Presenting a live 90-minute webinar with interactive Q&A Avoiding "Due on Transfer" Provisions in Land Trusts and Single-Member LLCs A Real-World Guide to Garn-St. Germain Act Exemptions WEDNESDAY, MARCH 22, 2017 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: William Bronchick, Principal Shareholder, Bronchick & Associates, Aurora, Colo. Bryan Dunklin, Law Offices of Bryan Dunklin, Dallas The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. NOTE: If you are seeking CPE credit, you must listen via your computer phone listening is no longer permitted.
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Avoiding "Due on Transfer" Provisions in Land Trusts and Single-Member LLCs Strafford Webinars Strafford Publications, Inc. 590 Dutch Valley Road NE Atlanta, GA 30324-0729 Tel: (800) 926-7926 x 12 Fax: (404) 881-0074 Presented by William Bronchick and Bryan Dunklin March 22, 2017 5
William Bronchick, Esq. Self-unemployed for 26 years Admitted to practice before New York Bar in 1991 Admitted to practice before Colorado bar in 1996 Practice limited to real estate, asset protection, and estate planning Author of six best-selling selling real estate and business books Licensed real estate broker 6
Bryan Dunklin, Esq. Admitted to practice law before Texas Bar in 1980 Licensed real estate broker in Texas for 28 years Taught real estate and business law at Southern Methodist University for 23 years Frequent speaker and author for various bar associations Chosen as Best Speaker by the State Bar of Texas Advanced Real Estate Law Course for Texas Series LLCs Former Chairman, Dallas Bar Association Real Property Section Frustrated musician Great joke teller 7
OUTLINE History of the due on sale clause, and of the Garn-St. Germain Depository Institutions Act Brief definition of due-on-sale/due-on-transfer provisions Exceptions that the Garn-St. Germain Depository Act provide to the enforceability of contractual due-ontransfer provisions in mortgages Drafting revocable living trust documents to hold encumbered real estate Structuring the transaction to avoid the acceleration provision Transfers into single-member LLCs 8
BENEFITS The panel will review these and other key issues: What are the specified transfers exempt from enforcement of due-on-sale/acceleration clauses as they relate to estate planning? What are the practical requirements that a trust must have to ensure that a transfer of qualified property does not trigger an acceleration clause? What are the specific traps that trust counsel must avoid in structuring a trust transaction? Sample language for trust documents 9
LEARNING OBJECTIVES After completing this course, you will be able to: Identify the transfers exempt from enforcement of due-on-sale/acceleration clauses for estate planning purposes Discern trust provision requirements to ensure that a transfer of qualified property does not trigger an acceleration clause Determine transfers into LLC structures that will not violate due-on-transfer provisions Recognize specific tax traps that trust advisers must avoid in structuring a trust transaction 10
History of the due on sale clause Before the early 1970s, mortgage loans typically did not contractually permit a lender to demand that a note be paid in full (accelerating the debt) ) merely because the borrower sold the property that was the lender s collateral. If the contract interest rate on such a mortgage loan was at a fixed rate, and if interest rates being paid in the market began to rise, the value of the note would decline as market interest rates rose. When inflationary expectations and pressures began to generally cause an increase in market interest rates in the early 1970s, lenders sought to protect themselves from increasing interest rates in various ways, including the addition of contractual language in real estate mortgages that would allow the lender to require the borrower to pay the entire balance owing if the property securing the loan was sold (a due-on-sale clause). 11
The due-on-sale clause The following is typical due-on-sale language contained in the early mortgages: In the event that the borrower sells the property without the prior written consent of the lender, the lender may, at its option, declare the entire principal balance of the loan immediately due and payable. 12
Borrower s tactics in dealing with a due on sale clause Creative borrowers began using various techniques to keep from technically selling the property, to prevent the lender from being able to require immediate payment of the loan in full, such as: Entering into contracts for deed Using long term leases coupled with an option granted to the tenant to purchase the property Selling the shares in a corporate borrower Transferring the beneficial interest in a trust 13
