Bulletin: NM2016002

Dear Associates:

Real estate contracts represent a substantial percentage of residential sales and purchases in New Mexico and represent the most commonly used form of seller financing, whether for residential or commercial transactions. Real estate contracts raise various special issues with respect to title insurance. This bulletin summarizes the basic legal principles associated with real estate contracts and provides guidelines when insuring real estate contract interests under various circumstances. This bulletin should be read in conjunction with Sections 3.48 and 3.52 of the Underwriting Manual found in Virtual Underwriter to the extent applicable.

A. Basic Legal Principles of New Mexico Real Estate Contracts

A real estate contract (“REC”) is an enforceable agreement by which a seller agrees to sell and a purchaser agrees to buy real property with the purchaser making installment payments to the seller for the term of the real estate contract. During the term of the REC the seller retains legal title to the real property, but the REC has the immediate effect of conveying equitable title to the purchaser. This has important ramifications, as discussed below. When the REC is paid off, the purchaser obtains a deed to the property, which conveys legal title to the purchaser. If the purchaser defaults under the REC, the seller has the right to take the property back without having to go through any court process, which is considered to be the advantage of the REC form to the seller. This is accomplished by a deed from the purchaser to the seller.

There are no New Mexico statutes that govern real estate contracts, so the law of real estate contracts is based on decades’ worth of court cases interpreting the law. RECs are very flexible legal instruments and can take many forms, but even lawyer prepared forms tend to follow the forms periodically updated and published by the REALTORS® Association of New Mexico (RANM).   

The typical structure of an REC transaction is as follows:

• The seller and buyer enter into a real estate purchase agreement with a REC financing addendum, such as RANM form 2402. The REC itself should not be a substitute for an actual sale and purchase agreement; the REC represents only the financing part of the deal. On the other hand, the RANM REC Addendum is not a substitute for the REC itself.
• At closing of the sale and purchase transaction, the seller and purchaser execute and deliver a real estate contract. The REC contemplates that the purchaser will make monthly payments to a third party escrow company (though that is not required). At the same time, the seller executes a deed in favor or the purchaser, and the purchaser executes a deed in favor of the seller. The two deeds are usually held in escrow by the designated third party escrow company (though again this is not required).
• Many RECs are structured as “wrapped” RECs. In this case the seller has an existing mortgage on the property or there is an existing REC, which is not paid off at the time of the sale to the REC purchaser. Rather the REC is set up so that payments under the REC are used to pay off the underlying mortgage or REC. If structured properly, the REC will fully pay the underlying “wrapped” loan, and when the REC is paid off, the purchaser will take legal title without the lien of the underlying mortgage. Stewart is willing to insure a single wrapped loan REC transaction, but will ordinarily not insure more than a single wrapped transaction. Stewart also will not insure a REC where the REC payments will not fully pay off the underlying wrapped transaction.
• Stewart is not willing to insure REC transactions that wrap a home equity line of credit (HELOC), an FHA or VA loan, or a REC where the purchaser’s monthly payment does not cover the underlying monthly mortgage payment.
• The REC or a memorandum of REC is recorded in the office of the County Clerk. This has the effect of creating record notice of the transfer of interest from the seller to the purchaser.
• If the purchaser obtains an owner’s title insurance policy, the policy will describe the insured interest as “contract purchaser.” See NMAC § 13.14.6.10.
• When the purchaser has completed making all required payments to the seller, the escrow company releases the two escrowed deeds to the purchaser, and the purchaser records the deed conveying the legal title to the purchaser. The purchaser should destroy the deed from the purchaser back to the seller.  At this point the purchaser owns the legal and equitable interests in the property.

