• Uphoff borrows $200K from Lambert to
pay his gambling debts
• Lambert takes a mortgage on Uphoff’s
home (worth $300K)
• Lambert also has Uphoff deliver a
deed conveying the home to Lambert
– Side agreement by Lambert: Lambert will
only record the deed and assert title if
Uphoff defaults; if Uphoff repays, Lambert
will tear up the deed
• Is that a valid “deed in lieu”?
The “Clogging” Rule
• Deed by mortgagor, delivered simultaneously with
execution of a mortgage, is an invalid clog on the
mortgagor’s equity of redemption
– 1) Deed intended only to circumvent the foreclosure process
and the mortgagor’s right to redeem the property prior to sale
– 2) The deed was not intended to effect a transfer of full title at
time it was executed/delivered
– Thus, Lambert would have to foreclose the mortgage
§ 3.1. The Mortgagor’s Equity of Redemption and Agreements
Limiting It
Contemporaneous Option as “Clog”
• Common law: “option” in favor of mortgagee to buy
mortgaged land, taken contemporaneously with the
mortgage, is a “clog on the equity of redemption” [p. 286]
– Concern: exercise of option may circumvent mortgagor’s right to
redeem and circumvent foreclosure process
• Restatement § 3.1: option taken contemporaneously with
the mortgage is not an invalid clog unless its effectiveness is
expressly dependent on mortgagor default. Why limit the
common law rule this way?
(a) From the time the full obligation secured by a mortgage
becomes due and payable until the mortgage is foreclosed, a
mortgagor has the right to redeem the real estate from the mortgage
….
(b) Any agreement in or created contemporaneously with a
mortgage that impairs the mortgagor’s right described in Subsection
(a) of this section is ineffective.
(c) An agreement in or created contemporaneously with a mortgage
that confers on the mortgagee an interest in mortgagor’s real estate
does not violate this section unless its effectiveness is expressly
dependent on mortgagor default.
Problem
• Lambert loans Strong $50,000
– Strong executes a deed of the home to Lambert
– Strong remains in possession of the home
– Agreement: if Strong repays $50,000 + interest to Lambert
within 2 years, Lambert will deed the home back to her
• Two years later: Strong does not repay, Lambert brings
unlawful detainer action to recover possession. Does
Strong have a valid defense?
Absolute Deed or Equitable Mortgage?
• Did Lambert really buy ownership of the land (was this an
actual “sale”), or was he just using title to the land to secure
Strong’s obligation to repay the money?
– If it is the latter, and this fact is proven by clear and convincing
evidence, then Lambert’s “deed” is deemed in equity to be a
mortgage
– He would have to foreclose (by judicial foreclosure, since the “deed”
would not have a power of sale in it)
• What info is relevant in making this judgment?
• Relevant Restatement factors [p. 301]
– Statements of parties (“This is a loan.”)
– Substantial disparity between loan amount and the fair market
value of the land
– Grantor (Strong) remained in possession of the land even after
deed was executed/delivered to Lambert
– Grantor (Strong) paid taxes or made improvements after
delivery of deed to Lambert
– Nature of the parties and their relationship prior to/after the
deed
• Case law factors:
– Was Strong in financial distress at the time of deed?
– Did Strong have legal counsel?
• If Strong kept possession, and FMV of land =
$200,000, the argument to re-characterize the deed
as an equitable mortgage is compelling
– The parties are using title to the land to secure
repayment of Strong’s debt (substance over form)
– Why would Strong rationally “sell” the land for $50,000?
– Argument is particularly compelling where borrower is in
financial distress (as in Perry, p. 292), where the
“grantor” of the deed was looking for a “rescue” from
imminent foreclosure action
• Lambert signs installment contract to buy a
flat-screen TV (12 payments @ $350
each) from “Tiger John” Cleek at Aaron’s
– K: Aaron’s retains title to the TV until all
payments are made by Lambert
• Lambert makes first 11 payments, but he
misses the 12th payment
• Can Aaron’s take back the TV, terminate
the contract, and keep all of Lambert’s
past payments as damages for breach?
UCC Installment Sale Contracts
• Under the UCC, Aaron’s is deemed to have a security
interest in the TV, which it must foreclose by sale
– Balance of debt = $350 (remaining payment) + any costs of
collection incurred by Aaron’s
– Before sale, Lambert can redeem TV from the security
interest by paying off remaining balance of the debt
– If sale price >> balance of debt, any surplus must be
returned to Lambert [§§ 9-610, 9-615, 9-623]
UCC: “Security Interest”
• § 1-201(b)(35) defines a “security interest” as “an
interest in personal property ... which secures payment
or performance of an obligation.”
• § 1-201(b)(35) also provides that “... [t]he retention or
reservation of title by a seller of goods notwithstanding
shipment or delivery to the buyer ... is limited in effect to
reservation of a security interest.”
