BARNES WALKER & GOETHE

Marcie Tanner

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The attorneys at Barnes Walker have represented a number of buyers in their purchases of lender-owned (or "REO," for real estate Owned by a lender properties. (For purposes of this article, "lender" includes not only banks who own real property that they have foreclosed upon, but also the FDIC, Fannie Mae, and Freddie Mac.)

As you probably know, most lenders have decided to sell their REO properties quickly by using low prices and a fast sales process from contract to closing in order to limit their losses on these properties. This creates the potential for buyers to find great deals on properties that can close quickly. To further limit their losses, however, the lenders are using "As Is" contracts (often the FAR/BAR "As Is" residential contract) with contract provisions or contract addenda to transfer all closing costs to the buyer and to shift all problems and risks - past, present, and future - of the REO property to the buyer. The contract or addendum provisions strip away almost all buyer protections found in the FAR and FAR/BAR "As Is" residential contracts. The lenders have apparently decided that, if they are going to take substantial losses on their mortgage loans by selling of their REO properties at low prices, the buyers of their REO properties will pay, in addition to the purchase price and the closing costs, for all risks and problems that develop regarding the REO properties. Thus, the buyers are actually agreeing in the REO contract to pay two prices: (1) the purchase price and (2) an unknown price in the form of all costs and expenses arising from all past, present, and future problems and risks associated with the REO properties. Buyers and their Realtors® should be aware that the lenders intend buyers to live by the reverse of the old maxim, "With great risks, come great rewards" - i.e., "With great rewards, come great risks."

On the other hand, we have found that if buyers do not sign the lender's REO contracts substantially as written, the lenders will not agree to sell their REO properties to the buyers. Therefore, our purposes for this article are threefold:

1. To convince you that you and your buyer must either (a) carefully read the REO contract or, if the FAR/BAR "As Is" residential contract is used, the REO addendum, or (b) retain a Barnes Walker attorney or another real estate attorney to do so. The REO contract or addendum is not a standard FAR or FAR/BAR contract and is filled with burden-shifting to buyers, uncommon disclaimers by the lenders, short deadlines for buyers, and multiple new obligations, indemnities, waivers, and releases required of buyers.

3. To assist you in determining which of these clauses the buyer, if necessary to obtain a contract, should accept, may accept with caution and/or mitigating action, or should not accept.

Following is a list of the problem-shifting and risk-shifting clauses or omitted language that you will find inserted in, or deleted from, an REO contract or REO addendum. While-they are not found in a standard FAR or FARIBAR contract, these clauses - and the risks associated with them - should be accepted by the buyer, if necessary; to obtain a contract from the lender. .

1. Property "As IS." As stated above, the lender will convey the property to the buyer in an "As Is, Where Is" condition. The purchase price should therefore be low enough to offset any deficiencies in the property's condition.

c. An obligation to keep the property in the same condition between contract execution and closing;

f. A representation that all construction work at the property was permitted and that there are no outstanding or open permits.

In fact, the REO contract or REO addendum will have a specific disclaimer that the lender is making no representations or warranties and that any statements made by the listing real estate agent, lender's employees, or any other party do not bind the lender and are not representations or warranties from the lender.

Representation and warranties give a buyer the right to sue a seller for any damages, costs, or expenses incurred by the buyer as a result of any representations or warranties being untrue. Without representations and warranties, the buyer will have to absorb such costs and expenses, so, again, the purchase price should be low enough to account for these additional risks and potential costs and expenses.

4. No lender corrective obligations. The REO contract or addendum will not obligate the lender to: (a) make any repairs to the property, (b) resolve any permitting issues, (c) rectify any title defects, or (d) remedy any survey problems. In fact, typically the .contract or addendum states that if any repairs are made, they are not warranted and not made for the benefit of the buyer, only the lender. The buyer should use a good home inspector to catch the need for any repairs or permitting problems. With any luck, the title insurance, if it has no exceptions for the title or survey defects, will pay for any of these defects that might arise. The lender having no corrective obligations is another reason why the price for the property should be low.

5. Releases by the buyer. The REO contract or addendum will require the buyer, in addition to taking the property "as is," to release the lender from responsibility and liability for: . ,

b. All undiscovered title issues, including unsatisfied mortgages, Judgments, taxes, and all other unsatisfied liens, which, if not found at or before closing will have to be paid by the buyer; and '

c. All unobserved survey issues, whether or not the condition or issue was disclosed by the lender.

