- January 09, 1996
- All California Issuing Agents
- Distressed Homeowner/Short Sale Transactions
Recently there has been a number of transactions involving "distressed homeowners" in which a corporation receives title from the distressed homeowner under a pretense that the distressed homeowner would not be liable to the Internal Revenue Service from any capital gains taxes and further, that they can protect their credit. Simply put, the homeowners pay a cash fee ranging anywhere from $1,000 to 1% of the original mortgage amount to the corporation who then takes title to the house. The corporation then lists the house for sale. They notify the existing lender to expect no further payments on the loan and then inform the major credit reporting agencies that they (not the borrowers) will be responsible for any delinquency or foreclosure action taken by the lender. If the property sells before the lender's foreclosure, the promoters send some, but not all, of the proceeds to the lender. Should the lender accept, this is known as a short sale. The difference between the amount of the debt due and the amount of the short sale is pocketed by the corporation. If the property does not sell and a short sale is not negotiated with the lender, the property will then go to a foreclosure sale. The tenant (former owner) will generally remain in the property as a tenant in possession until either the voluntary sale or the foreclosure sale is held by the lender.
In various newspaper accounts the IRS has already made it clear that they intend to proceed against the original homeowner for any capital gains should there be a short sale transaction. This is notwithstanding claims made by the corporation that they would be responsible for any capital gains. Also, many of the credit rating services have stated they would continue to reflect the foreclosure against the original owner and not merely the corporation. Based upon the above, the Stewart Title Underwriting Department through the California Quality Leadership Team has determined Stewart Title should not insure title where a ?distressed homeowner? transferred their property to a corporation under the above scenario or where the corporation transferred the property to its successor-in-interest for the following reasons:
- It may be deemed to be a fraud or sham upon the IRS as well as the original
homeowner, particularly if there is any equity left in the property. Although
the original homeowner voluntarily conveyed their title, their heirs, devisees,
and/or a trustee in bankruptcy might elect to attack the transfer based upon
the equity that the corporation obtained through the short sale.
- There is a potential risk of a class action suit brought by the "distressed
homeowner" if the IRS continues to look to them for any capital gains
taxes and/or their credit has not been protected as advertised. As the insurer
or as an escrow agent handling a sale, Stewart may run the risk of being involved
in such a class action.
- In addition to fraud or sham arguments as mentioned above, there may be
separate creditor's rights issues which can be asserted particularly
if the corporation retained monies as a result of the short sale.
- We are concerned about the tenants remaining in possession as a party-in-possession.
Even though they have transferred the title, they remain in possession of
the property under a form of tenancy arrangement. Do the tenancy agreements
suggest other rights or interests? Do the tenants believe they have a continuing
fee interest or option right? To assume otherwise may pose a greater risk
than what Stewart is willing to accept.
- The corporation may be deemed to be a foreclosure consultant. Under the California Civil Code, foreclosure consultants are subject to various sanctions. In addition, under Civil Code Section 2945.6, an owner's right of action is not limited to simply Civil Code Section 2945 et seq., but are entitled to other relief and remedies provided by law including potentially, the right to set aside the transaction. Please see California Land Title Association Manual Section 58.13(d)(3) for more information on this issue.
If you are requested to insure a voluntary sale from a corporation who took title from a "distressed homeowner" as mentioned herein, please consult your Underwriter before committing to insure said transaction.
THIS BULLETIN IS FURNISHED TO INFORM YOU OF CURRENT DEVELOPMENTS. AS A REMINDER, YOU ARE CHARGED WITH KNOWLEDGE OF THE CONTENT ON VIRTUAL UNDERWRITER AS IT EXISTS FROM TIME TO TIME AS IT APPLIES TO YOU, AS WELL AS ANY OTHER INSTRUCTIONS. OUR UNDERWRITING AGREEMENTS DO NOT AUTHORIZE OUR ISSUING AGENTS TO ENGAGE IN SETTLEMENTS OR CLOSINGS ON BEHALF OF STEWART TITLE GUARANTY COMPANY. THIS BULLETIN IS NOT INTENDED TO DIRECT YOUR ESCROW OR SETTLEMENT PRACTICES OR TO CHANGE PROVISIONS OF APPLICABLE UNDERWRITING AGREEMENTS. CONFIDENTIAL, PROPRIETARY, OR NONPUBLIC PERSONAL INFORMATION SHOULD NEVER BE SHARED OR DISSEMINATED EXCEPT AS ALLOWED BY LAW. IF APPLICABLE STATE LAW OR REGULATION IMPOSES ADDITIONAL REQUIREMENTS, YOU SHOULD CONTINUE TO COMPLY WITH THOSE REQUIREMENTS.