History of the due-on-transfer clause Lenders then responded to such tactics by adding additional language to exercise their right to accelerate the debt if such specific events occurred (then referred to a due-on-transfer clause). The following is contractual language in a mortgage containing a more lender friendly due-on-transfer clause, which makes a defined Disposition an event of default, and which would give the lender the right to accelerate the debt: 14
Example of a lender s due-on-transfer clause Borrower will not make a Disposition without obtaining Lender's prior written consent to the Disposition. Disposition was then defined in the mortgage to include: Any sale, lease (except as permitted under this Deed of Trust), exchange, assignment, conveyance, transfer, trade, or other disposition of all or any portion of the Mortgaged Property (or any interest therein) or all or any part of the beneficial ownership interest in Borrower (if Borrower is a corporation, partnership, general partnership, limited partnership, joint venture, trust, or other type of business association or legal entity). 16
History of the due-on-transfer clause Borrowers began to resist and started litigating the attempt by lenders to require the loan to be paid in full merely because the mortgage property was transferred or some interest in the underlying borrower was transferred, arguing that such limitations amounted to an unconstitutional restraint on alienation (the right to transfer your property). Because lenders also sometimes charged exorbitant pre- payment penalties, the courts recognized that the confluence of these two contractual provisions could effectively restrain alienation. The courts in different states began to interpret these contractual provisions, and the law was interpreted differently in virtually every state. 17
Garn-St. Germain Depository Institutions Act To eliminate the confusion surrounding the enforceability of due-on-transfer clauses, on October 15, 1982, Congress decided to preempt state law by passing a federal statute. This act was intended to give uniform treatment of these mortgage provisions in all of the jurisdictions. The Garn-St. Germain Depository Institutions Act specified when a lender could, and when it could not, require the borrower to pay the entire balance merely because of a transfer of an interest in the property securing the loan, or a transfer of an interest in the borrowing entity. 12 U.S.C. 1701j-3(d)(2000) 18
Garn-St. Germain - The statute 12 U.S. Code 1701j-3 Preemption of due-on-sale prohibitions (a) Definitions (1) the term due-on-sale clause means a contract provision which authorizes a lender, at its option, to declare due and payable sums secured by the lender s security instrument if all or any part of the property, or an interest therein, securing the real property loan is sold or transferred without the lender s prior written consent; (3) the term real property loan means a loan, mortgage, advance, or credit sale secured by a lien on real property, the stock allocated to a dwelling unit in a cooperative housing corporation, or a residential manufactured home, whether real or personal property; and 19
Garn-St. Germain - The statute 12 U.S. Code 1701j-3 Preemption of due-on-sale prohibitions (d) Exemption of specified transfers or dispositions With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, a lender may not exercise its option pursuant to a due-on-sale clause upon 20
Garn-St. Germain - The statute 12 U.S. Code 1701j-3 Preemption of due-on-sale prohibitions (1) the creation of a lien or other encumbrance subordinate to the lender s security instrument which does not relate to a transfer of rights of occupancy in the property; (2) the creation of a purchase money security interest for household appliances; (3) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety; (4) the granting of a leasehold interest of three years or less not containing an option to purchase; (5) a transfer to a relative resulting from the death of a borrower; 21
Garn-St. Germain - The statute 12 U.S. Code 1701j-3 Preemption of due-on-sale prohibitions (6) a transfer where the spouse or children of the borrower become an owner of the property; (7) a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property; (8) a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property; or (9) any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board. 22
