Contracts for Deed and Lease with Purchase Option

Legislation passed in 2005 amended the laws dealing with executory contracts. An executory contract is a contract that has unperformed obligations on both sides of the contract. A contract for the purchase and sale of real estate that has not yet closed is executory in that the seller has not yet conveyed title and the purchaser has not yet paid the purchase price. Sections 5.061 through 5.085 of the Property Code apply only to executory contracts for property used or to be used as the purchaser's residence which do not require delivery of a deed within 180 days of signing the executory contract. Therefore, most real estate earnest money of purchase and sale contracts, while executory, are not subject to these provisions since they call for closing and delivery of a deed in less than 180 days.

However, the definition of an executory contract was expanded in 2005 to include an option to purchase real property that includes or is combined with or executed concurrently with a residential lease. While all residential lease with option transactions will be executory contracts under the 2005 legislation, only some portions of the law will apply to lease option transactions having a term of three years or less, including any renewals or extensions. The provisions that do apply to lease option transactions with a term of three years or less are such that the use of such transactions will be seriously curtailed.

These provisions apply to lease option transactions with a term of three years or less:

1. The property seller/lessor must have fee simple title to the property with no liens other than a lien securing a loan "used only to purchase the property". Presumably, this provision will exclude any property which has a home equity loan, a home improvement loan, and maybe even a loan which has been re-financed, especially if any re-finance closing costs were rolled into the loan.

2. The holder of the permitted lien must consent to verify the status of the loan to the purchaser (lessee/optionee) and to accept payments directly from the purchaser if the seller defaults. Therefore, it will be necessary to inform the lienholder of the executory contract and obtain some form of consent. There is virtually no chance that a lender will agree to accept payments directly from the buyer under a contract for deed.

3. The lienholder must no have the contract right to prohibit the property from being encumbered by an executory contract. Most due on sale clauses do prohibit executory contracts.

4, The executory contract must include a notice in 14-point type stating that if the seller fails to make payments, the lienholder may foreclose the lien and sell the property at foreclosure sale.

5. Provisions applying to lease options with a term of three years or less also include a 60 day notice and opportunity to cure default, limitations on late charges and prepayment penalties, affirmation of the purchaser's rights under Property Code provisions relating to residential tenancies including repair provisions and penalties for improper platting of the property.

If a lease with purchase option extends for more than three years, the same provisions which apply to contracts for deed and other executory contracts apply. These provisions include the right of the purchaser to convert the purchaser's interest to "recorded, legal title...". The purchaser may tender to seller a promissory note in the amount of the unpaid balance of the executory contract containing the same interest rates, due dates and late fees as the executory contract and a deed of trust securing the note. The seller must deliver a deed to the purchaser or a written explanation that legally justifies why the seller is not complying with the conversion provision.

There is a requirement for the seller to provide annual status statements to the buyer. The penalty for failing to give an annual accounting statement is limited to $100.00 plus attorney fees for a seller with only one executory contract transaction per year. Sellers who have more than a single executory contract sale per year are subject to a penalty of $250.00 a day after January 31 until the seller provides the statement, but the penalty is capped at the fair market value of the property.

Sellers must provide purchasers with payoff statements within 10 days of written request. If a seller fails to do so, the purchaser may calculate the payoff and the burden is on the seller to challenge that calculation. Many violations of the executory contract statutory provisions are specifically stated to be deceptive trade practices.

The effective date of the new legislation is September 1, 2005. The expansion of the definition of “executory contract” to include options to purchase applies to contracts entered into on or after January 1, 2006. The provisions relating to a purchaser’s right to convert an executory contract to legal title and to obtain payoff statements on demand are effective as of September 1, 2005 regardless of the date of the executory contract. The requirement that a seller have fee simple title free of most liens is effective as to executory contracts entered into on or after September 1, 2005.