Contracts for Deed

In California financing of the purchase of property is normally accomplished with a Deed of Trustwhich allows the selling or financing party to claim the property if payment on the promissory note financing the property is not timely made.

An alternative method of financing with security for payment is for the selling party to retain the deed for the property and only transfer it when the full payments are made. This is often termed a Contract for Deed. Contracts for Deed are used as a form of owner financing of real estate.  Usually, the owner of property and a potential buyer contract such that the owner agrees to transfer to the buyer a deed to the property once the buyer pays the owner a certain amount of money.  Usually the contract requires the buyer to make payments over time with interest payable on the unpaid balance.  Once a buyer pays all of the payments called for under the contract, the owner transfers to the buyer a deed to the property. During the period while payments are being made, the buyer is granted possession of the real estate and may be required to keep the property insured and pay the real estate taxes, or/or reimburse the Seller for those payments. The essential document is the contract between the parties which describes their duties which may or may not be recorded to give notice to the world.

The Basics:

        Benefits to the Buyer  

This type of transfer may be attractive to buyers who might not otherwise quality for a loan. The buyer may also be able to purchase the property with a relatively low down payment which this process can provide. Also, in the event of a default in payments, the buyer need only bring payments current within the time period provided by the contract or by state law to preserve his or her equity in the property. Note that the law on the right to cure varies from state to state. And this right to cure is in contrast to most promissory notes containing acceleration clauses, in which upon default the buyer is responsible for the entire amount remaining under the loan. Contracts for deed are also faster and cost less to create than traditional mortgages or deed of trust in most circumstances. Closing costs, points, origination fees, appraisal costs and application costs are often nonexistent.

        Risk to the Buyer

A contract for deed has risk for the buyer. Because the seller keeps legal title to property until the contract price is paid in full, the buyer does not become the owner of the property until he or she completes his payment obligations and receives title from the seller. If the buyer defaults on the contract, the buyer runs the risk of losing all of the money that he or she has paid on the contract. Unless the contract for deed is recorded, third parties who rely on the state of the title recorded may remove the buyer from title rights and the only remedy of the buyer is to seek relief against the seller who may have left the jurisdiction or be insolvent.

        Benefits to the Seller

At first glance, the contract for deed may seem attractive to seller.  It is relatively simple to comprehend and allows the seller a quick method of canceling the transaction in the event of a default. While default on a Deed of Trust requires a set procedure often taking four to six months, the contract for deed may be enforced more quickly, depending on State law.  But, as discussed below, there are disadvantages which are major.

Termination of Contracts for Deed

In general, if the buyer defaults on an installment, the seller can cancel the contract, reclaim the land, retain the payments made and benefit without expenditure for any improvements that have been made on the premises by the buyer. The seller does this without a foreclosure sale or judicial action or taking the procedures required to enforce a Deed of Trust. The seller may alternatively elect to sue the buyer on the contract assuming the value of the property is less than the sums due on the contract and obtain damages and let the buyer keep the land. This is often not allowed for a Deed of Trust which may limit deficiency judgments in many states on residential property, including California.

Risks to the Seller

Contracts for deed may have greater risk for the seller. The seller is not solely on title on the land for the term of the contract.  Thus, if the buyer defaults, the seller will have to commence action and may be forced to reclaim the land. Just as troubling, the seller remains liable for environmental or other hazards on the land and subject to claims by third parties predicated on ownership of the land, from tort liability claims for those on the land to nuisance, prescriptive easements and adverse possession claims as well as any property taxes that may not have been paid by buyer. Some of these dangers can be limited by the proper drafting of the contract for deed documents.

Recording 

The buyer should record the contract for deed with the county recorder where the land is located and does so normally within four months after the contract is signed, though the time may vary depending on state law.

Contractual Rights and Remedies 

The contract for deed is simply a contract subject to various contractual restrictions that exist under state law and many of the rights and remedies of the parties are based solely on the provisions contained in the contract itself.  In short, it is not significantly different than any other installment purchase of a product except that title remains in the seller unlike many installment purchases.  The seller agrees to convey the property to the buyer by a specified form of conveyance, usually a warranty deed, once all of the payments are made under the contract, and to furnish an abstract evidencing good title in the seller at the time the contract for deed is executed.

