The Home Equity Theft Prevention Act

December 30th, 2013 | Posted by afear in Uncategorized - (0 Comments)

The Home Equity Theft Prevention Act became effective on February 1, 2007.  It amends 595 of the Banking Law, and adds new sections to both the Real Property Actions and Proceedings Law (RPAPL). This article will examine the new provisions created by the Act.

What is home equity theft? Home equity theft, also known as deed theft, occurs when investors agree to pay off the arrearage owed on a home and in return, require the homeowner sign the deed over to them.  The investors search court foreclosure records and call or send direct market mailings to vulnerable homeowners.  Promises are made that the homeowner may continue to live in the property renting it from the investor, and then buy back the property in a year or so once their credit has improved.  The reality, however, is that homeowners are often evicted within months and the investor sells the property to a third-party, keeping all the equity.  In other instances, the investor cashes out on the equity in the home upfront with a new mortgage, leaving the homeowner with a monthly payment that is wholly unaffordable.

Definitions and Covered Transactions: Under the Act, the homeowner is referred to as the Equity Seller.  An Equity Purchaser is defined as any person who acquires title to any residence in foreclosure or, where applicable, default, or his or her representatives [as defined in the law]. In an attempt to exempt genuine transfers of property for real value, the law exempts from the definition those who purchase a property so be used as their primary residence, lenders who receive a property through foreclosure proceedings or others who acquire a property through a referee sale, a transfer to a relative, the transfer of a property to a non-profit or governmental housing organization and bona fide purchases who pay real value for a home. Thus, the vast majority of real estate transactions between sellers and buyers are not affected by this law.

The Contract of Sale: Agreement for the transfer of property between both parties must be in writing, sighed, and dated by both the equity purchaser. If Spanish is primary language of the seller, the agreement must be provided in English and in Spanish. The Agreement must contain the following: the name, business address and telephone numbers of the purchaser, address of residence, total consideration to be given to the seller, a complete description of the terms of payment and services to be provided by the purchased, the time which physical possession is to be transferred, the terms of any conveyance agreement, and the notice of cancellation.

The seller has a non-negotiable right to cancel the transaction within five business days of the date of the transaction. Specific language regarding the seller’s right to cancel is provided in the law and must be printed in 14-point type on the Agreement, including instructions for how to cancel. Two copies of the contract and a separate notice of cancellation must be given to the seller. The law also includes several acts that are prohibited to be taken by the purchaser during this five day period.

The seller has a two year extended right to rescind the transaction for violations of certain sections of the law, including failure to provide a complete and accurate Agreement. If the purchaser or an affiliate still owns the property at the time a seller exercises their extended right to rescind, the property shall be returned to the purchaser. If the property has been sold to a bona fide third party, rescission does not affect the interest of this party, and the sellers remedy is to pursue claims or damages against the equality purchaser, including attorneys’ fees and cost.

Reconveyance Agreements: If the Contract of Sale grants the seller an option to repurchase the property, unless otherwise shown, the Agreement is deemed to be a loan transaction. In such reconveyance arrangements the equity purchaser must verify that the seller has a reasonable ability to repurchase the property within the term set forth in the Agreement. A formal closing must be conducted by an attorney not affiliated with the purchaser. The seller must also sign off on any transfer of the property to a third party within the term set forth in the Agreement. Lease and rental agreement terms during the reconveyance period must be commercially fair and reasonable.

If the property is reconveyed to the seller, the purchaser must ensure that the title is properly transferred. Should the seller be unable to repurchase the property at the terms end, then the seller is entitled to receive 82% of the fair market value (FMV) of the property, minus expenses paid by the purchaser. The time for determining FMV must be determined at the time of the original contract and set forth in the reconeyance agreement- it can be either at the time of the original transfer, or at the time the property is ultimately sold to a third party. The law sets standards for determining FMV, as well.

All deeds or conveyances subject to a reconveyance arrangement must state explicitly on the face of the document that the conveyance is subject to a reconveyance arrangement. Reconveyance arrangements must be simultaneously recorded by the purchaser along with the deed in the county clerks’ office, as well, to give title insurers and subsequent purchases or potential lien holders adequate notice.

