Freehold Licensing Defends Covenants

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Source of Title Blog

Freehold Licensing Defends Covenants
by Robert Franco | 2008/01/31 |

My last post, Patently Stupid, addressed the pending patent of Freehold Licensing, Inc. - “Springing Interests Flowing From Benefits That Run With Land”. The company has a patent pending on a "real estate strategy" that is basically a covenant that runs with the land and requires the declarant of the covenant to receive a payment of one percent of the purchase price on subsequent sales of the property for a period of 99 years. If you haven't read the post, you should do so. Then, read the comment by Freehold Licensing, which I will parse through below.

Freehold claims that my post was incorrect - that the Texas legislators did not ban the use of the covenant on residential real estate transactions, but only prohibits the buyer from paying the fee - not the seller.

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.

I don't know what the subcommittee drafted, or what the senate rejected. However, after reviewing Texas Property Code § 5.017 - I think that Freehold is wrong about that. It appears to me that such covenants are void and unenforceable in Texas, at least as applied to residential property.

Source of Title Blog ::

Texas Property Code § 5.017

[Effective January 1, 2008] Fee for Future Conveyance of Residential Real Property and Related Lien Prohibited

(a) In this section, "property owners' association" has the meaning assigned by Section 209.002.

(b) A deed restriction or other covenant running with the land applicable to the conveyance of residential real property that requires a transferee of residential real property or the transferee's heirs, successors, or assigns to pay a declarant or other person imposing the deed restriction or covenant on the property or a third party designated by a transferor of the property a fee in connection with a future transfer of the property is prohibited. A deed restriction or other covenant running with the land that violates this section or a lien purporting to encumber the land to secure a right under a deed restriction or other covenant running with the land that violates this section is void and unenforceable. For purposes of this section, a conveyance of real property includes a conveyance or other transfer of an interest or estate in residential real property.

(c) This section does not apply to a deed restriction or other covenant running with the land that requires a fee associated with the conveyance of property in a subdivision that is payable to:

(1) a property owners' association that manages or regulates the subdivision or the association's managing agent if the subdivision contains more than one platted lot;

(2) an entity organized under Section 501(c)(3), Internal Revenue Code of 1986; or

(3) a governmental entity.

Freehold may be reading the part that says "...that requires a transferee of residential property..." to mean that ban has no effect on the transferor. That would seem logical, except for the fact that the language continues to say "... or the transferee's heirs, successors, or assigns..." I would interpret this to include any future grantees of the property. Otherwise, the statute would be meaningless. Who cares whether the buyer or seller is actually listed on the HUD as the payor - if the buyer cannot pay the fee, the fee would surely be included in the purchase price. That could not be the intent of the legislators.

If the covenant is void and unenforceable against a buyer - but may be paid by a seller, as Freehold contends - does the covenant magically become enforceable again when the same person becomes the seller? That would seem contrary to the concept of "void and unenforceable."

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 is abstracted into the plant it need not be caught again and again.

This is exactly my point - the covenants are not repeated in the public records. What Freehold doesn't understand is that title plants are not common in many parts of the country, and even where they are many searches are still completed directly from the county records. Because 99-year searches on residential property are extremely rare, and current owners are very common, the odds that these covenants will be missed is huge. Of course, the title companies can include the covenant as an exception, even a blanket exception may be sufficient, but that is of little value to the unsuspecting purchaser.

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.

First, academic economists live in a world of theory and conjecture. Perhaps you have seen one of my earlier posts where I compared economists to weathermen. The covenant may have benefits to the buyer and seller... but that is where the benefits end. I can see where this covenant would allow a home to be sold more cheaply from the declarant-seller, who sees dollar signs in his future, and bought for less by a buyer, who now needs to come up with less money to close. But, what benefits are there to subsequent owners burdened by the fee for the remainder of the 99 years?

I have seen sellers experience great difficulties selling properties encumbered by special tax assessments levied by the local government for actual improvements to the land, such as water and sewer service. Buyers don't want to take on the extra burden, and in those cases, they are actually reaping the benefits of the assessment.

