Due on Sale Clauses Can Cause Problems for Investors
If you buy investment property, or property that is foreclosed on, you can get some great deals, and property that provides you continuing income. Of course, if you do not understand how to look for good property, or the legal effects of loan documents, you can also end up with a big problem on your hands.
Investor Ends up With Problems
Such was the situation in a recent case, when an investor found itself owing way more than anticipated. The problem came because of what is known as a “due on sale” clause, a clause that generally states that if property is transferred (bought, sold, assigned, given away, etc) in any way without the bank’s prior consent, the bank can accelerate the entire balance of the loan.
Usually, these clauses are thought to apply to voluntary transfers, such as if you sell the property. But what about involuntary transfers, like foreclosures? This is exactly what happened in the case. The owner of the property had a due on sale clause in the mortgage documents. The property was foreclosed on by the condominium association, and then purchased by the investor.
The bank, citing the due on sale clause, accelerated the loan. The investor, now threatened with losing the property it had just purchased if it could not pay the entire loan off, was left to defend the foreclosure brought by the original lender.
Voluntary or Involuntary Transfer?
The investor defended the foreclosure by saying that the due on sale clause did not take effect, and thus the loan could not be accelerated against the investor, because the foreclosure of the original owner was an involuntary transfer, and the due on sale clause should only be read to apply to voluntary transfers, such as sales.
Applying basic principles of contract law, the Court looked to the language of the mortgage. The mortgage did not specifically limit acceleration to voluntary transfers. All the loan documents said were that if the property was sold or transferred without the permission of the lender, the loan could be accelerated.
In prior cases cited to by the Court, loan documents had limited the Due on Sale clause to transfers made or initiated “by the borrower.” But this mortgage had no such language. Thus, the Court determined that it did not matter whether the transfer was voluntary or not—the property could potentially be foreclosed on, and the loan would be accelerated as against the investor.
Watch for Due on Sale Clauses
Due on sale clauses are not just for commercial property; many residential mortgages have them as well. They are usually not an issue in a typical real estate transaction, because in a purchase and sale, the prior loan is paid off through proceeds of the closing.
However, in cases where property is transferred without a traditional sale—such as a foreclosure, a divorce, or a voluntary transfer from one business entity to another—due on sale clauses can cause problems if permission from the lender is not obtained in advance.
Do you have a legal problem with a lender, creditor, debtor, or real estate transaction? Let our West Palm Beach business litigation lawyers at Pike & Lustig, LLP, help you. Call us at 561-291-8298 to get a consultation.