With the uncertainty posed by state-level marijuana legalization in direct conflict with federal drug laws that impose strict penalties on marijuana-related activities, real estate lenders must use caution now more than ever to avoid potential negative consequences resulting from illegal activity occurring at the collateral property.

Forfeiture Actions

One of the most powerful tools in the federal government's law enforcement toolbox is the power to seize private property that is associated with criminal activity, including real estate and any proceeds derived from such property. Unlike criminal forfeiture actions brought by the federal government, which are in personam actions requiring the government to indict the property along with the related criminal defendant, civil forfeitures are in rem actions brought against the property and do not require criminal charges to have been brought against the owner. A civil forfeiture action under 18 U.S. Code §981 is the federal government's preferred method of seizing property involved in illicit activities because the government need only prove a property's connection to illegal activity by a preponderance of the evidence (18 U.S. Code §983(c)), whereas a criminal forfeiture actions requires proof beyond a reasonable doubt. Additionally, a successful civil forfeiture action can result in the property being deemed forfeited as of the date the criminal activity occurred (18 U.S. Code §981(f)), which allows the government to capture proceeds that were generated from the property prior to the final adjudication of the proceeding.

In any event, civil and criminal federal forfeiture proceedings can result in the liquidation of property with the resulting sale proceeds distributed to federal authorities, bypassing the secured lender. Furthermore, in personam criminal forfeitures are not subject to a Bankruptcy Court's automatic stay under 11 U.S. Code §362(b)(1) (see U.S. v. Troxler Hosiery, 41 B.R. 457, 460 (M.D.N.C. 1984)), and although there is some debate on the issue of whether the automatic stay applies to in rem civil forfeitures, the majority view is that they fall within the police power exception to the automatic stay set forth in 11 U.S. Code §362(b)(4). Accordingly, while a secured lender would be prevented from foreclosing on collateral after their borrower files for bankruptcy, the federal government would likely be permitted to proceed with a forfeiture action unimpeded.

Lenders are afforded limited protection in connection with federal forfeiture actions. Federal law allows an innocent third party to obtain equitable relief from forfeiture. In federal forfeiture actions pursuant to the Controlled Substances Act, 21 U.S.C. §801, (CSA), the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. §1961-1968 (RICO), and other money laundering and obscenity statutes, third parties can assert their interest in collateral through an ancillary hearing process pursuant to Rule 32.2(c) of the Federal Rules of Civil Procedure. Furthermore, in U.S. v. 92 Buena Vista Avenue, 61 USLW 4189 (U.S. Feb. 24, 1993), the Supreme Court confirmed that, although not literally “owners,” mortgage lenders can invoke the “innocent owner” defense provided in 18 U.S. Code §983(d).

“Innocent Owner” Status

In connection with such a proceeding to determine a lender's status as an innocent third party, the government will insist on reviewing the lender's loan file, which may either confirm the lender's “innocent owner” status or indicate the lender's awareness of illegal activity at the property. A lender can avoid losing its collateral security if it can show it is an “innocent owner by a preponderance of the evidence” (18 U.S. Code §983(d)). In United States v. Funds Held in the Name or for the Benefit of Wetterer, 210 F.3d 96, 104 (2d Cir.2000), the court stated that “[o]nce the government establishes that there is probable cause to believe that a nexus exists between the seized property and the predicate illegal activity, the burden shifts to the claimant to show by a preponderance of the evidence (1) that the defendant property was not in fact used unlawfully, or (2) that the predicate illegal activity was committed without the knowledge of the owner-claimant, that is, that the claimant is an innocent owner.” To qualify as an innocent owner, a lender must either be unaware of the illegal activity or do everything reasonably expected to prevent the illegal activity after becoming aware of it (including, without limitation, issuing a notice of default under the loan documents and/or notifying authorities of the illegal activity). If the lender does qualify as an “innocent owner,” it would then be entitled to recover the value of its interest in the forfeited property and, if provided for in the mortgage documents, their attorney fees and costs. (See United States v. Federal National Mortgage Assoc., 946 F2d 264 (4th Cir. 1991); United States v. 6960 Miraflores Avenue, 731 F. Supp. 1563 (S.D. Fla. 1990). The quality of the lender's recovery as an innocent owner would, of course, depend on the amount of the ultimate post-forfeiture sale proceeds.