CONTRACTS FOR DEED: SELLERS BEWARE!

A trial judge in Harris County recently handed down a decision on a dispute involving the ownership of real property acquired by a contract for deed. Most homebuyers have never heard of this home purchase method because most Sellers are not willing to sell a home unless the buyer can obtain an FHA, VA or pay for their house through some other conventional financing method. This short article is for both Sellers and Buyers contemplating a sale or purchase of residential property on a Contract for Deed[1] and a short case study from a case decided by a trial judge in Harris County determining the rights of the parties in a Contract for Deed.

Overview of Contracts for Deed for Sale of Residential Property

Contracts for Deed (referred to as the “Contract”) allow a Seller to purchase the property in situations where they have immigrated to the United States and have no credit, or they have poor credit. In summary, the Contract is a form of self-financing that provides that the Seller agrees to sell the property over time and will complete the “sale” upon the occurrence of two basic events: (1) payment of the entire mortgage by assuming the mortgage (when the Buyer can qualify), assumption of the mortgage or by obtaining other acceptable alternative methods of financing. Many analogize this type of transaction to a rental agreement with an option to purchase, but differs because the Contract for Deed generally includes a “balloon”, up front payment that pays the entire profit to be realized by Seller if the Buyer completes payment under the Contract.

The Texas Property Code & Contracts for Deed

Contracts for Deed typically contain clauses that require Buyers to maintain the property in good repair, to pay the taxes and maintain adequate insurance. A breach of one of these provisions used to allow the Seller to re-take possession of the premises and effect a forfeiture of all the “equity” built up by the Buyer over the years the Buyer was in possession. When it became apparent that a significant number of Sellers were trumping up fictitious or baseless claims to evict Buyers and deprive Buyers of their “down payment” and the years of payment, sometimes five or even ten-plus years of equity, the Texas Legislature stepped in to protect Sellers by adopting a statute that required pre-contract disclosures and annual statements that advised the Buyer of a number of items which, among other things, advised the Buyer of the amount of equity in the home and payoff amount similar to a mortgage statement.[2] In addition, Sellers who set out to exploit unsophisticated Buyers, the Legislature added provisions that penalize Sellers for failing to abide by the Act, including a provision to impose attorney’s fees against unscrupulous Sellers.

The Act also requires warnings in bold, 14 point capital lettering advising the Buyer that Buyer has the right to cancel the contract at any time for two weeks following the Contract and provides the cancellation date as well as the delivery methods of notice (telegram, certified mail or registered mail. Moreover, if not delivered in the pre-contractual notices, Seller must advise Buyer that oral agreements are not binding and that the Buyer cannot rely on oral promises made by Seller prior to execution of the Contract. After sale, other key provisions include:

• Late payment fees: If included in the contract, penalties may not exceed the lesser of 8 percent of the monthly payment or the actual administrative cost of processing the late payment.

• The Contract cannot prohibit the purchaser from pledging the buyer’s interest as security for utility improvements, fire protection improvements or attempt to prevent the Buyer from pledging the property to obtain a loan to improve the property or to improve the safety of the property.

• The Contract cannot impose prepayment penalties or any similar fee if Buyer wants to pay the entire amount before the maturity date.

• Specifically, in Contracts entered after Sept. 1, 2005, Seller cannot contain provisions that cause Buyer to forfeit an option fee or other option payment as a penalty for late payments.

• The Contract cannot increase the purchase price, or impose a fee or otherwise penalize a purchaser for requesting repairs or for exercising other rights of a tenant under a lease-purchase option discussed later.

Default under a Contract occurs with failure to make a scheduled payment. At that point, Seller has the right to give notice in writing to the Buyer’s residence or business address on a separate page in conspicuous 14- point boldface type or in 14-point uppercase typed letters that includes stating:

NOTICE YOU ARE NOT COMPLYING WITH THE TERMS OF THE CONTRACT TO BUY YOUR PROPERTY. UNLESS YOU TAKE THE ACTION SPECIFIED IN THIS NOTICE BY (DATE), THE SELLER HAS THE RIGHT TO TAKE POSSESSION OF YOUR PROPERTY.

