Real Estate - Adjustments At Closing
( Originally Published 1911 )
First steps in title closing.—Before proceeding to an adjustment in a title closing, two things are necessary : First, a clear understanding of the commercial transaction which is to be adjusted; and, second, accurate understanding as to the present state of the title.
As to the first : if it be a sale or exchange of property, the closing of a mortgage loan or the making of a lease, there must be an intelligent study of the pro-visions of the contract or arrangement which is about to be carried out. It must be remembered that what is contemplated is the adjustment of a debit and credit account, which will adapt the present state of the title to the contemplated transaction, so that when the title closing is completed, each shall have his due, the purchaser will have his property, with all necessary allowances, and the seller will have his money without any deductions except such as he should justly suffer. If the transaction be the making of a loan, on the completion of the closing, the borrower should have the proceeds of the loan less only such things as he should justly pay out of it; and the lender should have parted with no more than the amount of the money which he is to lend.
The next step in a closing is to have a concrete and intelligible report of the present state of the title. It is not possible to adapt the present state of the title to the intended transaction unless there be such intelligible written report.
Having these two things before him, a person can determine whether the title is marketable, meaning thereby whether it is a title which the purchaser must take under the contract, whether making necessary adjustments, he will get a title of such character and with such encumbrances, and such encumbrances only, as were agreed to in the bargain. In order to determine whether a title is marketable, it must first be determined what is the estate to be transferred, and then if the seller or mortgagor can transfer that estate. If the purchaser has bought a title in fee simple, the report of title should state clearly and succinctly that the seller is vested with or can convey a title in fee simple absolute, subject only to the encumbrances specifically enumerated.
If a purchaser buy only a life estate or an undivided interest, he will be able to judge from the report whether he will be able to get it out of the transaction. If the seller be acting in any fiduciary capacity, it should be stated specifically whether the fiduciary has power to convey the estate which the purchaser expects to get.
Disposing of encumbrances.—Having a clear report of the state of the title the encumbrances can be considered with reference to the money which should be available in the transaction. If the property is so encumbered that the seller cannot get along with the money available to give such title as the purchaser should have, then the first inquiry is how to dispose of the encumbrances. It may be that the seller has outside means or methods of removing those encumbrances in some way other than out of the money due him from the transaction. When that has been determined, the report of title may then be considered with respect to the details of the encumbrances.
Encumbrances subject to which purchaser takes title.—Encumbrances are of two classes with respect to a title closing ; first, those subject to which the purchaser is to take the title; and, second, those which are to be removed. If a purchaser is to take subject to a mortgage, he should ascertain from the report of title the date of expiration of the mortgage, what rate of interest it bears, what special clauses, if any, it contains, and should compare them with his contract to determine whether or not they are in accordance with his agreement.
If there has been any reduction of the principal or rate of interest, or any extension or shortening of the time of payment, the purchaser is entitled to have evidence which can be recorded, to adapt the mortgage to the terms of the contract. If a mortgage does not by its terms disclose the expiration date or interest days, courts have held that this is no defect of marketability of title ; but the purchaser is entitled to have a reasonable opportunity to ascertain whether the mortgage does or does not comply with the contract. If he cannot ascertain this, if, for instance, the holder of the mortgage is away, or does not answer his inquiry, although the question has not yet been decided, it may be that the purchaser is entitled to hold up the closing until such time as will give him a reasonable opportunity to ascertain those important particulars.
In the same manner the leasing or lettings which are reported as affecting the property, should be examined before proceeding to a title closing. If there be a variance and the purchaser or person closing the transaction be not acting in his own behalf, he should not take the responsibility of waiving the variance without instructions.
A purchaser should require that the property be inspected and should check up to ascertain whether the rents are in accordance with representation. He should be particular to ascertain whether there is any one in possession claiming a title hostile to that about to be conveyed to him, because occupancy is notice of the claim. He should ascertain from the occupants not only whether they claim title, but the terms of the letting which they claim. It is not enough at a closing if the seller produce a set of leases which seem to comply with the contract. The purchaser should go to the property and find out what each tenant claims as to his rights in the property. A purchaser may be handed a set of leases, but he may not be told of the agreements for renewals, the promises of rebates and extraordinary repairs, unless and until he make an inspection to find out whether the tenancies and occupancies are in accordance with his contract.
A property may be encumbered by restrictive agreements. The purchaser should have precise information as to the form of restrictions and restrictive covenants which affect the property, before proceeding to the closing adjustment. It frequently happens that upon a report of closing there will appear restrictions or restrictive covenants which were not mentioned in the contract, and often they are considered not to be detrimental to the property or to injuriously affect its value ; but a closer should not waive them at the closing, if he is only a representative, without referring the matter to his principal. If the purchaser finds that the covenants and restrictions are in accordance with the con-tract or do not injuriously affect the value, he is ready to enter upon the financial adjustment, if there be no other encumbrance or defect.