Technically, the title is not rendered "unmarketable," but it sure doesn't make it easier to sell. It's a buyer's market right now... buyers have many options. If they have a choice between two similar homes, listed at the median price of $221,900, and one is saddled with this type of covenant, which one would they buy? Do you think it would be the one that would require them to pay $2,219 to some unknown third-party when they want to sell?

To put that fee into perspective, my title and closing fees on the transaction would be about $1,500 and that would include an owner's policy for the buyer. If you haven't seen the news lately, there is a growing consensus that title fees are over-priced... and, they actually get something in return. Remind me again, what is the benefit to a subsequent owner who has to pay the $2,219 private transfer fee?

So yes, the "real estate strategy" might have advantages for the declarant-seller and the first purchaser, and niether of them have much reason to object to the covenant, for which future owner's will have to pay. But, what it really does is benefit them by stealing equity from subsequent owners for 99 years.

Nobody is going to want to buy this property, if they know of the covenant, without a reduction in the sales price. The covenant makes the property less valuable due to the encumbrance on the title. Either they will be forced to sell the property for less, or hope to sneak the covenant by an unwary purchaser. The initial buyer could look at this covenant as a sort of seller-assisted financing and plan on future appreciation being available to "buy out" the covenant when he sells. However, as we have seen, betting on future appreciation can be risky.

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.

I agree that rational debate is a healthy activity (and I thank Freehold for participating). But, what I haven't seen is any claim that this 99-year covenant provides a single benefit to the future owners who would have to pay the price. Buyers and sellers are free to contract as they choose. However, when they begin to impose conditions without any real benefits on third-parties, who may not yet even be born, well... that would seem to cross a line that I am not comfortable with. Constructive notice by filing a covenant just doesn't seem sufficient to protect purchasers.

It would appear that I am not alone on that front. Looking at the legislative history of House Bill 2207, it would seem that they were addressing a broader issue and actual notice was most certainly a major concern.

BACKGROUND AND PURPOSE

Some Texans buy their homes without knowing that their home comes with an underlying mortgage or lien. An increasingly popular "get rich quick" scheme encourages profiteers to buy homes that are distressed or subject to foreclosure, and merely cure the default without informing the lender that the property has been sold. These profiteers then turn around and sell to a buyer who would not qualify for a traditional mortgage because of poor credit or little money for a down payment.

Buyers may not know the amount of the underlying mortgage, or its terms. Both buyers and mortgage lenders are victimized by these transactions. The buyer could be foreclosed upon either if the seller did not make the underlying mortgage payments or if the mortgage contains a "due on sale" clause that gives the mortgage lender the right to accelerate the underlying note when they did not approve the sale. Because a title insurance policy is rarely provided in these transactions, the buyers are not informed of the lien or the risks.

C.S.H.B. 2207 requires that buyers obtain proper notice before buying real estate that does not have a title insurance policy or all recorded liens paid within 30 days of the sale. C.S.H.B. 2207 does not outlaw the transactions, but makes sure that sellers disclose the lien and risks to the buyer.

Thus, the Texas legislators enacted a provision (Texas Property Code § 5.016) that requires actual notice of recorded liens , before buyers enter into contracts to purchase, on certain transactions. There are no notice provisions in Texas Property Code § 5.017 - which deals with covenants for private transfer fees. That would lead me to believe that they intended to prohibit them altogether - regardless of notice.

I am certain that we will see litigation over the enforceability of these covenants. It will be interesting to see how the courts interpret them and what actions legislators will take in other states. It is my sincere hope that the courts will find an insufficient nexus between the covenant and the property to hold that it runs with the land and that they will find them unenforceable. In the mean time, however, I hope that abstractors are now aware of the covenants and they will keep a sharp eye out for them when searching titles.

