Contracts for Deed, Lease-Options, and Lease-Purchases
by David J. Willis J.D., LL.M.
Executory contracts such as contracts for deed, lease-purchases, and lease-options have long been tools of Texas residential real estate sellers, especially raw land developers in the country. Why? Because it was easy to induce buyers into such arrangements with a minimal down payment and easy to evict them using the forcible detainer (eviction) process if they defaulted. The result was that the seller was able to confiscate the buyer’s down payment and accumulated equity and then sell the property again. The legislature rightly acted to stop such abuses.
Executory contracts traditionally gave a tremendous advantage to the seller who retained legal title to the property. The buyer, on the other hand, had only equitable title—a fuzzy concept that arises by operation of law and requires filing an expensive lawsuit to enforce. A buyer under financial pressure was therefore more likely to abandon the property, forfeit money paid, and move on.
Since 2005, executory contracts have been heavily regulated by Section 5.061 et seq. of the Property Code. Many requirements now apply and the burden is entirely on the seller to meet these. Violation may entitle the purchaser to cancel and rescind the contract and receive a full refund of payments made. The 2005 reforms also made seller violations actionable under the Deceptive Trade Practices-Consumer Protection Act (DTPA) which can result in treble damages plus attorney’s fees.
It is worth noting that the Property Code contains no significant defenses for well-meaning sellers who thought they were giving the buyer a fair deal—even if the whole arrangement was the buyer’s idea in the first place. The risks and regulatory burdens involved in executory contracts have significantly curtailed their use in the residential context.
Executory contracts include any transaction that defers material action by either party that pertains to ownership or possession of real property into the future.
An executed contract is one that is fully performed at closing. It is done, finished. An executory contract, on the other hand, leaves something dangling—usually the most important item of all, the delivery of title (a deed) to the buyer. The classic executory contract is the contract for deed (or land sales contract) which provides that the buyer gets title after completing a series of payments.
“In a typical real estate [earnest money] contract, the seller and purchaser mutually agree to complete payment and title transfer on a date certain, the closing date, at which time the purchaser generally obtains both title and possession. By contrast, in an executory contract [such as a contract for deed], the purchaser is usually given immediate possession, but is required to satisfy numerous obligations over an extended period of time before the seller has an obligation to transfer title.” Bryant v. Cady, 445 S.W.3d 815, 822 (Tex.App.—Texarkana 2014, no pet.).
Executory contracts are not limited to the classic contract for deed. Leases with an option to purchase are also defined as executory contracts:
Prop. Code Sec. 5.062(a)(2). [Lease with an Option to Purchase]. An option to purchase real property that includes or is combined or executed concurrently with a residential lease agreement, together with the lease, is considered an executory contract for conveyance of real property.
Options that are not combined with a residential lease as well as options on commercial property are not affected by Property Code Section 5.061.
Applicable law is found in Property Code Chapter 5, Subchapter D entitled “Executory Contract of Conveyance” (Sec. 5.061 et seq.). This is a complex law. For anyone contemplating engaging as a seller in an executory contract, there is really no avoiding a patient and careful reading of all forty-plus pages of the statute. This chapter is not a substitute for that; it is intended merely as a summary of the highlights.
The executory contract rules of Subchapter D apply only to contracts for residences with payment terms of longer than six months:
Prop. Code Sec. 5.062(a). [Residences Only]. This subchapter applies only to a transaction involving an executory contract for conveyance of real property used or to be used as the purchaser’s residence or as the residence of a person related to the purchaser within the second degree by consanguinity or affinity, as determined under Chapter 573, Government Code.
Prop. Code Sec. 5.062©. [180-Day Exception]. This subchapter does not apply to an executory contract that provides for the delivery of a deed from the seller to the purchaser within 180 days of the date of the final execution of the executory contract.
The 180 days or less exemption exists as an accommodation to real estate brokers, because otherwise the TREC 1-4 contract could violate this provision when combined with a TREC temporary lease.
Except as specifically provided, an executory-contract seller must be able to convey fee-simple title that is free of liens and encumbrances:
Prop. Code Sec. 5.085. Fee Simple Title Required; Maintenance of Fee Simple Title.
(a) A potential seller may not execute an executory contract with a potential purchaser if the seller does not own the property in fee simple free from any liens or other encumbrances.
