When foreclosing on property pledged as collateral for a loan, many banks have a practice of submitting a credit bid that is substantially less than the fair market value of the property. These bids are often calculated based on a fixed percentage of the fair market value or using a formula that is based on factors such as estimated holding costs and attorneys’ fees. But this common practice opens a bank up to a challenge by the defaulted borrower, who can seek an offset against any post-foreclosure deficiency based on a judicial determination of fair market value as of the date of foreclosure. This offset provision, which was enacted in 1991, is contained in Texas Property Code § 51.003. If the borrower asserts his rights under this provision and can prove that the fair market value of the property exceeded the foreclosure sale price as of the date of foreclosure, then the borrower is entitled to an offset for the difference.
If a bank wants to eliminate this exposure, it should include a provision in the loan documents containing an express waiver of the offset defense. Both the Supreme Court of Texas and the Fifth Circuit Court of Appeals have held that such a waiver is valid and does not violate public policy. See Moayedi v Interstate 35/Chisam Road, L.P., 438 S.W.3d 1, 6 (Tex. 2014); LaSalle Bank, N.A. v. Sleutel, 389 F.3d 837, 841 (5th Cir. 2002).
While not necessarily required, best practices include (1) specifically referencing Texas Property Code § 51.003 in the waiver provision and (2) making the waiver conspicuous by placing it in a separate section or using bold, underlined and/or all capital letters.
The waivability of the offset provision does create the possibility for abuse that has not yet been addressed by any Texas court. For example, if no third-party bidders appeared at a foreclosure sale, could a bank submit a credit bid for $1, leaving virtually the entire debt due and owing after the foreclosure? Practically speaking, such a situation is unlikely to arise. But what if a bank is foreclosing on a multi-million piece of property where the pool of potential bidders is extremely small. Can the bank still rely on the waiver of the offset if it submits a credit bid for only 30% of the fair market value? While existing authority would appear to support the bank, such a position invites extreme scrutiny from the courts and could create an extremely negative perception of the bank. Perhaps more importantly, doing so could also motivate the Texas Legislature to amend the Texas Property Code to expressly prohibit waiver of the offset defense. Thus, while current law might arguably support such a position, the best way to protect this valuable tool for future use by banks is to avoid abusing it.