Real Estate Transactions Mini-Outline

Professor DiLorenzo

I.

Introduction to Real Estate Transactions

Class is organized by 3 Basic Steps in Real Estate transaction(1) K stage (marketable
title is most important here); (2) Conveyance and (3) Closing Documentation and How it
Takes Place
Important to note throughout class differences between Residential (1-4 family
homes) vs. Commercial (everything else)
I have note on pg. 1 of bigger outline re: 3 levels of financing, check w/ Turo

A. Steps in Real Estate Transaction (think of risks @ each stage)

1.
List With Real Estate Broker When is broker legally entitled to fee? In majority of
states broker entitled to commission even w/o closing
2.
Examine Property By Potential Purchaser Must seller disclose defects? Does seller
warrant conditions? If not, how can purchase to ensure satisfactory condition?
Majority Rule for Disclosures in Residential There is usually a duty to disclose
Majority Rule for Disclosures in Commercial NO duty to disclose Buyer can
remedy this by doing examination then put in K a condition contingent on satisfactory
examination
Most common condition imposed subject to financing
Problem with inspections=out of pocket expenses also likely takes place before K closed
i.
Duty to Disclose v. Legal Warranty
Warranty = Promise that there is no problem and if there is, I will pay for it
Duty to Disclose = Only have to disclose problem, no future obligations
Very rare to get warranties Most common is building of new homes, can impose
certain level of fitness
3.
Parties Sign Binder (Residential) or Letter of Intent (Commercial) This is before
signing of formal K
Are these enforceable under statute of frauds? issue here is that no attorney has
been consulted thus far and parties mostly expect these to be non-enforceable
4.
Negotiating and Preparing Formal K of Sale and Executing It What contingencies
are important to seller? What representations and warranties are important to purchaser?
Down Payment most of time put down 10% as deposit that will be lost if dont sign K.
Important to have contingencies in case certain events dont happen and can get out!

i.

Time is Of the Essence Courts usually hold time is NOT of essence rather must take
place within reasonable time of date stipulated unless K is very explicit as to timing
Delays of Closing from Buyers Side usually lack of financing, bad title
Delays of Closing from Sellers Side usually unable to pay off mortgage, bad title,
lien on property
Practice Point Not wise to make time is of essence because shit happens in real estate
closings
Common Contingencies in K Marketable title and subject to financing

ii.

5.
Satisfy Pre-Closing Contingencies Common examples are inspection, financing,
state of title, surveying
For Apartments/Condosreview leases and service Ks, obtain tenant estoppel letters
For Commercial look at net operating income (how much business will make), look at
leases, insurance costs, make sure representations are true
Recording Statutes purchasers without notice take free of claims SO question is how
much notice? you can be charged with notice for failing to do certain things.
6.

Draft Closing Documents

7.

Close Title, Loan Documents and Record

8.
deed

Post-Closing Obligations Closing report, final title policy and receive recorded

May want to add more from pg. 67-73\

B.
Attorney Involvement in Real Estate Closing
Typical price in residential$700-$800 for whole package
Commercial Real EstateMUCH more!
Some states (Mid-West) Attorneys are completely out of picture for
residentialsurvey from 20 years ago showed that 35 to 40 states attorneys no longer
involved in drafting of K of sale (done by broker)

1.
Attorney Involvement in Greater NYC Area (North NJ included)Attorneys very
much involved in residential real estate
2.
Example of Attorney Involvement Varying Within StateIn re Opinion No. 26 of
Committee on the Unauthorized Practice of Law (NJ 1995)
i.
Advantages of No Attorney Involvement Biggest advantage is save a lot of
moneyin above case North Jersey for buyers=$1K for sellers=$750 vs. South
Jersey=$90 for seller and buyer paid NOTHING
ii.
Disadvantages to No Attorney Involvement

3.

i.

4.

(1) Brokers Have Conflict of Interest brokers only get paid if deal closes so have
obvious interest of closing no matter what buyers usually think there interest are being
protected by brokers but in reality everyone just gets paid if deal closes
(2) Lender and Buyer Interest May Align BUT not always bottom line is lender is
out for themselves not buyers
(3) Brokers are not trained lawyers and dont know legal requirements Think of
statute of fraud issues, duty to disclose, state of title etc.
New York Law Protects Real Estate Attorneys in 2 Ways
Judiciary Law 478 Unlawful for any person to render legal services unless
admitted to practice law
Judiciary Law 484 Only attorneys can receive compensation for preparing deeds,
mortgages or any other instrument related to real property
What are Legal Services
What Brokers can do can use standardized forms prepared by NY Bar Assoc.
What Brokers cannot do cannot extensively modify or add provisions to forms,
cannot provide legal advice it is a felony to provide legal advice without a lawyer
If Represent Seller What Info Do You Need
(1) need clients deed for description of property; (2) need title insurance to determine
who else has interest; (3) need to do survey of land for adverse possession claims; (4)
need certificate of occupancy; (5) need building inspection reports; (6) need to know who
existing lender is; (6) need to determine if there are existing leases, service Ks etc.

5.
How Should Parties Take Title (1) Residential=most take as individuals i.e. tenants in
common; (2) Commercial see big outline pg. 4-5 for breakdown of advantages v.
disadvantages for various corporate forms
II.

Brokerage Agreements and Broker Duties (K Stage)

A.

Introduction

1.
NY Licensing Requirements to get compensation must be duly licensed broker or
agent per RPL 442-d
i.

Real Estate Broker v. Mortgage Broker

Real Estate Broker act as intermediaries for parties, negotiate terms of sale, help
obtain financing
Mortgage Brokers must be separately licensed, main duty is to find lender get
separate fees for being real estate broker and mortgage broker

Conflict of Interest Issue for Mortgage Broker Owe fiduciary duty to get best deal
possible Conflicts may arise if Lender A gives you higher fee based on higher interest
rate charged to client

B.

Conflicts of Interest in Real Estate Brokerage

1.
Real estate brokers owe only seller fiduciary duty because they are agents and
seller is principal problem is most buyers think duty is also owed to them when it is not!
Most buyers dont realize duty only owed to seller
Some states impose duty to disclose relationship
Buyers can hire own real estate broker BUT doesnt happen often BUT once you
hire you are owed fiduciary duty
I have note about adding more about conflicts from book!
2.
Dual Agency Solutionsome states (including NY, CT, NJ) authorize broker to be
legal agent of both buyer and seller
Pros commission paid by each party generally less, also disclosure is required so
buyers better protected
Disadvantages conflicts still arise because same incentive exists to close
NY RPL 443applies only to residential real estate brokers brokers must
disclose if only acting as sellers agentIf dual agency then must disclose that and
notify of potential conflicts and that buyer can hire own agent

C.

Fiduciary Duties Owed

1.
General Rule is that brokers owe fiduciary duty of reasonable care and good faith (3
subdivisions)if violate duty may forfeit commission per Daubman v. CBS Real Estate
(Neb. 1998)
i.

Reasonable Care or Due Careskill and diligence in performing obligationssort of

like a negligence standard

ii.

Duty of Good Faith3 subdivisions

(1) Honestly tell principle what is going on
(2) Must disclose persons interested in buying property and what terms are full,
fair and prompt disclosure of info relevant to seller
(3) Undivided loyalty must do everything in best interests of principale.g. if
have 2nd buyer willing to pay more and dont tell seller b/c would cool
negotiationsviolation of duty of loyalty

2.

Sanctions Imposed if Violate Duties Owed

(1) Forfeit Commissionmost frequent sanction
(2) Damages can be imposed if willful breache.g. compensatory and punitive
damages assessed against broker who led seller to believe that only offer was $25K when
there was a $50K offer received
(3) Can have license revokedthis can be imposed w/o regard to whether victim
sustained loss or actual damages

i. Example of Conduct that Warrants Loss of Commission Daubman v. CBS Real Estate
Co. (Neb. 1998) (for longer set of facts see bigger outline pg. 7
ii.
Sellers Claims in Daubman Daubman held breach of duty of loyalty BUT DiLo
states this case is great example of how bad behavior can fit into many categories
(1) Broker did everything to close ONLY with buyers interests in mindPs argued
that broker was aware of buyers shitty financial situation and that there could have been
other buyers Court held NO breach of loyalty on this claim because P signed
exclusive sale agreement in advance in narrow set of circumstance like this it is
ok to ignore other buyers
(2) Ps argue broker misrepresented buyers financial situation and ability to close
broker told seller that buyers had cash to close, financing wouldnt be a problem and they
had a good credit historyDiLo states this could be breach of duty of care
(reasonable diligence) because if know that buyers cant get financing must disclose
it
(3) Representations about 2nd loan applicationbroker never notified seller that buyer
had problems obtaining financing broker told seller that they had no legal right to
cancel KIf broker knew this wasnt true would be breach of duty to disclose If
broker did not know if seller could cancel K THEN breach of undivided loyalty or
due care
3.
Lack of full disclosure can lead to withholding commissionTPL Associates v.
Helmsley-Spear (NY 1989)
4.
Without Broker-Client Relationship No Duty OwedHaldiman v. Gosnell
Development Corp. (AZ Ct. App. 1988)

D.

How To Brokers Obtain Commission

1.
General Rule to Get Commission(1) Licensed broker (covered above); (2) Writing
requirement pursuant to Statute of Frauds and (3) Satisfy standard in applicable
jurisdiction regarding whether K has to close or title has to close
i.

Three Types of Listings

(1) Open Listing seller obligated to pay commission only to broker who is procuring
cause of sale i.e. finds buyer ready willing and abletitle does NOT have to close
(2) Exclusive Listing seller Ks with particular broker to be exclusive agent, if another
broker procures sale original/exclusive broker must be paid a portiondoes NOT matter
who closes BUT dont have to pay anything if seller themselves find buyer
(3) Exclusive Right to Sell differs from (2) in that entitled to commission even if
seller themselves find purchaser
Brokers always want (3) and sellers always want (1) compromise often is 2

2.
Writing Requirement for Listing/Brokerage Agreements2 standards used in and
use one and the other uses other
(1) Strict Statute of Frauds Requirementmust be a writing to collect
commissionsome allow it to be fulfilled by K of sale1/2 states use this
(2) No writing requirement 1/2 of States and NY use this per Gen. Oblig. Law 5701
3.

Procurement of Buyer StandardClosing of K or Closing of Title?

i.

Maj Rule (NY Rule, Cornett v. Nathan)Procuring Cause StandardTo earn

commission broker must
(1) Produces/Procures a buyer who is
(2) Ready willing and able to buy readiness and willingness tested @ K stage
(K can be oral) AND ability is tested at date of proposed closing i.e. can you
finance deal
(3) On terms of seller
This test is friendlier to brokers

ii.

iii.
iv.

