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Source of Title Blog

Patently Stupid
by Robert Franco | 2008/01/29 |

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.
 

Source of Title Blog ::


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




Rating: 

Categories: Abstractors, Attorneys, Innovation, Legislation, Title Industry, Title Problems

2249 words | 5662 views | 18 comments | log in or register to post a comment


Trying to read the language in that...
Trying to read the language in that covenant made my eyes glaze over...but I have another question:

What kind of liability will there be for an abstractor who fails to note such a covenant on the abstract report?
 
by Scott Perry | 2008/01/29 | log in or register to post a reply

That is an excellent question... an...
That is an excellent question... and I would say "yes." Abstractors should always be checking the deeds in the chain of title for such things and they definitely have a duty to report them. Though it may be difficult to read, the shear length would make it hard to miss - that may be the only "good" think about the verbose passage. (Though someone could probably draft a much shorter version.) 
by Robert Franco | 2008/01/30 | log in or register to post a reply

This is very similar to the "first ...
This is very similar to the "first right of refusal" that used to be used in deeds, and now, which has arisen once again, with a number of developers- they insert that same kind of language in the first deed out of them with the clause that they have the rights to re-purchase the property if done in a short time frame- I suppose to eliminate the flipers that were doing their thing. It is just one more thing the "short searches" will miss and bring on more title insurance claims against the title companies that use these types of searches and in-experienced abstractors( like some one from a distant country ?) Of course they are not hard to spot- a multipage deed is a give away for most that know what they are doing anyway-just leave it to the ones that want to save a buck with a short search- good luck and let them start filling out the claims forms with their E&O carriers.

 
by Steve Meinecke | 2008/01/30 | log in or register to post a reply

The language seems to be written in...
The language seems to be written in such a way that the owner of lot owes 1% of the sales price for ANY lot in the subdivision, not just their own.

upon each transfer of title to a Lot in the Subdivision

That sounds like any lot, not just their own. Quite a scam if that's what they intended.
 
by David Jenkins | 2008/01/30 | log in or register to post a reply

1. David, the covenant clearly sta...
1. David, the covenant clearly states that the owner transferring title pays the fee. An owner clearly cannot transfer title to every lot. 2. Robert, the Texas statute (5.017), crafted in subcommittee after the senate rejected a ban, only prohibits the buyer from paying the fee - not the seller. 3. Covenants such as CC&R's are never restated in the deed. 4. The covenant is listed on schedule B, just like every other exception to coverage, including HOA dues, easements, etc. 5. The document clearly has a "Notice to Title Company" in bold at the top of page 1, with closing instructions and pertinent information. It would be very difficult to miss this and of course once it it abstracted into the plant it need not be caught again and again. 6. The transfer fee has real value that benefits buyers and sellers. Freehold has worked closely with title companies, and continues to do so. In example, a recent change incorporated at the suggestion of the title companies was to use a single trustee in lieu of tracking multiple beneficiaries.

It is unfortunate that you mischaracterize it as a burden with no purpose. A Harvard economist, Northwestern Univ. economist and others disagree with you. It may seem counter-intuitive at first, but the truth is that a property owner who can buy for less now in return for paying 1% at closing is better off. Plus, lets be real, 1% paid at closing will never render property unsellable, and to posit to the contrary is not a rational argument.

Call us or email us and tell us your concerns - we will listen. But if you criticize us, please do so based on the merits, or what you see as the lack thereof, of our business instead of repeating inaccurate information posted by others and doing so in an inflammatory way. Rational debate helps everyone.
 
by Freehold Licensing | 2008/01/31 | log in or register to post a reply

1. David, the covenant clearly s...
1. David, the covenant clearly states that the owner transferring title pays the fee. An owner clearly cannot transfer title to every lot.

Show me the language that you claim exists.

Owner of any Lot in the development ("Owner"), by acceptance of a Deed therefore...agree and shall be obligated to pay Declarant...upon each transfer of title to a Lot in the Subdivision...

