Don’t Let Your Contract Disappear (Merge) Into Your Deed

Other than the real estate purchase and sale agreement, the deed is the most important and often misunderstood document utilized in a real estate transaction. Like a certificate of title for an automobile, the deed is the document that actually transfers the title of real estate from one to another. Unlike a certificate of title for an automobile, however, the deed contains a specific legal description of the property; and may also contain warranties of title; reservations (e.g., right to reserve an easement over the property); and restrictive covenants (e.g., “this property may only be used for residential purposes”). Also unique to deeds vs. certificates of title (and bills of sale to transfer other personal property) the deed can, unwittingly erase protections or provisions in the real estate contract that the parties thought they would have after closing due to a principle of law entitled the “doctrine of merger by deed”.

The general doctrine of merger by deed holds that whenever a deed is delivered and accepted without qualification pursuant to a sales contract for real property, the contract becomes merged into the deed and no cause of action upon said prior agreement exists. The purchaser is limited to the express covenants of the deed only.

As with all general rules of law, of course there are exceptions to the rule. The first main exception is the “collateral exception”. “Provisions in the contract that are collateral to and therefore independent of the main purpose of the transaction are not merged in the deed. An agreement is collateral if it does not concern the title, occupancy, size, enjoyment, possession,or quantity of the parcel of land conveyed. If the agreements concern the use or enjoyment of the land, they are not collateral to the purchase agreement and are merged upon acceptance of the deed.” Westwinds Dev. Corp. v. Outcalt, 2009-Ohio-2948 (11th Dist. Ct. of App.).

Fraud and mutual mistake on the part of the original parties to an instrument are also exceptions to the doctrine of merger by deed. In such cases, the equitable remedy of reformation is available where it is shown that the written instrument does not express the true agreement entered into between the contracting parties by reason of fraud or mistake common to them. Equity, however, will not make a new contract for those who executed the writing sought to be reformed.

Two relatively recent cases in Ohio illustrate the need to make sure that deeds clearly mirror the intent of the parties contained in their real estate agreements.

In Wasserman v. Copsey, 2013-Ohio-1274 (6^th Dist. Ct. of App.), the Wassermans purchased an agricultural strip of land from the Copseys at auction in 1988. The real estate contract described the land as “75 acres more or less”, and there were boundary flags placed at several points along the perimeter of the property, indicating an acre or so less than 75 total acres. The deed conveying the land, however, identified the parcel as being “75 total acres”. In 2009, in anticipation of selling the property, the Wassermans had the property surveyed, which survey showed 75 total acres and different boundaries than had been set out at the day of auction. The Wassermans then brought a “quiet title” action to seek court affirmation of their 75 acre parcel in congruence with the 2009 survey, and the doctrine of merger by deed. The Copseys appealed, claiming mutual mistake. The trial court agreed with the Wassermans, upholding the merger doctrine, and finding no admissible evidence of mutual mistake. The 6^th District Court of Appeals affirmed, finding the trial court’s exclusion of evidence in the form of the boundary flags and contract language proper because “when a deed is delivered and accepted without qualification pursuant to a sales contract for real property, the contract becomes merged with the deed and no cause of action upon the prior agreement exists”.

In Mong v. Kovach Holdings, LLC, 2013-Ohio-882 (11^th Dist. Ct. of App.), Joseph Mong sold land to Kovach Holdings in 2009, pursuant to a contract of sale which provided, among other things,  the following clause: “Gas + oil royalty reserved by present owner”. The deed, however, provided no specific reservation of royalties language. The deed merely stated that the property is subject to “conditions and restrictions of record.” Mr. Mong brought suit after he was denied the royalty payments he was seeking. He claimed the deed should be reformed to provide for the reservation of royalties, due to a mutual mistake. Kovach Holdings defended the law suit on the basis of the doctrine of merger, and that there was no mistake on their part. Kovach further stated that it knew of the expiring reservation of royalties made by Mr. Mong’s seller; the then “present owner of the royalties”, and it would not have bought the property if Mr. Mong was going to reserve the royalties after the prior reservation expired.

