VENDOR/PURCHASER; LEASE OPTION; EXERCISE: Where purchaser deposits substantial cash payment at outset of lease option period, and purchasers rent thereafter corresponds closely to the varying payments on sellers underlying mortgage, purchaser may be viewed as having already exercised option, even though he dies nine years later without having formally exercised the option.

Lee v. Bass, 2007 Westlaw 505386 (2/20/07) (opinion not yet finally approved for publication)

The parties, personal friends, negotiated the sale of a home without benefit of counsel or anyone else who knew much about the law.  Lee was to purchase the house from Basses.  They originally agreed upon a standard purchase and sale agreement, selling the home for $84,500 subject to a mortgage of about $71,500.  They then came to realize that a due on sale clause in the existing mortgage would preclude the buyer from taking advantage of the payment terms under the existing loan.  They elected instead to do a do it yourself lease option arrangement, which they believed would permit them to circumvent the due on sale clause.  They therefore disregarded the already negotiated purchase and sale agreement.

The parties got a lease form from a stationery store and one of the sellers used that as the basis for their agreement.  The final version stated that Lee would make payments equal the Basses mortgage and escrow obligations. At one point in the contract, these payments were identified as rent, but at another point, the parties, in discussing the payments, crossed out language in the form document referring to them as rent.  The arrangement otherwise was set up as a lease, including a landlords termination right for tenants failure to perform, except that the option provision indicated that if Lee had an option to purchase within one year, and if he did, the purchase price would be $84,500 and Lee would pay $13,000 in cash as a down payment.  There is no indication in the agreement whether Lee was expected to pay the balance of the price in cash.  Further, although the agreement apparently doesnt so require, Lee paid all expenses and taxes. 

Lee in fact paid the $13,000 immediately upon signing the lease/option contract,  a few days before taking possession, but there were no further actions taken to effect a closing.  There was no assumption of the existing mortgage, no deed delivery, nothing.  Lee remained in possession and made rent payments for nine years.  Although the lease stated that Lee would pay about $690 per month in payments, in fact whenever the Bass mortgage payment went up, Lee made a larger monthly payment.  Then Lee died at age 57.

The Basses had treated the property for that nine years as rental property, taking depreciation deductions and treating the mortgage interest as an expense.  We dont know how they treated the $13,000.  Lee treated the deal as a purchase for tax purposes, and treated the contract as a wrap around mortgage, deducting the interest component of the payments as home mortgage interest.

Lees heirs attempted to perform the contract by tendering the balance of the purchase price, and the Basses refused to perform.  By their analysis, Lee had failed to exercise the option in the first year provided for in their agreement, and thereafter they were nice enough to permit Lee to live in the property as a tenant, an arrangement they were free to terminate on one rent periods notice.  (It should be noted that there had never been any default by Lee in any of his obligations.)

The Basses characterized the $13,000 payment as consideration for the option, to be credited to the option price if the option were ever exercised.  The trial court bought their argument and refused to grant specific performance.

The Missouri Court of Appeals reversed.  It noted that the parties had never indicated in their agreement that the $13,000 was consideration for receiving the option, but rather than the payment of the $13,000 was to be made in connection with exercise of the option.  In short, in the view of the appeals court, Lee exercised the option on the day the contract was signed, and the parties were very, very delinquent in carrying out the other elements of their arrangement.

Comment 1: The court reached the right result, but it is a little silly to try to treat the efforts of these parties as a bona fide real estate arrangement.  It was a complete mess.  In most cases, a contract that calls for a purchase of property subject to a mortgage and does not indicate whether the buyer is obligated to assume the mortgage, pay it off, or merely take subject to, might be regarded as unenforceable because it is impossibly vague (Of course, the buyer may avoid that defect by paying case, as apparently the heirs were willing to do here.)

The court makes nothing of the fact that the Basses treated the property as a lease from the start.  Although they in fact did raise the rent that Lee paid whenever their payments went up, they did not lower the amount when their payments went down, such as they did when the Basses refinanced.  Thats right - the Basses refinanced in the middle of what the court regards as a postponed closing of an already agreed upon sale.

In short, what the court did is impose order on chaos. 

Comment 2: Note that what the parties did would not, of course, have avoided the due on sale clause in a standard mortgage.  It might have prevented the lender from discovering the sale, but a lease with an option to purchase almost certainly is the transfer of an interest within the meaning of the standard clause. 

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