Installment Land Contracts in Purchaser Bankruptcy

• Publication year: 2013

Installment Land Contracts in Purchaser Bankruptcy

Seong-hee Lee

INSTALLMENT LAND CONTRACTS IN PURCHASER BANKRUPTCY

Abstract

The executory contract analysis under § 365 of the Bankruptcy Code has long challenged judges, practitioners, and scholars. The challenge of understanding the purpose of § 365 and reaching an equitable result thereafter is most profound when confronting installment land contracts. The parties to an installment land contract, typically the purchaser, can become insolvent and enter bankruptcy, and consequently, the rights of the parties may be altered dramatically as a result of applying bankruptcy law. The express provisions of § 365 have provided some clarity for the rights of the parties in seller bankruptcy. In the case of purchaser bankruptcy, however, the language of the Bankruptcy Code is not much help, and courts have devised inconsistent ways to characterize installment land contracts.

This Comment argues that an installment land contract should be presumed a mortgage in purchaser bankruptcy. When analyzing installment land contracts in purchaser bankruptcy, courts have asked whether the contract is an "executory contract" under § 365. However, this inquiry has resulted in distortion of the parties' property rights and inconsistent applications of bankruptcy law by courts, and has illustrated the lack of utility of § 365 for installment land contract purchasers. The proper question to ask is whether an installment land contract functions like a security device, to which § 365 is inapplicable. When asking this question and considering the benefit to the estate and equitable outcome, courts should presume that an installment land contract is a mortgage. The mortgage presumption, however, may be rebutted if the installment land contract does not function like a mortgage or if there are other equitable considerations against the presumption. The rebuttable mortgage presumption would preserve the purchaser's property rights while retaining installment land contracts as a viable real estate device.

Introduction

The executory contract analysis under § 365 of the Bankruptcy Code (Code) has long been challenging to judges, practitioners, and scholars. The challenge of understanding the purpose of § 365 and reaching an equitable

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result thereafter is most profound when the law confronts installment land contracts. The parties to an installment land contract, typically the purchaser, can become insolvent and enter into bankruptcy, and the rights of the parties may be altered dramatically as a result of applying bankruptcy law. Historically, inequity resulted from seller bankruptcies under the Bankruptcy Act of 1938 where the seller could reject the installment land contract and force the purchaser to lose the property and his past payments.¹ The express provisions in § 365 have provided some clarity for the rights of the parties in seller bankruptcy.² In the case of purchaser bankruptcy, however, the language of the Code is not much help, and courts have devised inconsistent ways to characterize installment land contracts.

An installment land contract should be presumed to be a mortgage in purchaser bankruptcy because applying § 365 would ignore the purchaser's property rights and would not provide any benefit to the estate. While state laws may allow installment land contracts to occupy an ambiguous place in between other real estate devices, such as mortgages or leases, the parties' rights have to be clearly categorized into either contractual rights or property rights in bankruptcy law.³ Because of the Code's dichotomous treatment of contracts and secured properties,⁴ the rights of the seller and purchaser of an installment land contract are inevitably skewed in purchaser bankruptcy. Two key issues that arise in purchaser bankruptcy are (1) whether a court should focus on contract law or property law by default in treating an installment land contract; and (2) whether the court should ultimately characterize the installment land contract primarily as a contract or a security device. This Comment explores the inconsistent treatment of installment land contracts in purchaser bankruptcy, discusses the inequities resulting from the executory contract treatment, and proposes that a rebuttable mortgage presumption would preserve the purchaser's property rights and benefit the estate while retaining installment land contracts as a viable real estate device.

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Part I discusses the nature of installment land contracts, the relevant Code provisions, and the judicial treatment of installment land contracts in various jurisdictions. Part II examines why applying § 365 to installment land contracts results in incoherent state property rights, especially in light of the true lease jurisprudence. This Part instead suggests a better approach would be for courts to presume that installment land contracts are mortgages. Part III discusses the functionality and equity considerations behind a possible rebuttal of the mortgage presumption of installment land contracts in purchaser bankruptcy.

I. Background on Installment Land Contracts and Executory Contracts in Bankruptcy

The most common way to purchase property is to obtain conventional long-term financing and convey to the lender a security interest in the property.⁵ In this context, applicable state mortgage law provides the rights of the parties and the procedures in case of default.⁶ Unfortunately, some buyers are not able to make the large down payments that may be required for conventional financing. Sellers may find state mortgage laws unattractive—perhaps due to the state's expensive foreclosure process. Instead of entering into a purchase money mortgage arrangement governed by state mortgage law, the purchaser and the seller may enter into a contract for selling the property for monthly installment payments over a decade or more.⁷ The simplicity of this instrument, commonly referred to as an installment land contract, has attracted purchasers (vendees) and sellers (vendors) for different reasons. state courts have struggled to characterize installment land contracts in a manner consistent with their respective property laws.⁸

This Part will first explore the ambiguous nature of installment land contracts and various states' enforcement of installment land contracts. Then, it will discuss the applicable Code provisions for installment land contracts and how federal courts have treated installment land contracts in purchaser bankruptcy.

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A. The Nature of Installment Land Contracts

Installment land contracts incorporate a combination of contract and property principles, and state courts and legislatures have often confronted difficulties characterizing them.⁹ Typically, the seller under an installment land contract—also called a "contract for deed" or "land sale contract"—receives monthly installments of the sale price of the property usually for over a decade or more from the purchaser.¹⁰ The purchaser may take immediate possession of the property once the contract period starts.¹¹ Often the contract is not recorded, and the seller retains full legal title against the purchaser until the very end of the contract's term.¹² Under the strict terms of the contract, the purchaser does not have any present or future interest in property, except for the current possession, until the full payment of the contract price. Therefore, the seller's title is not defeasible by the purchaser during the contract period or before full payment.¹³ Nonetheless, the purchaser usually pays taxes on the property and maintains the property as if he is the owner.¹⁴

A unique feature of an installment land contract is the forfeiture clause.¹⁵ The forfeiture clause usually provides that upon default of the purchaser, the seller as the title holder can repossess the property and keep the purchaser's past payments as liquidated damages.¹⁶ Although judicial and legislative responses in various states have greatly reduced the potency of the forfeiture clause, several states still enforce some versions of forfeiture.¹⁷ Installment land contracts provide greater protection for the sellers with this possibility of forfeiture. The enhanced seller protection of installment land contracts allows

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risk-averse sellers to enter into a contract with financially challenged potential buyers.¹⁸ An installment land contract is similar to a purchase money mortgage where the purchaser pays monthly installments over many years eventually to own the property.¹⁹ The purchasers who cannot obtain traditional mortgages because of their financial status can utilize the installment land contract to have a "mortgage" in effect.²⁰

one possible reason why the sellers and buyers enter into installment land contracts is the characteristics of the state mortgage law.²¹ Because of the prevailing understanding that an installment land contract is a pro-seller device, one may explain its popularity in pro-mortgagor states where the only recourse for a mortgagee is judicial foreclosure.²² Although some argue that installment land contracts should be abolished as more states allow power-of-sale foreclosures, installment land contracts still serve the purpose of providing low-income buyers a means to finance property in jurisdictions where sellers believe the risk involved in a mortgage with low-income buyers is too high.²³ These circumstances that typically accompany the use of installment land contracts raise important equity concerns in bankruptcy.²⁴

The best way to understand the rights of the seller and the purchaser in an installment land contract is to compare their respective rights to those of the parties in transactions structured using other devices, such as a short-term earnest money contract, mortgage, and lease. An installment land contract may share some similarities with each instrument but is not completely identical to any.²⁵

1. Installment Land Contract...