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

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

2858 words | 9169 views | 4 comments | log in or register to post a comment

	Robert is a third year law student ...
	Robert is a third year law student and, as such, he has a good grasp of the issues. His experience as a title agent also gives him an above-average insight and experience. However, his interpretation of the Texas statute depends upon a seriously strained approach to statutory construction. The original house bill proposed an outright ban on transfer fees. This bill was rejected. Robert's argument fails right there. Nonetheless, there are other significant statutory construction errors in his analysis. Robert argues that because a Transferee will one day be a Transferor the "Transferee" language should be bootstrapped to include both the buyer (Transferee) and seller (Transferor). However, this construction is seriously flawed. The term "Transferee" cannot mean "Transferor" any more than the term "Grantee" can mean "Grantor". In fact, any effort to interpret statutes by interchanging the terms "Grantee" and "Grantor", or "Transferee" and "Transferor", or "Buyer" and "Seller" would result in chaos. Words have meaning, and a Transferee is “one to whom title is conveyed”. In support of his position Robert points to the “heirs” language. However, after identifying what he believes to be the issue, and as is often the case with law students, his analysis again fails to reach the correct conclusion. This is not an uncommon occurrence with law students, and in fact law schools spend a lot of time dealing with this issue. The use of the "heirs or assigns" language addresses situations such as where an executory contract is pending at the time of death of a prospective buyer but where the estate succeeds to the contract. Of course the "assigns" language is self-explanatory. Simply put, misunderstanding the meaning of the “heirs and assigns” language led Robert to an erroneous conclusion. Had the legislature intended to ban all transfer fees they would have simply said that "a covenant that imposes a transfer fee on residential property is void", or used similar language. Instead, they specifically limited applicability of the ban to the "Transferee", and they did so to avoid a buyer being surprised at the closing table. To argue that the legislature intentionally obfuscated the language by throwing in the word Transferee, with the intention that everyone else would extend the line of reasoning out as Robert has done, is simply not credible. As the Texas Supreme Court has repeatedly noted, “Our analysis was based on the plain language of the statute. We needed go no further, for “[w]hen a statute is clear and unambiguous, courts need not resort to rules of construction or extrinsic aids to construe it, but should give the statute its common meaning. The Legislature’s intent is determined from the plain and common meaning of the words used.” Citing St. Luke’s Episcopal Hosp. v. Agbor, 952 S.W.2d 503, 505 (Tex. 1997).” Again, "Transferee" means "one to whom title is conveyed", and no amount of tortured logic will render it otherwise. In another example of misconstruing the statute, Robert points to the "void and unenforceable" argument. However, in order to reach his conclusion he was forced to ignore the phrase "that violates this section". Its omission distorts the statute. A covenant is void and unenforceable, IF it violates the statute. The statute prohibits the “Transferee” from paying the fee for transfers on residential property. Robert next attacks the economics, but he does so without benefit of the actual economic analysis. This same "shoot first, ask questions later" approach is also evidenced by his title "Patently Stupid" and his analysis undertaken without the actual information. Although Robert indicated a willingness to review the information, he posted his response without waiting for the reply. As Robert (and millions of others) no doubt heard in law school, when the facts are on your side, pound on the facts. When they aren't, pound on the table. The former is missing, so the latter is occurring. Everyone on this site understands that title companies are concerned about liability, particularly when undertaken for no additional compensation. However, not only are we working hard to insure that full disclosure occurs, and not only is a fee imposed by a deed restriction a common occurrence already well handled by title companies, but in engaging in rational debate it is important that it be undertaken without reliance upon partial information and distortion of the actual statute and the facts.
	by Freehold Licensing \| 2008/02/15 \| log in or register to post a reply

