Daily Development for Tuesday, August 23, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
dirt@umkc.edu

MORTGAGES; EQUITABLE MORTGAGES; CONTRACTS FOR DEED: Although Minnesota recognizes the validity of a contract for deed (installment land contract), such an instrument cannot arise out of transaction in which parties obtain title to real estate and reconvey it for cash to a third party who promptly executes with the transferors a contract for deed for them to buy it back, with transferors retaining possession.  In such a case, the transaction most likely will be deemed an equitable mortgage. 

Fraser v. Fraser, 2005 WL 1950201 (8/16/05) 

H&W were seeking to acquire a house and H’s Father (Father) agreed to help them.  The couple found a property listed at $99,000 that they could acquire at a good price if they could resolve some outstanding IRS liens against the property.  H, an accountant, assisted in resolving these liens, and in exchange obtained a  credit against the purchase price of the property. 

F, who was a licensed real estate broker, agreed to provide financing for the property, but only pursuant to a contract for deed.  H&W retained a lawyer who advised Father that it was necessary for H&W to first take title to the property because they were receiving a credit against the price due to H’s work on the property.  The lawyer told Father that, because Father was unable to take title directly from the then current owner, Father would not be able to structure the financing as a contract for deed, but rather Minnesota law would reconstruct the contract for deed into an effective equitable mortgage.  Father wrote to the lawyer stating that he acknowledged that the lawyer did not represent Father, and that Father had consulted his own attorney who informed him that he could achieve the characterization of the transaction as a contract for deed notwithstanding the fact that he took title from the buyers under the contract and promptly resold to them.   (For what it’s worth, th

e court comments that Father was unrepresented by counsel in the actual transaction.)

The parties carried out the transaction. H&W acquired title to the property.  F paid $52,000 for the property to H& W, who used it to pay for the house, including a portion of the tax liens, and then  H&W conveyed to Father, who agreed by contract by deed to deliver title back to them when they completed payment of the $52,000 according to an agreed schedule.  H&W remained in possession.

Later, H&W divorced. Under a divorce settlement, W got to live in the house but H had to make the contract for deed payments.  Guess What....  H defaulted on the payments and Father declared a forfeiture of the contract for deed.

In a prior series of skirmishes, one trial court awarded Father the right to evict, but this was stayed on appeal concerning the propriety of certain equitable defenses raised by W.  In the first appeal of these matters, the appeals court remanded for further consideration of these equitable matters.  During the second trial court hearing, apparently W opened another front in a second trial court and sought a declaration that the   transaction was an equitable mortgage.  The trial court reviewing W’s equitable defenses to the forfeiture of the contract for deed ruled in favor of Father, but the other court granted summary judgment to W that the transaction was a contract for deed.   On appeal, the Minnesota Court of Appeals in 2003 ruled that deed absolute on its face (such as that from H&W to Father) will be held to be an equitable mortgage only if it appears that both parties so intended, and remanded for further consideration of that issue.

The record in the trial proceeding at the hearing following the second appeal was replete with letters and statements by Father that he did not desire or intend to enter into a mortgage, but that he always intended to provide money only if he could have the repayment structured as a contract for deed.  Nevertheless, the trial court held that the evidence also showed that the intent of the transaction was a financing of the original acquisition of the property from third parties by H&W.  It further noted that the evidence showed that the value of the property conveyed to father exceeded the amount of “consideration” that he transferred to H&W in exchange for it.  (Since a portion of the purchase price was covered by the credit for H’s accounting services and Father did not have to finance that amount.)

On third appeal: Held: Affirmed.    Contracts for deed represent an exception to the usual rule finding protecting the equity of redemption and requiring characterization of real estate secured financing schemes as equitable mortgages.  The contract for deed device permits, in effect, forfeiture of a buyer’s equity of redemption essentially because it is a seller financing device in which the buyer never obtains title and thus does not “forfeit” it when the contact is cancelled for nonpayment.  Here, it was clear that this was neither what the parties intended nor carried out.  They knew that H&W  were obtaining title to the property before Father and that Father was “financing” this acquisition. This stamped the deal with the character of an equitable mortgage, regardless of the other self serving pronouncements that Father intended only to operate through a contract for deed and regardless of Minnesota authority that states that an absolute deed will not be an equitable mortgage

 unless it is clear that both parties to the deed so intend. 

The court found that the transaction was an equitable mortgage, whether or not the parties knowingly understood it to be one, because it fit the character of such a transaction, rather than the character of a contract for deed.  Therefore Father’s security interest could be realized upon only through a foreclosure proceeding.  More to the point (and likely what all the litigation was about over this small amount of money), the forfeiture of the property that Father had initiated more than five years before was set aside. 

Note: Although the court specifically upholds the lower courts determination that the value of the property exceeded the price paid by Father, it is not clear how relevant this was to the overall determination of the case.  In the editor’s view, the case turns more on the structure of the transaction, where title passed first to H&W and only thereafter to Father.  The value analysis may have had more relevance in the court’s consideration of Father’s argument that H, at least, obtained the original title as his agent.  Since H used some of his own credit (for the accounting services) in addition to the cash provided by Father, the court ruled that the lower court had amble evidence to reject the argument of agency.

Comment 1: Five years of litigation, five or six trial court proceedings, and three appeals - all to decide a dispute over a $50,000 debt.  How many trees died???  One suspects that interfamily resentment fueled some of the passion for litigation here, but also it may be that the house in fact rose substantially in value over time, making Father’s stake in the outcome of the forfeiture claim more and more significant.  Still, one suspects that the public paid well over $50,000 to resolve this little dispute, which makes everything seem pretty wasteful.  On the other hand, justice needs to be available to rich and poor alike.

Comment 2: The case demonstrates how some states cling to the widely criticized concept of the contract for deed as an alternative financing device.  Many farm states, an in particular Michigan, appear to view it as a necessary alternative to mortgages, even when the deed of trust device is available for rapid foreclosure, in order to encourage high risk financing for real estate.  The usual “story” supporting such devices involves an older couple anxious to pass on their farmstead to a deserving young family with lots of heart with no down payment.

As this case demonstrates, the device may be used just as often by real estate sharpies to play hardball with defaulting debtors.  One suspects that this is not the first Father had used the contract for deed device to circumvent the need for mortgage foreclosure.  It should be noted, however, that Minnesota is not a state that permits private foreclosure, and thus the motive to avoid a lengthy and expensive foreclosure in a cheap, low down, financing does seem defensible.  Certainly, however, if Father’s only motive was to get back his $50,000, a judicial foreclosure would appear to have been a cheaper and faster alternative in the end.  (Maybe, Father’s friend, the lawyer who told him that he’d be able to do this deal, carried his water in these various litigations for a bargain price.  Just guessing.)

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