This article reviews the financing disclosures agents must make to buyers and sellers in carryback transactions.
A seller is willing to help finance the sale of his one-to-four unit residential real estate by carrying back a note and trust deed, sometimes called an installment sale or credit sale.
The seller’s listing agent locates a qualified prospective buyer. The agent prepares an offer on a purchase agreement form and presents it to the buyer for his approval and signature since the buyer is not represented by an agent.
The terms offered for payment of the purchase price include a note and trust deed, to be signed by the buyer in favor of the seller, for the amount of the price remaining to be paid after the down payment and an assumption of the existing loan on the property.
A Seller Carryback Disclosure Statement is attached to the purchase agreement as an addendum. The addendum, prepared by the agent, contains numerous statements on the financial, legal and risk-of-loss aspects of the carryback note and trust deed.
The information entered in the carryback disclosure statement is based on the terms of the purchase offer, the title conditions, the activities to be undertaken in escrow and information obtained from the buyer.
However, the agent’s disclosures regarding other important aspects of the carryback paper which are not addressed in the disclosure form and might affect the transactional decisions of the buyer or the seller do not end on completion and presentation of the carryback disclosure form.
The form contains only the minimum disclosures legislatively mandated for inclusion in the carryback disclosure statement.
Both the listing agent and the buyer’s agent must be assured their respective clients, in addition to receiving the disclosure statement, understand and appreciate the risks and consequences which rise out of the financial, legal and tax aspects of the carryback transaction.
Controlled carryback transactions
All brokered transactions for the purchase of one-to-four unit residential property involving seller carryback financing are controlled by statute. For one-to- four unit residential properties, a written carryback disclosure statement is required to be presented to both the buyer and seller for their review and signatures. [Calif. Civil Code §§2956 et seq.]
Even the use of a masked security device, such as a land sales contract, lease-option and unexecuted purchase agreement with interim occupancy, requires the written carryback disclosures. The written carryback disclosures inform the buyer and the seller about the seriousness of the risks presented by failing to use grant deeds, notes and trust deeds to evidence an installment sale when the buyer takes possession. [See Form 300 and first tuesday Forms 309 and 312]
On a sale, any credit extended by the seller to accommodate the buyer’s deferred payment of the purchase price for a one-to- four unit residential property requires a written carryback disclosure statement when the credit extended to the buyer includes:
· interest or other finance charges;
· five or more installments running beyond one year;
· an installment land sales contract;
· a purchase lease-option or lease-option sale;
· credit (note) to adjust equities in an exchange of properties; or
· an all-inclusive note and trust deed (AITD). [CC §2957]
Further, carryback transactions creating straight notes which do not bear interest or include finance charges are not controlled. However, the carryback disclosures should be included as a matter of good brokerage practice since the risks and issues for the buyer and seller remain much the same.
Now consider a real estate agent who is acting as a property manager or leasing agent negotiating a lease for the landlord of a single-family residence (SFR).
A prospective tenant makes an offer to lease which contains an option to buy the property. The terms for payment of the price under the proposed option include:
· a carryback note, to be executed on exercise of the purchase option (on expiration of the lease) for the balance of the seller’s equity in the property after a down payment; and
· part or all of the lease payments applying as a credit toward the price or down payment.
Here, the tenant’s offer to lease under a purchase option builds up an equity in the property due to the rent credit to the price. Thus, the agent is required to make the mandated carryback financing disclosures on a written form as an addendum to the lease-option. [See first tuesday Form 309]
Who prepares the disclosure
The carryback disclosure statement must be prepared and submitted to all parties in a carryback transaction on one-to- four unit residential property by:
· the real estate broker, or his agent, negotiating the carryback sales transaction and preparing the buyer’s purchase offer on behalf of a buyer or seller for a fee; or
· the buyer or seller if either one is a real estate licensee or attorney, when neither the buyer nor the seller is represented by a broker. [CC §2957(a)(2)]
· When both the buyer and seller are represented by different brokers, the carryback disclosure statement is prepared by the broker or his agent who prepared the buyer’s offer.
Offer includes disclosures
As a minimum requirement, the carryback disclosure statement is to be signed by the buyer and seller prior to closing the carryback sales escrow. [CC §2959]
However, after a purchase agreement has been entered into, and until the carryback disclosure statement is approved by the buyer and seller in a one-to-four unit transaction, a statutory contingency exists in favor of the buyer allowing the buyer to cancel the transaction. The contingency does not arise if the carryback disclosure statement is attached as an addendum to the offer or counteroffer.
If the buyer has a reasonable basis for disapproval of the carryback disclosures he receives after entering into a purchase agreement, the buyer may cancel the transaction and terminate his obligation to purchase the property.
However, the buyer may not arbitrarily cancel the sale when he is presented with the carryback disclosure statement for his acknowledgment and approval during escrow. To cancel, the buyer must act in good faith, by showing the carryback disclosures are inconsistent with his reasonable expectations when he entered into the purchase agreement.
