November 03, 2015

Purchasing property on a land sale contract is fairly straightforward. The buyer (vendee) provides the seller (vendor) with a down payment for the home and the seller acts as the bank, financing the balance of the purchase price. Thereafter, the buyer continually makes monthly payments until the land contract is satisfied.

 

In practice, the vendee receives equitable title to the property and the vendor retains legal title until the purchase price is satisfied. In the interim, the buyer can assign, sell, and devise his equitable interest in the property. The seller can also convey, sell, and devise his legal title. While this seems straightforward, more often than not, issues involving land contracts wind up in bankruptcy court.

If a bankruptcy proceeding is filed by (or against) the land contract vendor or vendee after execution of the land contract, the land contract will be construed under 11 USC 365 to determine whether it is an executory contract. Notably, executory contracts can be “assumed, assigned or rejected by the trustee” in bankruptcy or debtor in possession.

 

A. Vendor is Debtor

When the vendor is the debtor in bankruptcy, 11 USC 365(i) and (j) serves as a protective measure to the vendee’s interest. First and foremost, the vendee is not harmed if the trustee assumes or assigns the land contract. The vendee’s interest is preserved and he or she would continue to make payments. On the other hand, if the trustee elects to reject the land contract, under which the vendee is in possession, the vendee is protected and may elect either to treat the contract as terminated or remain in possession. If the vendee treats the land contract as terminated, it is granted a lien on the property in the amount of the purchase price paid. 11 USC 365(j). If the vendee elects to remain in possession, it must continue to make the scheduled payments and does not have any other right to damages, other than to offset against the payments due any damages caused by the nonperformance of any obligation of the debtor after rejection. 11 USC 365(i)(2). The trustee, pursuant to 11 USC 365(i)(2)(B), must deliver title to the property after the vendee has satisfied its obligations under the land sale contract.

B. Vendee is Debtor

If the vendee is the debtor in bankruptcy, the bankruptcy courts are divided as to whether the vendee (or trustee) must assume or reject the contract as an executory contract or whether he or she can treat the land contract as equivalent to a mortgage. “While some courts consider installment land sales contracts to be executory because performance remains on both sides, numerous other courts categorize them as non-executorybecause they are in the nature of a sale and security device.” Kane v Inhabitants of Harpswell (In re Kane), 248 BR 216, 223 (BAP 1st Cir, 2000). The Sixth and Eighth Circuit characterize land sale contracts as executory. See In re Terrell, 892 F2d 469, 473 (6th Cir., 1989) (finding a purchaser’s interest in a land sale contract was executory because both parties had unperformed obligations); see also In re Speck, 798 F2d 279, 280 (8th Cir., 1986) (holding land sale contracts are executory because obligations remain on both sides). For example, in In re Terrell, the Sixth Circuit Court of Appeals found that the debtor-purchaser’s interest in the land sale contract was an executory contract because there were material obligations left to be performed by both parties to the contract. The Sixth Circuit stated:

Under Michigan law, the failure of either party to perform his remaining obligations would give rise to a material breach allowing the other party to avoid continued performance. The failure of a vendee to continue paying installments gives the vendor a number of remedies for breach, including forfeiture and foreclosure . . . Likewise, if a vendor fails to transfer title when promised or impairs his or her ability to deliver title in the future, he or she has committed a material breach entitling the vendee to sue for specific performance or to cease performance and sue for rescission. [892 F2d at 473.]

However, other courts and commentators have disagreed and found that land sale contracts are non-executory and not subject to 11 USC 365. See In re Heward Bros, 210 BR 475, 479 (Bankr D Idaho, 1997) (finding land sale contract was security device not an executory contract under 11 USC 365); See also In re Rehbein, 60 B.R. 436, 441 (BAP. 9th Cir., 1986) (finding land sale contract was not an executory contract where debtor had fully performed by placing deed in escrow). In fact, Collier on Bankruptcy has taken the approach that land sale contracts are non-executory contracts because they are indistinguishable from mortgages.

In some places, it is common for purchasersof real estate to enter into installment land sales contracts, under which at the end of the installment payments the seller transfers title to the buyer. In virtually every other respect, such as responsibility for taxes, insurance and maintenance, the transaction is indistinguishable from a sale in which the seller takes back a mortgage to secure payment. Because of the similarity of such contracts to secured mortgage loans, courts have often treated them as secured debts rather than executory contracts. The classification of a particular contract depends on the terms of the transaction. If the seller has no significant duty to the buyer other than to convey title upon completion of payments, the contract should be found to be a secured debt and not an executory contract. Treatment of the contract as a secured debt rather than an executory contract has a number of ramifications, including the inapplicability of section 365. [3 Collier on Bankruptcy P 365.02[1][a] (15th ed. rev. 2000)(footnote omitted).]

Courts that are willing to take the latter approach – land sale contracts are non-executory – tend to compare land sale contracts with leases that are disguised security agreements.[1]

In sum, courts disagree on the source of law used to evaluate the status of land sales contracts. While some courts focus on the definitions thathave evolved under federal bankruptcy law, other courts have ruled that the nature and extent of parties' contractual obligations depend upon the terms of the particular contract and the classification of such contracts under relevant state law, recommending a case by case analysis.

Nicholas Laue

Associate Attorney


[1] When leases are disguised security agreements, the provisions of 11 USC 365, do not apply.

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