Real
Estate Finance Notes
We’re
skipping time of performance and time to be conveyed. The former, he figures we’ve already covered;
the latter, we’ll 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 don’t need perfect title,
just a good one.
Equitable conversion
This
is a very odd doctrine, and it’s the kind of thing that creates traps if you’re
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 you’re 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. It’s 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 don’t 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. What’s we’re
doing is recharacterizing real and personal property: that’s the “conversion”. 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
there’s 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 doesn’t
seem consistent with regular people’s 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 won’t even think of discussing this.
This isn’t consistent with the way people generally insure real property! The vendor is the one who is likely to have
the insurance, and the vendee won’t 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 doesn’t apply when the vendor causes the damage. You can’t burn your own house down and then
ask for the full purchase price. It also
doesn’t 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 don’t 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.
That’s more in line with ordinary people’s 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 doesn’t promise to fix the damage in writing.
If
the vendor has the risk of loss, the purchaser can rescind. We’ll 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 doesn’t 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 don’t 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. It’s the buyer’s 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
can’t 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 “material part”? 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
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. What’s 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? We’re talking about material damage. There’s 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 we’re
assuming that the difficulty was not caused by the vendor. The doctrine of mutuality of obligation says
that if the vendor doesn’t have the right to seek other damages, then the vendee
shouldn’t be able to either.
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 that’s 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 let’s 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 he’ll 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
Do
the two rules seem consistent? If the statute
says that a judgment attaches to any interest
in real property, then that’s 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. It’s a contract between the insurer and the
insured. It doesn’t benefit anyone
else. The insurance company doesn’t want
to pay off to the vendee, even if the vendee has the risk of loss. That’s pretty uniform, good law. Some courts will say: that’s 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 there’s a contract
with, and they say that the vendor hasn’t 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 purchaser’s
claim based on the contract. The son
must deed the land. The daughter gets
the purchase price. That doesn’t seem
fair! Wouldn’t this have surprised the vendor
before his death and frustrate his intent after his death? It’s a bad result! What happens if it’s 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 testator’s
intention. But that’s the way the
doctrine would work. If the purchaser
agreed to pay cash, then it doesn’t matter whether the purchaser dies during
the executory period of the contract or after it’s executed. But it the purchaser finances the
transaction, the result is different!
Real estate finance
We’ll
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, we’ll make
generalizations that aren’t always true, as we’ll 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. It’s 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 don’t pay on the promissory note, the
mortgaged capital serves as collateral.
The note is the “dog” and the mortgage is its “tail”. When the dog “dies”, so does the “tail”. 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 that’s 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 don’t
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. That’s very unusual for a long-term mortgage,
though. It doesn’t 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 won’t be in place for a very
long time. But these aren’t 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. It’s 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.