The Illinois Installment Contract to Purchase Real Estate

Dated: June 1, 2010

The Illinois Installment Contract to Purchase Real Estate:

A Discussion

Richard F. Bales

Chicago Title Insurance Company

Wheaton, Illinois

(Author’s note: This later version of my article contains additional information that does not appear in the original article.)

Introduction

In the early 1980s, mortgage interest rates hovered near 15-20%. Because of this, many homeowners sold their homes “on contract”--that is, by executing an installment contract to purchase with a “contract purchaser.” Today, interest rates are very low. Unfortunately, it is not as easy to qualify for a home mortgage as it was a few years ago. For this reason many people are again using an installment contract as a means of buying (and selling) their homes and other real estate.

This article will discuss various legal and title insurance issues such as:

How title companies can insure the contract purchaser;

How an endorsement can be added to the title insurance policy that increases the coverage to the contract purchaser;

How the due-on-sale clause of the seller’s mortgage affects the contract sale.

A bibliography appears at the end of these materials. The author is especially indebted to the late Peter A. Hess. His treatise on contract forfeitures was on every real estate attorney’s required reading list in the early 1980s. The section of forfeitures borrows heavily from Hess’ work.

Preliminary Title Insurance Considerations

The Statute of Frauds is a statutory requirement that provides that certain contracts must be in writing in order to be enforceable. This requirement is set forth in 740 ILCS 80/2, which states:

No action shall be brought to charge any person upon any contract for the sale of lands, tenements or hereditaments or any interest in or concerning them, for a longer term than one year, unless such contract or some memorandum or note thereof shall be in writing, and signed by the party to be charged therewith, or some other person thereunto by him lawfully authorized in writing, signed by such party.

Exceptions to this can be found in Illinois case law. For example, the court in Thomas v. Moore, 55 Ill. App. 3d 907, 370 N.E.2d 809, 12 Ill. Dec. 898 (1978) stated that the payment of consideration and the possession of property was sufficient consideration to remove an oral contract from the Statute of Frauds. However, title company underwriting procedures dictate that all installment contracts be in writing.

In Leach v. Hazel, 398 Ill. 33, 74 N.E.2d 797 (1947), the court stated:

A contract for the sale of real estate cannot be enforced unless the writings contain the names of the vendor and the vendee, a description of the property sufficiently definite to identify it, the price, the terms and conditions of sale, and the signature of the party to be charged. 398 Ill. at 39.

Concerning this, it should be noted that the description of the property should be a legal description; a street address is not sufficient. See Thomas v. Moore, supra. Also, although the court in Ullsperger v. Meyer, 217 Ill. 262, 75 N.E. 482 (1905) held that a contract signed by one party was enforceable, it is a requirement for underwriting purposes that all contracts be executed by both parties (that is, by both buyer and seller).

The Title Insurance Policy

People often speak of a “contract purchaser’s title insurance policy.” Such a term is misleading; there is no such policy. Rather, title insurance companies simply insure the contract purchaser by using a conventional owner’s title insurance policy.

In the 1980s, title insurance companies would insure either the contract seller and the contract purchaser, “as their interests may appear,” or just the contract purchaser. Today, most attorneys seem to prefer that the title company insure just the contract purchaser’s interest. In either instance, a Schedule B exception relating to the “terms of the contract” should be shown in Schedule B of the policy.

Equitable Conversion

The Illinois Supreme Court in Shay v. Penrose, 25 Ill.2d 447, 185 N.E.2d 218 (1962) defines equitable conversion as follows:

Equitable conversion is the treating of land as personalty and personalty as land under certain circumstances. Hence, as between the parties and those claiming through them, when the owner of land enters into a valid and enforceable contract for its sale he continues to hold the legal title, but in trust for the buyer; and the buyer becomes the equitable owner and holds the purchase money in trust for the seller. The conversion takes place at the time of entering into the contract. It stems from the basic equitable principle that equity regards as done that which ought to be done. The doctrine of equitable conversion has been recognized in Illinois, as it has in practically every other jurisdiction, since earliest times. 25 Ill. 2d at 449.

Through the doctrine of equitable conversion, the contract purchaser acquires an equitable interest in the land. The ramifications of this basic principle are enormous, and will be discussed throughout the remainder of these materials.

