Presenting a live 90-minute webinar with interactive Q&A Avoiding "Due on Transfer" in Trusts: Structuring Transfers to Avoid Triggering Acceleration Clauses A Real-World Guide to Garn-St. Germain Act Exemptions TUESDAY, APRIL 9, 2019 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: William Bronchick, Principal Shareholder, Bronchick & Associates, Aurora, Colo. Brendan Bybee, Attorney, Rushforth Lee & Kiefer, Las Vegas Bill Goldberg, Attorney, Bill Goldberg, Denver The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 1.
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Avoiding "Due on Transfer" Provisions in Land Trusts and Single-Member LLCs Strafford Webinars Strafford Publications, Inc. 590 Dutch Valley Road NE Atlanta, GA 30324-0729 Tel: (800) 926-7926 x 1 Presented by Attorneys: William Bronchick, Bill Goldberg and Brendan Bybee April 9, 2019
What You Will Learn... History of the due on sale clause, and of the Garn-St. Germain Depository Institutions Act Brief definition of due on sale/due on transfer provisions Exceptions the Garn-St. Germain Depository Act provides to the due on transfer provisions Drafting revocable living trust documents to hold encumbered real estate Structuring the transaction to avoid the acceleration provision Transfers into single-member LLCs 6
Benefits for the Viewers The panel will review these and other key issues: What are the specified transfers exempt from enforcement of due on sale/acceleration clauses as they relate to estate planning? What are the practical requirements that a trust must have to ensure that a transfer of qualified property does not trigger an acceleration clause? What are the specific traps that trust counsel must avoid in structuring a trust transaction? Sample language for trust documents 7
Take-Aways After completing this course, you will be able to: Identify the transfers exempt from enforcement of due on sale/acceleration clauses for estate planning purposes Discern trust provision requirements to ensure that a transfer of qualified property does not trigger an acceleration clause Determine transfers into LLC structures that will not violate due on transfer provisions Recognize specific tax traps that trust advisers must avoid in structuring a trust transaction 8
Bio: William Bronchick, ESQ. Self-unemployed for 26 years Admitted to practice before New York Bar in 1991 Admitted to practice before Colorado bar in 1996 Practice limited to real estate, asset protection, and estate planning Author of six best-selling real estate and business books Licensed real estate broker 9
Bio: Bill Goldberg, ESQ. Solo practice specializing in real estate and business transactions for over 20 years Helped draft key provisions of the Colorado Foreclosure Protection Act Co-Author of Colorado Foreclosure Investing Manual Frequent speaker at real estate and business seminars 10
Bio: Brendan Bybee, ESQ. Eight years practicing in the areas of estate and business planning and trust administration. Regularly co-counsels with attorneys looking to take advantage of Nevada s favorable trust and asset protection laws. Admitted to practice in Nevada in 2011 Admitted to practice in Utah in 2012 11
History of the due on sale clause Before the early 1970s, mortgage loans typically did not allow a lender to require a note to immediately be paid in full (accelerating the debt) merely because the borrower sold the property that was the lender s collateral. If the contract interest rate on such a mortgage loan was at a fixed rate, when interest rates being paid in the market began to rise, the value of the note would decline and if the rates raised substantially, banks would have capital investments locked in at rates that may not even meet inflation rates. When inflationary expectations and pressures began to generally cause an increase in market interest rates in the early 1970s, lenders sought to protect themselves from increasing interest rates in various ways, including the addition of contractual language in real estate mortgages that would allow the lender to require the borrower to pay the entire balance owing if the property securing the loan was sold (a due-on-sale clause). 12
The due-on-sale clause The following is typical due-on-sale language contained in the early mortgages: In the event that the borrower sells the property without the prior written consent of the lender, the lender may, at its option, declare the entire principal balance of the loan immediately due and payable. 13
Borrower s tactics in dealing with a due on sale clause Creative borrowers began using various techniques to keep from actually selling the property, to prevent the lender from being able to require immediate payment of the loan in full, such as: Entering into contracts for deed Using long term leases coupled with an option granted to the tenant to purchase the property Selling the corporate or other entity borrower and not the property itself Others 14
History of the due on transfer clause Lenders responded to such tactics by adding additional language to exercise their right to accelerate the debt if such specific events occurred (a due-on-transfer clause). The following is contractual language in a mortgage containing a more lender friendly due-on-transfer clause, which makes a defined Disposition an event of default, and which would give the lender the right to accelerate the debt: 15
