REAL ESTATE LAW PRACTICE “KEYPOINTS”

(OCTOBER, 2002)

 

By Steven B. Bashaw

Steven B.  Bashaw, P.C.

Suite 1012

1301West 22nd Street

Oak Brook, Illinois  60523

Tel.: (630) 472-9990

Fax.: (630) 472-9993

e-mail:  sbashaw @bashawlaw.com

(Copyright 2002- All Rights Reserved)

 

In addition to encouragement from the Illinois Institute of Continuing Legal Education and the Illinois State Bar Association’s Real Estate Section Council,  it should be noted that Chicago Title Insurance Company helps underwrite the monthly production of these real estate law “Keypoints”. Chicago Title is committed to the role of attorneys in real estate transactions and their continuing education in this area.  Its staff attorneys are pleased to offer their view points on various developments in the law as set forth below from the perspective of a title company serving the public and the attorneys who represent their clients in real estate transactions.

 

1.  INJUNCTIONS; WATER FLOW AND DRAINAGE RIGHTS, DISPLACEMENT VERSUS IMPEDING THE NATURAL FLOW OF WATER: 

There can be no question that controversies relating to water run-off onto adjacent properties in urban and suburban areas are becoming more prevalent.  Landscaping which diverts the natural flow of water and affects neighboring property is common place.  Large scale developments displace a great deal of land surface that once absorbed rainfall and runoff with concrete and parking areas. Real estate practitioners need to update their understanding of the problem and laws surrounding these issues.  The recent case of Sparks v. Gray, (5th Dist., September 24, 2002), http://www.state.il.us/court/Opinions/AppellateCourt/2002/5thDistrict/September/Html/5000382.htm is a good starting point.

Sparks brought a suit against his neighbors, the Grays, due to a alterations Gray made to their property,  seeking to enjoin the  alteration of  the natural flow of water which resulted in flooding on Sparks’ property.  Sparks  alleged that Gray placed dirt fill on their property raising the surface level, and constructed a levy/dam so that water flowed onto the Sparks’ parcel. They also complained that Gray’s actions affected the operation of  “flap gates” in the ditches between the parcels which were designed to drain water into a canal constructed near the interstate highway. As a result of the fill and resulting water flow , the “flap gates” were overwhelmed and did not function, which then caused water to overflowed on to Sparks’ land.

The trial court granted the injunction and ordered that Gray no longer diverted water into the ditch at a time when the water would overflow onto Sparks’ property and enjoined defendants from placing further fill on their property.  The Fifth District reversed on appeal.

The decision by Justice Welch notes that the parcels are in a low lying area known as the “American Bottoms” subject to retaining water and constituting a flood plain.  The local ordinances condition granting building permits for new structures on  a requirement that the ground floor of a new structure  have an elevation of at least 417 feet above sea level; representing the  height of the 100-year flood.  Gray’s property lies below that level, and Sparks approximately 6 feet above. In order to meet the condition for building, Gray began placing a significant amount of fill on his parcel to raise the level to 417 feet.  At the same time, there was a common ditch that drained from between the properties to a canal, and finally to a detention basin near the interstate highway.  There were “flap gates” in the ditches whose purpose was to facilitate the drainage into the detention areas.  When the ditch overflowed, however, the flap gates were held closed by the overflowing water and would not work properly to drain Sparks’ property to the same level in the canal and ditches, and water back-up would spread over the land.

Plaintiffs are entitled to a permanent injunction only where there is (1) a clear and ascertainable right in need of protection,  (2) irreparable harm will occur without an injunction, and (3) there is no adequate remedy at law. Here, the Court held, Sparks did not have a clear and ascertainable right in need of protection. While Illinois law prohibits an owner of real estate from impeding the natural flow of surface water from a dominant to a servient estate, and the owner of a servient parcel can not interfere with the dominant parcel’s drainage rights,  both Gray and Sparks were owners of  estates servient to the drainage canal,  rather than to each other. Gray’s action did not interfere with the natural flow of water to the canal by diverting water, causing it to back-up, or impounding the natural flow.  Rather, Gray simply raised the level of his land with fill and thereby displaced water.  The case is “about water displacement and not a case about impeding water’s natural flow or interfering with one’s drainage rights…The parties cite to no law, and we have found none, that prohibits a landowner from engaging in an act that merely results in water displacement while the same act does not impede the natural flow of water or interfere with one’s drainage rights….A finding to the contrary would produce absurd results.  It would allow an upper landowner to sue a lower landowner for sandbagging around his or her home during the time of a flood because the lower landowner’s actions result in the displacement of water to the detriment of the upper landowner….In the instant case, because defendants’ actions only result in the displacement of water and do not resulting in impeding its natural flow, plaintiff’s have failed to show that they possess a clear and protectable interest thereby entitling them to an injunction.”

