Real Estate I MAY 23, 2017

Personal Loans that become commercial and the Illinois Credit Agreements Act

Illinois Credit Agreements Act

Times are good.  Many people are taking on more debt to buy new homes.  Eleven percent of homeowners own at least one rental property.  Sometimes homeowners move on to a nicer house and then rent their former residence to increase their asset base and cover their old mortgage payments.   Does the Illinois Credit Agreements Act (“ICAA”), 815 ILCS 160/1, et seq., apply if the formerly residential property takes on a commercial purpose over the life of the loan?

The mortgagors’ first home started out as what the Illinois Mortgage Foreclosure Law (“IMFL”) defines as residential real estate. 735 ILCS 5/15-1219.  Because residential mortgages are not commercial, provisions of the IMFL apply.  Public policy favors protecting consumers, while business is about taking risks. The ICAA does not apply to residential mortgage transactions because they are “primarily for personal, family or household purposes.”  815 ILCS 160/1(1).  However, what about after the mortgagors move out and become landlords renting their former residence?

If a lender wants to avail itself of the protections of the ICAA then it must document such loans appropriately when the use of the property shifts from consumer to commercial.  The ICAA protects lenders from actions related to commercial loans, with only the narrow exception of contract formation.  See Schafer v. UnionBank/Central, 2012 IL App (3d) 110008. Therefore, the lender should immediately restructure the loan upon discovering that the house is no longer being used for the primary residence.  Some forms of residential mortgages provide that real estate no longer being used as the primary residence is an event of default.  This default can provide the lender with the opportunity to modify the loan into a commercial loan subject to the ICAA.

Banks usually maintain two sets of mortgage forms: commercial and residential. The residential forms contain required federal disclosures.  The mortgage forms often come from document providers that use standard provisions.  When a residential use has transformed into a commercial use, the modification of the existing mortgage should include a custom provision that specifies that the mortgagors acknowledge the current commercial use of the property and the nature of the loan so that the ICAA now applies.  Other commercial mortgage provisions regarding waiver of the rights of redemption and reinstatement and mortgagee in possession can also be added.  The lender can request that the borrowers sign an assignment of rents to further secure the loan.

Failure to properly redocument the residential mortgage into a commercial one can also result in the application of long redemption periods and more expensive and time consuming litigation.  Again, residential loans are designed for consumers to be protected by additional IMFL provisions and other regulations that implement this public policy.  The ICAA bars anything a debtor may claim about changes to the commercial loan agreements unless changes are in writing and signed by both the debtor and creditor.  815 ILCS 160/3.

The protections given to lenders by the ICAA are only for commercial loans to stop business debtors from raising lender liability claims after they have defaulted on their loans.  In contrast, claims that are barred by the ICAA for a commercial debtor can be brought by a consumer debtor.

A motion to strike the affirmative defenses can be foiled by the debtor raising the question of whether the loan on his or her former residence is outside the scope of the ICAA.  There is no Illinois case law interpreting whether the ICAA applies to mortgage loans on residential properties that later become rental properties.  A trial court facing such a question of first impression will probably take a conservative approach protecting the mortgagors.  In light of this, documenting the formerly residential mortgage loan into a commercial real estate loan is all the more important.

The economy is currently healthy.  However, some experts predict that the next global recession is less than two years away.  Lenders should police their residential real estate collateral now to ensure that their borrowers have not become landlords. The borrowers could have easily gotten a new home mortgage from another mortgage bank. Very specific steps must be taken to bring the formerly residential mortgage loan under the shield that the ICAA provides to commercial lenders.  When the loan goes bad in the next recession, it will be too late to take advantage of this opportunity.