Installment Contract Purchaser Endorsement “A”

Title companies offer two endorsements that can be appended to title policies that insure a contract purchaser. The first endorsement reads as follows:

Installment Contract Purchaser Endorsement “A”

1. The contract to purchase shown in Schedule B is an interest covered by this policy vested in the insured contract purchaser. The Company insures against loss or damage sustained by the contract purchaser by reason of:

A. The unenforceability of the right to receive a deed under the contract, unless the insured contract purchaser does not fulfill the terms of the contract, and

B. The refusal of a trustee, in the event of the seller’s or record title owner’s bankruptcy, to issue a deed under the terms of the contract, unless the insured contract purchaser is not in possession of the land.

2. This policy does not insure against loss or damage sustained by the insured contract purchaser by reason of:

A. Matters that first affect title to the land after the policy date.

B. Failure of the insured contract purchaser to do everything necessary:

(A) To secure proper deeds from the seller, seller’s successor in interest or the record title owner;

(B) To secure releases from other persons then having an interest in the title or a lien on the land, or;

( C ) To secure a final court order that determines the persons then entitled to receive payment from the insured.

C. Costs, attorneys’ fees and expenses to secure the final court order referred to above in paragraph 2.B.( C ) or to enforce the contract.

Installment Contract Purchaser Endorsement “A”--A Discussion

This endorsement gives assurances to the installment purchaser of a 1-4 unit residential property that:

the contract is valid;

the right to receive a deed under the installment contract is enforceable if the purchaser’s obligations have been met, and;

the trustee in a seller’s bankruptcy may not refuse to issue a deed if the purchaser is in possession of the land.

Note that the title company does not insure that it will take the necessary steps to enforce the contract. It does insure against a decree of final determination that the installment contract is unenforceable even though the purchaser has fulfilled the terms of the contract. Thus, the contract purchaser may have to file a cause of action against the contract seller in order to obtain a deed to the property. Only if the contract purchaser has fulfilled all the terms of the contract, but the court still determines that the contract purchaser is not entitled to a deed, will the title company insure against loss.

Section 365(I) of the Bankruptcy Reform Act provides that when the vendee is in possession of the property, the trustee’s right to reject the contract will be subject to the vendee’s right to obtain title if he completes the contract payments. When the vendee is not in possession, however, the trustee can reject the contract and leave the vendee with a claim for damages for breach of contract. See Section 365(j).

In Hinsdale Federal Savings & Loan Association v. Gary-Wheaton Bank, 100 Ill. App. 3d 746, 427 N.E.2d 963 (1981), the contract seller executed a mortgage after the date of the installment contract. The contract purchasers did not join in the mortgage, nor were they asked to subordinate their contract, of which the lender was aware, to the mortgage. The contract seller defaulted on his loan, and the lender initiated a foreclosure suit. The court made the following conclusions:

1. The contract purchasers’ equitable interest was superior to the lender’s mortgage interest;

2. The fact that the contract purchasers had a prior equitable interest did not affect the validity of the mortgage as a lien that could be foreclosed;

3. The contract purchasers were entitled to an equitable lien on the property, as against the contract seller’s lender, for the amount of money they paid on the contract prior to the time they had actual knowledge of the contract seller’s mortgage. This was an equitable lien that was prior to the lender’s interest in the proceeds of the foreclosure sale;

4. Even though the mortgage lien was subordinate to the contract purchasers’ equitable lien, the contract purchasers were not entitled to an award of specific performance as against the lender.

This case suggests that once the insured learns of parties having an interest in the property, he must secure releases from these parties, going to court, if necessary, to obtain a letter of direction as to whom he is to make his payments. Any future payments made by the contract purchaser to the contract seller after he has such actual knowledge are made at his own risk. (See paragraphs 2.B.(B) and 2.B.( C ) of the endorsement.)

Perhaps this case illustrates the need for the contract to include a provision that any mortgage executed by the seller should be consented to by the buyer. In addition, perhaps the contract should contain a provision that after the buyer receives notice of a foreclosure of the seller’s mortgage (a party in possession is a permissible party to the foreclosure action; see 735 ILCS 5/15-1501(b)(1)), the buyer should make all future payments to the seller’s lender. In exchange for these payments, the lender would agree to honor the contract and allow the buyer to remain in possession of the land as long as the buyer continues to make contract payments to the lender.

Installment Contract Purchaser Endorsement “B”

The second endorsement is similar to the first endorsement, but with one important additional coverage. Paragraph 1.C. adds protection over possible future judgments against the contract seller of a single family residence or condominium residential unit as long as the contract purchaser remains in actual physical possession of the property.

Installment Contract Purchaser Endorsement “B”

A. The unenforceability of the right to receive a deed under the contract, unless the insured contract purchaser does not fulfill the terms of the contract, and

C. Entry of any court order that constitutes a final determination enforcing the lien of any judgments for monetary damages against the contract seller, or his successors or assigns, rendered after the date hereof and while the insured contract purchaser continues to occupy the insured premises.