A purchaser is entitled to delivery of a house in practically the same physical condition as it was at the time the contract was made. If it has been materially injured or changed to its detriment, he can decline to take it. Orders and requirements of municipal departments are not encumbrances for which a purchaser can reject title or for which he can require adjustment, unless he has specially stipulated in his contract to that effect.
After looking over a report of title and contract, and determining whether he will or will not take the property, a purchaser should inquire what are the encumbrances which are to be removed from the property and whether the proper discharges are present. If they are not present, he should inquire of the holders of the encumbrances where the discharges are and what sum of money is required to obtain them. He should also inquire how to draw the checks. The purchaser is en-titled to have his property free of taxes, assessments or specific encumbrances before he pays his money. It is the seller's business to have the title clear and to have all instruments which are necessary to clear it present at the time of closing. It is customary, if satisfaction pieces are in known places in the hands of holders who can be found when they are wanted, for the purchaser to go and get them, if the other adjustments have been made; but, as matter of legal right, he is not required to do it.
Under the contract, the seller is entitled to insist upon legal tender money. It is customary that certified checks be accepted, but nothing less than a certified check, or the check of a well-known financial institution is usually accepted. Checks of a bank, or savings bank, or insurance company, or title insurance company, are usually accepted, if the signatures are known.
Debits against purchaser.—The adjustment is made in the form of a debit and credit account. The first debit against the purchaser is the gross price which he agreed to pay. Assuming for the purpose of illustration that a transaction closes on the 1st of March, in which the purchaser has agreed to buy a piece of property for $25,000, this amount would be the gross debit against the purchaser. Usually, the only other debit to adjust is the value of the fire insurance policies. Assuming, in this case, that the purchaser either is under obligation or is willing to take and pay for the insurance policies, the method of adjustment is to take the gross premium and apportion it, so that the purchaser pays the proportion of the gross premium represented by the unelapsed time of the policy. If the policy had three years to run when it was issued, for which $10 was paid, and has still six months to run at the time of closing, the value of the premium for that unelapsed time would be one-sixth of $10 — $1.66, which is a debit against the purchaser. There may be one other debit; for instance, if the closing is as of the 1st of March, but the actual exchange of instruments and payment of consideration does not take place until the 9th. If the contract provided for closing on the 1st, and there had been adjournments as of the original date, there would be interest chargeable against the purchaser upon the unpaid balance of the purchase price from the 1st until the 9th of March. If no stipulation had been made as to the interest rate, it would be at the legal rate. The stipulation may be that the rate shall be greater or less than that, and it would not be usurious if it were greater, because it is not payment for a loan of money, but a stipulated penalty for an adjournment or variance of the terms of the contract.
Purchaser's credits.—The purchaser's first credit is the amount which he has paid upon making the con-tract. Assume in this case the amount so paid to be $1,000. Although the seller may have had this money since the contract was signed, he does not pay any interest on it, because it was part of the transaction that $1,000 be paid when the contract was signed.
The next credit on the purchase price is the mortgage subject to which the purchaser takes the property. Assume in this case that the amount of the mortgage is $15,000, the interest rate 5 per cent, and the interest days the first of December and the first of June. On the first of June the purchaser will be required to pay six months' interest, but the seller has had the use of the money during December, January and February, therefore the next credit will be three months' interest -$187.50
If, in addition to taking the property, subject to mortgage, the purchaser gives back a purchase money mortgage of, say, $3,000, that would be the next credit.
If a property be tenanted, and some tenants have paid their rent beyond the time, as of which the adjustments are made, the purchaser is entitled to have adjusted to him at the closing or that he have cause of action against the seller for rent collected out of the premises beyond the time as of which the adjustment is made. In this case, if some of the tenants have paid in advance from 15th to 15th, the seller will have on hand rent from the 1st to the 15th belonging to the purchaser; and if there be a store which has paid rent quarterly in advance on January 1st, the seller will have on hand rent for the store for the month of March. Assuming that he has advance rents of $125 on hand, this amount would be the next credit. It is customary that the rent allowance be made on the gross amount of the rents, not on the net amount. If the seller has employed an agent to collect his rents, the purchaser does not bear a part of the agent's commission.
Payments to be made by the seller.—A report of title may show that the property is encumbered by taxes. Unless the contract specifically provides that there shall be a division of the taxes, it is not customary that there be any adjustment on that subject, but a memorandum should be made elsewhere of the things that the purchaser expects the seller to pay. There will really be two balances, one the balance between buyer and seller, which will be the money which the buyer must provide ; and the other, the net balance, which will be the money the seller will carry away with him.
Assume the amount of taxes to be paid to be $350. If this title were to close the day before the taxes became a lien, the seller would not pay them; if it closed the day after the taxes became a lien, the seller would have to bear them. If there are assessments against the property which have become a lien, the seller must pay them. Assume assessments of $25. There may also be water rates. There is no adjustment customary with respect to water rates ; if they have become a lien, they are chargeable against the seller. If water has been used and measured by meter, such meter charges as are fixed by the reading of the meter by the public authorities are chargeable against the seller from the last time when the meter was read up to the time of adjustment, either by estimating and averaging or by holding up a deposit so that when the meter is read the exact amount may be taken out. Assume in this case, the water charges against the property to be $10.
