Real Estate Finance Notes 9/1/04


Weíre skipping time of performance and time to be conveyed.The former, he figures weíve already covered; the latter, weíll get to later.


In every contract involving the sale of real estate, there is an implied covenant that the vendor will deliver marketable title.Marketable title means good title, one that a majority of lawyers in a particular jurisdiction would advise a purchaser to accept without discounting the price due to some defect in the title.You donít need perfect title, just a good one.


Equitable conversion


This is a very odd doctrine, and itís the kind of thing that creates traps if youíre not aware of the doctrine.Most people think that the risk of loss is on the seller until you complete the purchase: as long as youíre in the contract stage, if something happens to the property you get out of the contract.But the doctrine of equitable conversion is to the contrary.Itís an old, stupid law.There are lots of proposals to change it.We have the idea that as soon as the contract is signed, equitable title is in the purchaser.The purchaser is considered to be the owner.The vendor still has legal title to the property, but not equitable title.If the property is damaged, for example, then the purchaser (as the owner of the property) suffers the loss, just as all owners do.But most people donít think that way, so the doctrine has the potential for causing problems.Around the time of hurricanes, you get lots of cases along these lines.Whatís weíre doing is recharacterizing real and personal property: thatís the ďconversionĒ.The vendor starts with real property, and the vendee starts with personal property (money).When the contract is signed, the vendor is said to have only personal property (the proceeds of the sale) and the vendee is said to have real property (in equity): the title to the real estate.


If thereís no clause in the contract allocating casualty loss, then who has it? The vendee does, because we consider the vendee the owner of the property.This doesnít seem consistent with regular peopleís expectations.Pretty much every real estate contract written by a lawyer shifts the risk of laws and eliminates the conversion rule.If people do this without an attorney, they probably wonít even think of discussing this.This isnít consistent with the way people generally insure real property!The vendor is the one who is likely to have the insurance, and the vendee wonít get the insurance until the contract closes.The vendee might fail to take the usual precautions that an ordinary vendee would.


Note that this doctrine doesnít apply when the vendor causes the damage.You canít burn your own house down and then ask for the full purchase price.It also doesnít apply when equitable title has not yet passed to the purchaser, for example, if the title is not marketable or a condition specified in the contract has not been fulfilled.If the vendor is entitled to specific performance, the law treats it like it has already occurred.But if the vendor is not entitled to specific performance, then the effects donít kick in.


When we say the purchaser has the risk, we mean that the purchaser has no right to rescind and is obligated to complete the purchase at the agreed price.In the contract on p. 21, we see that the risk of loss is on the seller until closing.Thatís more in line with ordinary peopleís expectations, at least with a marketing contract as opposed to an installment sale contract.Then the contract tries to make a distinction between major and minor damage, using the figure of 10% of the purchase price as a cutoff. If the damage is greater than 10%, the buyer can choose to proceed if the seller agrees to repair or to back out of the transaction.If the damage is less than 10%, the buyer must proceed unless the seller doesnít promise to fix the damage in writing.


If the vendor has the risk of loss, the purchaser can rescind.Weíll talk about this doctrine more when we get into title, but the other possibility is that the purchaser has the right to specific performance, but doesnít want to have to pay full price.The purchaser may want specific performance with abatement.They may want the transaction to go through, but they donít want to pay full price.If the damage or defect is not substantial, the buyer has the right to specific performance with abatement.This usually comes up when the vendor agrees to sell 1,000 acres of land when it turns out he only has 998 acres.Itís the buyerís choice of remedy to sue for specific performance in the first place, and equally so to sue for specific performance with abatement.


Uniform Vendor and Purchaser Risk Act


This Act provides that when neither legal title nor possession has been transferred, and all or a material part is destroyed or taken in eminent domain, then the vendor canít enforce the contract and the purchaser is entitled to recover her earnest money or any price paid.So if neither possession nor title has passed, the risk of loss is still on the vendor.But what is a ďmaterial partĒ?It means different things in different circumstances.There is a case where the building was destroyed and the buyer wanted to proceed with the contract anyway.It came up under New York law.The seller wanted to get out of the contract.The court said that the damage wasnít material because the buyer wasnít buying the building: the buyer planned to tear the building down as soon as the land was purchased.So one of the circumstances is what the intended use is by the buyer.Maybe the building that was destroyed wasnít a material part of the consideration.