Minority Rule (NJ) per Dworak v. Michals (Neb. 1998)3 part testBUT requires
closing of titleHOWEVER note the BF exception!
(1) Broker produces a buyer ready willing and able to buy on terms of seller
(2) Purchaser enters into binding K with seller on terms
(3) Purchaser completes transaction by closing title in accordance with terms of K
If the closing does not occur due to the sellers fault or refusal, the brokers are entitled to
commission; exception is when failure to clear title even after every reasonable effort by
the seller
This is thought to be more in line with what seller expects because sellers dont want to
pay unless title closesBUT if seller lacks GF in not closingbroker entitled to fee
The more important is the terms of sale, which is the most litigated: When a seller comes
to you, ask first: what are the most important terms for you? Also date of sale matters.
Example of Min. Rule and Lack of Good Faith of Seller Enabling Broker to
FeeDworak v. Michals (Neb. 1998)
National Association of Realtors Summary of Procuring Cause StandardNY
adopts this view
6

(1) Broker must be sine quo non of closingclosing would not have occurred but
for brokers effortsBUT if all broker does is introduce parties NOT entitled
(2) Must show property to buyers
(3) Must make continuous effort to get parties to sell
(4) Must participate in negotiations to ensure parties come to agreement

v.

NY Adopts NAR Standard but call it Chain and Proximate Link

StandardGreene v. Hellman (NY 1980)(Broker just pointed out property to buyer,
tries to argue for commission)Court holds broker was not procuring cause of sale
only alerted buyer to property NOT enough to get fee

vi.

Procuring Cause is Just a Default Rulemost sellers dont expect to pay fee if title
doesnt close SO often K around rule
Bigger outline has hypo illustrating this classsee pg. 10

III.

Statute of Frauds (K Stage)

A.
Statute of Frauds
DiLo Hypo on pg. 10-11 of big outline

1.
Residential Real EstateParties Sign a Binder that lists purchase price, name of
parties, deposit amount, premise descriptionThis MAY be enforceable as a writing via
SoF
2.
Commercial Real EstateParties Sign Letter of Intentmight list some conditions
such as satisfactory title report, environmental site inspectionsThis is a writing for
statute of frauds purposes
3.
Subject to Attorneys Reviewsome binders and letters of intent attempt to
explicitly make them not-enforceable via SoF
4.
NY Gen. Obligations Law 5-703Conveyances and Ks Concerning Real Property
MUST be in writing
(1) Any estate or interest in real property cannot be granted unless in writing and
only the seller needs to sign
(2) No monetary threshold for rule
(3) Interest= mortgage, right of way etc.
(4) Lease for longer than year must be in writing
5.
Case Law Supplements 5-703 Courts hold all essential terms must be in
writing or terms so important parties would not agree to be bound without them

(1) Identify Parties; (2) Identify Subject Matteruse metes and bounds and actual
physical address; (3) Expression of intent to be bound; (4) Consideration; (5)
Signature and (6) All other essential terms that parties wouldnt close w/o

6.

Most Courts Hold Oral Ks CAN Supply essential terms

Parole Evidence Rulewritten Ks are NOT subject to parole evidence but it can be
shown that K incomplete if can be proved written K not in compliance w/ SoFnot
sure what this means Check with DILO!
B.

Does K Have to Be One Document or Can it Be Multiple?

1.
Integration Doctrineseveral writings can be used to satisfy statute of frauds
if(1) refer to same transaction or (2) they are physically annexed to each other this was
rule adopted by Kovarik v. Vesely
i.

Kovarik v. Vesely (WI 1958

2.
NY Rule is More Forgiving Than Kovarik per Crabtree v. Elizabeth Arden Sales
Corp2 writings can be even if one is unsigned sufficient for statute of frauds if(1) refer
to same transaction and (2) connection between them can be established by parole evidence
rule

1.

C.
Exceptions to Statute of Frauds Requirements
Two ways to get oral K enforceable in court(1) Equitable Estoppel Doctrine and
(2) Part Performance Doctrine
Equitable Estoppel Doctrine4 Requirements
(1) Oral K; (2) 1 party has changed their position and the change of position is
reasonably expected; (3) Change of position made in reliance to oral K; (4)
Significant loss imposed on 1 partyif no loss, will not impose doctrine
VERY discretionary doctrine by courts
Damages= Maj. and NYNO specific performance ONLY restitution

2.
Part Performance DoctrineCan only raise if (1) substantial loss that cannot be
restored and (2) It is so unfair not to enforce oral KWhen Successfully Argue This Can
Get Specific Performance
i.

ii.

Two Things Must Prove

(1) Substantial Loss or Benefit That Cant Be Restorede.g. partial payment of
purchase price PLUS significant improvements to property OR seller relinquishes
possession to buyer
(2) Loss must be unequivocally referable to oral KDifferent articulations of this
found in Holman and Wilson
Maj. Rule Requires Unequivocally Referable BUT it is stated in 2 different
ways
(1) No other possible explanation for what was done besides oral K between parties
BUT if court can think of another explanation NOT unequivocally referable
(2) There is actual evidence of another possible explanationthis is different than
(1) that just requires an imagined other explanation

iii.

Example of Another Possible ExplanationHolman v. Childersburg Bancorporation,

Inc. (AL 2002)

iv.

Example of Differences Between 2 Standard of Unequivocally Referable Wilson v.

La Van (NY 1968) (P and D entered into oral K for land owned by Dagreement was P
would take possession of property, maintain buildings, pay taxes and make mortgage
paymentin return D would covey propertyP took possession in 47 and complied
with all termsin 60 mortgage paid off and P demanded deed be conveyed but Ds
refusedPs sued for specific performance via partial performance doctrine)Court
held NOT unequivocally referable because only possible evidence not actual
evidence of oral KHERE just possible evidence of oral K because alternatively
could have been land-lord tenant agreementmortgage and tax payments COULD
HAVE been consideration for right to use land

3.
Electronic Signature StatutesCongress passed Electronic Signature Act that stated
signature can be in electronic form
Electronic Signature=electronic sound, symbol or process, attached to or logically
associated w/ contract or other record and executed or adopted by person with intent to
sign the record
IV.

Conditions on Property: Disclosure Obligations

1.

A.
Intro to Duty to Disclose
Note hypo from DiLo on pg. 15 on bigger outline
If actively conceal something and dont say anythingfraud

2.
Affirmative Duty to Disclose in Residential Propertymost jurisdictions have
rejected caveat emptor and imposed duty to disclose
3.

No Duty to Disclose in Commercial Real Estate BUT might have an action in fraud

4.
General Rule for Duty to Disclose(1) Is there a material defecta defect that
materially affects the value or desirability of property AND would have significant or
measureable effect on FMV; (2) Does seller/broker have actual knowledge of such defect
and (3) Is defect discoverable upon reasonably attentive and observant purchaser? If yes
to all 3 then owe a duty
Note these cases involve(1) Broker is D or (2) Seller is D
B.
1.

Duty to Investigate?

Maj. Rule/ Cooper Standard for ResidentialOnly have duty to investigate if

(1) D knows or has actual knowledge of defect
(2) Material defect exists i.e. one that effects value or desirability of sale

(3) Material defect known only to broker/seller i.e. buyer could not determine defect
after diligent and reasonable observation

2.
Min. RuleEaston v. Strassburger (CA 1984)duty of real estate broker
representing seller includes (for unknown and unobservable defects) an affirmative duty to
conduct a reasonably competent and diligent inspection and to disclose to purchaser all
facts materially affecting value or desirability of property
i.

Easton v. Strassburger (CA 1984)

3.
Commercial Real Estate (same in NY)No duty to disclose BUT may have action in
fraud6 elements below of fraud
(1) affirmative misrepresentation or active concealment of (2) material fact (3) that
is false and known to be false OR reckless indifference to falsity; (4) Intention to
deceive purchaser (5) Actual or justifiable reliance i.e. could buyer have ascertained
truth? IF YES no fraud but if have profession inspection and cant ascertain truth
then DO have action and (6) Injury

C.
NY Rule on Duty to Disclose
Note for commercial real estate and fraud EXACT same rule as above BUT different than
Maj. and Min. for residential

1.
NY Rule via Stambovsky v. Ackley (NY 1991)(1) Where condition has been created
by seller; (2) Condition is material i.e. impairs value of house and (3) Material condition is
within the knowledge of seller and not discoverable on observation or visual inspection of
property THEN affirmative duty to disclose
i.

Stambovsky v. Ackley (NY 1991)

2.

NY Statutes on Brokers/Sellers Duty to Disclose

NY RPL 443-aDisclosure obligations of brokersmust disclose known and
material defectsNO requirement that defect only known to brokerMAY want
to add more to bigger outline from case book that has statute listed
NY RPL 460Disclosure obligations for seller based on actual knowledge AND
specific problems such as asbestos, led pipe poisoning, pol leaks, water damage,
termites, defects in electric services, water in basement, defective heating etc.

i.

Remedies for Failure to Disclose

(1) If no disclosure by sellerliability limited to $500 and whatever liability via
Stambovsky Test; (2) If do disclose and its false i.e. material misrepresentation then
labile for all active damages
Downstate NY Practicesay nothing and take $500 penalty (with risk of
Stambovsky liability)
Upstate NY Practicedisclose everything

10

V.

Condition on Property: Warranty of Quality (K Stage)

A.

Implied Warranties (mostly apply to residential real estate)

1.
Majority Rule/ Albrecht Rule on Construction of New Home 5 Elements to prove
breach of implied warranty of habitability
(1) P bought new home from D/builder; (2) house contained latent defect; (3) Defect
manifested itself only after purchaseStatute of Limitations important here; (4) Defect
caused by builders improper design, material or workmanship AND (5) Defect created a
substantial question of safety or made house unfit for human habitationMaj. Rule is
narrow because only requires building is safe
i.

Illustration of Maj. RuleAlbrecht v. Clifford (MA 2002)

2.
Minority RuleMuch broader than Maj. Compliance with (1) Local building
codes; (2) Built in workmanlike manner and (3) suitable for human habitation

3.
NY Rule for Implied Warranty of Quality in Sale of New Home NY Gen. Bus.
Law 777
i.

One Year from warranty datewarrant home free from defects due to failure to
have been constructed in skillful manner

ii.

Two Years from warranty dateplumbing, electrical, heating, cooling and

ventilation systems of home free from defects due to failure by builder to have
installed such systems in skillful manner

iii.

Six Years from warranty datehome free from material defects

iv.

Unless K states otherwise implied warranty does not extend to(a) defects not (i)
defective workmanship by builder or agents; (ii) defective materials supplied by
builder or agents or (iii) defective design (b) does not extent to patent defects
which examination ought to have revealed

v.

Damagesreasonable cost of repair/replacement and property damage to home

proximately caused by breach of warranty but no more than replacement cost of
home

4.

Summary of Implied Warranty of Habitability

(1) Suitable for human habitation and/or
(2) Built in workmanlike manner i.e. in compliance with generally accepted
standards and/or
(3) Compliance with all building and house codesStates have combo from just (1) to
all 3 to somewhere in between

11

B.

Can As Is Clause Waive Implied Warranties?

1.
Maj. Rule for Construction of New HomesImplied warranties CANNOT be
waivedwhole purpose of rule is to give minimum level of protection
2.
Maj. Rule for Existing Homeshave duty to disclose defects and cannot waive
implied warranties by as is clausewhole purpose of rule is buyers cannot protect
themselves
3.
Maj. Rule for Commercial Real Estateremember all actions brought in fraud
herecannot waive implied warranties OR duty not to be fraudulent
4.

