This article analyzes a seller-in-foreclosure’s after-closing right of rescission and restoration when a buyer- investor takes unconscionable advantage of the seller, and where in an intervening bona fide purchaser (BFP) or lender acquires and interest. estate.
As the strength of real estate sales deteriorate and the market cycle for real estate turns vicious, it’s the best of times for people with cash to invest. With prices dropping, they see an opportunity to either fill their boots with cheap real estate or to acquire and flip property for a handsome profit. The match investors seek is an owner in foreclosure who does not have the good luck of the investor nor the time to maneuver. Both are where they are financially because of decisions they made in the recent past.
The opportunity allowing investors to bottom fish and acquire real estate with low-ball offers submitted to the financially down-and- out homeowners will also cause a few investors to over reach. In doing so, they will suppress the owner’s ability to further market the property and locate a better match for himself than offered by the investor.
The mix of personalities is a picture of strong versus the weak, of greed compounding another’s fear of loss, of all the time in the world to act and of time running out.
The emotional environment, with the investor buoyed by the success of the moment’s negotiations and the individual humbled by his financial failure to provide homeownership for his family, drives some investors to suppress any further marketing of the property by the seller-in-foreclosure as a condition of entering into a sale with the investor. The use of a confidentiality agreement, while prudent in contracting between a buyer and seller of somewhat equal bargaining positions, serves only to interfere with the seller’s chances to locate another buyer at a better price. Even the foreclosure sale the owner soon faces will be a very public auction with every bid made known to each prospective bidder — until the highest bidder takes home the property.
On the other hand, the investor has no duty to be charitable about the terms of his offer or to bail out a homeowner who did not see his plight coming. Most first-time homeowners do not have a clue a recession will affect them adversely, mush less an appreciation for the economic forces which control all ownership of real estate. Yet, the investor’s proper view of an equity purchase (EP) transaction is an exchange of cash for property and an opportunity in the future to risk getting more cash out of a real estate sale or maturing the property as a rental and building his net worth and income flow.
The un-American low price combination
The procedures used or conduct employed by the EP investor may deprive the seller-in-foreclosure of a reasonable choice between buyers and their offers. Without a meaningful choice or alternative to the EP investor’s offer an unconscionable advantage may have been given to the EP investor. An unconscionable advantage aspect of a reasonable choice of action for the seller occurs depending on whether the EP investor exploited an element of oppression or surprise in exacting an unreasonably low and favorable purchase price which otherwise would not be a problem.
Oppression by the EP investor exists when inequality in bargaining power results in no real negotiations between the seller-in-foreclosure and the EP investor — a “take-it-or-leave-it” environment devoid of competing buyers. The foreclosure environment itself often produces a one- sided bargaining advantage for the EP investor who does not want his offer “shopped around”, using it in an marketing effort to solicit a better deal during the five-day cancellation period.
Surprise occurs due to the post-closing discovery of terms which are hidden in the lengthy provisions of the agreement. The price and how it will be paid is not a surprise. The price is well known to the seller-in-foreclosure and, on rescission, will likely be the only provision in the agreement contested by the seller.
The greater the marketplace oppression or post-closing surprise in the transaction, the less an unreasonably favorable price paid by an EP investor will be tolerated. [A & M Produce Co. v. FMC Corporation (1982) 135 CA3d 473; Carboni v. Arrospide (1991) 2 CA4th 76]
Prudent investor conduct
Thus, to weaken the ability of the seller-in- foreclosure to later show an unconscionable advantage existed, the EP investor begins by entering into an EP agreement on a form which meets all statutory requirements.
Also, an EP transaction involving a seller-in- foreclosure’s listing broker or a counteroffer from the seller lessens and certainly weakens any future attempt by the seller to show an unconscionable advantage was exercised by the EP investor.
The EP investor might be required to further defend his actions by demonstrating the EP agreement was not entered into through:
- misrepresentation of facts or law in deceitful conduct of the investor;
- undue influence arising out of a prior relationship with the seller-in-foreclosure; or
- duress applied in the negotiations by the EP investor to obtain the seller-in-foreclosure’s acceptance and close the transaction.
Two-year right of rescission for a seller-in-foreclosure
Consider the recording of a Notice of Default (NOD) on a homeowner’s personal residence after several months of unpaid installments.
The homeowner, now in foreclosure, is willing to sell on almost any terms to salvage his remaining credit and equity in the property.
The property is listed with a broker. The broker promptly markets the property to buyers who will occupy the property as their personal residence.
However, an offer is submitted directly to the seller-in- foreclosure by an equity purchase (EP) investor, acting on his own account without broker representation. Under the EP offer, the seller-in-foreclosure will receive cash for his equity.
Additionally, the EP investor agrees to cure the seller ’s loan delinquencies.