Example of a lender s due on transfer clause Borrower will not make a Disposition without obtaining Lender's prior written consent to the Disposition. Disposition was defined in the mortgage to include: Any sale, lease (except as permitted under this Deed of Trust), exchange, assignment, conveyance, transfer, trade, or other disposition of all or any portion of the Mortgaged Property (or any interest therein) or all or any part of the beneficial ownership interest in Borrower (if Borrower is a corporation, partnership, general partnership, limited partnership, joint venture, trust, or other type of business association or legal entity). 16
History of the due on transfer clause Borrowers began to resist and litigated the attempt by lenders to require the loan to be paid in full merely because the mortgage property was transferred, arguing that such limitations amounted to an unconstitutional restraint on alienation (the right to transfer your property). The courts in different states began to interpret these contractual provisions, and the law was interpreted different in virtually every state. 17
Garn-St. Germain Depository Institutions Act To eliminate the confusion surrounding the enforceability of due-on-transfer clauses, on October 15, 1982, Congress decided to preempt state law by passing a federal statute. This act was intended to give uniform treatment of these mortgage provisions in all of the jurisdictions. The Garn-St. Germain Depository Institutions Act specified when a lender could, and when it could not, require the borrower to pay the entire balance merely because of a transfer of an interest in the property securing the loan. 12 U.S.C. 1701j-3(d)(2000) 18
Garn-St. Germain 591.5(b) Specific limitations. With respect to any loan on the security of a home occupied or to be occupied by the borrower, (A) A lender shall not (except with regard to a reverse mortgage) exercise its option pursuant to a due-on-sale clause upon: (iii) A transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety; (iv) The granting of a leasehold interest which has a term of three years or less and which does not contain an option to purchase (that is, either a lease of more than three years or a lease with an option to purchase will allow the exercise of a due-on-sale clause); 19
Garn-St. Germain (v) A transfer, in which the transferee is a person who occupies or will occupy the property, which is: (A) A transfer to a relative resulting from the death of the borrower; (B) A transfer where the spouse or child(ren) becomes an owner of the property; or (C) A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement by which the spouse becomes an owner of the property; or 20
Garn-St. Germain (vi) A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy. 21
Garn-St. Germain (B) A lender shall not impose a prepayment penalty or equivalent fee when the lender or party acting on behalf of the lender (i) Declares by written notice that the loan is due pursuant to a due-on-sale clause or (ii) Commences a judicial or nonjudicial foreclosure proceeding to enforce a due-on-sale clause or to seek payment in full as a result of invoking such clause. 22
Can the lender call the note due if there is a due on sale clause and the property is sold without the lender s consent? Generally the answer is yes. But there s some possibility that there might not be a due-on-transfer clause if the lender is not an institution (need to check) The lender might grant permission (particularly if you assign the lender additional legal rights) So if a lender has this contractual right, why wouldn t it exercise its right to call the note due? Market interest rates are below the note s rate Property s value is less than the amount owed Lenders don t want to foreclose Lender s don t want to own property (taxes, maintenance, property is vacant) Loan is performing, vs. recognition of loss if property is foreclosed 23
Will the lender exercise it s right to call the note due under its due-on-transfer clause? As mortgage interest rates have fallen from the high levels of the early 1980s, lenders have frequently not been aggressive in exercising their rights under the due-on-sale clause. Instead many lenders have sometimes preferred to allow the loan contract to remain in place so long as it is being timely paid. As current interest rates rise, it can be expected that more lenders will elect to accelerate the debt when it is discovered that the borrower has transferred an interest in the property without the lender s consent. As the market improves, they can, and they might, call the note. 24
Case law on due-on-sale clauses Courts in some state, like Texas, routinely uphold the enforceability of due-on-sale clauses In recent case law developments in Texas, the Dallas Court of Appeals in 2005 refused to find in favor of the borrower asserting a cause of action for wrongful foreclosure of a commercial loan as a result of the borrower's transfer of the mortgaged property to a corporation owned by the borrower under an unrecorded deed which the borrower claimed was never delivered. Adams v. First National Bank of Bells/Savoy, 154 S.W.3d 859 (Tex.App. Dallas 2005, no pet.). The court found that there was evidence in the borrower's corporate financial statement and in the borrower's own comments to the lender that the property had been transferred. Even though the lender did not give the borrower a notice of its intent to accelerate the debt, the court found that the borrower had waived her right to notice of intent to accelerate. 25
