Some courts and legislatures have stepped in to address concerns over equity and fairness for the buyer
Typically contract law carries the underlying principle of “freedom to contract,” which allows parties to decide whatever terms they want—within the confines of the law—and the courts will enforce the contract as written. An employment contract can’t, for example, say that the employee agrees not to accept minimum wage if the law requires employers to pay minimum wage, as that would be outside the confines of the law. But anything that is “legal” is typically fair game when parties sit down at the negotiating table. The land contract, however, has become a unique kind of contract. Some states have put restrictions on forfeiture clauses that are written into land contracts based on principles of fairness or equity.
Some state courts and legislatures have stepped in to offer buyers using land contracts additional protection even though the parties have freely contracted and agreed to harsh forfeiture clauses. Another way of looking at it is that some courts and state legislatures think of the land contract as a unique legal document given the extended timeframe and all that is at stake—an irreplaceable piece of land. They’ve basically said that in fairness to the buyer who has invested in and grown attached to the land, somewhere along the span of a land contract—during phase two—the title to the land “equitably converts” from the seller to the buyer. In effect, at this equitably manufactured point in time, the title is deemed to be no longer in the hands of the seller despite the fact the land contract says otherwise.
This is what’s known as the equitable conversion doctrine. Once the title equitably converts in this way, the legal concepts of property override the contract terms calling for forfeiture.
Based on this reasoning, some courts and state legislatures have transformed the land contract into something that is functionally similar to a lease or a mortgage. For example, by drawing upon mortgage law, some states grant the purchaser some or all of the protections enjoyed by people who bought land under a mortgage, such as the rights to reinstate the contract after default, to redeem property, to seek restitution of excess payments, and in some cases to demand foreclosure. This serves to reduce some of the risks farmers face in entering a land contract to purchase farmland.
The parties are free to negotiate their own terms, but the courts may step in if the buyer defaults and the terms are not fair to the buyer
As we discussed before, you can go ahead and negotiate and draft your own land contract as you want. That is always a helpful initial approach; going through the negotiation and drafting process itself can help clarify expectations, which ultimately helps prevent confusion, problems, and disputes down the road.
But let’s say things do go wrong. Despite all your intentions, you might want to go to court to resolve the dispute, and as we discussed, the court could do something different than you agreed. Some folks benefit from knowing beforehand what the court might do, just so they have it in the back of their minds. Others don’t want to know until things go down. If you are one of those people who wants to know, the following provides some general summaries of how forfeiture clauses in land contracts are handled in various states. For the curious farmer who wants to learn more about the legal idiosyncrasies of land contracts, be sure to read Section 5, Why Are Land Contracts Treated Differently by the Courts.” Keep in mind that this is a state-specific area of law, and the details and differences by state are far too detailed and nuanced for this guide to cover. Farm Commons strongly recommends that farmers choosing to enter a land contract seek the advice of legal counsel in their state to more fully understand how forfeiture clauses are dealt with and to fully grasp the specific risks and processes involved.
Equity of redemption—a grace period to reclaim the property upon default
A number of states lessen the harsh nature of forfeiture clauses by allowing the buyer a “grace period” in the case of a default, during which she can pay the contract balance. In essence, once a buyer misses a payment, she can pay the remaining balance on the contract and obtain legal title, rather than entirely forfeiting her right to the property. States allow a grace period, usually between 30 and 90 days after the seller provides notice of default, during which the buyer can pay the balance owed in full. Some states additionally require that the buyer has established “substantial equity” in the property already, meaning that a significant number of payments have been made. Other states are even more specific and require that the past payments exceed the fair rental value of the land. They treat it as a lease-option scenario, and say to the buyer, “You essentially paid ‘rent’ to use the land and you lose your option in buying the land when you default.”
This safeguard is what courts refer to as the equity of redemption. It basically allows a grace period for the buyer to reclaim the property upon default. While the buyer must come up with a substantial payment to avoid forfeiture, this method does afford the buyer some additional protection in a final opportunity to fulfill the contract. The farmer will have anywhere between 30 and 90 days to pay the remaining balance owed and retain the property. Otherwise, she loses everything.