The trial court in Mong (affirmed by the 11^th Dist. Ct. of App.) first established that the doctrine of merger by deed is alive and well in Ohio and most other jurisdictions. Further, reservation of mineral rights was not a collateral issue, and there was no reservation of royalties clause in the deed. The court then reasoned that there was no evidence of mutual mistake. Contrary to Mong’s position, the court explained that by its reading of the real estate documents, the contract of sale did not express an intent contrary to the terms of the warranty deed. The contract provided that oil and gas royalties were reserved by “the present owner.” The court took that to mean the present owner of the royalties (Mr. Mong’s predecessor in interest) vs. the present owner of the property. Since the predecessor’s (soon to expire) royalty agreement was of record, the court reasoned that the deed provision (subject to “conditions and restrictions of record”) actually mirrored the contract language.

What is the moral of this story? There are two morals to this doctrine of merger story. The first is a common theme articulated in a featured category of articles on this Blog: Watch your language. Namely, “Say what you mean precisely, or a judge will tell you what you meant”. Clearly, Mr. Mong should have reserved the royalties to himself, the Seller vs. an undefined “present owner”. Even more clearly, Mr. Mong should have inserted “survival language” in the contract to the effect: “the terms and conditions of this contract shall survive the closing, and not be merged into the deed”. Buyers and sellers can provide that all provisions survive, or negotiate which provisions survive and which do not, as well as negotiate survival periods.

The second moral to this story is to “respect the deed.” The deed should not be thought of as a mere formality. Buyers should request a draft of the deed prior to the end of diligence periods. Even better would be to attach a draft deed as an exhibit to the contract so buyers can be sure they are getting what they fought hard for at the contract stage.

In other words, don’t let your contract rights disappear (merge) into your deed.

Land Installment Contracts: An Overview

What is a land installment contract?

A land installment contract (also known as a land contract, a contract for deed or an installment sale agreement) is a contract between a seller and a buyer regarding real property in which the seller provides financing to the buyer at an agreed-upon price and other terms, and the buyer makes payments in regular installments. Under such contracts the  seller retains title to the property until payment is full is received, but the buyer takes possession of the property.

 

Why use a land contract?

 

Land installment contracts are used by buyers and sellers for many reasons but some of the common reasons are:

 

• Buyer lacks sufficient down payment—short-term seller financing is provided with a large balloon payment at the end, with payments during term designed to provide for sufficient equity at the end allowing buyer to qualify at the end for conventional mortgage financing;
• Buyer doesn’t qualify for conventional financing due to bad credit;
• Seller wants to close quickly and there is not sufficient time for a buyer to arrange for traditional mortgage financing; or
• Purchase price of the real property is so low that the costs associated with conventional financing doesn’t make sense.

 

What provisions must be included in a land contract?

 

Land installment contracts are subject to Chapter 5313 of the Ohio Revised Code. Section 5313.02 requires that every land contract must be executed in duplicate with each of buyer and seller receiving an original copy.  Section 5313.02 also lists a minimum of 16 provisions that must be included in a land installment contract. Besides the obvious inclusion of the identity of the parties, a legal description of the property and all of the economic terms, the contract must (i) disclose any encumbrances on the property, such as a current mortgage lien, and any pending order of a public agency against the property, (ii) require the seller to record a copy of the contract, and (iii) unless the buyer and seller expressly agree otherwise, require the buyer to pay the taxes, assessments and other charges assessed against the property from the date of the contract.

 

What are limitations or responsibilities are placed on a seller?

 

A seller cannot hold a mortgage on the property that exceeds the purchase price under the installment contract unless the mortgage covers more property than that sold to the buyer under the contract. If the latter is the case, the seller must disclose to the seller the amount of that mortgage and the release price, if any, that is attributable to the property that is subject to the contract.

