Daily Development for Wednesday, October 8, 2008
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

VENDOR/PURCHASER; BUYER’S REMEDIES; SPECIFIC PERFORMANCE:  Defaulting seller of overencumbered property who would have received nothing on performance may be entitled to interest on purchase price in specific performance action (and maybe not). 

Kassir v Zahabi, 164 CA4th 1352, 80 CR3d 1 (2008)

In 2002, in exchange for an advance payment of six months' rent, Moe Zahabi granted his lessee, Hassan Kassir, an option to buy the leased premises for $480,000. Kassir assigned the option contract to Hassan Mannaa, with Zahabi's consent.

In July 2002, when Mannaa formally exercised the option, Zahabi refused to transfer title. Kassir and Mannaa sued for specific performance, among other things.  Kassir remained in possession and paid rent into court (which rents later were transferred in trust to plaintiff’s counsel) and thereafter into court again in connection with an interpleader action.  In July 2004, the trial court ordered judgment for specific performance, ordering Zahabi to convey the property "free and clear of all claims, liens and encumbrances" to Mannaa for $480,000 and retaining jurisdiction for further proceedings, including the disposition of funds on deposit with the court and held in trust by counsel.

The court of appeal affirmed a money judgment, without offset, against a seller who had breached an option contract to sell residential property. The seller had failed to comply with a judgment of specific performance, declared bankruptcy, and lost his overencumbered property to foreclosure.
Zahabi refused to cooperate; the property had been overencumbered with both legitimate liens and fraudulent liens created by Zahabi.  Kassir and Mannaa amended their complaint to add the lienholders. Zahabi then declared bankruptcy.

By the time Kassir and Mannaa obtained relief from the automatic stay and invalidated the fraudulent liens, the senior lienholder had foreclosed on the property, leaving no equity after satisfaction of the liens. The foreclosure occurred in 2005, and at that time Kassir apparently vacated the property and stopped paying rent. 

In 2007, the trial court tried the remaining issues.  The court found that, due to his exercise of the option,  Mannaa became the equitable owner from the date in 2002 when Zahabi should have transferred title to him until the senior lien foreclosure in 2005.  Mannaa therefore was entitled to receive the rent for that period. The amount that had been collected through the two escrows (the private attorney and the interpleader action) were not equal to that amount, and Mannaa elected to accept that amount in cash.

On appeal, Zahabi contended that the trial court lacked jurisdiction to award rents.  Further, Zahabi pointed to California precedent involving a somewhat similar case that had held that if the specific performance plaintiff is awarded rents for the period of delay in the owner’s transferring the property, then the owner is entitled to an offsetting credit for the lost interest for that same period on the amount of the purchase price that would have been paid had the deal lclosed on time.     and had erred in not according him an offset in the amount of the interest he would have earned on the purchase price if the sale had closed.

The court rejected the jurisdictional argument because the trial court's specific performance "judgment" was an interlocutory order. The trial court had expressly retained jurisdiction to provide further relief.

As to the offset, the court of appeal agreed that it is the general rule that when specific performance has been granted, both the seller and the buyer are entitled to receive the value of the full performance of the contract, with financial adjustments relating back to the contract date. Mannaa was entitled to a credit against the purchase price for the rents and profits from the date when title should have been transferred, and Zahabi was entitled to receive the value of his lost use of the purchase money during the period of nonperformance. Here, however, Zahabi the court ruled that Zahabi could not profit from his wrong - any award for his lost use of the purchase money could not exceed the amount of rents and profits awarded to the buyer.

The court stated that the purpose of awarding additional compensation in a specific performance action is to bring the parties as close as possible to the position they would have had if the contract had been performed. It indicated that if the escrow had closed when it should have, Zahabi still would have received nothing because the entire purchase price would have been applied to the existing liens.
Notwithstanding this, the court basically seemed to say that any discussion of an offset to Zahabi was moot, since Mannaa had elected to accept the amounts in the escrow in lieu of a judgment for the fair rental value, and the difference between those two numbers exceeded the amount of any offset to which Zahabi was entitled.

Reporter’s Comment:  It is difficult to know just what the court held in this opinion. Justice Sills says, in one paragraph, that the seller should receive no offset for interest because his property was fully encumbered, but then in the very next paragraph appears to uphold precisely that kind of calculation. (Although I cannot figure out why interest on $480,000 for a period of three years amounts to only $14,000.)

It is hard to see why a seller who is forced to specifically perform a sales contract, and who is held liable for the rents the purchaser would have received during the delay period, should not also get a credit for the interest on the purchase price that he would have received, whether or not his property was encumbered. Even if he was not paying his mortgages during that period, that much less of the purchase price would ultimately get to him, because the escrow officer would have to use those funds to deliver a marketable title to the purchaser - but the interest should still be included in the calculations.

Editor’s Comment: The editor selected the case in order to highlight the computations that apply when specific performance is ordered, but not carried out.  He hasn’t seen this issue before, and the court’s general analysis seems correct.  He concurs with Roger Bernhardt, however, that the seller ought to be credited with the interest.  In theory, of course, the seller would have had to pay interest on the senior liens encumbering the property, which he might have avoided had he received the money by performing the contract.

The Reporter for this item was Roger Bernardt of the Golden Gate Law school, writing in the California CEB Real Property Repoter.  Reprinted with permission, but edited ruthlessly without approval. 

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