 

2.  TAX DEEDS AND ADVERSE POSSESSION:

Real Estate Taxes are a primary lien, superior to all other liens.  When real estate is sold and a tax deed issued,  existing mortgages, judgments, and federal tax liens are all extinguished.  What happens to other interests in land, such as title acquired in the interim by adverse possession?  Killion v. Meeks, (Fifth Dist., September 18, 2002),  http://www.state.il.us/court/Opinions/AppellateCourt/2002/5thDistrict/September/Html/5010924.htm confirms the superior nature of the lien of real estate taxes by holding that a tax deed extinguishes the rights of an adverse possessor.

Defendant Meeks acquired title to the real estate by a quitclaim deed from the Marion County trustee, who had acquired the land by a tax deed. Maurice and Nina Killion owned an adjacent parcel of land and claimed that they had acquired ownership of a 18  by 207.5 foot portion of  defendant’s property by adverse possession, claiming to have been in open, notorious, and continuous use of the property for a period of more than 20 years.

In a case of first impression, the decision holding in favor of Meeks begins with a recitation of the history of legislative enactments and amendments affecting the title acquired by a tax deed. Section 266b added in 1965, (now 35 ILCS 200/22-70), provides that a tax deed shall not extinguish or  affect easements, covenants, conditions, restrictions running with the land, or rights of way for utility or public service use.  Nonetheless, there is a “strong public policy statement which the several amendments to the Revenue Act represent, in encouraging the recognition, validity[,] and commercial acceptability of tax deeds…”  Section 22-55 of the Tax Code provides that tax deeds are intended to convey merchantable title and the law is to be liberally construed to that end.  While the Code does provide that a tax deed will not extinguish easements and covenants that run with the land, there is no provision suggesting an intent to provide protection to one who claims by adverse possession from the impact of a tax deed.  Accordingly, “the proper issuance of a tax deed extinguishes the claims of the adverse possessor.”

 

3. PREMISES LIABILITY; SIDE WALK CAFES:

Over the last few years almost every restaurant and café with street frontage has bought a set of tables and chairs to set out front for summer night dinning.  There are, of course, the issues relating to property lines and local ordinances governing outside dinning, but of interest this month is a case relating to premises liability for personal injury due to the condition of the sidewalk next to the café seating area.  In Friedman v. City of Chicago, Main Street and Main Incorporated, d/b/a Red fish Restaurant and State and Kinzie Associates, (1st Dist., September 17, 2002), a suit was filed when Ms. Friedman fell on the sidewalk outside the Red Fish Restaurant at the corner of State and Kinzie Street in Chicago. The restaurant had erected a barrier for an outdoor eating area that took over a portion of the sidewalk.  When the Plaintiff walked around the barrier, she fell on a cracked and uneven portion of the sidewalk.  Her suit alleged that the restaurant and its owners were responsible due to an agreement with the City of Chicago to occupy, manage, and control the sidewalk area.  The Plaintiff asserted that the Defendants assumed the duty to maintain and repair the sidewalk by contractually exerting control over the area.  The trial court found that if the Defendants have a duty to maintain the sidewalk, that duty extended only to the portion of the sidewalk they were actually using and not to the entire sidewalk.

Noting that the restaurant was required to provide a reasonably safe means of ingress and egress, but ordinarily will not be responsible for injuries on a public sidewalk under the control of the city, the First District reversed nonetheless and remanded to  the trial court.   Because the sidewalk is used for ingress and egress, and the Defendants had appropriated a portion of the sidewalk for its business use, they were responsible to assure that their conduct did not place the public at a greater risk.  Referring to cases in which a laundry increased the risk of slipping on snow and ice by dragging large laundry baskets across the sidewalk, a passerby tripped over a roll of wire mesh which fell on the sidewalk in front of her during construction, and a canopy on a building over a sidewalk and six feet into the street which obscured vision, the court held that “by building over the public sidewalk and street for their own business purposes, the defendants subjected themselves to the duty to act with reasonable care toward anyone lawfully on the street….To be clear, we are not imposing a duty upon defendants to repair or maintain the public sidewalk.  We find that by sectioning off a portion of the sidewalk for use as an outdoor café’, the defendants subjected themselves to the duty to act with reasonable care toward anyone lawfully on the sidewalk.”  Whether the restaurant acted with that reasonable care was an issue of fact.  The trial court’s ruling that, as a matter of law, the restaurant was not responsible for any resulting condition on the abutting sidewalk not being used was an error.  Whether the restaurant breached its duty of  reasonable care  “should be left to a jury’.

