Equitable Interest

Equitable Interest

November 17, 2007

Last Revised: May 23, 2012 4:50 PM

Court Decisions Mentioning "Equitable Interest" or "Lease Option"

Top

Issue: A "renter" pays rent and does not build up any "equitable interest" in the property he rents.

He is paying to occupy the space but not to attain legal ownership of the property.

A "buyer" pays a mortgage payment and DOES build up an "equitable interest" in the property he is buying. Usually while he is still making payments another person retains a lien on his legal ownership or actually holds the title until a lien is removed. There is usually a lender who may be also the lien holder. The lender usually has a declining equitable interest while the buyer has an increasing equitable interest.

The buyer is paying to have eventual legal ownership of the property and also has the immediate right to occupy the space or control that occupancy

A "lease" is usually a rental with more formal terms and often with a term of occupancy that is longer than a rental.

An "option" is the right to do something, such as "to purchase" at some future date or when some condition is met.

A "lease-option" (sometimes called a "rent-to-own") agreement would usually be an agreement to pay some sum of money regularly where some of the payment could be considered like "rent" for the right to occupy and some part might be classified as payment toward "purchase."

In a typical "lease-option" the part of the payment that would apply to the purchase is low -- perhaps 20% of the payment, and the time during which the option can be exercises is short -- usually one or two years.

In immediate contrast with the "Esposito/Troescher" agreement, 100% of the payment is applied on the purchase and the length of time during which the option can be exercised is 10 years.

These two differences, and others, so distinguish the "Esposito/Troescher" agreement that it should be held as building up an equitable interest by Troescher.

If the payment toward purchase can be determined to develop an "equitable interest" then the "lease" could not be ended with an eviction (in the case of non-payment), but rather with a foreclosure.

If an owner of property conveys occupancy to someone where that person builds up an equitable interest and that owner works to cause the person sufficient upset that he "leaves," or the owner creates such obstacles to the lease-option agreement that the person reasonably believes that he will not be able to exercise his option and just "leaves," the person would typically lose any equitable interest because he did not exercise the option to take advantage of his equitable interest.

Thus, an owner who finds an improper way to prevent a person from exercising the option could be found guilty of depriving the person of his equitable interest.

__________________________________

This and the related pages are relevant to a "lease-option agreement" between Mr. Edward L. Esposito and Loren C. Troescher, to "buy and also occupy" the residence at 15431 Cohasset St., Van Nuys, CA 91406.

These pages are the preparation of a law suit by Troescher against Esposito relative to Esposito's apparently fraudulent efforts to cause Troescher to "give up" and leave without receiving any advantage of his substantial "equitable interest" in the property.

A special part of this issue is that is the "lease-option" is decided to NOT build up any equitable interest by Troescher, and he does not pay the usual monthly payment, then Esposito could use the laws on 'eviction' to remove Troescher from the property whereas is a court decides that Troescher has an equitable interest in the property, then Esposito would not only have to use the laws of 'foreclosure' to remove Troescher from the property, (not "eviction laws") but Esposito could be found liable for substantial Court-awarded damages and return of all Troescher's equitable interest.

_________________________________

Equitable Interest in Lease Option

Article by expert in real estate law

Source: I get a lot of emails and calls from people concerned about selling a property by lease with option because of the fear of the "equitable interest".

What does this mean and how big of a danger is it? Before we discuss the equitable interest, we need to discuss the basic owner-financed sale.

When you sell a property, you give the buyer a deed to transfer ownership. If you owned the property free and clear before you sold it, you would take back a note for part of the purchase price, secured by a lien on the property (in some states a "mortgage", in others a "deed of trust"). So, after the closing the buyer would have title (deed) and you would have a recorded lien against the property ("mortgage" or "deed of trust"). If the buyer stopped paying, you'd have to initiate foreclosure proceedings as specified by the mortgage or deed of trust. In mortgage states, the process is generally a lawsuit (judicial foreclosure), while deed of trust states the process is a "power of sale" (non-judicial) process.

Before we move on to the lease/option, let's discuss the installment land contract.

he installment land contract is an agreement by which the buyer makes payments under an agreement of sale in installment payments. The transaction is also known by the expressions, “contract for deed,” and “agreement for deed.”

The seller holds title as security until the balance is paid. In many respects, the land contract is identical to a mortgage, in that the buyer takes possession of the property, maintains it and pays taxes and insurance. However, title remains in the seller’s name until the balance of the debt is paid.

In many states, the installment land contract is considered the equivalent of a mortgage, in that the seller must commence foreclosure proceedings to remove the defaulting buyer.

If you sell the property by lease with option to purchase, it's not really a "sale" at all. The lease creates a landlord-tenant relationship. The option gives the buyer the right to purchase the property during the lease term at a specified price. If the tenant/buyer defaults, you evict him like any other tenant.

