This article examines a seller’s use of a recourse vendor’s lien in place of a non-recourse trust deed to recover on a carryback note.
by Connor Wallmark
Vendor’s lien as an alternative foreclosure
Consider a seller whose equity in his income-producing real estate is less than 20% of the value of the property. Also, the rental income produced by the property is insufficient to pay its operating costs and the loan payments. Thus, a negative cash flow exists on the property.
The seller wants to sell the property to rid himself of the carrying costs and avoid what he anticipates will be a further decline in its value under his ownership.
A creditworthy buyer is located who sees potential in the property and has substantial net worth as reflected in to his financial statements.
The buyer offers to buy the property for a price acceptable to the seller, on terms calling for:
- a 5% down payment;
- the assumption of the existing first trust deed loan equal to 80% of the price; and
- the seller carrying back a trust deed note for 15% of the purchase price.
The seller and his broker know a carryback note secured by the property sold is nonrecourse paper. Thus, the carryback seller must look exclusively to the equity in the property he sold to recover on the note should the buyer default. A money judgment for any deficiency in property value is barred by anti- deficiency laws since the carryback arrangement included a trust deed on the property sold. [
Further, if the buyer defaults on the first trust deed loan, the seller will face the loss of his second trust deed on a foreclosure by the first trust deed holder. A default on the first trust deed would force the seller to either bring the first trust deed current and keep it current, or pay it off if he is to avoid seeing his trust deed (and exclusive source of recovery on the note) wiped out at a foreclosure sale by the first trust deed holder.
However, the property lacks sufficient equity to allow the seller to foreclose and recover on a carryback note secured by a trust deed junior to a first trust deed loan with a loan balance constituting an 80% loan-to-value (LTV) ratio. The ability to foreclosure under such conditions poses little financial incentive for the seller to hold a trust deed on the property he sold to secure the carryback note.
As disclosed by his broker, the costs to foreclose, carry and resell the property should the seller have to foreclose would equal about 20% of the property value by the time of the resale. Much of these costs will be paid in cash before reacquiring and reselling the property. [See first tuesday Form 303]
The financial position of the carryback trust deed would not justify foreclosing and taking back the property unless the property’s value increases in excess of 10%, which is an unlikely development in the flat or declining real estate market existing at the time of the sale.
Little equity: go unsecured
Continuing with our previous example, the seller counters, agreeing to carry back a note. However, the note will not be secured by a trust deed on the property sold. Thus, the carryback seller will avoid the nonrecourse risk of being unable to pursue recovery from the buyer for lack of sufficient property value to cover the first trust deed loan, satisfy his carryback note and return his foreclosure and carrying costs. The risk of loss inherent in a nonrecourse note would exist if the carryback note was secured by a trust deed on the property sold, called the value-deficiency risk.
Now consider another seller whose equity is about 40% of the value of the property he wishes to sell.
A buyer makes a no-cash offer to buy the property, agreeing to take over the existing first trust deed and execute two notes in favor of the seller. One note is for 20% of the purchase price and will be secured by the property. The other note is for the remaining 20% of the price and will be unsecured.
The buyer has substantial net worth, including equities in other real estate he owns. However, the buyer does not want to use the other real estate he owns as primary, additional or substitute security for either of the two carryback notes. [See first tuesday Form 154]
The buyer wants the real estate he presently owns to remain unencumbered so he has easy access to cash to manage his real estate acquisition programs.
Do the sellers in both of these unsecured carryback examples have any remedy if the buyers default on the unsecured carryback notes, besides obtaining a judgment for monies due on the notes?
Yes! The carryback sellers also have a vendor’s lien on the property they sold for the amount of the notes which were never secured. The lien allows the sellers to foreclose on the property they sold as the initial source of recovery for the amount of the purchase price which remains unpaid — the unsecured carryback note. The vendor’s lien is waived if the debt owed them by the buyers is ever secured. [
On a default in payment, the seller can choose to exercise his vendor’s lien and foreclose on the property sold. However, unlike the money judgment lien for a deficiency which attaches to all properties owned by the buyer, the vendor’s lien only attaches to the property sold, and only if the buyer still owns it.