 

4.  ZONING; EXPANSION OF AN EXISTING NONCONFORMING USE:

In Fisher v. Burstein, (2nd Dist., September 24, 2002),  http://www.state.il.us/court/Opinions/AppellateCourt/2002/2ndDistrict/September/Html/2010661.htm neighbors of the Chestnut Mountain Resort in Galena, Illinois, sought declaratory and injunctive relief against the resort to prohibit the expansion of the facility for the operation of a new snowboarding  and “Village Ski Center”  area on the east side of the mountain.   The resort was originally opened as a ski resort in 1959.  In 1995, the Joe Daviess County zoning ordinance limiting the use of structures on the property became applicable, with the exception  that “Uses lawfully established on the effective date of this Ordinance may be continued…”.  The neighboring landowners took the position  that the term “continued” as applied to the Defendant’s nonconforming use, did not permit the expansion of the use for the snowboard trails and center, but only allowed the existing uses to be “temporally” continued or maintained, not “spatially” developed or expanded.  The trial court disagreed and Second District affirmed.

A governmental body may restrict a nonconforming use to prohibit extension or expansion for public health, safety or welfare reasons, but must do so expressly by legislation. The Jo Daviess zoning ordinance did not contain a prohibition of the expansion of a nonconforming use.  “Under the principal of inclusio unius est exclusio alterius, the enumeration of an exclusion in  a statute or ordinance is construed as the exclusion of all other others…While the county could have imposed some similar restriction on the expansion of nonconforming uses, it did not do so, and we will not impose such a restriction on our own accord….In the absence of any explicit restriction on the expansion of a nonconforming use in the ordinance, we conclude that such expansion was not prohibited as a matter of law.”  The ordinance allowed nonconforming uses to continue, but did not expressly limit their expansion or development, and therefore did not prohibit the snowboarding park and Village Ski Center.

 

5.  MORTGAGES; ARBITRATION AND DOCUMENT CONSTRUCTION:

In Dannewitz  v. Equicredit Corporation of America, (1st Dist.,  September 5, 2002), http://www.state.il.us/court/Opinions/AppellateCourt/2002/1stDistrict/August/Html/1020858.htm, Douglas and Ellyn Dannewitz brought suit against Equicredit Corporation of America for imposing an allegedly unlawful prepayment penalty on their residential mortgage.  Equicredit filed a motion to dismiss based upon the provision contained in the mortgage that “any Claim shall be resolved, upon the election of your or us, by binding arbitration pursuant to this Arbitration Agreement.”  The original mortgage was made by and between Dannewitz and HomeGold, Incorporated.  HomeGold thereafter sold the note and assigned the mortgage to Equicredit.  The issue before the trial court was whether Equicredit was entitled to elect arbitration as the assignee of HomeGold under the definition of “us” in the document.  Equicredit argued that it fell within that definition as an assignee of HomeGold.   Dannewitz argued that Equicredit was not defined as “us” in the agreement, and as an assignee of HomeGold,  Equicredit could only compel arbitration if is was named as a co-defendant in an action against one of the entities defined as “us” in the document according to its terms.   The trial court found that there was an inconsistency in the document between differing provisions of who could compel arbitration, resolved the inconsistency in favor of Dannewitz, and denied Equicredit’s motion to dismiss and compel arbitration.

The First District affirmed finding that there was an inconsistency in the mortgage provisions relating to who could compel arbitration under what circumstances and noted that “an ambiguity or inconsistency in the mortgage must be construed against the lender”. The Court also  rejected the argument that Equicredit was a third party beneficiary of the arbitration clause stating that “defendant is not an intended beneficiary…Here, the issue is whether plaintiffs can be compelled to arbitrate with the assignee of the entity with which they first agreed to arbitrate”, and because  of the inconsistency clouded the intent of the parties, the document must be construed against the lender, The trial court’s denial of the motion to dismiss was affirmed.

 

6.  RESCISSION; TRUTH IN LENDING AND RETURN OF PRINCIPAL:

In Regency Savings Bank v. Chavis, (2nd Dist., September, 2002), http://www.state.il.us/court/Opinions/AppellateCourt/2002/2ndDistrict/September/Html/2011321.htm Sigmund J. Chavis and Harriet Chavis appealed the sale confirmation at the end of a long and tortured mortgage foreclosure.  Initially, the trial court in Lake County found that Chavis was entitled to rescind the mortgage and note because they were not provided with documentation of the right of rescission under Truth in Lending.  The trial court also held that rescission would be conditioned upon Chavis’ return of $349,572.00 to Regency Savings Bank as  a refund of the principal loan amount.  Defendants failed to make the tender within 29 days as originally ordered, and still did not tender the funds over a five month period during which post judgment motions were pending. The trial court then entered a judgment of foreclosure, and approved the sale which followed.