However, once you go into court, the tenant/buyer may raise the "equitable interest" argument.

In essence, the tenant/buyer is arguing that the lease/option agreement is essentially the equivalent of a sale, similar to an installment land contract. The tenant is asking the judge to rule that the buyer "owns" the property (even though title has not passed) and that the landlord is the equivalent of a lender. If true, the landlord must now proceed with a judicial foreclosure process instead of an eviction, which takes several extra months.

Return to Top

Logistically, the proceedings follow a certain path through the courts. In most parts of the country, the local civil courts have three levels - small claims, limited jurisdiction, general jurisdiction.

The small claims court are like the "People's Court" shows on T.V. - nobody can bring a lawyer and the maximum you can sue for is limited to about $5,000, give or take. The general jurisdiction courts can hear any kind of claim from a divorce to a foreclosure to a slip and fall case for $10,000,000.

The limited jurisdiction court is in between the two; you can use a lawyer and bring certain types of claims, including an eviction proceeding. The different courts have different names, depending on which state you live in. In my state (Colorado), the limited jurisdiction court is called "County Court" and the general jurisdiction court is called "District Court". In New York, where I used to practice law, there were called "City" courts (limited jurisdiction) and "Supreme Courts" (general jurisdiction).

The limited jurisdiction court cannot hear foreclosure cases or property ownership disputes.

Since the eviction proceeding is brought in the limited jurisdiction court, there is the risk that the tenant may raise the "equitable interest" argument.

If this happens, the judge cannot decide the dispute because he lacks jurisdiction. The judge will have to transfer the case to the general jurisdiction court for a hearing. This may cause a delay of a few weeks to a few months.

Since time is money, this is not good for the landlord, which is why some lawyers will start the eviction in the general jurisdiction court if they believe the tenant plans to fight the eviction (this may cost more in attorney fees than bringing an eviction in the lower courts, but will be faster if there needs to be a hearing on the equitable interest).

Either way, in most cases the general jurisdiction court will reject the tenant/buyer's argument and permit the landlord' eviction.

Why? Well, the tenant/buyer is asking the court to use it's "equitable" powers to rule that a lease/option is not a lease/option, but a sale. The court is being asked to turn a document into something it isn't in the matter of "fairness" (equity). Obviously, it's a judgment call for a judge, but in my experience this rarely happens. Here are some of the factors the judge will consider:

How long has the tenant been in the property?
How substantial was the default?
How were the documents drafted (i.e., does the lease/option look more like a contract for deed?)
Has the tenant done improvements, and are those improvements valuable?
How much money did the buyer put down?
What's the difference between the tenant's option price and the current market value of the property?

The last two factors are extremely relevant, since they will determine how big of a piece of the pie the parties are fighting for.

If the option price was $200,000, the tenant put up $5,000 and defaulted a year later and the market value is now $210,000, it is doubtful a judge would rule in the tenant's favor. It's not "equitable".

On the other hand, if the tenant put up $20,000, lived in the property three years and the market value was now $250,000, the judge might rule in favor of the tenant's equitable argument.

In this case, there's $70,000 of equity worth fighting over, so it's not that big a deal if you have to pay a lawyer $5,000 to foreclose.

In the "Esposito/Troescher" Agreement the downpayment will have been well in excess of $400,000 by the likely time of exercise of the option and Troescher will have lived in the house for ten years. The fact that the option price is much higher than was the current market price at the time of the agreement means that Troescher is taking a "buyer's risk" in the agreement. The fact that Esposito had advertised the house for a monthly rental of $2,800 and that Troescher is paying $3,200 -- further should support the finding that Troescher's intentions have clearly been "to buy" and that all his improvements, care for the house, investment in improvements -- all of these suggest a substantial equitable interest for Troescher.

Return to Top

The reverse logic to this shows Esposito's probable motivation to find ways to force Troescher to abandon his lease-option and equitable interest. When Esposito first entered into the lease-option agreement, he admitted to be on a short cash string to keep up his mortgage payments on the Van Nuys house and on his new fixer-upper house in Glendale. He has since then made an investment purchase of a residence in Phoenix and continues pursuing his investment in Caribbean real estate. He could now very likely carry the mortgage on the Van Nuys property as well as his other obligations and thinks that he need not "give away" all the profit he sees himself losing when/as Troescher exercises his option.

In short, don't believe the urban myth that all lease/options end up requiring a foreclosure.

Most of the time the "fairness" doctrine works just fine - the tenant/buyers without equity end up being evicted and the tenant/buyers with substantial equity get to keep it (or get foreclosed).

And, of course, you should have a well-drafted lease/option agreement with your tenant/buyer.