What happens if the damage is not material?The risk stays on the buyer because there is no provision in the Uniform Act that would change it.Whatís material to a very wealthy person or not material to a very wealthy person may be very material to someone who has less money.So for non-material damage, the equitable conversion doctrine continues to apply.Can the purchaser get abatement under the Uniform Act if damage is not material?The common law applies. If the purchaser would be entitled to specific performance with abatement under the common law, then the purchaser is entitled to it here.Can the purchaser recover other expenses and costs?Is the specific performance remedy exclusive?Weíre talking about material damage.Thereís nothing here that precludes the vendee from other remedies.But it would be unlikely that the vendee would be entitled to damages as well, because weíre assuming that the difficulty was not caused by the vendor.The doctrine of mutuality of obligation says that if the vendor doesnít have the right to seek other damages, then the vendee shouldnít be able to either.


Fulton v. Duro


The vendor sells land under an installment sale contract.Then a judgment is entered against the vendor.We have a situation where legal title is in the vendor.The vendor fails to pay a bill, for example, and a judgment is entered against the vendor.Once a judgment is entered against you, it becomes a lien against all of the real property thatís owned by the judgment debtor in that county.Its priority dates from the date the judgment is recorded.The lien holder could go to court and ask that the property be sold at public auction and have the judgment paid out of the proceeds.Now letís say that the vendee continues to make payments on the contract and sells it to another vendee.Is the property, in the hands of vendee #2, subject to the judgment lien?Vendee #2 will check the title before purchasing the property and heíll see the lien.But once we say that vendee #1 has good title, it means he can alienate it.One way of looking at this is to say that under the doctrine of equitable conversion the real property is in the hands of the vendee, and the judgment lien only applies to real property.At the time of the judgment, there was nothing the vendor owned that the lien could attach to.


How is the situation described different from Fulton?The judgment lien had been recorded in Fulton before the vendor sold.What else?The lien was against the purchaser, not the vendor.The action is brought against the purchaser from the vendee.Is this a risk of loss case?No, itís a characterization issue.We must decide whether the vendee has any interest in real property.If the vendee, who was the debtor, has any interest in real property, then the judgment lien will attach to that interest, and anyone who purchases from the vendee will take the property encumbered by that judgment lien.On the one hand, the court could say that bare possession is an interest in real property, or the court could say that under the doctrine of equitable conversion, the vendee had equitable title and so the judgment lien attaches to the equitable title the vendee has and follows the property into the hands of any subsequent vendee.


Do the two rules seem consistent?If the statute says that a judgment attaches to any interest in real property, then thatís easy.If the statute says that the judgment attaches to any real property of the debtor, then it might be trickier.But Braunstein says that this is the former case, and the court made it more complicated than necessary.The two results seem consistent: (1) the vendee, not the vendor, is considered the owner when the lien is based on a judgment against the vendor and (2) we do consider the vendee to be the owner when the lien is against the vendee.The doctrine of equitable conversion leads to the same result.


Insurance and equitable conversion


The courts try to find a way around the insurance issue.The difficulty is that insurance is a personal contract.Itís a contract between the insurer and the insured.It doesnít benefit anyone else.The insurance company doesnít want to pay off to the vendee, even if the vendee has the risk of loss.Thatís pretty uniform, good law.Some courts will say: thatís fine, but once the insured gets the money, the vendor holds the money in trust for the vendee.This is a way of ameliorating the harsh effect of equitable conversion.At least to the extent that there was insurance, the vendee will be protected to that extent.It might not be the full amount of the loss, but at least it helps to some degree.