After closing, the only legal remedy available to the buyer or seller for inadequate or nonexistent financial disclosures is to pursue the broker for any money losses actually incurred as a result of the nondisclosure. The judicial remedy for failure of the broker or his agent to make mandated carryback disclosures would be no less than a return to the injured party of brokerage fees received on the transaction, based on a failure of agency duties.
Thus, the best policy for the buyer’s agent is to eliminate the need for further approval of the statutory carryback disclosures by preparing and attaching the carryback disclosure statement as an addendum to the purchase agreement. If it is not attached, it would be prudent for the listing agent to include it as an addendum to a counteroffer. If neither agent prepares and includes the disclosures as an addendum in the offers, the buyer’s agent becomes responsible for preparing the disclosures and obtaining both the buyer’s and seller’s approval before closing.
Consider a buyer and seller of a single-family residence who enter into a purchase agreement. The terms call for carryback financing in the principal amount of $50,000 with an interest rate of 9%, monthly payments on a 30-year amortization and a five-year due date.
The purchase agreement does not state the amount of the balloon payment due on the carryback note at the end of five years. The risks imposed and the consequences of a five-year due date are not discussed.
A carryback financial disclosure statement is not presented to the buyer or seller for their signatures as part of the purchase agreement or counteroffer. Thus, closing is automatically contingent on the buyer’s and seller’s further approval of the financial and legal aspects of the carryback note and trust deed as presented in the carryback disclosure statement.
Prior to closing, the buyer is handed the carryback disclosure statement. He discovers his final balloon payment at the end of five years will be approximately $48,300. The buyer is now concerned about the financial risks of ownership since he has no assurance he will be able to refinance, modify or extend the note, much less have the ability to accumulate funds for payoff of the final/balloon payment.
The buyer cancels the purchase agreement and escrow, claiming he did not previously realize the extent of the financial risk created by the due date in the carryback financing. He is now aware he could be forced, by the due date, to either sell the property or lose it to foreclosure should he be unable to arrange refinancing or an extension of the carryback note.
Can the buyer cancel the transaction prior to closing?
Yes! The buyer did not sign the carryback disclosure statement prior to agreeing to buy — a failure which triggers the statutory further-approval contingency. The risk of loss imposed by the amount of the due date payoff is far greater than the buyer realized when entering into the purchase agreement. Thus, the buyer has justification for exercising his right to cancel.
Buyer’s ability to pay
A buyer’s ability to meet the terms and conditions of the carryback note is of great importance to a seller who is carrying back a note on a sale. Thus, the listing agent must alert his seller to facts about the buyer’s financial condition which are known to the broker and not previously disclosed to his seller.
For example, a listing agent locates a buyer willing to purchase his seller’s property.
The agent advises the seller that the buyer is financially qualified to handle the large cash down payment, but will require carryback financing for the remainder of the purchase price.
Believing his agent’s representations regarding the buyer’s financial qualifications, the seller agrees to carry paper to finance the sale.
Before escrow closes, the buyer tells the agent he does not have the cash down payment and will need to obtain a loan. The listing agent does not disclose the buyer’s lack of capital to the seller. Further, the listing agent makes the buyer a money loan to help fund the down payment.
Escrow closes and the buyer takes title to the property. Soon the buyer defaults on the carryback note and trust deed held by the seller. The seller suffers a total loss on his carryback note due to a foreclosure sale on the first trust deed.
The seller then discovers his listing agent made a separate loan to the buyer for the down payment. The seller also discovers the agent knew the buyer was financially unstable prior to closing.
Here, the listing agent has an agency duty to advise the seller about the buyer’s reduced financial capability to repay the carryback note, a significant fact which came to the agent’s attention prior to closing. Thus, the listing agent and the agent’s broker are liable to the seller for the seller’s money losses on the carryback note since the listing agent failed to disclose his knowledge of the buyer’s revised or altered financial status. [Ziswasser v. Cole & Cowan, Inc. (1985) 164 CA3d 417]
A seller willing to carry back paper needs to know if the prospective buyer will be able to make the payments and pay the operating costs incurred as owner of the property. As carryback financing becomes more prevalent during periods experiencing a declining real estate market or tight mortgage money conditions, more unqualified buyers are produced with whom agents must contend.
As part of the carryback disclosures, the listing agent has an affirmative duty to obtain a written financial statement from the buyer and hand it to the seller of one-to-four unit residential property. [See Form 300 §4]
The primary purpose of the carryback disclosure statement is to inform the seller so he understands that owners and lenders are bound by different rules and face different risks based on the respective ownership and security interests they hold in the real estate.
For example, while the buyer is concerned with paying no more than the fair market value (FMV) for a property, the carryback seller is concerned with his loan-to-value (LTV) ratio, whatever may be the price, since he will become a “financier” on the close of escrow.
Typically, a seller wants to receive the highest sales price negotiable for his real estate. However, the seller as a “carryback lender” wants assurance the buyer’s down payment is a large enough percentage of the purchase price to establish adequate equity value in the real estate, over and above the amount of the carryback trust deed note, to allow full recovery of the carryback note from the property in the event of a default which requires the seller to foreclose.