It says "a Lot" not their own lot and that is not spelled out in any of the exceptions. That could very easily be interpreted to mean that if I am a existing homeowner in the subdivision, then upon the transfer of any lot in the subdivision I am obligated to pay the declarant 1% of the sale price whether or not I am the owner.
 
by David Jenkins | 2008/01/31 | log in or register to post a reply

Freeholdlicensing: Your points are ...
Freeholdlicensing: Your points are well intentioned, the big problem as I see it is the fact that so many sales and transactions are based on the "cheapest" title search available- they only reflect the status and conditions as stated in the current deed- no mention of past conditions- and since the title companies seem to love the increased money they can scrap up with this kind of search- there just is no way to protect those of us that might fall victim of their money schemes- we just might go along with what is referred to as a "short search" or a one or two owner search- neither would necessarily reveal this outstanding condition in any form. The current crop of settlement agents and document preparers just don't care about this because the liability will not eventually fall on them- it will always default to the "first" in line- the title examiner or abstractor- and our liabilty insurance premiums are just about to put a lot of us out of business because of these types of traps.
There needs to be a more honest approach to the proper type of title examinations needed- no more off-shore deals, no more short searches and no more "cheapest title available" transactions- those of us that have put in the time to become the professionals that we are like to think we are providing the best there is to the public and this undermines all of what we do our best to represent- the integrity, honesty and completeness of the title examinations we prepare for our clients. In the end, none of us want to get that dreaded phone call saying "we missed something"!!!
 
by Steve Meinecke | 2008/01/31 | log in or register to post a reply

Here is the language that David ref...
Here is the language that David refered to:

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)

Looks pretty clear that every conveyance is subject to this fee and by every lot owner of "a" lot in the subdivision- a great deal if one is the "developer"- they are the only ones that reap the benefit of this scheme.
 
by Steve Meinecke | 2008/01/31 | log in or register to post a reply

Freehold Licensing: Thank you for ...
Freehold Licensing: Thank you for the comments. I certainly appreciate the opposing point of view and it is nice to see someone standing up for what they believe in - even if it's wrong (in my humble opinion).

However, you made several points the deserve a little more research... I'll follow up with a new post, as it would be too much to address in a comment here.

 
by Robert Franco | 2008/01/31 | log in or register to post a reply

Robert,
Sounds like a 'revisi...
Robert,
Sounds like a 'revisionist' form of the popular 19th century 'ground rent'! Thanks, Fran
 
by Fran Gaspari | 2008/02/03 | log in or register to post a reply

David- You may be looking at an ol...
David- You may be looking at an older version. The actual language says "the party conveying title (“Seller”) shall pay to Declarant or assigns consideration (the “Transfer Fee”) payable in U.S. Dollars equal to one percent (1%) of the “Gross Sales Price” of the Property being conveyed." It also has a definitions section that defines the terms more closely. We work with title companies to insure that ambiguities (and any other concerns they have) are addressed. 
by Freehold Licensing | 2008/02/03 | log in or register to post a reply

Steve- We agree with you that ever...
Steve- We agree with you that every precaution needs to be undertaken to insure that the process works as intended, without surprises for anyone (including the title company). Fortunately most lenders require a comprehensive search by a reputable title company and don't allow offshore/short search" policies. Practically speaking, the transfer fee is disclosed in the same method and manner as HOA fees, etc. (which are fairly common) so if the HOA fees are caught then the transfer fee is caught as well. No title company likes another lien to have to catch, but ours is not unusual and we are working closely with title companies to insure that we integrate into the system in a professional, responsible and transparent way.  
by Freehold Licensing | 2008/02/03 | log in or register to post a reply

Last comment, and I will quit monop...
Last comment, and I will quit monopolizing the board. Developers by and large are honest decent people, and they look at transfer fees as a way to allow them to sell for less now. We had a developer sign up recently. He has now lowered the sales price of his lots. The builder is now able to lower the price of the homes they sell. The buyer has a lower purchase price, and lower acquisition costs, and will make more when he sells, despite the transfer fee. A buyer who buys for less can also sell for less, which is an advantage. The economic model really does help buyers and sellers by deferring a portion of the sales price in such a way as to increase the owners economic benefits. I know it may sound illogical at first, but studies by several economists, which followed the "trail" from seller to buyer to seller", bears this out. Last, but not least, we are generating and deferring to charity a significant sum of money. Even our critics have to admit that our system provides a necessary incentive for property owners to fund good works in their community and has generated a significant future income stream for charities, estimated at literally hundreds of millions of dollars. Yes, we also benefit, but that isn't a bad thing when we also create value for the communities while lowering the cost of ownership for property owners.  
by Freehold Licensing | 2008/02/03 | log in or register to post a reply

Freehold has worked closely with...
Freehold has worked closely with title companies, and continues to do so.

At least one Underwriter in Michigan has issued an alert explicitly requiring the termination of the covenant if found.

Fortunately most lenders require a comprehensive search by a reputable title company and don't allow offshore/short search" policies.

Most large lenders utilize one of the major underwriters, MOST of whom use short searches/offshore facilities. Last I heard, they are still 'reputable'. I have yet to hear of a lender mandating that short searches and/or offshoring is not allowed. It was the lender community that led to the development of short searches in the first place, but that is another topic.
 
by James Powell | 2008/02/04 | log in or register to post a reply

"Fortunately most lenders require a...
"Fortunately most lenders require a comprehensive search by a reputable title company and don't allow offshore/short search" policies."

