Sub2 - Is it legal?

[ronb107]

I've been doing a bit of research on Sub2 and I'd like to get some feedback on the following...

I'm quite familiar with William Bronchick's site and I've taken the time to review the case law he cites.  I'm disturbed that much of what he states is (imo) a mistatement of the facts (upon reviewing each case).  I've even discussed this with a former prosecuting attorney to get some additional opinion.

There is federal law dealing with Fraudlent Concealment, a felony. For fraudulent concealment to be committed, you have to knowingly
conceal or cover up by any trick, scheme, or device, a material fact
(18 USC § 1001 Section of the US Code).

With a Sub2, when the Investor tells the
Homeowner (either verbally or in writing – the CYA letter) to
refrain from informing the Lender(s) of the sale, this is fraudulent
concealment.

While I understand the risk of Due on Sale, the greater risk would be with a Homeowner (Seller) who changes his mind and decides to sue (or worse, contacts the state Attorney General).

Here's an example of an investor who ran afoul with the state Attorney General:
http://www.thecreativeinvestor.com/ViewTopic31297-34.html

Please help me to understand where I might be wrong here.

Thanks,
Ron

[Admin]

Ron,
The NC case is old news and has been on numerous boards for many months.  HUD has a specific line on the national, standardized closing statement for Sub2.  Yes, the U.S. governmental agency that deals with housing provides for that type of acquisition.  So, illegal?  No.

As to fraudulent concealment, just don't do it.  You don't send anything in writing or tell the lender verbally anything that isn't true.  Your CYA letter shouldn't tell the seller to do or not do anything - it merely explains the potential consequences per the lender's rights in the initial documentation.

Are there numerous details that have not been provided in the NC case?  Yes, obviously.

Did they likely make mistakes in the way things were handled both during and after the transaction?   Probably.

Can the government come after you to make you an example if it wants?  Absolutely.

Would it have mattered if they had bought the property using owner financing, a pre-executed lease option, a PacTrust, or any other creative acquisition method?  Probably not.

Should you be doing Sub2's if you don't have the ability to hire a decent attorney and/or refinance and/or take a financial loss if need be?  Not in my opinion.  Granted, that may conflict with some guru courses out there, but it's simple loss mitigation logic.

If you do your research into recently publicized cases over the last few years, you'll see instances of several investors who got national attention for Sub2's gone bad.  Many of these folks had 50 or more deals go bad and it was typically due to the inability to sustain the financial hardships created by poor business decisions and/or vacancies due to market changes.  Yet, to my knowledge, none of these more recent cases included criminal charges.

Can the government come after you to make you an example if it wants?  Absolutely.

Hope that helps.

[ronb107]

TRandle:

Thanks for the response.  I really do appreciate it.

I am a little confused with some of your statements, so I'll try to briefly describe my confusion.

HUD has a specific line on the national, standardized closing statement for Sub2...
Yes, I understand this.  But if you inquire about the purpose of this line the answer is: it's there for formal assumptions (i.e., the Lender allows for an assumptiion of the loan, and you have formerly assumed it); this occurs a lot with private lenders.  So I'm confused: how does this line indicate that it is legal to conceal the sale from the Lender (as occurs with Sub2)?

As to fraudulent concealment, just don't do it...
This one is very confusing.  Concealment occurs if I don't tell the Lender that I've acquired the property (Title transferred to me); and the CYA letter shows clear intent to assume the payments.   Remember, the concern is with the Seller taking me to court, not the Lender (he will just foreclose if not paid in 30 days).  So my confusion is: are you telling me to inform the Lender that I've acquired the property? If so, then this is not what Sub2 is about (not telling the Lender about the sale).

Would it have mattered...
I think the other methods avoid the fraud issue, and thus the contracts would be valid.  You probably would face the Due on Sale risk with a Lease-Option (but not fraud), and I don't see how owner financing is illegal.  So my confusion is: what specifically would be considered illegal with the other methods?

Should you be doing Sub2's...
I think most investors don't have the resources (I know I don't); but they do it because they are not aware of the fraud risk (the Due on Sale is the only risk considered).  So my question is: wouldn't it be better to use another method that accomplishes the same thing and avoids the fraud issue, like Lease-Options?

