Real Estate Transactions Part II: Risks; Title Issues; Deeds & Recording Acts - Mar. 21

Question 1

How many basic layers are there to the allocation of any given risk? (Barros)

Answer 1

Three. (403)

Question 2

What is the first layer to the allocation of any given risk?(Barros)

Answer 2

The first layer is the default allocation of risk. (404)

Question 3

What is the default allocation of risk? (Barros)

Answer 3

The law in any jurisdiction tends to establish default rules for the allocation of any given risk. These default rules may be established by the common law or by statute. (404)

Ex: Most U.S. jurisdictions place risk of physical defects in commercial transactions on the buyer (the rule for residential transactions is more buyer friendly). If you buy a shopping mall, and it turns out that the roof leaks, then under this default rule the leaky roof is your problem, not the seller’s problem.

Question 4

What is the second layer to the allocation of any given risk? (Barros)

Answer 4

The second layer is the contractual allocation of risk. (404)

Question 5

What is the contractual allocation of risk? (Barros)

Answer 5

Contracts, deeds, and other legal documents can change the default allocations of risk, and one of the most important functions of contracts and other transactional documents is to allocate risk between the parties. (404)

EX: As we just saw, in a commercial transaction the default physical condition risk typically is on the buyer. The buyer and seller, however, can change this risk allocation by contract. If you buy a shopping mall, the default risk of a leaky roof is on you, not the seller. You and the seller, however, can agree to contractually shift this risk back to the seller.

Question 6

What is the third layer to the allocation of any given risk? (Barros)

Answer 6

The third layer is embodied by the problem of counterparty risk. (404)

Question 7

What is the problem of counterparty (credit) risk? (Barros)

Answer 7

Broadly speaking, counterparty risk is the risk that the counterparty will default on an obligation and will be unable to satisfy a court judgment of damages for that default.

Ex: Imagine that you have a contractual agreement from me that I will pay you $100,000 on January 1 of this year. My contractual obligation is ironclad, and any court in any U.S. jurisdiction would award you an enforceable judgment against me if I fail to pay. Now imagine that I am broke, bankrupt, and living on a beach in Bali. As a practical matter, your ironclad contractual obligation from me is worthless.

Question 8

What is a counterparty? (Barros)

Answer 8

A counterparty is a person on the other side of a transaction or contract from you. (404)

Ex: If you are the seller, the buyer is the counterparty. If you are a borrower, the lender is the counterparty.

Question 9

What are the two major risks that real estate transactions present? (Barros)

Answer 9

Title risk and physical condition risk. (405)

Question 10

What is title risk? (Barros)

Answer 10

The buyer in a real estate transaction is faced with the risk that there will be problems with the title delivered by the seller. (405)

Question 11

What are the three most common types of title problems? (Barros)

Answer 11

(1) There might be core problems with the ownership of the property.
(2) There may be one or more encumbrances on the property.
(3) There may be an encroachment on the property. (405)

Question 12

What is an encumbrance on a property? (Barros)

Answer 12

Liens, mortgages, easements, and covenants all encumber the title to property. (405)

Question 13

What is an encroachment? (Barros)

Answer 13

An encroachment is a physical intrusion onto the property, typically by a neighboring property owner.

Ex: A neighbor, for instance, might have built a fence or a part of a building that crossed over the property boundary.

Question 14

What are easements? (Barros)

Answer 14

Easements are property interests that give a party the right to physically enter and use the property of another. (405)

Ex; I might have an easement that gives me the right to use a driveway across your property. The easement is an encumbrance on your property, because it restricts your right to exclude me from the property.

Question 15

What are covenants that run with the land? (Barros)

Answer 15

Covenants that run with the land are promises that bind the present and future owners of property. (405-406)

Ex: A covenant might require that any house built on your property be at least two floors and 2,500 square feet. The covenant is an encumbrance because it restricts your use of the property. In some contexts, covenants are often referred to as deed restrictions.

Question 16

What are liens? (Barros)

Answer 16

Liens are security interests in property that provide security for a debt or other obligation. (406)

Question 17

What happens if the owner of the property defaults on the obligation secured by the lien? (Barros)

Answer 17

If the owner of the property defaults on the obligation secured by the lien, the holder of the lien can force the sale of the property through foreclosure and use the proceeds to satisfy the obligation. (406)

Question 18

What is the most common type of lien? (Barros)

Answer 18

The most common type of lien is a mortgage. (406)

Question 19

What is a mortgage? (Barros)

Answer 19

A mortgage is a security interest that the borrower grants to the lender to secure a loan. (406)

Ex: If you borrow money from a bank to buy a home, you give the bank a mortgage.

Question 20

What can happen if you fail to repay the bank in a mortgage? (Barros)

Answer 20

If you fail to repay the bank, the bank can foreclose on the mortgage and use the proceeds to repay the debt. (406)

Question 21

What are the two major categories of liens? (Barros)

Answer 21

The two major categories of liens are consensual liens and involuntary liens. (406)

Question 22

What are consensual liens? (Barros)

Answer 22

Consensual liens are created by a voluntary transaction. (406)

Ex: If you grant a mortgage to a bank, you do so in return for the bank loaning you money as part of a voluntary transaction.

Question 23

What is a common example of a consensual lien? (Barros)

Answer 23

A mortgage is a common example of a consensual lien. (406)

Question 24

What is an involuntary lien? (Barros)

Answer 24

Involuntary liens are created by operation of law and do not arise out of a voluntary transaction. Some involuntary liens arise out of common law. Others arise out by statute and, not surprisingly, are called statutory liens.

