Distressed sales have unfortunately become a part of the landscape in these times of economic downturn. Transactions designed to avoid foreclosure or to sell properties that have been foreclosed are all too commonplace. REALTORS® have tried to assist these distressed sellers and work with buyers interested in purchasing these properties. These sales are often complicated, but one key focus in them all is delivery of clear title to the buyer.
Short Sales
When homeowner efforts to refinance, modify the loan or otherwise avert a foreclosure fail, many will attempt to sell their homes before the foreclosure runs its full course as a short sale. In a short sale, a reasonable sales price in the current market is not sufficient to pay the mortgage(s), other liens and expenses at closing. The seller must either pay additional money at closing to cover the shortage or negotiate an agreement with the lender(s) whereby the lender(s) accept less than the full amount owed.
When listing a property that is a potential short sale or a property where foreclosure proceedings have commenced, prudent listing agents do their homework before the listing contract is signed and determine whether the owner will be able to provide clear title if a buyer can be found. Will there be enough money to pay all liens and encumbrances? Obtaining a search and hold from the title company and having the owner complete the WRA Listing Questionnaire Regarding Title Issues (page 22 at www.wra.org/LU0903 and on ZipForm as WRA-QST) will help the broker and seller answer this question. The search and hold will show liens and encumbrances of record, while the questionnaire helps identify potential liens and problems that may soon impact title.
Filling the Short Sale Gap
Buyers are at risk for any title defects which appear of record after the effective date of a title insurance commitment and before the buyer’s deed is recorded, otherwise known as the “gap period.” Some of the title defects that may appear of record during the gap period include mortgages, deeds to third parties, lis pendens filings for foreclosures or other litigation, construction liens, federal tax liens and judgments. The actual risk to the buyer of an intervening lien may be greater in short sales or with REO properties because the owner or prior owner oftentimes just endured serious financial difficulties.
Lines 343-347 of the WB-11 Residential Offer to Purchase (2011) require the seller to provide a gap endorsement, provided the title company will issue the endorsement. If a gap endorsement is not available, the buyer may give written notice to trigger the Title Not Acceptable for Closing subsection on lines 353-359. While the intent of this provision is more to cause the parties to reach a mutually agreeable solution than to cause the offer to become null and void, that can be the result. This is a serious issue for the buyer, and intervening liens can be very expensive for all involved.
Whether a particular title company will provide a gap endorsement in a particular transaction or for particular types of closings - such as short sales or REO sales - is basically a business risk decision for the title company. Prudent agents may wish to become familiar with which title companies in their market do not provide gap endorsements in certain types of transactions. If gap endorsements are not available, it would be wise to point this out to buyers so that they may discuss this with their attorneys.
Enforcing Subsequent Sale Restrictions
In short sales, there typically is a contract between the seller and the lender specifying the terms and conditions of the lender’s agreement to release the mortgage on the property for less than what is owed on the mortgage note. Often there are restrictions on any immediate resales of the property. For instance, in the Home Affordable Foreclosure Alternatives (HAFA) Short Sale Agreement, the lender and the seller agree that the offer will provide, “The Buyer agrees not to sell the property within 90 days of closing of this sale.” See pages 5-8 of the March 2010 Legal Update, “Uniform Short Sales,” at www.wra.org/LU1003. This restriction might also be stated in the deed. Parties who assume this is not enforced are mistaken because lenders do ask title companies for title updates and may try to rescind the mortgage satisfaction if the property is resold before the restriction expires.
Deeds in Lieu of Foreclosure
Gap endorsements likely will not be available in instances where the owner gives a deed in lieu of foreclosure to the lender. A deed in lieu of foreclosure occurs when a property owner in default on his or her mortgage decides to quitclaim the property back to the lender rather than attempt a short sale or go through the foreclosure process. When a deed in lieu of foreclosure is considered, the lender may work with the title company to determine the status of the title to the property because any mortgages, judgments or liens filed against the property or created by the borrower will likely remain against the property if deeded to the bank. Thus, a deed in lieu of foreclosure is generally used only when title is clear. If other liens have attached to the property, a foreclosure action becomes necessary because a foreclosure removes the liens of all lenders, creditors and other lienholders named as parties in the foreclosure complaint.
Title Reports for Sheriff’s Sale Buyers
Just because the sheriff’s sale is part of a foreclosure process that involves both the court and the sheriff does not mean that title is necessarily clear. The sheriff’s deed is not a warranty deed – it is in essence a quitclaim deed. The sheriff’s deed passes the former owner’s title after barring all parties named in the foreclosure action holding liens and encumbrances on the property and barring any parties filing any liens after the lis pendens was filed with the register of deeds. Any priority liens and any liens that are not included in the foreclosure action will remain, and the property will be subject to any unpaid real estate taxes and assessments. Sometimes the mortgage being foreclosed is not the first lien – and buyers unhappily might learn there is still a mortgage in place. Therefore prospective sheriff’s sale buyers should contact a title company or an attorney to perform a title search before making any bids on the property. See the description of the sheriff’s sale process at www.danesheriff.com/foreclosure_sales_info.aspx.
Why Can’t the New Owner Fence in His Backyard?
Most real estate purchasers assume when they receive a title insurance commitment that the title company first did a full search of various public records. But another approach has surfaced in Wisconsin where the title insurance company does not search for or list any easements or restrictions of record, and instead provides a coverage exception for “covenants, conditions and restrictions, if any, affecting title which appear in the public records; easements, if any, which appear in the public records or are shown on any recorded plat or certified survey map; reservations of mineral rights or mineral rights, if any, appearing in the public land records.” (Recorded Covenants Exception).
While most consumers expect that the title company will search the public records for liens and encumbrances that negatively impact title to property they are purchasing and will list them in the title insurance commitment, this Recorded Covenants Exception is saying that the title company will not search for, or provide coverage for, recorded covenants, restrictions, easements and mineral rights. As a result, new property owners may be dismayed to later learn that they cannot build the fence, dog kennel, gazebo or other improvement they had their hearts set on because it violates recorded restrictions or easements.
How can a buyer know if they will receive a commitment with a Recorded Covenants Exception? Unfortunately there may be no indication until the title insurance commitment is delivered to the buyer and/or the buyer’s attorney. If the Recorded Covenants Exception language appears in Schedule B-II, the agent should point out the language and recommend that the buyer immediately discuss this with his or her attorney, who may decide to send it back to the title company for revision.
To prevent this sticky situation from arising, agents drafting offers to purchase may wish to add a requirement that any title insurance commitment include a full search for restrictions and easements currently in force with respect to the property. As an alternative, the offer may be drafted to require that the buyer be provided with copies of all binding easements and restrictions of record, which should trigger a full search and provide the buyer and his attorney with the opportunity to review covenant language and subdivision restrictions.
Debbi Conrad is Senior Attorney and Director of Legal Affairs for the WRA.