Land Contracts and Title Insurance
The following blog was reprinted with permission from David Phillips, an underwriter, title examiner and friend. Now more than ever, Land Contract Vendees should obtain a policy to protect their interest. If you want to know why, read on. Have a great weekend – John Shepard
The person or entity selling the land is referred to as the vendor.
The person or entity purchasing the land is referred to as the vendee.
The vendor is typically the fee owner of the subject property. However, some contracts recite the vendor as an existing vendee. This is called a second land contract. It works like this: Bill Smith, fee owner and vendor, sells to Mike Thomas, vendee. This is the original land contract. Subsequently, Mike Thomas, as vendor, sells to Shirley James, vendee. This is the second land contract. Mike Thomas is both a vendee on the first contract and a vendor on the second contract. Both contracts exist concurrently and both contracts must be properly fulfilled before Shirley James can receive marketable title.
A purchaser in a land contract is similar to a purchaser in a garden variety purchase agreement. The difference is in the timing. A land contract is executory and extends over a period of time, whereas a purchase agreement calls for a single transaction, that being a concurrent transfer of money from the purchaser with receipt of deed from the seller.
Now, why should a land contract vendee obtain title insurance?
The reasons for insurance should seem obvious. However, many people believe that a land contract vendee interest is not insurable. This is incorrect, as a vendee interest is fully and necessarily insurable. Additionally, a vendee may figure they can just wait until the contract is fulfilled and then obtain title insurance upon receipt of their warranty deed. This is possible but extremely risky!
First off, a vendee will want to verify the proper fee owner of the land. Take this scenario for instance: Dave Phillips, fee owner of blackacre, leases his property to Brian Bosworth, former football hero. Subsequently, Mr. Bosworth sells on a land contract to Barry Switzer, his former coach. In this scenario, Mr. Switzer would not be purchasing anything, as Brian Bosworth has no ownership interest and consequently no authority to sell blackacre. A title company would disclose the fee interest of Dave Phillips and lessee interest of Brian Bosworth. Consequently, Mr. Switzer would not be fooled into signing a bogus contract. Establishing the proper fee owner establishes the legality of the proposed land contract.
Next, the tax monster. Prior to the execution of the contract, property taxes affecting the land may fall into many categories: (1) Taxes may be paid current; (2) taxes may be delinquent; (3) taxes may be forfeited; or (4) Taxes may have been foreclosed. For the unsuspecting vendee, categories 2, 3, or 4 can be a tremendous headache. Note: taxes always have superior lien position. Who pays the taxes will be spelled out in the land contract itself. However, a vendee will want to verify that there are no surprises. For instance, if a Judgment of Foreclosure has been rendered, and the relevant 21 days to redeem has passed, the property will be owned by the Foreclosing Governmental Unit (FGU), not your land contract vendor!
How about stray interests? Stray interests ‘cloud’ the title. There is usually no way a vendee can be aware of stray interests without a proper title search. If a stray interest exists, a title company can procure proper documentation to remove such interests, thereby relieving the vendee of future attacks on title.
Now, a big one: Senior liens. Any and all recorded liens in existence, prior to the recording of the land contract, will have priority over the vendee interest. Senior liens can be deadly to a contract vendee. If such lien falls into default and is foreclosed, the vendee interest will be wiped out. In the best case scenario, the vendee, after notice from the foreclosing party, would have to redeem such lien and then battle it out with the vendor regarding contribution or indemnification. You see, many contracts are executed with an existing lien on the property, usually a mortgage. The benefit of having vendee title insurance is this: The title company will record the land contract, or a memorandum thereof. You, as the vendee, will know what senior liens exist and, furthermore, all senior lien holders will have record notice of your vendee interest.
I have disclosed some of the major reasons why a land contract vendee should obtain title insurance. The vendee simply has too much at stake. Title insurance discloses the condition of the land prior to the vendee obtaining its interest. However, there are situations that may arise, subsequent to execution of the contract, that may impact the vendee’s interest. Bankruptcy filed by the vendor, as well as defaulted senior liens, are two of the big ones. Note: If a vendor files bankruptcy, the contract is typically not affected. The trustee will usually give the vendee the option of either rejecting the contract or continuing the contract with payments being remitted to the trustee instead of the original vendor. It is possible that the trustee may try to argue that the land contract itself is part of a fraudulent transaction, but for general purposes, a garden variety land contract will survive a vendor bankruptcy filed subsequent to recordation of the land contract.
Important: Title insurance does not insure the land contract itself; it insures the vendee as to the condition of the land they are purchasing, as shown on the policy. The land contract itself is a contract between the vendor and the vendee. The title company is not a party to this contract. As a result, the terms and conditions of such land contract are set out as a specific exception on the title policy. This all focuses on “autonomy” of contract. The parties are free to make any legal contract they so desire. The vendor and vendee both have correlative ‘rights’ and ‘duties’ relative to such contract. The title company has no rights or duties relative to such contract and, therefore, cannot be asked to police or insure the contract.
Conclusion: A vendee should obtain title insurance. It would be extremely negligent to do otherwise.
Hope this helps,