A deed in lieu of foreclosure (lieu deed) is a conveyance, by the owner of property encumbered by a mortgage, to the mortgagee, in full satisfaction of the obligation secured by the mortgage. 735 ILCS 5/15-1401. The mortgagee takes title to the property subject to existing claims or liens affecting the property, but the mortgage is not merged with the lender's title to the property. Id. Acceptance of a lieu deed terminates the liability of the borrower and all other persons liable for the mortgage debt unless there is an agreement to the contrary made contemporaneously with the lieu deed transaction. Id. The terms and conditions under which a borrower will grant and a lender will accept a deed in lieu of foreclosure are highly negotiable and will depend on the relative bargaining positions of the respective parties. Because Illinois, Wisconsin, and Indiana case law on this topic is sparse, an examination of federal case law and case law from other states is helpful.

Advantages to Lender

There are several advantages to a lender in accepting a deed in lieu of foreclosure. First, the lender becomes the owner of the property, allowing the lender to control its operation, take immediate steps to maximize its economic value, use and obtain all its income, and preserve valuable contracts and tenants. Second, the transaction can be quickly negotiated and completed with fee title vesting in the lender upon recordation of the deed so that title is immediately marketable. Third, the publicity, time, and expense of a foreclosure action can be avoided. Finally, if there is no equity in the property above the amount of the outstanding debt, the transaction will not be susceptible to being set aside by a bankruptcy court or a court of equity if the borrower later files for bankruptcy or attempts to rescind the transaction based on fraud or coercion. See, e.g., Sprunk v First Bank Western Montana Missoula, 741 P2d 766 (Mont 1987) (mortgagee did not fraudulently induce mortgagor to grant deed in lieu of foreclosure where mortgagee prepared documents stating amount of debt owed by mortgagor, truthfully stated total amount of debt, and released mortgagor from personal liability).

Disadvantages to Lender

Sometimes a lender should not accept a lieu deed. For example, the lender should not accept a partial conveyance of the property unless the entire mortgage debt is released as a result of the partial conveyance. Otherwise, the lender may face valuation and allocation problems, title problems, and/or problems in connection with subsequent foreclosure of the remainder of the property still subject to the mortgage, with all the additional cost and time involved. A lender should also hesitate before accepting a lieu deed where there are outstanding subordinate liens or judgments against the property. In such a situation, the lender will have to foreclose its mortgage, with the attendant expense and time involved to obtain clear title. Even if the debtor promises to remove subordinate liens and encumbrances prior to transfer of the property, he/she may not be able to do so, especially where there are numerous liens or judgments outstanding. Such matters are often outside the lender's control, and title matters must be cleared quickly in order to close the transaction expeditiously. The lender must also be careful in this situation that the lieu deed is structured in a manner that will not result in merging the mortgage lien with title to the property upon consummation of the transaction, thereby preventing the lender from foreclosing subordinate liens. See, e.g., Downstate Nat Bank v Elmore, 224 Ill App 3d 1075, 587 NE2d 90, 167 Ill Dec 208 (5th D 1992) (where mortgagee accepts a deed in lieu of foreclosure and subsequently conveys title to third party by special warranty deed containing the words "grant, bargain and sell," merger of the mortgage interest and title to the property has occurred). See also Felbinger and Co v Traiforos, 76 Ill App 3d 725, 394 NE2d 1283, 31 Ill Dec 906 (1st D 1979).

Advantages to Borrower and Other Persons Liable on the Mortgage Debt

Advantages to a borrower in offering a lieu deed include, first, the release of the borrower and all other persons who may owe payment or the performance of other obligations secured by the mortgage. However, such persons remain liable if they agree to do so contemporaneously with the lieu deed transaction. 735 ILCS 5/15-1401. See also Flora Bank & Trust v Czyzewski, 222 Ill App 3d 382, 583 NE2d 720, 164 Ill Dec 804 (5th D 1991) (regardless of whether quitclaim deeds executed by mortgagors were viewed as deeds in lieu of foreclosure, mortgagors signed contemporaneous agreement indicating the intent that if deficiency existed, judgment would be entered against mortgagors; thus, bank was entitled to deficiency judgment against mortgagors). In addition, authority predating the Mortgage Foreclosure Law provides that a guarantor will not be discharged by the lender's acquisition of security for the loan if the guaranty so provides. Du Quoin State Bank v Daulby, 115 Ill App 3d 183, 450 NE2d 347, 70 Ill Dec 874 (5th D 1983) (guarantors of a mortgage loan remained liable for any deficiency to the mortgagee up to the stipulated amount of the guaranty, notwithstanding that the mortgagee purchased the principal obligors' mortgaged property at the foreclosure sale for the full amount of the indebtedness, where the contract of guaranty specifically provided that it would not be affected by any sale or disposition of indebtedness or any security or collateral thereof).