The seller-in-foreclosure contacts his listing broker who, after reviewing the offer, recommends the seller accept the EP investor ’s offer. The listing broker will use the existence of the cancelable purchase agreement to entice the prospective buyer to make a better offer. In other words, he will use the offer to shop for a better offer. If an acceptable backup offer is received within the cancellation period, the seller will accept the backup offer and cancel the EP agreement.
The broker advises his client he has five business days after his acceptance of the EP offer to cancel the sale since the sale involves the seller ’s home which is in foreclosure.
The seller-in-foreclosure accepts the EP investor ’s offer. The five-day cancellation period expires without receiving a backup offer, and escrow is opened on the EP agreement. The EP transaction is later closed and the property conveyed.
Does the EP investor receive good title when he accepts the grant deed?
No! The EP investor ’s title remains subject to the seller-in-foreclosure’s right of rescission for two years after closing. If at any time during the two years following the close of escrow and recording of the grant deed conveyance, the seller believes the EP investor’s conduct and the price paid gave the EP investor an unconscionable advantage, the seller may attempt to rescind the transaction and recover the home he sold. [Calif. Civil Code §1695.14]
Seller’s right to rescind a closed sale
To protect homeowners who are sellers-in-foreclosure from buyer- investors who are “rip-off artists,” the California legislature gave sellers of their personal residences a two-year right of rescission after closing a sale.
During the two-year period after closing, the seller- in-foreclosure rescinds the completed EP transaction by:
- notifying the EP investor of his decision to rescind the transaction, called a notice of rescission; and
- returning all funds and items of value received from the EP investor/buyer under the EP agreement, called restoration. [CC §1691, 1695.14(b)]
To perfect his claim for restoration of his property to his ownership, the seller-in-foreclosure also records the notice of rescission in the county in which the real estate is located.
The notice of rescission describes the real estate and contains the name of the rescinding seller, the EP investor, and any successor-in-interest of the EP investor who is not a bona fide purchaser (BFP).
Once served with a notice of rescission, the EP investor (or his non-bona fide successor) has 20 days to reconvey title to the rescinding seller free of any encumbrances he or his non-bona fide successor placed on title after acquiring the property from the seller. [CC §1695.14(b)]
If an EP investor further invests any amount of money and effort into rehabilitating or carrying the expenses of owning the property, the rescinding seller has no obligation under EP law to reimburse the EP investor for the expenditures.
The EP investor’s improvements during the two-year recession period good faith improvements since the expenditures are made while the EP investor held a defective ownership interest in the property. The EP investor’s conduct, which took unconscionable advantage of the seller-in-foreclosure, charges him with the knowledge of his defective title. Equity purchase law then acts to sanction him.
If the EP investor fails to timely reconvey title to the seller-in-foreclosure on notice of rescission, the seller can sue the EP investor to enforce the rescission and recover the residence. The prevailing party in the rescission action is entitled to his attorney fees. Remember, the seller- in-foreclosure is basically insolvent but believes the return of the property will be financially rewarding. [CC §1695.14(b), 1695.14(d)]
The unconscionable advantage and restoration
The two-year rescission period is effective to recover the property only if the seller-in-foreclosure can demonstrate the EP investor took unconscionable advantage of him when negotiating the purchase of the property.
Showing the existence of and defending against an unconscionable advantage in the EP investor’s conduct is problematic for both the seller-in-foreclosure and the EP investor. The legislature has not defined what exactly constitutes an act of unconscionable advantage.
What was a reasonable sales price under the circumstances surrounding the seller-in-foreclosure when the transaction was entered into might appear to be unconscionable to the seller in the future — due only to fast fluctuating market factors and a asset inflation, not the conduct of the EP investor. Thus, an EP investor assumes the risk a fast rising economy or a quick downward shift in interest rates may provoke the seller to attempt to rescind (without a valid legal reason).
If real estate values rise rapidly and significantly, the “greed factor” may set in, turning a formerly desperate, thankful seller-in-foreclosure into an astute rescinding seller.
However, any increase in the value of the property after acceptance of the EP investor’s offer may not be considered in the restoration to place the parties in their original position. The test of unconscionable advantage is not determined based on events taking place after the seller-in-foreclosure entered into the purchase agreement.
Market circumstances existing at the time of the negotiations, or when the parties entered into the agreement, are the economic considerations which form one of the two elements for testing unconscionable advantage. [Colton v. Stanford (1890) 82 C 351]
Unconscionability has two linked aspects:
- the lack of a meaningful choice of action for the seller-in-foreclosure when negotiating to sell the home to the EP investor, legally called procedural unconscionability; and
- a purchase price or method of payment which is unreasonably favorable to the EP investor, legally called substantive unconscionability.