Foreclosure Notice: One of the strongest pieces in the law is the foreclosure notice. In an attempt to prevent vulnerable homeowners from falling prey to the enticement of foreclosure rescue schemes that might not be in their best interest, the law mandates that foreclosing parties send a consumer education notice with the summons and complaint. The notice must be on colored paper and in bold 14-point type and state:

Help for homeowners in foreclosure New York state law requires that we send you this notice about the foreclosure process. Please read it carefully. Mortgage foreclosure is a complex process. Some people may approach you about saving your home. You should be extremely careful about any such promises.

The state encourages you to become informed about you options in foreclosure. There are government agencies, legal aid entities and other non-profit organizations that you may contact for information about foreclosure while you are working with your lender during this process.

To locate an entity near you, you may call the helpline maintained by the New York State of Banking Department. The State does not guarantee the advice or there agencies.

The Banking Department is responsible for providing a telephone number and web address, and this information is readily available for lenders.

Remedies: In addition to the five day right to cancel the Agreement, and the two year extended right to rescission for violations of certain sections of this law, sellers may bring a private cause of action for damage or equitable relief, treble damages and attorneys fees and costs within six years after the date of the violation. In addition to civil penalties, and equity purchaser can be held criminally liable for violations of the law as either a Class E Felony or a Class A misdemeanor.

The Attorney General is also empowered to bring an action against an equity purchaser for violations of this law.

Ownership of real estate in New York City can be one of four distinct legal types – traditional home ownership of a townhouse or three different  forms of ownership for apartments in multi-unit buildings: a co-op, a condo or a condop.

Townhouse (brownstone) ownership is no different from ownership of any traditional single-family or duplex home.  Legally, it’s called “fee simple” ownership and permits the owner ( a single person, a married couple, or a group of people) all of the traditional rights of owning property that you might think of – you can sell the property to whomever  you want (within the confines of non-discrimination laws) and can alter it as you wish (subject to zoning laws or landmark restrictions).

Co-op ownership was traditionally the principal way of owning an apartment in New York City until about 30 years ago when New York caught up with the rest of the nation and permitted the condominium form of ownership.  As a legal matter, when you own a co-op you do not own real estate.  Rather, you own stock in a corporation whose principal (and usually only) asset is the building in which the apartment is situated. Each apartment has stock allocated to it according to the size of the apartment.  As owner of the stock you have right to exclusive occupancy of the apartment to which the stock is allocated, and you are a tenant under a “proprietary lease”.  In many ways this lease is no different from any other residential lease except that it does not have a finite term of occupancy. Rather, the right to occupy the unit lasts for such time as you remain a stockholder in the co-op corporation.

As does any corporation, the co-op operates under its by-laws which in most cases requires the board of directors to approve any new owners of shares so that all purchasers need to be approved, most usually after submission of financial information and an interview. The board (answerable to the shareholders) generally sets the minimum financial requirements for ownership, although all of the stockholders could be asked to approve changes at a shareholders meeting.  A board can reject a purchaser for no reason or for any reason at all, except for legally prohibited reasons (e.g., race or religion).  However, since a board is not currently required to articulate reasons for rejection, it’s often difficult to determine if a rejection was, in fact, legal.

Because a co-op shareholder does not own real estate, he pays no real estate tax to the city. Instead, the co-op corporation as the building owner pays tax on it and then allocates the tax among all of the apartments based on shares owned.  The allocated charge is then included in the monthly maintenance charge for the apartment.   At the end of the year each shareholder receives a statement of the real estate taxes paid and obtains a deduction against income.    If the corporation has a mortgage on the building, it also allocates the interest paid on the mortgage to each stockholder/tenant.  These interest charges are included in the maintenance and reported to the shareholder at tax time so that he can take the appropriate tax deductions. The shareholder can, of course, also deduct any interest on his own mortgage.

