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The SBA’s Right of Redemption Following Non-Judicial Foreclosures: Lenders, Fear Not
Author: Michael P. Menton
In recent years, internet articles, discussion forums, and advertisements for various workshops have touted the potential danger to lenders in connection with real property foreclosures on which the United States holds an inferior lien position. Specifically, the discussion relates to the one-year post-foreclosure right of redemption in favor of the U.S. Small Business Administration (“SBA”) in connection with SBA 504 loans.
SBA loans, in general, are loans guaranteed or partially funded by the federal government to incentivize lenders to lend capital to small businesses nationwide. The SBA 504 loan program funds a percentage of the overall project cost and in return takes a second lien on the collateral (real property and/or machinery and equipment). It is this inferior lien position that is the crux of the redemption issue outlined in this article.
The right of redemption, and its surrounding confusion, appears to arise from a single sentence taken from a single federal statute; 28 U.S.C. § 2410 (referred to herein as the “Redemption Statute”). The right of redemption in favor of the United States pursuant to the Redemption Statute has created an environment of uncertainty for lenders foreclosing real property that is subject to an SBA 504 loan. This uncertainty is caused, in large part, due to the lack of a definitive answer on whether or not the right of redemption survives a non-judicial foreclosure (a foreclosure conducted without the necessity of the courts via a power of sale granted in a deed of trust).
To further this uncertainty, the SBA, at times, has even attempted to negotiate a release of its right of redemption with a foreclosing lender following a non-judicial foreclosure sale. While it is clear that the SBA does possess a one-year right of redemption following a judicial foreclosure (a foreclosure action conducted via a court proceeding), the SBA’s right of redemption following a non-judicial foreclosure is somewhat unfounded.
As set forth above, the confusion regarding the SBA’s right of redemption following a non-judicial foreclosure sale stems from an apparent misreading of the Redemption Statute coupled with a lack of any case law dealing with this specific issue. To understand the scope, applicability, and extent of the Redemption Statute as it relates to SBA 504 loans, it is essential to assess the overall context and structure of the statute as well as the language employed by Congress in drafting the statute.
Further, when assessing the post-foreclosure risk associated with the right of redemption, it is also imperative to understand the SBA’s view and application of the Redemption Statute. As such, this article is necessarily a hyper-technical analysis in order to illustrate the conclusion that the right of redemption under the Redemption Statute does not apply to non-judicial foreclosures. Regardless of whether the Redemption Statute is applicable or not applicable to non-judicial foreclosures, state law or contractual provisions may grant the SBA a right of redemption separate and apart from the Redemption Statute (note: Texas law does not grant such a right). Absent a right of redemption under applicable state law or contract, the Redemption Statute is the only vehicle for redemption of real property available to the SBA under a 504 loan.
Context and Structure of the Redemption Statute
An understanding of the effect of any statute must begin with an analysis of its provisions in its entirety and the context of the statute as a whole within the chapter and/or title of which it is found. The United States Supreme Court holds that in construing a statute, “we must not be guided by a single sentence or member of a sentence, but look to the provisions of the whole law…” U.S. Nat’l Bank of Oregon v. Indep. Ins. Agents of Am., Inc., 508 U.S. 439, 454 (1993).
The Redemption Statute is located in U.S. Code, Title 28, Part VI, Chapter 161. Chapter 161 is entitled “United States as Party Generally” (emphasis added). The use of the word “party” in the title of Chapter 161 suggests a formal action, pleading, complaint or procedure in which parties will be named. The actual title of the Redemption Statute reads “Actions affecting property on which the United States has lien” (emphasis added). At least to this point, the Redemption Statute appears to relate solely to “actions” in which the United States is a “party” or, in the context of foreclosure, a judicial foreclosure action. The actual language and structure of the Redemption Statute, discussed below, furthers this view.
The Redemption Statute consists of five sub-sections, (a) through (e) (sub-section (d) and (e) relate to required amounts to be paid by the United States to redeem property and to the process of obtaining a release of a lien in favor of the United States. These subsections are not relevant to the analysis and are not discussed in this article). The first sub-section under the Redemption Statute, subsection (a), is a permissive provision allowing the United States to “be named a party in any civil action or suit in any district court, or in any State court having jurisdiction of the subject matter....to foreclose a mortgage or other lien.” (See 28 U.S.C. § 2410(a)(2)).
The second sub-section of the Redemption Statute, sub-section (b), describes the specific pleading and service requirements that a plaintiff must follow when naming the United States as a party to such an action or lawsuit. It is not until the third sub-section of the Redemption Statute, sub-section (c), that the right of redemption is addressed. The fourth sentence in subsection (c) of the Redemption Statute states “where a sale of real estate is made to satisfy a lien prior to that of the United States, the United States shall have one year from the date of sale within which to redeem...” As one can see, this sentence plucked from the statute and quoted out of context could be cause for legitimate concern to a lender conducting a non-judicial foreclosure sale involving an SBA 504 loan. This sentence, however, must be read in the context of the Redemption Statute as a whole.