On the other hand, if the purchaser fails to perform under the REC, the seller has the option to judicially foreclose the REC or to take the property back without judicial process and retain all payments made to date. Most sellers opt for the non-judicial process. The seller takes the following steps:

• The seller sends notice of default to the purchaser as required by and in accordance with the terms of the REC. There is usually a thirty-day period in which to cure defaults.
• If the purchaser fails to cure the default within the cure period established under the REC, the seller will prepare an Affidavit of Default that confirms that seller has complied with the default provisions of the REC. The Affidavit of Default is provided to the escrow company, and the affidavit may or may not be recorded, though as noted below, Stewart requires that it be recorded as a condition of insurability. Upon receipt of the Affidavit of Default, the escrow company releases the escrowed deeds to the seller. The seller records the deed into seller’s name which terminates the REC and the purchaser’s interest in the property.

Even though the REC seller retains legal title to the property, the New Mexico Supreme Court has been clear for over seventy years that the legal title retained by the seller is a bare or naked legal title for security only and that the purchaser holds equitable title and all of the incidents of ownership. Most importantly from the title insurance perspective, the seller’s REC interest is considered to be personal property (in the nature of a contractual right to receive a stream of payments), notwithstanding that seller retains legal title, and the purchaser’s REC interest is considered to be real property, even though the purchaser doesn’t have legal title until the REC is paid off. It is important to understand and bear this distinction in mind as you are requested to insure interests under RECs.

B. Insuring the Real Estate Contract Purchaser at the inception of the REC transaction

The REC contract purchaser’s interest is an insurable interest. NMAC § 13.14.6.10. When asked to insure the REC purchaser’s interest proceed with the title examination and preparation of the binder as you would for any other transaction where you would be insuring the purchaser.

• Stewart strongly prefers that the REC or a Memorandum of the REC be recorded as a condition of insuring the contract purchaser’s interest, but Stewart is willing to insure an unrecorded REC in compliance with Section 3.48.3 of the Underwriting Manual found in Virtual Underwriter.
• On Schedule A the insured is the REC purchaser and the insured interest in Item #2 should be described as “contract purchaser.”  In Item #3 vesting should be shown as the name of the REC seller.
• A specific exception must be made in the binder and the policy for the REC itself. See e.g., Stewart Underwriting Manual §3.48.3. The following is appropriate:

“Rights, terms, provisions, conditions, and limitations contained in that Real Estate Contract (or memorandum of same) entered into by _____, seller, and _____, purchaser, dated ______ and recorded _____ in Book ___________ Page _______, as Doc. No. ______, in the records of the County Clerk of ______ County, New Mexico.”

• If the REC or a memorandum of REC is not recorded (such as VA installment contracts), include an additional exception for any loss or damage arising from the failure to record. See Stewart Underwriting Manual §3.48.3.
• Include an exception for failure to deliver the deed upon payoff of the REC, as follows: “Any loss or damage resulting from any defect, lien, encumbrance or matter of any nature arising after the date of this policy, which could adversely affect the title of the Insured, by reason of the lack of delivery of proper deed(s) conveying title to the subject property to the Insured and the effect of such lack of delivery, and by reason of the failure to have such proper deed(s) recorded with the County Clerk of ___________ County, New Mexico.”
• Include an exception for potential lack of compliance with federal laws (as discussed below in Section G), as follows: “any loss or damage arising from the Insured’s exercise of any right of rescission pursuant to applicable federal laws, including without limitation the Truth-in-Lending Act and the TILA-RESPA Integrated Disclosure Rule.”  
• If you have any questions about the sufficiency of the instrument as a real estate contract, please contact your underwriter.

C. Continuing to insure the interest of the Real Estate Contract Purchaser upon payoff of the Real Estate Contract

Under current law there is no change to the contract purchaser’s title policy when the REC is paid off. The contract purchaser has the option of purchasing a new policy after the payment.

Effective March 1, 2016, there are new rules designed to address issues related to the payoff of a real estate contract.  

Pursuant to NMAC 13.14.6.10(B) upon payoff of an insured REC and recordation of the deed into the insured purchaser’s name, the contract purchaser policy automatically converts to a “fee simple” policy. There is no requirement for an endorsement and there is no charge for the conversion. The date of policy is not changed or down dated.