Defendant’s appeal contended that the trial court had no authority under Truth in Lending to condition the rescission on the return of the principal of the loan. The Second District rejected this theory.  Truth in Lending, (15 U.S.C. 1635), provides that a security interest becomes void upon rescission, and “places the consumer in a much stronger bargaining position than the consumer enjoys under the traditional rules of rescission” because it alters the common law requirement that the rescinding party tender the property he has  received before the contract is void and rescinded. Nonetheless, the statute provides for the return of the property to the creditor and expressly provides that “the procedures prescribed by this subsection shall apply except when otherwise ordered by a court.”  (15 USC 1635(b) )  The clear intention of the Congress is to return the parties to the position the had been in prior to the transaction following rescission.  Additionally, Illinois Courts have previously held that the trial court has authority to order the defendant to return to the plaintiff all property which the defendant had received in the transaction as a condition of providing rescission as equitable relief “to avoid the perpetration of stark inequity”.  While Truth in Lending may be read to not impose return as a condition of rescission, this is “not a realistic recognition of the full scope of the statutory scheme”, and while rescission itself may be complete at the time of notice, the courts have the power to “otherwise order”  conditions for completion of the remedy.   Here, the Court granted rescission, but given the equitable considerations required that the security interest remain in place until the principal was paid.  When payment was not forth coming, (and the Defendants did not tender payment over the next five months during post trial motions), the court’s equitable powers allowed the entry of judgment and sale of the property.

 

7.  MORTGAGE FORECLOSURE; FIXTURES AND TRADE FIXTURES:

Joseph Dietl took over operation of the family farm on his father’s death in 1978, and cared for his mother until her death in 1998.  In 1997, as guardian of her person, Joseph obtained a loan secured by a mortgage on the family farm.  The mortgage specifically provided that the security included all improvements and fixtures on the property.  When Dietl defaulted on the mortgage,  the lender filed a foreclosure action.  In the proceeding, all notices and publications described the property as the land and including all improvements and fixtures on the land. A judgment was entered, and at the sale, Nokomis Quarry Company was the highest bidder and obtained a sheriff’s deed to the property.  The deed did not specifically mention the fixtures, and at the sale, Joseph Dietl advised Nokomis that he was in possession of the property by virtue of a lease with his mother to farm the land.  At the time of confirmation of the sale, by the agreement of the parties, the award of possession to Nokomis as the successful bidder was modified to acknowledge Joseph’s leasehold interest and provided that he could continue to farm the  land until December 31st, at which time he would owe Nokomis $8,000 in rent and be required to vacate the property.  In the seven month period between the confirmation of sale and December 31st,  Joseph remove the tops of grain silos, a one-car garage building, an egg-house building, a storage building, and fencing.  

Nokomis brought suit against Joseph for damages resulting from the removal of these items claiming that they were fixtures that were included in the sale.  Joseph defended asserting that since they were used in the trade or business of farming and he was a tenant/farmer that the items were ‘trade fixtures’ and he  could therefore remove them.  The trial court ruled against Joseph.  The Fifth District in Nokomis Quarry Company v. Dietl, (5th Dist., August, 2002).   http://www.state.il.us/court/Opinions/AppellateCourt/2002/5thDistrict/August/Html/5010740.htm affirmed, finding that the fixtures were not ‘trade fixtures’ and properly foreclosed.

The tests for determining it an item is personal property or a fixture is  (1) the intent of the annexor, (2) the method and nature of attachment, and (3) its adaptation to the premises.   “Intent is the critical factor”, and here there was no doubt that Joseph’s parents intended the items to become permanent improvements and  affixed to the real estate.  While a tenant can remove personal property he installs on property that would have otherwise become a fixture due to intent, annexation, or adaptation if the item is used in a trade or business, the property here pre-dated Joseph’s lease and was not installed by him as the tenant, but by his parents as the owners.  Accordingly, the property constituted fixtures which were not trade fixtures.  Finally, the mortgage which pledged all fixtures on the property pre-dated the lease. When Joseph obtained the lease from his mother, the fixtures at issue had already been pledged by the mortgage and, since Joseph could only obtain that which his landlord/mother  retained, any interest he had in the fixtures as a tenant was subject to the mortgage of those fixtures.   He could not obtain greater rights in either the real estate or the fixtures than his mother had.   Because fixtures are conveyed as part of the real estate, the Sheriff’s deed need not specifically reference the conveyance of the fixtures.  Conveyance of the land transfers the real estate and all fixtures, unless specifically excluded.

 

8. RESPA; NEW  REGULATIONS PROPOSED WITH  COMMENTS:

As recently noted in the ISBA Legislative Update materials,  http://www.isba.org/Legislative/, the Secretary of Housing and Urban Development is soliciting comments on the new proposed RESPA regulations  though October 28, 2002.    The proposed rules and comments can be viewed at http://www.hud.gov/offices/ogc/respa.cfm.

