Seller financing holds significant risks for seller

When a seller acts in the role of financing the sale of real property, residential or commercial, there are significant potential downsides for the seller.

In this article, we explore the three primary vehicles for seller financing in the sale of real property: (i) lease with option or obligation to purchase, (ii) land installment contract, and (iii) deed with note and mortgage back from the buyer.  In each of these three vehicles, the seller risks non-payment by the buyer.  That blog entry then explores the legal paths to recovering clear title and possession  of the property, and collecting on the indebtedness.

But beyond the simple action to collect on the debt, seller financing situations frequently involve further complications for the seller:

1) First, with the seller’s security for payment of the debt being recovering possession of and title to the property, the “security” of the seller is getting the property “back.”  But the buyer could in the interim, significantly impair the condition of the property.  Commercial buyers could environmentally contaminate the property or make modifications that impair the structure.  Residential buyers may make “improvements” to the property that impair its marketability.

2) Second, we have experienced all too-frequently that the buyer tends to assert claims against the seller as a defense to the payment  of the seller financing.  These claims range from fraud in failure to disclose claimed defects in the real property to misrepresentation as to the rent roll and the P&L statement provided before the closing.

3) Seller can encounter significant legal complications due to unpaid contractors for work on the property (giving rise to mechanics lien claims), unpaid taxes, and unpaid utility bills.

And taking a second mortgage position for a portion of the purchase price (where a deed is exchanged for a portion of the purchase price)  can be even more precarious.  A second mortgage holds all of the risks set forth above, and in addition, second mortgagees are, obviously, subordinate, to a first mortgage.  To the extent that the value of the property to a foreclosure sale is inadequate to pay the first mortgage, the second mortgage is valueless.

Thus, seller should carefully weigh the risks associated with seller financing of real property.