Sorry, but my experience here in southwestern PA doesn't bear this out. I've seen title problems with some foreclosure searches I've done that should have been caught by a "comprehensive search", which in my opinion means that either a title company was issuing a policy on a "short search" or was simply insuring over problems.

Furthermore, the offshoring of title searches is a subject that has been discussed ad nauseum on this and other blogs. First American Corp. just had a 52% spike in claims for Q2 2007, and I think the main reason is because of their reliance on overseas "thin" title plants and shoddy searches by unqualified personnel.
 
by Scott Perry | 2008/02/04 | log in or register to post a reply

I am convinced that in those 17 sta...
I am convinced that in those 17 states that have a marketable title act, the "restriction" would expire. But that would take years.

And how does one "find" the declarant, or assigns (or presumably heirs?) Ugly - I think this one may take legislation, state by state, to clear titles.
 
by Jeanne Johnson | 2008/02/04 | log in or register to post a reply

Response to post by Jeanne-
<...
Response to post by Jeanne-

The restriction does expire under its own terms. It is not perpetual, and in some cases it can expire in as little as 10 years. Given that only one or two transfers of title are likely to occur within that period, and given that it is common for deed restrictions to run 30-40 years and to then auto-renew, it is not unusual. The maximum is can run is 99 years, and of course ground leases often run for 99 years or more, so, while the maximum term can be lengthy, it is not unusual in terms of restrictions and encumbrances.

As to finding declarants and heirs, there is a single trustee, just as there is with a deed of trust, so there is no need for a title company to hunt them down. Also, any failure to readily ascertain the beneficiary would simply result in escheatment to the state.
 
by Freehold Licensing | 2008/02/15 | log in or register to post a reply

Responding to Robert's economic com...
Responding to Robert's economic commentary... Here is just one example of how this works. Builder imposed transfer fees and lowered his prices from $250k to $245k. Buyer A paid less. Buyer B bought a house without the fee and paid $250k.

Here is the economic impact: Buyer A's closing costs were less, cash outlay was less, etc. More importantly, Buyer A's cost basis is less than Buyer B's, so when Buyer A sells he can sell for less, but make the same, or more, than Buyer B, even with the transfer fee. Buyer A saved more on closing costs, and had the use of his $5k (maybe paid down some credit card debt?), with net savings equal to or more than the 1% paid at the future sale. Buyer A is better off. Critics might argue that there is no guarantee that Buyer A will sell for less, and so Buyer A2 may not benefit. However, this argument fails for the simple reason that if Buyer A doesn't sell for less then there was no impairment of the value (which is a common complaint lodged by critics). If you suppress the price by 1-3% in return for a 1% transfer fee paid at the time of future sale, each successive buyer benefits and when the transfer fee term expires the price readjusts upwards because the impairment is removed. We have a number of developers who have used the system to add a larger amenity center, lower the price, etc., and in fact a lower sales price is almost always the first thing that happens. Property owners WANT to sell for less and there is no reasonable dispute (based upon an informed analysis) that can dispel the notion that this is simply a financial tool that helps make it possible.

On a final note, we know that this is a simplistic analysis, so before you go and try to figure out a way to calculate the numbers to show how it might not work under a given situation, understand that we already concede that such an analysis can be done. The point here is that it can work, it usually will work, and it is a tool that allows property owners to re-examine the financial structure of a property transaction. It will not always be a perfect economic transaction that operates to everyone's benefit every time, but then again I know of no other product financial product or tool out there that will. To cry for legislative protection simply because you don't like it or don;t understand it is to deprive property owners of the ability to conduct their affairs as they see fit, and yes this applies to future buyers as well. No seller will ever pay a transfer fee without first having been a wiling buyer of property with a transfer fee, and after having negotiated a price that takes the future fee into account. To assume anything less is to assume that the buyer lacks basic intelligence, and that would not only be a presumptuous assumption that is not supported by the facts but would at most argue for a disclosure statute, which we have always supported and indeed encouraged.
 
by Freehold Licensing | 2008/02/15 | log in or register to post a reply
Source of Title Blog

Robert A. FrancoThe focus of this blog will be on sharing my thoughts and concerns related to the small title agents and abstractors. The industry has changed dramatically over the past ten years and I believe that we are just seeing the beginning. As the evolution continues, what will become of the many small independent title professionals who have long been the cornerstone of the industry?

Robert A. Franco
SOURCE OF TITLE

 

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