Noting that "Americans spend approximately $50 billion each year on settlement costs without knowing exactly what they are paying for or having the opportunity to shop effectively for the best mortgage to suit their needs," and that "The Bush Administration believes it is time to take the confusion and uncertainty out of the home buying process by making loan shopping and settlement less frustrating and more understandable and ultimately, less costly.", HUD says that the major thrust of the new regulations are to implement a “Homebuyer’s Bill of Rights” based on the stated principals that homebuyer’s have a right:

To receive settlement cost information early in the process, allowing them to shop for the mortgage product and settlement services that best meet their needs;

To meet these principles, HUD states that the regulations would reform the home buying process by altering the current RESPA procedure by :

The primary focus appears to be on the fees and costs paid to or incurred by the mortgage broker in the transaction and the perceived confusing nature of the Good Faith Estimate.

In response, the ISBA Real Estate Section Council, in conjunction with IRELA members and officers, have formulated the following comments, which are under consideration for approval by the ISBA Board of Governors:

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The undersigned, for themselves and on behalf of the Illinois State Bar Association, provide the following comments to the above-referenced proposed rule published in the Federal Register at Volume 67, number 145, pp. 49134-49174 (Monday, July 29, 2002).

In general, the undersigned opposed the proposed changes because the proposed cure to the perceived problem creates more problems and is worse for the consumer than the original problem.  While we recognize that the process of financing or refinancing a home is complicated, the solution proposed by the Department of Housing and Urban Development in the proposed rule would not make any transaction any less complicated and will likely increase the costs and the risks to purchasers and borrowers. 

As we understand it, HUD has analyzed the current process and determined that:

1. Origination costs and fees paid to mortgage brokers are not adequately disclosed, and

2. There are several problems with the current regulations involving the Good Faith Estimate.

We find it curious that HUD recognizes, as we do, the failure to adequately disclose the brokerage fees paid to brokerage brokers, while criticizing the Good Faith Estimate process for making too much disclosure.  We strongly support additional disclosure - specifically, a full and complete description of the amount, and source of the mortgage broker's fee (whether it is hidden in the prospective interest charges due to a discount or paid out of the loan origination fee at the time of settlement).  

    The Good Faith Estimate and HUD’s Proposed Rule

With regard to the Good Faith Estimate, we understand that HUD is concerned that the current regulations are inadequate because the borrower only receives a Good Faith Estimate after the payment of the origination fee, which process, in the opinion of HUD, discourages shopping for loans from the various lenders.  It is also our understanding that HUD considers the current Good Faith Estimate process as providing unreliable information without sufficient disclosure to the extent that the current rules provide little guidance on how to create or provide the proposed settlement charges in the Good Faith Estimate.  It is also our understanding that  HUD is criticizing the current rules because they fail to highlight the major costs yet, according to HUD, the process of delineating each of the separate costs has led to, in HUD's opinion, a proliferation of additional charges (e.g., various “origination” fees, document preparation and document review fees) that are being incurred by Borrowers without any additional work by the Lender. We recognize the problem, and agree with HUD’s analysis, except to the extent that we remind the Department that neither HUD nor the Borrower would have known of the charges unless those charges had been specifically described on the Settlement Statement pursuant to current RESPA rules.   Mandated, detailed disclosure did not create the problem, unscrupulous lending practices did, and regulated disclosure requirements only brought the problem to the Department’s attention.

 On the one hand, we certainly agree that costs charged by lenders have proliferated, some of which appear to be self-indulgent, and we note that the Good Faith Estimate often times does not identify those charges.  This is a problem with the Lenders, and perhaps, the Department should regulate those document preparation and document review fees out of existence.  Indeed, in our experience, borrowers do not see those charges until those charges finally appear on the Settlement Statement at Closing.  Obviously, the Good Faith Estimate rules and procedures need to be standardized so that such charges will appear in the Good Faith Estimate, and the Good Faith Estimate could, as the Department suggests, be provided at the time of the application and before any origination fee is paid.  The Department’s proposed changes to the current rules regulating the Good Faith Estimate are reasonable, significant and relatively simple modifications within the Department’s statutory mandate from Congress.  And, to the extent that the Department considers the opportunity to shop for alternative loans as important, the proposed changes will provide the borrower with the opportunity, if he or she chooses, to shop for similar programs among the various lenders.

       Guaranteed Mortgage Package Agreements

The proposed Rule changes errantly assume that various third-party services are within the control of the Lender.  To the contrary, Lenders’ services do not include title insurance services, closing services, brokerage services, legal services, inspection services or appraisal services – and they should not, because those third-party services must be performed by independent, third-party service  providers to, and for the benefit of the Borrower-- not at the direction nor under the control (cost or otherwise) of the Lender.

Remember, the perceived problems were created by a few lenders -- not the Borrower or the independent, third-party service providers.  The third-party providers did not create or participate in the problem unless they sacrificed their independence, and acted in collusion with the Lenders -- a more insidious problem to be sure. 