VI.

What Is Purpose of as is clause then?

Can eliminate causes of action in Kbuyers only representations can sue on are those
made in this K not earlier ones
No reliance or intention requirements
Integration doctrineas is clause eliminates possibility of other representations made
orally

Risk of Loss (K Stage)

Focus here is one who bears the loss if something happens in between closing of K and
closing of title? this comes up often when natural disasters, fires etc., no party to blame
A.

Three Approaches (note these are default rules, can be Kd around)

1.
Massachusetts Rule (extreme minority)Risk of loss is on the seller until title
passesafter loss buyer can complete K or rescind it
2.
Majority Rule or Doctrine of Equitable Conversion Risk of loss is on buyer after K
is signedrationale is that buyer after K signed is considered to have all indicia of ownership
except titlepossession is not a requirement (even though many instances will be true)
Majority rule followed because many times sellers have insurance policy so
purchase price is abated/reduced by amount of insurance seller has
Buyers still can force sale of property by bringing action in specific performance
but critics argue why should buyers have to do this?

12

3.
ALI/NY Rulefocus on possession of propertyparty who has possession bears
risk of loss until title transferredrationale for rule is that party who has possession has
greatest interest in protecting property
B.

Massachusetts RuleRisk of Loss on Seller Until Title Passes

1.

Skelly Oil Co. v. Ashmore (Mo. 1963)

2.

Remedies in Mass Rule Discussed in Skelly Oil

(1) Loss of fire, etc. falls on seller/ownerif no insurance than he bears loss but K not
binding on seller or buyer
(2) If buyer has advanced any part of price can recover for it
(3) IF change of property not greatspecific performance can be awarded with
compensation for any breach of K

3.
What if Damage is Immaterialbuyer entitled to abatement of purchase price in
same amount that property is damaged
4.
What if Damage to Property is Materialin Skelly Oilcourt states can get specific
performance of K with abatement at the buyers option OR can terminate the K
C.
Majority Rule/Equitable Conversion Doctrine i.e. From Moment K is Signed
Risk of Loss on Buyer
1.
Insurance Trust DoctrineWhen risk of loss on purchaser at moment K signed and
seller has insuranceamount must pay seller is reduced by amount of insurance proceeds
paid to seller to mitigate loss of purchaser
2.
How Are Purchasers Protected in Majority Ruleshift risk of loss to seller via
King around default rule but if seller doesnt agree then have insurance trust doctrine
Problem with insurance trust doctrineno requirement that seller has insurance!
SO attorneys should obligate seller to have insurance at certain level

D.

ALI/NY Rule (followed in 11 States)Focus is on who has possession

1.
ALI Version (note NY is slightly different)Any K made in this state for purchase
and sale of realty shall be interpreted as included an agreement that parties shall have
following rights and duties UNLESS K states so otherwise
(a) If, when neither legal title nor possession of subject matter of K has been
transferred, all or material part thereof is destroyed without fault of
purchaserseller CANNOT enforce K and purchaser entitled to any portion of
price paid

13

(b) IF when neither legal title or possession is transferred, and all OR ANY part
thereof is destroyed without fault of purchaser purchaser NOT relieved from duty
to pay price NOR is he entitled to recover any portion thereof paid

2.
NY VersionNY Gen. Obligation Law 5-1311 (note NOT exactly same as
ALI)Any K for purchase or exchange of realty shall be interpreted, UNLESS K states
otherwise, as including an agreement that parties shall have following rights and duties
(a) When neither legal title nor possession of subject matter is transferred to
purchaser(1) If all or a material part thereof is destroyed without fault of
purchaserseller CANNOT enforce K and purchaser is entitled to recover any portion of
price paid BUT nothing shall be deemed to deprive seller of any right to recover damages
against purchaser for any breach of K by purchaser prior to destruction
(a)(2) If an immaterial part thereof is destroyed without fault of purchaser
NIETHER seller nor purchaser is deprived of right to enforce K BUT there shall be,
to the extent of destruction or taking, an abatement of purchaser price THIS
SECTION is unique to NY for immaterial
(b) when either legal title or possession of subject matter of K has been transferred
to purchaser if all or any part is destroyed w/o fault of seller purchaser is not
relieved from duty to pay price nor is he entitled to recover any portion he has paid BUT
nothing here is deemed to deprive purchaser of any right to recover damages against the
vendor for any breach of K by vendor prior to destruction or taking
NY does NOT defined possession or material loss
ALI equates material loss to K doctrine of substantial breach of material
promise i.e. damage SO bad as to material promise
3.
When is there a substantial breach of a material promise? Apply K Law
Doctrine
i.

Substantial Portion of Subject Matter of K Damaged or Not DeliveredIn real estate

if loss of substantial value then material breachno exact % and not necessarily more
than 50%

ii.

Is Buyer Deprived of Purpose of AcquisitionIf Yes then material/loss substantial

breach
Exampleif buying a marina, docks on marina must be less than 5% of total property
but if they are destroyeddeprived of purpose of acquisition

iii.

Example of Different StandardsNational Factors v. Winslow (NY) (K with sales

price of $180Kfire occurred and 1/18 of the building destroyed but buyer was going to
destroy that building anyways)(1) Substantial value NOT here because just 1/18; (2)
Deprivation of PurposeNO because was going to tear down anywaysno material
loss so buyer can get abatement only

4.
When is Possession Delivered to Purchaserneither ALI nor NY defined
possession
Two standards used for commercial and residential
14

i.

Control Facts that Might Lead to DamageLook to What Degree of control over
factors that might lead to damage i.e. did buyers leave windows open during rain, did
they shovel snow

ii.

Buyer as substantial owner does buyer have almost all rights that owner
hasif yes then impose risks

5.
What Remedies to SeekLucenti v. Cayuga Apartments (NY 1979) (Fire destroyed 1
of 2 buildings, buyer wanted specific performance w/ abatement but seller refusedparties
agreed it was material but DiLo thinks could be arguedissue was did buyer have option to
enforce K and seek abatement)Court holds can enforce K with abatementonly purpose
of NY law was to put risk of loss on sellerdid NOT want to change remedies at CLBUT
NY does NOT recognize constructive trusts!
6.

VII.

How Can You Agree Otherwise

(1) Can re-allocate risk of loss in K i.e. shift risk to purchaser; (2) Parties can alter
remedies available i.e. say only remedy is termination of K not specific performance; (3)
Parties can define terms of statute that are vague and undefined i.e. can define what
is material
SEE summary of risk of loss in bigger outline on pg. 21

Marketable Title (K Stage)

Seller promising that at the time of closing, there is a marketable title
Purchaser orders title search title report (owner, estate in the property, any third party
interest in the property); shared by seller & buyers attorney (if found unmarketable, then
theres a right to terminate).
Sellers attorney has an obligation to clear the interest by third party that might render the
property unmarketable. If cannot, then a default by the seller. Purchaser may have
damages (loss of benefit of bargain) remedy.
A.

Obligation of Marketable Title

1.
If K is silent marketable title implied promise of marketable title even if K does
NOT expressly state it BUT can be Kd around per Voorheesvile Rod & Gun case
2.
Marketable Title Definition if a reasonable person, knowing the facts about the
owners title including chain of title, encumbrances against it and any opposing claims of
ownership would accept title without hesitation THEN title is marketable
Common modification of duty to deliver insurable title not marketable title

15

o Insurable title Such title any insurance company licensed to do business in

the state of X (where the property is) is willing to insure, subject ONLY to
standard exception.
o Marketable title and Insurable title- Seller has title and there is no
encumbrance. Existence of encumbrance determined by title insurance company;
seller can challenge to remove the title encumbrance; if failed, then no insurable
title. Seller can find ONE out of many, then insurable title can be found.
as is relate to physical condition of the property, not title issue.

3.
Two Parts of Promise(1) Title promise or that it is fee simple absolute (own whole
thing) and (2) Lack of encumbrances. Look at the possible outcome of the breach.
i.

(1) Title Promise likely breached if K has description of property but title report
is contrary to Kown less than the whole thing!

ii.

(2) Lack of Encumbrances Any right in a third party, consistent with Sellers fee
estate, that interferes with the fee owners full use and enjoyment. General rule is that
buyer has right to be free of detrimental encumbrances.
a. Examples: Restrictive covenants (height of house etc.) Mortgage encumbrance,
Lease encumbrance. Anything that would deprive buyer of possession
b. Encumbrances violation of federal, state and local laws

iii.

Exception: Visible Easements if visible upon reasonable inspection even though K

doesnt mention it courts have held that buyer agrees to take title subject to easements

iv.

Exception: Beneficial EasementsRights exist in 3rd party BUT right is beneficial to

your interest courts will NOT declare it to detrimental E.g. is gas/electric lines
under your property so utility co has right to make any repairs they see fit Generally
considered beneficial to your interest

B.
Standard of Breach of Marketable Title
2 standards used(1) is general and (2) is specific to when purchaser wishes to terminate

1.
Reasonable Doubt Standard (general rule) sellers title and freedom from
encumbrances must be free from reasonable doubtNOT mere possibility or suspicion
i.e. remote and improbable contingency but not right to be free from every doubt just
reasonable doubtscase-by-case determination
Do NOT need to prove defect actually exists JUST reasonable doubt see Brokaw case
Do NOT need to actually prove 3rd party has detrimental rights JUST reasonable doubt
Regan v. Lanze a marketable title is a title free from reasonable doubt, but not from
every doubt

16

i.

Remedies if Breach(1) specific performance; (2) termination of K or (3)

abatement of purchase price

2.
If purchaser wishes to terminate then use reasonable person standard (specific for
when buyer seeks termination)standard is would reasonably prudent person in
circumstances refuse to purchase? General idea is that should NOT be compelled to take
title and possession via threat of litigation
i.

How serious must breach be to terminate? must be substantial breach of

material promiseIn other words if property is readily sold to person of
reasonable prudence NOT substantial breach to warrant termination

3.
Case showing when government zoning restriction becomes an encumbrance that
breaches marketable titleVoorheesville Rod & Gun v. Tompkins (NY 1993)
Mere existence of a government regulation/restriction is not per se an encumbrance; a
violation of a government regulation is an encumbrance.
When does the violation occur? Action by the owner or when the agency finds a
violation. Latent violation is excused.
No breach because the court interpreted the agreement as having subject to government
regulation provision.
Do the exceptions apply?
o Exception 1: Latent violation if the current owners action violates a
government regulation, but the owner or the purchaser wasnt aware of such
violation and the government agency has not issued a formal violation.
o Exception 2: Regulation of Use (NY) What is the consequence of failure to
remove encumbrance? Some govt regulation regulates USE, and not title, of
property (e.g., inability to occupy). Penalty of violation of USE is fine. And this
has nothing to do with the marketable title (e.g., a lien is imposed on a property)
4.

Cases Showing Different Aspects of Marketable Title Promise

i.

Example of Reasonable DoubtWhat you have to do to prove defectBrokaw v.

