UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 8, No. 1FALL 1984
Forfeiture Clauses in Land Installment Contracts: Time for Equitable Foreclosure
I. Introduction
Washington courts often quote the maxim "equity abhors a forfeiture."(fn1) Yet the courts' treatment of a defaulting buyer under a land installment contract contradicts these words. When a land installment contract includes a forfeiture provision,(fn2) Washington courts generally limit the defaulting buyer's equitable remedy to a "grace period."(fn3) During the grace period,(fn4) a defaulting buyer may be able to reinstate the contract by bringing the payments up to date, but the contract is forfeited if the grace period expires before the buyer performs.(fn5) Upon forfeiture, the seller retains all prior installment payments and repossesses the property regardless of the seller's actual loss.(fn6) The buyer loses the entire investment.(fn7)
The Washington courts' reliance on grace periods stems from their refusal to order foreclosure by judicial sale(fn8) if the land installment contract includes a forfeiture clause.(fn9) This was not always the case. Early Washington courts declined to enforce forfeiture provisions that constituted penalties rather than provisions for liquidated damages.(fn10) Nonetheless, this treatment of forfeiture clauses in land installment contracts subsequently lost favor with the Washington courts.(fn11) As a result, grace periods remain the sole equitable remedy in Washington for defaulting buyers under land installment contracts containing forfeiture clauses.
Washington courts should reinstate foreclosure by judicial sale as an equitable remedy for a defaulting buyer because grace periods often fail to relieve the harsh results of forfeiture when the buyer has a large equity in the contracted property.(fn12) A two step approach is needed when dealing with defaulting buyers under a land installment contract that contains a forfeiture provision. First, the court should apply a liquidated damages analysis to the forfeiture clause and refuse to enforce the provision if a forfeiture would result in a disproportionate loss to the defaulting buyer.(fn13) Second, the court should order foreclosure by judicial sale as an equitable remedy if the forfeiture acts as a penalty, rather than as compensation for the seller's actual loss.(fn14)
This Comment will trace the history of the Washington courts' decision to deny foreclosure by judicial sale in land installment contracts with forfeiture clauses and will demonstrate the viability and preferability of foreclosure by judicial sale as an equitable remedy for a defaulting buyer. The Comment will also describe how other states, either legislatively or judicially, have resolved the inequity of forfeitures.
II. The Historical Rejection of Foreclosure Under Forfeiture Clauses
Early Washington courts allowed equitable foreclosure of installment contracts by judicial sale on the theory that the seller's retained legal title acted as security for the debt and, thus, created an equitable mortgage.(fn15) Courts often treated a forfeiture clause in a land installment contract as a provision for liquidated damages.(fn16) If the buyer's loss considerably exceeded the seller's loss, the courts held that forfeiture acted as a penalty and refused to enforce the forfeiture.(fn17) Instead, the courts ordered the property foreclosed by judicial sale and limited the seller's recovery to the amount of the debt owed, plus any damages resulting from the default.(fn18)
In Pease v. Baxter,(fn19) decided in 1895, the Washington Supreme Court held that forfeiture provisions destroyed any possible application of the equitable mortgage theory, which allowed for foreclosure by judicial sale.(fn20) The rationale was that, by construing the contract as an equitable mortgage and by ordering foreclosure through judicial sale, the courts were "flatly contradicting the express terms of the contract itself."(fn21) The court held that a forfeiture clause created a contract of conditional sale, rather than an equitable mortgage.(fn22) Thus, the Pease court, without a clear explanation, dropped any reference to the liquidated damages analysis(fn23) and set the stage for removing equitable foreclosure as a remedy when a buyer defaults on a land installment contract containing a forfeiture clause.
