Due On Sale Clause - Misunderstood?

Question

I have seen several conversations lately which have had some form of Due On Sale or Alienation Clause concept in them.  As such I want to address the topic and provide a little opinion as well.

First let's start with the clause itself:
[b]Transfer of the Property or a Beneficial Interest in Borrower. If all or any part of the Property or any interest in it is sold or transferred (or if a beneficial interest in Borrower is sold or transferred and Borrower is not a natural person) without Lender's prior written consent, Lender may, at its option, require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if exercise is prohibited by federal law as of the date of this Security Instrument.

If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is delivered or mailed within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.[/b]

So there you have it, pretty straight forward if you ask me.  It seems this clause in the RE world is just not that simple.  To fear or not to fear?  To disclose or not to disclose?  Do lenders ever enforce this?

To the topic of enforcement, first let me point out the clause does not prohibit the transfer nor does the clause obligate the lender to accelerate.  The right to accelerate is reserved to the lender's discretion.  Additionally there is no term to which the lender has to enforce the clause, so it does not expire.  (a point that we will come back to)

Secondly a common question is that of disclosure, do you report the transfer to the lender?  Well within the clause there is no duty for the borrower/seller to report the transfer nor is there a duty for the buyer to report.

So then what is the big deal?  Why have the clause if they do not act on it?  Commonly folks site how crazy the lender would be to enforce the clause if the buyer represents performance in the form of timely payments on the debt.  The lender is mostly concerned with getting paid back.  Obviously the current economic climate and the lack of DOS clause enforcement speaks to that concept.

To truly understand when it is in the best interest of the lender to enforce such a clause all we have to do is look at when and why the clause came into existence.  In the 1970's interest rates started to rise.  The clause was written into security instruments to stifle the assumption of loans against the rise in interest rates.  As an incentive to transact with a seller, if the seller had say a 7.0% interest rate they offered the assumption of their loan while new originations in the market were at 12.0% (yea, the 1980's were not interest rate friendly)  This had two fundamental consequences, one was lenders were loosing control of the party responsible for payments.  An assuming buyer may not be as credit worthy as the previous borrower.  The second consequence was lenders not being able to recoup principal and then re-issue the principal at current market rates.

So the fight over DOS then started and was settled by an act of congress known as "Garn-St. Germain Federal Depositary Institutions Act" in the early 1980's.  The act solidified the ability of a lender to enforce the DOS despite state statue to the contrary.  You can view the act along with the exceptions to the rule here: http://www.law.cornell.edu/uscode/text/12/1701j-3

Following that later in the 1980's (1986 to 1989) FHA loans and VA loans established and enforced strict rules around the capability of their loans to be assumed.  These loan types do not have a DOS clause and do allow for assumption.  Most other residential conventional loans have the DOS clause and thus do not allow for assumption.

So now we have an idea of when and why but how does that relate today?  Certainly millions of subject to transactions take place and involve real estate agents, attorneys as well as unlicensed public.  The lender has two remedies in theory to the event which would be civil suite (it is not a criminal offense) and foreclosure.  A lender in order to prove a civil suite against a borrower or agent or attorney would have to prove "tortious interference with contract".  The layman's version of that is interfering with a contract, which is what a mortgage or deed of trust is.  The problem with proving this would include a duty to the borrower to notify the lender of transfer and that duty is not present in the document or clause.  Further, a counter concept to the suit would be that the borrower has multiple other options to breach their contract with the buyer aside from DOS which would include just stopping to pay and walking away.

So not too likely to see too much civil suit action around this clause.  The likely and most reasonable remedy would simply be accelerate the loan and call it all due.  In the event of failure to pay the lender could enforce their right to foreclose.

So to come full circle back to why very little of these clauses are enforced in today's market it starts to become a bit obvious.   The large number of foreclosures in the market and the current market rate of mortgages drives the lenders away from wanting to enforce the clause CURRENTLY.  A common statement amongst folks in finance, there is but one guarantee I can make and that is the market will go up and the market will go down.  As long as current interest rates remain lower in relation to past rates the incentive is not high for lenders to enforce the clause. For those with foreshadowing skills, as rates rise, whenever they do, the incentive for enforcement on this clause will come back to head.  Interestingly enough at that time there maybe such a large number of subject to transactions in the market place that additional concepts may have to be introduced into the Garn Act or clause as I doubt we as a nation want to go from one foreclosure pit to the next.