Several financial consequences arise from the fact that cooperative ownership is not ownership in real estate.  First –and all else being equal – co-ops generally sell for less than condos because of the restrictions traditionally imposed on sales of co-op shares by the boards of directors.  These restrictions often result in a built-in market discount of price because the pool of purchasers acceptable to the board is somewhat restricted, and a portion of potential purchasers just won’t pass muster. Even those that may be acceptable to the board often self-select and don’t even shop for a co-op because of the intrusive nature of the approval process.  On the other hand this is not always the case as many purchasers actually seek the exclusivity of a co-op ownership.   Second, when purchasing a co-op a buyer need not purchase title insurance (although there may be reasons for doing so).  Instead, he relies on the title insurance held by the corporation which insures the entire building as a single entity.  Third, many banks charge a higher interest rate for mortgages on co-ops.  They do so because in the event of default and a foreclosure, the coop boards’ restrictions on sales may make recoupment of the bank’s loss that much more difficult than it would otherwise be.  Fourth, there is no mortgagee recording tax on co-op mortgages because these are not mortgages on real estate to which the tax applies. The tax savings can be substantial, especially on mortgages of $500,000 or more where it is assessed at $2.80 per $100 of mortgage amount (a small portion of the tax is actually paid by the lending institution).

As distinct from co-op ownership, condo ownership is, in fact, ownership in real estate.  The purchaser actually owns his individual unit.  As well, he owns a percentage of all parts of the building which are used in common by all unit owners, such as the lobby, elevators, hallways and amenities such as a gym, pool or rooftop terrace.  As a real estate owner you pay real estate taxes assessed directly on your property so that unlike a co-op there is no real estate tax element included in your monthly common charges.  This often results in lower monthly charges for condos than for co-ops.  Also,  for various reasons condos generally have no  mortgage or only a small mortgage on the underlying building so that there is  no  allocated mortgage interest charge included in your  monthly common charges.  An exception to this occurs where a condo association owns the superintendent’s apartment, in which case it may be mortgaged, with the debt service costs being allocated to the individual owners.

Like a co-op, a condo is managed by a board, but it is called a board of managers rather than a board of directors. The board is answerable to the Condominium (or Homeowners) Association in which all unit owners are members with an equal vote.

For the reasons alluded to in the above discussion of co-ops, market  prices of condo apartments relative to co-ops are often  higher, and closing costs include mortgage recording taxes and premiums for title insurance,  which can be costly items (especially the mortgage recording tax). Like co-ops, condos operate by their by-laws.  These are traditionally- but not necessarily- less restrictive on sales than are the by-laws of co-ops.  Condo boards typically do not have the right to reject a purchaser, but almost universally require the submission of financial statements and, sometimes, even an interview.  Instead of rejection, Condo boards can prevent a sale by what is known as a right-of-first refusal. This allows the board a period of up to 30 days to match a purchaser’s offer to buy a unit and, by doing so, prevent a sale to an “undesirable”.  But to exercise its right the board on behalf of the condominium association has to come up with the money to buy the unit at the same price and on the same terms and conditions as the applicant-purchaser. These rights-of-first-refusal are virtually never exercised because of the cost and complexities involved, but it has been known to happen.

A condop is a hybrid of a co-op and condo. The term is used to describe two different concepts. One is a purely legal description where a building is conceptually (and sometimes physically) divided into a condo portion and a co-op portion. Typically this occurs where there are residential units in a tower portion of a building and retail or institutional spaces (for example, a school) at the lower levels.  Ownership in the retail or institutional portion might be retained by the developer in a condo form while the residential units are owned by a co-op corporation all the shares of which initially are owned by the developer and sold to individual purchasers of units. The respective management boards of the condo and co-op portions are represented on a master board of directors of the two units.

The second use of the condop appellation is a short-hand description of an entity legally structured as a co-op which has adopted by-laws resembling those of a typical condo association.   Often, buildings with land-leases (i.e., the building actually sits on land owned by a third party and pays rent to the owner of the land) are condops because under New York’s condominium law  a condo cannot lease the land on which it is situated but must own it.  Where the underlying land is not owned the entity adopts the co-op legal structure but operates as a condo under condo rules.  The principal operating distinction is that the co-op’s rules relating to the resale of units are not nearly as restrictive as a co-ops and the board has no right to blackball a prospective purchaser.  Rather, the board instead has the right-of-first–refusal typical to a  condominium.

Landlords use lease assignment provisions to maintain control over the quality, composition, and financial capability of their tenants. However, assignment provisions can have a chilling effect on a corporate tenant’s business operations and ownership structure. In this article, we explore the various pitfalls that corporate tenants should avoid when negotiating and drafting assignment provisions in commercial leases.

