Real Estate Contracts and the Doctrine of Equitable Conversion in Washington: Dispelling the Ashford Cloud

• Publication year: 1983

UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 7, No. 2WINTER 1984

Real Estate Contracts and the Doctrine of Equitable Conversion in Washington: Dispelling the Ashford Cloud

Linda S. Hume(fn*)

I. Introduction

The installment real estate contract is often called the "poor man's mortgage."(fn1) Historically, it was used by sellers to finance land sales when there was no institutional funding available or when the buyer could not meet institutional lender criteria for funding. Once again, due to high interest rates and the unavailability of institutional funds, sellers are financing property sales with the poor man's mortgage.

Given the long history and recent increased use of the installment real estate contract (hereinafter referred to as the "installment contract"), it might be expected that the underlying doctrine was well-understood and furnished a high degree of certainty and predictability to the parties. Sadly, this is not so. Much confusion exists in Washington law about the nature of the respective interests of the buyer and seller in property that is subject to an installment land contract. Most of the confusion results from one line of decisions that held that the buyer had no interest, legal or equitable, in property being purchased under an installment contract containing a forfeiture clause.(fn2) This line, of course, includes the infamous Ashford v. Reese.(fn3) Ashford was overruled after fifty years of making mischief. The Ashford legacy, however, still causes confusion about whether Washington courts apply the doctrine of equitable conversion. It is also still unclear which legal principles Washington courts should use to solve real estate contract problems.

In addition to the confusion created by Ashford, further confusion results from the failure to distinguish between the installment contract, wherein seller retains legal title as security for performance, and the marketing or earnest money contract, wherein the parties intend that title will be transferred to the buyer after a short closing period. The installment contract resembles a mortgage because it divides the incidents associated with property ownership between the parties to the contract.(fn4) Typically, however, the earnest money contract does not give any incidents of ownership to the buyer. Yet, in cases involving both kinds of contracts, courts often decide cases by applying property labels without considering relevant contract doctrine.

It is the principal thesis of this article that property and contract questions should not be solved independently and are most usefully approached in a distinct order. Because the installment contract divides the incidents of property ownership usually associated with legal title between the parties to the contract, it should be treated differently than the earnest money contract in which the incidents of ownership are not divided. In addition, it is important to first answer some remedial questions before proceeding to make decisions about the property interest of each party to the contract. To support this thesis, this article will explain in detail how the Ashford legacy has affected the treatment of real estate contracts in Washington. It will then compare the Washington approach with the doctrine of equitable conversion. Finally, it will suggest an analysis for real estate contract problems and apply that analysis to some remaining problem areas.

II. The Forfeiture Clause and Equitable Conversion

Prior to the appearance of the Ashford line of cases, the Washington Supreme Court had developed a consistent approach to real estate contracts. The decisions recognized that both parties to the contract had equitable interests with respect to the property.(fn5) Moreover, legal and equitable remedies attendant upon those interests and the contract itself were consistently treated in the decisions.(fn6) Following the appearance of Ashford, however, the courts began to treat questions about the nature of the "property" interest of each party in the subject matter of the transaction as separate from the contract aspects of the transaction. Now that Ashford is overruled, there should be no impediment to recognizing that both property and contract questions are present in each transaction, and to using principles from both doctrinal areas to resolve real estate contract cases.

A. The Ashford Problem

Although the judicial treatment of the installment contract forfeiture clause and its relationship to other remedies were established early and fairly consistently applied,(fn7) a separate line of cases appeared wherein the courts stated that the purchaser had absolutely "no title or interest, either legal or equitable," in property that was subject to an installment contract containing a forfeiture clause.

The notion that the purchaser had no interest in the property that was the subject matter of the contract if the contract contained a forfeiture clause blossomed in Schaefer v. Gregory(fn8) and Ashford v. Reese.(fn9) Both were risk-of-loss cases. In Schaefer, the seller was unable to deliver title to the buyer because the property under contract had been condemned for use as a military base; in Ashford, the buildings on the property under contract had been destroyed by fire. In both cases, the purchasers were permitted to rescind the contract and recover the purchase price. The court reasoned in each instance that the purchaser had no interest in the property subject to the contract because the contract contained a forfeiture clause. The loss, therefore, had to fall on the holder of legal title, the seller, who could no longer deliver his promised performance.

The reasoning in these cases drew immediate criticism. The dissenting judges in Ashford demonstrated quite clearly that nothing in Washington precedent justified the statement that an installment contract purchaser had no property interest in the subject matter of the contract.(fn10) Law review commentators also pointed out that nothing about the presence or absence of a forfeiture clause in a contract supported such a statement.(fn11) The seller was not required to elect forfeiture; it simply was one of the remedial options open to the seller in the event the buyer defaulted.(fn12)

The Ashford court believed that it had to decide that either the buyer or the seller had the "property" that was the subject of the contract in order to decide which of the parties to the contract would bear the loss. This position is understandable because the doctrine of equitable conversion, the principal means for placing risk of loss in the real estate contract setting, was based on a similar premise-that risk of loss must be assigned to the party who had the property.(fn13) In fact, however, it is quite impossible to decide which party to an installment contract has "real property," because the usual incidents associated with ownership are divided between the parties in an installment land contract. A brief exploration of some of the well-known principles underlying the areas of contract and property will illustrate the difficulty of placing a label on an interest that amounts to less than the full panoply of rights we associate with legal title.

The law of property jealously guards the formalities accompanying the transfer of property, particularly real property, lest that bundle of rights we call "ownership" will not be acquired.(fn14) Without appropriate transfer, a buyer is left without rights to the property; she has only contract or tort claims. A contract claim can, of course, ultimately lead to a transfer of full legal ownership to the buyer, because specific performance is routinely awarded in cases where the subject matter of the contract is real property.(fn15) In order to obtain specific performance, however, a buyer must tender her own promised performance and pay the entire purchase price.(fn16) This is the typical earnest money situation. There is usually no need to worry about whether a buyer has rights in the property under this agreement, because such rights can be acquired as described above. More importantly, a buyer will not usually receive any of the usual incidents of real property ownership under the terms of an earnest money agreement.

The installment contract presents a different problem. Because legal title, together with the incidents of ownership it represents, remains in the seller, the formalities of legal transfer have not been observed, and theoretically the buyer can have no legal interest in the property.(fn17) Nonetheless, it is common to transfer such important incidents of property ownership as the right to possession to the installment buyer under the real estate contract itself. The buyer is not, however, in a position to require formal transfer of any property rights associated with the incident of ownership because part of the buyer's own performance is still owed to the seller.(fn18)

If the parties to the contract agree to divide the incidents of ownership between the seller and the buyer over a period of time, it is incorrect to think of the seller as the "owner" of the property; some of the most important attributes of that ownership have been transferred to someone else. It is similarly inappropriate in property terms to think of the purchaser as the "owner," because the purchaser has only some of the rights associated with ownership, not the...