona fide tenant. It is reasonable to presume that a resident of a foreclosed property is a bona fide tenant unless the successor owner demonstrates otherwise.” While the Act does not specifically address who has this burden, an interpretation similar to that of the New York court is likely in Colorado.

While Congress has clarified the term “notice” the phrase ‘substantially less than fair market rent for the property” remains undefined. In the two reported cases on this point, courts determined that 43% and 30% below fair market were both “substantially less.” In one of these cases, after the tenant lost her argument that 30% less was not substantial, she appealed the decision arguing that the Act’s reference to “fair market rent” was “unenforceably vague and indefinite.” The appellate court refused to decide this argument as it was not raised in the initial proceeding. So, even if the holder of the PT Deed meets its burden of demonstrating that a lease provides rent substantially below fair market value, tenants may raise other arguments to delay an eviction.

Another requirement of a “bona fide lease” in the Act is that it must be the “result of an arm’s length transaction.“ As of the date of this article, there are no reported case interpreting this portion of the Act. But, Black’s Law Dictionary defines “arm’s length” to mean “dealings between two parties who are not related or not on close terms and who are presumed to have roughly equal bargaining power” (9th Edition 2009). It is easy to envision a situation where an owner of a property tries to enter a last minute lease and, because of the foreclosure, does not have the same bargaining power a normal landlord would posess. This may be evident in the purported lease through terms such as pre-paid rent, reduced rent, lack of security or pet deposits, lack of an attorney’s fees clause or provisions essentially turning over all aspects of the property to the tenant.

Finally, while some have read that portion of the Act related to “any foreclosure on a federally-related mortgage loan“ as providing a possible exception to its provisions in some foreclosures, that is not likely the case. Specifically, the United States Department of Housing and Urban Development has expressly stated that “[t]he responsibility for meeting the [Act’s] new tenant protection requirements applies to all successors in interest of residential property, regardless of whether a Federally related mortgage is present.” If this interpretation is accepted by a court, then the Act applies to all foreclosures of residential property.

In my experience working with successful foreclosure investors, one trait that is generally present is the ability to assess risk correctly more often than not. The recent amendment and judicial interpretation of the Act provide one more risk factor that should be considered when deciding whether and how much to bid on any particular property.

For questions, please contact Mike Smeenk.

William Robinson is no longer with the law firm of Frascona, Joiner, Goodman and Greenstein, P.C.
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