• Sometimes, an owner of land sells it to buyer by installment
land contract or “contract for deed”
– Buyer agrees to pay purchase price in monthly installments
over time (perhaps as long as 40-50 years)
– By terms of ILK, even though Buyer typically takes immediate
possession of the land, Seller is not obligated to deliver a
deed to Buyer until Buyer has paid all installments
– ILK typically provides that if Buyer defaults, Seller retains title
to land AND may retain all of Buyer’s prior payments under
the ILK as liquidated damages for Buyer’s breach!
Russell v. Richards
• Richards sold land to Buyer via ILK
• Buyer later resold to Russell (who paid Buyer $11,188 in
cash, took possession, took over monthly payments, and
assumed liability for balance of ILK = $37,938)
– Russell made monthly payments for next 6 years, reducing ILK
balance to $26,504 ($10,782 principal reduction)
• Russell then defaulted (FMV of land at time = $82,735)
• Richards declared forfeiture of ILK
• $11,188 down payment? Court says it was not appropriate to
consider that payment, b/c it was made to the original Buyer, not
Richards [p. 312]
– Huh? Downpayment reflected, in part, prior payments the original
Buyer made to Richards!
• $33,746 in market appreciation?
– Court: this only “belonged” to Russell if she performed (her
“equity” was contingent), but she didn’t perform, so it wasn’t hers to
“lose” [p. 312]
• Held: trial court appropriately considered “loss” of $10,782 paid
on K, but that loss isn’t “shocking” amount
• Court: contract enforced as written; Russell forfeited
her interest, which does not “shock the conscience”
• Result: Russell loses her “equity” in the land
– She lost the $10,782 in principal payments that she made
over past 6 years
– She lost the $11,188 down payment she made 6 years ago
– She lost the $34,754 in market appreciation that occurred
during the life of the contract
• Why isn’t this magnitude of loss sufficiently “shocking”
to the conscience?
Vendor
(Seller)
Contract
Vendee
(Buyer)
! Vendee agrees to pay contract price
in installments
! Vendor does not deliver deed (title)
until Vendee pays final installment
The Purchase Money Mortgage Compared
Purchase
Money
Mortgagee
(Seller)
Deed (Title)
Note and Mortgage
Purchase
Money
Mortgagor
(Buyer)
Contrast: If Deal Had Been Structured as a
Purchase Money Mortgage
• After default, Richards (as PM mortgagee) would have had to
foreclose the mortgage
• If land sold for $82,000 at foreclosure:
– Richards would’ve gotten $26,504 (balance of debt), plus any
accrued but unpaid interest and costs of collection (e.g.,
attorneys’ fees)
– Balance would have gone to Russell (her equity, not
“contingent” upon her full performance)
Watkins v. Eads [p. 329]
• Any attempt to use title to land as security for a debt should
have the same legal effect; thus, ILK should be treated as a
mortgage (and must be enforced as a mortgage)
• Cf. Restatement of Mortgages: “A contract for deed creates
a mortgage.” [§ 3.4(b)]
• Note: many installment land contracts don’t contain a power
of sale, so in most states following Watkins approach, Seller
would have to bring judicial foreclosure action
Petersen v. Hartell
Petersen: Majority Holds …
• Seller and Buyer entered into ILK for small plot of raw land
• ILK is not a “mortgage” per se
• If Buyer has not made “substantial payments,” or if default is
nonmonetary (e.g., waste), seller can terminate ILK
• But, if Buyer has made “substantial” payments or
improvements to the land, and the default is purely financial,
the Buyer has a right to specific performance, even after
default [p. 319]
– Price = $9,162, payable in $50 installments (possible terms of this
contract: 40 years @ 6%)
• Buyer makes a total of 58 monthly payments ($2,900 total)
but missed a total of 7 payments
• Buyer tendered a check for $250 for “back payments,” but
Seller refused to accept it and purported to terminate ILK
• Buyer then tendered the full unpaid balance of the ILK into
court, and sued for specific performance of ILK
– Court calls this a right to “redeem” Buyer’s interest in land [p. 321]
• Pro-Restatement view: ILK buyer and purchase money
mortgagor are in essentially the same position and should
be treated the same
Petersen v. Hartell
• Note: even the majority calls the
Seller’s interest a “security interest”
[p. 320], and says Petersen had a
“right to redeem” [p. 321]
• So why not take the final step (like
Chief Justice Byrd), and treat ILK as
a mortgage for all purposes?
– Both purchase money mortgagee and ILK Seller are using title
to land to secure payment of a debt
• Pro-ILK view: ILK buyers are different
Rose Bird
Chief Justice
California Supreme Court
Chief Justice 1977-1987
• Problem: California Civil Code § 2924c gives
mortgagors not only a right to redeem, but also a
statutory right to reinstate (to cure the default by
making only “back payments”)
– The Petersen holding precludes a defaulting ILK Buyer
from being able to reinstate
– Instead, the defaulting Buyer can only protect its
redemption right by paying off the full balance of the debt
– Often ILK buyers have poor credit, and can’t qualify for
conventional institutional mortgage financing
– ILK Buyers are “riskier,” so ILK Sellers should be able to
bargain for a remedy commensurate with transaction risk
– Displacement of contract remedy should be implemented by
legislature, not the court
• While mortgage law has always recognized an
equitable right of redemption, it never granted the
mortgagor an equitable right to reinstate
• Defaulting mortgagor can’t reinstate unless
– (a) Applicable statutes grant such a right (see Cal. Civ.