The buyer agrees to pay a purchase price for the property as specified. He or she also usually agrees to pay real estate taxes and assessments and to maintain specified insurance on the premises, including insurance for the benefit of the seller. The buyer also agrees that all buildings, improvements and fixtures currently on or subsequently added to the land may not be removed, but will remain on the property until the contract is fully performed.

Many other provisions, such as due on sale clauses, contained in a contract for deed are similar to those contained in a mortgage or deed of trust. It may, however, be more common to find a provision in a contract for deed that prohibits the purchaser from prepaying all or any portion of the contract ahead of schedule. The seller may be looking to the contract for deed payments as a source of retirement income and may not desire early payment for various tax reasons.

Acceleration clauses are less common in contracts for deed. In most states, however, there is no legal restriction against including an acceleration clause in a contract for deed. Without an acceleration clause, if a seller wants to forego his or her claim against the land, he or she must bring an action for each installment as it comes due under the contract for deed. He cannot accelerate the balance due under the contract. That is seldom to the benefit of a seller.

Such standard clauses as arbitration and attorney’s fees to the prevailing party should be included in the agreement. See The Acid Test Clause.

Nature of the Relationship

Under a contract for deed, the buyer does not own the land but rather purchases an equitable right in the land. This allows the buyer to occupy and utilize the land. Although it is generally considered that the seller retains legal title to the land and is so treated for many purposes,  many state courts have held that the seller has a security title only and that the buyer is the equitable owner of the property. As such, the relationship is in substance similar to that created by a deed and a mortgage in many states.

Completion of the Contract

When the total purchase price and all interest due has been paid to the seller, the buyer receives the type of conveyance provided for in the contract. Generally this will require the execution and delivery of a title deed to the buyer. When the title to real estate is transferred by a warranty deed, the seller is guaranteeing that he or she has full legal title in the property subject only to those exceptions specifically noted on the deed. In contrast, a quit claim deed transfers all rights in the property of the seller, but provides no guarantee that others do not have prior claims. Once the purchase price has been paid, the seller must convey legal title to the buyer. If the seller has died or is otherwise unable to make the conveyance, it is the duty of his heirs or representatives to furnish the proper conveyance without any additional cost to the buyer. When the buyer has received the deed from the seller, he or she should file the deed with the county recorder in the county where the land is located.

Improvements 

As noted earlier, improvements a buyer makes on the property may be lost if the buyer defaults on the contract. In the event the buyer plants crops, the crops may likewise be lost if the seller terminates the contract for deed. It is therefore important for a buyer of farmland to make provisions for paying the contract installments during the time that the buyer has growing crops on the land. Otherwise such crops could be forfeited to the seller.

The California Statutory Law:

Chapter 2c. Real Property Sales Contracts

§ 2985 Civ.
Update Notice: This section has been amended by Chapter 51 of 2006

A real property sales contract is an agreement wherein one party agrees to convey title to real property to another party upon the satisfaction of specified conditions set forth in the contract and which does not require conveyance of title within one year from the date of formation of the contract.

CALIFORNIA CIVIL CODE
DIVISION 3. OBLIGATIONS
PART 4. OBLIGATIONS ARISING FROM PARTICULAR TRANSACTIONS
TITLE 14. LIEN
Chapter 2c. Real Property Sales Contracts

§ 2985.1 Civ.

A real property sales contract may not be transferred by the fee owner of the real property unless accompanied by a transfer of the real property which is the subject of the contract, and real property may not be transferred by the fee owner thereof unless accompanied by an assignment of the contract.

Nothing herein shall be deemed to prohibit the assignment or pledge of a real property sales contract, as security or for the purpose of effecting collection thereon, to the holder of a first lien on the real property which is the subject of the contract without a transfer of the real property or the transfer of a fee title in trust without the concurrent assignment of the sales contract.