There is, however, a significant exception to this rule: a pre-existing purchase-money loan may continue to exist so long as “the lienholder (i) does not prohibit the property from being encumbered by an executory contract; and (ii) consents to verify the status of the loan on request of the purchaser and to accept payments directly from the purchaser if the seller defaults on the loan; and (D) the following covenants are placed in the executory contract: (i) a covenant that obligates the seller to make timely payments on the loan. . . .” (Prop. Code Sec. 5.085(C)).
The existing purchase-money indebtedness may not be greater than the amount of the total outstanding balance that will be due under the executory contract. The executory contract must also state that the seller is obligated to make timely payments on the existing loan and provide monthly statements to the buyer. These must include notice to the buyer if the existing loan goes into default (Prop. Code Sec. 5.085(b)(3)(B)).
Because of the history of past abuses in this area, oral executory contracts are prohibited:
Prop. Code Sec. 5.072. Oral Agreements Prohibited
(a) An executory contract is not enforceable unless the contract is in writing and signed by the party to be bound or by that party ’s authorized representative.
(b) The rights and obligations of the parties to a contract are determined solely from the written contract, and any prior oral agreements between the parties are superseded by and merged into the contract.
One can still do a transaction by means of an executory contract but many regulations now exist that did not apply before 2005. Among these are various required disclosures and notices that must be given by executory-contract seller to the buyer before closing. The next two sections discuss these.
Property Code Section 5.069 contains a bundle of seller disclosure requirements which must be met before the executory contract is signed by the purchaser. This means before the principal closing document (the contract for deed, for instance) is signed at closing. The following is a summary of the most prominent features of Section 5.069:
Recent Survey. Property Code Section 5.069(a)(1) requires that the seller provide the purchaser with a survey which is no older than a year, or a current plat. Subsection (a) also requires the seller to notify the buyer that there “are no restrictive covenants, easements, or other title exceptions or encumbrances that prohibit construction of a house on the property.” An additional notice is required advising the buyer to “obtain a title abstract or title commitment covering the property and have the abstract or commitment reviewed by an attorney before signing a contract of this type, and purchase an owner’s policy of title insurance covering the property.”
Copies of Liens. Property Code Section 5.069(a)(2) requires that the seller provide the purchaser with copies of liens, restrictive covenants, and easements affecting title to the property.
Availability of Utilities. Property Code Section 5.069(b) states that if “the property is not located in a recorded subdivision, the seller shall provide the purchaser with a separate disclosure form stating that utilities may not be available to the property until the subdivision is recorded as required by law.”
Miscellaneous Disclosures. Property Code Section 5.069(a)(3) requires that a statutory disclosure be given to the buyer addressing such issues as whether or not the property is in a recorded subdivision; if water, sewer, and electric power are available; if the property is in a floodplain; who is responsible for maintaining the road to the property; and the like. An affirmative statement is required to the effect that no one but the seller owns or claims to own the property or have an interest therein.
What happens if Section 5.069 disclosure requirements are not met by a seller under an executory contract? First, failure to do so is defined by Section 5.069(d)(1) as a “false, misleading, or deceptive act or practice” pursuant to Section 17.46 of the DTPA; second, the purchaser is entitled under Property Code Section 5.069(d)(2) to “cancel and rescind the executory contract and receive a full refund of all payments made to the seller.” That includes the down payment plus any money expended by the buyer on permanent improvements to the property.
What about monthly payments in such a case? Not included. “While the buyer remains entitled to a ‘full refund of all payments made to the seller,’ cancellation and rescission of a contract also requires that the buyer restore to the seller the value of the buyer’s occupation of the property.” Morton v. Nguyen, 412 S.W.3d 506 (Tex. 2013).
Property Code Section 5.074(a) entitles a purchaser to cancel an executory contract for any reason within 14 days of signing, even if all statutory requirements have been met.
The seller must also disclose to the buyer matters relating to taxes and insurance.
Property Code Section 5.070(a)(1) requires the seller to provide the purchaser with a tax certificate from the collector for each taxing unit that collects taxes due on the property.
Property Code Section 5.070(a)(2) requires the seller to provide the purchaser with a copy of any insurance policy, binder, or evidence that indicates the name of the insurer and insured; a description of the insured property; and the policy amount.
