Real Estate Divorce
Considerations Relating to Pennsylvania Real Estate in a Divorce
The following is intended as a practical guide to the attorney who is representing a client in a divorce proceeding in Pennsylvania where the parties own real estate:
1. Title. Property acquired by spouses after marriage is owned as tenants by the entireties (which automatically includes the right of survivorship) unless there is clear, written manifestation to the contrary. But what of property acquired by either or both parties prior to the wedding?
1.1. Sole Title. If either party acquires property prior to the marriage, for equitable distribution purposes it will not be deemed marital property unless the owner conveys it formally by deed after marriage to both spouses as tenants by the entireties; if such a conveyance occurs it will be deemed marital property.
1.2. Joint Ownership. It is not uncommon for couples to acquire real estate jointly in anticipation of marriage. Unless the deed manifests a different intention, they will own the property as tenants in common without survivorship (i.e., on the death of one of them, his or her interest will pass to the estate of the decedent not to the surviving tenant). Unless they convey it to themselves as tenants by the entireties after the marriage, each will continue to own an undivided interest in the property after the marriage and it will not be deemed marital property. Note further that if they made unequal contributions to the purchase price when they acquired the tract, their respective percentage interests in the property will mirror their contributions; however, if subsequent to the marriage they convey it to themselves as tenants by the entireties, each will be deemed an owner of an undivided one-half interest. Incidentally, in Pennsylvania, contrary to what many active real estate practitioners may believe, there is no difference between ownership as tenants in common or as joint tenants (see Act of 1812, P.L. 259, 68 PS §110). There is a common misbelief that joint tenancy implies survivorship (i.e., upon death of one of the tenants, the decedent’s undivided interest passes automatically to the surviving tenant), but it does not; there must be something specific in writing, usually in the deed, or there is no survivorship.
1.3. “Coerced” Transfer. Suppose A owns a property prior to marriage and after marriage decides to borrow funds to improve it. The bank agrees to lend the funds only if A will convey to A and B as tenants by the entireties and both A and B sign the note and mortgage. A reluctantly does so. The property is now part of the marital estate, irrespective of the reason for the transfer. Although banks will often require such conveyances in a matter-of-fact manner, they really do not need the conveyance if the other spouse is willing to sign the note in which case the bank would be just as secure as though A had transferred title to A and B. A should have resisted the bank’s demand but probably felt it was an innocuous request.
2. Engaging a Broker to Sell Residence. As a part of a marital settlement, the parties’ home is to be sold; what are the pitfalls in engaging a broker?
2.1. Brokers’ Puffery. Above all else, seek and engage a highly reputable broker. It is a common practice among the less-reputable brokers to approach possible sellers and exaggerate the value of their property to lure them in. If the owners believe their property is worth, say, $250,000, and a broker comes along and tells them he thinks he can get $350,000, he’s going to get their attention since they see him as an “expert”. Understandably excited and enthusiastic, they sign a listing agreement which requires them to pay the broker his commission irrespective of the actual sale price. So, the unsuspecting owners may find themselves locked in to a long-term listing agreement with a broker who is totally incapable of producing a decent buyer. Of course, if another broker brings the owners an acceptable offer (let’s say $235,000 in our scenario above), the listing broker will receive at least a portion of the fee.
2.2. The Listing Agreement. Most likely the parties will engage the services of a licensed broker to sell the property. Most brokers will ask for an exclusive agency agreement which assures the broker of the agreed upon commission (commonly 6% of the sale price) irrespective of which broker actually sells it; attached as Exhibit 2.2 is a form used by a large brokers’ office. While a listing agreement can perform a valuable service in promoting the sale of a home, it is a document which requires abundant caution and is often the source of great lament. Obviously, much of it depends on how ethical a broker is. The justification for the exclusive listing is that the broker will then devote more effort and advertising dollars to the sale because he is assured of a fee if there is a sale during the period specified. What to look for in these agreements:
2.2.1. Term. What is the period of the listing? Brokers will ask for as long a period as possible, up to a year. You should strive to reduce it to 60 or 90 days; at the conclusion of the period, if you are satisfied with the broker’s efforts, you can always extend. There is hardly anything as frustrating as a listing agreement which runs for many months beyond the owners’ realization that this broker is sitting on his hands, doing nothing.
