A foreclosure protection strategy?

Q: My landlord, who's been a great guy, told me that he thinks he's probably going to lose the property to foreclosure. My lease runs out in a couple of months, and I was hoping to stay here for at least another year. The landlord offered to renew the lease now, for as long as I want, because he says there's a new law that makes foreclosing banks honor existing leases. If we do this, will it work? --Paul L.

A: Your landlord is correct about the new law. Signed by President Obama in May 2009, the Protecting Tenants at Foreclosure Act of 2009 requires foreclosing banks who become the owner upon foreclosure to honor existing leases.

If someone buys the home at a foreclosure sale intending to occupy it, however, the new owner can terminate the lease with 90 days' notice. (Incidentally, for month-to-month tenants, both the bank and any new occupying buyer have the right to terminate the rental agreement, but must give tenants 90 days' notice.)

Your landlord's idea would give you the long-term protection you need as long as the bank buys the property rather than a buyer who plans to live there. Even if the bank turns around and sells to someone else, that new buyer will have to honor the lease.

However, even if the bank becomes your landlord upon foreclosure, you might face some problems if the bank learns of your last-minute lease-signing. Reasoning that an empty home will be easier to sell than an occupied one, and realizing that any subsequent buyer will be shackled with you as a tenant for the length of your new lease, the bank may decide to challenge the validity of your last-minute lease.

Undoubtedly, the bank would start by offering you some money to move fast and quietly (known as "cash for keys"). If you don't go for it, they'd proceed by terminating your tenancy. If you refused to move, the bank would file an eviction lawsuit.

You could argue that the bank must honor your new lease, but the bank would likely contend that the lease was an effort to defraud the bank and shouldn't be enforced. Ultimately, the judge would be asked to decide whether the new lease is valid.

Your landlord's plan is clever, but that doesn't necessarily mean that it's legal. You and the landlord are taking advantage of a legal right (signing a new lease) knowing that it will tie the hands of the bank later. Is this fraud?

Lots of maneuvers that businesspeople engage in do just this -- cleverly use the law to their own advantage, and perhaps at the expense of others down the road. These ploys become illegal when, for example, the actors owe some duty of care or loyalty to the person who ends up disadvantaged by their act.

But does the landlord's relationship with his lender make him duty-bound to make life easier for the bank when the landlord defaults on his loan? Perhaps. When two people are parties to a contract, they owe each other a duty of "fair dealing," which generally means that they must not act in a way that will harm the interests of the other.

Your landlord and his lender were under contract -- but does extending your lease and making the property less salable constitute active harm? If the landlord were dealing with the neighborhood bank, maybe ... but these days, the lender could be one of many subsequent owners of this mortgage, which might have been chopped and bundled and sold repeatedly to unknown buyers.

The new federal legislation you're relying on may itself supply the answer. Section 702(b) specifies that the new duty to honor your lease applies only when you're a "bona fide" tenant.

According to the law, tenants must not be the spouse, parent or child of the owner; tenants are paying rent that's not "substantially less" than fair market rent; and the lease transaction must have been conducted at "arm's length." This last requirement probably doesn't describe the plan hatched by you and your landlord, which might doom your chances of staying. ...CONTINUED

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