Statutory limitations on prepayment penalties (B) A lender shall not impose a prepayment penalty or equivalent fee when the lender or party acting on behalf of the lender (i) Declares by written notice that the loan is due pursuant to a due-on-sale clause or (ii) Commences a judicial or nonjudicial foreclosure proceeding to enforce a due-on- sale clause or to seek payment in full as a result of invoking such clause. 23
Garn-St. Germain Regulations The Federal Home Loan Bank Board, in consultation with the Comptroller of the Currency and the National Credit Union Administration Board, was authorized to issue rules and regulations and to publish interpretations governing the implementation of this section. Those regulations can be found at: 12 CFR 591.5 24
Garn-St. Germain Regulations 12 CFR 591.5 - Limitation on exercise of due-on-sale clauses 591.5(b) Specific limitations. With respect to any loan on the security of a home occupied or to be occupied by the borrower, (A) A lender shall not (except with regard to a reverse mortgage) exercise its option pursuant to a due-on on-sale clause upon: (iii) A transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety; (iv) The granting of a leasehold interest which has a term of three years or less and which does not contain an option to purchase (that is, either a lease of more than three years or a lease with an option to purchase will allow the exercise of a due-on-sale clause); 25
Garn-St. Germain Regulations 12 CFR 591.5 - Limitation on exercise of due-on-sale clauses (v) A transfer, in which the transferee is a person who occupies or will occupy the property, which is: (A) A transfer to a relative resulting from the death of the borrower; (B) A transfer where the spouse or child(ren) becomes an owner of the property; or (C) A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement by which the spouse becomes an owner of the property; or 26
Garn-St. Germain Regulations 12 CFR 591.5 - Limitation on exercise of due-on-sale clauses With respect to any loan on the security of a home occupied or to be occupied by the borrower, (A) A lender shall not (except with regard to a reverse mortgage) exercise its option pursuant to a due-on on-sale clause upon: (vi) A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy. 27
Effect of Garn-St. Germain After Garn-St. Germain, residential lenders generally Changed the language of their due-on-transfer clauses to specify the exceptions stated in the Act. Stopped charging prepayment penalties if they accelerated the debt as a result of a transfer without the lender s consent Began to respect circumstances that fell within the exceptions to enforceability of a due-on-transfer clause See the residential mortgage language that follows: 28
Texas Real Estate Forms Manual due-on-sale clause "If Grantor transfers any part of the Property without Lender s prior written consent, Lender may declare the debt secured by this deed of trust immediately payable and invoke any remedies provided in this deed of trust for default. If the Property is residential real property containing fewer than five dwelling units or a residential manufactured home occupied by Grantor, exceptions to this provision are limited to (a) a subordinate lien or encumbrance that does not transfer rights of occupancy of the Property; (b) creation of a purchase-money security interest for household appliances; (c) transfer by devise, descent, or operation of law on the death of a co-grantor; (d) grant of a leasehold interest of three years or less without an option to purchase; ; (e) transfer to a spouse or children of Grantor or between co-grantors; (f) transfer to a relative of Grantor on Grantor s death; and (g) transfer to an inter vivos trust in which Grantor is and remains a beneficiary and occupant of the Property." 29
Can the lender call the note due if there is a due on sale clause and the property is sold without the lender s consent? Generally the answer is yes. But there s some possibility that there might not be a due-on- transfer clause if the lender is not an institution (need to check) The lender might grant permission (particularly if you assign the lender additional legal rights) So if a lender has this contractual right, why wouldn t it exercise its right to call the note due? Market interest rates are below the note s rate Property s value is less than the amount owed Lenders don t want to foreclose Lender s don t want to own property (taxes, maintenance, property is vacant) Loan is performing, vs. recognition of loss if property is foreclosed 31