If the value in the property is insufficient to recover the unsecured amount remaining due on the purchase price, the seller obtains a money judgment for the deficiency. The seller can also obtain a money judgment if the vendor’s lien is wiped out by a foreclosure sale on the first trust deed or no longer available due to the buyer’s resale or further encumbrancing of the property to a third party who does not have knowledge of the fact the buyer still owes the seller payments on the purchase price, called a bona fide purchaser (BFP).
On obtaining a money judgment for a deficiency in value, an abstract of judgment is recorded. Unlike the vendor’s lien which only attaches to the property sold, a recorded judgment lien attaches on title to all of the properties in the county vested in the buyer’s name.
Now consider a seller who carries back both a secured note and an unsecured note to evidence separate amounts remaining owed on the purchase price, as occurred in our last example.
The buyer defaults on both notes and the seller forecloses on the note secured by the property sold. On completion of his foreclosure, the seller’s right to a vendor’s lien for the separate amount owned on the unsecured note is wiped out. However, the seller is still entitled to a general money judgment for the amount of the unpaid balance remaining due on the unsecured note.
Further, if a buyer misrepresents his net worth to the seller to induce him to carry back the unsecured note and then later files a bankruptcy petition, the carryback note is a nondischargeable debt since the seller financing was obtained through misrepresentation by the buyer. [11 United States Code §523(a)(2)(A)]
Vendor’s lien for error in closing funds
A vendor’s lien is available to the seller to recover a shortage in the buyer’s funds should an escrow officer miscalculate the demand on the buyer for funds to close escrow, leaving escrow with insufficient closing funds from the buyer.
For example, a buyer purchases a parcel of real estate on terms which include his taking title subject to a first trust deed lien of record.
Escrow is opened and a demand is made on the lender to furnish a beneficiary statement. The statement is needed to determine prorates and adjustments in the loan balance, accrued interest, impounds and insurance, and the amount of cash proceeds to be paid to the seller on the close of escrow.
The first trust deed is an add-on loan which computes interest due over the life of the loan and adds it to the principal to set the face amount of the note.
The outstanding balance remaining on the note as stated in the beneficiary statement is not the actual principal balance, but is the principal and unaccrued interest over the remaining term of the loan. Thus, the outstanding balance of the debt is stated as an amount which includes the precomputed, unaccrued interest.
Escrow fails to note the loan is an add-on loan or that the payoff amount stated in the beneficiary statement (under the rule of 78) is greater than the amount of principal actually owed by the seller.
The amount due the seller for his equity as calculated by escrow is less than the amount actually due the seller on the close of escrow. The demand on the buyer for closing funds is short by the amount of the unaccrued interest (or prepayment penalty) included in the loan balance stated in the beneficiary statement submitted by the add-on lender. The closing is not contingent on the seller receiving and approving an estimated closing statement from escrow.
After closing, escrow realizes its mistake and makes a demand on the buyer for the shortage in cash remaining due on the purchase price. The buyer refuses to pay escrow’s demand for the shortage.
The escrow company, acknowledging its mistake, advances the seller the balance still owed on the purchase price. In exchange for full reimbursement, the seller agrees to cooperate with the escrow company in its effort to collect the outstanding balance the buyer owes the seller on the purchase price.
The escrow company will handle all litigation. Accordingly, the escrow company’s attorney files, among other claims, the vendor’s lien recovery action in the name of the seller. The vendor’s lien is an unassignable equitable interest which must be pursued in the name of the seller.
In return, the seller agrees to assign any final judgment he might receive to the escrow company. Thus, escrow will ultimately recover their cash advances, costs and attorney fees.
A vendor’s lien is an equitable interest in the property sold and cannot be assigned to anyone, such as the escrow company. The vendor’s lien is held personally and solely by the seller. Thus, only the seller can enforce a vendor’s lien. [Avery v. Clark (1891) 87 C 619]
Establishing a vendor’s lien
Vendor’s lien rights are not available to sellers who retain legal title to the real estate until amounts remaining due on the purchase price are paid. A vendor’s lien is an unrecorded interest held by the seller in the property he sold.