Garn St. Germain Due-on-sale clauses are enforceable in residential loan transactions except in the following situations: 1. Death of the borrower transfer to the heirs 2. Divorce of the borrowers transfer to one spouse 3. A lease, not coupled with an option to purchase, of less than three years 26
12 USC Sec. 1701j-3 Sec. 1701j-3. Preemption of due-on-sale prohibitions (d) Exemption of specified transfers or dispositions With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units... a lender may not exercise its option pursuant to a due-on-sale clause upon - 27
Garn-St. Germain (a) Definitions For the purpose of this section (1) the term "due-on-sale clause" means a contract provision which authorizes a lender, at its option, to declare due and payable sums secured by the lender's security instrument if all or any part of the property, or an interest therein, securing the real property loan is sold or transferred without the lender's prior written consent; 28
Garn-St. Germain Notwithstanding any provision of the constitution or laws (including the judicial decisions) of any State to the contrary, a lender may, subject to subsection (c), enter into or enforce a contract containing a due-on-sale clause with respect to a real property loan. 29
Garn-St. Germain (d) Exemption of specified transfers or dispositions With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon- 30
Garn-St. Germain (8) a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property; 31
The regulations Section 591.5(b)(1)(VI) A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy. 32
Garn-St. Germain regulations (vi) A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy. 33
Drafting Trust Provisions Which exemption are we relying on? Transfer by devise, descent, etc. does that include the transfer into trust? A transfer into an intervivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property Does the trust exemption also apply to non-owner occupied properties (ie, rentals)? Transfer to a spouse or children exemption? 34
Definition in the Regs (12 C.F.R. 591.5(b)(1)): A lender shall not exercise its option pursuant to a dueon-sale clause upon:(vi) A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy. 35
Definition in the Regs: In other words, does it only apply to the grantor s principal residence? What if grantor is only person on the mortgage and transfers into trust for benefit of grantor and his spouse? Does transfer to trustee in trust vs. transfer to trust itself matter? In this regard, is transfer to an irrevocable trust ok if the beneficiaries are spouse and kids? 36
More Trust Issues Garn Act only applies to 1-4 family (not commercial) What about an installment sale to a trust for benefit of grantor and/or his spouse or kids? QPRT (spouse and kids are remainder beneficiaries)? Illinois Land Trust (aka nominee or realty trust Does Irrevocable vs. Revocable Trust matter? Refinancing trust property 37
Practical Implications of a Due on Sale Violation Lender s Remedies: Do nothing Inquire further Accelerate the loan Laches No obligation in note or mortgage to notify lender, thus is the regulation implying that notification is required even enforceable? Does non-notification prevent laches argument? 38
Ultra-Vires Doctrine Usually applies to corporate players acting beyond their scope of authority Sometimes applied to administrative agencies action beyond scope of their enabling statute (more common in CA, NZ, and England). Garn Act refers any other exception promulgated by the FHLBB (and presumably its successors) Thus, did the FHLBB act beyond their powers in shrinking the trust exemption to owner-occupied? 39
Sample Trust Language In the event the holder of the mortgage(s) or liens against real property held by this trust seek to enforce the due on sale provisions of said mortgage(s) or lien(s), the Trustee is authorized to transfer the property or property to the grantor(s)/borrower(s) of this trust or enter into any agreement that is required by said mortgage or lienholders to avoid enforcement of said due on sale provisions. 40
Transfer to LLC Property owned by LLC provides more protection than a property owned by a living trust. Courts have held that transfer from H&W to a limited partnership of H&W would trigger due on sale. Does transfer to a disregarded LLC trigger due on sale? LLCs were rarely used in 1983, thus is a single member LLC a separate owner from the member? 41
Tax Issues in Transferring to Trust Transfer to a grantor trust (I.R.C. Secs 671-678) is a non-taxable event. Would apply to typical living trusts, intentionallydefective trusts, etc. Does a trust file a return or get an EIN number? 42
Wrapping it Up Due on sale clause is an almost universal provision of mortgages and deeds of trust in America Federal law supports the validity of these provisions Federal law carves out exceptions for enforcement Exceptions are vague at best, and practitioner should be both creative and cautious when drafting around these provisions. 43
Questions?? 44