6. Lender's right to cancel. Probably half of REO contracts and addenda we have seen give the lender a right to cancel the sale at any time up to closing. This allows a lender to obligate a buyer to purchase the REO property while the lender continues to try to sell the property at a higher price or on better terms and conditions to another buyer. The lender will also try to use the threat of cancellation to avoid performing any of the few obligations that the lender has under the contract or addendum if the performance of those obligations becomes onerous.

Even if the REO contract or addendum does not have the right to cancel, all of them provide that the buyer's only remedy, if the lender does not perform under the contract, is the return of the contract, deposit to the buyer, still giving the lender, in essence, the right to cancel, since there is no penalty to the lender other than returning the buyer's deposit.

An REO buyer should be warned that this express or de facto right of the lender in all REO contracts or addenda to cancel the contract leaves the buyer potentially liable, in all REO transactions, for paying for the costs of the buyer's appraisal, survey, inspection, and moving, even if the lender cancels and the buyer does not receive the property, since these costs are incurred prior to closing. (The Fannie Mae REO addendum is so brazen that it states that a return of the contract deposit - the buyer's own money - to the buyer upon Fannie Mae's default "adequately and fairly compensates" the buyer. for all of the costs, time, and effort the buyer spent preparing to purchase the property.)

7. Waivers by the buyer. The REO contract or addendum will further require that the buyer waive almost all of the buyer's contractual rights and legal remedies against the lender such as:

c. The right to have a court enjoin (prevent) the lender from selling the.REO property to another buyer; . .

d. The right to specific performance, i.e., the right to obtain a court order to force the lender to abide by the contract; and

e. The right to a trial by jury, since a Jury 1S typically more sympathetic to an individual than a lending institution. These waivers create additional risks for which the buyer will not be compensated if wronged, and the buyer should not only be forewarned about them, but compensated up front with a sales price appropriately lowered in exchange for the assumption of these risks.

8. Covenant not to sue. In addition to the buyer having to waive all the rights and remedies discussed above, the typical REO contract or addendum also requires the buyer to covenant (agree) not to sue the REO lender for any reason. If the buyer does sue contrary to the covenant, the contract or addendum will require the buyer to pay the lender's attorney's fees incurred in defending the buyer's lawsuit and also indemnify (reimburse) the lender for any other costs the lender incurs. In addition to attorney's fees and the indemnity, approximately half of the covenants not to sue also require the buyer to pay a penalty if the buyer sues in violation of the covenant.

9. Restriction on resale. Not only are the lenders shifting problems and .risks to the buyer, but many of them are then trying to prevent the buyer from profiting from the resale of the property. About half of the REO contracts and addenda also restrict the buyer from reselling or even refinancing the property for a certain period of time after closing and require this restriction be placed in the deed. As a result of this restriction, any resale or refinance would probably be legally void. Fortunately, the resale restriction period is typically only two to three months long, but investor buyers should be forewarned that the restriction prevents simultaneous flipping or an immediate cash-out refinance.

10. Personal property. Typically, the REO lender in its contract or addendum will not warrant that it owns the personal property (everything from appliances to abandoned vehicles) on the real property, will not guarantee their presence or condition at closing (they could be repossessed or stop working in the interim), will therefore not contractually agree to sell them to the buyer, and will make the buyer assume responsibility for the disposal of any junk such as abandoned vehicles, tires, etc. The latter disposal issue can create problems and expense. For example, salvage yards may not take junk vehicles without a certificate of title for fear that the vehicles are stolen, and 'then there are the towing costs. Old tires are considered environmentally detrimental, and therefore the buyer will be charged for their disposal. The buyer should be warned of these costs, if applicable. The buyer should also be aware that, if appliances are missing at closing, the buyer will have to replace them at the buyer's expense. (With the reward of a low price comes the risk of extra costs.)