 

Within 20 days after a land installment contract has been signed by the buyer and seller, the seller must cause a copy of the contract to be recorded and deliver a copy to the county auditor where the property is located. The installment contract must also conform to all legal formalities required by law for deeds and mortgages.

 

At least once a year (or, on demand of the buyer, no more often than twice each year), a seller must furnish a statement to the buyer that shows the amount credited to principal and interest based on buyer’s payments during that year and the balance due under the contract.

What happens if the buyer defaults?

 

Section 5313.05 of the Revised Code provides that a buyer’s interest may be forfeited under the contract only after the expiration of a 30 day cure period. After expiration of this 30 day period a seller can proceed to serve a notice on the buyer as described in Section 5313.06. 

 

If a contract has been in effect less than 5 years, and a buyer has paid less than 20% of the purchase price, then, in addition to any other remedies permitted under the law, a seller may bring an action for forfeiture of buyer’s rights in the contract and request restitution of the property under Chapter 1923 of the Revised Code.

 

However, if a contract has been in effect for 5 years or more, or a buyer has paid an amount equal to or greater than 20% of the total purchase price, then a seller may only recover possession of the property by initiating a foreclosure proceeding.

 

Terminating the land contract by forfeiture or foreclosure is a seller’s only remedy, subject to limited exceptions when a buyer has paid less than the fair rental value plus deterioration or destruction of the property caused by seller.  In such cases, a seller may also recover the difference between what seller paid on the contract and the fair rental value of the property plus an amount for the deterioration or destruction of the property causes by such seller’s use.

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Owner/User Buyers Making a Comeback

Banks Increasingly More Willing To Finance Sale/Leaseback, Build-to-Suits and Corporate Investments

Reprinted with permission from: Mark Heschmeyer, the CoStar Group

 Even well into a recovery, companies that own facilities have remained net sellers, raising cash by selling their property to investors and leasing back the space. 

Lately however, with increased financing options and a dwindling supply of large blocks of available space, more companies are warming up to the idea of owning their buildings once again.

"Owner/users are still net sellers, but there has been a pick-up in the amount volume of properties bought for occupancy," said Mark Gallagher, senior strategist in CBRE's Investment Strategy Services Group. "There are a number of owner buyers that have sufficient cash to either acquire or seek a developer of property in order to build-to-suit now that fewer large vacant floor spaces are available in strongest markets,” Gallagher said.

According to data from CoStar COMPs, while more corporate owner/users bought property last year valued at more than $500,000 than sold (5,577 buyers vs. 5,125 sellers.) However, the dollar volume of deals clearly weighed in favor of the sellers: $20.6 billion in properties sold vs. $16.8 billion bought.

“We're seeing a few things at play that are influencing corporate occupier decisions,” said Christian Beaudoin, director, Americas corporate research at Jones Lang LaSalle. “Among the majority of our clients, flexibility and agility seem to be key priorities, coming directly from the C-level. This is driving some very successful sale leasebacks, which give the occupier more flexibility and a huge gain on the value of their assets, while giving the buyer a stable credit tenant.”

Corporations are getting smarter about their real estate too, said Jones Lang LaSalle’s Rod “Lo” Loschiavo, a senior vice president in Fort Lauderdale.

“The most significant value creation in commercial real estate is in the lease as opposed to the bricks and mortar. A company with good credit could purchase a vacant building, execute a long-term lease and resell the property at a substantial profit,” Loschiavo said. “Often times, companies do not have the foresight to sell the property until it is no longer needed, resulting in a lower sale price down the road. But it appears as though more companies are selling these assets in the form of sale/leasebacks to maximize their return and take advantage of the premium investors are willing to pay today for the assets secured by the leases.”

Banks have re-entered the lending markets in a strong way last year after having sharply reduced the foreclosed properties and distressed loans in their portfolios as property values and the economy picked up. And owner-occupied loans are making up a big part of that lending increase.