	Nice post, Freehold Licensing! I re...
	Nice post, Freehold Licensing! I really appreciate the spirited debate. One more thing that I have as a third year law student, is unlimited access to Lexis/Nexis and Westlaw. God am I going to miss that when I graduate! I certainly wouldn't expect anyone to believe a third year law student when it comes to interpreting the phrase "heirs, successors, or assigns," even one with 15 years of experience in the title industry. So, here are a few words written by men in black robes. Notwithstanding plaintiff's argument to the contrary, use of the term "assigns" rather than "successors" does not suggest that the parties intended to preclude subsequent owners of the dominant estate from enforcing the covenant. To the contrary, "it is well settled that where a restrictive covenant contains words of succession, i.e., 'heirs and assigns,' a presumption is created that the parties intended the restrictive covenant to run with the land." The word "assignee" is generally defined as "one to whom property rights or powers are transferred by another." Black's Law Dictionary 114 (7th ed. 1999). See Gardner v. Jefferys, 878 A.2d 259,264 (Vt. 2005). It is said that "where a party covenants in a deed for himself, his executors and assigns, the word assigns embraces any person to whom the property or interest described in the deed may happen at any future time to be assigned, either by deed or by operation of law." See Bartlett v. Judd, 21 N.Y. 200 (N.Y. 1860). Hence, the term [assigns] has been held to include: An assignee of an assignee, a subsequent assignee or grantee, successive transferees, [and] a successor in title to real property. See Gluck v. Polakoff, 1932 Pa. Dist. & Cnty. Dec. LEXIS 185 (Pa. C.P. 1932). I chose these cases for their clear explanation of the terminology, not their precedential value. But, I think you can see that it is very well settled that when you are speaking about interests in real property, the phrase "heirs, successors, and assigns" clearly includes future grantees. Ownership in real property consists of a "bundle of rights;" including the rights to control, use, possess, enjoy and dispose of the property. Another way to look at a transfer of real property is as an assignment of those rights. Thus, an "assigns" includes the future grantees of the property. That being the case, I agree with you that the term "transferee" cannot mean "transferor." However, it is clear that the "transferors" you are speaking of are the "assigns" of the original transferee and are thus included within the statute's prohibition on paying the transfer fee. Regarding the original house bill that proposed an outright ban on transfer fees, that still does not change my analysis of the legislative intent. In the law that was passed, they did not completely ban the transfer fees, but left them an option for funding homeowners' associations, government entities, and not-for-profit organizations. And, there are no prohibitions on commercial transactions. This is still reconcilable with their refusal to implement a complete ban. Also, it would make no sense to interpret the legislative intent of the bill as "to avoid a buyer being surprised at the closing table." Buyers, can back-out of a transaction if they get to the closing table and are surprised by an unexpected transfer fee covenant. It is the seller at the closing table that needs protected here. If he doesn't discover the transfer fee until he reaches the settlement, he is just stuck. Furthermore, prohibiting a buyer from paying a fee is senseless because, as we all know, it can easily be added to the sales price and assessed against the seller if that is their desire. I don't find the statute ambiguous either. I think it is very clear that these types of transfer fees have been banned in Texas, except for those involving one of the exceptions mentioned above. However, the fact that we can both frame arguments of contrary construction means that this statute is ready to be tested in court. I'm sure that sooner or later it will be and one of us will be able to say "see, I told you so." Or, "judges don't know anything about real property law." (...think Kelo v. City of New London... even the Supreme Court makes mistakes).
	by Robert Franco \| 2008/02/16 \| log in or register to post a reply

	Freehold Responds...
	Robert, Once again you try to torture the statute's plain language into support for your contentions. To argue that the legislature used the term "transferee", when they really meant "everyone in the chain of title", and when they could have simply said that the fee is invalid, is untenable. I also suggest that no attorney would advise their client that they should walk away from the closing table whenever they find something "unexpected". If the "unexpected" item was of record (actual notice) and in the title commitment (constructive notice), and/or otherwise disclosed (some states have separate disclosure requirements) then the advice to would quickly lead to a meeting between the attorney and their malpractice carrier. Your contention that it is "senseless" to prohibit the buyer from paying the fee, because the seller might not discover the fee until closing, is incorrect. The seller was advised of the fee when he or she bought the property. The seller is exiting the property and can price accordingly. The seller is not having to bring cash to the table (the fee is a deduction on the seller's side of the HUD-1). The seller does not have to deal with loan limits and loan to value ratios. Instead, the seller bought for less, and can sell for less, and can price and plan accordingly. You also miss the economic benefit that derives from a seller-pays system. If the buyer paid the fee then the buyer would have higher acquisition costs and higher carrying costs. However, by defering payment until the s=time of sale, the buyer has lower acquisition costs and lower carrying costs. At this time Freehold has nineteen attorneys, including numerous attorneys with 25+ years of real estate law practice, an attorney of 20+ years experience that owns a title company, as well as graduates of Stanford Law, Princeton, Yale, etc. The statute has been reviewed by large multinational firms for clients doing projects over one billion dollars in Texas, and those firms, without exception, have concured with our interpretation. I believe your continued insistence that they are all wrong, and you are right, is seriously misplaced. Disclaimer: Nothing herein shall be construed as legal advice. Readers should consult with legal counsel of their own choosing regarding their rights and obligations under the law.
	by Freehold Licensing \| 2008/09/18 \| log in or register to post a reply

