In a recent opinion and order, the US Bankruptcy Court for the Southern District of Illinois denied a secured lender's motion for relief from the automatic stay in order for the lender to record a deed being held in escrow relating to an Illinois commercial property. The debtor had given the deed to the lender pursuant to a forbearance agreement, under which the lender was permitted to record the deed in lieu of foreclosure in the event the borrower defaulted under the forbearance agreement. The Court's decision in In re DJK Enterprises, LLC presents key practical and legal considerations for lenders in real estate loan workouts.1
Factual Background
The facts in DJK Enterprises are straightforward. The debtor owned and operated a hotel in downstate Illinois. The debtor had received a loan from a bank, and the loan was secured by a first mortgage lien on the hotel and substantially all of the debtor's other assets. The loan matured in late 2023 and was assigned to a different lender a few months later.
The debtor and new lender then entered into a 75-day forbearance agreement, under which the debtor agreed, among other things, that if the debtor failed to pay off the loan within the forbearance period, it would agree to convey the real estate and other collateral to the lender via a deed in lieu of foreclosure and bill of sale. As consideration for the forbearance, the debtor delivered a signed deed to be held in escrow by a title insurance company. The forbearance agreement provided that the deed could be recorded and the bill of sale released to the lender in lieu of foreclosure if the debtor failed to pay off the loan by the end of the forbearance period. However, the title insurance company designated in the forbearance agreement to be the escrow agent refused to hold the deed in escrow, so the deed was ultimately delivered to a different title insurance company unilaterally chosen by the lender.
Under the forbearance agreement, in the event the debtor filed bankruptcy and the property subject to the deed and bill of sale were deemed property of the bankruptcy estate, the debtor agreed that the forbearance agreement would constitute its consent to relief from the automatic stay, allowing the lender to record the deed and recover its collateral. The debtor ultimately filed for bankruptcy shortly before the forbearance period expired. About a month later, the lender filed a motion for relief from the automatic stay to allow its chosen title insurance company that was serving as the escrow agent to release the deed to the lender, and to allow the lender to record the deed in lieu of foreclosure.
The Court's Holdings
The first issue the Court addressed was whether the debtor had waived its right to contest the motion for relief from the automatic stay. The Court acknowledged a split of authority regarding the enforceability of pre-petition waivers of the automatic stay, but held that such a waiver was per se unenforceable, reasoning that this approach best protects the interests of the debtor-in-possession and all creditors.
The Court then addressed whether the lender was entitled to relief from the automatic stay for "cause" under Section 362(d)(1) of the Bankruptcy Code. First, the lender argued that the debtor transferred all of its equitable interest in the property upon execution of the deed in escrow, and that the debtor no longer had an interest in the property when the bankruptcy was filed. Therefore, the lender argued, it should be granted stay relief to record the deed.
The Court disagreed. The Court relied upon Illinois statutes to conclude that the deed in escrow given in connection with the forbearance agreement was not intended to transfer title to the property, but was intended as additional security for the existing debt "given the conditional nature of the instrument and the Agreement's failure to forgive the indebtedness upon execution of the Deed in this case."2 For this reason, among other things, the Court described the deed in lieu of foreclosure (regardless of whether it was validly held in escrow) as an "equitable mortgage." The Court also put particular emphasis on the fact that lender reserved its rights and remedies, including the right to foreclose if the debt was not paid in full. It is common practice for lenders to consistently employ language reserving all rights, remedies and options, which is intended to be protective of the lender, but which this Court interpreted as being noncommittal and contingent. As such, the deed in escrow was nothing more than a mortgage for purposes of the Illinois Mortgage Foreclosure Law, which defines a mortgage to include "every deed conveying real estate, although an absolute conveyance in its terms, which shall have been intended only as security in the nature of a mortgage" and not a matter that justifies the lifting of the automatic stay.3
Moreover, the Court interpreted Illinois law to provide that an agreement made in advance to provide a quit claim deed upon a future default or to waive the equitable right of redemption where it is part of or in connection with an original mortgage is unenforceable. Thus, the Court strongly suggested that, in its view, the transaction presented was unenforceable as a matter of state law.
Finally, the Court held that the lender failed to establish any other "cause" for relief from the automatic stay, for reasons including the fact that the parties had stipulated that the lender was oversecured, and that there was no evidence that the hotel property was deteriorating or that it was in violation of its franchisee license and at risk of losing the license.
Takeaways
The decision in DJK Enterprises merits careful review by lenders when evaluating their options for managing a distressed real estate loan. The deed in escrow structure has received attention in the current market as a potential option for lenders in handling distressed real estate loans. However, the DJK Enterprises decision highlights important practical and legal considerations for lenders, including balancing whether the potential uncertainty regarding enforceability under state law justifies the resources that would be incurred in pursuing a deed in escrow strategy in the first place.
Footnotes
1. In re DJK Enterprises, LLC, No. 24-60126 (Bankr. S.D. Ill. Feb. 13, 2025).
2. Id. at 24.
3. See 735 ILCS 5/15-1207(c).
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