The second sentence of subsection (c) of the Redemption Statute states that “an action to foreclose a mortgage or other lien, naming the United States as party under this section, must seek a judicial sale” (emphasis added).
Comparison of the Redemption Statute with Language of 26 U.S.C. § 7425 (Federal Tax Liens)
Many lenders, experienced in real property foreclosures, are all too familiar with the effects of a federal tax lien and the post-foreclosure right of redemption granted to the Internal Revenue Service (“IRS”) in connection with these liens. The right of redemption granted to the IRS under 26 U.S.C. § 7425 (referred to herein as the “IRS Statute”) clearly applies to both judicial and non-judicial foreclosures. It is this express and unequivocal application to both judicial and non-judicial foreclosures that highlights the relevance of the IRS Statute in construing the meaning of the Redemption Statute.
In any analysis of the Redemption Statute, it is important to assess and compare the IRS Statute. Although the IRS certainly qualifies as the “United States” in connection with the Redemption Statute, the right of redemption available to the IRS pursuant to a federal tax lien is governed solely by the IRS Statute, not the Redemption Statute.
Pursuant to the IRS Statute, the post-foreclosure redemption period for the IRS is limited to 120 days from the date of foreclosure. As set forth above, the Redemption Statute grants the United States a right of redemption for one year after the foreclosure if the United States holds an inferior lien on the subject property.
In fact, the Redemption Statute specifically references the IRS Statute (See28 U.S.C. § 2410(d)) which is quite revealing regarding the application of the one-year right of redemption to non-judicial foreclosures. It should be noted that while the Redemption Statute never employs the term “non-judicial sale,” the IRS Statute expressly states that the 120-day right of redemption applies “to a nonjudicial sale.” Congress’ omission of the term “non-judicial sale” in the Redemption Statute likely reveals its intent to specifically limit the Redemption Statute’s application to judicial foreclosures.
Practical Effects of the Redemption Statute: The SBA’s View and Practices
Mundane statutory analysis aside, the potential negative effects of the Redemption Statute on a foreclosing lender at a non-judicial foreclosure sale appear to be minimized when viewed together with the SBA’s Standard Operating Procedures (“SOP”). Despite attempts to negotiate a release of a right they do not likely possess as mentioned above, the SBA, at least according to its SOP, takes the position that any redemption rights under a 504 loan pursuant to the Redemption Statute arise solely from a “judicial foreclosure.”
According to SOP 50-51-3, Chapter 10, Section F(1)(a), the SBA’s redemption rights are “granted by statute” and “as an agency of the Federal Government, 28 U.S.C. § 2410(c) provides SBA (but not a 7(a) Lender or CDC) with one year from the date of a judicial foreclosure sale to redeem” (emphasis added). Moreover, in referencing foreclosures in subsequent provisions, the SOP employs terms such as “order confirming the foreclosure sale” (SOP 50-51-3, Chapter 10, Section F(3)(b)(2)(d)) and “foreclosure action,” (SOP 50-51-3, Chapter 10, Section F(3)(c)(1)). Both terms suggest that the SBA views the redemption rights under the Redemption Statute to be triggered only by a judicial foreclosure (involving a complaint, lawsuit, action etc.) rather than a non-judicial foreclosure.
Effective March 1, 2013, the SBA will institute SOP 50-57, which furthers the view that the Redemption Statute only applies to a judicial foreclosure. While SOP 50-57 specifically applies to SBA 7(a) loans only, its language and treatment of the Redemption Statute proves telling and may put an end to the confusion. In discussing the right of redemption of the SBA in the 7(a) loan context, the SOP states that “Under federal law, as an Agency of the Federal Government, SBA (but not a 7(a) Lender) has one year from the date of a judicial foreclosure sale to redeem, i.e., buy back, the foreclosed-upon property (28 U.S.C. § 2410(c)).” (SOP 50-57, Chapter 13, Section C(3)(d)(1)) (emphasis added).
In addition to the SOP provisions stated above, the SBA sets forth specific guidelines/formulas to assess its economic position with respect to a property and whether or not to bid on the property at the actual foreclosure sale or to redeem the property post-foreclosure. The negative effects of any potential redemption appear to be somewhat softened by the practicalities of the SBA’s redemption process.In all likelihood, the SBA has already analyzed its position with respect to the foreclosed property prior to foreclosure and if it elected not to bid on the property at the non-judicial foreclosure sale, then, absent some drastic change in circumstances (increase in property value, unusually low foreclosure bid, etc.), it will likely not elect to redeem under the Redemption Statuteat some point in the future (assuming arguendo that a redemption right even exists). And last, but certainly not least, it should also be noted that many title insurers, who hold a significant financial risk in this issue, recognize, at least in Texas, that the Redemption Statute applies only in the judicial foreclosure context.