If you do your research into recently publicized cases...
I would like to research these cases. Could you provide the links?  With regard to criminal prosecution, I think a complaint has to be filed with the Attorney General (to bring it to their attention), and then they review the case to determine if it warrants prosecution.  The cases you refer to are civil cases; criminal cases are handled separately (and are not referred to in the civil cases).

Can the government come after you...
I hope they do so only if they have probable cause (a good case).  If this is not true, we should take a very close look at changing our current state administration.  My minor confusion is: are you saying, then, don't do Sub2s, or this is just the risk in the RE business?

Thanks.
Ron

[Admin]

Ron,
You raise some interesting points and I'll do the general punt disclaimer that I'm not an attorney and no one should act on my opinions and experiences.  That said, here they are...

My understanding and interpretation of the subject to line on the HUD-1 is that it is for any type of owner financing, which would include Sub2.  Formal assumptions result in new loans typically nowadays.

I still don't understand how you've wrapped "concealment" around Sub2.  There is absolutely nothing in the original purchase docs that even hints at Sub2 being illegal.  If it's that big a concern, then by all means, tell the lender about it.  Of course, the number of successful transactions will decrease dramatically, but lenders will allow it on occasion.

Your post indicates that you think typical owner financing and lease option transactions are shared with the lender.  That's generally not true.  Sub2 is merely an owner financing acquisition method - nothing more, nothing less.  So, there is no "fraud issue" and again, I don't understand the rationale behind that question. There is nothing inherently illegal about any of these methods.  With some original docs, there may be a risk of breach of contract, but the lenders rights are clearly spelled out in the docs.

As far as the "sub2 gone bad" stories, you can probably Google 'em.  There was a lady in Ohio who lost 60 plus properties, a guy named Rocky Shaw in Dallas, Texas (there may have been rent skimming in that one) and another person in Houston, Texas ( I think), all within the last 18 months.  I'm aware civil doesn't equate to criminal, but I guarantee you that with the press these instances received and the following by investors, that if there had been criminal charges brought, it would be well known, at least by those of us who travel in the investor web circles.

No, I'm not saying don't do Sub2.  What I am saying is do it right.  And that is an entire course in and of itself.  The simple rules are buy with sufficient equity so it can be sold or refinanced, buy with sufficient cash flow so rents can be lowered as local markets demand, and have the right paperwork.

There is no fraud and no illegal actions inherent in a Sub2.  How one goes about doing the deal could alter that statement.  And doing numerous transactions that all go bad due to financial issues could certainly bring unwanted attention.  However, a mass default carries significant risk regardless of acquisition method, in my opinion.

It's like anything else.  You learn and analyze the risks and do your best to mitigate them.  A few years ago everyone was raving about Countrywide (C/W) calling loans due.  I had several C/W sub2 loans then and still have some today.  I've spoken with the lender on different occasions to get various issues resolved.  If C/W was actually out looking for loans to call, I would think I would have made the list at least once. It hasn't been an issue.

In my opinion a properly presented and properly documented sub2 transaction poses minimal risk in and of itself.

[ronb107]

Tim:

Great response.  Let's walk this thru...

My understanding and interpretation...
I agree (are you surprised?).  But my point is, this does not address the issue of fraudulent concealment.  You're assuming that it does (a sort of leap of faith).  Also, I don't believe that the subject to term on the HUD-1 has anything to do with the creative financing technique of the same name.  If we change the name of the technique, do you think HUD would rename the term?  Best way of finding out is to call them.

I still don't understand how you've wrapped "concealment" around Sub2...
Fair enough.  The federal law states that you have to knowingly conceal a material fact.  The Sale of the property (when Title is transferred to your name) is a material fact.  As a result of this, a breach has occurred with regard to the Due on Sale clause.  Case Law has shown that the Title holder is responsible for informing the Lender when a Sale occurs that causes a breach; else fraud has been committed.  This is consistent across the case law I have read (and the ones Bill Bronchick cites); it is also the opinion of a former prosecuting Attorney I discussed this with.  Sub2 relies on informal assumption, which (as you recognize) will generally breach the Due on Sale requiring an assumption or refinance.

Your post indicates that you think typical owner financing and lease option transactions...
Whether the Lender needs notification rests on the Transaction: if Title transfers ownership (a Trust in which the Beneficiary is the Homeowner is excluded under Garn-St. Germain) and a breach occurs, then notification is required.  In a Lease-Option this does not (should not) occur (although the Option is considered a Sale in some states); with Sub2, this does occur (i.e., Sub2 relies on a Sale; Sale results in breach of the Due on Sale; notification required).