Duffy (NY 1901) (case regarding possible insane owner who transferred to sister then
sister tried to sell propertyhowever later came out that original owner may have been
incompetent at time of conveyance thus making sister not true ownerlitigation was
pending on whether original owner was incompetent and buyer argues no marketable
title)Court holds no marketable title here because not free from reasonable
doubtbuyer does NOT have to prove whether or not original owner was actually
incompetent rather just trying to determine if there was a reasonable
doubtmost people who know the facts of this case would be in doubt as to title

ii.

Private restriction CAN be encumbranceCheseboro v. Moers (NY 1922) (private

homeowners association divided parcels of land and imposed building restrictionsthe
sellers home was in violation of these private restrictions because house and garage were
not within requisite distance from the street)Court held that this private restrictive
covenant was an encumbranceK stated would be free from all encumbrances

17

and here an encumbrance existed based on private covenantdouble check this is

all we need to know about case

C.
Right to Cure (by seller)
Condominium--Discussion Problem B: (100-unit Condominiumreal property; 45
sold out; 55 remain with developer)
Right to terminate: Failure to disclose a pending lawsuit? Possible title issue. Failure
to disclose material information (under decision making standard); duty to disclose
applies to physical defects in the condition of the property, not fraud lawsuit. Also
information not accessible only to the seller; purchaser could discover the lawsuit.
Right to terminate: Lien on Condominium? Encumbrance.
1. Reasonable doubt standard: Lien on Condominium yes. A pending lawsuit (brought
by the State department; outstanding over a year without dismissal) may be a reasonable
doubt, therefore defect in title.
2. Reasonable person standard: Lien ($3000 per owner; most purchaser would refuse?
No. Abatement of purchase price). A pending lawsuit (owners will receive restitution.
Most will still walk-away; how much will you recover? No ownership interest)
Termination: Seller must be given a notice and an opportunity to cure until date of
closing and a reasonable time thereafter. Is a pending lawsuit incurable? The seller is not
the party to the lawsuit and has no power to settle. If incurable, then there is a right to
terminate (but wait until the closing date, because the case might be settled before).

1.
General Rule Before any remedy there is a right to cure until date of closing and a
reasonable time thereafter unless K states otherwise Exception to general rule is that if
defect is incurable (breach of K right to terminate)
i.

Performance is due @ closing of titleprior to closing, purchaser must give notice

of defect that would violate marketable title and allow seller to cure unless defect is
incurable

2.
When Buyers Can Rescind KLuette v. Bank of Italy (9th Cir. 1930) (K is installment
payments for landwhen all payments made get titlebuyers want to terminate because of
claims that land is owned by government not sellercan buyers rescind K)Court holds that
sellers have right to cure defects unless defect is incurable BUT general rule is that can
cure up until closing and possibly a reasonable time thereafter.
Curable v. Incurable? Notify and give the seller opportunity to cure. The seller can look
at the state & local law and find ways to cure. Ownership issue? Maybe the property to
cure the defects; easement? Yes, contact the owner and pay for it. Covenants and
restrictions? Who has the power to release? Many adjoining owners then maybe difficult.

18

D.
Remedies (after a buyer has given seller chance to cure)
Can get(1) specific performance, (2) damages, (3) termination if reasonable person
standard satisfied

1.
At K stagebuyer can always seek specific performance, damages or termination if
reasonable person standard satisfied
2.
Once Title ClosesDoctrine of Merger i.e. all covenants of title are merged into
deed and can only sue for breaches of covenants NOT ones in K

VIII. Time of Performance (K Stage)

Time of performance can be important for remedy i.e. specific performance likely
requires breach of this

A.

General Rule for Time Being of Essence

1.
Time is NOT of the essence unless a contrary purpose is disclosed by its terms or
indicated by the circumstances or conduct of the parties
RationaleWant to give sellers time to cure AND dont want to force parties to close on
specific date UNLESS intent is very clear courts understand shit happens in real estate
i.

Example of General RuleKasten Construction Co. v. Maple Ridge Construction Co.

(MD 1967) (D-buyer entered into K of sale for building lotsencountered financial
difficulties so closing date extendedK never stated time of essence but did say on or
before March 1stseller had difficulties developing land and K stated lots would be
developedclosing date passed and seller claims K null and voidbuyer seeking
specific performance)Court holds that terms on or before March 1st not
sufficiently clear to impose time being of essence or to order a closing general
rule that time is of essence unless contrary intention found in K or circumstances
HERE no evidence that delay was anything but reasonable

2.
Exception to General RuleCANNOT have unreasonable delay in
closingvague standard for attorneys seeking to use exception because was is definition of
unreasonable
Reasonable time: Either party can send a date of performance and stipulate that time is
of the essence with a new closing date after the original closing date has passed.

19

3.

4.

IX.

Examples of Delay
Seller: Failure to vacate the property
Buyer: Failure to close due to financing issue (e.g., if time is of the essence based on a
firm commitment, it is still possible that buyer fails to close even after a firm
commitment)
Attorneys Seeking Termination for Unreasonable Delay
For Buyermust go to closing, wait for other side to show up and if they dont THEN
they are in default
For Sellermust show up with deed ready to hand over if dont then in defaultseller
must be ready to tender performance AND seller always has reasonable time to
cure default

Four Remedies in Contract Stage

A.

One: Termination of K

1.
To seek termination must prove (1) substantial breach of a material promise
(e.g., marketable title, condition of the property) in other words, very important
promise and nature of it is substantial
i.

Substantial Breach
a. (1) Loss of substantial value i.e. look to % deprived of the FMV does not have to
be 50% but likely has to be more than nominal or
b. (2) Deprived of purpose of K. Is this issue curable? If not, deprived of purpose
of K. i.e. if bought marina, and dock gets destroyed by fire, dock only 5% of
value but that was purpose of K

ii.

Material Promise = very important promise such as water damage, in compliance

with zoning laws, things that would prevent you from moving in

2.
Parties can make anything material or substantial as they see fit to allow
termination of K as long as put in K this is common for commercial real estate
E.g., more than $500 in damage for repair it is a substantial breach of a
material promise. The court will enforce.

20

B.

Two: Specific Performance

1.
General rule = Specific performance can only be granted if have an irreparable injury
where damages would not provide adequate compensationusually buyers seek!
2.
Exception to Rule Court will not order vain judgment i.e. one that has no
possibility of being carried out
3.

Buyers vs. Sellers Seeking Specific Performance

For buyersCourts generally allow specific performance because piece of property is
always unique and buyer always suffers irreparable injury
For Sellersseller always entitled to specific performance because time and efforts
put into closing, now have to find new purchaser, spend more time and efforts, factors of
market also likely changed also sellers often times are selling their property to buy
another so lost opportunity
C.

Three: Liquidated Damages

1.
Maj. Rule for 10% or less of K price for down payment/depositalways a
reasonable estimate of loss as a matter of law and seller has an implied right to retain down
payment per Maxton and Lawrence
No need for a liquidated damages clause: In real estate Ks10% or less is per se
reasonable as a matter of law vs. K Law which requires reasonable estimate and loss
being uncertain @ time of K
2.
Maj. Rule for Above 10% need case-by-case determination to determine if
reasonable per Uzan
Factors that are deemed important per Uzan for over 10% deposit(1) was property
under construction; (2) were there foreign purchasers that are harder to reach (3) Was it
investment property; (4) What are typical down payments for similarly situated property
i.

ii.

Uzan v. 845 UN Ltd. Partnership (NY 2004) (Donald Trump caseseller is Trump
selling luxury apartments near UNbuyers are Turkish billionairesK required 25%
down payment which was standard for luxury apartments, also luxury apartments were
under construction at timeboth sides represented by lawyersafter 9/11 Ps backed out
of deal claiming this building was now terror targetTrump refused to give back
25%)Court adopts majority rule that 10% or less as a matter of law is reasonable
but for over 10% need case-by-case determinationHERE Trump was
reasonable in asking for 25% because(1) apartments under construction; (2)
long time between K signing and title closing; (3) risks associated with luxury
apartments i.e. he kept them off the market and now Ps defaulting he must find another
buyer; (4) 20% to 25% standard for luxury units and (5) parties were sophisticated
and represented by counsel and negotiated at arms-length
Provisions are negotiable; never later than 5 years after construction, etc.

21

D.
Four: Remedy of Damages: Loss of Benefit of Bargain
Two types(1) Loss of benefit of bargain and (2) Consequential damages

1.
Loss of Benefit of BargainDifferent Rules depending on if buyer or seller
seekingfor both parties are default rules that can be Kd around
2.
When Seller Seeks per Jones court must determine FMV of property @ time of
breach and compare that with the K priceresale price can be evidence BUT not
determinative of FMV
i.

Jones v. Lee (NM App. 1998) (buyers entered into K for real estate for $610Kweeks
after signing K and giving $6K in deposit buyers informed sellers unable to finalize b/c
of financial difficultiesbuyers offered to void K in return for sellers keeping $6K but
sellers refusedthey ended up selling house for $70K below sales price with buyers and
wanted $70K in damages)Court adopted above rule and stated lower court erred in
only looking at resale price and comparing that with sales priceproper test is
determining FMV @ time of default and compare that to K pricecourt remanded
on this issue.

3.
When Buyer Seeks Loss of Benefit of the Bargain2 sets of rules that states
follow for each
i.

ii.

Mokar/NY RuleGood Faith/Bad Faith Distinction (only when defendant is a seller)

a. (1) If seller acted in bad faith or willfully disregards Kpurchaser can recover
for amount already paid, expenses incurred pursuant to K AND loss of benefit of
bargain BUT
b. (2) If seller acted in good faith but is unable to give good title Purchaser can
only recover for amount already paid and reasonable expenses pursuant to K
Rationale for Distinction btw GF and BFnot fair to impose liability on party who
cant deliver
Examples of GFunable to convey because what you own is less than what you Kd for
Examples of BFif seller able to transfer title but refuses to do so because got better
price; or if seller can cure the defect, but refuses to do so.
No GF/BF Distinction (1/2 states follow)does NOT matter at all reasons why couldnt
deliverif dont deliver can get loss of benefit of bargain
E.

1.

Remedy of Damages: Special or Consequential Damages

Elements in Order to Recover Consequential or Special Damages

(1) Causation i.e. Natural and Probable Consequence of Breache.g. is buyer
defaults, seller has to find another purchaser, make insurance payments, taxes etc.
(2) Damages are Reasonably Expectedmost prove that expense occurred @ time
of formation of K and breaching party reasonably knew or should have anticipated
damages would probably be incurredin Real Estate Ks taxes, insurance
premiums ALL reasonably expected
22

(3) Damages in question must be provable to reasonable certaintythis is usually

easy just show the bill!

2.
Example of what is and what is not reasonably expectedJones v. Lee (NM 1998)
(case discussed above w/ buyers defaulting and sellers ultimately selling to 3rd party for $70K
less than in original Ksellers also sought special or consequential damages for other expenses
such as mortgage payments, solar heating inspection and architect fees on a lot they were
purchasing once moved out)Court adopts above test and applies it to each specific fee
incurred(1) Mortgage payments would have been paid off if closed but now seller had to
pay interestthese are reasonably expected; (2) Inspection of solar and
heatingcommon practice was for seller to pay for these but because of delay new
purchaser will likely want new one doneif buyer knew this then reasonably
expectedNOTE in NY would be reverse because buyer usually pays for these so NOT
common practice like in Jones(3) Fees from separate lotthese were not expected
because they were incurred before K was even signed
See hypo on page 28 of bigger outline
3.