Seller must also detail the dates and amounts of the breaches of the Contract, any missed payments or late payments itemized by principal and interest, or any additional charges such as late payments. Other breaches of the Contract, such as failure to maintain the property in good order and repair, must be also detailed in the Notice of Default.

After Buyer has received a statutorily compliant Notice to Buyer then has 30 days to pay the amount in default under Contract specified in the Notice. Otherwise, Buyer has 60 days. If Buyer does not comply within the 30- or 60-day period, Seller has three options: (1) rescind the Contract by returning all payments made by Buyer; (2) accelerate the Note and cause a forfeiture of all the buyer’s prior payments. Seller has the absolute right to select the remedy to pursue in a Notice of Default. However, If Buyer has paid more than 40 percent of the Note, the seller has only one option— to appoint a trustee to sell the property.

The seller must send a 60-day notice prescribed by the Legislature:

NOTICE YOU ARE NOT COMPLYING WITH THE TERMS OF THE CONTRACT TO BUY YOUR PROPERTY. UNLESS YOU TAKE THE ACTION SPECIFIED IN THIS NOTICE BY (DATE), A TRUSTEE DESIGNATED BY THE SELLER HAS THE RIGHT TO SELL YOUR PROPERTY AT A PUBLIC AUCTION.

The foreclosure sale must be conducted pursuant to with Section 51.002 of the Texas Property Code, which also governs foreclosure sales under deeds of trust. The trustee must post, file and serve notice of the sale in the county where the property is located at least 21 days before the sale is conducted. Like all other foreclosure sales, the sale is conducted on the first Tuesday of the month after the 21-day period. At sale, the trustee conveys title to the purchaser and warrants that the property is free from encumbrance. Any proceeds that exceed the debt go to the Buyer who defaulted. Buyer is subject to the same collection procedures allowed by Sections 51.003–51.005 of the Texas Property Code unless the Contract provides for different collection procedures. Upon sale, Seller is required to convey legal title to the foreclosure buyer and record the deed within 30 days after receiving final payment.

Brief Case Study

Seller, who emigrated from overseas, decided to sell his home after experiencing financial problems and return home. Buyer wanted to buy the home. A mutual friend (the “Friend”) put Buyer and Seller together and worked out a Contract for Deed that Friend obtained on the internet. Unfortunately, this particular Contract was drafted before the Legislature adopted statutory protections in 2001.

Seller claimed that there were late payments made while he was gone, and that the home was in disrepair. Seller went to the premises unannounced and talked to a renter who had leased the premises from Buyer. Seller claimed that this was a breach of the Contract, although nothing in the Contract prohibited renters so long as the monthly payments were made. Buyer demanded payment of $5,000 to “reinstate” the Contract and threatened to re-take the premises, and further told the renters (“Renter”) not to pay the monthly amount to Buyer and that Renter did not have to pay the last month’s rent when she stated that she wanted to vacate the premises. When Seller continued to threaten to re-take the premises, Buyer applied for and was granted a Temporary Restraining Order and Temporary Injunction, sued for Seller’s breach of contract and interference with contract and contended that the alleged “disrepair” was a pretext for Seller attempting to re-take the premises or make extortionate demands. None of the statutory notices were given by Seller.

The District Court found against Seller and in favor of Buyer awarding $21,500 in attorney’s fees, $5,000 in damages and $2,000 for interference with contract. The Court decided the case based on the contract language but did not reach the issues under the provisions pertaining to contracts for deed. However, Buyer obtained almost the same relief that he would have received with a judgment under the statutory provisions discussed above.

Conclusion

Based on the evidence, Sellers under a Contract for Deed must follow the terms of a Contract and cannot interfere with a buyer’s landlord-tenant relationship. Failure to include the statutory disclaimers or to provide statutory notices and reports may well result in denial of a default and foreclosure by Seller. In addition, Seller may be penalized with monetary penalties under the Code.

[1] See Tex.Prop. Code § 5.061-080 et. seq.

[2] The description of the state of the law is information only. Readers are advised that the law has periodically changed over the last fifteen years and that this article partially describes the current state of the law in Texas.