Also, we do not agree that  itemization has been excessive, nor has itemization had any adverse effect on title or other third-party closing services.  As a matter of fact, independent third-party services are not currently within the control of the lenders - nor should they ever be.  HUD's proposed rule changes in creating the GMPA would create a vertical monopoly for those services, resulting in additional, largely unreviewable and undisclosed costs by design, which costs may not be for the required or necessary services that a Borrower may require, and which would not achieve the results intended.  In other words, title insurance and title services, settlement services, and related activities (appraisals, attorneys' services, real estate brokerage services, inspections, and the like) are designed to protect the Borrower and are only ancillary services to the Lender.

It is axiomatic that the Lender’s concerns in a real estate transaction are distinctly indifferent to the legitimate concerns of the Borrower and the Seller.  Indeed, sometimes, the concerns of each party are opposed.  No prudent Buyer/Borrower should ever rely on the scope of services that a Lender will require to close a loan because the Lender’s concerns are not synonymous with the concerns of the Buyer/Borrower or Seller.  There is no place on the Good Faith Estimate currently for those independent, third-party charges, nor should there ever be -- and, more importantly, those independent services should not be packaged or otherwise under the control of the Lender.  Those services are provided by independent service providers for the benefit of the borrower - not for the lender.  The Lender is the more sophisticated party at the closing table, and we have no doubt that Lenders are in a better position to seek modifications to those third-party ancillary services prepared by independent service providers for the benefit of the Seller and the Buyer/Borrower, than the reverse. 

It seems remarkably apparent to us who practice law on behalf of individual clients, that HUD's proposed rules assume that the Lender’s best interest is the paramount interest, and that the Lender is in complete control of all of the required settlement services, costs and procedures.  The Department’s position is naive.  The proposed rules will simply provide a safe haven for unscrupulous lenders who have compliant (not independent) service providers under their control, all to the ultimate detriment of Sellers and Buyer/Borrowers for whom those services were designed. 

We note with particular interest, that HUD has described industry and consumer advocates and supporting the proposed rules in order to "lower prices to borrowers." We have no doubt that Lenders, seeking to expand their businesses out of traditional lending into the so-called “ancillary” closing services, applaud the Proposed Rule because is provides them with cover.  Lower prices is almost never the appropriate consideration in analyzing ancillary settlement services.  If so, then, HUD could promote a rule that would prohibit charges for these “ancillary” services, thus dramatically lowering the costs associated with a Closing.  However, such a rule would push those formerly independent, third-party service providers out of the market, and those third-party services would not be available to Sellers, Buyer/Borrowers or to Lenders.  Accordingly, lending would become a very risky proposition, and many Lenders’ would either leave the market, or develop their own risk analysis mechanisms (e.g., higher interest rates or in-house title examinations, appraisals etc.) and the costs for that risk would be added to the loan to protect the additional risks involved to the Lender (which risks were created by an ill-advised rule change).  No one would support such a rule on its face, but that is precisely the risk that the Proposed Rule will inflict on Sellers and Buyer/Borrowers, and they do not have as powerful a lobby to protect their interests as do Lenders.

We fully expect that national third-party service providers will bid for the work, and because of the strength of their market power, they will likely underbid local, independent service providers. In the long run, the national providers will not be able to maintain that business at the artificially low rates, and, in response, they  will either cut the scope of the services they provide (to or for the benefit of the consumer –Sellers and Buyer/Borrowers) unchecked by any independent service provider, or after they have successfully captured the market at the expense of local providers, these national service providers  will raise the price for those services to artificially high rates to make up the difference – all under the protection of HUD’s Proposed Rule.  

Suffice to say, that these, at-risk,  independent, third-party services are not ancillary services to the Sellers and Buyer/Borrowers.  Those independent third-party services are essential services to Sellers and Buyer/Borrowers in the single biggest transaction of their lives.  Those services are “ancillary” only to the Lender, whose experience and sophistication will be available to protect their interests.  Accordingly, all of the Department’ efforts should be directed at maintaining the independence of those third-party closing services, and not providing any safe haven for packaging those services under the control of the Lender.  RESPA Section 8 should not be suspended or (in effect) amended by the Proposed Rule, because the statute is directed at keeping the settlement and closing process independent and available to protect the Buyer/Borrower from just the sort of problems that the GMPA will create and condone.

The most significant concern to the Buyer/ Borrower is the adequacy of the service for the particular transaction and  needs of the Buyer/Borrower.  Candidly, HUD's proposed rule changes, as sponsored by the so-called industry and consumer advocates, insidiously assumes that the settlement process is designed for the benefit of the lender, when the fact is, the settlement process is there to provide services for the benefit of the Borrower.  Making those services dependent upon and within the control of the Lender would provide overwhelming economic advantage to the lender at the expense of the Borrower.  Indeed, the reason the costs may be initially lower is because the services and independence that had been available to the Borrower is missing. 