“Certainly for 2013, commercial real estate term loans was an area of solid growth,” Andrew L. McDonald - chief credit officer and executive vice president of Columbia Bank in Tacoma, WA, told analysts last month. “Growth in commercial real estate term loans was centered primarily in owner-occupied properties, which accounts for approximately $25 million of the $31 million increase in this classification. Growth was centered in agricultural land, manufacturing facilities and warehouses.”

For the 12-months ended Sept. 30, 2013 (the last full quarter for which bank statistics are available), the nation’s banks increased the amount of owner-occupied CRE loans in their portfolios by $8.11 billion - a 1.7% increase to a total of $475.14 billion.

At the same time, borrowers are opting for shorter-term loans of from 3- to 5-years, which are right in banks’ wheelhouse.

“Banks have been pro owner-occupied lending for the past several years,” said Patrick Mahoney, principal, president and COO for NAI Realvest in Orlando. “The challenge until recently has been the financials of the underlying business. As the economy has improved businesses balance sheets are stronger and banks are more likely to look favorably on lending to them.”

Mahoney sees several factors tipping the buy vs. lease scale towards buyers.

“Property values were reset lower during the recession and if you couple that with the ability to get 90% leverage utilizing a combination of traditional and SBA loans, then owner-occupied real estate becomes a pretty good investment.”

Chris Crabtree, senior vice president, principal of Cassidy Turley in Pleasanton, CA, agrees that the owner/user buyer is making a comeback.

"As the economy strengthens, I’m finding that businesses are growing and they are beginning to feel more confident in taking risk so they are willing to consider an expansion," Mahoney said. For many small business owners, it makes sense to own as it is another tool, which is used to build wealth and spread risk."

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Protecting Claims for Indemnity Obligations When a Commercial Tenant Files Bankruptcy

As a landlord of commercial property, one of the more frustrating situations to endure is a tenant in bankruptcy. While the bankruptcy code provides more protections for commercial landlords than in the residential context, there are still many gray “no man lands” that can trap a landlord.

 

One area that can create issues for a landlord is the indemnity obligation a tenant may owe the landlord under a lease.  Consider a scenario where tenant signs a lease and proceeds to initiate a very expensive build out of the premises only to file bankruptcy before the construction is completed and the contractor paid.  Contractor proceeds to file a mechanics’ lien on the property. The landlord can be forced to spend significant amounts of money in litigation and settlement costs with the contractor to resolve and remove the lien, not to mention the litigation costs in bankruptcy court over the priority of its related indemnification claim against the tenant debtor.

 

This was the situation the landlord, WM Inland Adjacent LLC (MW Inland), found itself in after its tenant, Mervyn’s LLC (Mervyn) filed for relief under chapter 11 of the Bankruptcy Code.

 

MW Inland requested that its claim was entitled to priority treatment under section 365(d)(3) of the Bankruptcy Code while Mervyn objected claiming it should be treated as a general unsecured claim.  Section 365(d)(3) of the Bankruptcy Code provides that the debtor much timely perform all of its obligations under an unexpired lease until that lease is assumed or rejected.

 

Critical to the bankruptcy court’s decision in favor of MW Inland was the distinction of an “obligation,” which is “something one is legally required to perform under the terms of the lease” from a “claim,” which is “an unmatured right to payment.” (WM Inland Adjacent LLC v. Mervyn’s LLC (In re Mervyn’s Holdings LLC), No. 08-11586, Adv. Pro. No. 09-50920, 2013 WL 85169 (Bankr. D. Del. Jan. 8, 2013)) The court further found that the obligation arose when the contractor recorded the mechanics’ liens and sued WM Inland to foreclose upon the liens (prior to rejection of the lease), which entitled WM Inland’s claim to treatment as WM Inland had requested under section 365(d)(3).

 

The takeaway for a commercial landlord is to consult competent commercial bankruptcy counsel as soon as possible after a tenant files for relief in the bankruptcy court to develop a useful strategy for preserving pre-and post-petition claims it might have related to the tenant’s lease obligations.