The second advantage to the borrower is the avoidance of the publicity, expense, and time involved in proceedings to enforce the mortgage loan and other obligations, with eventual loss of the property. Third, it is possible that the lender will agree to pay all or part of the expenses of the transfer or even additional monetary consideration if there is equity in the property over the mortgage debt. However, the amount that a lender will pay is generally less than a third party would pay, if one can be found. Finally, it is possible that the lender will grant certain limited possessory or other property rights back to the borrower, such as a lease of all or part of the property, an option to purchase, a right of first refusal, and the like. However, lenders generally resist granting such remaining rights to the borrower in order to obtain the property free and clear of all outstanding interests. If an option or a right of first refusal is granted, the lender will ordinarily limit the time within which it is available to a relatively brief period of time.

Disadvantages to Borrower and Other Persons Liable on the Mortgage Debt

The primary disadvantage to the borrower is the loss of the property, the income from the property, and the borrower's investment in the property. The conveyance of the property is also taxable.

Offer to Deed

A borrower's offer to convey mortgaged property back to the lender must be truly voluntary. There must be no pressure, actual or constructive fraud, unconscionable advantage, duress, undue influence, or grossly inadequate consideration on the part of the lender. See, e.g., First Illinois Nat Bank v Hans, 143 Ill App 3d 1033, 493 NE2d 1171, 98 Ill Dec 150 (2d D 1986) (an express provision in a mortgage requiring the mortgagor to execute a quitclaim deed in lieu of foreclosure upon default is null and void, since transforming a mortgage into an outright conveyance upon default deprives the mortgagor of the redemption rights and is against public policy). If the borrower attacks the transaction on any of these grounds and wins, he/she will have the option to set aside the transaction and recover the value of the property, the equity of redemption, or the profits on resale of the property by the lender. In addition, punitive damages may be assessed against the lender if the lender's conduct is flagrant or outrageous. However, it must be clearly shown that the borrower's necessity was used to drive a hard bargain, and the borrower must conclusively prove wrongful conduct by the lender. See, e.g., Heller v Jonathon Investments, Inc, 113 Ill 2d 60, 495 NE2d 589, 99 Ill Dec 142 (Ill 1986) (evidence of alleged duress and undue influence was not clear and convincing and was insufficient to justify rescission of deeds or imposition of constructive trust; mortgagor's evidence must be clear and convincing and sufficient to prove mortgagor's case by preponderance of evidence).

To avoid a claim that the transaction was involuntary, it is customary for the borrower to initiate the offer to deed the property back to the lender. Accordingly, the borrower mails a written offer to the lender, voluntarily offering to deed the property to the lender and stating the reasons therefor. This procedure also prevents the borrower from claiming that the lender did not act in good faith, or that the transaction should be set aside as an "insider" transaction under the Bankruptcy Code. The transaction must be closed promptly after the lender's receipt of the written offer to convey, or else the lender should proceed with foreclosure to avoid delay tactics by the borrower. After receipt of the offer from the borrower, the lender should send a reply letter acknowledging the offer, stating the express conditions under which the lender will accept a conveyance, and confirming that no contractual obligation to accept the property exists until all required documentation is fully executed and all considerations are paid and/or delivered. The borrower is not relieved of personal liability on the mortgage debt until the transaction closes. The mere tender of an executed deed by the mortgagor or the recording of a deed by the mortgagor to the mortgagee shall not constitute acceptance by the mortgagee of a deed in lieu of foreclosure. 735 ILCS 5/15-1501. See also In re Estate of Shedrick, 122 Ill App 3d 861, 462 NE2d 581, 78 Ill Dec 462 (1st D 1984) (deed must be delivered and accepted to render it operative to pass title; mere fact of recordation or possession of deed by grantee is not necessarily an acceptance thereof). Bank of Benton v Cogdill, 118 Ill App 3d 280, 454 NE2d 1120, 73 Ill Dec 871 (5th D 1983) (mortgagee's written statement to mortgagor did not constitute offer that mortgagor could accept by tendering deed to mortgagee, and alleged statement by mortgagee that he would "start the paper work" did not constitute acceptance of mortgagor's offer to convey property; absent contract waiving its right to a deficiency judgment, mortgagee was entitled to a deficiency judgment).