States allowing equity of redemption: California, Florida, Hawaii, Missouri, Montana, South Dakota, Arizona, Iowa, Minnesota, North Dakota, Oregon, Texas, Washington
Restitution to the buyer—an opportunity to get some payments back
Other states offer less protection, but still allow the buyer to recoup part of the payments to the seller. In these states, when the buyer misses a payment she still forfeits her interest in the land, but the seller will be required to repay the buyer for all payments in excess of the “actual damages.” Often courts will calculate damages as the fair rental value plus any repair costs. Let’s say a farmer makes 20 monthly payments of $500 under a land contract and isn’t able to make the next payment. The seller provides a notice of default. Based on the land contract, the farmer won’t have a chance to pay the contract balance and will forfeit her $10,000 equity in the land. However, in states that allow restitution to the buyer, the farmer could recover anything above the fair rental value of the land. If the court determines that the fair rental value of the farmland is $400 per month, and the farmer did not damage the property, the seller will be forced to pay $2,000 back to the farmer. While this payment is a small consolation, it affords the farmer more protection than forfeiting all of the land.
States allowing for restitution to the buyer: California, Alaska, New Hampshire, Hawaii, and Pennsylvania. Utah and Idaho also allow restitution; however, they require that payments made before default be “significant.”
Treatment as a mortgage—requiring the seller to foreclose on the property
A growing number of states are giving buyers under land contracts greater protection by transforming land contracts into mortgages in certain situations and giving the buyer all the rights and privileges of a mortgagor. For example, many state laws allow the buyer to retain the right of redemption so long as she has made “more than nominal” payments on the land contract. The equity of redemption is the right granted to the debtor whose property has been foreclosed upon to reclaim the property if she is able to come up with the money to repay the debt. However, if the buyer cannot pay the contract balance within the statutory period (typically between 30 to 90 days), the land will be subject to a foreclosure sale. Under this scenario, the normal mortgage laws apply, meaning that the purchaser can still pay the balance owed on the land until the date of the foreclosure sale. Also, just like a traditional mortgage foreclosure, if the property sells at a higher price than the land contract price, the buyer retains the surplus. However, if the land sells for less, the seller can bring suit against the buyer for the difference.
For example, let’s say that Gene entered a land contract with Chris for $100,000. The land contract has a forfeiture clause that specifies that Chris gets to keep all the payments upon default and that Gene loses out on buying the property. Over a span of eight years, Gene makes 80 payments of $1,000 each. He then fails to make the 81st payment, so Chris enters a notice of default. In the states that transform land contracts into mortgages upon a default, instead of automatic forfeiture, the mortgage laws would now automatically kick in. This forces Chris to go through the foreclosure process and file all the necessary paperwork to foreclose on the land to preserve his rights to the land. If Chris starts the foreclosure process, Gene then has a set period of time under his right of redemption to come up with the $20,000—usually somewhere between 30 to 90 days. If Gene does so before the foreclosure sale, the property is his. Let’s say Gene doesn’t come up with the money and the property goes to judicial auction on the courthouse steps. If the property sells for $104,000, Gene would get the $4,000 surplus; however, if the property sold for $96,000, Chris could sue Gene to recover the $6,000 loss.
As this example illustrates, treating the land contract as a mortgage provides the buyer the greatest degree of protection. Upon default, the onus is really on the seller to preserve his interest in the land. If the seller does nothing, the land contract is still in place and if the buyer continues to make payments the land will ultimately be his. is more likely for a buyer without good credit or for whatever reason is not able to “qualify” for a traditional mortgage. Nevertheless, if a farmer can find a seller who is still willing to enter a land contract despite this, it can be an ideal scenario.
As this example illustrates, treating the land contract as a mortgage provides the buyer the greatest degree of protection. Upon default, the onus is really on the seller to preserve his interest in the land. If the seller does nothing, the land contract is still in place and if the buyer continues to make payments the land will ultimately be his.
While this is all good news for farmers who want to purchase land under a land contract, the backlash is that, in such states, sellers are becoming more reluctant to enter land contracts with buyers who would not ordinarily qualify for a mortgage. They fear that they will end up having to go through the time and expense to engage in the drawn-out mortgage process to get their land back upon a default, which is more likely for a buyer without good credit or for whatever reason is not able to “qualify” for a traditional mortgage. Nevertheless, if a farmer can find a seller who is still willing to enter a land contract despite this, it can be an ideal scenario.
States treating land contracts as mortgages: Indiana, Kentucky, Maryland, and Oklahoma. Ohio treats land contracts as mortgages as long as the contract is at least five years old and 20% of the principal has been paid. Additionally, courts in Nebraska, New York, Florida, and California are moving in the direction of treating land contracts as mortgages—allowing purchasers many, but not all, of the protections.
Mortgage foreclosure procedure: All states have slightly different foreclosure laws, but in general they follow a similar procedure.
- The seller files suit in court
- Buyer receives notice in the mail demanding payment
- Buyer must respond within 30 days with payment in order to avoid foreclosure
- If payment is not made after a certain time period, the mortgaged property is then sold through judicial auction