For example, a buyer and seller enter into a land sales contract (or lease-option sale agreement). In it, the seller agrees to convey title to the buyer on the buyer’s completion of payments on the purchase price.
The buyer later defaults on payments due under the land sales contract. The seller attempts to obtain a vendor’s lien against the buyer’s interest in the property since the value in the property has fallen below the amount remaining due on the land sales contract. If the seller can enforce a vendor’s lien, he will be entitled to a money judgment for the deficiency in the property’s value to reimburse him for the dollar amount remaining due on the land sales contract.
The buyer claims the seller, having retained title to the property under a land sales contract, is a secured creditor, barred from using the vendor’s lien to recover the money due on the purchase price.
Is the seller entitled to a vendor’s lien?
No! The seller waived the vendor’s lien. He sold the real estate and retained title (as security) until the amount remaining due is paid. The seller is entitled to a vendor’s lien only when he conveys legal title and does not waive his vendor’s lien for the unpaid portion of the purchase price by receiving any security for its payment. [Allen v. Wilson (1918) 178 C 674]
A land sales contract is a security device evidencing the buyer’s debt owed to the seller for the unpaid amount of the purchase price and stating the terms on which the seller retains title to the property. The contract must be foreclosed by sale of the property, even though the property is vested in the seller’s name, to terminate the buyer’s right to pay off the land sales contract and obtain clear title, called a right of redemption. [Petersen v. Hartell (1985) 40 C3d 102]
Thus, a vendor’s lien is not a security device, as is a trust deed, mortgage, land sales contract or lease-option sales agreement. A vendor’s lien is an unrecorded equitable interest in property, retained by the seller for monies due. The lien does not exist until it is judicially imposed on the property sold in an action brought by the seller, and then judicially foreclosed.
No formal notice for lien
Consider a seller who carries back an unsecured note signed by the buyer. Even though the buyer is not in default, the seller records a document entitled a notice of vendor’s lien. The recording is an attempt to put future buyers and lenders on notice of the seller’s lien rights.
The notice of vendor’s lien references the property’s legal description, the buyer’s name, the amount remaining due and unpaid, and states a claim under the vendor’s lien statutes. The notice is signed by the seller and his signature is notarized.
Later, the buyer conveys the property to a new buyer who executes a note and trust deed for the remaining amount of the price he owes on his purchase of the property.
The policy of title insurance does not disclose the existence of the prior seller’s notice of vendor’s lien, and the new buyer has no actual or imputed (via his broker) knowledge of the facts giving rise to the seller’s lien rights.
After closing escrow on the resale of the property, the unsecured note held by the original seller becomes delinquent. The seller files an action to foreclose his vendor’s lien. The seller claims his lien rights have priority over the buyer’s conveyance and trust deed lien entered into after the seller’s notice of vendor’s lien was recorded.
However, recording the notice of vendor’s lien does not create such a lien or affect title. The statute authorizing the vendor’s lien does not provide for notice of vendor’s lien. Only a court can establish the lien. A recorded notice of vendor’s lien does not create any rights against future buyers and lenders since it is outside the chain of title. Prior to recording the notice, the seller had conveyed his entire ownership interest in the property.
A self-serving statement, by an individual who is no longer on title and has nothing to convey, is not an instrument which transfers or reserves an interest in title to property now owned by someone else. Thus, its recording does not give notice of the lien to later buyers or lenders. Except for the cloud of the lis pendens in the vender’s lien action, the vendor’s lien has no effect on title until the court finds that the vendor’s lien exists as an equitable interest held by the seller in the property and orders the lien to be foreclosed. [Brown v. Johnson (1979) 98 CA3d 844]
However, a seller will record a lis pendens when he files his action to foreclose on his vendor’s lien since the action is a claim for an interest in title. From the time of recording, the lis pendens puts any subsequent buyer or lender on constructive notice of the seller’s claim to an interest as a lienholder on title to the real estate. [CCP §405.24]
Priority of the vendor’s lien
A vendor’s lien has priority against all later acquired interests in the property sold, except a resale buyer who purchases the property, or a lender who further encumbers the property, for value and without notice of the seller’s right to the lien. [CC §3048]
Consider a sales transaction on terms involving a new 90% first trust deed loan to be obtained by the buyer to fund his purchase of the property. The seller is to carry back an unsecured note for the 10% balance of the purchase price, a piggyback financing arrangement. The new lender receives copies of the purchase agreement and escrow instructions prior to closing. The instructions state the seller will not be fully paid in cash and will hold an unsecured note for the balance due on the price when the lender’s trust deed records.
