A Texas-based company, Freehold Licensing, Inc., has filed for a patent of a deed covenant that requires that the creator of the covenant be paid one percent of the sales price on any future transfers of the property for 99 years. (United States Patent Pending No. 11/176,724 styled “Springing Interests Flowing From Benefits That Run With Land”). Not surprising, the company will license its patent to sellers of real property and they will get a portion of the one-percent transfer fee.

A reader of the Source of Title Blog recently sent me an article on this issue, but it is not the first I have heard of it. At least one other abstractor called me when she first saw one of these pop up in a rural Ohio county. They are out there now - so be aware.

According to the patent application, "the device of the invention may be created by reciting language such as:"
 

"Within, and for the benefit of, the subdivision and the Lots therein, Declarant has created a master subdivision plan, set aside parkland and common areas, and constructed streets, drainage and other improvements, (jointly and severally "Improvements"), which a party taking possession of any Lot stipulates all and singularly benefit said Lot. In consideration therefore, the Owner of any Lot in the development ("Owner"), by acceptance of a Deed therefore, whether or not it shall be express in the Deed, and for the foregoing benefits and other good, valuable and independent consideration, receipt of which is acknowledged by acceptance of the Deed, and as a covenant running with the land, is deemed to covenant, agree and shall be obligated to pay Declarant or assign(s), upon each transfer of title to a Lot in the Subdivision, a "Conveyance fee" equal to one percent of the Gross Sales Price of the Lot (including any improvements thereon). No Conveyance fee shall be levied upon the transfer of a Lot (a) by the Declarant; (b) by a Builder; (c) by a co-Owner of a Lot to a person or entity who was a co-Owner of the Lot immediately prior to such transfer; (d) by a Grantor to any entity wholly owned by Grantor; provided, upon any subsequent transfer of any ownership interest in such entity, a Conveyance fee shall become due; (e) by an institutional lender pursuant to a mortgage that is superior to Declarant's lien or upon foreclosure of a mortgage that is superior to Declarant's lien; (i) for transfers made on or before the first occurrence of (i) Jan. 1, 2010 or (ii) completion of improvements on ninety percent of the total Lots within the subdivision (g) if the Lot being conveyed is unimproved. For purposes hereof, the term "Builder" refers to a person or entity who purchases a Lot in the Subdivision from Declarant for the purpose of constructing a residential dwelling thereon and who is regularly engaged in the business of constructing homes for sale to individuals, and the term "Gross Selling Price" of a Lot shall mean the total consideration paid by the purchaser of the Lot, as is (or ordinarily would be) indicated on the title company's closing statement or, if a contract for deed or similar instrument, as indicated in the contract for deed or similar instrument, including consideration paid for all improvements on the Lot."

Aside from the fact that this just smells bad - some have referred to it as a scam - the idea of patenting a "legal strategy" is... well... patently stupid and absurd.
 

First, let's address the simple question, is such a covenant even enforceable? Well, some states think that it might be, which has prompted legislation to ban them. Texas, where Freehold is based, banned them on residential transactions. Apparently they felt that those involved in commercial transactions were sophisticated enough to enter into these types of arrangements. Florida is currently considering their own legislation to deal with the use of these types of private transfer fees.

The company that is attempting to patent the "real estate strategy" believes that they may help land owners in the current market slump. According to an article on DailyBusinessReview.com:

 

Freehold's method is clever but it's a little too clever, said attorney Burt Bruton of Greenberg Traurig in Miami. He is chairman of the legislative review committee of the Bar's Real Property section and helped draft the proposed legislation.

Title attorney Michael Lyons of Lyons and Smith in Hollywood and Miami said the notion “hits me wrong in the gut. This is like a pyramid scheme in real estate.”

...

Freehold executives claim developers and owners of commercial and residential properties struggling in the current market slump could sell a property at a discount because they would reap proceeds from the fee for decades.

...

The company calls the fee a “unique business method,” a form of intellectual property it says can be patented, thus giving it and its licensees exclusive use of the system. Freehold licenses its covenant, which has a patent pending, to a seller for a $249 fee.

Miami Beach attorney Rjon Robins, Freehold’s Florida operations director, said the tactic is simply an allocation of cash that would benefit any property owner.

Instead of developers, for example, trying to recoup infrastructure costs upfront with the sale of each lot, they could sell at a slightly lower price with the 1 percent fee covenant recorded with the sale.

Then every buyer would pay a transfer fee to a closing agent who would distribute the proceeds to various parties, including the developer — unless the developer removes the covenant or buyers negotiate to pay it off.

The company's Web site reads more like a late-night infomercial, than a legitimate business. Just take a look at a few of the testimonials that pack the homepage:

 

“It is an amazing system, and the income potential is impressive.”
Doug M. - Bank President

“I can sell homes for less than my competitors and still make more money. It is an astounding competitive advantage.”
Cheryl V. – Pres. Texpro Builders

“Freehold's Covenant is the first NEW idea in real estate I've seen during my 40+ years in the business. Keep it for long term income, sell it for cash or donate it to charity, the possibilities are endless. ”
Jim W . - Florida Real Estate Broker and Investor

“Since 1954 we have built quality homes of lasting value. I only wish the Freehold System had been used on every home.”
Todd B. – Prestige Homes.

Now, think for a moment about what these covenants will do to the title insurance industry. If enforceable, these covenants only need to be filed once and they will run with the land. Who will be responsible for ensuring that the covenant is complied with? The title companies that close, and insure, most of the real estate transactions in the country.

How will this fit in with the industry's dependence on short searches? From the language in the patent application the transfer fee does not apply on the sale from the creator of the covenant to the first subsequent owner - it is only charged on future transactions. Future transactions which may not repeat the covenant language on the new deed, and, could potentially be missed on a short search. Will the title insurance companies be liable on a title policy for the transfer fee if the covenant is not found?

And this doesn't even begin to address the real problem here... burdening real estate with no purpose other than to collect future unearned revenue. Consider the property owner who unknowingly buys property encumbered with such a covenant. Would others be willing to buy the property subject to the covenant, or would the owner be forced to buy it out in order to sell it? This is a serious trap for the unwary.

Second, there is a larger problem with these types of patents that lawyers should be concerned about. Tax strategies have been patented in the past - more than 52 of them have been issued and many more are pending. Does this mean that a lawyer must do a patent search before giving legal advice to clients? And, if the best course of action is a strategy that someone has already patented, will the client have to pay a licensing fee before he can implement the advice? And... what happens if the holder of the patent refuses to sell a license to create a benefit only available to his clients?

Though I think that the covenant developed by Freehold is terrible idea to begin with, the thought of doing a patent search before you can prepare a deed is horrifying.

There is a great article from May 2007 on ABAjournal.com, Crisis Pending, that explains the extent of patenting this kind of "strategy," and the consequences.

Besides Texas and Florida, Freehold also has offices in Nevada, New York, Ohio, and Connecticut. Hopefully, these states and others will pass legislation to protect homeowners and our already suffering real estate markets from these covenants requiring payment of private transfer fees. These types of burdens on real estate should not be enforceable, but who wants to be the first to test them in court? This is clearly a job for our legislators.

Robert A. Franco
SOURCE OF TITLE
rfranco@sourceoftitle.com