Sale Of Property Coupled w/ Buyback Right Under Contract For Deed Deemed An Equitable Mortgage; MN Federal Court Looks To Substance Over Form Of Deal

A U.S. District Court in Minnesota recently had an opportunity to review a somewhat complex transaction involving a title transfer of real estate by a property owner to another, coupled with a Contract for Deed calling for a future title transfer back to the property owner that was designed to obtain needed funds.

In declaring the arrangement to be an equitable mortgage,(1) the court disregarded the form of the arrangement as an outright sale with a repurchase contract and ruled that the deal, in substance, was merely a financing transaction intended to generate needed cash.(2)

For the ruling, see Hartman v. Smith, Civil File No. 09-01618-MJD/RLE (D.Minn. Sept. 17, 2010) (ruling available online courtesy of courtops.org, a service of the Minnesota State Bar Association).

(1) For the treatment of sale transactions coupled with leaseback or other deferred buyback arrangements as equitable mortgages, see generally:

• When is a Sale-Leaseback an Equitable Mortgage?,
• Sale-Leasebacks: Things May Not Be What They Seem,
• Online References On Sale Leaseback Recharacterization.

(2) The court made the following analysis of Minnesota law in reaching its conclusion (bold text is my emphasis, not in the original text):

• Courts generally presume that a deed is a conveyance. Ministers Life & Cas. Union v. Franklin Park Towers Corp., 239 N.W.2d 207, 210 (Minn. 1976).
  
  However, Minnesota courts have adopted the doctrine of "equitable mortgage" "to prevent any overreaching by one party which would unfairly exploit the other party's financial position or relative lack of experience in real estate dealings." Id.
  
  Essentially, if "the real nature of the transaction between the parties is that of a loan, advanced upon the security of realty granted to the party making the loan, it may be treated as an equitable mortgage." First Nat'l Bank of St. Paul v. Ramier, 311 N.W.2d 502, 503 (Minn. 1981).
  
  The intent of the parties is paramount, and to overcome the presumption that a deed is a conveyance, it must be clear that both parties intended that the transaction result in a mortgage. Ministers Life & Cas. Union, 239 N.W.2d at 210.
  
  In order to determine intent, courts may look to the documents relating to the transaction. Id. The lack of terms such as "debt," "security," or "mortgage" are strong evidence indicating that the transaction is not a mortgage. Id. However, the fact that documents do not express the existence of a loan is not conclusive, and the intention of the parties is to be ascertained by looking at "all the facts and circumstances surrounding a transaction." Gagne v. Hoban, 159 N.W.2d 896, 899 (Minn. 1968). "In the final analysis, the question of whether the parties to a conveyance really intended it to be absolute or security for indebtedness is for the triers of fact." Id. at 900. The true inquiry is whether the parties intended an outright sale or whether the "purpose and effect of the transaction is to give security on real property for a debt." Id. at 899.

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• In addition to looking to the intent of the parties, courts will also consider the following factors in making a determination as to whether a conveyance should be construed as an equitable mortgage:
  
  1) the disparity between the value of the property and the price paid;
  2) the nature of the solicitation that gave rise to the transaction;
  3) attempts to sell the property on the open market;
  4) whether there was a negotiated sale price; and
  5) whether there was continuous occupancy.
  
  Brown v. Grant Holding, LLC., 394 F. Supp.2d 1090, 1098-99 (D. Minn. 2005).
  
  Turning to the Brown factors, the Court concludes that they also weigh in favor of finding an equitable mortgage. The vast disparity between the Subject Property’s sale price of $280,000 and the appraised value of $2.5 million suggests that the transaction operated as a loan. See Jones v. Rees-Max, LLC, 514 F. Supp. 2d 1139, 1146 (D. Minn. 2007) (holding that a disparity of $278,000 in value and purchase price of $214,000 was large enough to weigh in favor of equitable mortgage).
  
  The nature of the solicitation involved frequent assurances from Smith that this arrangement would allow them to keep their home. The home was never placed on sale in the open market. There was no negotiated sale price, but rather an amount of money needed for the Plaintiffs’ financial needs at the time.
  
  Plaintiffs continued to occupy the premises upon executing the Contract for Deed and continued to pay real property taxes and homeowner’s insurance as a part of their monthly payments.
  
  Finally, Plaintiffs made post-conveyance improvements to the property.
  
  In light of these facts, the Smiths’ admissions, and Prime’s failure to state a position on this issue, the Court finds it appropriate to enter a declaratory judgment that the agreements the Smiths and Plaintiffs entered into on February 21, 2007 constituted an equitable mortgage.