CALIFORNIA CIVIL CODE
DIVISION 3. OBLIGATIONS
PART 4. OBLIGATIONS ARISING FROM PARTICULAR TRANSACTIONS
TITLE 14. LIEN
Chapter 2c. Real Property Sales Contracts

§ 2985.2 Civ.

Any person, or the assignee of such person, who sells a parcel of land under a sales contract which is not recorded and who thereafter causes an encumbrance or encumbrances not consented to in writing by the parties upon such property in an amount which, together with existing encumbrances thereon exceeds the amount then due under the contract, or under which the aggregate amount of any periodic payments exceeds the periodic payments due on the contract, excluding any pro rata amount for insurance and taxes, shall be guilty of a public offense punishable by a fine not exceeding ten thousand dollars ($10,000), or by imprisonment in the state prison, or in the county jail not exceeding one year, or by both such fine and imprisonment.

CALIFORNIA CIVIL CODE
DIVISION 3. OBLIGATIONS
PART 4. OBLIGATIONS ARISING FROM PARTICULAR TRANSACTIONS
TITLE 14. LIEN
Chapter 2c. Real Property Sales Contracts

§ 2985.3 Civ.

Every seller of improved or unimproved real property under a real property sales contract, or his assignee, who knowingly receives an installment payment from the buyer under a real property sales contract at a time when there is then due any payment by the seller, or his assignee, on an obligation secured by an encumbrance on the property subject to the real property sales contract, and who appropriates such payment received from the buyer to a use other than payment of the amount then due on the seller’s or assignee’s obligation, except to the extent the payment received from the buyer exceeds the amount due from the seller or assignee, is guilty of a public offense punishable by a fine not exceeding ten thousand dollars ($10,000), or by imprisonment in the state prison, or in the county jail not exceeding one year, or by both such fine and imprisonment.

CALIFORNIA CIVIL CODE
DIVISION 3. OBLIGATIONS
PART 4. OBLIGATIONS ARISING FROM PARTICULAR TRANSACTIONS
TITLE 14. LIEN
Chapter 2c. Real Property Sales Contracts

§ 2985.4 Civ.

Every seller of improved or unimproved real property under a real property sales contract who receives pro rata payments for insurance and taxes shall hold these amounts in trust for the purpose designated. These amounts shall not be disbursed for any other purpose without the consent of the payor and any person or corporation holding an encumbrance on the property.

This section shall not apply to a state- or federal-supervised assignee of a seller who as agent for the seller receives and disburses payments.

CALIFORNIA CIVIL CODE
DIVISION 3. OBLIGATIONS
PART 4. OBLIGATIONS ARISING FROM PARTICULAR TRANSACTIONS
TITLE 14. LIEN
Chapter 2c. Real Property Sales Contracts

§ 2985.5 Civ.

Every real property sales contract entered into after January 1, 1966, shall contain a statement of:

(a) The number of years required to complete payment in accordance with the terms of the contract.
(b) The basis upon which the tax estimate is made.

CALIFORNIA CIVIL CODE
DIVISION 3. OBLIGATIONS
PART 4. OBLIGATIONS ARISING FROM PARTICULAR TRANSACTIONS
TITLE 14. LIEN
Chapter 2c. Real Property Sales Contracts

§ 2985.51 Civ.

(a) Every real property sales contract entered into on and after January 1, 1978, where the real property that is the subject of such contract resulted from a division of real property occurring on or after January 1, 1978, shall contain or have attached thereto a statement indicating the fact that the division creating the parcel or parcels to be conveyed:

(1) Was made in compliance with the provisions of the Subdivision Map Act, Division 2 (commencing with Section 66410) of Title 7 of the Government Code and local ordinances adopted pursuant thereto, and in such event the statement shall expressly refer to the location, in the records of the county recorder for the county in which the real property is located, of a previously recorded certificate of compliance or conditional certificate of compliance issued pursuant to Section 66499.35 of the Government Code with respect to the real property being sold, or the statement shall describe the real property to be conveyed as an entire lot or parcel by referencing the recorded final or parcel map creating the parcel or parcels to be conveyed and such description shall constitute a certificate of compliance as set forth in subdivision (d) of Section 66499.35 of the Government Code. Provided, however, where reference is made to a recorded parcel map and the approval of such map was conditioned upon the construction of specified offsite and onsite improvements as a precondition to the issuance of a permit or grant of approval for the development of such parcel and the construction of the improvements has not been completed as of the date of execution of the real property sales contract, then the statement shall expressly set forth all such required offsite and onsite improvements; or

