This article reviews the assignment of the investor’s purchase rights held in a property to a substitute buyer, be it an investment group or a resale buyer on a flip.
Syndicating or flipping a property
An enterprising, but undercapitalized, equity purchase (EP) investor thoroughly investigates a residence in foreclosure. He is ready to make an offer to purchase the property from the owner- occupant.
However, the investor is not financially capable, or does not want to purchase, rehabilitate and carry the property by himself. Accordingly, the investor will sell or exchange his purchase rights to:
- a buyer who will pay cash to acquire the EP investor’s purchase rights, becoming the substitute buyer — an activity called flipping; or
- a group of cash investors who will join with the EP investor to form an LLC and fund the purchase price and carrying costs of ownership — called syndication.
In the case of a resale to a buyer other than his investment group, the investor will either:
- assign his right to purchase the real estate to a substitute buyer and escrow will close in the name of the substitute buyer; or
- resell the property through a separate purchase agreement escrow instructions to close concurrent with the closing of the EP investor’s original purchase escrow.
The “initial” buyer
Acting as an individual, the investor contracts to purchase the residence by entering into an EP agreement with the seller-in-foreclosure. Escrow is opened after the seller’s five-business-day cancellation period expires.
Prior to closing, the investor will assign his purchase rights either to his investment group or another buyer.
The closing documents will be prepared in the name of the substitute buyer. To convey title to the property and close escrow, the seller needs to cooperate by signing supplemental escrow instructions consenting to the substitution of buyer and deeds naming the substituted buyer as the grantee.
[Copy on presumption of assignability goes here] [CC §1457; Masterson v. Sine (1968) 68 C2d 222]
Title vesting/assignment provision
Seller cooperation with the substitute buyer on the investor’s assignment of his purchase rights is agreed to by implication in the title vesting provision in the EP agreement in addition to being an adjunct to the presumption of assignability of contract rights. [See first tuesday Form 156 §13.5]
The title vesting provision provides for a substitute buyer — called an assignee — to take title to the property on closing of the EP transaction. [See Fig. 1]
The “buyer or assignee” wording in the vesting provision of a purchase agreement places the seller on notice of the EP investor’s right to assign his purchase rights to another who will close escrow in their name as the buyer. [See Fig. 1]
Having negotiated an agreement calling for the seller to cooperate in an assignment, the EP investor intending to flip the property seeks out a substitute buyer, negotiates the amount he is to be paid for his purchase rights and enters into an agreement for the sale of his rights to the property.
The resale by assignment
The EP investor, by an assignment, transfers his purchase rights to the substitute buyer, called the assignee.
The substitute buyer agrees to fully perform all the EP investor’s obligations under the purchase agreement and escrow instructions, called an assumption.
Documentation of the assignment is typically handled by escrow as supplemental escrow instructions. [See first tuesday form 401-2]
After the EP investor assigns his purchase rights, the substitute buyer “steps into” the EP investor’s position as the buyer in escrow. Having been assigned all the purchase rights, the substitute buyer may enforce the EP agreement against the seller. [San Francisco Hotel Co. v. Baior (1961) 189 CA2d 206]
Also, the substitute buyer, on becoming the assignee, assumes all of the investor’s obligations under the EP agreement. Thus, the substitute buyer must pay the purchase price and close escrow on the transaction, or be liable to the seller for wrongfully failing to close escrow. [Fanning v. Yoland Productions, Inc. (1957) 150 CA2d 444;
Should the substitute buyer fail to close escrow without an excuse, he will also be liable for the investor’s losses if the seller should pursue the investor for money losses or specific performance. [Bank of
A separate resale
An investor may not want to disclose to a substitute buyer the purchase price the investor has agreed to pay for the property. Also, the seller might refuse (wrongfully) to cooperate and close escrow with a substitute buyer on an assignment by the EP investor of his purchase rights.
Rather than assign his purchase rights under the EP agreement and escrow instructions to a substitute buyer, the investor can simply resell the real estate.
On a resale of his ownership of the property, the investor and the new buyer will enter into an entirely new purchase agreement and escrow instructions, separate from the investor’s transaction with the seller-in-foreclosure.
In the context of a resale, the investor becomes the seller, making all the disclosures required of a seller of real estate, including using the condition of property disclosure (TDS) he has received from the owner.
A separate escrow will be opened for the resale, which will be funded by the resale buyer.
The original purchase escrow and the separate resale escrow will close concurrently. The closing of the resale escrow should be contingent on the close of the original purchase escrow. The investor’s net sales proceeds from his resale escrow will be the source of the funds used to concurrently close his purchase escrow with the seller.
Through this legitimate double escrow process, two grant deeds will be concurrently recorded — one from the seller to the investor, who in turn, will further convey the property by grant deed to the resale buyer in this variety of a flip.
