Lease Option vs. Land Contract, that is the question.

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Creative investors are always trying to balance the risk and reward formula for their properties.   Oftentimes, there is a philosophical debate concerning the use of “Lease Options” as opposed to “Land Contracts.” We are asked to evaluate what is the “best” way to protect the investor and which strategy is strongest for them.

The Issue becomes one of control and responsibility. On the one hand, a Tenant under a lease can be evicted quickly (relatively speaking) through the Small Claims Courts if they fail to pay rent or otherwise breach their lease.  The Lease may have an Option to Purchase as well. In this type of transaction, the Landlord/Seller receives some upfront consideration, the option consideration, which gives the Tenant the right to purchase the property and become a homeowner. This aspect of control is important to investors who don’t want a tenant to maintain control and possession of their property if they default on payments of the lease. Regaining control of the property is a prime motivator for this type of investor.

On the other hand is responsibility. When an investor sells on Land Contract, one strong motivator is that the buyer has full responsibility for the property including taxes, insurance, maintenance, and repairs. The Seller is no longer liable for these costs and the buyer is gaining equity in the property in exchange for these responsibilities. If there is a default, Seller must foreclose to regain possession of the property.

Financially, one can consider very similar transactions and it becomes confusing to determine which transaction is actually in play.

For example, consider a “Lease Option” wherein the tenant pays $1000 per month in “rent” plus a $5000 Option Consideration to purchase a single-family home valued at $80,000. The Agreement calls for some or all of the “Rent” to apply towards the purchase of the home.

On the other hand, consider a “Land Contract” with a $1000 per month payment of principal, interest, taxes, and insurance, plus a $5000 down payment. With similar financial terms, it is crucial to determine if the agreements are Leases or Land Contracts, in the event of a default.

These two (2) concerns can overlap, and investors sometimes draft or attempt to draft, documents that give them the upper hand no matter what happens.  

The Courts then are left to struggle with an agreement and determine what is REALLY happening in a given transaction despite what the title of the Agreement says.   Courts will look at the actual language of the document to determine a party’s rights, and conflicting provisions will have to be analyzed and sorted.

On September 27, 2018, the Indiana Court of Appeals was faced with just such a determination and its reasoning and holdings are instructive to all investors wishing to protect themselves. See Rainbow Realty Group, Inc. vs. Katrina Carter and Quentin Linter: 49A02-1707-CC-1473

THE FACTS of Rainbow:

Carter and Linten signed a contract with Rainbow in May of 2013. The agreement was styled as a “rent to buy” contract for an uninhabitable home in Indianapolis. The Agreement provided that the Lintners were purchasing the house, were responsible for all repairs, could retain all profits if they sold the house for more than their contractual payoff, would be subject to eviction if they defaulted, and would have their payments applied to the purchase price if timely made for two (2) years.   The agreement did not require that it would end with a reversion of the Property to Rainbow. The Lintners failed to make consistent payments on the agreement.

THE CASE AT ORIGINAL TRIAL:

The Trial Court entered Summary Judgment in favor of Lintners finding that Rainbow had violated the Landlord-Tenant Act and awarded $4000 for Rainbow’s fraudulently deceptive statements and $3,000 of attorneys fees.

THE ISSUE ON APPEAL:

Rainbow appealed and asserted the agreement was really not a lease and therefore it could not be held liable under the Landlord Tentant Act. Lintners’ appealed the grant of attorney fees because they originally requested $35,000 and were only awarded $3000.

COURT OF APPEALS DECISION AND ANALYSIS:  

The Court of Appeals analyzed the agreement and found that a “Lease” exists only in certain situations. In this case, the Court of Appeals reversed and decided there was NO Lease.   First, the court looks at the unambiguous language of the contract. Second, the court determines if the agreement lasts a definite term. Third, the court determines if there is a reversion to the grantor.

In this case, the agreement DID NOT end after a definite term, much less end with reversion to Rainbow. Therefore, the agreement is NOT a lease, but rather a purchase agreement.   Since the agreement is NOT a lease, the Landlord Tenant Act does NOT apply, and Rainbow is not liable for fraudulent statements or attorney fees.   The Court made this finding even though the agreement provided that: (1) required Lintner to make monthly payments which generated no immediate equity; (2) allowed them to be evicted, not foreclosed; (3) explicitly referred to the first twenty -four (24) payments as “rent”; and (4) placed restrictions on their use of the property such as limitations on plaster and stud removal and forbidding pets and unused vehicles.   Lintner argued the agreement is a contract that mingled the concepts of lease and purchase, selectively using them to exclusively benefit Rainbow.

The Court further disposed of Lintner’s claims that the agreement’s terms were unconscionable and unfair to them all for the benefit of Rainbow. 

The Court instead held that even if it accepts the proposition that a broad reading of the Landlord Tenant Act is sound public policy, it simply cannot be read broadly enough to make a lease out of something that lacks of a lease’s most fundamental characteristics.   Thus, the lack of a definite term and a lack of reversion back to Rainbow controlled the Court’s decisions. Further, the court reasoned that even though the Lintners and others argue that rent to own contracts such as the Agreement is against public policy, alleging that they are used to prey on ignorant and unsophisticated “buyers” lured by the dream of home ownership who almost invariably end up with neither the home nor their investment in it.   This may happen in some cases. Such concerns, however, are beyond the scope of this opinion and are the province of the General Assembly.

 

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