Requirement That Damages Be Provable by Reasonable Certainty

See hypo on page 29 of bigger outline illustrating problems involved here

i.

Maj. and NY Rule per Whitner & Ferris v. Buffalo Structural Steel (NY 1985) (lease
of property allowed tenant to build a sign across a highwaytenant had option to
purchase 2nd signowner sold to 3rd party in breach of K with tenanttenant sought
potential profits would have gotten from 2nd sign)Court holds that to recover lost
profits must show lost profits from that business at that same location or else no
recoverybecause no business had ever existed NO recovery

ii.

Minority Rule/Modern Rule per Anchor v. OToole (6th Cir.)DONT require a

business to existcan calculate damages for new business can show by expert
testimony, financial data, business records of similar enterprises etc.

X.

Title Insurance (K Stage)

See steps of title search on page 29 of bigger outline
Lenders usually requiretitle insurance to secure priority of their lien
Buyers should ALWAYS purchase insurance because they lack recourse if an issue
comes up later and they dont have anything

A.

Covered Risks

23

1.

2.

3.

Owners Policy
(1) Covered if title vested in someone other than listed in Sch. Awill pay for loss if
not held by seller
(2) Covered if existence of any lien and encumbrance on titleVery close to
marketable title and only covered up until date of closingNOT covered if defect
created after closing title
(3) Duty to Defendtitle policy includes commitment by insurer to defend against
any claim relating to titleif other person does have superior title insurance
company must pay for losssee hypo on pg. 30
(4) Violation of enforcement of any law but caveat is that must be recorded on land
records
Lenders Policy
(1) title vested in owner described by policy
(2) insure against lack of priority of mortgage order or any other lien/encumbrance
Off-Record RisksRisks/Defects not matter of public record
Covered in both lenders and owners policyinclude defects in title arising
fromforgery, fraud, undue influence, duress, incompetency, incapacity, document
affecting title not properly witnesses/executed, document not properly filed, lien of real
estate taxes etc.

4.
Recording Statuteany person taking title in GF not adversely affected by
recording statutefor a fee title company will record for you after closing but if interest
recorded against you before closing title company will cover
B.

Specific Exceptions

1.
Insurance company will not insure against know exceptions i.e. known defects in
title such as easement etc.
C.

Standard Exceptions

1.
Not included are laws or regulations restricting(i) occupancy use or enjoyment of
land; (ii) character or dimension of any improvement on land; (iii) subdivision of land (iv)
environmental protection etc.
2.
Not included are known defects, liens, encumbrances, adverse claims or other
created defects
3.

What if judgments against insuredwhen do judgments become liens?

Lis pendensif lawsuit is pending, P can file lis pendens which is notice of existing
lawsuitwhen title company does search it will come up
Existing judgmentssome states say not a lien until recorded on land recordsNY
rule is not lien until docketed i.e. on court records not land records

24

XI.

1.
i.

Deeds and Warranties of Title (Real Estate Conveyance)

To allege a breach of covenant must show(1) encumbrance/defect actually
exists; (2) Must be in existence @ time of conveyance and (3) violates either present
promise @ closing or future promise within SoL
A.
Three Types of Deeds
(1) General Warranty Deed or Full Warranty Deed in NY
(2) Special Warranty Deed or Bargain and Sale Covenants in NY
(3) Quit Claim Deed or Bargain and Sale Deed W/O Covenants in NY
General Warranty Deed6 promises (3 present and 3 future)

ii.

iii.

3 Present Promises that are breached @ closing

(1) Seisinwarrants that seller owns property and implied that it is fee simple
absolute (similar to marketable title) e.g. if grantor doesnt own estate, doesnt own
entire land described in deed and if deed doesnt say otherwise must be fee simple
absolute
(2) Right to Conveygrants seller has right to covey property(1) and (2) often go
hand-in-hand
(3) Covenant Against Encumbrancesgrants that 3rd party does not have any
detrimental interest in propertygenerally 2 types(i) governmental restrictions
and that grantor hasnt violated any; (ii) private encumbrances i.e. grantor did not
violate/create covenant that could have avoided
3 Future PromisesBreach does NOT occur at closing but rather @ ousteractual
ouster=physical dispossession or constructive ouster=payment to avoid physical
dispossess
(4) Covenant of General Warrantygrantor will compensate grantee for any loss of
superior title
(5) Covenant of Quiet Enjoymentgrantor warrants to grantee that he will not be
disturbed in possession
(6) Covenant of further assurancesgrantor warrants will execute any other
documents to perfect title
Doctrine of Mergerpromise of marketable title contained in K that purchaser can
enforce up until closing BUT cannot enforce once it closes
Merger as a matter of lawmost Ks contain a merger clause that none of
representations in K of sale survive closingonly title covenants survive closing and
only future ones!
Damages recoverable for breach of covenants
o Same standards applied if breach of a present covenant or a future covenant
o Purpose: limit liability of grantor
o In the event of a complete failure of title:
FMV at time of conveyance

25

Never more than amount grantor received, and

Never more than grantees loss

2.
Special Warranty Deeddefect in title must be (1) Made by/Created by grantor or
(2) Suffered by grantor=permitted by grantor and could have fixed it but did not do so
What are future obligations of grantor (check with DiLo)It seems that future
obligations only arise from future promises i.e. quiet enjoyment when ouster
3.
Quit Claim Deedno covenants of title at all, grantee receiving whatever happens
to exist on property
See pg. 32 of bigger outline for Other Deeds mostly variations of QCDs
B.

What if K is Silent on What Type of Deed?

1.

Maj. RuleGrantor must provide special warranty deed

2.
title

NY Rule (Min.)grantor has duty to provide any type of deed sufficient to convey

3.

Marketable Title vs. Promises in Deed

Marketable Titleonly must prove reasonable doubt as to state of title vs.
Defect in Title or Encumbrancemust prove it actually exists at the time of
conveyance which is way more demanding standard what about future promises?

C.

When Does Violation of Local Ordinance Become Encumbrance

1.
Maj. Ruleviolation of zoning regulations existing @ time of conveyance is an
encumbrance when violation has substantial impact on use and enjoyment of landno
requirement of actual inspection or formal violation mere act of not complying is
violation

2.
Min. Rule from Bianchi encumbrance is present when seller can determine from
municipal records that property violates local zoning regulations @ time of conveyance and
violation substantially impairs purchasers use and enjoyment of propertygovernment
must actually inspect property and declare violation of law (sellers knowledge means
nothing)
i.

Bianchi v. Lorenz (VT 1997) (in 86 D bought 4 bedroom homeinstalled septic tank
for only 3 bedroom homebuilding permit required compliance with local laws and
certificate of occupancylaws required inspectionDs never got inspection or
certificate of occupancy3 years later D sells home and K is silent of complying with
local laws or certificate of occupancyclosing occurred with full warranty deedbuyers
later discover wrong septic tank installed and dont have certificatecosts them $40K to
fix and they sue grantor/D for breach of violating government laws)Court adopts
minority rule and holds that encumbrance is present when seller can determine
from municipal record that property violates local zoning laws at time of
26

conveyance and violation substantially impairs purchasers use and enjoyment of

propertyviolation not latent merely because purchaser must examine records of
separate agency and not latent merely because D must examine municipal and land
records
See notes on summary of rule and violation of federal conservation law on pg. 33-34
D.

When Does an Encumbrance Exist

1.
General rule is defect in title must (1) actually exist at (2) time of conveyanceif
defect arises later may not be cause of action (unless future covenant?)
Depending on jurisdiction violation may arise at different time
2.

When Does Judgment Become a Lien/Encumbrance

i.

Maj. RuleWhen judgment filed on county land records it becomes a

lien/encumbrance

ii.

NY Rule per CPLR 5018judgment becomes a lien on debtors real estate when
docketed in court records not land records

iii.

Example of Maj. RuleNortheast Petroleum Corp. of NH, Inc. v. Vermont (VT 1983)
(P got judgment against Hallihan on real estate he co-owned with a 3rd party not involved
in debtHallihan and co-owner subsequently to lien conveyed property to State of
VT)Court adopts maj. rule and states judgment lien recorded before
conveyancegeneral warranty deed includes warranty against encumbrances and
conveyance itself was a breach of warranty
Second Issue of Northeast Is judgment enforceable against co-owner not
Hallihan? Court holds that warranty against encumbrances is made by both parties
in general warranty deed so both parties are jointly and severally liablegeneral
warranty promises no liens so doesnt matter who creates it!

3.
Differences between made by and suffered by in Special Warranty DeedsElgi
v. Troy (Iowa 1999) (Ps discovered home being built on land they thought was theirsbrought
action against Troys and other neighbors asserting dominion over what they thought was there
landTroys then brought in the party that sold them property asserting breach of special
warranty deed given to themessentially claim was that their seller had permitted adverse
possession to take place)Court holds Special Warranty Deeds contain 2 promises(1) No
breach of covenant made by me i.e. actually created by me and (2) No breach of covenant
suffered by me i.e. I permitted it to happen by inaction and had power to prevent it but
didnthere if grantor of special warranty dead was owner during any of 10 year period
and had power to prevent someone else from acquiring interestTHEY are liable
E.

Defenses Raised for Breach of Warranty

1.
Statute of Limitationscan be very effective defenses especially to present
covenants
NY CPLR 2136 years generally (the date cause of action accrued (@ conveyance)

27

2.

3.

NY CPLR 206breach of covenant of seisen or covnenat against

encumbrancestime of action must be computed from an eviction6 year period
does not run until there is an ouster even though present covenantsee hypo on pg.
35 of bigger outline illustrating
Covenant vs. Cause of Action
Majority Rule is that covenants RUN with land but causes of action DONT
Remember for covenants 3 present promises breached at closing and 3 future
promises breached on ouster (actual or constructive)
NEED some clarification on this topic after practice problems on 4/27
Causes of Action Run With Land?
Maj. rulecovenants run with land NOT causes of action
Minority Rule (NY)causes of action RUN with land b/c no reason why they
shouldnt

i.

Example of Min. RuleRockafellor v. Gray (Iowa 1922) (owner is originally DD

conveys to Rockafellor who when owner had debt he owed GrayGray got judgment
and brought foreclosure actionat foreclosure sale transfer made to CC transfers to
Dixon via GWDixon transferred to H&G via SWdefect was C, Dixon and H&G
never had valid title because foreclosure sale not validH&G couldnt sue Dixon
because transfer made via special warranty deed and Dixon did not create
foreclosureIssue=can H&G sue C)Court adopts minority rule and says causes of
action run with landnot fair for current owner who didnt know of defects to not
be able to sueperson suffering loss should sue

ii.