Bill Gulley · Answer

And as opinions go. While giving notice is not required it is part of the legal chess game to make it more difficult for any lender to accelerate the obligation after they have given consent to the transaction, with consent being given by silence over a period of time. But this ploy can only be used if notice is given.

It goes like this; Hey lender, next Monday I'm buying this house subject to!

Lender never replies, they say nothing and accept the next payment due.

9 months go by and the lender sends a notice saying, hey,you aren't the owner of that place anymore and we want all our money under this due on sale clause.

Then you call them up and say, hey banker, we gave you notice and you never objected! Your keeping quiet for so long constitutes acceptance of this arrangement. In fact, you kept accepting payments without objection. Your original borrower is still responsible as initially agreed and there is no change in your risk in this loan, our deal is with your borrower, not the bank. Further, your interest rate exposure (what ya get) has not changed and current rates are less, so ya can't yell about that and after all, that's why the DOS was initially put in place! You accepted the transaction! Our deal will be over in 4 more months as the property is scheduled to be sold!

Then, the bank gets quiet again and accepts the next payment.

Actually, this has worked and it's why you give notice.

Dion DePaoli · Answer

Bill Gulley and with that clarity of post I am in agreement with you in full.  Which I add is why I continually give you the respect you deserve.

Dion DePaoli · Answer

Bill Gulley, I respect the hell out of you but to assume some minor skill set of the posters here is not always a correct assumption.  I have been Director of Operations and Principal Broker for a correspondent lender with a warehouse line, appraisal company and title company.  Additionally, I have been the senior portfolio manager of $85 MM AUM for a investment fund which primarily invested in mortgages and real property and in that role was the primary decision maker.  Albeit, your experience with FDIC is a feather in your hat which I can not claim, my regulatory and compliance experience stems from my interaction from hiring folks like you for consultation.  Our servicing contracts were restrictive to ensure all decisions were made in our house and only carried out through my servicers.  We did not use a servicer who guaranteed payments.  We used in house and external attorneys, one of which is counsel to FDIC matters.

That said, I have foreclosed in judicial states based on DOS.  I will add we didn't have any notice of transfer from any party to the transfer but I have never been made aware that would change the rights as mortgagee we had.  Your point is during your serving years, you managed to negotiate the mortgagee to a place of comfort to not pursue DOS.  I would agree in some cases it is practice to let the subject to continue but that is not always.  In one of our instances we had a church in the middle of the deal and still foreclosed with the blessing of the mentioned external counsel.

Certainly there is some emotion which follows the "was I duped?" initial discovery.  But I believe there are justifiable reasons to pursue DOS.  The majority of that is getting past the emotion and objective reviewing the file condition and overall plan of the subject to.  A couple of the files we pursued were straw buyer files and it was in out best interest to pursue FCL.  A benefit to some of those was the occupant had interest in obtaining the property once it became REO.  In that sense, the subject to found us our buyer and I said thank you into space at closing.  In other situations where we did not believe in the likelihood of a permanent finance structure replacing the subject to in short term we pursued our rights to foreclose.  This view was also echoed with our trading counter parties as subject to is treated as an investment property carrying a little more of a discount.  This is aside from the situations where the loan went delinquent or non-performing and in a couple instances we invoked our assignment of leases and rents within the security instrument.

So from my experience, DOS enforcement is still a matter of mortgagee preference and I personally do not know of any legal obstruction to enforcing that right.

Bill Gulley · Answer

Obviously, those who argue this have not actually been in a situation where a lender threatened to invoke the DOS. Now all the folks who love to look for case law and find that there isn't any you might ask why that is.

If a lender invokes the DOS it is as a violation of the DOT and the remedy is to proceed to foreclosure, which is a non-judicial process that means most often it never goes to court. For the issue to get to court, the borrower has to file suit.

Here are my actual experiences with the matter. First of all, you can't really put me in the same seat as most all other investors. I have yet to meet anyone on BP or any other RE site that owned a mortgage company that serviced loans. Yes, there are a bunch of "loan officer types" there may be someone who works for a bank who works in operations, but I don't think they are the director of servicing opertations and make the call on such issues related to the DOS.