(2) Was exempt from the provisions of the Subdivision Map Act and local ordinances adopted pursuant thereto, and in such event the statement shall expressly set forth the basis for such exemption; or

(3) Was the subject of a waiver of the provisions of the Subdivision Map Act and local ordinances adopted pursuant thereto, and in such event the contract shall have attached thereto a copy of the document issued by the local agency granting the waiver. Provided, however, where the granting of the waiver was conditioned upon the construction of specified offsite and onsite improvements as a precondition to the issuance of a permit or grant of approval for the development of the parcel and the construction of the improvements has not been completed as of the date of execution of the real property sales contract, then such statement shall expressly set forth all such required offsite and onsite improvements; or

(4) Was not subject to the provisions of the Subdivision Map Act and local ordinances adopted pursuant thereto, and in such event the statement shall expressly set forth the basis for the nonapplicability of the Subdivision Map Act to the division.

(b) Every real property sales contract entered into after January 1, 1978, where the real property that is the subject of such contract resulted from a division of real property occurring prior to January 1, 1978, shall:

(1) Contain or have attached thereto a signed statement by the vendor that the parcel or parcels which are the subject of the contract have been created in compliance with, or a waiver has been granted with respect to, the provisions of the Subdivision Map Act, Division 2 (commencing with Section 66410) of Title 7 of the Government Code and local ordinances adopted pursuant thereto, or any prior law regulating the division of land, or, were exempt from or not otherwise subject to any such law at the time of their creation. Provided, however, where the division creating the parcel or parcels being conveyed was by means of a parcel map, or in the event that a waiver of the provisions of the Subdivision Map Act has been granted, and the approval of the parcel map or the granting of the waiver was conditioned upon the construction of specified offsite and onsite improvements as a precondition to the issuance of a permit or grant of approval for the development of such parcel and the construction of the improvements has not been completed as of the date of execution of the real property sales contract, then such contract shall expressly set forth all such required offsite and onsite improvements.

(2) In lieu of the above, the vendor may include in the real property sales contract a description of the real property being conveyed as an entire lot or parcel by referencing the recorded final or parcel map creating the parcel or parcels being conveyed and such description shall constitute a certificate of compliance as set forth in subdivision (d) of Section 66499.35 of the Government Code. Provided, however, where reference is made to a recorded parcel map, or in the event that a waiver of the provisions of the Subdivision Map Act has been granted, and the approval of the parcel map or the granting of the waiver was conditioned upon the construction of specified offsite and onsite improvements as a precondition to the issuance of a permit or grant of approval for the development of such parcel and the construction of the improvements has not been completed as of the date of execution of the real property sales contract, then such contract shall expressly set forth all such required offsite and onsite improvements.

(3) Notwithstanding paragraphs (1) and (2), in the event that the parcel or parcels which are the subject of the real property sales contract were not created in compliance with the provisions of the Subdivision Map Act, Division 2 (commencing with Section 66410) of Title 7 of the Government Code and local ordinances adopted pursuant thereto, or any other prior law regulating the division of land, and were not exempt from, or were otherwise subject to any such law at the time of their creation, the real property sales contract shall contain a statement signed by the vendor and vendee acknowledging such fact. In addition, the vendor shall attach to the real property sales contract a conditional certificate of compliance issued pursuant to Section 66499.35 of the Government Code.