Before accepting an offer for a lieu deed, the lender should be sure that, first, if he/she were to foreclose and obtain a deficiency judgment, the judgment would not have any practical value. Second, that there are no junior liens or encumbrances that will be outstanding on the property when it is conveyed to the lender, unless the lender is willing to take title subject to such liens or encumbrances. Third, that there are no conditions imposed on the offer, such as a reservation of possessory rights or a right of first refusal to repurchase, unless such rights are limited (and insured) to avoid the deed being construed as a continuing security device or equitable mortgage. Fourth, that the total expense (not including cost of title insurance) of accepting the voluntary conveyance will be less to the lender than the expense of pursuing a foreclosure action and bidding at the foreclosure sale to protect its investment. Fifth, that taking immediate possession of the property will be beneficial to the lender, considering the market for the property, any environmental cleanup work that must be done on the property, the tax aspects of taking possession, and any difficulties in retaining or evicting tenants and occupants of the property. Sixth, that the borrower has no equity in the property that could be realized by a sale to a third party within a reasonable time. A deed may still be taken if an appraisal indicates that there is equity in the property, but there is a risk that such a transaction may be set aside unless the borrower is adequately compensated for the equity. And finally, that an owner's policy of title insurance will be provided by the title insurance company without exceptions for equitable mortgage claims.

Drafting the "Settlement" Agreement

All the terms and conditions of the lieu deed transaction should be set forth in a written agreement between the parties, commonly referred to as a settlement agreement. Lenders generally have the upper hand in negotiating the agreement, since the lender has the power to refuse to take the property back or to release the borrower from personal liability on the mortgage debt. The agreement should not be structured so that a deed is placed in escrow until certain conditions are met, as this may be challenged as an equitable mortgage, and the borrower might claim that a foreclosure is required to enforce the provisions of the agreement. See, e.g., Coffin v Green, 185 P 361 (Ariz 1919) (delivery of deed into escrow by mortgagor, with stipulation that it would be delivered to mortgagee if mortgagor should fail to pay preexisting mortgage on the property before a specified date or else be delivered to mortgagor if mortgagor satisfied the mortgage before such date, constituted delivery of an instrument of additional security for the mortgage rather than a conditional sale of the mortgaged property). In addition, title insurance coverage may not be available for such an escrow arrangement.

The agreement should describe the consideration for its execution, which usually consists of the lender's agreement to cancel the borrower's indebtedness, waive any right to immediately foreclose the mortgage and to exercise any other remedies, and release the lien of the mortgage (unless no merger is intended). The agreement should contain an acknowledgement by both parties that the value of the property (plus any additional consideration the borrower may deliver to the lender) is less than or equal to the outstanding indebtedness (plus any additional consideration the lender may provide to the borrower). Under certain circumstances, a voluntary conveyance may be accepted even if the value of the property exceeds the debt; however, there is a greater risk to the lender in such a situation that the transaction will be set aside if the borrower subsequently files bankruptcy or makes a claim of duress or unfair advantage. In addition, the title insurance company will likely raise exceptions for those matters.

If the lender intends for any person liable for the mortgage debt to remain liable after the lieu deed transaction, the settlement agreement must expressly so provide. If the borrower is not released from personal liability, the borrower, and any guarantor, will remain liable for the mortgage debt or even for a deficiency when the lender later sells the property. See, e.g., Du Quoin State Bank, 115 Ill App 3d 183, 450 NE2d 347, 70 Ill Dec 874; Flora Bank & Trust, 222 Ill App 3d 382, 583 NE2d 720, 164 Ill Dec 804.


Under the Illinois Mortgage Foreclosure Law, a deed in lieu of foreclosure does not automatically cause a merger of the lender's interest as lender and the lender's interest as purchaser of the property. 735 ILCS 5/15-1401. See also Olney Trust Bank v Pitts, 200 Ill App 3d 917, 558 NE2d 398, 146 Ill Dec 435 (5th D 1990) (mortgagee brought foreclosure action against wife's undivided one-half interest in property to which husband had granted mortgagee deed in lieu of foreclosure; court held that since 735 ILCS 5/15-1401 expressly provides for non-merger and thus no satisfaction of mortgage debt occurred, mortgagee could properly foreclose on wife's one-half interest in property but could not obtain deficiency judgment against wife, who did not agree to be personally liable). The intention and interest of the lender will determine whether a merger takes place. See, e.g., Hooper v Goldstein, 336 Ill 125, 168 NE 1 (Ill 1929); Miller v McDonough, 13 Ill App 2d 290, 141 NE2d 749 (2d D 1957). The borrower ordinarily prefers a merger, since that extinguishes any outstanding liability on the mortgage debt. The lender, however, usually seeks to avoid a merger in order to preserve the priority of the mortgage as to mechanics' liens and other encumbrances, and to preserve the lender's first lien position if the deed is later set aside. A provision as to the parties' intent concerning merger should therefore be included in the settlement agreement and the deed. In order to protect itself, the lender may refuse to release the mortgage of record after the voluntary conveyance until the property is subsequently conveyed or transferred by the lender. Or, the lender may insist that instead of stating that the mortgage debt is extinguished, the settlement agreement and the deed must state that the lender agrees not to bring a personal action on the debt against the borrower.

