The primary California law governing Preforeclosure Sales is Civil Code Sections 1695-1695.17. (In addition there are other California statutes governing foreclosure consultants in Civil Code Sections 2945-2945.11 and predatory lending in Financial Code Sections 4970-4979.6.) Federal bankruptcy law can also have an impact. Finally, there are practical considerations.
California Law
The California preforeclosure sale statutes are relatively intricate. They apply to any residential real property consisting of one-to-four family dwelling units, one of which the owner occupies as his or her principal place of residence, and against which there is an outstanding notice of default. Here are the high points.
1. Every equity purchase contract must be written in at least 10-point bold type and must be fully completed and signed and dated before execution of any instrument of conveyance of the residence in foreclosure. The contract must include the entire agreement of the parties, including but not limited to the terms of any rental agreement. See Section 1695.3 for the full requirements list.
2. In addition, each contract must contain the following notice in at least 14-point boldface type, if the contract is printed or in capital letters if the contract is typed, and completed with the name of the equity purchaser, immediately above the notice of cancellation:
NOTICE REQUIRED BY CALIFORNIA LAW
Until your right to cancel this contract has ended, (Name of Equity Purchaser) or anyone working for __________(Name of Equity Purchaser) CANNOT ask you to sign or have you sign any deed or any other document.
3. The equity seller has the right to cancel any contract with an equity purchaser until midnight of the fifth business day following the day on which the equity seller signs the contract or until 8 a.m. on the day scheduled for the sale of the property pursuant to a power of sale conferred in a deed of trust, whichever occurs first.
4. Immediately before the equity seller's signature, the contract must contain a conspicuous statement in a size equal to at least 12-point bold type, if the contract is printed or in capital letters if the contract is typed, as follows:
You may cancel this contract for the sale of your house without any penalty or obligation at any time before ________________________________________ (Date and time of day). See the attached notice of cancellation form for an explanation of this right.
5. The contract must be accompanied by a completed form in duplicate, captioned 'notice of cancellation' in a size equal to 12-point bold type, if the contract is printed or in capital letters if the contract is typed, followed by a space in which the equity purchaser must enter the date on which the equity seller executes the contract. The form must be attached to the contract, must be easily detachable, and the text of the form must be in type of at least 10-points, if the contract is printed or in capital letters if the contract is typed. See Section 1695.5(b) for the wording of the cancellation notice.
6. Until the time within which the equity seller may cancel the transaction has fully elapsed, the equity purchaser cannot do any of the following:
(1) Obtain or induce the equity seller to execute any instrument of conveyance of any interest in the residence.
(2) Record with the county recorder any document, including, but not limited to, any instrument of conveyance.
(3) Transfer or encumber or purport to transfer or encumber any interest in the residence in foreclosure to any third party.
(4) Pay the equity seller any consideration.
7. An equity purchaser cannot make any untrue or misleading statements regarding the value of the residence in foreclosure, the amount of proceeds the equity seller will receive after a foreclosure sale, or any other untrue or misleading statement concerning the sale of the residence.
8. Whenever the equity seller is given an option to repurchase the residence, the equity purchaser cannot cause any encumbrance to be placed on the property or grant any interest in such property to any other person without the written consent of the equity seller.
9. Where the equity seller is given an option to repurchase, the presumption is that the transaction is a loan transaction unless there is 'clear and convincing evidence to the contrary?. Unfortunately, no one yet knows what would be sufficient evidence. For example, is it enough if there are no monthly payments (for rent or otherwise) due from the equity seller? One has to assume that any attorney later representing the equity seller would argue that the presumption applies, since then certain loan statutes apply. Still, language should be inserted in the agreement that will help prove the transaction is not a loan.
a. If the transaction is deemed to be a loan, the California usury laws apply. That means the interest rate cannot exceed the greater of a) 10% per year or b) 5% per year plus the rate established by the Federal Reserve Bank of San Francisco on advances to member banks. As of December 2004 the federal reserve rate was 3.25%. Presumably the interest in an equity purchase situation would be calculated by comparing the buy-back amount to the purchase amount ? and attributing the difference to interest. The contract could presumably designate a reasonable portion of that amount to costs and fees. Note that there is an exception for loans made or arranged by any person licensed as a real estate broker by the State of California and secured in whole or in part by liens on real property. For this reason, paying a real estate agent to handle the transaction should exempt it from the California usury laws.
b. Also, if the transaction is deemed to be a loan, the requirements set out in Financial Code Sections 4970-4979.6 to avoid a predatory loan must be met. Actually, those provisions should not apply if the right to repurchase lasts for one year or less so that it falls in the 'bridge loan' category. As a result, if possible, any option to repurchase should last for no more than one year. If the right lasts for more than one year, then numerous requirements regarding the interest rate, amount of points and fees and the option holder's ability to pay to exercise the option come into effect.