Will the lender exercise it s right to call the note due under its due-on-transfer clause? As mortgage interest rates have fallen from the high levels of the early 1980s, lenders have frequently not been aggressive in exercising their rights under the due-on-sale clause. Instead many lenders have sometimes preferred to allow the loan contract to remain in place so long as it is being timely paid. As current interest rates rise, it can be expected that more lenders will elect to accelerate the debt when it is discovered that the borrower has transferred an interest in the property without the lender s consent. As the market improves, they can, and they might, call the note. 32
Case law on due-on-sale clauses Courts in some state, like Texas, routinely uphold the enforceability of due-on-sale clauses In recent case law developments in Texas, the Dallas Court of Appeals in 2005 refused to find in favor of the borrower asserting a cause of action for wrongful foreclosure of a commercial loan as a result of the borrower's transfer of the mortgaged property to a corporation owned by the borrower under an unrecorded deed which the borrower claimed was never delivered. Adams v.. First National Bank of Bells/Savoy,, 154 S.W.3d 859 (Tex.App. Dallas 2005, no pet.). The court found that there was evidence in the borrower's corporate financial statement and in the borrower's own comments to the lender that the property had been transferred. Even though the lender did not give the borrower a notice of its intent to accelerate the debt, the court found that the borrower had waived her right to notice of intent to accelerate. 33
Garn St. Germain Limitations on enforceability of due-on-transfer clauses Due-on-sale clauses are enforceable in residential loan transactions except in the following situations: 1. Death of the borrower transfer to the heirs 2. Divorce of the borrowers transfer to one spouse 3. A lease, not coupled with an option to purchase, of less than three years 34
Drafting Trust Provisions Which exemption are we relying on? Transfer by devise, descent, etc. does that include the transfer into trust? A transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property Does the trust exemption also apply to nonowner occupied properties (i.e., rentals)? Transfer to a spouse or children exemption? 35
Definition in the Regs: In other words, does it only apply to the grantor s principal residence? What if the borrower is the only person on the mortgage and transfers into trust for benefit of grantor and his spouse? Does transfer to trustee in trust vs. transfer to trust itself matter? In this regard, is transfer to an irrevocable trust ok if the beneficiaries are spouse and kids? 36
More Trust Issues Garn-St. Germain Act only applies to 1-4 family (not commercial) What about an installment sale to a trust for the benefit of the borrower and/or his spouse or kids? QPRT (spouse and kids are remainder beneficiaries)? (Qualified Personal Residence Trust) Illinois Land Trust (aka nominee or realty trust ) Does Irrevocable vs. Revocable Trust matter? Refinancing trust property 37
Practical Implications of a Due-on-sale Violation Lender s Remedies: Do nothing Inquire further Accelerate the loan (personal experience ) Laches an unreasonable delay in the exercise of an equitable remedy No obligation in note or mortgage to notify lender; thus is the regulation requiring notification enforceable? Does non-notification notification prevent laches argument? 38
Ultra-Vires Doctrine Usually applies to corporate players acting beyond the scope of their authority Sometimes applied to administrative agencies action beyond the scope of their enabling statute (more common in CA, NZ, and England) Garn-St. Germain Act refers to any other exception promulgated by the FHLBB (and presumably its successors) Thus, did the FHLBB act beyond their powers in shrinking the trust exemption to owner-occupied? occupied? 39
Sample Trust Language In the event the holder of the mortgage(s) or liens against real property held by this trust seek to enforce the due on sale provisions of said mortgage(s) or lien(s), the Trustee is authorized to transfer the property to the grantor(s)/borrower(s) of this trust or enter into any agreement that is required by said mortgage or lienholders to avoid enforcement of said due on sale provisions. 40
Transfer to LLC Property owned by LLC provides more protection than a property owned by a living trust. Some courts have held that transfer from H&W to a limited partnership of H&W would trigger due on sale. Does transfer to a disregarded LLC trigger due on sale? LLCs were rarely used in 1983, thus is a single member LLC a separate owner from the member? 41
Tax Issues in Transferring to Trust Transfer to a grantor trust (I.R.C. Secs 671-678) is a non-taxable event. Would apply to typical living trusts, intentionally-defective trusts, etc. Does a trust file a return or get an EIN number? 42
Wrapping it Up Questions: Bill Bronchick bill@bronchicklaw.com Bryan Dunklin texaslaw@email.com 43