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Exit Strategies and Credit Problems
The transaction documents should describe what will happen if the tenant defaults on the lease, fails to exercise the option, or is unwilling or unable to close on the purchase after exercising the option. If the tenant is to use bank financing, then generally the option fees will be forfeited to the landlord if the tenant does not close on the purchase for any reason. However, if the landlord is providing the financing, another credit report should be required immediately prior to closing as a condition of the financing. If the tenant then does not have good credit, the landlord must have the right to refuse to provide the financing. If the deal then does not close because the tenant is unable to find other financing, the tenant is likely to be very upset unless the tenant clearly understood the risks. Of course, there is nothing to prevent the landlord and tenant from negotiating a new deal if the old one does not close.
Small Claims Court
Indiana small claims courts have limited jurisdiction, meaning that these courts can only do certain things and hear certain cases. As of January 2014, Indiana small claims courts are limited to two types of cases: landlord-tenant disputes and cases involving disputes of $6,000 or less. Marion County Small Claims Courts have jurisdiction over cases involving $6,000 or less, exclusive of attorneys’ fees.
Indiana small claims courts cannot order foreclosure. So, if a lease-option dispute is viewed by a small claims court judge as a land contract case requiring foreclosure, the case must be transferred to another court. That results in a delay in the eviction of months or possibly years. In Marion County, some small claims court judges refuse to hear any landlord-tenant case, if there is an option agreement between the parties. Those cases automatically are delayed and get sent to the Marion Superior Court, where the court rules are more complicated and a lawyer is usually required to represent the landlord. This is just another reason why it is so important properly to structure lease-options.
“Sweat Equity” Side Deals
Often, landlords will sign lease-option agreements with tenants, expecting the tenant to make significant repairs as part of the tenant’s “down-payment.” That approach causes several problems. First, making repairs to a building do not neatly fit into a lease or option agreement. Secondly, that is a taxable transaction, and the failure to report that transaction is tax evasion. Thirdly, landlords do not properly document that tenant’s agreement to make repairs. Fourthly, these “sweat-equity” deals look more like purchase terms, rather than leases. In short, these deals are usually a mess and rarely documented properly. Avoid “sweat-equity” deals, and seek help from an attorney if you insist on doing such a deal.