(c) In the event that the parcel or parcels which are the subject of the real property sales contract are found not to have been created in compliance with, or a waiver has not been granted with respect to, the provisions of the Subdivision Map Act, Division 2 (commencing with Section 66410) of Title 7 of the Government Code, or any other prior law regulating the division of land nor to be exempt from, or otherwise subject to such laws and the vendee has reasonably relied upon the statement of such compliance or exemption made by the vendor, or in the event that the vendor has failed to provide the conditional certificate of compliance as required by paragraph (3) of subdivision (b), and the vendor knew or should have known of the fact of such noncompliance, or lack of exemption, or the failure to provide the conditional certificate of compliance, the vendee, or his successor in interest, shall be entitled to: (1) recover from the vendor or his assigns the amount of all costs incurred by the vendee or his successor in interest in complying with all conditions imposed pursuant to Section 66499.35 of the Government Code; or, (2) the real property sales contract, at the sole option of the vendee, or his successor in interest, shall be voidable and in such event the vendee or his successor in interest shall be entitled to damages from the vendor or his assigns. For purposes of this section, damages shall mean all amounts paid under the real estate sales contract with interest thereon at the rate of 9 percent per annum, and in addition thereto a civil penalty in the amount of five hundred dollars ($500) plus attorney’s fees and costs. Any action to enforce the rights of a vendee or his successor in interest shall be commenced within one year of the date of discovery of the failure to comply with the provisions of this section.

(d) Any vendor who willfully violates the provisions of subdivision (a) of this section by knowingly providing a vendee with a false statement of compliance with, exemption from, waiver of, or nonapplicability of, the provisions of the Subdivision Map Act, with respect to the real property that is the subject of the real property sales contract, shall be guilty of a misdemeanor punishable by a fine of not to exceed one thousand dollars ($1,000), or imprisonment for not to exceed six months, or both such fine and imprisonment.

(e) For purposes of this section a real property sales contract is an agreement wherein one party agrees to convey title to unimproved real property to another party upon the satisfaction of specified conditions set forth in the contract and which does not require conveyance of title within one year from the date of formation of the contract. Unimproved real property means real property upon which no permanent structure intended for human occupancy or commercial use is located.

(f) The provisions of this section shall not apply to a real property sales contract which, by its terms, requires either a good faith down payment and a single payment of the balance of the purchase price or a single payment of the purchase price upon completion of the contract, and the provisions of such contract do not require periodic payment of principal or interest.

CALIFORNIA CIVIL CODE
DIVISION 3. OBLIGATIONS
PART 4. OBLIGATIONS ARISING FROM PARTICULAR TRANSACTIONS
TITLE 14. LIEN
Chapter 2c. Real Property Sales Contracts

§ 2985.6 Civ.

(a) A buyer shall be entitled to prepay all or any part of the balance due on any real property sales contract with respect to the sale of land which has been subdivided into a residential lot or lots which contain a dwelling for not more than four families entered into on or after January 1, 1969; provided, however, that the seller, by an agreement in writing with the buyer, may prohibit prepayment for up to a 12-month period following the sale.

(b) Any waiver by the buyer of the provisions of this section shall be deemed contrary to public policy and shall be unenforceable and void; provided, however, that any such waiver shall in no way affect the validity of the remainder of the contract.

Key California Case Law: The Right to Cure Default:

Peterson v. Hartell, 707 P.2d 232, (Cal.Sup.Ct. 1985). party may be relieved from forfeiture; § 3275 not exclusive source for the right to relief under forfeiture; even willfully defaulting vendees will be awarded specific performance in proper cases; vendee must be allowed reasonable opportunity to complete performance.

 

Conclusion:

The overwhelming majority of secured sales of real estate in California utilize the Deed of Trust method which has worked well for millions of people and has a great deal of statutory and case law providing for clear remedies and obligations of all parties involved. Only in unusual situations in which the seller wishes to remain on title and the buyer’s financial situation does not allow a standard Deed of Trust do we find such methods as Contracts for Deeds, as well as real estate transactions involving development, joint ventures and the like. As one client put it, using a Contract for Deed requires the parties to negotiate an entire contract to achieve what the standard Deed of Trust accomplishes just as well.

But in those circumstances when an installment sale method must be used, both the buyer and seller must carefully craft the various rights and remedies to be held under the contract and check state law to ensure that the agreement is in conformity with local law.