Only one title insurance policy will be issued, and one set of loan assumptions or loan documents will be completed — all in the name of the resale buyer.
The seller in an EP transaction has a two-year right of rescission when investor misconduct exists under the EP statutes. Under an assignment of the investor’s purchase rights, the seller-in-foreclosure retains his rescission rights against the substitute buyer since the right to rescind arose under the contract acquired by the substitute buyer.
However, if the investor sells the real estate to a buyer in a separate “arms length” resale, the buyer is a bona fide purchaser (BFP) exempt from the seller’s two-year right of rescission under equity purchase law.
Disclosures on assignment
On entering into a purchase agreement to sell and assign his purchase rights to a buyer on a resale, the EP investor, as a seller of a one-to-four unit residential property, must make a full disclosure of the physical, operating, possessory and title conditions of the property. The substitute buyer receives copies of the purchase agreement, escrow instructions and disclosures.
As part of the assignment, the substitute buyer acknowledges receipt of the documents delivered. [See first tuesday form 401-2 §5]
Consider an owner of one-to-four unit residential property who sells the property to an investor. The investor, acting as a dealer, intends to flip the property by reselling his position in escrow by assignment. [See Form 156 §13.5]
The seller hands the dealer/investor a condition of property disclosure statement which does not disclose night-time noise conditions known to the seller, but not the investor.
The dealer/investor locates a buyer prior to closing and assigns the buyer his purchase rights. The buyer is handed the seller’s condition of property disclosure statement.
On closing escrow and occupying the residence, the substitute buyer discovers the undisclosed noise condition. As a result, the buyer suffers a loss since the price paid for the property exceeded its value at the time of closing.
The buyer makes a demand on the seller, not the dealer/investor, for the loss.
The buyer claims he is entitled to recover the loss from the seller since the seller intended, by giving the dealer the right to assign, that his condition of property disclosure statement be relied on by a buyer other than the dealer/investor.
The seller claims he incurred no obligation to the buyer since he did not contract to sell the property to the buyer, only to the dealer/investor.
However, the seller contracting with a dealer/investor with the right to resell the one-to-four unit residential property is liable for the buyer’s lost value due to nondisclosure. The seller knew or should have known the condition of property disclosure statement would be relied on by a buyer the dealer/investor located and who acquired the investor’s purchase rights by an assignment (or by grant deed). [Shapiro v. Sutherland (1998) 64 CA4th 1534]
Consider an EP agreement which calls for the seller-in- foreclosure to carry back a portion of his equity in a note and trust deed.
The EP agreement contains an assignment clause noting title will be vested in the buyer “or assignee.”
The investor assigns his right to purchase the real estate to a substitute buyer. However, the seller-in-foreclosure refuses to carry back a note executed by the substitute buyer.
Does the seller-in-foreclosure have to extend credit to the substitute buyer in the form of a carryback note?
Not automatically, since a standard of reasonableness applies to the consent and cooperation in the investor’s assignment on a resale. The seller-in-foreclosure may refuse to permit the substitute buyer to perform the personal obligation to execute the promissory note and trust deed if the substitute buyer, unlike the EP investor, is not creditworthy or would mismanage the property under his ownership. [
The carryback seller may require the substitute buyer to meet the same standard of creditworthiness and property maintenance required of the original EP investor.
When a purchase agreement contains obligations only of a non- personal nature for the buyer to perform, an assignment of acquisition rights can be enforced by the substitute buyer.
For example, when an EP agreement provides for payment in cash in exchange for the seller’s equity in the property, which may or may not include funding by a purchase-assist loan taken out by the buyer, all rights under the EP agreement may be assigned and enforced without the seller’s consent. [King v.
Nor may a seller-in-foreclosure refuse to cooperate in the EP investor’s assignment of his purchase rights to a warehousing agent so the investor can complete a reverse IRC §1031 transaction, called a parking transaction by the IRS. The warehousing agent is not a substitute buyer, but a middleman who will merely deed the property on to the investor at a later date. [Nicholson v. Barab (1991) 233 CA3d 1671]
Release of liability
On assigning the purchase rights and obligations under an EP agreement to a substitute buyer, the EP investor should seek the seller’s approval of the substitute buyer and a release of his obligations under the purchase agreement and escrow instructions, called a novation. [CC §1530; See first tuesday form 401-2 §§7 and 8]
A release and substitution agreement requires the seller to look solely to the substitute buyer for performance of the purchase agreement and escrow. [Gates v. Quong (1906) 3 CA 443]
To comply with escrow instructions after the assignment of the original EP investor’s purchase rights, escrow prepares all closing documents in the name of the substitute buyer. Closing documents include deeds, carryback notes and trust deeds, closing instructions and statements, approvals and assumptions of any existing loans, title insurance and clearance of any other items necessary for escrow to close.