In Pease, Justice Dunbar relied upon his opinion in Reddish v. Smith(fn24) as the basis for the court's decision that a land installment contract with a forfeiture clause could not be foreclosed as an equitable mortgage, but must be forfeited as a contract of conditional sale.(fn25) Justice Dunbar dismissed objections to his reliance on Reddish by stating merely that "the equitable interests of the vendee [buyer] were contended for in that [Reddish] case, and the principle discussed was the same."(fn26) Reddish, however, was an action of ejectment, and the question before the court was whether the seller could retain the payments received prior to the forfeiture.(fn27) The buyer was arguing that the forfeiture referred only to the contract and not to the payments already received.(fn28) The Reddish court did not discuss title, the buyer's equitable interest, or foreclosure as an equitable remedy. Justice Dunbar, therefore, erroneously relied on Reddish to determine how a forfeiture clause affected the interest of a buyer under a land installment contract.
After the Pease court determined that a forfeiture clause created a contract of conditional sale, Washington courts held repeatedly that executory contracts with forfeiture clauses conveyed no title to buyers.(fn29) In 1925 Ashford v. Reese(fn30) extended the Pease holding to include all executory contracts. Thereafter, executory contracts conveyed no title or real estate interest to purchasers.(fn31)
In 1977 the Washington Supreme Court overruled Ashford in Cascade Security Bank v. Butler(fn32) and held that a buyer's interest under a land installment contract is "real estate."(fn33) The court made no distinction between contracts with or without forfeiture clauses.(fn34) Although Cascade reinstated the buyer's interest as "real estate" and did not differentiate between contracts with or without forfeiture clauses, the court failed to overrule Pease and has continued to enforce forfeiture provisions.(fn35)
Continued enforcement of forfeiture clauses may be a result of the Cascade court's specific refusal to recognize the doctrine of equitable conversion.(fn36) Equitable conversion treats the seller's retained legal title as security for the unpaid purchase price, while treating the lien as a mortgage.(fn37) Consequently, the buyer's interest becomes real property, and the seller's interest becomes personal property.(fn38) The seller's retained legal title then acts as security for future payments by creating a vendor's lien,(fn39) an equitable right that permits the seller to enforce payment of the purchase price.(fn40) Under a vendor's lien, the standard remedy for a buyer's default is foreclosure by judicial sale.(fn41)
Despite the Cascade court's rejection of the doctrine of equitable conversion, Washington courts have applied the doctrine's principles.(fn42) In Freeborn v. Seattle Trust and Savings Bank,(fn43) the Washington Supreme Court characterized the seller's interest under a real estate contract as personal property and the buyer's interest as real property when the seller retained legal title to the property. The court's characterization of the parties' respective property rights coincides with the parties' rights under the doctrine of equitable conversion. Yet, despite the application of some of the doctrine's principles, Washington courts continue to refuse to apply the principles of foreclosure by judicial sale to land installment contracts that contain forfeiture clauses.(fn44)
Equally confusing is the attitude of the Washington courts regarding vendors' liens. For years, Washington courts refused to recognize a vendor's lien.(fn45) Recently, however, the Washington Supreme Court based its decision in In re Washburn(fn46) on a vendor's lien. In Washburn, the court created a fiction in order to find that the purchasers had a vendor's lien.(fn47) After the purchasers had taken possession of a house under an earnest money agreement, they returned possession of the house to the sellers before title passed. When the sellers failed to return the earnest money according to a rescission agreement, the court held that the purchasers had a vendor's lien on the property.(fn48)
The recognition of a vendor's lien in Washburn may reflect another step by the Washington Supreme Court towards accepting foreclosure by judicial sale as an equitable remedy for defaulting buyers. If the court accepts foreclosure as an equitable remedy for defaulting buyers, the court should take the next step and treat forfeiture clauses in land installment contracts as provisions for liquidated damages. If that step is taken in cases when forfeiture will act as a penalty and not as liquidated damages, the court can refuse to enforce the provision and can order foreclosure of the property by judicial sale.
III. The Case for Judicial Sale Instead of Forfeiture
A. The Case Against Forfeitures
When a defaulting buyer has a large equity in the property, the loss under forfeiture is frequently...