NY RuleGriezler v. DeGraff (NY 1901) (D transferred to Knobb with covenants but

lien existedKnobb transferred to BB transferred to P with covenant against
encumbrancesP paid off debt now seeking reimbursement)Court holds (1) CoA do
run with land because no reason not to; (2) Court holds that once 1 owner takes title
subject to defect as was case here CoA NO LONGER transferrable
subject to provision prevents the CoA from being assigned? Did not allow CoA to run
(but there is a division of authority) if underlying factor is intention of the parties, then
it may matter, but if not, doesnt matter.
o Example
A conveys to B by GW deed. B conveys to C by SW deed. A predecessor
of A had forged the signature of a co-owner. As a result, C is not the sole
owner of the parcel. Rather O is a co-owner. O prevails in an action to
quiet title and forces C to share possession and/or rents with O
Does C have a CoA against B? No, because there is a SW.
Does C have a CoA against A for breach of the covenant of seisin?
No, only B can sue.
Does C have a CoA against A for breach of the covenant of quiet
enjoyment? Yes, there has been an ouster due to O having been
declared a co-owner.

28

XII.

A conveys to B by GW deed. B conveys to C by GW. A had created an

easement in favor of X that has not been exercised for a number of years.
C learns of the existence of the easement
Does C have a CoA against B?

Recording Statute and Priority of Claims (Real Estate Conveyance)

Note skipping over discussion of Types of Indexing and importance of chain of title on
pg. 36 of bigger outline
A.

What Can Be Recorded

1.
Only documents that create an interest in real estate can be recordedtypical
practice is to record in county where real estate located
i.

NY RPL 291 only conveyance in real property can be recorded

ii.

NY RPL 290 conveyance is written instrument where interest in real property

created, assigned, terminated, granted etc. BUT short term leases of less than 3
years and wills (at best contingent interest) NOT recordable
Examples of interestowner gives X a right of way, lien on property that can force
sale if default like mortgage

iii.

Common Requirements for County Land Records

(1) Notarization requirements (outside SoF); (2) Requirements of street address i.e.
not just metes and bounds; (3) Being the same parcel as earlier recorded documents
i.e. same chain of title
Index
o Grantor-grantee index: Start with the latest owner from grantee index and go
backward using the grantee index (to the original source). Chain of title made.
Then from the original source check the grantor index to the latest owner.
o Tract index (minority): identify a parcel (e.g., R/E tax number). Every transfer,
mortgage, lien is recorded on this parcel.
B.
Three Types of Recording Statutes
NOTE that CL rule of first in time, first in right applies when recording statute
fails this kicks in!

29

1.
Race Statutes (2 states)protects (1) subsequent in time (2) purchaser who is (3)
first to record with valid titlenotice does NOT matter AT ALL!
HypoA to B but B doesnt recordsubsequently A to C but C does recordC has
valid title and is owner NOT B
2.
Notice Recording (24 states)to be protected must be (1) subsequent purchaser who
(2) at time of conveyance was without notice of earlier interestdo NOT need to record
first to be protected against prior unrecorded interest that has no notice of
Hypo(1) A to B but not recordedsubsequently A to CC not protected if have notice
of earlier interestneither is B because not a subsequent purchaserif neither
protected then CL rule kicks in first in time, first in right and B would be owner(2)
Same as above but C has NO noticeC is subsequent in time with no noticedespite
not recording first C is owner!
See example of statutory language on pg. 38
3.
Race-Notice Recording (23 states and NY)To be protected must be (1) purchaser;
(2) subsequent in time; (3) at time of conveyance had no notice of prior interests and (4) 1st
to recordIF YES to all 4 then protected by race-notice recording
Hypo(1) A to B, B does not recordsubsequently A to CIf C did have notice of Bs
interests C is NOT protectedB also not protected because not a subsequent purchaser
SOCL rule kicks in and B is owner because first in time, first in right
See example of statutory language on pg. 38
i.

NY Race-Notice StatuteRPL 291 every such conveyance not so recorded is

void as against any person who subsequently purchases or acquires by exchange or
contracts to purchasein good faith and for valuable considerationand whose
conveyance is first duly recorded
a. Purchaser
i. Parts with value in reliance on the public record (in the good faith belief
he/she is acquiring good title)
ii. A substantial sum; a more than nominal sum
iii. McDonald & Co. v. Johns: Valuable consideration requires something of
actual value parting with money, or moneys worth, or an actual change
in the purchasers legal position for the worse. Examples are a
contemporaneous advance of money, a transfer or exchange of property,
the surrender or extinguishment of an existing legal right, or the
assumption of a new legal obligation
1. Johns owed money to M and then V. V asks for mortgage first. M
asks for mortgage the next day. M records before V.
2. M is subsequent in time; M was not aware of Vs mortgage; was M
a purchaser? No. No other consideration than mortgage.
3. M could have changed the maturity date or interest rate change in
legal position.

30


1.

C.
Concept of Notice
Care about notice @ time of conveyancethree types are (1) actual; (2) constructive
and (3) inquiry
Notice examples
a.

Review 4
O is the owner of a parcel or R/E/ O sells the parcel to A. That
conveyance is not recorded. M makes a loan to A and A grants M a
mortgage on As parcel. The mortgage is recorded. O then sells the
same parcel to B. B is not aware of Ms mortgage. Assume the
parcel in question is vacant land.
If B searches title under O's name, unrelated to chain of title, there
is no reason that B would search for A or M

b.

Review 5( O-A-B)
O is the owner of a parcel of R/E. O sells the parcel to A at FMV. A
does not have th cash to complete the purchase but receives a
mortgage loan from O. The deed from O to A conveys title to A
subject to a mortgage in favor of O. That deed is recorded.
Before Os mortgage is recorded, A conveys to B for FMV. The
conveyance makes no mention of Os mortgage, and B is not told
of it. In a notice jurisdiction, does B take free of Os mortgage?
No. B does have notice. Unlike example 1, where deed was
instrument creating the life estate, here the reference merely
mentions mortgage, so B has an inquiry notice.

c.

Review 6 (O-A..T
O-B)
O = owner. O sells the parcel to A. That deed is not yet recorded.
Through a R/E management company, A grants a two year lease of
the parcel to T. Six months later O sells the same to B. O tells B
that O has lease the parcel to T. B asks T about the leas and T
confirms that it has a lease from the owner. T is not asked who
is the owner. The deed from O to B is recorded and then the deed
from O to A is recorded. In a race-notice jurisdiction, tis the owner
A or B?
Must consider whether inquiry is required. Here, it is because
whenever a third party is in possession, there is always a duty of
inquiry. T is in possession, so this triggers a duty of inquiry.
Does the inquiry extend only to the rights the occupant has under
the lease, or does it extend further? It extends further, to any and
all rights the party has to the property. B must, therefore ask T
about the lease and about any rights T has to the property (see page
567 Miller decision, at bottom). If you do not do an inquiry that a
reasonably prudent individual would, then you are still charged
with having that knowledge. Here, a reasonable inquiry would
have revealed this, so B is charged as knowing.

31

d.

Review 7: O-A-C
O-B
OA. The deed to A is not recorded. One month later OB. B is
not aware of the earlier conveyance to A. The deed to B is not yet
recorded. A then learns of the conveyance to B and records its
deed. Thereafter AC. C is not told and is not aware of the
conveyance to B. Assume the parcel is vacant land. In notice
Jurisdiction, is the owner B or C?
C is the subsequent purchaser without notice or actual knowledge;
shelter principle; C is protected.

e.

Discussion Problem C
leases are rarely recorded. However, long term leases are typically
recorded
option agreements are sometimes recorded. This one could have
been, but wasn't
On final, will get statue, and will be required to determine what
type of recording statute it is. NY RPL 291 is race-notice
Rockefeller has no signifigance, because not suing immediate
grantor

f.

Planning problem - real estate financing

dividing line for financing is 1 or 2 family homes (sometimes also
that are owner-occupied) are considered residential, but everything
else is commercial. This definition of residential RE differs from
the usual definition, which is 1-4 family homes.
If ABC had no desire to convert the bldg, would still need perm
and construction financing.
who provides residential unit purchase loans? commercial banks,
savings banks and savings and loans, and mortgage companies
when you transform a bldg into a condo, there are two levels of
review that lender conducts: 1) building review (safety of building,
upon review of proforma financials, is bldg over-leveraged?) 2)
borrower review (credit-worthiness of individual unit-purchaser)

g.

Notes re financing - MOVE ELSEWQHERE

Freddie Mac lost a lot of money, and had the fed govt not bailed
them out, there likely would have been no secondary market
during the recession
Ginnie Mae - secondary mortgage market participant. Purchases
residential mortgages, but only those insured by the VA or FHA.
Fannie and Freddie don't have these limitations
Mortgage servicers - do not own the loans they are servicing. The
loans have been sold to third parties, often Fannie and Freddie,
however, the servicers deal with the admin of the loans, for a fee
which is typically 250 basis points or .25% of interest rate.
Problems arise when mortgage servicers records are in disarray or
32

when owner of loan isn't the one with which the homeowner can
negotiate. their envolovement complicates things. incentives not
aligned
TILA section 129C(a)(1) through (4) and the Bureau's rules thereunder, 1026.43(c), prohibit a
creditor from making a residential mortgage loan unless the creditor makes a reasonable, good
faith determination, based on verified and documented information, that the consumer has a
reasonable ability to repay the loan. TILA section 129C(b) provides a presumption of compliance
with regard to these ability-to-repay requirements if a loan is a qualified mortgage. Creditors
may view qualified mortgage status as important at least in part because TILA section 130(a) and
(k) provide that, if a creditor fails to comply with the ability-to repay requirements, a consumer
may be able to recover special statutory damages equal to the sum of all finance charges and fees
paid within the first three years after consummation, among other damages and costs, and may
be able to assert the creditor's failure to comply to obtain recoupment or setoff in a foreclosure
action even after the statute of limitations for affirmative claims has passed. TILA section
129C(b)(3)(B)(i) authorizes the Bureau to prescribe regulations that revise, add to, or subtract
from the criteria that define a qualified mortgage upon a finding that such regulations are, among
other things, necessary or proper to ensure that responsible, affordable credit remains available to
consumers in a manner consistent with the purposes of TILA section 129C. (ability to repay
requirement) http://www.consumerfinance.gov/eregulations/sxs/1026-43-b-4/2013-13173?
from_version=2015-01321
assets and income verified
3 levels of safety from dodd-frank act (get from someone)
Dodd-frank act imposes certain sanctions. Borrower can recover 4 things: all actual damages
they have suffered (i.e., if borrower suffers because lendor didn't do job in verifying that had
ability to repay), special statutory damages (all interest paid on loan), statutory damages (small,
but up to $4000), all court costs and attys fees in bring actions for recovery
civil penalties

2.
Actual Notice purchaser has actual knowledge of a conflicting interest in the real
property told at any time prior that someone else has an interest in propertyif you
know of prior interest NOT protectede.g. could be if know someone has lease, or if know
someone else has a mortgage etc.
3.
Constructive Noticeif conflicting interest is a matter of public record (i.e.
recorded in land records or in NY on docketed on court records), AND are in a
purchasers chain of title (e.g., Buffalo Academy) chargeable with knowing if you did not
adequately investigate
i.