The buyer defaults on both the unsecured carryback note and the lender’s loan. The lender forecloses on the property under its first trust deed.
The seller claims he has a vendor’s lien which is senior to the lender’s trust deed since the lender was aware when its trust deed was recorded that the seller had not been paid in full when he conveyed title to the buyer and thus did not receive its security interest in the property as a good faith encumbrancer.
In this example, the lender has a priority position ahead of the carryback seller’s unsecured vendor’s lien.
The lender’s knowledge of the facts which give the carryback seller an equitable interest in the property under the vendor’s lien law does not destroy the lender’s priority position when the lender’s loan and the unsecured carryback note are concurrently created by conditions for subordination stated in the purchase agreement agreed to by the seller. [Brock v. First South Savings Association in Receivership (1992) 8 CA4th 661]
Now consider a lender who originates an equity loan secured by property the buyer had previously acquired by executing an unsecured note in favor of the seller as part of the price paid for the property. The lender is aware the unsecured carryback note held by the seller exists and has not been paid.
The loan is not a purchase-assist loan since it was not provided for in the purchase agreement entered into by the buyer and seller. Also, the proceeds from the equity loan (or refinancing) do not fund any part of the sales price received by the seller.
Further, the seller does not waive his vendor’s lien interest in the property or agree to subordinate it to the lender’s trust deed. Thus, should the buyer default on the lender’s trust deed and the lender foreclose by a trustee’s sale, the seller will retain his vendor’s lien rights. Here, the seller’s interest has priority over the lender’s trust deed. The lender knew the seller had not been paid in full and the loan originated by the lender was unrelated to the sales transaction which produced the seller’s right to a vendor’s lien without agreeing to a future subordination. [McGreevy v. Constitutional Life Insurance Company (1965) 238 CA2d 364]
Additionally, a vendor’s lien is given priority over a judgment lien against the buyer. A judgment creditor is not a bona fide encumbrancer since the abstract of judgment lien is not an encumbrance for value, whether or not the judgment creditor has knowledge of the seller’s lien rights in the property. [Schut v. Doyle (1959) 168 CA2d 698]
Waiver of vendor’s lien
A seller can also waive his right to a vendor’s lien by his conduct in the future. For instance, a seller holds an unsecured carryback note which he sells and assigns to an investor.
Here, by the assignment of his unsecured carryback note, the seller waives his vendor’s lien right since he no longer is owed money by the buyer. The right to a vendor’s lien is personal to the seller and cannot be transferred to another person. [CC §3047]
Additionally, a seller waives his vendor’s lien rights by taking any security, such as stock, now or later, to assure payment of the balance due on the purchase price. [McGreevy, supra]
Consider a seller who seeks a money judgment for the unsecured balance outstanding on the sale of his property. No equity remains in the property he sold to justify pursuing foreclosure of his vendor’s lien interest in the property.
If the seller obtains a money judgment on his unsecured note without first foreclosing on his vendor’s lien, he waives his right to later enforce his vendor’s lien since he is no longer owned money on his note, but on a money judgment. Thus, the seller would lose his right to priority over abstracts of judgment previously recorded against the buyer by other creditors.
Also, when the seller does foreclose on his vendor’s lien and is awarded a money judgment for any deficiency in the property’s value, his recording of an abstract of judgment for the amount of the deficiency attaches as a lien on all other real estate owned by the buyer. However, the judgment lien on those properties will be junior to all liens of record, whether they are voluntary trust deed liens or involuntary judgment liens.
Finally, the recording by the buyer of a declaration of homestead exemption does not interfere with or have priority over a vendor’s lien. The buyer knows of the seller’s outstanding unsecured debt he owes the seller on the purchase price and is not allowed to avoid the vendor’s lien by a claim of homestead. [CC §3048]