There is a new endorsement for the purpose of converting and down dating the existing policy. The NM form 91 Owner’s Contract Purchaser’s Conversion Endorsement may be issued when the insured wishes to convert and down date the policy. If you are issuing this endorsement, see the guidelines for NM form 91 Contract Purchaser Conversion Endorsement.

It is possible to issue an entirely new owner’s policy upon the pay off, as well. Issuance of a new policy will be more likely and may be more appropriate, if the REC purchaser is obtaining a new mortgage loan to pay off the REC balance.  

D. Insuring a Buyer of the REC Purchaser’s Interest

Since the REC purchaser holds equitable title and is deemed the owner of the property, the REC purchaser can sell his or her interest. There are a variety of ways in which this transaction can be accomplished, but this bulletin focuses on the most typical form: the REC purchaser assigns his or her rights in the REC to the buyer and deeds the property to the buyer subject to the REC. This assignment and conveyance can be made in separate instruments or may be combined into a single assignment and conveyance document.  If you are asked to insure the buyer, treat this much as you would insuring the original REC purchaser and proceed as follows:

• Stewart strongly prefers that the Assignment and Deed be recorded as a condition of insuring the contract purchaser’s interest, but Stewart is willing to insure an unrecorded assignment and deed in compliance Section 3.48.3 of the Underwriting Manual found in Virtual Underwriter.
• On Schedule A the insured is the REC buyer and the insured interest in Item #2 should be described as “contract purchaser.”  In Item #3 vesting should be shown as the name of the original REC seller.
• If the REC seller is required to consent to any transfer by the REC purchaser, confirm the existence of such consent as a condition of insuring the buyer.  
• A specific exception must be made in the binder and the policy for the REC itself and for the Assignment of the REC. See e.g., Stewart Underwriting Manual §3.48.3. The following is appropriate:

“Rights, terms, provisions, conditions, and limitations contained in that Real Estate Contract (or memorandum of same) entered into by _____, seller, and _____, purchaser, dated ______ and recorded _____ in Book ___________ Page _______, as Doc. No. ______, in the records of the County Clerk of ______ County, New Mexico, as assigned to [Buyer] pursuant to that certain Assignment of Real Estate Contract by ___________, assignor, and ________________, assignee, dated ______ and recorded _____ in Book ___________ Page _______, as Doc. No. ______, in the records of the County Clerk of ______ County, New Mexico.”

• If the underlying REC or a memorandum of REC is not recorded (such as VA installment contracts) or the Assignment and Deed are not recorded, include an additional exception for any loss or damage arising from the failure to record such instruments.  See Stewart Underwriting Manual §3.48.3.
• Include an exception for failure to deliver the deed to the REC purchaser upon payoff of the REC, as follows:  “Any loss or damage resulting from any defect, lien, encumbrance or matter of any nature arising after the date of this policy, which could adversely affect the title of the Insured, by reason of the lack of delivery of proper deed(s) conveying title to the subject property to the Insured and the effect of such lack of delivery, and by reason of the failure to have such proper deed(s) recorded with the County Clerk of ___________ County, New Mexico.”
• Include an exception for potential lack of compliance with federal laws (as discussed below in Section G), as follows: ““any loss or damage arising from the Insured’s exercise of any right of rescission pursuant to applicable federal laws, including without limitation the Truth-in-Lending  Act.”  

E. Insuring a Lender who obtains a Mortgage on the REC Purchaser’s Interest

Since the REC purchaser’s interest is a real property interest, the New Mexico Supreme Court has held that it is a mortgageable interest. Shindledecker v. Savage, 96 N.M. 42, 627 P.2d 1241 (1981). However, it is an equitable mortgage only, since it encumbers only the REC purchaser’s equitable title. Although these transactions are infrequent, you may insure a lender who takes a mortgage on the REC purchaser’s interest. The lender’s interest in the REC is subject to the terms and conditions of the REC, and lender’s interest is lost, if the purchaser’s REC interest is forfeited after the REC purchaser’s default. Conceptually, insuring a lender in these circumstances is similar to insuring a junior lienholder. If insuring a lender:

• Insure using a lender’s policy. NOTE: this is different than what is required under Section 3.48.5 of the Underwriting Manual and reflects New Mexico’s treatment of the REC purchaser’s interest as real property.
• Require a mortgage of the REC purchaser’s interest. A collateral assignment or similar instrument is not sufficient to create a mortgage lien against the REC purchaser’s interest.
• Take exception to the terms and conditions of the REC (as noted earlier herein).
• Add the following exception:

“any loss or damage resulting from the failure of the insured mortgage to encumber legal title to the subject property.”