11. The REO lender's closing agent. In most REO contracts or addenda, the lender agrees to pay for the documentary stamp tax on the deed and for the title insurance cost if the lender's title insurance agent is used to handle the closing. Our experience is that most of these title agents are unskilled, inexperienced, overworked, probably undercompensated, and have little incentive to cater to the Realtors® or the buyer, since most of the closings are outside their market area, and the agents know that they will not be dealing with the Realtors® or the buyer again. Further, they only review the land records, not the foreclosure file, even though the review of that file is necessary to ensure that title to the foreclosure property actually vested III the REO lender. Because of this omission by the lenders' title agents and their general lack of skill and experience, we are concerned that buyers are buying homes with title and survey defects. Even if they are provided title insurance coverage without exception for these defects, the buyers will have to expend frustrating amounts of time, effort, and worry correcting these defects when they are discovered. It is like buying a lemon automobile which is still under warranty. While most of the car buyer's repair costs are paid by the manufacturer, the buyer is not reimbursed for the frustration, time, effort, and worry that are also involved. Why would a buyer want to buy into these problems? A very few REO contracts and addenda allow the buyer to select the title agent if the buyer pays for the title insurance. If presented with this opportunity, the buyer's money would be well spent in paying for the title insurance in exchange for being able to select a Barnes Walker attorney or another local real estate attorney to serve as the title agent. Such an attorney would be able to review the foreclosure file, and close the transaction with skill and speed while extending' the proper attention and courtesy due to Realtors® and their buyers.

12. The phantom attorney review. Most REO contracts and addenda have the buyer represent that they have consulted an attorney prior to signing the contract, whether in fact they have done so or not. Therefore, if the buyer or the buyer's Realtor® overlook something detrimental or unfair to the buyer in the contract, the REO lender will use the attorney consultation provision (which cannot be orally contradicted) to convince a judge that the contract should. be enforced, since the buyer had the benefit of an attorney reviewing the contract. Realtors® should warn their buyers of the effect of this clause and advise them that, if they wish to have an attorney like one at Barnes Walker review the contract, the attorney should do so before the buyer signs the contract (unless the contract allows the buyer to have the contract approved by an attorney after execution, and, if the attorney does not approve, gives the buyer a right to cancel and receive a return of the buyer's deposit). Once a contract without an attorney approval clause is signed, the buyer will be firmly obligated to the lender under the contract, so having an attorney review the contract at that point is of little help. As you can see, all of these clauses contain risks of which buyers should be aware. Provided that buyers understand these risks, however, buyers in most cases should accept these clause~, if they are necessary to obtain the contract.

C. Clauses That May Be Accepted With Caution and/or Mitigating Action by the Buyer, if Necessary.

Following is the next set of problem-shifting and risk-shifting clauses or omitted language that you will find inserted in, or deleted from, an REO contract or REO addendum. While they are not a part of a standard FAR or FAR/BAR contract, these clauses, and the risks associated with them, may be accepted with caution and/or mitigating action by the buyer, if necessary, in order to obtain a contract from the lender.

1. Short inspection periods and quick closings. Almost every REO contract or addendum has an inspection period (with a right to cancel the contract) and closing deadlines that are very short. Given that the REO lender is selling the property "As Is" with no representations, warranties, or disclosures, a careful, thorough, and complete inspection of the home and other improvements on the property should be conducted, since, as indicated before, the REO lender is actively shifting problems and risks to the buyer. Thus, Realtors® and their buyers should insist on adequate time to inspect the REO property. If an inspection reveals one or more significant problems, the buyer and the buyer's Realtor® should press the lender for the repair or a repair credit at closing (in exchange for not cancelling). REO lenders and their agents are under pressure to liquidate all of these REO properties, so buyers and their Realtors® who have made, and not backed down from, demands for repairs or repair credits have typically been successful. Further, astute REO lenders know that once a needed repair is brought to their attention, they are legally responsible and liable for either repairing it before selling the REO property to the next buyer or disclosing it to the next buyer. Therefore, the smart decision for the REO lender is to repair the property or give a repair credit to the current buyer and save the time and effort necessary to find another buyer. Finally, Realtors® or. their buyers should. insist on adequate time to close, factoring in not only the time needed to inspect, but also time to obtain a survey, document review time for any attorney involved, and, most importantly, adequate time for the buyer's lender to provide financing.

