contract for deed as a mortgage: The case for the restatement approach, The

Brigham Young University Law Review, 1998 by Nelson, Grant S

Grant S. Nelson*

I. INTRODUCTION

My interest in the contract for deed goes back to early childhood in Minnesota. I can remember as a child of six or seven listening to my parents bemoan the fact that they were purchasing their first home on such a contract. They envied their neighbors, most of whom were "lucky" enough to be financing their house purchases with mortgages. My parents were unable to come up with a large enough down payment for a conventional mortgage. Nor did my father qualify for a "no-down-payment" loan guaranteed by the Veterans Administration. Instead, the seller agreed to take back a contract for deed. Why were they so apprehensive about doing this? Why did they find a mortgage comparatively so appealing? While I clearly did not understand the details, I can remember my mother telling me that if they ever had trouble making the payments, they would lose the house faster with a contract for deed than with a mortgage. A few years later my parents were clearly happy and relieved when a somewhat lower contract balance and market appreciation enabled them to refinance the house with a traditional mortgage. I next remember confronting the contract for deed in Professor Terry Sandalow's second year law school course in Real Estate Transactions and being both intrigued and confused by whether it should be governed by its contract language form or its mortgage financing substance. Little did I know then that within a few years it would assume a major role in my professional career as a lawyer and academic.1

For most of this century, the contract for deed has been the most pervasively used substitute for the mortgage or deed of trust. First, some terminology is important. Depending on the jurisdiction, this financing device is also called an "installment land contract," an "installment sale contract," a "bond for deed" or a along-term land contract." A contract for deed is not an "earnest money contract" or a "binder." The latter device is simply an executory contract for the sale of land and does not serve a mortgage function; rather, it governs the rights and obligations of the parties during the short period between the time of its signing and the closing of the transaction. At the closing, a deed is delivered to the purchaser who usually executes and delivers a purchase money mortgage to an institutional lender or, in some situations, to the vendor. Indeed, it is usually at this stage that a contract for deed is executed to serve as a substitute for a mortgage to the vendor. While a precise definition of the contract for deed is elusive, it is perhaps appropriately described as "a contract for the purchase and sale of real estate under which the purchaser acquires the immediate right to possession . . . and the vendor defers delivery of a deed until a later time to secure all or part of the purchase price."2

From an economic perspective, the contract for deed thus serves the same purpose as a vendor purchase money mortgage. Both devices provide security for a seller of real estate who finances all or a part of the purchase price. In a typical contract for deed transaction, the vendee takes possession and makes monthly payments of principal and interest on the contract obligation until the contract is paid off. This amortization period may vary from a few years to twenty years or more. The vendor conveys legal title to the vendee only after the full contract obligation has been satisfied. During this contract period, the vendee is required to perform the normal obligations associated with being a mortgagor in possession. These include payment of real estate taxes, maintenance of casualty insurance, and keeping the property in good repair.

Vendors have traditionally favored contracts for deed over purchase money mortgages or deeds of trust. Why this preference for a nontraditional financing device when it serves the same economic function as its well-established mortgage counterpart? The answer lies in the forfeiture clause found in virtually every contract for deed. This language makes "time of the essence" and provides that when a purchaser fails to comply with the terms of the contract, the vendor has the option to declare it terminated, to retake possession of the premises, and to retain the purchaser's prior payments as liquidated damages. To the extent that the forfeiture provision is effective, the contract for deed enables the vendor to avoid the purchaser's equity of redemption, the foreclosure process, and other traditional protections afforded to debtors under the law of mortgages.

This attempt to avoid the consequences of mortgage law is hardly unique in our legal history. For example, lenders for centuries have used as a security device an absolute deed from the borrower to the lender that contains no defeasance language. This deed is accompanied by an oral or written side agreement by which the lender-grantee agrees to reconvey the property to the borrower if the debt is satisfied. If, on the other hand, the borrower fails to pay as promised, the parties agree that the deed becomes absolute, and the borrower's interest in the land is terminated. Under the "conditional sale" variant on the absolute deed transaction, the deed may be accompanied by a second written document which purports to give the borrowergrantor either the option or contractual obligation to purchase the real estate described in the absolute deed. Courts have long been unsympathetic to these two attempts to circumvent the law of mortgages. Indeed, they have long permitted the grantor in each case to establish by parol evidence that the parties intended a security transaction and, where this burden is satisfied, treated the arrangement as a mortgage.3