10. If any of these provisions are violated, the equity seller may be able to rescind the agreement and/or to recover actual damages, attorneys' fees and costs, and exemplary damages in an amount equal to the greater of three times actual damages or $2,500. Fraud or deceit may additionally be punished by a fine of $25,000, by imprisonment in the county jail or in state prison for not more than one year, or by both for each violation. Other remedies may apply as well.
11. In addition, potential equity purchasers are forbidden from taking 'unconscionable advantage' of the property owner in foreclosure. This would certainly apply if the seller were incompetent or did not understand the transaction, and might apply in other situations as well. If 'unconscionable advantage' is taken, the transaction may be rescinded within two years of the date of the recordation of the conveyance of the residential property.
12. Any provision of a contract which attempts or purports to limit the liability of the equity purchaser is void and, at the option of the equity seller, renders the equity purchase contract void.
Bankruptcy Law
If the seller is already in bankruptcy, any contract will be very likely be void unless the bankruptcy court approves it. You should call the bankruptcy court that has jurisdiction over the seller's residence to check for a possible filing. Of course, if the seller filed bankruptcy in another bankruptcy court, you probably won't be able to find it. The contract should have the seller state that he/she/they are not in bankruptcy; this may not solve the problem ? though it can only help ? and at least you are far less likely to be accused by the Court of trying to subvert the bankruptcy process.
Because the seller may go into bankruptcy immediately after the transaction, the deed should be recorded as soon as legally allowed (meaning, as soon as possible after the cancellation period). Otherwise you may have to get bankruptcy court approval to record the deed ? which might or might not be a problem.
Unfortunately, even if the seller is not in bankruptcy at the time but goes into bankruptcy after the transaction has been completed, the bankruptcy trustee may be able to require you to deed back the property for up to three years after the transaction. This falls under the bankruptcy term 'fraudulent transfers?, which includes a transfer by an insolvent debtor for less than 'reasonably equivalent value' even when there is no fraudulent intent. If the equity purchaser does not realize that the seller is a financially troubled debtor, then the equity purchaser at least gets a lien on the property equal to the amount that the equity purchaser invested. Ideally, the contract should have the seller represent that he/she/they are not insolvent and do not expect to become insolvent ? assuming that is true.
Practical Considerations
The practical considerations are mostly a matter of common sense, but here are some for what they are worth.
The following are often included in equity purchase agreements:
a. A ?Subject to' clause that allows you to exit the deal under specified conditions. This could be for undisclosed damage, general condition of the property, undisclosed liens, termite damage, etc.
b. A provision that allows you to show the property to others.
c. A provision indicating that the property has to appraise at a certain value.
d. A requirement that the property must be vacant, with all tenants and possessions out by a specified date.
e. An agreement that the payments for the current loans total a specified amount.
f. A provision indicating the sale is subject to the condition of the loan and/or encumbrances against the title being as represented.
g. A provision indicating the buyer will pay all closing costs.
h. Provisions indicating the seller:
i. Will deed the property to the buyer.
ii. Authorizes the buyer to record said deed at the appropriate time.
iii. Is aware that the buyer may resell the property.
iv. Is aware that the purchase price may be below market value.
v. Will leave the premises in good condition and pay for damages incurred after the contract has been signed and before the seller has left.
vi. Will pay for any damages or repairs necessary as discovered by termite and roof (and possibly other) inspections.
vii. Will vacate the premises on the date specified.
viii. Agrees that all net proceeds paid to seller will be paid at closing.
If you have negotiated a settlement with a lien holder, you should record a Release of Lien (signed by the lienholder) just prior to closing.
A preforeclosure seller may be desperate and lie about the condition of the property, so have inspections done if at all possible. (Often the seller will be judgment-proof, so one cannot expect to sue and recover any money.) Check the title report because there may be another person on the title or liens on the property that the seller 'forgets' to mention. Check to see if there are large outstanding utility bills or large amounts of unpaid property taxes.
If you do not arrange new financing to pay off the existing lender, the existing lender can exercise its 'due on sale' rights and foreclose on that basis even if you have brought the loan current. Most mortgage lenders do not want to foreclose on property ? they generally lose money on it ? and they are unlikely to do this unless interest rates have gone up (or go up) significantly. Still, they can do this at any time during the life of their loan, even if the equity purchaser makes payments for years.
The foregoing article constitutes general information only and should not be relied upon as legal advice.