Failure of the seller to comply with either requirement is a DTPA violation.
An executory-contract seller must give a three-day notice to the buyer that pertains to an existing loan that will not be discharged:
Prop. Code Sec. 5.085(b)(3)(A). . . the seller, not later than the third day before the date the contract is executed, [must notify] the purchaser in a separate written disclosure: (i) of the name, address, and phone number of the lienholder or, if applicable, servicer of the loan; (ii) of the loan number and outstanding balance of the loan; (iii) of the month payments due on the loan the due date of those payment; and (iv) in 14-point type that, if the seller fails to make timely payments to the lienholder, the lienholder may [foreclose].
An executory-contract seller is required to provide the buyer with financial information similar to a RESPA-style disclosure pertaining to the owner financing being extended. This must be done before closing (i.e., before execution of the principal closing documents).
Prop. Code Sec. 5.071. Seller’s Disclosure of Financing Terms. Before an executory contract is signed by the purchaser, the seller shall provide to the purchaser a written statement that specifies:
(1) the purchase price of the property;
(2) the interest rate charged under the contract;
(3) the dollar amount, or an estimate of the dollar amount if the interest rate is variable, of the interest charged for the term of the contract;
(4) the total amount of principal and interest to be paid under the contract;
(5) the late charge, if any, that may be assessed under the contract; and
(6) the fact that the seller may not charge a prepaying penalty or any similar fee if the purchaser elects to pay the entire amount due under the contract before the scheduled payment due date under the contract.
Property Code Section 5.016 contains a general notice requirement that applies in all cases where one or more recorded liens against the property will remain after closing. The requirement that the seller give these seven-day notices is not limited to executory contracts:
Prop. Code Sec. 5.016(a). Conveyance of Residential Property Encumbered by Lien
A person may not convey an interest in or enter into a contract to convey an interest in residential real property that will be encumbered by a recorded lien at the time the interest is conveyed unless, on or before the seventh day before the earlier of the effective date of the conveyance or the execution of an executory conveyance binding the purchaser to purchase the property, an option contract, or other contract, the person provides the purchaser and each lienholder a separate written disclosure statement in a least 12-point type. . . .
The seller must give a seven-day notice to the purchaser and to each lienholder. The statute sets out the required content of this notice which includes specific details concerning all existing liens.
The seller must give a seven-day notice to the purchaser and to each lienholder. The statute sets out the required content of this notice which must include specific details concerning all existing recorded liens. The notice begins with: WARNING: ONE OR MORE RECORDED LIENS HAVE BEEN FILED THAT MAKE A CLAIM AGAINST THIS PROPERTY. . . . (Prop. Code Sec. 5.016(70).
If the notice is not timely given, “the purchaser may terminate the contract for any reason on or before the seventh day after the date the purchases receives the notice in addition to other remedies by this or other law.” (Prop. Code Sec. 5.016(b)).
Section 5.016(b) states that “a violation of this section does not invalidate a conveyance.” Accordingly no discernable penalties are imposed other than allowing the buyer a pre-closing right of rescission. Anticipate that a future legislature may revisit this statute and insert penalties for non-compliance.
The notice requirements contained in this section of the Property Code apply not only to executory contracts but to any conveyance of residential property that will continue to be encumbered by a recorded lien after closing.
It is not only required that an existing purchase-money lender be notified; the lender must also affirmatively consent “to verify the status of the loan on request of the purchaser and to accept payments directly from the purchase if the seller defaults on the loan. . . .” (Prop. Code Sec. 5.085(b)3(C(ii)).
Effectively, this requires that the existing lienholder give consent to the executory contract and agree to cooperate with the buyer if the need arises.
As a practical matter, the consent requirement of Section 5.085 calls upon an executory-contract seller to go well beyond the seven-day lender notice required by Section 5016. Active discussions with the lender must in fact be opened and some sort of written consent obtained that meets the statutory requirement.
An executory contract buyer must be advised in the executory contract itself of the right to cancel:
Prop. Code Sec. 5.074. Purchaser’s Right to Cancel Contract without Cause
(a) In addition to other rights or remedies provided by law, the purchaser may cancel and rescind an executory contract for any reason by sending by telegram or certified or registered mail, return receipt requested, or by delivering in person a signed, written notice of cancellation to the seller not later than the 14th day after the date of the contract.