	Freehold Responds (2) ...
	Robert, you wrote "Remind me again, what is the benefit to a subsequent owner who has to pay the $2,219 private transfer fee?" and "the 'real estate strategy' might have advantages for the declarant-seller and the first purchaser, and niether (sic) of them have much reason to object to the covenant, for which future owner's will have to pay. But, what it really does is benefit them by stealing equity from subsequent owners for 99 years." The answer lies in your own post. You wrote, "Nobody is going to want to buy this property, if they know of the covenant, without a reduction in the sales price." A Developer files a transfer fee and lowers the sales price. Since the present value of the future income stream is worth roughly 5% of the property value, assume a 2% reduction (in many cases it is more than that). Plus, as you pointed out, the property must sell for less because of the fee. In example, a $250,000.00 will sell for $245,000.00 (2% less). Buyer 1 has a 2% lower purchase price, lower closing costs (including a lower title policy...) and lower carrying costs (less mortgage interest). In essence, he has deferred part of the sales price. He then pays the 1% fee when he sells. He is clearly ahead, having saved $5k at time of purchase, plus lower carrying costs and lwoer closing costs. In return, he pays $3,000 +/- when he sells (and the title company keeps the greater of 2% or $100.00 where allowed by law. This provision is directly within the tranfer fee instrument). The trustee issues an estoppel letter/release and coordinates with the title company. Buyer #2 pays less (because, once again, as you pointed out, the property will sell for less because of the encumbrance). Although Buyer #1 sells for less, he bought for less, so he is no worse off. In fact, he has a competiive advantage, because someone can buy his house for less than a comparible house with no transfer fee. This meanshisouse will likely sell faster (which Realtors like). Buyer #2 then receives the same benefits as Buyer #1 (a lower sales price, lower closing costs (including a lower title policy...) and lower carrying costs (less mortgage interest). BUyer #2 then pays the fee when he sells. In essence, he too has deferred part of the sales price. So far, Buyer #1 and Buyer #2 have lived in a $250,000 house for $245,000 (2% under market) and had lower carrying costs and acquisition costs. This process occurs in each sale until the transfer fee instrument expires. The question then becomes, "where does the money come from?" It comes from lower acquisition costs and lower carrying costs. In esssence a small amount comes from the title company (but they wrote a smaller policy); a small amount comes from the lender (but they made a smaller loan), and from less interest (because the loan amount is smaller). The economic efficiency comes from NOT doing things as they are done now, to wit: forcing the first time buyer to pay 100% of the costs of amenities and improvements that will enjoyed by all buyers over time. Under our current system we stick the first time buyer with 100% of the costs, ask him to absorb the carrying costs for this extra fee, and then tell him to just pass it along to the next buyer. This is economically much less efficient than fairly apportioning costs over time, which is exactly what our transfer fee accomplishes. The instrument (or an abstract) is refiled every 20 years or less as required by the applicable recording statutes (which defeats your "99 year title search argument"). The title company need look no further than the public records and the trustee (they do not need to search out beneficiaries). This careful approach to title concerns is why numerous title companies have endorsed us. Also, within each instrument we file is a provision that mandates that 5% of the gross transfer fee go back into the community from which it originated. This is administered by a third party trustee and cannot be omitted. Freehold has built a tremendous charitable endowment that will generate hundreds of millions of dollars to charity for clean air, clean water, affordable housing and more. There are two homes for sale: One is $245,000 with a 1% fee when (and if) you sell and one is $250,000 with no fee. The homes are identical. Which one would you buy? The answer is obvious, and that is why this is an important funding tool that is gaining popularity and which does not, as you suggest, unfairly burden any buyer in the chain.. In fact, quite the opposite.
	by Freehold Licensing \| 2008/09/18 \| log in or register to post a reply

Source of Title Blog

Robert A. Franco The 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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