Maj. Rule/NY Rule per Buffalo Academy subsequent purchaser has constructive
notice on all restrictions on direct chain of title BUTonly have to investigate chain
of title for your lot, not on every lot conveyor owns because would be too
burdensome.

33

ii.

Min. Rulerequires search on chain of title on all property owned by

conveyore.g. if owner owned a 100 unit apartment building would have to check chain
of title on EVERY unit (all 100 units!)

iii.

Example of Maj. Rule/NY Rule on Chain of TitleBuffalo Academy of Scared Heart

v. Boehm Bros, Inc. (NY 1935) (Univ. Terrace originally owned large piece of land that
broke up into 96 lotsoriginally deed restricted all 96 except four from being anything
but residential (the four mentioned about gasoline filling station)Ps predecessor
transferred deed to P that did not mention this restrictionP bought parcel to build gas
stationother deeds did have restriction listed BUT not PsP claimed NOT on notice
of restriction because direct chain of title did not mentionDs argued they should have
searched ALL 100 parcelsCourt holds that one only has constructive notice for his
chain of title-- NOT all 100 lots Justification was that it would be too burdensome
to search all 100 and goes against purpose of recording statute.

4.
Inquiry Notice To begin if a document that creates interest in real estate is recorded,
then constructive, if not, inquiry 2 Aspects(1) When must you make inquiry? Must
make inquiry when the purchasers have actual knowledge i.e. subjective standard and
(2) would a reasonable person having same information become suspiciousonce duty to
inquire is imposed NOT on notice yet Only on notice if reasonable inquiry would expose
defect in title
(1) Is there a duty to inquire? Subjective test what does the purchaser actually or
should know? Objective test -- Only if reasonably prudent person would become
suspicious; (2) Type of inquiry requiredtype of inquiry a reasonably prudent
person would perform in circumstances If DONT investigate at all you are
charged with knowledge of what you would have uncovered
Most common example of suspicionwhen someone else that is not seller is in
possession. Dont just ask the sellers; ask around.
i.

Maj. Rule for 3rd Party in PossessionMiller v. Green (WI 1953)General Rule is
that possession of land is notice to the world of whatever rights the possessor has in
premisesmust always inquire when 3rd party in possession and if you dont you
are charged with knowing because always should be suspicious

ii.

Miller v. Green (WI 1953) (D is selling propertyfirst gives property to P via lease with
option but then conveys to someone else Hines Hines investigated property but later
claims he has no notice and that he recorded first) Court adopts majority rule above
and states when 3rd party is in possession of property at time of conveyance should
always be suspiciousHERE P had farming gear all over property and obviously D
knew that someone else could have been in possessionEVEN IF an explanation is
offered that is a lie STILL have to investigatemust ask tenant about any and all
rights they have under lease and not related to lease or else chargeable w/ knowing.

iii.

Does this apply to multi-tenant apartment buildings? YES per Martinique Realty
Corp v. Hill (NJ App. 1960) (in apartment building if potential suspicion must you ask
every tenant about their rights?)Court holds must ask every single tenant about
34

rights under lease and if you do not you are chargeable with knowing This case
limited the extent of the questions in a multi-unit building to: tenants need be asked what
rights they have under their leases. But this is not the case in many other jurisdictions.
iv.

Practice PointIf purchaser of large multi-tenant buildingssend a demand estoppel

letter to every tenant in building (e.g., what rights do you have under your lease; then ask
do you have any other rights?)this is condition precedent to purchaser basically tenants
waiving all of their rights.

v.

If tract index Out of box transfer to a third party would require the purchaser to
inquire about the parcel.

D.

Who is Purchaser

1.
General Rule Only protected if subsequent purchaser and must part with value in
reliance of public record in good faith belief that acquiring good titlevalue does not have
to be monetary BUT MUST BE more than nominal
2.
Minority Rulemust be substantial sum over and above more than nominal in
maj. rule BUT does not have to be monetary

3.
Who is Purchaser Protected by Recording StatuteHorton v. Kyburz (CA 1959) (Coowners made oral K in 31 that when either died of their home would go to each respectives
children from other marriageshusband died first and wife conveys entire property to her own
childrenHs son tries to enforce 31 K and Wifes family argues cannot do this because they are
subsequent purchasers w/o notice and they contributed labor by farming)Court holds that (1)
to be purchaser must pay more than nominal consideration and must be a substantial
sum but (2) do not have to pay cash as long as labor more than nominalHERE wifes
family did contribute via labor so are protected purchaser under recording statute.
Discussion Problem C
Ts right to exercise the First Purchase Option against P
o Unreasonable restraint on alienation void and unenforceable?
Fixed price at $2.5 million possibly less than FMV
o Void and unenforceable because of recording statute?
Race-Notice: To be protected must be (1) purchaser; (2) subsequent in
time; (3) at time of conveyance had no notice of prior interests and (4) 1st
to record.
(1) Subsequent in time: Ts claim arose in 2011 when FPO granted;
Ps claim arose in 2016
(2) Purchaser: $2.5 million. Substantial sum or more than nominal.

35

(3) 1st to record: Ps deed immediately recorded.

(4) (main issue) good faith purchaser: actual, constructive, inquiry
notice?
o No actual: P was not told and not aware
o No constructive: The instrument that creates the interests in
question option agreementnever recorded
o Inquiry notice? Actual or should have knownTs in
possession of the property. Whenever a 3rd party is in
possession, there is a duty of inquiry (Miller) not only the
lease rights but other rights as well. P charged with
knowledge of what you would have uncovered.
If P actually inquired but, T liedno inquiry notice
Assume a court rules that T has a right to exercise the FPO, and T does exercise it.
Discuss Ps right to sue O for breach of the covenants contained in its deed.
o FPO first created by O. Which covenant of title has been broken?
o FPO: O did not have a right to convey to P.
o Breach of covenant against encumbrance: Ts title voidable? T didnt exercise
FPO so acknowledged the sale by O to P.
o Breach of right to convey freely: P cannot sell freely.
o Covenant of quiet enjoyment: depends on existence of ouster (physical
disposession) - constructive ouster=payment to avoid physical dispossess if P has
to pay T not to exercise the FPO.
o Damages recoverable for breach of covenants: Present covenant v. future
covenant? Only matters if situated outside of Scofield jurisdiction. Decline in
FMV at the time of conveyance from O to P; same standards applied if breach of
a present covenant or a future covenant
Purpose: limit liability of grantor
In the event of a complete failure of title:
FMV at time of conveyance (the difference is not necessarily
$500k. Need more information on FMV of property with a FPO)
Never more than amount grantor received ($2.5MM) and
Never more than grantees loss ($500K)
Here, if the FMV difference was $300k, and the loss was $500k, the
damages are $300k, not the ceiling-- $500k

XIII. Financing (Real Estate Conveyance)I am not adding this to mini-outlinefor

whole section see pg. 41-42 in bigger outline

Financing Planning Problem

o Reason: Cost of funds Leverage and tax deduction on interest payment.
o 1. Where can ABC seek construction financing? Where can ABC seek possible
permanent financing for unit purchasers?
Construction loan

36

Permanent financing (commercial R/E loan) commercial banks,

insurance companies, mortgage companies
Loan origination fee
o 3. What type of available permanent unit loans will ABC seek for potential unit
purchasers to make purchases more affordable? What are the benefits and the
risks of each of these loan options?
30-year loans; residential loan self-amortizing: all the accrued expenses
and principals are amortized and paid at the end
Index, adjustment period, and cap
o Index
LIBOR, national mortgage rate
o Adjustment period
When will the initial interest rate will change? Sometimes 1, 3 years
o Cap
o Residential (usually recourse);
o Risk-based pricing based on: loan-to-value ratio; credit history; income compared
to the loan amount; employment history
Commercial R/E loans
o Term: Typically, 10 years and typically non-recourse (cant get personal assets of
borrower)
o Consideration: Track record of developer/borrower
o Non-recourse carve-out: principals of the borrower will be personal on certain
circumstancesfailure to maintain the property properly; allowing other liens to
be asserted against the property; filing of bankruptcy petition.
o Re-finance: loans might go default if failed to refinance
o Shopping center loans might have a profit sharing arrangement; return of
interest is usually lower than the market rate + profit of the retail center
o Shared appreciation loan low fixed interest return and share appreciated value of
property.

Page 193Mechanics liens

o Protects contractors; laborers; engineers; anyone that provides construction
materials or laborlien on underlying land and building.
o Date that lien attaches: varies from state to state
1. Date that the construction under question commences most states
2. Date the particular contractors/laborers provided the materials
3. (NY) Date that the contractors/laborers actually file the lien as a matter
of public record
o Schedule for payment (installment) (pg. 185)
Construction loans
o Lien priority for the construction lenders if these two sections are included:

37

Section 13 of building loan: Borrower will use the money into a trust to
pay the employees
Section 22: borrower promises to use the money for indirect cost of
improvement
o Payment bond insurance policy if any materialman or suppliers goes unpaid, the
insurance company will pay
o Performance bond insurance bond, builder will be compensated for losses
because the work is incomplete.
Underwriting requirements
o Commercial R/E loan government regulations dictate almost nothing (FDIC rule
that governs only the maximum loan-to-value ratio), but residential mortgages
o Fannie Mae initially buys the residential mortgage (government holding the
mortgage)
o Internal policy of the institutions and insurance companies dictate the
underwriting requirements.
LTV Loan to value; if one has to foreclose, less than market value will be recovered
thus give more cushion to cover the principal of the loan.
Debt-coverage ratio (in commercial R/E): NOI must equal 1.1-1.4 times debt service
o 10% to 40% cushion after paying all the operating expenses to pay the debt
service.