Who has suffered a loss?What if the insurance company says that the vendor is the only person thereís a contract with, and they say that the vendor hasnít suffered a loss because under the doctrine of equitable conversion the loss falls to the vendee?These issues are discussed in the notes.How does insurance come into play in these situations?You can get around this by simply contracting around it.You agree to keep the risk of loss with the vendor until closing, the transfer of possession, or whatever.


One more characterization issue: what if the vendor dies, leaving all of his real property to the son and all his personal property to the daughter?Who gets what?What does the son get?He gets legal title, subject to the purchaserís claim based on the contract.The son must deed the land.The daughter gets the purchase price.That doesnít seem fair!Wouldnít this have surprised the vendor before his death and frustrate his intent after his death?Itís a bad result!What happens if itís the other way around, and the purchaser dies, having left all his real property to his son and all his personal property to his daughter?The daughter has to pay the purchase price, and the son gets the land!Again, that frustrates the testatorís intention.But thatís the way the doctrine would work.If the purchaser agreed to pay cash, then it doesnít matter whether the purchaser dies during the executory period of the contract or after itís executed.But it the purchaser finances the transaction, the result is different!


Real estate finance


Weíll do an overview of the subject matter, and then discuss these concepts in more detail.We want to get the big picture first.As we go through this, weíll make generalizations that arenít always true, as weíll see when we get into the details.


We have two parties: a mortgagor and a mortgagee.There is a promissory note between them that is the principal obligation: namely, the obligation to pay back the money.Itís pretty much that simple.You give me $100,000, and I promise to pay it back.But you may not want to rely just on my word.So in addition to the promissory note, you have a mortgage.The mortgage is a lien for the repayment of the loan.If you donít pay on the promissory note, the mortgaged capital serves as collateral.The note is the ďdogĒ and the mortgage is its ďtailĒ.When the dog ďdiesĒ, so does the ďtailĒ.When the note is satisfied, the mortgage goes away.


If there is a default, then the lender has an option.The lender can either (1) sue on the promissory note, saying: just pay me my money, or (2) foreclose on the mortgage, have the property sold, and get the proceeds of the sale to satisfy the note.If thatís not enough, the mortgagee can sue on the note.Or the lender can do both at the same time.Up until recently, these were all options of the mortgagee. As we proceed, a lot of the notions of consumer protection from torts and contracts have been incorporated into the law of real estate finance.When we get to foreclosure, we will find that there are some limitations designed to protect borrowers.But for now, it works well to look at these as options the mortgagee has.There are two sets of obligations: the promissory note and the mortgage.The purpose of the mortgage is to aid in collection, and the way that happens is by foreclosure.But there is another set of obligations if you donít want to use the mortgage in aid of collection.


There are many different ways to pay off a loan.What does the promissory note say?It tells you that you must repay, and it says how you must do so.You can enter into a loan for 90 days, at which point all interest accrued and the principal is paid all at once.Thatís very unusual for a long-term mortgage, though.It doesnít make sense!You could also have level payments with interest only: pay the interest each year, and then pay the principal back at the end of the loan.This type of loan is used frequently for a commercial loan where the loan wonít be in place for a very long time.But these arenít used very often in residential real estate transactions.These were used before the Great Depression, when the idea of interest-only was more popular.Mortgages were much shorter in length.But interest-only led to a lot of defaults, and a kind of cascading effect.You could have a level payment that is some arbitrary amount.You could pay interest plus a certain amount of principal each month, followed by a payment of the remainder of the principal at the end of the loan.This is used with income-producing property.You pay the interest plus a given amount of the principal.You negotiate based on what the income of the building is.


The last and most common way to pay off the loan is the fully amortized mortgage, meaning that once you establish a term and an interest rate, you do a calculation.If you make a payment of a certain amount, then at the end of the term, the mortgage will be paid in full: principal and interest.Itís a constant payment of the same amount every month, and by the time you make the last payment, the loan is fully repaid.The last payment will be the same amount that the first one was.This is the most common mortgage, especially for residential transactions.


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