Bankruptcy Problems

A borrower may seek to set aside a lieu deed as a preferential transfer if the transfer occurs within 90 days prior to the filing of a petition in bankruptcy, or between 90 days and one year before the date of the filing of the petition, if the creditor was an "insider" at the time of the transfer under 11 USC § 101(30), or if the creditor had reasonable cause to believe that the debtor was insolvent at the time of the transfer. 11 USC § 547(b). To constitute a preferential transfer, the transfer must be made to or for the benefit of a creditor, for or on account of an antecedent debt (which will always be the case with a lieu deed), be made while the debtor was insolvent, and enable the creditor to obtain more than it would have received had the borrower's property been liquidated before the transfer was made.

A lieu deed may also be set aside as a fraudulent conveyance if made within one year prior to the filing of a petition in bankruptcy. 11 USC § 548. To constitute a fraudulent conveyance, the conveyance must have been made with actual intent to hinder, delay, or defraud a creditor, or the borrower must have received less than reasonably equivalent value for the property. In addition, the borrower must have been insolvent on the date of transfer or must have become insolvent as a result of the transfer. Id. If a court finds a voidable preference or fraudulent conveyance, it may set the conveyance aside and return the mortgagee to the status quo ante as a secured creditor, or it may order the mortgagee to pay the difference between the value of the property, as determined by the court, and the sales price. See, e.g., In re McClintock, 75 BR 612 (Bankr W D Mo 1987) (court refused to avoid foreclosure sale but ordered mortgagee, who had successfully bid in its debt, to pay difference between its foreclosure bid and fair market value of property). In certain circumstances based on lender misconduct, the court may even subordinate the lender's interest to other claims, transfer the lien to the estate, or disallow the claim completely. 11 USCS § 502(h). See also Re Werth, 37 BR 979 (BC DC Colo 1984) (bank had terminated all funding under loan without notice; debtor-guarantor claimed bank had breached oral loan commitment to loan additional money; court disallowed bank's claim in full); Re American Lumber Co, 5 BR 470 (DC Minn 1980) (bank took control of borrower's plant and cash disbursements; court held bank had received preferential transfer and voidable preference; judgment entered against bank and bank's claim was subordinated). Equitable subordination may be ordered even if the particular transaction is not a fraudulent conveyance or a preferential transfer. Therefore, the lender should be sure to obtain a financial statement from the borrower showing that the borrower is not insolvent, obtain an appraisal establishing that the value of the property is less than or equal to the outstanding mortgage debt, and release the borrower from all personal liability or give some other valid consideration. In addition, the settlement agreement should contain the borrower's representation that he/she is not presently insolvent and will not be rendered so as a result of the lieu deed transaction.


A deed in lieu of foreclosure can be very beneficial to both a lender and a borrower, enabling both to avoid the time and expense of foreclosure. However, the lender must be careful and provide sufficient consideration to ensure that the transaction is upheld against any potential claims of duress, fraud, or unconscionable advantage. The lender must make sure that accepting a lieu deed is a good choice in the given situation. To do so, the lender must evaluate any junior liens or encumbrances on the property, conditions imposed on the offer, equities in the property, or other circumstances that may make taking immediate possession of the property and forfeiting any potential deficiency judgment uneconomical. The lender should be sure that the deed is carefully drafted to avoid merging the mortgage lien with title to the property. Finally, the lender should obtain certification from the borrower that the borrower is not currently insolvent and will not be rendered so as a result of the transaction. The borrower must be careful that all required documentation is fully executed and all considerations paid so that he/she will be released from personal liability on the mortgage debt. If all of the above requirements can be satisfied, then conducting a lieu deed transaction may be a good choice for both lender and borrower.

EDITOR'S NOTE: If you are asked to underwrite a deed in lieu of foreclosure, please contact the Underwriting Department at 800.252.0402, or, for guidance.

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