Most assignment provisions in commercial leases restrict two types of circumstances. The first is the proposed assignment of a lease to an unrelated third party or to an affiliate company of a corporate tenant. The second is the deemed assignment of the lease by operation of a change in control or ownership of a corporate tenant.

As a general rule, in the absence of a specific provision in a commercial lease restricting assignment, a tenant is free to assign its lease to a third party without notifying the landlord or obtaining the landlord’s prior approval. However, most modern commercial leases contain assignment provisions that either prohibit or restrict the circumstances under which a tenant may make an assignment of its lease. Provisions that restrict assignments require tenants to obtain the landlord’s prior consent to an assignment of the lease. Courts in New York State have consistently held that if an assignment is conditioned upon the landlord’s prior consent, the landlord may arbitrarily withhold its consent to the assignment unless the lease states to the contrary.[1]1 To prevent a landlord from arbitrarily withholding its consent to a lease assignment, a tenant should negotiate and include a provision that states that the landlord shall not “unreasonably withhold, condition, or delay its consent” to a proposed assignment.

Even in those instances where a commercial lease assignment provision prohibits the landlord from unreasonably withholding its consent to a proposed assignment, the landlord’s consent will generally still be conditioned upon the satisfaction of certain conditions. These conditions typically include, but are not limited to, information regarding the proposed assignee and its use of the premises, copies of the proposed assignee’s financial statements, the payment of additional rent or security if the landlord approves the assignment, execution of an assignment and assumption agreement by the proposed assignee, and payment of the landlord’s attorney’s fees in connection with document review. Additionally, landlords often require that the assignor-tenant remit to the landlord all monies or assignment profits that the assignor-tenant receives from the assignee-tenant. The calculation and division of any such assignment profits is a matter of negotiation between the parties. However, the lease should provide that the assignor-tenant’s brokerage costs, expenses expended to ready the premises for the assignee-tenant’s occupancy, and its attorney’s fees be deducted from the amount of the assignment profits that the assignor-tenant is required to pay the landlord under the lease.

In addition to restricting assignments, commercial leases often contain recapture provisions whereby if a tenant requests the landlord’s consent to a proposed assignment of the lease, the landlord has the option of recapturing the leased premises and terminating the lease. If a tenant is not able to exclude the landlord’s recapture right, it is advisable to negotiate and include a specific provision in the lease giving the tenant the option to revoke and rescind its original request to assign the lease if the landlord exercises its recapture right thereby allowing the tenant to remain in possession of the premises and negating the effect of the landlord’s recapture election. This rescission right provides a tenant the flexibility to stop the recapture process depending upon the particular facts and circumstances and commercial exigencies of the tenant.

A well-drafted commercial lease assignment provision should expressly exclude transfers of the lease to an affiliate of the tenant from the restrictions of the assignment approval process. The definition of a tenant “affiliate” should be as broad as possible and include all entities related to the corporate tenant to provide maximum flexibility. Additionally, if the tenant contemplates transferring the lease to a specific entity in the future, it is advisable to incorporate this right into the text of the lease to avoid the assignment approval process and the landlord’s right of recapture.

With regard to change in control provisions, courts in many states including New York have consistently held that a transfer of a controlling shareholder’s ownership interest in a corporate tenant does not violate basic assignment provisions, which merely state that the lease may not be assigned without the landlord’s prior consent.[2]  The rationale behind these holdings is that a landlord entering into a lease with a corporate tenant should be aware that a corporation is an entity that exists separately from its stockholders and that a change in the ownership structure of a corporate tenant does not result in a change in the actual tenant entity that signed the lease. Consequently, if a landlord desires that a change in ownership or control of a corporate tenant be deemed a lease assignment, the lease must explicitly state so. Many commercial leases contain comprehensive anti-assignment provisions aimed at restricting changes in ownership and control of a corporate tenant. These provisions deem certain actions, such as the transfer of the corporate tenant’s stock, changes in the management or decision making of a corporate tenant or the sale of the corporate tenant’s assets to be assignments of the lease, which require the prior written consent of the landlord and trigger the landlord’s recapture rights.

