TENANTS AND SHORT SALES: SHOULD THE TENANTS BE NOTIFIED?
I wanted to send out a blog regarding Tenants and Short Sales. I have had several agents, landlords, and/or clients that have asked me about whether or not they should notify their tenant(s) when they are or about to become delinquent on their mortgage. Also, whether or not they should shed light on the fact that they may be pursuing a short sale transaction. Landlords, Tenants, Agents, and Clients have also asked me whether it is illegal to collect rents while owner/landlord is in default on the mortgage and/or deed of trust. I wanted to address some key points and issues that are involved both legally and practically speaking.
•Let’s start by reiterating that agents should NOT give legal or tax advice to their clients.
•Short sales are difficult enough, without having to deal with an angry and disgruntled tenant. So honesty, integrity, good faith dealing, and communication between all involved Parties is always the best approach.
Here is the LONG VERSION:
1. Contractually speaking:
a. It is typically a contractual breach by landlord to collect rents, while defaulting on a mortgage or deed of trust;
b. A completed Short Sale does not terminate a lease or rights within such lease, so tenant can become burden of potential buyer, or throw a wrench into a potentially successful short sale;
c. Landlord has right to enter property to show prospective buyers per Civil Code and most lease contracts (Reasonable Notice: Typically 24 hours), but it is still difficult to enforce when you have a disgruntled tenant in place;
d. Disgruntled tenant can lead to problems in enforcing contractual obligations in Residential Purchase Agreement as well;
e. Rent Assignment Clause: Lenders have added protection in the event the borrower becomes delinquent on the loan payments. An assignment of rents clause, which is included in most mortgages and deed of trust documents, gives the Beneficiary the legal power and authority to collect rent, other income and profits that are generated by the property. Often, the beneficiary is not required to give notice or go into court in order to exercise this right. If the buyer clears of the default, Beneficiary might instruct the tenants to once again make rent payments directly to the owner;
f. Eviction: Current Owner/Title Holder can file Unlawful Detainer for defaulting tenant, even if they are delinquent on mortgage. Often times, since Seller is in negative equity position and in current financial hardship, sometimes they do not have the legal acumen, resources, or interest in filing and successfully concluding Unlawful Detainer Action (“eviction”). If property transfers, and the new Buyer takes title after the successful short sale, but tenant or Hold Over Occupant still occupies the property, the burden of occupancy will land on the shoulders of the buyer. It is always a good idea in all short sale transactions, that potential buyer and buyer’s agent uses the protections given in paragraph 5(C) of the C.A.R. Form RPA-CA, which deals directly with Tenant-occupied property, and obligation to vacate prior to COE.
2. Practically Speaking:
a. Often times, tenants will receive notice of pre-foreclosure by way of Notice of Default, and feel as though they have been duped and/or hoodwinked. Their initial response is to be scared and angry. If they are not aware of the situation, they are typically angered, and make it difficult on all Parties to complete the short sale transaction. Sometimes, they stop paying rent altogether, and attempt to make it difficult to show property to potential buyer’s and/or agent needing to complete interior BPO, and/or refuse to leave or vacate premises upon conclusion of short sale. They may also hold contractual lease rights that should be reviewed by all involved Parties;
b. Most Sellers do not want to pay for and or file Unlawful Detainer (“UD”) when they are in default, and thus the onus often times falls on future buyer; It is also common for some Tenants to hope outcome is non-judicial foreclosure versus short sale, because they may have further protections under the New Federal Law TITLE VII--PROTECTING TENANTS AT FORECLOSURE ACT of 2009 SEC. 701, and/or they have knowledge that they may be offered a Cash-For-Keys offer or relocation assistance from the Beneficiary or Third Party Investor after the completion of the Trustee Sale.
c. In my opinion Sellers and Agent should never list a property and/or put sign in the yard, without having direct communications with the Tenant. In my experience successful short sale involving tenant occupied properties typically occur, when all Parties are honest about the situation at hand, and choose the route of communication and diplomacy;
3. Legally Speaking:
a. Remember, completing rental or investment property, and then concluding short sale and/or doing short sale on investment property has different potential tax consequences than completing short sale on principal residence (i.e.: The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence, and includes certain exemptions and elements to fall within the scope of its purview, so it is essential that all Seller consult with a professional tax advisor and CPA regarding any potential tax liabilities that the short sale may create)
b. Carve-Outs: A carve-out is a lender exception to pursue borrower for personal liability on non-recourse loans. The term typically related to the foreclosure process, but a point can be made, that lenders have a right to pursue borrowers for certain misconduct. The "thinking" behind non-recourse carve-outs is that the borrower will still be personally liable for certain losses to a lender, regardless of purchase money quality of loan. The bulk of the nonrecourse carve-outs are for those acts or omissions that fall under the "bad boy" rubric. These include waste, fraud, and other intentional acts of misconduct injurious to the lender: (Such as)
i. Losses for fraud or intentional misrepresentation;
ii. Losses for waste;
iii. Losses for misappropriation of tenant security deposits or rents;
iv. To enforce the assignment of leases and rents.
c. It is also never a good idea to tell Sellers to default on their mortgage, breach a contract, or become delinquent while collecting rents. It is true, that most defaulting landlords may not fall into the defined category of Rent Skimming under the statutory language of the following Civil Code, but it is a good idea to tell your clients that they should contact a licensed real estate attorney to discuss these matters in further details. I would not advise agents to discuss any legal ramifications involved, but knowledge is power, so I at least thought I should pass on the information to you to review.