Question 25

What are some examples of liens? (Barros)

Answer 25

Tax liens, Mechanic’s liens, Judgment liens, and Agister’s liens. (406)

Question 26

What are tax liens? (Barros)

Answer 26

Tax liens are created when the property owner fails to pay taxes to the state, local, or federal government. Tax liens typically are statutory liens. (406)

Question 27

What are mechanic’s liens? (Barros)

Answer 27

Mechanic’s liens secure payment for contractors and other people making improvements to property. Mechanic’s liens have common-law origins, but today they are typically statutory liens. (406)

Ex: If you have a contractor remodel your kitchen, a mechanic’s lien will secure your obligation to pay the contractor for the work.

Question 28

What are judgment liens? (Barros)

Answer 28

Judgment liens secure the payment of a court judgment. In other words, judgment liens provide a legal mechanism that allows the winner of a judgment for money damages to access the judgment debtor’s property to satisfy the judgment. (406)

Ex: Imagine that you win a court judgment against me for $100,000. I refuse to pay the judgment voluntarily. You can get a judgment lien on property that I own. If I still fail to pay the judgment, you can foreclose on the property.

Question 29

What are agister’s liens? (Barros)

Answer 29

Agister’s liens secure the payment of money owed for the care and feeding of an animal.

Ex: If I care for your dog for six months, an agister’s lien secures your payment to me for the cost of caring for and feeding the dog. Compared to the other liens we list here, agister’s liens are not particularly common.

Question 30

What are physical condition risks? (Barros)

Answer 30

The buyer in a real estate transaction is faced with the possibility that there will be problems with the physical condition of the property being purchased. The most common physical condition problems arise from defects in buildings and other improvements on the land. (406-407)

Ex: If you are buying a home, for example, you would be concerned with the risk that the roof might leak. You would also be concerned with the potential presence of problems like foundation cracks, termites, and lead paint. There may also be problems with the physical condition of the land itself that might render it unsuitable for building.

Question 31

What three major things to the state Recording Acts do? (Barros)

Answer 31

The State Recording Acts:
(1) Create a system of public land records.
(2) Establish consequences for the failure to record a document.
(3) Establish priority between competing claims relating to the property. (407-408)

Question 32

What sometimes happens if you fail to record a deed? (Barros)

Answer 32

It might be rendered invalid and unenforceable against other people who might assert ownership claims. (408)

Question 33

Why can people who perform diligent title searches feel reasonably comfortable about title risk? (Barros)

Answer 33

(A) They will be aware of recorded documents, and
(B) Unrecorded documents typically will be unenforceable against them.

Question 34

Where are name indexes used? (Barros)

Answer 34

Name indexes are common in the Eastern states, where the title systems were developed in colonial times. (408)

Question 35

Where are tract indexes commonly used? (Barros)

Answer 35

Tract indexes are more common in the Western states, where the title system developed later. (408)

Question 36

What are the two basic steps to a title search using a name index? (Barros)

Answer 36

(1) The title searcher goes back in time to determine who owned the property at what time.
(2) Having established the times of ownership, you would now go forward in time to look for recorded documents other than the fee simple deeds regarding the property. (409)

Question 37

What is a prior unrecorded interest? (Barros)

Answer 37

An interest in the property that is prior in time of creation to B’s interest but is unrecorded. (411)

Question 38

What is a subsequent interest? (Barros)

Answer 38

An interest that is created after another interest. (411)

Question 39

What does it mean that Recording Acts typically protect subsequent purchasers for value? (Barros)

Answer 39

They protect the person in B’s position if that person purchased her interest for money or other valuable consideration. (412)

Question 40

What are subsequent creditors for value? (Barros)

Answer 40

People who lend money secured by an interest in the property. (412)

Question 41

What is a race statute? (Barros)

Answer 41

In a race statute jurisdiction, the first person to record wins. (412)

Question 42

What is a notice statute? (Barros)

Answer 42

With a notice statute, subsequent purchasers or lenders will win so long as they had no notice of a prior unrecorded interest at the time they acquired their interest. (413)

Question 43

What is a race-notice statute? (Barros)

Answer 43

As their name implies, race-notice statutes combine both race and notice elements. To win under a race-notice statute, a subsequent interest holder must both (a) take the subsequent interest without notice of the prior interest and (b) record first. (414)

Question 44

What happens under the shelter rule? (Barros)

Answer 44

Under the Shelter Rule, if a person who would win under the applicable Recording Act conveys the property to another person, that other person (the conveyee) would also win under the Recording Act. (415)

Question 45

What is the purpose of the shelter rule? (Barros)

Answer 45

The purpose of the Shelter Rule is to allow the winner under a Recording Act (B in our example) to convey the property. (415)

Question 46

What are the three types of notices? (Barros)

Answer 46

(1) Actual Notice
(2) Record Notice
(3) Inquiry Notice (416)

Question 47

What is actual notice? (Barros)

Answer 47

Actual notice is exactly what it sounds like—a person has actual notice of a fact if the person has been given notice of the fact. (416)

Question 48

What is record notice? (Barros)

Answer 48

Record notice is notice that a person would obtain by performing a diligent record search. A person is on record notice of all documents that have been properly recorded and that as a result would have been found in a title search. A person is on record notice of all recorded documents even if that person does not perform a title search. (416)

Question 49

What is inquiry notice? (Barros)

Answer 49

Inquiry notice is notice of facts that would have been found if (a) a reasonable person under the circumstances would have inquired further into the facts, and (b) a person had performed a diligent inquiry into these circumstances. Inquiry notice is triggered by facts that would cause a reasonable person to ask further questions or otherwise investigate the facts. If the person at issue does not perform this further investigation, she will be charged with inquiry notice of the facts that the further investigation would have discovered. (417)

Question 50

What is a marketable title? (E&E)

Answer 50

Marketable title, while allowing for the possibility that the buyer’s title might be successfully challenged, is a title secure enough that a reasonable person knowing all the facts would accept and pay for it. (366)