2. Undisclosed tenants. Another reason for a thorough inspection of the REO property is that the great majority of REO contracts and addenda state that the buyer will .take subject to any undisclosed tenants (read that also to mean "trespassers" and "squatters") in possession of the REO property and will be responsible to the tenants for any security deposits or last month's rents. Therefore, the buyer or the buyer's Realtor®, prior to signing the contract, should-determine if there are any people in possession of the property and whether that is acceptable to the buyer. In making that decision, remember that, if the buyer wishes the people to vacate the property and they refuse, the buyer will have to hire an attorney to evict the people, . which can be accomplished only if there is no lease or the lease is currently terminable. Further, ,evictions take time and money. Even if no one is present on the property prior to execution of the contract, the inspector should be asked to look for evidence of any trespassers or squatters during the inspector's visit to the property.

3. Late penalty. Most REO contracts or addenda have a $100.00+ per day penalty for every day that the buyer delays closing beyond the initial closing date. Therefore, a Realtor® should warn the buyer in advance of signing the contract or addendum about this penalty, and they should jointly determine whether they and their lender can meet the stated closing deadline or whether they need to negotiate extra time to close before they sign the contract.

4. No re-prorations. Almost all of the REO contracts and addenda do not allow a recalculation of any prorations after closing, such as real estate taxes, homeowners' and condominium association assessments, and rents. Therefore, a buyer and the buyer's Realtor® should check the prorations carefully. Fortunately, with property prices dropping or stabilizing, buyers do not have to worry so much about the actual amount of taxes on the real estate tax bill being higher than the tax amount used on the closing statement for proration purposes.

5. The deposit trap. Most REO contracts and addenda require that the contract deposit be held by the REO lender's Realtor®or, most often, the lender's closing/title agent. Keep in mind that the REO lender's closing/title agent is typically the lender's attorney. In about half of these REO contracts and addenda, the document further states that, if the lender declares the buyer is in default, the buyer agrees that the escrow agent holding the deposit and release the deposit to the lender. This provision is contrary to normal contracts. For example, m a standard FAR Contract, both seller and buyer have to agree on the release of the deposit or an arbitrator or judge must order the deposit's release to a party. The lender's self-declared default clause works to the lender's advantage if: the buyer finds a problem with the REO property, the lender disputes whether it has an obligation to remedy or repair a problem, the buyer needs additional time to close, or the buyer otherwise misses the contract's tight inspection or closing deadlines. In such cases, the lender can convincingly threaten the buyer with default and seizure of the deposit if the buyer does not drop its demands, even if these demands are perfectly reasonable requests. Therefore, a buyer should either be certain that the buyer can perform all of its duties and obligations under the REO contract or addendum on time or insist upon deletion of the lender's self-declared default clause. As indicated above, all of these clauses contain risks which buyers, in order to obtain a contract, can either cautiously accept as tolerable risks or mitigate by taking such actions as inspections, negotiating additional time, double checking calculations, or negotiating the deletion of the clauses.

Following is the last set of the most common problem-shifting and risk-shifting clauses or omitted language that you will find inserted in,or deleted from,an REO contract or REO addendum. These clauses, and the risks associated with them, should not be accepted by the buyer, even if the lender refuses to sign a contract without them.

1. Personal liability for officers of an entity. A significant number of REO contracts and addenda have a clause that states if an individual signs the document for a buying entity (e.g., a corporation, an LLC, or other limited liability entity), and the entity does not purchase, the individual signing is personally obligated to perform all of the buyer's duties and obligations under the contract, including purchasing the REO property. Therefore, a Realtor® representing an entity should check the REO contract or addendum for such a clause .and, if the clause is found, warn the individual officer or manager of the entity of that individual's potential personal liability. Usually, in such a case, the clause will be deleted by the REO lender if the buyer stands firm in its insistence that the clause be deleted.