• Add the following exception:

“any loss or damage resulting from the failure of the Insured to receive notice of the real estate contract purchaser’s default under the real estate contract [describe the REC in the same manner as the general REC exception].”

F. Insuring the Seller’s Interest after Forfeiture of the Purchaser’s Interest

There are two different circumstances under which you may insure the seller’s interest after forfeiture of the purchaser’s interest. Underwriting requirements vary depending on whether the forfeiture is involuntary or voluntary. In all cases you must conduct a title examination and issue a binder. If your examination reveals a pending bankruptcy for either seller or purchaser, contact your underwriter. 

1. Involuntary

• Require the execution and recordation of an Affidavit of Default. You may rely on the Affidavit so long as you do not have actual knowledge or have reason to believe that the Affidavit is not accurate. For example, if the REC requires 30 days in which to cure a default and the Affidavit states that it is 15 days, that would be an inconsistency that might call into question the reliability of the Affidavit. If fewer than 90 days have passed since the Affidavit of Default or if the REC purchaser has not vacated the Property, please contact your underwriter before insuring.
• Require recordation of the deed from purchaser into seller.
• Because a proper involuntary forfeiture operates like a judicial foreclosure to wipe out junior liens, you do not need to take exception to liens attaching to the purchaser or the purchaser’s interest, except as noted below with respect to federal tax liens.
• If there are any outstanding federal tax liens, confirm that the seller gave proper notice to the IRS as required by IRC § 7425. This federal statute requires a “lender” conducting a non-judicial foreclosure to give written notice to the IRS not less than 25 days prior to the sale. This provision has been deemed to apply to real estate contracts and the date of sale is deemed to be the day the deed into the seller is recorded. If such notice has not been given, include an exception for lack of compliance with IRC § 7425, as follows: “any loss or damage arising out of the lack of compliance with IRC § 7425 and its related regulations.”
• If there are any federal tax liens, be aware that the IRS has a 120 day right of redemption, and you must take exception to such redemption right, if you are insuring within 120 days of the date the deed into the seller is recorded.
• The REC purchaser may have a lien for improvements constructed by the purchaser depending on the circumstances. Absent a waiver of such lien, include the following exception: “any statutory lien in favor of [Purchaser] with respect to improvements to the property made buy [Purchaser.]”
• If the REC purchaser has not vacated the Property, please make a specific exception for Purchaser’s possession and do not delete standard exception 1.  

2. Voluntary

• Conceptually a voluntary forfeiture is similar to insuring a lender after a deed in lieu of foreclosure of a mortgage. All liens and other matters attaching to purchaser’s interest must be shown as exceptions, unless they are satisfactorily released of record. For example, any transcripts of judgments against the purchaser will have attached to the purchaser’s REC interest. 
• Obtain a mutual termination of REC in recordable form and record the termination in the office of the County Clerk. The mutual termination should contain provisions similar to those found in an estoppel affidavit for a deed in lieu of foreclosure (see generally Section 4.12 of the Underwriting Manual in Virtual Underwriter and the estoppel affidavit form found at (http://www.vuwriter.com/en/forms/2014-2/FM126841696300000076.html?search=%22deed%20in%20lieu%22&searchType=allwords) , as the same concerns that apply in a deed in lieu apply in the termination of REC situation. Please contact your underwriter if you have questions about the form of mutual termination. 
• If there are any outstanding federal tax liens, the same rules apply as to compliance with IRC § 7425 and the IRS’s 120 day right of redemption.  
• If the REC purchaser has not waived its lien for improvements constructed by the purchaser, include the following exception: “any statutory lien in favor of [Purchaser] with respect to improvements to the property made buy [Purchaser.]” 
• If the REC purchaser has not vacated the Property, please make a specific exception for Purchaser’s possession and do not delete standard exception 1. 