California Civil Code §890.
(a)(1) "Rent skimming" means using revenue received from the rental of a parcel of residential real property at any time during the first year period after acquiring that property without first applying the revenue or an equivalent amount to the payments due on all mortgages and deeds of trust encumbering that property.
(a)(2) For purposes of this section, "rent skimming" also means receiving revenue from the rental of a parcel of residential real property where the person receiving that revenue, without the consent of the owner or owner's agent, asserted possession or ownership of the residential property, whether under a false claim of title, by trespass, or any other unauthorized means, rented the property to another, and collected rents from the other person for the rental of the property. This paragraph does not apply to any tenant, subtenant, lessee, sublessee, or assignee, nor to any other hirer having a lawful occupancy interest in the residential dwelling.
(b) "Multiple acts of rent skimming" means knowingly and willfully rent skimming with respect to each of five or more parcels of residential real property acquired within any two-year period.
(c) "Person" means any natural person, any form of business organization, its officers and directors, and any natural person who authorizes rent skimming or who, being in a position of control, fails to prevent another from rent skimming
(a) A seller of an interest in residential real property who received a promissory note or other evidence of indebtedness for all or a portion of its purchase price secured by a lien on the property may bring an action against any person who has engaged in rent skimming with respect to that property. A seller who prevails in the action shall recover all actual damages and reasonable attorney's fees and costs. The court may award any appropriate equitable relief. The court shall award exemplary damages of not less than three times the actual damages if the defendant has engaged in multiple acts of rent skimming and may award exemplary damages in other cases.
(b) A seller of an interest in residential real property who reacquires the interest from a person who has engaged in rent skimming with respect to that property, or a law enforcement agency, may request the court for an order declaring that the reacquired interest is not encumbered by any lien that is or has the effect of a judgment lien against the person who engaged in rent skimming if the lien is not related to any improvement of the property and does not represent security for loan proceeds made by a bona fide lien holder without knowledge of facts constituting a violation of this title. The motion or application shall be made with at least 30 days' advance written notice to all persons who may be affected by the order, including lien holders, and shall be granted unless the interests of justice would not be served by such an order.
(c) A mortgagee or beneficiary under a deed of trust encumbering residential real property may bring an action against a person who has engaged in rent skimming with respect to that property as one of multiple acts of rent skimming, whether or not the person has become contractually bound by an obligation secured by the mortgage or deed of trust. The mortgagee or beneficiary who prevails in the action shall recover actual damages to the extent of the amount of the rent collected on the encumbered property and attorney's fees and costs. The court also may order any appropriate equitable relief and may award exemplary damages.
(d) A tenant of residential real property may bring an action against a person who has engaged in rent skimming with respect to that property for the recovery of actual damages, including any security, as defined in Section 1950.5, and moving expenses if the property is sold at a foreclosure sale and the tenant was required to move. A prevailing plaintiff in such an action shall be awarded reasonable attorney's fees and costs. The court also may award exemplary damages; it shall award exemplary damages of at least three times the amount of actual damages if the payments due under any deed of trust or mortgage were two or more months delinquent at the time the tenant rented the premises or if the defendant has engaged in multiple acts of rent skimming.
(e) The rights and remedies provided in this section are in addition to any other rights and remedies provided by law.
(f) Rent skimming is unlawful, and any waiver of the provisions of this section are void and unenforceable as contrary to public policy.
(g) Sections 580a, 580b, 580d, and 726 of the Code of Civil Procedure do not apply to any action brought under this title.
(a) Any person who engages in multiple acts of rent skimming is subject to criminal prosecution. Each act of rent skimming comprising the multiple acts of rent skimming shall be separately alleged. A person found guilty of five acts shall be punished by imprisonment in the state prison or by imprisonment in the county jail for not more than one year, by a fine of not more than ten thousand dollars ($10,000), or by both that fine and imprisonment. A person found guilty of additional acts shall be separately punished for each additional act by imprisonment in the state prison or by imprisonment in the county jail for not more than one year, by a fine of not more than ten thousand dollars ($10,000), or by both that fine and imprisonment.
(b) If a defendant has been once previously convicted of a violation of subdivision (a), any subsequent knowing and willful act of rent skimming shall be punishable by imprisonment in the state prison or by imprisonment in the county jail for not more than one year, or by a fine of not more than ten thousand dollars ($10,000), or by both that fine and imprisonment.
(c) A prosecution for a violation of this section shall be commenced within three years after the date of the acquisition of the last parcel of property that was the subject of the conduct for which the defendant is prosecuted.
(d) The penalties under this section are in addition to any other remedies or penalties provided by law for the conduct proscribed by this section.
(a) It is an affirmative defense for a natural person who is a defendant in a civil action brought under Section 891, or a criminal action brought under Section 892, if all of the following occurred:
(1) The defendant used the rental revenue due but not paid to holders of mortgages or deeds of trust to make payments to any of the following:
(A) Health care providers, as defined in paragraph (2) of subdivision (c) of Section 6146 of the Business and Professions Code, for the unforeseen and necessary medical treatment of the defendant or his or her spouse, parents, or children.
(B) Licensed contractors or material suppliers to correct the violation of any statute, ordinance, or regulation relating to the habitability of the premises.
(2) The defendant made the payments within 30 days of receiving the rental revenue.
(3) The defendant had no other source of funds from which to make the payments.
(b) The defendant has the burden of producing evidence of each element of the defense specified in subdivision(a) in a criminal action under Section 892 and the burden of proof of each element of the defense in a civil action under Section 891.