Short Sales & No-Flip Clauses in the Approval Letter – Removing a Roadblock

In our current distressed market, there are a few avenues available to distressed, underwater homeowners: loan modification, Deed-In-Lieu, small sale or foreclosure. For those that lack the necessary income to qualify for a loan modification, a small sale is often the best choice. If the property is the homeowner’s principal residence, the debt forgiven in a small sale will not be taxable (with a few exceptions).

Small sale transactions are essential to go properties in furtherance of rebuilding our economy. They directly benefit several parties including:

• the distressed homeowner: unburdened by debt he cannot afford without the same level of credit score hurt a foreclosure would cause as well as possible deficiency judgments;
• the real estate agent: earns commissions (provides jobs etc);
• the small sale bank: removes nonperforming assets from its books,  usually at far less of a loss than if the property became an REO; and
• real estate investors: acquiring properties at a discount provides incentive to negotiate as well as to seek out qualified purchasers

Part of the fallout from the real estate market crash is a rash of negativity aimed directly at real estate investors.  They, along with mortgage brokers and other members of the real estate community, are being made the scapegoats for the Housing Bubble.  I’m going to clue you in on a small secret – it really wasn’t them.  Not that there weren’t unscrupulous investors, loan officers etc. – far from it.  Point the finger directly at the Banks and the Government. The Banks needed those deals to package up and sells as mortgage backed securities on Wall Street.  When there was not enough product, they lowered their standards to bring in more loans. They blatantly ignored fraud reports and lended on questionable properties. The banks made exotic loan products and recklessly offered them without regard to ability to pay.  The Government wanted to increase homeownership among minorities – hence ACORN. It made several programs and incentives to push the percentage of homeownership way above the standard amount.  I am also going to point the finger at the American Homeowner who chose to use their home as an ATM, or who lied on their loan applications because they needed to compete with the Joneses.  Lets also add real estate agents to the mix who fought for higher and higher appraised values and selected comparables for their Broker Price Opinions (BPO) to influence the appraiser to come in higher. (RANT finished)

These very parties, who irresponsibly handed money to unqualified buyers on overvalued properties, as part of their attempt to pass the blame to real estate investors, are throwing around the “fraud” mark with regard to flipping small sale transactions (for more discussion on Small Sale Fraud please read my prior blog post). In an attempt to curtail the investor’s ability to flip these properties, some banks are including “no-flip” clauses in their small sale approval letters. I have seen this language in Bank of America, GMAC, EMC,Countrywide to name a few.  There are varying forms of this language from purporting to restrict the transfer of the subject property for 30 days post closing to voiding the transfer and reinstating the note and security agreements, post-closing, if the bank determines that there was fraud.

The simplest language to address in the 30 day post-closing restriction on transfer.  Lets review basic contract law and the doctrine of privity.  Basically a contract does not confer rights or impose obligations upon anyone except for the parties to it. The contractual relationship is between the homeowner and the bank. The small sale approval is a settlement of the debt obligation between these parties.  The bank has no contractual relationship with the investor and/or buyer and therefore this language, purporting to impose a restriction on the investor/buyer, is unenforceable against the investor/buyer. With respect to the other no-flip clauses, Bob Massey does an brilliant job of explaining how to handle those banks in his video:

I have located an underwriting bulletin from Stewart title which addresses these problematic clauses in small sale approval letters.  It indicates that such language makes the transaction “uninsurable”.  As Massey suggests, request that the clause be removed from the small sale approval letter as title will not insure the transaction and provide a copy of the title bulletin to support your argument. You might have to bypass the negotiator and contact a supervisor but this should be sufficient to persuade them to delete the offending language.

What have you encountered and what has worked for you? Please comment!

Related posts:

1. Mortgage Assignments are Not the Real Estate Investor’s Dream!
2. PropertyShark University – Short Sales Class – Tues June 17, 2008 – Don’t Miss It!!!
3. Buyer $5,000 Short – How to Close the Gap…from a NY Point of View
4. Seasoning and FHA’s Time Restrictions on Resales – a Legal Analysis
5. DON’T SAY I DIDN’T WARN YOU! NY Attorney General’s Crackdown on the Loan Modification Industry