A common investor buyer practice, especially among wholesalers, is to file a document in the public records to preserve their contract rights and “cloud” the property’s title in case the seller fails to honor the contract. Investors are taught to file a “notice of contract” or similar document, which will turn up during a title search if the seller attempts to sell to another buyer.
Notice of Contract
Upon discovering this filing, the title insurance underwriter makes it a requirement to record a release of the previous buyer’s rights under the notice. The notice forces the parties in the next deal to go through the previous investor buyer in order to close.
It is generally legal to file a notice of contract, or similar document with the same effect, unless the purchase and sale agreement says it is prohibited. A common example is the well-known “FAR/BAR” contract created by the unholy alliance of The Florida Bar and Florida Association of Realtors. The FAR/BAR includes standard language (found in Clause “O,” lines 507-508) prohibiting the recording of the contract or any notice of it. This is one of several reasons why investors should avoid using the FAR/BAR. It’s also so long and full of legalese that it tends to intimidate the average seller.
Legal “Land Mines”
A common problem arises when the deal for which the notice of contract is filed fails to close, and the notice remains in the public records to be discovered. Though the purpose of the recording is to protect the contract rights of the buyer, the notice hurts sellers who failed to close with that buyer due to no fault of their own. Deals do not close for many reasons, including a wholesaler failing to find an end-buyer.
Investors should appreciate and respect the legal power of a notice of contract and take care not to let it hurt property owners like a legal land mine waiting to explode. If the buyer using the notice remains ready, willing and able to close but the seller has a wandering eye, it is legal and ethical to use the cloud to bring the seller back to them or negotiate a buyout of the first purchaser’s contract rights to allow the next deal to close. The situation that can create legal trouble for that buyer, as well as an unjust hardship to the seller, is when the cloud blocks a future deal after the first buyer has walked away.
Some investors may intentionally allow the land mine to remain in the public records after their deal is dead in the hope of getting an anxious call from the title agent working on the next sale. The previous buyer now has leverage to shake down a payment for signing a release of their notice that would clear title for the next closing.
Any investors doing business this way should seriously reconsider their methods and their “why” for being in the game. The most successful and effective investor coaches advocate finding win-win deals and following an ethical path. This way of doing business is actually more profitable in the long-run, as well as the right thing to do.
Clouding the title of a property for which they have no valid legal claim in the hope of extorting a payoff is not a long-term success strategy. Whether you call it karma or anything else, it all comes around. If doing the right thing for its own sake and for the benefit of their former seller isn’t enough motivation, investors should understand how an invalid notice of contract can get them into legal trouble.
The seller can pursue a claim against their former buyer for illegally clouding the title. Sometimes, the next buyer, likely also an investor, will bankroll the effort and pay the seller’s legal fees to preserve their deal. For example, an investor recently retained my legal services to help salvage their deal being thwarted by a stale notice of contract and uncooperative former buyer. In that matter, I was able to get the notice released under the threat of a lawsuit against the former buyer known as “slander of title.”
What Is Slander of Title?
Slander of title is a cause of action that may be filed against someone who wrongfully clouds the title to real property. The elements of the case are as follows.
- The offending party (“defendant”) must make a false statement. I would argue that if the notice of contract asserting the buyer’s rights was true when recorded, it became false after the deal died and the buyer’s rights expired.
- The false statement must be published to a third party. Recording the notice in the public records publishes it to the world.
- The person making the false statement knew or reasonably knew it would likely result in inducing others not to deal with the property owner (the “plaintiff” in the lawsuit).
- The false statement plays a material and substantial part in inducing others not to deal with the plaintiff.
- The published false statement directly causes damages to the property owner. If the seller proves these elements in court, an investor can be on the wrong end of a money judgment, on top of the legal fees and intangible stress they have suffered along the way.
Solutions to Notice of Contract Issues
To avoid the potential pain to both the seller and buyer, I’ll suggest some solutions and preemptive action to take. When a deal for which there is a recorded notice of contract fails to close, record a release to clean up the mess. In the alternative, you can avoid another recording fee by putting an expiration date on the notice. If the deal fails to close by the stated date, the land mine self-destructs.
A recorded notice of contract is an effective legal tool to protect the buyer’s rights in a deal. As discussed here, that tool can also become an unjust title cloud and legal liability. All investors who want to protect their rights as buyers should record a notice of contract. To walk the walk on the concept of ethical business dealings and to avoid legal liability, investors should take care to avoid clouding the title of properties they are not going to purchase.
If you have any questions about the information in this article or would like to discuss real estate legal strategies and others to build and protect wealth as a real estate investor, please contact me.