G. Other Situations Insuring the REC Seller’s Interest

There are a variety of circumstances where you may be asked to insure the REC seller’s interest, including the following:

1. Use of a REC as the Structure for a Private Loan. In this situation the owner of a property obtains a loan from a private lender. Instead of using a note and mortgage or deed of trust, the deal is structured as a real estate contract. The owner/borrower conveys fee title to the property to the private lender. The private lender then simultaneously sells the property back to the owner/borrower/purchaser on a REC. If this type of transaction is presented to you, contact your underwriter. It may be insurable, but that will require review of the documents and the possible inclusion of special exceptions.

2. REC Seller sells his REC interest to an Investor. In this situation the REC seller wishes to cash out of the REC and sells the REC interest to an investor who pays the REC seller some amount of money based on a discounted present value of the remaining stream of payments under the REC. Stewart does not consider this to be an insurable transaction.

3. REC Seller’s Collateral Assignment of REC Interest as Security for a Loan.Sometimes an REC seller will use his interest in the REC as collateral for a loan and typically this is done with a collateral assignment of the seller’s interest or similar instruments. Stewart does not consider this to be an insurable transaction.  

H. CFPB Enforcement Issues

Please also be aware that the Consumer Finance Protection Bureau (CFPB) is now regulating residential real estate transactions involving seller financing. A private seller may be subject to the loan originator requirements of the federal Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act) and may be subject to the TRID requirements of the federal Dodd-Frank Wall Street Reform and Consumer Protection Act.” See Bulletin SLS2015017. The lack of compliance by a seller financer with the SAFE Act or Dodd-Frank may expose the seller financer to certain enforcement actions and penalties, and may allow the buyer to rescind the transaction. Although the insured buyer’s rescission is likely a post-policy matter that is not covered or may be an exclusion as a matter created or suffered to by the insured, in an abundance of caution we ask that you include the following exception: “any loss or damage arising from the Insured’s exercise of any right of rescission pursuant to applicable federal laws, including without limitation the Truth-in-Lending Act.”  

If you are aware or become aware that a lender is making more than five loans per calendar year, we recommend encouraging that lender to consult with legal counsel.

I. Closing Issues

While these issues are not underwriting matters and therefore outside of our agent contract, please be aware that closing REC transactions can be more complicated than typical transactions and, especially if a wrapped transaction, may expose the settlement agent to escrow liability claims or to claims related to a lack of explanation about the effect of the REC and related documents. We encourage you always to work with outside legal counsel for preparing REC documents and disclosures and encourage you to advise the customers to seek their own legal advice about the REC and its ancillary documents.

[1] Seller financing may also be accomplished with a promissory note and mortgage or a promissory note and deed of trust. One of the advantages of a real estate contract is that upon the buyer's default the seller can take the property back without judicial process. On the other hand, if a mortgage or deed of trust is used in a residential transaction, that mortgage or deed of trust must be judicially foreclosed. 

[2] The RANM 2401 is the Real Estate Contract form and the RANM 2402 is the Addendum to Purchase Agreement – Real Estate Contract. The latter form is attached to the RANM purchase agreement form and is used to memorialize the terms and conditions of the seller financing. The RANM 2401 can be the actual document used to create the seller financing at closing. 

[3] The federal bankruptcy laws treat a real estate contract as an executory contract if either the seller or buyer is in bankruptcy, and there are particular rules that may apply. 

[4] For example, your title examiners may discover through their routine name search that a particular lender has recorded several real estate contracts over the course of a calendar year.  

If you have any questions relating to this or other bulletins, please contact a Stewart Title Guaranty Company underwriter.

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