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WATCH YOUR LANGUAGE WITH ASSIGNMENTS OF COMMERCIAL LEASES

As I have mentioned in other “Watch Your Language” articles for our Blog, as a general rule, courts will uphold language in a commercial lease (and ancillary lease documents such as assignments and amendments), unless it is contrary to statutory law or public policy. Because of this judicial deference to lease language, you must say what you mean, precisely, or a judge will decide what you meant. Failure to follow this principle cost the buyer in 17 Mile, L.L.C. v. Kruzel, 2013-Ohio-3005 (8^th Dist. Ct. of Appeals, Cuyahoga Cty.) $8,200 (representing past due rent of one of the property’s tenants), plus costs and attorneys’ fees.

In the 17 Mile case, Richard and Mary Kruzel sold a communications tower (leased by A T & T and T-Mobile) to 17 Mile LLC, the buyer. In conjunction with the sale, the Kruzels and 17 Mile LLC executed a lease assignment/assumption agreement. While typically, a landlord’s lease rights and obligations transfer to a buyer with notice of the lease, without need for an assignment/assumption agreement, such an agreement provides certainty to the process, and presents a good vehicle to decide upon issues such as indemnifications (e.g., buyer indemnifies seller for post-closing landlord obligations; seller indemnifies buyer for pre-closing landlord obligations), responsibility for outstanding leasehold improvements and obligations re: past due rents owed by tenants.

The assignment of leases and assumption agreement in the 17 Mile case, provided, in pertinent part: “[the Kruzels] hereby grants, conveys, sells, assigns, transfers and delivers to [17 Mile] all of its right, title and interest in and to the AT&T Lease and T-Mobile Lease. [17 Mile] hereby accepts the assignment of the AT&T Lease and T-Mobile Lease and hereby assumes, and otherwise agrees to pay, satisfy and discharge all liabilities of [the Kruzels] under the AT&T Lease and T-Mobile Lease before and after the Closing Date…”

17 Mile LLC argued that the trial court erred when it interpreted the assignment agreement and the Kruzels’ transfer of “all right, title and interest in and to the AT&T Lease and T-Mobile Lease” to 17 Mile LLC to not include the right to past-due rents owed by AT&T that accrued prior to the assignment. The Kruzels argued that the trial court got it right when it applied the following general law: “The general rule of law is that rent, which has accrued and remained unpaid at the time of a sale, is due and payable to the [seller], in the absence of an agreement between the [seller] and the [purchaser] that it shall be payable in whole or in part to the latter.”  17 Mile LLC had no problem with the general law as stated, just the court’s failure to recognize that the language: “all right, title and interest in the lease…” constituted an agreement to assign the right to collect past due rents to the purchaser.

The 8^th District Court of Appeals upheld the trial court’s decision in favor of the sellers (the Kruzels). The court first cited prior case law (including the Federal 6^th Circuit Court of Appeals) establishing the common law presumption that back rent belongs to the seller, absent agreement to the contrary. The court further explained that the assignment agreement in question did not evidence a clear intention on the part of seller to relinquish this right.  Since the lease did not include a specific provision regarding past due rents of a tenant to be paid to a successor of landlord, the right to such rents was not a specific right of the lease being assigned. Also important to the court was the fact that the assignment agreement contained specific language calling for the buyer to be obligated for lease liabilities before and after the closing date, but was silent as to lease rights accruing prior to the closing date.

What is the moral of this story? Clearly, the buyer intended for “all lease rights” to include buyer’s rights to past due rent. However, the lease assignment, according to the court, did not grant buyer such rights. In other words, “Say what you mean, precisely, or a judge will tell you want you meant.”  As a result of this case, lease assignments must specifically assign rights to past due rents to buyers, in order for buyers to be entitled to same. Prospective buyers can also protect themselves by requiring, as a condition to closing, acceptable estoppel certificates from tenants certifying as to no defaults (and no, uncured, prior defaults); and/or, an escrow holdback agreement re: past due rents.