18.00 Sale-Leaseback Transactions


In General

A “sale-leaseback” is a general real estate transaction in which a sale of real property is executed simultaneously with a lease of the same property back to the original owners, so that the possession of the seller remains undisturbed although his status changes from that of a “fee owner” to that of a “lessee”.

In some instances, courts and statutes have viewed this type of transaction as the creation of a “mortgage” rather than a true “sale and lease”.

From the title insurance point of view it is vital to ascertain the real nature and scope of any of these transactions.


Determination that the Transaction is not a Mortgage

The existence of any of the following does increase the possibility of a judicial determination that the transaction was intended by the parties to be a mortgage:

·   The grantor is in financial difficulty.

·   The grantor is liable on a pre-existing debt owed to the grantee.

·   The purchase price being paid for the property is clearly much less than the fair market value of property.

·   The rent to be paid during the term of the lease appears to be equivalent to the amount required to repay the purchase price plus an additional amount, which if held to be interest, would be usurious.

·   The seller has an obligation to repurchase the property (not just an option), The obligation may be contained in the lease or in a separate instrument. Such obligation is sometimes in the form of an option to the purchaser to sell back to the seller.

·   The tenant has an option to repurchase the leased property for an amount far below the amount which the purchaser paid, or for an amount which gradually reduces to a token sum.

·   The transaction contemplates that the seller-tenant will build valuable improvements on the land but the term of the lease appears to be unreasonably short for amortizing that investment (indicating an economic compulsion on the part of the tenant to buy back the property at the termination of the lease--even if the lease has no specific provisions concerning repurchase).

·   The lease or some other document in the transaction contains language reflecting the fact that the parties intend the transfer of title to be for security purposes only, (for example, references to “the lender” or “this mortgage”).


Structuring and Insuring the Transactions

  ·   Basic Sale and Leaseback--No Attempted Separation of Land and Improvements

The owner of property may convey land and improvements to an investor who then leases the same property back to the grantor for a specified period. This creates the opportunity to issue two policies of title insurance, an owner and a leasehold owner, each of which requires the application of careful underwriting procedures.

The owner policy insuring the purchaser’s fee simple title should be issued for an amount equal to the value of the land and existing improvements and contain the following exception:

“Lease from _______________, to _______________, dated _______________, recorded ______________, in Book ________, Page _____.”

The leasehold owner policy insuring the lessee must be issued following the normal guidelines pertaining to the insurance of leaseholds. (Refer to “Leasehold Insurance” Section 11.04).  Also review R-22 providing for the Leasehold owner policy to be issued for 30% of the fee owner policy.  Also review P-65 for determining the policy amounts.
  ·   Sale and Leaseback with Mortgage--No Attempted Separation of the Ownership Land and the Ownership Improvements

In this case, and in order to finance construction, the investor may also make a construction loan on the leasehold interest of the lessee.

Usually, three policies can be issued, to wit:
  ¨   No. 1 - An owner policy to the investor insuring its fee title.

This policy, covering the investor’s fee title, should be issued for the full amount of the land and improvements existing at the time the policy is issued. That is, if the investor wants a policy on the vacant land and dated prior to the commencement of construction, the policy may be issued for the value of the land alone. If, on the other hand, the policy is to be dated after construction is completed, it must be issued for the full value of the land and improvements.

In either case, the policy should have an exception in Schedule B relative to the terms and provisions of the lease and, if the mortgage is recorded as part of the same closing, it should also have an exception for the mortgage. If the lessor does not join in the execution of the mortgage, the exception for the mortgage can be followed by a statement that it affects the leasehold only.
  ¨   No. 2 - A leasehold owner policy to the lessee, insuring its leasehold estate.

This policy, covering the interest of the lessee, should be issued for the amount required Rate Rule R-3.a.

NOTE: In the event the aggregate liability of the policies issued exceeds the then retention limit of the Company, you will need to obtain reinsurance.
  ¨   No. 3 - A mortgagee policy to the lender/investor covering the leasehold mortgage.

This policy, covering the mortgage, must be in the amount of the mortgage. If it is issued at the same time that Policy No. 2 is issued, this may be charged as a simultaneous issue.

Any request to issue Policy No. 1 in the full amount of the land and improvements together with Policy No. 3 can be treated at a simultaneous issue rate if the following wording is shown in Schedule B of the owner policy:

“NOTE: This policy is issued concurrently with Mortgagee Policy No. ______. Any payment made under said Mortgagee Policy reduces the coverage of this policy by a like amount.”
  ·   Sale and Leaseback--Separation of the Title to Building from the Title to the Land

This is a specific variation of the “sale and leaseback” transaction. It involves a sale of a parcel of property with the seller reserving title to the building on the land. The purchaser of the land then leases it back to the owner of the building. These transactions are usually entered into for tax reasons and can create some difficult title problems, particularly as to the rights of the various parties regarding the building. (For more information, see “Severance of the Fee and Improvements” Section 18.12).

Because these transactions involve difficult questions concerning the effectiveness of the attempted severance, the character of the improvements, and the nature of the estates created, any examination involving such severance should always be made by a person with a high degree of experience and expertise in these matters.

In this regard, it is necessary to obtain the prior approval of the Company before issuing any title commitment or policy.

Usually, three policies can be issued.
  ¨   No. 1 - An Owner Policy covering the fee ownership of the land.

This policy must comply with the following:
  “It must describe the estate in Schedule A as: “Fee Simple in the Ground Only”.
  “The description set forth in Schedule A must contain the following: “Except the buildings, improvements and structures located thereon.”
  “Schedule B must contain in an exception as to “The terms and provisions of the lease, recorded in Book ________, Page _____.”
  “The policy should be in an amount equal to the value of the land and improvements.
  ¨   No. 2 - Leasehold Owner Policy covering the leasehold estate in the land and the title to the improvements located on the land.

NOTE: Title to a “severed” building should not be insured unless the owner of the building also has an estate in the ground on which the buildings are situated. An easement for ingress and egress and the right of support are not sufficient; titles to buildings are insurable only if the owner has an estate in the ground sufficient to render the building a fixture.

A separate estate of “buildings and improvements” cannot be insured unless the Company simultaneously insures a leasehold estate in the party who owns the buildings and the improvements.
  “The leasehold owner policy issued to the lessee-owner must describe the estate in Schedule A as follows:

“The estate or interest in the land described herein and which is covered by this policy is:

The leasehold estate, as leasehold estate is defined in Paragraph 1(g) of the Conditions and Stipulations of this policy, created by instrument herein referred to as the Lease, executed by _____________, lessor, and _____________, lessee, dated ____________ and recorded __________ in Book ________, Page _____, of ____________, _________, for a term of ______ years, commencing _________, and ending __________, leasing and demising the land except the buildings, improvements and structures now located on said land.

The ownership of the buildings, improvements and structures now located on the land.”
  “In addition to any exception ordinarily shown in policies insuring leases, the following exceptions must be shown in Schedule B:

“Rights of the owner of the land, ___________, in and to the building, improvements and structures, as created by the lease described in Schedule A at 2-A and as created by the deed recorded in Book ______, Page ______, from _________ to ________, reserving said buildings, improvements and structures.

“Lessor’s title to the buildings upon termination of the leasehold estate as provided in the lease set forth in Schedule A hereof creating the estate hereby insured.”
  ¨   No. 3 - Mortgagee Policy insuring a mortgage on the leasehold estate and on the buildings and improvements.

The loan policy must, of course, be for the amount of the mortgage.

(For more information, see “Leasehold Insurance” Section 11.04)