The buyer must also be given a notice of cancellation form to use.
In order to reinforce for the buyer that no oral agreements are allowed, Property Code 5.072(d) requires that an executory-contract seller give the following notice in 14 point bold type:
THIS EXECUTORY CONTRACT REPRESENTS THE FINAL AGREEMENT BETWEEN THE SELLER AND PURCHASER AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES.
This notice requirement (included in Section 5.069) speaks for itself:
NOTICE: SELLER ADVISES PURCHASER TO: (1)OBTAIN A TITLE ABSTRACT OR TITLE COMMITMENT COVERING THE PROPERTY AND HAVE THE ABSTRACT OR COMMITMENT REVIEWED BY AN ATTORNEY BEFORE SIGNING A CONTRACT OF THIS TYPE; AND (2) PURCHASE AN OWNER ’S POLICY OF TITLE INSURANCE COVERING THE PROPERTY.
In the past, executory contracts did not need to be recorded in the real property records. This changed in 2005. Property Code Section 5.076(a) states that “the seller shall record the executory contract, including the attached disclosure statement . . . on or before the 30th day after the date the contract is executed.” Additionally, any instrument that terminates the contract must be recorded.
Since initial passage, Section 5.079(a) has been amended to provide that a “recorded executory contract shall be the same as a deed with a vendor’s lien. The vendor’s lien is for the amount of the unpaid contract price, less any lawful deductions, and may be enforced by foreclosure sale under Section 5.066 or by judicial foreclosure. A general warranty is implied unless otherwise limited by the recorded executory contract.”
Even so, it would be imprudent for a buyer to take the statute’s word for it and simply assume that a recorded executory contract is as good as a deed. Nothing is as good as a general warranty deed that conveys a fee simple interest.
Property Code Section 5.077 requires that the seller provide an annual accounting statement every January. It must include amounts paid, the remaining amount owed, the number of payments remaining, the amount paid in taxes, the amount paid for insurance, an accounting for any insurance payments by the insurer, and a copy of the current policy—a comprehensive status report to the buyer, in other words. There is no requirement that this be recorded.
Failing to provide an annual accounting statement is a clear violation of the statute; but what if the seller makes a good-faith error in the statement? Does that trigger statutory penalties? Is that a DTPA violation? Probably not “unless the statement is so deficient as to be something other than a good faith attempt by the seller to inform the purchaser of the current status of their contractual relationship.” Morton v. Nguyen, 369 S.W.3d 659 (Tex.App.—Houston [14th Dist.] 2012). The Texas Supreme Court later reviewed this case but left this part of the appeals court opinion in place, so this is the law.
In Smith v. Davis, the Tyler Court of Appeals further discussed the issue of damages for failure to provide an annual accounting statement. The court noted that Civil Practices & Remedies Code Section 41.008 limits the amount of exemplary damages that a plaintiff can recover in lawsuits generally. The issue was whether or not this statute specifically applies when an executory-contract seller fails to provide the required accounting statement.
In Smith, the plaintiff failed to show actual damages. The court ruled that Chapter 41 applies in these situations. In other words, to recover the exemplary damages provided by Section 5.077, actual damages in more than a nominal amount must be proven by clear and convincing evidence. Smith v. Davis, 462 W.W.3d 604 (Tex.App.—Tyler 2015, pet. denied).
The buyer has an absolute right “at any time and without paying penalties or charges of any kind” to convert an executory contract (such as a contract for deed) to “recorded, legal title” under Property Code Section 5.081. That means a deed, probably a general warranty deed, but no less than a deed without warranties. The seller has no choice in the matter so long as the buyer tenders the balance owed under the contract. This is true whether or not the executory contract was recorded.
If the contract was recorded, as is now required, Section 5.079(a) states that the recorded contract is the functional equivalent of a deed with vendor’s lien. This is helpful, but an actual deed in hand is still the best outcome for an executory-contract buyer.
After payment, Section 5.079(b) requires that a seller execute and deliver a deed to the buyer within 30 days of receiving the buyer’s final payment whether the contract was recorded or not.