Sources of litigation
o Loan sold to secondary market (e.g., Fannie Mae) default secondary market
sues the originators to buy back the loans Fannie Mae would use the
underwriting standards as a reason because the originators must certify the
compliance.
o Misrepresentation and violation of securities laws by investors (of RMBS,
CMBS) originators represented safety of the loans (LTV, DTI ratio) but the
loans defaulted.
o Dodd-Frank noncompliance when a foreclosure action claim that
underwriting standards are not met
Borrower protections - Requirement on originators; Allow defenses to borrowers
o State - Usury statutesw
Moran v. Kenai Towing
Sale-lease transaction Is this a loan transaction? Look at the
nature/structure of transaction: sale and lease back after leases,
the title of the property conveyed back to the borrower this is in
reality a loan usury law would apply
o Maximum rate in Alaska = 8%
o Any and all sums payable in return for the loan is interest:
any fee charged except for the cost of the transaction (e.g.,
appraisal or review) is interest

38

o Loan origination fee = interest; profit or equity

participation arrangement = interest;
Remedy
o Interest rate of at least 10% violation by the lender
forfeiture of all of the interests on the loan no obligation
to pay interest at all
Varies by state to state
NY: 16%; IL: 9%; NJ: 30%; NE: no rate limit
o NY: Anything made in consideration for making the loan is
interest
Criminal usury statutes
NY penal law: above 25% felony
Sanctions
Either losing all the interest or both interest and principal (civil
usury statute)
NY usury statute: Banking institutions loss of all interests; all
other institutions all interests and all principals
Large loan exemptions
If loan is very large, then the borrower is a savvy individual and
does not need protections. (e.g., NY = $250k enacted decades ago)
Corporate borrower exemption: Feller v. Architects Display
$250k large loan and usurious? If borrower is a corporation
(mostly LLC as well) then the borrower cannot use the defense of
civil usury statute to any action brought against the said
corporation.
Exception: If the corporation is formed for the purpose of avoiding
the usury law, the exemption would not apply But not
recognized in most states including NY
State legislative enactment: 1980 depository institution/deregulation
statute
Enacted in response to high inflation in the 70s; lenders withdrew
from the market because cant make any money; 13 states opted
out but 37 states stayed still in place for residential real property
Only applies to residential real property
Any originators making loans on residential real property are
completely exempt from the usury statutes
o Federal regulations should give borrowers information they need
1968 Truth in lending act
Information about interest rate and closing cost when they apply
loan should be available
1974 Real estate settlement procedures act
Provided information at closing list of actual fees that will be
charged not very useful because the information is provided at
closing
39

The two acts only apply to residential real estate transactions; borrowers
can sue the lenders for violation of the acts
Remedy: Damages or rescinding of the loan and receiving all the
interests paid
o Congress -- Dodd-Frank
Wanted the disclosures to be uniform and information be provided to
borrowers in advance new requirement since 2015
Model forms that lenders could use (look at the handouts)
Loan estimate must be provided at least before 3 days after
receiving of application for residential loan
o Loan amount; interest rate; monthly principal & interest;
balloon payment; projected payments
Estimated closing estimate must be provided at least 3 days before
the closing
o Closing disclosure
Remedy from violation of the disclosure obligation: Damages any
borrowers suffered; option given to the borrowers to rescind the loan and
receive all the interests paid.
Dodd-Frank Acts Ability to repay Requirements
Duty to verify on lenders
o Any originator of any residential mortgages has a duty to
verify the income and assets of the borrower; must make a
reasonable and good faith determination of borrowers
reasonable ability to repay the loan.
o Sanctions and remedies:
Borrower has the right to sue for actual damage
damages from foreclosure, loss of equity, decline in
credit rating
Statutory damages not less than $400, not more
than $4000
Special statutory damages receive back all the
finance charges and fees they paid
Court cost and attorney cost
o Qualified mortgages exemption
Absolute defense: if you/lender makes a qualified
mortgage, then absolutely satisfies the duty to verify
Requirements
Term of the loan can never exceed 30 years
Loan origination fee can never exceed 3
points
Mortgage cannot be interest only; cannot
have a negative amortization

40

While under federal conservatorship (shortterm), any loan meeting the Fannie Maes
requirements
Bureau determines the DTI ratio 43%
maximum (e.g., 36%, cannot exceed 40%;
Fannie Maes standard is maximum 45%)
Duty to originator to make a reasonable and good faith
determination the consumer has a reasonable ability to repay the
loan 15 U.S.C. 1639c
Defense to Foreclosure action
Consumers granted a defense in a foreclosure action (judicial or
non-judicial) by recoupment or setoff
Amount of recoupment or setoff (15 U.S.C. 1640)
o First three years, actual damages, statutory damages,
special statutory damages, court costs and attorney fees
o Thereafter, finance charges and fees paid during first three
years of loan
Credit Risk retention requirements (15 USC 78 o)
5% risk retention required if loans securitized
Not required if loans sold are qualified residential mortgages
o QRM not defined
Dodd-Frank 1031
The Bureau may take any action authorized under part E of this
subchapter to prevent a covered person or service provider from
committing or engaging in an unfair, deceptive, or abusive act or
practice under Federal law in connection with any transaction with
a consumer for a consumer financial product or service, or the
offering of a consumer financial product or service.
Abusive
o Materially interferes with the ability of a consumer to
understand a term or condition of a consumer financial
product or service; or
o takes unreasonable advantage of a lack of understanding on the part of the consumer
of the material risks, costs, or conditions of the
product or service;
the inability of the consumer to protect the interests
of the consumer in selecting or using a consumer
financial product or service; or
the reasonable reliance by the consumer on a
covered person to act in the interests of the
consumer.
o Transfer of property

41

When commercial property sold -- loan remains in place will the buyer
assume the loan or pay the principal?
Due on sale provision: The buyer has to pay the principal. Lenders prefer
this because they get the principal back earlier.
States prohibited at least in residential mortgages But Congress
intervened to prevent the states from prohibiting these.
If loans not assumed by the new buyer, only recourse for the lender: a
cause of action against the original borrower
If loans assumed by the new buyer, lenders recourse are against the new
owner (foreclosure of title) and against the original borrower (personal
action).
If lender brings a deficiency of payment suit the original
borrower has a contractual action against the new owner for breach
of contract (of assuming the loan)
Mortgage process
o Promissory note obligation to repay
o Mortgage documents security interest on collateral interest pledged
Recites pledged collateral (E.g., land, improvement, building, fixtures)
lender is given a lien on these collateral in case of a default
Two party transaction
Owner (borrower) pledges the collateral and gives lien to lender
Lender
No present right to collect
o Alternatively, Deed of Trust:
Three party transaction
Owner/borrower transfers (not under mortgage) the title to the
trustee
Trustee keeps the title for lender; organizes public sale of
property without any judicial involvement
Lender beneficiary of the trust
No present right to collect; just like a lien on real estate before default
o In order to be a proper plaintiff for a foreclosure, what do you need?
Present interest in the property?
Present interest in the promissory notes? A must
Or both?
Commercial Real Estate Mortgage Security of Collateral
o Insurance
Insurance against loss or damage by fire
In no event be less than 100% of the full replacement value
FMV < the replacement value
Preserving the condition of property
o Payment of taxes
Payment of all taxes, assessments against the property

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Payment of any and all insurance premium (the Taxes)

So that no municipal authorities can place real estate liens against the
property
Escrow Fund
The Mortgagor will, at the option of the Mortgagee, pay to the Mortgagee
on the first day of each calendar month one-twelfth of an amount which
would be sufficient to pay the Taxes payable, or estimated by the
Mortgagee to be payable, during the ensuing twelve (12) months.
Assignment of leases and rents
The Mortgagor hereby absolutely and unconditionally assigns to the
Mortgagee all of its right, title and interest in and to all Leases and any
extensions
Notwithstanding the foregoing, so long as no default shall exist the
Mortgagor shall have a license to collect the Rents
The license granted to the Mortgagor to collect the Rents may be revoked
by the Mortgagee upon any default by the Mortgagor under the terms of
the Note or this Mortgage by giving notice of such revocation to the
Mortgagor
Leases: provided that the Mortgagor is not in default hereunder, the
Mortgagor shall have the right to terminate or modify any existing Lease
provided that the replacement Lease shall provide for the payment of rents
that are at least equal to the existing payment provided for in the existing
Lease and for a term to end no sooner than that of the existing Lease.
Maintenance of the mortgaged property
Maintain a good condition (ordinary repairs)
Avoid against active waste (no significant changes to the property, unless
prior written agreement)
The Mortgagor shall promptly comply with all existing and future
governmental laws, orders, ordinances, rules and regulations
The Mortgagor shall promptly repair, replace or rebuild any part of the
Mortgaged Property which may be damaged or destroyed by fire
Transfer or encumbrance of the mortgaged property
No part of the Mortgaged Property shall in any manner, directly or
indirectly, be further encumbered, sold, transferred or conveyed without
the prior written consent of the Mortgagee (sole discretion)
Events of default
Repeats all the provisions mentioned above. If violates any of them, then
an event of default.

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XIV. Foreclosure and Remedies for Lender

A.

NY Rules on Foreclosure

1.
New York Uses Judicial Foreclosure Proceeding Exclusivelyno power of sale for
either residential or commercial
Steps in Foreclosure in NY
2.
Power of Sale is much quicker proceeding than in NY where average is almost 2
yearsquicker because NO court involvement
B.

Defenses to Foreclosure

1.
Who is Named Party to Foreclosure Proceeding?borrower is always required
defendant to action but anyone else with interest can be made a defendant BUT NOT
required
If you are named defendantpurchaser in foreclosure sale takes title free of your
interestCAN BE advantageous if want party to stay on the lease and keep income
from tenant!
i.

Springer Corp. v. Kirkeby-Natus (NM 1969) (2nd mortgage holder not named party in
actionissue is what happens to 2nd mortgage holders interest?)Court holds that
general rule is that if DONT name a party to foreclosure their rights NOT affected
by any judgment or foreclosure salethis failure to name 2nd mortgage holder left
his rights in tactcase shows importance of doing diligence in figuring out who is
party

ii.

Como, Inc. v. Carson Square Inc (Ind. 1997) (tenant not named as D in
foreclosurewhat rights do they have?)Court adopts general rule and states if not
named party then your lease still existssome lenders may prefer this to keep
income

iii.

In Practiceevery lease has subordination provision that states lease is sub to any
existing or future loanADD turos notes on what if no sub provision

2.

Is there a duty to get highest possible price at foreclosure sale?

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i.

Maj. Rule per Manoog v. Mile (MA 1966)even if mortagee and mortgagor are
same person NO DUTY to get highest possible pricejust being below FMV not
enough to prove deficiencydifference in sales price vs. FMV NOT enough to show
deficiency

ii.

Exception to RuleIf chilled the sale might be an action in deficiency per

Manoog Chilling Factors
(1) Did mortagee assume position that preempt field of bidders and discourage
potential bidders; (2) Did mortagee indicate in advance to other bidders that he
intended to bid a price beyond reasonable figure at sale unless they agree to buy
property from him at reasonable price once he bought property for low pricethese
two likely lead to deficiency as chilling BUT ON OTHER HAND(3) mortagee
should be allowed to make deals prior to sale with persons interested

iii.

ExceptionIn extreme cases where bid on land at foreclosure sale shocks the
conscience may be a deficiencyin Johnson v. Johnson Standard Life Ins. Co. (AZ
1967)foreclosure sale price was $5K for property worth $73K is TOO LOW!

3.
Actions for Deficiencyif sales price at foreclosure is not enough to make up
balance can lender seek action to recover balance?
i.

ii.

Residential vs. Commercial Loans

Commercial Loans are NON-RECOURSElenders only alternative if deficient is to
sell collateralNO FURTHER cause of action against borrowers other assets
Residential loans are RECOURSElender can sue you for deficiency by reaching
YOUR personal assets
Recourse Laws VARY GREATLY by JurisdictionExamples
AZfor residential loans, if collateral is insufficient lender has NO right to recourse
CA (Hybrid Approach)Allows judicial foreclosure and non-judicialif lender
goes judicially CAN seek deficiency BUT if NOT judicially THEN NO recourse
NY RPL 1371(1) When motion is made for summary judgment, upon motion
court determines FMV as of the date of the saledeficiency judgment=amount
owed less than FMV as determined by courtDOES NOT compare price owed vs.
price at sale RATHER price owed vs. FMV @ time of foreclosureTHIS ALMOST
always higher than what is owed

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