SECURITY INTERESTS IN contracts for deed

Northwestern Financial Review, Jun 15-Jun 30, 2004 by McCool, Brian S, Ranum, Mary S

In Minnesota, real property is frequently sold by contract for deed. With a contract for deed, the seller provides financing for the buyer's purchase of real property by agreeing to accept payments from the buyer over a period of time. In return, the seller retains an interest in the property that permits the seller to reclaim possession and fee ownership of the property if the buyer fails to meet its obligations.

The interests of the seller and the buyer under a contract for deed are valuable assets. Accordingly, as with any other asset of value, lenders frequently seek to take a pledge of contract for deed interests as collateral for loans. Contract for deed interests are characterized by law as both real estate and personal property. Proper perfection of a security interest can be complex, and this article will provide guidance on perfection and enforcement of security interests in contracts for deed.

SELLER'S INTEREST

Contract for deed sellers own both the fee title to the real estate, a real property interest, and a right to a stream of payments, a personal property interest. Under Revised Article 9 of the Uniform Commercial Code (RA9), the seller's right to receive the stream of payments under a contract for deed qualifies as an "account," a type of personal property. Because security interests in "accounts" are controlled by the provisions of RA9, any lender that accepts a pledge of a seller's interest under a contract for deed must follow these provisions.

Pursuant to RA9, a lender may obtain an enforceable security interest in the seller's interest through a "security agreement," executed by the seller, granting such a security interest to the lender. Typically, lenders will use a mortgage that also includes a security agreement that describes personal property collateral related to the real estate, including accounts receivable and other rights to payment. To perfect its security interest in the stream of payments, the lender must complete and file a financing statement in the state where the seller resides if the seller is an individual, or in the state of the seller's incorporation or formation if the seller is an entity. The lender should also record the mortgage in the county real estate records to establish its priority in the real estate.

In the event the contract seller/borrower defaults in its obligations to the lender, the remedies available to the lender will depend upon the status of the contract for deed. If at the time of the seller's loan default, the buyer has paid off the contract for deed, the lender will no longer have any collateral for its loan because the seller will have already provided the buyer a deed. Conversely, if prior to the seller's loan default, the contract for deed was canceled as a result of a default by the buyer, the seller will own the real estate and the lender's remedy will be to foreclose its mortgage.

If the contract for deed remains in effect when the lender seeks to enforce its remedies against the seller, the lender will need to enforce its security interest in accordance with RA9. RA9 requires that the lender complete and execute a "transfer statement," a document which sets forth that:

1 the seller has defaulted in its loan which is secured by the seller's interest in the contract for deed;

2 the lender is enforcing its post-default remedies with respect to the collateral; and

3 by exercising its remedies, the lender has acquired the seller's rights under the contract for deed.

This "transfer statement" also must include:

* the name and mailing address of the lender and the seller;

* the date of the contract for deed;

* the names of the parties to the contract for deed;

* the recording information for the contract for deed;

* the legal description of the real estate; and

* a statutory acknowledgment.

After executing a transfer statement containing all of the aforementioned information, the lender must record the statement in the county real estate records. Although the transfer statement is only signed by the lender, once recorded, the transfer statement is the equivalent of a deed and has the effect of transferring fee title from the seller to the lender. Thus, following this "conveyance," the lender will be entitled to collect the payments under the contract for deed and, in the event of a default by the buyer, cancel the contract for deed. If the buyer fully performs the obligations under the contract for deed, the lender/new fee owner must give a deed to the buyer in satisfaction of the contract for deed.

BUYER'S INTEREST

In contrast, a security interest in a buyer's interest is not subject to the provisions of RA9 but is created and perfected in the same manner as all other security interests in real property. Thus, a lender simply must require the buyer to execute a standard mortgage and record the mortgage in the county real estate records.

There are, however, a couple of unique issues that lenders must consider when accepting a mortgage on a buyer's interest in a contract for deed. First, contract for deed buyers own the real property subject to the rights retained by the contract for deed seller. Thus, because some contracts for deed require the consent of the seller before the buyer may grant a security interest, the lender should require the buyer to provide a consent by the seller to avoid a breach of the contract for deed.