For example, title insurance is not a function of the lending process.  To the contrary, each Seller in a real estate transaction (or borrower in a refinancing situation), must prove that he or she is in title to the property in order to perform the contractual obligations provided in the conveyancing section of the contract.  It is that party’s contractual obligation to prove and provide evidence that it is has sufficient  title to the property in order to perform its various obligations under the contract and support its contractual representations and warranties -- issues that are remarkably not a concern of the Lender.  Title insurance has become the preferred vehicle for parties to satisfy their contractual obligations.  HUD's proposed rules not only ignore this reality, but make a sham of it by suggesting ardently that lenders are in control or should be in control of this very vital contractual service that is provided well outside of the standard lender transaction. 

In short, HUD's proposed rule changes that provide for the packaging of services is short-sided, wrong and significantly ignores the rights and obligations of the real parties in a real estate transaction, and unnecessarily and inappropriately focuses unwarranted control to the Lender.  It is absolutely wrong to package these services, not only for the clear opportunity for illegal kick-backs (no matter what safe harbor is described) but clearly because the current horizontal system of independent service providers, while not always the most efficient method of proceeding, is the most protective of owners of real estate and prospective purchasers of real estate.  It is absurd to suggest that providing control of the process to the Lenders who created the problem is in any way appropriate.  

The undersigned strongly urges HUD to scrap the GMPA portion of the Proposed Rule and modify the current rules to reflect the modest changes in the Good Faith Estimate process identified above.  In our view, it is particularly offensive to consider that HUD would allow the packaging of these services without any itemization of the costs.  In our view, packaging the services would remove the independence of the third-party providers and failing to disclose the costs would bury any indication of the appropriate scope of the services provided by the formerly independent service providers.

Like real estate itself, each and every transaction is unique and the Department’s Proposed Rule ignores that reality it its attempt to provide a universal, albeit, ill-conceived standard.

The Department Does Not Have the Statutory or Constitutional Authority to Promulgate the Proposed Rule

Finally, we call into question HUD's legal authority to promulgate a rule providing for the packaging of lender's services as described in the Proposed Rule.  On the one hand, we recognize HUD's authority to modify the rule to make the changes in the Good Faith Estimate. On the other hand, we respectfully deny that the Department has the authority to suspend application of Section 8 of the Real Estate Settlement Procedures Act, and then to amend  the statute by the Proposed Rule.  The Department’s proposed administrative procedure is unconstitutional and in clear modifications the Department proposes to make in the current regulations promulgated pursuant to the Real Estate Settlement Procedures Act.  We recognize, however, that the Good Faith Estimate process is mired in uncertainty, and that the Department of Housing and Urban Development should spend its time preparing a formula and a process that applies across the country to adequately disclose the appropriate Lender's charges (exclusive of the so-called ancillary charges).  Disclosure should occur at an appropriate time to allow shopping. 

We strongly and adamantly disagree that so-called “ancillary” services are services provided exclusively to the lender or that the Lender should have any control over the charges for those services (title insurance, legal counsel, appraisals, inspections, brokerage services and the like). Those services must not be packaged by the lender or under the control of the lender if the integrity of the process is to be maintained to recognize that the process is there for the Sellers, Buyers and Borrowers primarily.

In addition, HUD's Proposed Rule is not only unconstitutional and in violation of its statutory authority and in violation of the Administrative Procedure Act, but the Proposed Rule seeks to modify substantive state law, and will unnecessarily and unlawfully conflict with contractual rights, duties and obligations of the parties in existing and prospective contracts for the sale, purchase and refinancing of real estate.  violation of the statutory authority provided to the Department by Congress in the enabling statute.  Furthermore, under the Administrative Procedure Act, the Department does not have the authority to establish the GMPA to the extent that the Proposed Rule exceeds the Department’s statutory authority and to the extent that the Proposed Rule is a de facto rescission of portions of the Real Estate Settlement Procedures Act, and only Congress can do so. 

In sum, we find little support for the remarkable and major and significant

We strongly urge the Department of Housing and Urban Development to reconsider the Proposed Rule, and reject the GMPA provisions and focus its attention on the Good Faith Estimate formula and practice.

John G. O’Brien

Joseph R. Fortunato, Jr.