If a corporate tenant effectuates a change of ownership or control of the tenant entity that is prohibited by the assignment provisions of the lease without obtaining the prior written consent of the landlord, the consequences can be devastating. Once the change of change of ownership or control of the tenant entity occurs and the tenant has failed to obtain the written consent of the landlord, the tenant may have committed an incurable default under the lease. If the lease contains a conditional limitation provision and the landlord discovers that a prohibited change of ownership or control of the tenant entity has occurred, the landlord can serve a notice to cure the default upon the tenant and if the default is not cured within the stated cure period, the landlord can simply terminate the lease. Depending upon the particular facts and circumstances, the corporate tenant may not be able to reverse the change of ownership or control of the tenant entity that has occurred in order to cure such default, which could then lead to the termination of the lease and forfeiture of the tenant’s entire leasehold estate. To avoid the draconian consequences of an incurable lease default, a corporate tenant should strive for clarity and precision in drafting change in control provisions.

By way of example, assume that Corporation X is a tenant under a commercial lease whose voting stock is owned 30 percent by Corporation A and 70 percent by Corporation B. Assume also that Corporation E owns 60 percent of the voting stock of Corporation B and that Corporation F owns 40 percent of the voting stock of Corporation B. If the lease contains an assignment provision that merely prohibits an assignment of the lease without the landlord’s prior written consent, then Corporation A and Corporation B may transfer and assign their respective shares in Corporation X to each other or to any third party without violating the terms of such assignment provision.

However, if the lease contains an assignment provision providing that any change in control of the tenant entity shall be deemed an assignment under the lease, then the transfer by Corporation B of 21 percent or more of its ownership interest in Corporation X to Corporation A or Corporation B’s transfer of 21 percent or more of its stock ownership in Corporation X to a third party would be deemed an assignment under the lease, if the term “control” is deemed to mean 51 percent or more of the voting stock of an entity.

Courts have generally held that lease assignment provisions that merely state that a change in control of the tenant entity shall be deemed an assignment only restrict transfers of stock ownership at the first level of ownership of a corporate tenant. Thus, in the foregoing example, a change of control of Corporation B would not be deemed an assignment under the lease. However, if a lease states that any “direct or indirect” change of control of a corporate tenant shall be deemed a prohibited assignment under the lease, then the transfer by Corporation E of 11 percent or more of its ownership interest in Corporation B to Corporation F or the transfer of 11 percent or more of its stock ownership in Corporation B to a third party would be deemed an assignment under the lease requiring the landlord’s prior consent. While New York courts have consistently held that a change in the indirect control of a corporate tenant will not be deemed a lease assignment unless the lease states so, it would behoove corporate tenants to negotiate and obtain a specific carve-out in the anti-assignment provisions stating that indirect changes in control of the tenant entity will not be deemed assignments under the lease, to avoid any confusion or applicability of anti-assignment provisions to these situations.

When drafting lease assignment provisions, tenants should clearly define the terms “control” and “change of control.” In doing so, a corporate tenant will help ensure that the correct determination is made in the future as to whether or not a proposed corporate reorganization or stock transfer will be deemed an assignment under the lease requiring the landlord’s prior written consent and/or triggering the landlord’s recapture rights. Further, the general criteria applicable to the granting of landlord’s consent in lease transfer situations should be tailored to exclude certain criteria that are inapplicable to change of control situations, such as the requirement that a corporate tenant pay an assignment fee or assignment profit to the landlord, an evaluation of the general reputation of the assignee, submission of the financial statements of the assignee, execution of an assignment and assumption agreement, and, if possible, the landlord’s recapture option.

In conclusion, in an ever-changing economic environment, commercial tenants may be forced to make certain decisions regarding their corporate structures and leases. In order to maintain the maximum flexibility and predictability, it is very important that special attention be paid to negotiating and including comprehensive language and exceptions to the anti-assignment provisions found in most modern commercial leases. The consequences of vague or incomplete lease assignment provisions for a corporate tenant could prove not only problematic, but in certain circumstances, a commercial and legal disaster.

[1]  See Kruger v. Page Management Co., 105 Misc. 2d 14 (N.Y. 1980).

[2]  See Rubenstein Bros. v. Ole of 34th Street, Inc., 101 Misc. 2d 563 (N.Y. Civ. Ct. 1979), citing: Ser-Bye Corp. v. C.P. & G. Markets, 78 Cal App 2d915; Burros Motor Co. v. Davis, 76 A2d 163; Alabama Vermiculite Corp v. Patterson, 124 F. Supp 441.