Intense scrutiny is rarely focused on condemnation clauses in security instruments, but they will set the tone for potentially drawn out litigation as the parties work through the complexities specific to condemnation. In preparation, the language of the security instruments provided to borrowers must be considered. Because the condemnation clause is not typically a deal breaker when a borrower is seeking financing, the time to make condemnations run smoothly is at origination.
The first step in defending a condemnation is having a robust process to allow the holder of a security interest to accept service and file a timely claim. Some states have a statute of limitations for response with no right of default if the deadline is missed. It is critical that a litigation triage process be in place so counsel can file a timely response.
The next step is to manage the expectations of, and relationship with, the borrower. The lender should reach out to the borrower as soon as an answer is filed and determine if the borrower has a strategy in place to protect the value of the property. The lender should also explicitly inform the borrower of the duties set forth in the security instruments, including their duty to defend the lender by paying attorney and expert fees, or risk default. Borrowers often feel entitled to all or a portion of the funds received in condemnation. If a borrower has early notice that the condemnation proceeds will be applied against the outstanding balance, the case is more likely to proceed to a mutually desirable outcome.
To the extent allowed by law, security instruments should accomplish several things:
- Assign 100% of all condemnation proceeds to the lender to be applied in the same manner payments are applied to the borrower's outstanding balance.
- Refrain from offering a formula that applies condemnation proceeds based on a formula regarding equity or market value. Having to resolve these ambiguities can result in an expensive and inefficient distribution of the proceeds.
- Require a borrower to notify the lender of a condemnation in writing. If possible, the borrower should also provide a copy to counsel. Failure to notify the lender should constitute an event giving rise to a default.
- Authorize the lender to withdraw funds from any court in a relevant jurisdiction. This would eliminate a step for the attorney who must apply to the court to withdraw funds and affirmatively show the lender is entitled to the funds.
- Require the borrower to pay the costs to defend the property against the condemnation, and allow the lender to charge the borrower with any costs spent to defend the collateral. This bargaining tool often helps lenders negotiate more efficient settlements with certain borrowers.
An experienced condemnation attorney can analyze the risks a condemnation poses to collateral, assist the lender by minimizing costs and risks related to the taking and properly advise a lender regarding experts and other complications that may be difficult to foresee. Defending a condemnation case can take a significant investment in appraisal or engineering experts to understand the implications of a public project associated with a condemnation. If a lender does not want to make that investment, the matter may be open for an extended amount of time, until the project is complete and all the physical attributes of the public project are apparent. However, experienced condemnation attorneys can spot pitfalls concerning prime physical attributes like grade issues, access, etc., and advise the lender how best to expend its resources to protect the collateral.
Condemnations can be difficult to manage if the borrower and the lender do not communicate effectively. Lenders that take proactive steps to gain control of the situation will encourage cooperation by borrowers, which will allow the case to proceed in a manner that will minimize risk to the collateral and maximize efficiency in collecting and applying condemnation proceeds.
Ivy Cadle is an attorney with Baker Donelson in Macon, Ga.