Civil law deals with contracts; Criminal law looks at actions and intent (i.e., knowingly concealing a material fact).  Whenever the Lender forecloses (due to a Sale that is not reported), and the foreclosure is challenged, fraud is the Lender's defense (which is overwhelmingly upheld).  

So, what this means is: the Lender's right to foreclose is supported by the fraud defense.  If the Seller wishes to reverse the transaction, one very powerful defense is fraud (afterall, the responsibility to disclose the sale rests with the Title holder).

It's like anything else...
Lenders have discretionary power; that is, they can either accelerate the payments or not.  There is no law requiring them to do so.  Homeowners also have discretionary power (althought the CYA letter implies that they don't).  If the Homeowner wants out of the deal, without compensating the Investor, then fraudulent concealment is a very powerful tool both at the civil and criminal levels.

In my opinion a properly presented...
That's the point of this discussion, to test our opinions.  I think the next level (for us non-Attorneys) is to get some additional expert opinions.  I, for one, plan to call my state AG just to get a feel for their position on this.  What do you think?

Again, a really good post.
Ron

[Admin]

Ron,
This response may be a bit harsher because it harkens back to my risk mitigation theory.

HUD is well aware of sub2 and VA loan guidelines have special provisions for contract for deed (not to muddy the waters).  Whether or not the HUD-1 line was specifically designed for pre-90 loans when sub2 was commonplace with transactions and lenders didn't have DOS rights or was also intended to include non-notice sub2's doesn't really matter to me.  The line is there and title company underwriters sign off on it.  Good enough for me.

I'm not familiar with any case law stating titleholders are responsible for notifying the lender, and I don't plan to research it.  My understanding is that lease options are a specific, named example of a potential DOS breach, as well as leases longer than three years.    Does this same case law you refer to not address these by name?  Does this case law apply only to sub2 or any and all owner financing (wraps, installments, etc.)?  Because the way you've framed this thing makes all creative transactions that include title transfer (now or to be executed later) suspect.  Perhaps Gatten's PacTrust survives since seller shares beneficiary rights, but who knows?  Anyway, there's no way I buy that.

I've seen numerous original purchase docs that don't include breach language, only the lender's rights if sale without notice occurs.  I still don't get how "concealment, material fact" universally apply across all states to any owner financing, and still don't really care, :.

If an investor were smart, a refinance could happen to take the lender out before any of this got ugly, at least when analyzing this on a case by case basis.  Again, mass default is a different story and we've decided not to include that in this discussion.

Lender is collateralized and either gets the property or gets taken out so no harm there.  Homeowner is a nut job and wants their property back.  Fine, they can take it and all that comes with it.  Granted, minimizing harm to the tenants gets tricky.

So, to summarize, risk primarily stems from sellers.  I don't understand how a complicit seller can yell "fraudulent concealment" as a method to get their property back, but perhaps so.  If that's the case, then how is it they can cause an action and then expect to be protected from the results of those actions, be it damage to credit, civil suits from tenants, etc.?

I don't know the exact numbers, but my guess is that I've done 40 to 50 Sub2's and not had an issue remotely close to any of this.   Am I just lucky?  Am I just smarter?  Couldn't tell you, but amongst myself and folks I call friends, we're talking thousands of Sub2's and no problems.  To be fair, I do have a friend who had issues in the 80's, but the circumstances are not what we're talking here.

Hmmm...

What that tells me is the risk is low.  What that tells me is the risk is acceptable, assuming other criteria discussed previously.

[dwt1020]

Ron,

I think you believe the DOS clause is there to keep track of whose name is on the title.  It's not. The reason the DOS clause was introduced was to give banks the ability and right to force people to get new loans at HIGHER interest rates and not to keep track of whose name is on the title. With rates being so low with nowhere to go but UP, I'm sure we'll see more and more enforcement of this clause in the future. And not to find out whose name is on the title, but to make new loans at higher rates.  


david

[ronb107]

Tim and David (below):

Tim, I have no arguments with your risk assessment.  I may not share your assessment (that the risk is low), but this is a subjective area (based on perception, primarily from your experience and the experience of your friends) and I have no intention of debating that issue.  My intent, as initially stated in the first post, was to determine if there is a legal risk with a Sub2 (due primarily to the concealment).