Executory contracts are a form of owner financing and therefore both the federal Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act) and the Texas version (T-SAFE) apply. However, the seller is required to be licensed only if the property is not the seller’s homestead and/or the sale is not to a family member. The Commissioner of the Texas Department of Savings and Mortgage Lending (TDSML) has for now ruled that T-SAFE will not be applied to persons who make five or fewer owner-financed loans in a year. Note that the T-SAFE licensing rule applies only to residential owner financing.
Dodd-Frank and the SAFE Act were both born of the 2008 real estate collapse. Dodd-Frank generally requires that a seller-lender in an owner-financed transaction involving a residence (this includes executory-contract sellers) make an informed determination that the buyer-borrower has the ability to repay the loan. Most sellers are therefore obligated to qualify the buyer-borrower in the same way any regular lender would. This law also has a de minimis exception that excludes persons doing no more than three owner-financed transactions per year, at least so long as the seller-lender is not in the building business. Although Dodd-Frank is roundly criticized by some politicians as an example of over-regulation, there is no doubt that corrective action was necessary in order to avoid another epidemic of toxic loans.
Property Code Section 5.073 prohibits these in executory contracts. Excessive late fees are banned as are prepayment penalties and any clause that “prohibits the purchaser from pledging the purchaser’s interest in the property as security to obtain a loan or place improvements.” This codifies the traditional view from the justice court bench: exorbitant late fees are almost never allowed in an eviction judgment.
Section 5.073 also declares purported waivers of rights by executory-contract buyers to be void.
It is not permissible to simply evict a buyer under an executory contract if there is a default. Why? Because the buyer has equitable and enhanced statutory rights and is therefore more than an ordinary tenant. An executory-contract buyer must be given ample notice and opportunity to cure a default. Property Code Sections 5.063 and 5.064 specify the content of the default notice, which must be followed to the letter if it is to be valid.
The buyer must be allowed a 30-day unconditional right to cure the default before an eviction may be filed. If the judge grants possession to the seller at the eviction hearing, then and only then is the buyer’s down payment forfeited.
There is also the 40 or 48 Rule contained in Property Code Section 5.066(a): if the buyer has paid in 40% or more of the purchase price, or the equivalent of 48 monthly payments, then a 60-day notice is required and, if the default is not cured, a traditional foreclosure (not an eviction) must be used to regain title. Clearly, the intent is to keep sellers from unfairly confiscating down payments and buyers’ accumulated equity.
Property Code Section 5.073(a)(4) prohibits forfeiture of a buyer’s down payment or option fee if a monthly payment is late. This is an important change, because it codifies what judges and juries have been saying for quite some time. They hate forfeitures. The trend is to view any substantial forfeiture as unreasonable and unconscionable, whether within the context of an executory contract or not, if it results in a consumer losing either a large down payment or the home itself.
Courts and juries tend not to favor real estate investors and landlords who are often perceived as predatory profiteers. It does not matter how clever one’s legal argument is. If a transaction does not pass the smell test, an executory-contract seller will likely lose.
Even if the executory contract rules are found not to apply, the court can look to the laundry list of offenses under the DTPA including “any unconscionable action or course of action” (Bus. & Com. Code Sec. 17.50(a)(3)). That is a very large hammer a jury can use against sellers they dislike.
Pretending that an executory contract is something else by renaming it will fool no one, particularly after the document is deconstructed and scrutinized in court. It is astonishingly difficult to deceive a jury of six or twelve of one’s peers.
A judge or jury may even be angry with a seller who tries to pull a fast one with overly-clever conveyance documents that pretend to be something other than an executory contract—and may therefore be more inclined to consider a finding of fraud and treble damages plus attorney fees.
Executory contract requirements are numerous and intricate and liability for a non-complying seller is high. Such penalties fall completely upon the seller even if the purchaser was a willing participant in the transaction—and the seller has no significant defenses.
It is essential for an executory-contract seller to have the ongoing guidance of expert attorney who is both able and willing to do this sort of work (many simply will not).
Combine the foregoing with the blanket cancelation right under Property Code Section 5.074 (the buyer may cancel for any reason within 14 days after closing even if the seller has worked diligently to comply with the statute) and the safest course may be to avoid residential executory contracts altogether.
DISCLAIMER
Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. No attorney-client relationship is created by the offering of this article. This firm does not represent you unless and until it is expressly retained in writing to do so. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well.
Copyright © 2024 by David J. Willis. All rights reserved. Mr. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.