2. This policy does not insure against loss or damage sustained by the insured contract purchaser by reason of:

A. Matters that first affect title to the land after the policy date.

B. Failure of the insured contract purchaser to do everything necessary:

(A) To secure proper deeds from the seller, seller’s successor in interest or the record title owner;

(B) To secure releases from other persons then having an interest in the title or a lien on the land, or;

( C ) To secure a final court order that determines the persons then entitled to receive payment from the insured.

C. Costs, attorneys’ fees and expenses to secure the final court order referred to above in paragraph 2.B.( C ) or to enforce the contract.

Installment Contract Purchaser Endorsement “B”--A Discussion

Shay v. Penrose sets forth the concept of equitable conversion, that upon the execution of a contract, the contract purchaser is the equitable owner of real estate, subject only to the lien of the contract seller for the unpaid balance of the purchaser price. Therefore, while subsequent judgment creditors of the contract seller who have notice of the equitable rights of the contract purchaser have an interest in the property, this interest is subject to the contract purchaser’s interest. This rule is illustrated in Reuss v. Nixon, 272 Ill. App. 219 (1933):

The contract of purchase was on record at the time the judgment was taken and the vendee was then in possession of the real estate. Conceding for the sake of discussion that the judgment creditor has a lien on the legal title remaining in the vendor after the execution of the contract of purchase, such lien is subject to the equities and rights of the vendee. . . . The time for the performance of the contract has arrived and as against the holder of the legal title and as against judgment creditors claiming a lien on the legal title bound by notice of the vendee’s rights, the vendee is entitled to a deed conveying the real estate to him clear of any liens which do not secure any debts or liability of the vendee. 272 Ill. App. at 224, 227.

The key to this protection for the contract purchaser is two-fold. One, the contract purchaser must be the equitable owner of the land, and two, there must be notice--i.e., notice to third parties of the rights of the equitable owner. Note that in Reuss, notice was by both recorded document and possession. The effect of recording as notice to third parties is set forth in 765 ILCS 5/30:

All deeds, mortgages and other instruments of writing which are authorized to be recorded, shall take effect and be in force from and after the time of filing the same for record, and not before, as to all creditors and subsequent purchasers, without notice; and all such deeds and title papers shall be adjudged void as to all such creditors and subsequent purchasers, without notice, until the same shall be filed for record.

Notice by possession is discussed in Burnex Oil Co. v. Floyd, 106 Ill. App. 2d 16, 245 N.E.2d 539 (1969):

The parties agree on the general rule that a bona fide purchaser of real property from the record owner acquires good title thereto free and clear of any interest therein except such interest of which he has notice. . . . Such notice may be actual or constructive and contemplates the existence of circumstances or facts either known to a prospective purchaser or of which he is chargeable with knowledge which imposes upon such purchaser the duty of inquiry. Where real estate is in the possession of someone other than the record owner, such possession is generally regarded as notice to the world of the interest represented thereby and is legally equivalent to the recording of such interest (Citations omitted). A purchaser is bound to inquire of the person in possession by what tenure he holds and what interest he claims in the premises (Citations omitted). Possession having the same effect as recording, charges a prospective purchaser with notice of all legal and equitable claims of the occupant (Citations omitted). Because possession has such substantial significance and consequences it follows that the possession or evidence of continuing acts of ownership thereof must be visible, open, exclusive and unambiguous. 106 Ill. App.2d at 21, 22.

Burnex Oil Co. makes it clear that possession of the property is equivalent to the recording of the installment contract. As long as the contract purchaser remains in possession of the property, title companies should be able to give the coverage set forth in paragraph 1.C. of the endorsement without requiring that the contract be recorded. On the other hand, it would not be unreasonable for the title company to ask that the contract, or memorandum thereof, be recorded before offering this coverage. If, as discussed below, the parties are concerned about the due-on-sale clause in the seller’s mortgage, and therefore do not wish to record the contract or memorandum, then the title company might be inclined to raise an exception for the “rights of parties who may acquire an interest in the land without knowledge of the equitable interests insured by this policy.” But in that regard, see 765 ILCS 70/2, which provides as follows:

After the effective date of this Act all contracts for the sale of a dwelling structure may be recorded or registered with the recorder or the Registrar of Titles in the same manner as a deed or other document relating to the title of the real estate to be sold. Any provision in a contract for the sale of a dwelling structure which forbids the contract buyer to record the contract or provides that recording shall not constitute notice or provides for any penalty for recording is void.