The Due on Sale Clause in Colorado
| Jurisdiction | Colorado,United States |
| Citation | Vol. 10 No. 5 Pg. 972 |
| Pages | 972 |
| Publication year | 1981 |
1981, May, Pg. 972. The Due on Sale Clause in Colorado
Due on sale clauses give lenders the right to accelerate balances due on promissory notes executed by borrowers if real properties described in deeds of trust given as security for such notes are transferred to third parties without the lenders' prior consent. In the present economic climate, many lenders are aggressively pursuing their rights under such clauses to obtain increased rates of interest by forced loan assumptions or to require that low interest loans be refinanced.
This article discusses a number of issues surrounding the due on sale clause, including the current outlook for its continued enforceability in Colorado; the provisions of a Colorado statute limiting lenders' rights under the clause; and the risks inherent in concealing property transfers from lenders in attempts to avoid the effects of the clause.(fn1)
Due on sale clauses are usually found in deeds of trust. While the exact wording varies among lenders, the typical clause states that if all or any partial interest in the property described in the deed of trust is transferred to a third party without the prior consent of the lender, the lender may accelerate the underlying note and foreclose the deed of trust.
Due on sale clauses are found in most conventional financing documents, including the standard form FNMA/FHLMC ("Freddie Mac---Fannie Mae") deed of trust.(fn2) The clause is also often found in private deeds of trust; most publishing companies which prepare deed of trust forms used in Colorado transactions offer forms either including or omitting the clause. Veterans Administration deeds of trust usually do not contain the clause.
If no due on sale clause appears in the financing documents, then the lender has no right to accelerate the loan upon sale or transfer of the real property given as security, and the lender's consent to the transfer need not be obtained. Particularly where the lender is an individual rather than an institution, an attorney should carefully inspect both the deed of trust and the promissory note for due on sale language. This is important because, occasionally, a note will provide for acceleration upon transfer of the property given as security, while the deed of
The due on sale clause is widely used throughout the United States, but has been challenged in numerous jurisdictions on a variety of grounds. The Colorado Supreme Court upheld the validity of the clause in 1973. There have been numerous cases concerning the clause in other jurisdictions since that time, some of which invalidated the clause or severely limited its applicability. It is therefore virtually certain that the Colorado Supreme Court will soon be asked to review, and perhaps overrule or modify, its prior decision.
The Colorado Supreme Court upheld the clause's validity in Malouff v. Midland Federal Savings and Loan Association,(fn4) which remains the leading case in Colorado. Malouff held that the clause is not inherently an unreasonable restraint on alienation and that a lender may justifiably use the clause to force subsequent purchasers to pay increased interest rates. However, the increase sought cannot exceed the general market rate at the time the clause is invoked and the lender must exercise its right to accelerate within a reasonable length of time after receiving notice of the transfer.
The challenges in other jurisdictions since Malouff have involved arguments by borrowers that the clause is an unreasonable restraint on alienation. Lenders have argued that their security may be jeopardized if the clause is invalidated because new owners may be less able to pay than the original borrowers or may allow the property to deteriorate. Lenders have also argued (as in Malouff) that they expect even long-term loans to be refinanced within a relatively short period of time---perhaps from five to eight years---and that invalidating the clause, thereby curtailing their ability to review loans periodically, would force them to protect themselves by charging higher interest rates when loans are initiated.
The leading case invalidating due on sale clauses is Wellenkamp v. Bank of America.(fn5) In that case, the California Supreme Court held:
. . . a due on sale clause contained in a promissory note or deed of trust cannot be enforced upon the occurrence of an outright sale unless the lender can demonstrate that enforcement is reasonably necessary to protect against impairment to its security or the risk of default.(fn6)
The heavy burden placed upon lenders by Wellenkamp is virtually a total repudiation of the rights purportedly granted them by the clause. Wellenkamp was the culmination of a series of cases by which the California Supreme Court reversed its direction, overruling an earlier decision identical in principle to Malouff.(fn7)
In Colorado, Amendment No. 4, the FAIR Amendment, which would have invalidated due on sale clauses by constitutional amendment, was defeated in November 1980.
Numerous cases involving the validity of the clause are now pending in trial courts throughout Colorado. Krause v. Columbia Savings and Loan Association(fn8) has just been decided by the Colorado Court of Appeals, which felt bound to follow Malouff and uphold the validity of the clause. It should be noted, however, that Krause involved a review of a trial court's decision not to grant a preliminary injunction against foreclosure; it is possible to argue, therefore, that the Court of Appeals has not yet squarely confronted the issue of the clause's validity.
It appears certain that the issue will again reach the Colorado Supreme Court, perhaps by the end of this year, and it will then be seen whether that Court is sufficiently impressed by Wellenkamp and other recent cases in other jurisdictions to overturn or revise Malouff.
Obviously, any...
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