Bill Bronchick

William Bronchick, CEO of Legalwiz Publications, is a Nationally-known attorney, author, entrepreneur and speaker. Mr. Bronchick has been practicing law and real estate since 1990, having been involved in over 600 transactions. He has appeared as a guest on numerous radio and television talk shows including CNBC Power Lunch. He has been featured in Who's Who in American Business, Money Magazine, the Los Angeles Times and the Denver Business Journal. William Bronchick has served as President of the Colorado Association of Real Estate Investors since 1996.

Source (missing from the web on Dec 2, 2007, found in Google Cache at: http://72.14.205.104/search?q=

cache:rd7Vg16PJe0J:www.legalwiz.com/

freearticles/lotips.shtml+Avoiding+

The+%22Equitable+Mortgage%22&hl

=en&ct=clnk&cd=1&gl=us)

Lease/Options can be fun and profitable,but there are certain pitfalls. The following are some practical, legal and tax tips I have learned from doing many lease/options deals over the years.

Protecting Your Option

Lease/options are great, except when the seller decides not to live up to his end of the bargain. Sure, you can always sue the seller to force him to sell you the property, but this can cost you thousands of dollars in legal fees and take years to accomplish. You need to be in a better position if you want your investment to be protected.

Here are three good ways to protect your option:

Record the Option. If your option was signed before a notary, you can record your option in the public real estate records. This will give the world public notice of your interest. If the option was not notarized, you can sign an affidavit called a "memorandum of option" and file it in the real estate records where the property sits. Keep in mind that this does not create a lien, it only creates a "cloud" on the title.

Escrow the Deed. If your seller has died or disappeared, you will have a big problem getting him to sign a deed. An escrow should be created up front in which a title company or attorney holds an executed deed. When you are ready to exercise, you simply tender the money to the escrow agent and collect the deed.
Record a Mortgage. Typically a mortgage is recorded to securepayments on a promissory note. A mortgage can be recorded to secure performance of any agreement, even a purchase option. You as optionee (buyer) will now be a lienholder, in the same position as a secured lender. If the seller refuses to sell the property, you foreclose. Now the seller has to go to court to protect himself, rather than the other way around.

Avoiding The "Equitable Mortgage"

Do the opposite to create an equitable mortgage interest

Tenant/buyers who default on a lease/option do not always go away quietly. Sometimes, they fight the eviction and go into court kicking and screaming, "I HAVE AN EQUITABLE INTEREST IN THE PROPERTY." What they are arguing is that the lease/option is not a landlord/tenant relationship, but rather a seller/buyer relationship. If the Judge agrees, your lease/option is "re-characterized" as an installment land contract. This may require you to foreclose the tenant, not just evict him.

Return to Top

Here are some tips for avoiding the equitable mortgage:

Use Separate Agreements. Give your tenant a lease and a separate option agreement. Make certain the lease does not refer to the option. More than 75% of the time, the tenant loses his paperwork.
In the "Esposito/Troescher Agreement" ("ETA") there is only one agreement not two.
Keep Your Term Short. Do not give tenants more than one year lease/options at a time. If the tenant insists on three years, give him a one year with 2 rights to renew. Draw up a brand new lease and option agreement each time he renews. If you give a cumulative rent credit, raise the purchase price each time.
In the ETA the term is ten years with an obvious "artifice" of that being "two five year options." such length is relatively unheard of in the world of Lease-Option.
Take a Security Deposit. Sellers don't take security deposits, landlords do. Make it look like a landlord/tenant relationship, even if the security deposit is small.
In the ETA there is NO security deposit.
Pay the Taxes and Insurance. Do not let the tenant pay the taxes and insurance. This makes it look like a sale.
While taxes and insurance are paid by Exposito, there is the other factor of the difference in the option price from the current value at the time of the agreement. The difference of some $400,000 is such that only a person who considers himself as a "buyer" with a long-term perspective could enter into such an agreement.
Don't Give Large Rent Credits. The more "equity" the tenant has, the more likely a judge will favor an equitable mortgage.
In the ETA the "rent credit" is as large as it could theoretically could be at 100% and also inlcudes large "option fees."
Watch Your Language. Refrain from using the words "credit," "seller" and "buyer" in your agreements. Instead, use the words "non-refundable option," "landlord" and "tenant."
The ETA was drafted by Troescher, not Esposito, and Troescher's frame of reference was as a buyer, not as a renter.

_______________________________________

Options

An option is defined as the right to buy a property for a specified price (strike price) during a specified period of time.

An owner of a property may sell an option for someone to buy it on or before a future date at a predetermined price.

The buyer of the option hopes the value of the property will either go up or is already low.

The seller receives a premium called "option consideration". The buyer may then either exercise the option by buying the property or sell the option to someone else to exercise (or sell). This is often done to obtain control over a property without much cash.

Option premiums are typically non-refundable.

The option represents an equitable interest in the property and may be recorded at the county recorders office.

Home Page - Restricted

Home Page Public