Let me clarify that I’m interested in determining if the legal risk has foundation; not to convince you that it does.  To the extent that you have responded with reasons why you feel it may not, I am appreciative, and I thank you.

HUD-1 is simply a form (it is almost universally employed at every closing whether required or not).  Sub2 does not initially involve a closing, so the form is not even filled out.  And, I’m pretty confident that there is nothing illegal with acquiring properties subject to an existing loan.  But I’m not confident that line on a form would be a defense against fraud in Court, since the form does not express or imply any legal guidelines with regard to transacting a subject to.  This is probably why when the fraud defense is presented by the Lender in a suit, the HUD-1 line has never been presented as a counter defense.

There’s plenty of case law which upheld the fraud defense against the Buyer (Title Holder) specifically for concealing the transfer.  (For example, Medovoi v. American Savings and Loan, 1979: http://www.legalwiz.com/medovoi.htm ).  

Contract law defines breach, so it’s not necessary to include the language in a contract.  And, since Fraudulent Concealment is a federal law, it is my understanding that it is applicable to all states, and supersedes state law (if there is any conflict).

I think you raise a very interesting (and valid) question regarding complicit Sellers.  I don’t have an answer.  The only reason might be that the Courts and the AG consider the Seller a victim; that the Buyer devised this scheme, and convinced the Seller (who is under duress) that it was perfectly legal.

Again, no argument with your risk assessment.  The point is, the legal risk (even if it’s small, as you believe) appears to be a valid risk (so far).  If so, I think it should be acknowledged by the marketing gurus so an Investor can make the same determination as you did: that the risk is acceptable.


David:

I don’t think the DOS clause is there to keep track of anything. I’m not sure where you got that impression; but it’s wrong.  In fact, I’m not particularly concerned about the DOS (it’s a well understood risk).  My concern is with the risk associated with concealing the transfer of title (i.e., are you committing fraud by doing this).

Ron

[Admin]

Ron,
I'm done with this topic.  I'm not an attorney and really don't care so I only scanned the briefing.

Yes, I agree that if you KNOW the lender REQUIRES assumption for title transfer, you agree to it, you default on the loan, then change your mind, then attempt to hide it, then yes, a logical argument can be made for "concealment".

However, in my mind, that case does not apply to the vast majority of Sub2's.  The method has been around for probably longer than I have as has traditional owner financing.  If fraud were an issue, it would be very well-known and certainly not only applicable to Sub2.

[dwt1020]

Ron,
            I'm not a lawyer, and have read elsewhere if you violate the terms of a contract, it would be breach of contract with remedies being limited to civil action in civil courts.

[ronb107]

David:

Read the first post to see that if you conceal a breach it's fraud.  In case law, if the Lender forecloses (because of the breach due to Sub2) and then you sue the Lender for improper foreclosure, the Courts will uphold the foreclosure due to the fraud defense presented by the Lender.  In other words, the Lender always includes the much stronger fraud defense (along with the Due on Sale).

Think about it.  If concealment of a breach was not a criminal offense, then contracts would be breached at an unacceptably high rate.  Criminal action is a very effective way to ensure contracts will not be intentionally breached just because the breach is easy to conceal.

Ron

[lovetoknow]

this sounds serious...did  u get the final answers on this ?

anyone want to comment ?

[mtnwizard]

Just my two cents worth.

The "subject to" is always a DOSC violation, but certainly not a crime.  However, intentionally telling the seller to conceal the transfer from the lender will definitely provide banks a fraud argument and  ammunition if they want to foreclose.

As to the DOSC clause itself, Banks fought against consumer groups very hard to get Congress to pass Garn-St. Germain in 1982.  That law allows banks to call loans when a transfer occurs.  In a period of low interest loans, the DOSC will seldom be invoked, but as interest rates rise, watch out.  When the banks got their bill passed, they specifically exempted land trusts to satisfy their biggest depositors as land trusts have long been preferred by the wealthy because of the privacy and asset protection.  For this reason, land trusts will probably always be exempt from the DOSC and provide a legal method of subject to transactions.

Da Wiz

[lovetoknow]

mtnwizard,

Thanks for your comment. How do get update on new law?

If I put property in land trust, can I still refinance it or take HELOC ? should I find out from lender before refinancing ?

[mtnwizard]

Most lenders require that you take the property out of the trust, refi, then reinstate the trust.  I have done this many times.

Da Wiz