So far all the discussions on BP about the DOS have been with investors, Realtors and lower level bank or lender employees that state opinion without experiences in the matter. We have had this discussion before on BP and no one said I lost my property over this issue to my knowledge. Not trying to be demeaning in any way, everyone has opinions and I believe in this matter those opinions are formed by what they have researched and that's okay.

Now, from the trenches of servicing thousands of obligations and as the first servicer in the midwest of privately held obligations, I had to address the DOS issue several times a year with Sub-2s, contract-for deeds and other installment arrangements.

Most all of those issues were taken car of on the phone, not in court. The discussions are close to what I mentioned above.

There are basically two ways a lender begins to investigate or start the DOS issue with their borrower, formally and informally, a registered letter or a phone call. I found the best way to answer such inquiries of initial deamands was with a phone call or, with me taking my time and going over to the lender if they were local and meeting face to face.

Now, what is unusual that no one here has experienced is the fact that a third party servicer has gotten involved presenting the contracts being administered. This makes a big difference to an underlying lender, the transaction is not what they initially thought, it was not two individuals doing something between themselves who have no real estate lending knowledge. So, it would not be accurate to say experiences by investors would be the same as mine.

In the beginning, we did not give notice on installment deals and simply filed documents for record as appropriate. In those instances where a lender talked about the DOS the only leg we had to stand on was that the issue was being professionally serviced and guaranteed.

Sorry, failed to mention that we guaranteed payments and had the right to step in the shoes of the note holder, secure the collateral and dispose of it paying the amounts remaining.

Under those circumstances our and my contracts were not such a critical issue that any lender continued with the DOS, that includes BoA several times, Wells Fargo, Citi Corp and many others. 
Sometimes they wanted to see the docs related to the deal, those were provided. I know that in some instances the issue went to a legal department of the lender and we would discuss the issues. They chose not to continue with what absolute right they had to make a demand.

Later on, we began giving notice and heading these issues off early instead of having problems arise later on. I found that doing so there was usually no immediate response. We also used three attorneys, one in St.Louis, one in KC and one here in town. I mention that because it was their opion, not that of a loan officer, that we should defend such issues using their acceptance by not acting in a timely manner after having benn given notice. So I did.

In those matters when I brought up the defense some lenders I spoke to acted as if they were not impressed but after going through and giving in depth details, they simply fell silent and did nothing. Some lenders thought they had been had by not acting and let go of the issue. I had more success in defending the matter when I gave notice.

And another "unfair" point that might have helped me in keeping the wolves at bay was that when I spoke to another lender I could do so as a past FDIC Bank Examiner speaking their language and showing concerns for their position, protecting their collateral and guaranteeing the transaction. I say unfair because I only know of one other regulator on BP and others here won't have that advantage, so it's unique and not at all like the transactions done by investors.

Now, I can't say I always won either (I did in the end, but with problems) there were about five times where I simply agreed to payoff the underlying lender as I did bump into a few hard noses, BoA in KC, a state bank in Little Rock and some secondary market servicers, Lincoln Service. Time periods varied but probably about 6 months on the average, none sooner than 3 months as I recall.

But over the years, holding these deals together with DOS concerns more than 90% of the time has been my experience. And it was easier to accomplish by giving notice. It also adds to the integrity of the deal and not conducting business in a manner that could appear to be doing something sneaky, that tics off a lender.

I'm sorry this is so long and I have never spilled the beans like this before. So hopefully you can all see that wit respect  to these issues, I'm not giving an opinion so much as I am advising based on actual experience and that experience is unique, not at all like that the average investor will bump into. That's also why I strongly suggest the use of servicers on such deals!

Dion DePaoli · Answer

K. Marie Poe we must have been posting at the same time.  Ironically we draw the same conclusion.  IMO, this concept is a myth and has no legal foundation.  I would even point to the case law leading up to the Garn Act as actual support on how it is truly a myth, the essence of the law is that the lenders did not give consent in writing just as the typical clause states.

It is one thing to ignore or knowingly ignore but it seems incorrect to pretend some new set of rules or rights emerged around DOS.

Dion DePaoli · Answer

Bill Gulley, while that is common thought around ethical practice and common belief about outcome I am not sure it carries true merit.  Let us debate a bit.