William J. Anaya

 

9. TAXES; CAPITAL GAIN ON THE SALE OF PRINCIPAL RESIDENCE:

Some of us “mature” practitioners still get a little confused by our history when we think about the income tax implications of the sale of  a client’s residence.  In 1997, Congress eliminated capital gains taxes for most home sellers.  Prior to 1997 the tax code “deferred” capital gains on the sale of a principal residence, provided a new residence was purchased for the same or greater price within a specific period, by ‘rolling-over’ the gain into the sale into the new residence.  Most taxpayers would continue to ‘roll-over’ until they could claim an “exemption” on the gain from the sale of their residence after age 55.  In 1997, the tax code was amended to provide that each person can exclude as much as $250,000 of gain from the sale of a principal residence.  If married and filing jointly, a couple can exclude as much as $500,000.00 .  The only ‘hitch’ was that the property had to be owned and lived in as a primary residence for at least two of the last five years prior to the sale.  

A recent article in the Wall Street Journal pointed out that there are three exceptions to the two-year-rule, and that one of them may be a most timely exception following September 11, 2002. http://homes.wsj.com/buysell/mortgages/20020905-herman.html.  A seller may exclude up to $500,000 in gain from the sale of the residence even if the sale occurred before two years if the sale was due to (1) health reasons, (2) a change in place of employment, or (3) “unforeseen circumstances”.    The Department of Treasury and IRS are expected to issue an interpretation of the “unforeseen circumstances” provision of the Tax Code in the near future. Comments from the public have suggested that the exemption be granted regardless of less than two years of ownership/residence  if the sale is occasioned by the death of spouse, ‘man-made disasters’, divorce, or acts of war under the “unforeseen circumstances” provision.  Of obvious application are the situations of persons affected by the September 11 terrorist attacks, and it should certainly be appropriate to exclude gain on the sale of the residence of a person who lost a spouse or job due to the aftermath.

 

10. FROM THE TITLE COMPANY PERSPECTIVE; TENANCY BY THE ENTIRETY AFTER U.S. vs. Craft:

By now every real estate attorney has heard about the U.S. Supreme Court case UNITED STATES v. CRAFT.  After all, how often does the highest court in the land hear a real property issue? This was the decision, you will recall, where the court found that a spouse's interest in tenancy by the entirety property was subject to the federal revenue lien of that spouse.  This case offers a chance to review title insurance practices relative to tenancy by the entirety.

EXAMPLE: Husband and Wife want to buy a home with a purchase money mortgage. The title commitment discloses that there is a judgment against Husband. Husband and Wife will take title to the land as tenants by the entirety.

The title company will probably underwrite the judgment by showing the lien on the owner's policy.  But the title company may be willing (with the approval of the lender) to either endorse over the judgment or show the judgment on Part II, Schedule B of the loan policy, thereby insuring that the judgment is subordinate to the mortgage.  But it is important to understand that the title company is doing this because of the purchase money mortgage doctrine (a previously recorded judgment or lien is automatically subordinate to the lien of a subsequent purchase money mortgage) and not because title is held as tenants by the entirety.  In many respects the protection of tenancy by the entirety is illusory.   Consider the following example for an explanation:

EXAMPLE:  Husband and Wife own a home as tenants by the entirety.  The title commitment discloses that there is a judgment against Husband.  Husband and Wife want to refinance the existing mortgage on their property.

In this case the judgment will have to be paid off or otherwise underwritten.  The tenancy is of little use in this second example.  The judgment is still valid; it simply is not enforceable against the land as long as title to the property is held as tenants by the entirety.  But if Wife dies, the couple divorce, or the land ceases to be the couple's homestead, the tenancy ceases, and the protection of the tenancy ceases as well.   The heretofore inchoate judgment becomes an enforceable first lien that is superior to the refinance mortgage.  For this reason, when insuring a refinance or second mortgage, title companies are unwilling to waive a judgment or other lien from the loan policy simply because title to the land is held as tenants by the entirety.  Similarly, this is why the judgment will be an exception to any owner's title insurance policy that is issued, such as the policy referred to in the first example.

EXAMPLE:  Husband and Wife own a home as tenants by the entirety.  They decide to sell their home. The title commitment discloses that there is a federal tax lien against Husband.

Before the CRAFT decision, some title companies--assuming that the tenancy by the entirety was still in effect at the time of closing--might have considered waiving the federal tax lien upon a conveyance to a bona fide purchaser.  But now title companies must ignore the tenancy when underwriting federal tax lien issues.  On any sale (or refinance or second mortgage, of course), federal tax liens will have to be cleared from title in one of the traditional means.  For example:

A payment of the lien pursuant to a payoff letter from the IRS;

Release of the lien;

Certificate of discharge (this releases the lien, but only from the land in question);

Expiration of lien pursuant to the statute of limitations;

Title indemnity deposit with payment of lien post-closing.

When insuring the purchase of property, some title companies may continue to waive judgments or state tax liens against one seller spouse when the land has been continuously held in tenancy by the entirety by the married couple. But this underwriting philosophy is probably not absolute across the state. Attorneys should contact their title companies before closing when faced with this type of lien fact pattern.

Dick Bales

Chicago Title Insurance Company

Wheaton, Illinois