Price, like any other provision in a purchase agreement, can be considered unconscionable. When determining the unconscionability of the purchase price, both the basis and justification for the price at the time of the sale will be examined. [Perdue v. Crocker National Bank (1985) 38 C3d 913]
While the price may be justified, the buyer may have employed terms which constitute an unconscionable method of payment, including:
- a carryback note held by the seller with an unreasonably low interest rate, long amortization or no due date, bearing no relationship to current market rates and payment schedules; or
- an exchange of worthless land, stock, gems or zero coupon bonds at face value with a 20-year maturity date.
Any form of payment which is uncollectible, unredeemable, and with no present value would also be unconscionable.
However, the existence of unreasonable pricing and payment alone is not enough to show an unconscionable advantage sufficient for rescission of the closed transaction. Both the lack of a meaningful choice and favorable terms must exist to show unconscionability existed.
Title insurance companies have few qualms about insuring property purchased during the foreclosure period. The reason: title insurance does not defend or cover claims made by the seller-in- foreclosure arising out of his two-year right of rescission against the EP investor. The claim by the seller by definition is based on the conduct of the buyer on exclusion from coverage.
Some title companies insist the seller-in-foreclosure sign an estoppel affidavit declaring the seller:
- fully understands the nature of the equity purchase transaction;
- appreciates the finality of the consequences of the sale;
- agrees the purchase price is reasonable and fair under the circumstances; and
- the transaction is not merely financing which allows the seller to reacquire title to the property.
The signed affidavit makes it a little more difficult for the seller-in-foreclosure to later decide to rescind the transaction and recover his home, as it may increase the seller’s burden of proving unconscionable advantage.
However, the affidavit does not and cannot waive the seller-in- foreclosure’s two-year right of rescission if unconscionable pricing and an oppressive marketplace environment due to the conduct of the buyer actually existed. Any waiver of the seller’s rescission rights is void as a violation of the home equity sales law. [CC §1695.10]
The BFP on a flip of the property
Consider an EP investor who acquires ownership in an EP transaction with a seller-in-foreclosure. The EP investor then resells (flips) the property for a fair market price to a bona fide purchaser (BFP) before the seller’s two-year right of rescission expires and before the seller records a notice of rescission.
The seller-in-foreclosure then seeks to recover title to the residence and follows the necessary steps to rescind the transaction.
However, rescission is not available to the seller-in-foreclosure against the BFP or an encumbrancer for value if the property is purchased or encumbered prior to recording the seller’s notice of rescission. [CC §1695.14(c)]
A BFP is a person who, in good faith, purchases property and pays a fair price. The BFP’s knowledge of the fact the property was previously purchased by the EP investor during the foreclosure period does not affect the resale buyer’s status as a BFP. [CC §1695.14(c)]
Despite the BFP preventing the seller-in-foreclosure from recovering the property, the seller can recover money from the EP investor equal to the value of the lost equity established at the time of the sale to EP investors, not the resale value. The money recovery claim must be filed within four years of the EP investor’s violation of the EP statutes. [CC §1695.7]
The BFP’s title insurance
Obtaining title insurance poses no problem for the BFP. A title insurance company will insure over the seller- in-foreclosure’s two-year right of rescission, unless a notice of rescission has been recorded.
Title insurance only insures against what is not known by the buyer at the time the insurance is obtained or not listed as an exclusion from coverage.
However, the statutes allow for the BFP to have knowledge that a recorded NOD existed when the EP investor bought the residence without affecting his status as a BFP. The seller-in-foreclosure has no right of rescission against the BFP. Yet, the title insurance company has a duty to defend the BFP against any later rescission claim made by the seller-in- foreclosure against the BFP.
Also, a BFP must deal at arms length with the EP investor.
If the title insurance company can show the subsequent buyer is not a BFP, but a successor-in-interest involved in a title flipping scheme with the EP investor for the purpose of avoiding the seller- in-foreclosure’s right of rescission, the title insurance company can refuse to defend the successor against the seller’s enforcement of his right of rescission. [Calif. Insurance Code §330 et seq.]
Sale-leaseback to the insolvent seller
A resale buyer from an EP investor (or any seller) is still on notice to inquire as to the property rights of any person in possession of the property before the resale buyer can qualify as a BFP. [CC §1695.14(c)]
A seller-in-foreclosure may still occupy the property under a sale- leaseback. The BFP must inquire as to occupant’s rights.
If the seller-in-foreclosure holds an option to purchase under the sale-leaseback, then the sale-leaseback is really a mortgage, not a sale. Thus, the vested title holder has nothing to sell but his right to receive money as holder of a security interest in the property, not as an owner.[CC §1695.12]
Possession of property by any person other than the current vested owner of record imparts constructive notice to a potential buyer to inquire as to the right, title and interest of the person in possession. [Gates Rubber Company v. Ulman (1989) 214 CA3d 356]