Posting for

Thursday, August 20, 1998

by: Bert Rush

brush@firstam.com

CASH-TO-BUYER DEALS/BONA FIDE PURCHASER/ESCROW AND CLOSING

Cash-to-buyer transactions--as touted by "How to Get Rich in Real Estate" gurus--frequently leave innocent parties holding the bag.

A recent example is provided by the Oregon case of Akins v. Vermast, 150 Or.App. 236, 945 P.2d 640 (1997).

Jack and Vivian Reynolds contracted to sell a lot to Lynda Vermast for $40,000, with a down payment of $5,000 and the Reynolds to "carry back" a purchase-money deed of trust for $35,000.

Unbeknownst to the Reynolds, Vermast soon advertised to borrow $20,000 to make this purchase. Vermast's ad was answered by James Akins, Trustee of the Akins Loving Trust, who agreed to loan Vermast $21,500 at 15% interest, to be secured by a first deed of trust on the property.

Some time before closing, Vermast and Akin agreed that some of the Akin loan proceeds could be retained by Vermast through closing.

The transaction closed with Akin loan proceeds used as follows: $5,000 paid to the Reynolds for the down payment, $1,500 paid to Akins as prepaid interest, and $15,000 paid to Vermast. The deed of trust given by Vermast to Akin was recorded minutes before the carry-back deed of trust from Vermast to the Reynolds.

Vermast disappeared with the $15K, leaving her lenders in conflict as to who should have priority.

Akins filed suit, and the trial court ruled in favor of the Reynolds--based on their status as holders of a purchase money mortgage. (This comports with the law in many jurisdictions--in California by statute--which favors the interests of vendors over new lenders.)

Akins appealed, and the Reynolds cross-appealed. For their part, the Reynolds argued the trial court erred in not canceling the deed from the Reynolds to Vermast--as it was obtained by fraud--and consequently canceling the Akins deed of trust.

The Court of Appeal agreed with the Reynolds, reversing and remanding the case for entry of an order canceling the deed into Vermast and the trust deed in favor of Akins.

In so holding, the Court of Appeal said the deed into Vermast should be canceled as procured by fraud, and

Here, the Court said Akins was not entitled to bona fide purchaser/encumbrancer status, because he was on notice of facts which should have caused him to inquire further about the transaction and to discover Vermast's apparent fraudulent scheme. The Court acknowledged there was no evidence Akins understood before closing that Vermast would retain as much money as she did. Still, when Vermast and Akins agreed that Vermast could retain new loan proceeds--rather than use them for the avowed purpose of completing her purchase--Akins was chargeable with "inquiry notice." Akins testimony that he had assumed Vermast had located some other source of funds was held an insufficient explanation for his inattention to details of the closing.

Comment: Chalk this up to strong public policy to protect the vendor's equity in property. There is nothing in the reported decision to suggest that Akins was in on the fraud--a conspirator--nor that he was sophisticated enough to have suspected fraud even if more facts about the closing were known to him. Typically, the buyer in a cash-to-buyer deal represents that they plan to use money paid to them at closing to make improvements to the property--enhancing its value. So if Akins had inquired, and Vermast told him she would use the $15,000 to grade the lot and make site improvements for a mobile home, what then? He probably would've fallen for her story, with the same consequences for the Reynolds.

What usually happens in cases such as this is that the party who stands to lose sues the escrow company for negligence. The Reynolds might have done so, claiming the escrow officer should have suggested they obtain title insurance and/or should have caused them to be notified of the incoming Akins deed of trust--to be recorded first.

Likewise, Akins might sue the escrow company, claiming that if the transaction was as suspicious as the Court later found it to be, the escrow officer should have alerted him.

We can only speculate that Akins may have title insurance, so his loss may be covered and he'll be disinclined to sue escrow. But...what if a title insurance claims handler denies Akins' claim as a matter excluded from coverage because it was "created, suffered, assumed or agreed to" by the insured, or because of the insured's inability to claim the status of a bona fide purchaser/encumbrancer?

Cash-to-buyer transactions are often legitimate--but, then again, frequently they are not. Experience teaches us they are very risky--and should always be handled with great care.

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