Lis Pendens: What Lenders Must Know Before Closing
A lis pendens can render collateral unmarketable and a lien unenforceable. Here is how lenders identify, evaluate, and respond to this title threat.
A lender can underwrite a building. It cannot reliably underwrite a judge. That single distinction explains why a lis pendens filing should stop any loan transaction in its tracks until the lender fully understands what is at stake.
article continues after advertisement
What a Lis Pendens Actually Is
A lis pendens is a recorded public notice that a lawsuit is pending involving the real property. When filed with the county recorder, it creates a cloud on the owner’s title. That cloud must be resolved or removed before the owner can sell the property or use it as collateral.
The moment a lis pendens appears, the lender is no longer underwriting only real estate. It is underwriting the litigation risk attached to it. Ownership, title, possession, or property rights are now in dispute, and the outcome sits with a court, not a spreadsheet.
Ten Risks a Lis Pendens Creates for Lenders
1. Collateral Value Risk
The property may be physically unchanged, but its market value can fall sharply once litigation is attached. Buyers retreat. Financing tightens. Title insurance becomes limited. Investors demand discounts to compensate for the uncertainty. If foreclosure becomes necessary, the lender may inherit collateral worth far less than it was originally underwritten for.
The risks to the lender include lower loan-to-value protection, greater loss severity, and increased foreclosure exposure.
The building may not have changed. The market’s willingness to buy it may have.
2. Title Priority Risk
The most dangerous question for any lender is simple: who actually owns the property? If the lawsuit attacks ownership and the borrower is ultimately found to hold no valid title, the lender’s lien may be unenforceable. A first lien on disputed ownership can be weaker than a second lien on a clean title.
Specific risks include challenges to lien validity, title defects, weakened collateral security, and higher legal costs.
3. Foreclosure Delay Risk
Foreclosure requires clear, enforceable rights. A pending property dispute can slow or block that process entirely. Borrowers, claimants, courts, title insurers, and attorneys may all enter the fight. A routine foreclosure can turn into years of litigation, with the lender absorbing higher carrying costs, delayed recovery, greater legal expense, and asset deterioration throughout the delay.
Time quietly destroys lender yield.
4. Exit Liquidity Risk
Lenders often assume a failed loan can be resolved by selling the collateral. A lis pendens can sharply reduce that option. Foreclosure buyers frequently avoid properties tied to active litigation, and fewer bidders produce lower sale prices. The result is reduced foreclosure sale proceeds, longer disposition timelines, and higher REO carrying costs.
Collateral has value only when a buyer is willing to take it.
5. Refinance and Payoff Risk
Many lenders build their exit around refinance proceeds. A lis pendens can cut off replacement financing entirely. New lenders commonly reject transactions clouded by active title litigation, which means the expected payoff source can simply vanish. The borrower is left with loan extensions, maturity default risk, and a sharply lower probability of repayment.
An exit strategy fails when the next lender refuses to enter.
6. Title Insurance Risk
Title insurers often respond aggressively to lis pendens filings. Common responses include coverage exceptions, refusals to insure, added underwriting conditions, and litigation review requirements. Without title insurance, many deals cannot close. For the lender, that means lower collateral marketability, impaired foreclosure disposition, and greater legal uncertainty.
When title insurers hesitate, lenders should stop and investigate.
7. Construction and Development Loan Risk
Construction lenders face heightened exposure because development projects depend on timely execution, investor funding, reliable draw schedules, entitlement stability, and continued construction financing. A lis pendens can disrupt all of these at once. Even if the lender ultimately prevails in court, the project’s economics may already be damaged beyond recovery, leaving cost overruns, depleted interest reserves, contractor disputes, and potential project abandonment.
Development projects can withstand weak markets. They rarely withstand prolonged uncertainty.
8. Fraud and Borrower Misrepresentation Risk
A lis pendens may be the first visible sign of a much deeper problem. Undisclosed ownership disputes, fraudulent conveyances, partnership conflicts, probate claims, and forged deeds can all surface through a recorded notice. The filing itself may not be the defect. It may be the first warning that one exists. Lenders face exposure to loan fraud, potential repurchase liability, increased due diligence costs, and greater regulatory scrutiny.
9. Regulatory and Investor Risk
Warehouse lenders, institutional investors, securitization buyers, and regulators all require confidence in collateral integrity. Loans secured by litigated properties can trigger investor concerns, repurchase demands, higher reserve requirements, and expanded audit scrutiny. Uncertainty at the property level eventually becomes uncertainty at the portfolio level.
10. Judgment Collection Risk
A foreclosure win does not guarantee full recovery. The lender may still face multiple claimants, competing ownership interests, bankruptcy filings, and additional litigation. Collection becomes costlier, slower, and less predictable, producing higher loss severity, lower net recovery, and longer resolution timelines.
Winning in court does not always mean recovering in dollars.
Lender Underwriting Checklist When a Lis Pendens Appears
When a lis pendens surfaces, the lender needs immediate answers to these questions:
- Who filed the lis pendens?
- What property interest is being claimed?
- Does the lawsuit challenge title, possession, or ownership, or does it only seek money damages?
- Has the title insurer issued exceptions?
- Can the filing be expunged?
- What is the estimated litigation timeline?
- Will foreclosure rights be impaired?
- What is the collateral value under prolonged litigation?
- Does the borrower have enough liquidity to survive the dispute?
- Is the lender’s exit strategy still realistic?
article continues after advertisement
The Central Question Changes
For lenders, a lis pendens is more than a recorded notice. It is a warning that the collateral may no longer function under normal market conditions. The risks span collateral value impairment, title uncertainty, foreclosure delays, reduced market liquidity, refinance failure, title insurance complications, development disruption, fraud exposure, investor and regulatory scrutiny, and increased loss severity.
The lender’s real collateral is not the building. It is the enforceable right to recover against it.
Once a lis pendens is filed, the central underwriting question shifts from what is the property worth to which rights survive if the lawsuit succeeds. That answer reveals where the risk truly sits.
Dan Harkey
Educator & Private Money Real Estate Lending Consultant
[email protected] 949 533 8315
www.danharkey.com