Payments made by the purchaser.—These include the drawing and recording of the purchase money mortgage and the mortgage tax on it, if there be any.
The purchaser must provide, in order to carry through this transaction, $5,689.16. In addition he must pay the seller's attorney $28. Out of this $5,689.16 the seller must pay $385, leaving his net balance $5,304.16. The amount paid by the purchaser to the seller has been called the "gross balance"; that which the seller carries away the "net balance."
Encumbrances not provided for in contract.—Every transaction may not be as simple as the foregoing. It may be that there are encumbrances upon the seller's property which are not provided for in the contract. The general rule with respect to such en-cumbrances is that it is the duty of the seller to remove them at his expense, and to discharge them of record. If there were a second mortgage, all the expense of paying principal and interest, paying for drawing of satisfaction piece and of recording satisfaction of mortgage would have to be paid by the seller. Where there are judgments which are liens upon the property, or decedents' debts or mechanics' liens, things which while encumbrances and troublesome, could perhaps be adjusted in a few days, the custom is that the seller shall leave with a safe depository which both parties are willing to trust a sum of money which is estimated to be sufficient to provide for clearing those encumbrances, and something in addition, both as safeguard to the purchaser and as incentive to the seller to get his encumbrances off.
Closing of exchange contract.—The adjusting of the closing of an exchange of real property is made upon the same principle as that just outlined. It is a debit and credit account. If it is desired to simplify the account, instead of charging each buyer and each seller with the purchase price or the fictitious contract price of each parcel, if there is a difference to be paid in cash as the result of the exchange, that difference may be charged to the person who is to pay it, as a first debit, - and then the items adjusted in each parcel which do not figure in the contract. For instance, if a person were to exchange one house for another, and it was n even ex-change, it might be that the permanent encumbrances could be eliminated from the contract; and in that case all there would be to adjust would be the interest on the respective mortgages and the rents collected. Each party would be charged with these items, and the difference between them paid by check by the one who owed that difference. If there was a payment to be made of the difference of exchange, that would also be charged against the one who was to make it.
Closing of transfer of leasehold.—The adjusting of the transfer of a leasehold is simple, except where the ground rent is paid at the end of the term, as it often is, when the seller would be charged not only with the rents which he had collected from the tenant, but, having had the property for the period from the time up to which the ground rent was paid up to the time of adjustment, he would turn over not only the advance rents which he had collected, but also a proper adjustment of the ground rent. If the situation were re-versed and the seller had paid rent in advance, he would be entitled to get from the purchaser the ground rent for the unexpired term up to which rent had been paid.
Closing of loan transaction.—In a loan transaction the principle is entirely different; the only principle that governs a loan transaction is that the borrower pays everything. The lender does nothing but advance the principal sum which he has agreed to lend, and all adjustments are on the other side of the account. The borrower pays the expense of examining the title for the lender, the expense of title insurance and furnishes the fire insurance policy; he pays off all other mortgages and encumbrances, all taxes, brokerage, the mortgage tax, and the expense of recording all instruments. There is no debit and credit account ; it is all debit.
Rents due and not paid.—This is a difficult matter to adjust. If there be a responsible agent in charge of the property, it is customary to permit him to finish collecting, and give him instructions as to the division of the rents. It is a delicate matter for a purchaser to refuse to trust a seller to collect such rents, or for a seller to refuse to trust a purchaser; it must be adjusted by mutual accommodation.
Methods of figuring interest.—Interest is customarily figured, in real estate transactions, on the basis of a 360-day year; each month is considered to be one twelfth of a year; and it is customary for the purpose of short figuring to take each day as the thirtieth of a month, so as to use the ordinary 6 per cent method of calculating interest. As matter of law, when figuring interest for a period consisting of months and days, each month is considered to be one-twelfth of a year, and only the odd days are figured on the basis of a 365-day year. When figuring interest, it is proper to exclude the first day and include the last day.
Rejection of title.—If a purchaser has good reason for rejecting the title, he is entitled to have returned to him any sum which he has paid on the contract, together with interest at the legal rate from the time when he made the payment up to the time when it was re-turned to him. He is entitled also to have returned to him his reasonable expenses of examination of title, which means that a person can charge merely the actual value of the expense of examining title in accordance with the customary rate. He cannot obtain consequential damage or compensation for loss of prospective profit, or brokerage incurred upon the re-sale of the property, unless the seller is convicted of fraud in making the contract, then only can the purchaser get secondary damage.
In a contract of exchange, if there be rejection and a payment has been made, the purchaser is entitled to recover the amount paid and also his reasonable expense of examination of title to the property which he was to receive. He is not entitled to recover commission paid for bringing about the contract. Commissions are paid for obtaining the purchaser and bringing about the making of a contract.