Land contracts remain popular among non-lawyer real estate educators and websites. Yet, in Indiana, the land contract remains a risky mechanism for a property owner to sell real estate. The primary risk is that the buyer can retain possession and control over the property, even after months of breaches and defaults under the land contract.
Foreclosure versus Forfeiture
Most land contracts are written so as to permit the owner to seek forfeiture and obtain possession of the property relatively quickly. However, in 1973, the Indiana Supreme Court, in a case called Skendzel v. Marshall, held that land contracts are to be treated like notes and mortgages, subject to Indiana’s expensive, slow and cumbersome foreclosure process. The rule of law established by Skendzel v. Marshall was supposed to be limited to cases in which the buyer had acquired a “substantial interest” in the real estate. That means the buyer should have acquired meaningful equity in the property by paying down the purchase price. In reality, trial courts almost always apply Skendzel v. Marshall to deny a request for forfeiture.
In short, the safe bet is to treat your land contract like it is a note and mortgage. The safer bet is to avoid using a land contract to sell real estate.
Fancy Land Contract Drafting
In response to Skendzel v. Marshall, cleaver lawyers began drafting land contracts with language defining a “substantial interest” in the real estate. For example, a land contract might provide that forfeiture was available to a seller until the buyer paid no less than 10% of the contract price, excluding interest. The effect was to define a “substantial interest” in the real estate as an amount equal to 10% of the contract price. Unfortunately and despite the right freely to contract, the courts rejected this contract drafting approach. The courts have held that the courts, not the seller and buyer, will decide what constitutes a “substantial interest” in real estate. In essence, Skendzel v. Marshall has turned virtually every land contract into a note and mortgage, subject to foreclosure law.
The SAFE Act
Land contracts started gaining popularity again in early 2011, because some Indiana governmental officials have speculated that land contracts are exempt under Indiana’s SAFE Act. That law, in very general terms, requires a seller to hold a mortgage originator’s license to sell residential real estate on terms. However, it should be noted that many residential real estate owners are exempt from the requirements of the SAFE Act when selling their own home. Mortgages are not generally exempt under the SAFE Act. Consequently, many sellers are opting to use land contracts, rather than mortgages, to sell real property.
A Buyer’s Bankruptcy
Skendzel v. Marshall has had another impact on sellers when the buyer files for bankruptcy protection. In essence, a trial court’s order of foreclosure enables the buyer more favorable treatment in a bankruptcy case. Again, it is the seller who suffers.
Building & Health Codes
Most local health and building codes impose liability on the person who holds legal title. In a land contract arrangement, the seller still holds legal title. So, if the buyer does not maintain the property or otherwise subjects the property to a citation for a health or building code violation, the city or county will send the bill to the seller.
Land contracts do have one unique advantage. If a land contract on a residential property requires the buyer to pay the real property taxes and the land contract is recorded, the buyer will qualify for the homestead exemption and the residential cap on real property taxes.
Leases With Options
Sellers should consider using a lease with an option to avoid the problems caused by Skendzel v. Marshall. The lease with option is not always appropriate and must be drafted properly, but a well written lease with option will enable a seller to avoid the trap set by Skendzel v. Marshall.