2. Encumbrances, encroachments, liens, etc. The worst of all REO contracts and addenda require the buyer to take "title subject to all easements, liens, encroachments, encumbrances, and oil, gas, and mineral rights" and eliminate all obligations of the REO lender to remedy any of these problems. Easements (the right of one party to use, undisturbed, for a particular purpose, a part of the property of another) can include easements that run through the middle of a property or lie under the property's home or other improvements. Encroachments can be intrusions by structures into easements or setbacks or across property boundary lines and can be from structures on or off the property. Encroachments, other than those by fences, can be very serious, since it is very difficult andcostly to remove all or part of a structure that is encroaching. Liens and encumbrances include mortgages, judgments, and tax liens that must be satisfied with monetary payments to be removed. Oil, gas, and mineral rights with the right of entry onto a property give the holder of the mineral rights - such as a drilling or mining company - the right to cause the home and any other improvements to be bulldozed in order to drill on, strip mine, or otherwise extract minerals from the property. Anyone of these title problems would be costly and time-consuming to remove or otherwise eliminate. A contract that requires a buyer to take title subject to these problems also usually means that the title insurance will not cover the remedying of these problems, and therefore the buyer should not sign the REO contract or addendum, unless the buyer (a) has had Barnes Walker or another local real estate attorney conduct a full title search and (b) has had a survey performed in advance to ensure that none of these problems actually exist.

3. "Insurable" versus "marketable" title. The REO contracts and addenda that require the buyer to take title to the issues referenced in paragraph 2 above will also typically state that the REO lender will provide the buyer only with "insurable title," rather than "marketable title." Under Florida law, "marketable title" is ownership of real property, free and clear of all liens, encumbrances, easements, encroachments, reservations, and other restrictions, with only limited, standardized exceptions such as plat restrictions, recorded declarations of condominium or protective covenants, boundary line utility and drainage easements, etc. (The FAR-9 Residential Sale and Purchase Contract very accurately recite this law on marketable title in its Paragraph lO(a).) "Insurable title," literally means ownership is insured, but the potential exceptions· to the title insurance coverage are unlimited in number and impact. Thus, the exceptions to title insurance coverage could potentially be so numerous and substantial as to render the property either totally unusable andlorvalueless, since the exceptions to coverage could include: high mortgage, judgment, and tax liens; oil, gas, and mineral rights with the right of entry and the right to remove improvements; and easements that are located through the middle of the property or under the property's home or other improvements, etc. Therefore, as alluded to in the paragraph above, if the buyer signs an REO contract or addendum with this language in it, not only will the title be subject to these problems, but the title insurance will not pay to remedy, remove, or resolve them. Again, the buyer should not sign the REO contract or addendum unless the buyer (a) has had Barnes Walker or another local real estate attorney conduct a full title search and (b) has had a survey performed in advance to ensure that none of these problems actually exist.

As you can see, the buyer should not accept the preceding clauses and should not sign the REO contract or addendum, unless the lender agrees to delete these clauses, or in the case of the latter two clauses, has a title search and survey performed before signing the contract or addendum.

Purchases of REO properties can be great deals for buyers price-wise, but buyers and their Realtors® need to be careful in signing REO contracts and addenda. We therefore hope that you found this article helpful in identifying REO contract and addendum clauses that shift problems and risks from the REO lender to the buyer and in determining which of these clauses the buyer, if necessary to obtain a contract, should accept, may accept with caution and/or mitigating action, or should not accept We also hope that you agree with us that an informal inspection of the property (for tenants, squatters, or trespassers) prior to executing the contract, along with negotiation of adequate time for the formal inspection, financing, and closing, followed by a careful, thorough, and complete formal inspection after contract execution, and insistence on a repair credit for any costly defects, are appropriate and necessaryin the purchase of REO properties. Finally, we hope .you can use the information provided inthis article to educate and prepare your REO buyer for the additional and significant risks, costs, and expenses that invariably coincide with the low price of an REO property.

While we have identified the issues for you, keep in mind that different REO contracts and addenda use varied wording which can be very subtle or obscure, but significant because of what is inserted or omitted. Therefore, because of the substantial problems and risks that your buyers may inadvertently or unintentionally assume by signing an REO contract or addendum based upon your advice, and the liability that advice creates for you, you may wish to have your buyers retain an attorney at Barnes Walker or another real estate attorney to assist them in analyzing and negotiating a contract with an REO lender. Finally, even if a relatively satisfactory REO contract or addendum is negotiated with the REO lender, you or the buyer's attorney should carefully review the deed and the title insurance commitment to ensure that the REO closing agent did not pass along to the buyer in the deed and commitment (like some REO closing agents have done that Barnes Walker has caught) any problems and risks that the buyer did not agree to assume in the contract or addendum.

If you have any questions about helping your buyers navigate the risks and rewards offered by REO purchases, please do not hesitate to call or email us. As always, we will answer your questions at no charge.

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