Code § 2924c), or
– (b) The mortgage itself expressly creates such a right
(see Fannie/Freddie single-family mortgage form, ¶ 19,
page 1452)
Petersen: The Restitution Remedy
• If the defaulting Buyer can’t pay off the full balance of the
contract, then what happens?
– Seller can cancel ILK, terminate Buyer’s equity of
redemption (analogous to strict foreclosure)
– But, Seller must make restitution of Buyer’s past payments,
to extent they exceeded Seller’s actual damages due to
Buyer’s breach [Freedman v. The Rector, p. 319]
– This should prevent Seller’s “unjust enrichment”
Restitution: Clampitt v. AMR Corp. [p. 325]
• Amounts paid by Buyer
–
–
–
–
Principal payments
Interest payments
Taxes
Improvements
• Total = $752,874
• Damages
–
–
–
–
–
Rental value
Physical damage
Cost of resale
Attorney fees
Post-contract reduction in land
value (if any)
• Total = $747,100
• Buyer has been paying on an installment K for 10 years
when Buyer breaches and cannot redeem
– Original ILK price = $57,000; Interest rate = 10%
– Buyer’s total payments = $60,000 ($500/month)
• Principal reduction = $5,300; Interest = $54,700
– Principal balance due at time of breach = $51,700
– Value of land at time of breach = $65,000 (land has increased in
value)
• Seller argues: ILK provision said that in case of breach,
reasonable rental value was agreed to be $500/month; thus,
I shouldn’t have to make any restitution
• Is this a sound argument?
• In Long v. Smith, on similar facts, MO
court of appeals held that Seller did not
have to make restitution to Buyer
– Rationale: contract had a stipulation that
rental value of property during Buyer’s
possession = amount of monthly payment
due under contract
• That makes little sense; why would
Seller agree to sell full title for payments
only = fair rental value?
• How should the court determine the value of the Seller’s
“lost opportunity” when calculating the Seller’s damages?
– Is it the lost use of the land (which would customarily be
measured by the fair rental value of the land)?, or
– Is it the lost value of the money that the Seller decided to forgo
by selling the land on credit, rather than for cash (customarily
measured by interest)?
• Long v. Smith result allows “double counting” by Seller
(Seller retained the “fair rental value” but did not have to
disgorge any of the interest it had collected on the ILK)
• Note: in personal property context, special legislation in
Missouri protects “rent to own” (RTO) dealers from having
their contracts re-characterized as Article 9 security
interests
– If recharacterized as security interests, Aaron’s would have to
foreclose on defaulted RTO contracts and return any surplus
sale proceeds
• By analogy, under rationale of Long v. Smith, “rent to own”
contract for land would appear to allow landlord/seller to
terminate lease upon default and retain all prior payments
“Rent to Own” Contracts
• Result in Long v. Smith can be replicated through the
use of a “rent to own” contract
– Under such a contract (think Tiger John Cleek and TVs), the
tenant leases on a month-to-month contract
– E.g., If T renews the lease for 360 consecutive months and
pays timely rent each month, T becomes owner after 360
months; but if T defaults (or ever fails to renew the lease), L
can terminate lease and keep all prior payments!
Statutory Regulation of ILKs
• Legislatures in several states that do not treat ILKs as
mortgages have enacted statutes that regulate seller
enforcement [pages 338-342]
– Most require notice/cure period before Seller can terminate ILK
(e.g., Minn. Stat. Ann. § 559.21, p. 339-340)
– Some allow the defaulting Buyer to reinstate by catching up
back payments (rather than Petersen or Long, which require
payoff of full contract balance)
Tex. Prop. Code § 5.066. EQUITY PROTECTION; SALE OF
PROPERTY. (a) If a purchaser defaults after the purchaser has
paid 40 percent or more of the amount due or the equivalent of
48 monthly payments under the executory contract, the seller is
granted the power to sell, through a trustee designated by the
seller, the purchaser's interest in the property as provided by
this section. The seller may not enforce the remedy of
rescission or of forfeiture and acceleration.
Texas’s statute effectively converts an installment land K to a mortgage after
Buyer has paid 40% of price or 48 monthly payments, whichever occurs first
Specific Performance: Gershman [p. 348]
• Remaining balance of ILK = $108,000 at time of breach
• FMV of condo = $73,000
• Buyer wanted to “walk away,” but Seller sued for specific
performance
– Seller got judgment = $108,000, and had condo sold to satisfy
judgment; condo sold for $73,000; Buyer (Summit) was held
liable for $35,000 deficiency!
– In CA and some anti-deficiency states, Buyer would be
protected from deficiency after sale
Specific Performance as Alternative Seller
Remedy to Termination
• In “down” markets, or if the property has suffered an
uninsured casualty, the value of property at time of breach
may be much less than the balance due on the ILK
• In such cases, Seller might seek specific performance of
the ILK, rather than instead terminating the contract and
retaining past payments as liquidated damages