Consent assumed through silence is not consent.  Contracts can not be imposed by silence.  Felthouse v Bindley 1862 - Tacit consent brought to light that concept.  So the lender's lack of response is not grounds for acceptance of the transfer.

That said, performance is a form of consent.  The question then becomes is there some performance done by the lender which consents or is there some waiver of right to accelerate and foreclose?  This would seem to only relate to the payments received and accepted.

Let's deal with the waiver first.  Until Notice of Default is issued the act of waiving rights to foreclose couldn't take effect.  The function of taking payments even in waiver to foreclosure is, as you know, not as straight forward as it sounds.  Upon immediate "re-notice" of balance due a partial payment is not considered a waiver.

Further, the act of receiving a timely payment (which is presumably what the subject to payment would be) is not a waiver of any rights of the lender.  So how could real justification for acceptance of payments make the case for acceptance of the transfer?

On other side note, in the example where "you" was the assuming party.  That party has no affinity to the mortgagee, they are not a party to the mortgage contract to begin with.  How could they create any obligation or contractual relationship or amend a contract relationship they have nothing to do with?  It would be more like someone in Nigeria saying "Hey tomorrow I am selling your house".  Which sort of also supports the failure of silence is consent.  Would you respond to the guy in Nigeria?  (think of all the spam to follow)

The fact of the matter is there is not that much case law to support this claim of silence or notice to be true.  I would then hold true that in the future it would be possible for the lender to accelerate and foreclose within their rights with little to stop them.  This is the risk the seller takes in that they are the one who is foreclosed and the buyer takes in loosing their equity.

Account Closed · Answer

In CA, there is no such case law that I've found.  A deed of trust lives virtually forever and statute of limitations do not apply.

Account Closed · Answer

I think the big deal about DOS, if there is one, is the randomness if and when it happens. Almost every discussion on message boards about DOS suggests that lenders don't prefer to foreclose, they just want to be paid, and that DOS is rare.  It think it's unwise to depend on logic or some projected idea of what lenders want or need.  Lenders have all kinds of systems in place that audit title and that will trigger DOS, regardless of how upside down it is, regardless if the payments are being made on time and there has never been a default.  You don't know what the lenders are focusing on to preserve and secure their collateral.  Many of us already know and have plenty of experience that different departments at the big banks don't communicate with each other.  The title audit people don't check with the account people who don't check with the loan mod people who don't check with the BK dept.
Maybe no one here knows of any loans called due?  Well, I do.  So far, none of them have been on my props.  But I've planned for it.

I have a deed of trust right in front me, from a property I bought subject to a few weeks ago, that has additional clauses that allow the lender to invoke DOS upon "abandonment" of the property.  In this deed of trust, the property is considered abandoned if the borrower is no longer using it as their primary residence.  That abandonment allows the lender to call the loan due, regards of loan status, and to enter and secure the property against the borrower.  That's incredibly extreme and there may be state laws that override that clause.  Regardless, the deed of trust spells out terms to protect the lender's collateral and they should not be ignored.

I've done quite a bit of research to find case law or any example that giving notice to the lender somehow bars them from invoking DOS after a certain amount of time.  I have found none, and certainly not in CA, which is a trust deed state.  In fact, the deed of trust in front of me specifically states that not acting upon default or notice of transfer waives nothing.  The lender give themselves all the time in the world to foreclose or not foreclose.  There are no time barriers to DOS, whether they are noticed or not.

Just a fact of life in sub-2 land.  I have no problem with it.

Todd Ebach · Answer

From 1985 until 2005, I worked in mortgage banking in REO, Loss Mitigation and Foreclosures.  I worked for several mortgage companies, including the largest one in the country.  I can honestly say that I did not encounter one foreclosure that was triggered by a DOS clause.

Most people in mortgage servicing would not even know what a DOS clause is.  They are robots.  Payments come in, they pull up the loan number and apply the payment.  All they are concerned about is getting the work off their desks.

Things may have changed since 2005 but I highly doubt it.  If you really want to be safe, just have a back plan in place just in case but I would say odds are very low.

Dion DePaoli · Answer

Thanks, J  Scott, this has, in a short amount of posts I might add, been a fairly robust conversation around the topic thanks to Bill Gulley and K. Marie Poe.  Well done.

Due On Sale Clause - Misunderstood?

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