2.2.2. Post-Term Sales. What are the residual effects after the termination date of the listing agreement? Most agreements will contain a provision that if anyone who was “introduced” to the property by the broker buys the property even after the listing agreement has expired, the broker is to receive its fee. The attached form, which is used by a large brokerage firm, provides that the broker is to receive its fee after the agreement terminates if a buyer is someone who “has heretofore been negotiating” for the property; the language is impossibly vague. The word “negotiating” should be limited to someone who was clearly identified by the broker in writing to the owner/seller before the agreement terminated; and in any event there should be a time limit of 30 to 60 days after the termination of the agreement. Beyond that whether a buyer was “negotiating” or not should be irrelevant.
2.2.3. Possible Double Fees. It should provide that the broker shall share its fee with a cooperating broker so that in the end, if 6% of the sale price is the agreed upon fee, the total brokerage fees will not exceed 6%. A grotesque scenario can develop when a poorly performing broker has done virtually nothing, and another broker brings a buyer to the sellers who have forgotten the listing agreement exists because of the inactivity and end up incurring a double brokers’ fee. It happens. Never permit a client to accept an offer from other than the listing broker without a clear agreement in advance among the brokers and the owner regarding fees. You may wish to insist that your broker list the property with the Realtors’ Multiple Listing Service; virtually all brokers who are Realtors will do so routinely.
2.2.4. Leases Included. Note that the form attached includes leasing as well as selling the property. This may be perfectly acceptable, but be aware and advise clients accordingly during negotiations with the broker regarding the listing agreement. This form requires the owners to pay one-half of the first month’s rent plus 6% of all rental payments thereafter; there is room for negotiation of that provision.
3. The Sale. Once a broker is chosen and potential buyers begin to inspect the marital residence, negotiations begin with those that have a serious interest. This is a critical moment; the ability to negotiate well is a deft art. Owners may over-value their property and as a result may drive away buyers who might have made a serious offer if the price were reasonable; it is self-evident that the expenses of maintaining a property (the real estate taxes, mortgage interest, utilities, repairs, etc.) for a protracted period may more than exceed the difference between a reasonable asking price and one that is excessive. There is the peace-of-mind factor; the effort to sell a residence can generate enormous angst in an owner, and the greater the delay, the greater the angst. As to value, seek advice of a professional (a well-chosen broker should be of invaluable assistance in setting an asking price), and spruce up the property by cleaning, painting, and repairing broken items. Make it as attractive as possible; first impressions of potential buyers are indelible, and a quick sale for a good price will generally offset the expenses of preparing it for the market. When an offer is received, there are any number of things to consider:
3.1. Personalty. Are items of personalty to be included? They must be listed with specificity.
3.2. Financing Contingency. Is there a financing contingency? Again, be specific by requiring the buyer to make application within a brief period and setting a fairly tight time-table for mortgage approval and settlement. In setting the parameters of the mortgage application, insist on (a) a minimum loan amount (more than 80% of the purchase price can be difficult to obtain), (b) maximum interest rate, and (c) amortization period that are realistic. It will only delay things to enter into an agreement which contains a mortgage contingency that is unlikely to be met. Insist on the buyer’s keeping the seller advised on the application and its progress.
3.3. Buyer’s Sale Contingency. A highly undesirable, but sometimes necessary, contingency is the sale of the buyer’s residence. Unless the buyer’s property is under agreement, this obviously could take many months to achieve. If the buyer’s property is under agreement, scrutinize it carefully and try to discover as much as you can about the likelihood of its being successfully completed on schedule. The risk is obvious: the buyer’s sale may fail for any number of reasons over which your client has no control; and if it does fail, your client’s property may be off the market for several months while several potential buyers are lost or the economy turns south, forcing a reduction in the asking price.
3.4. Inspections; Owners’ Limits. Most buyers now ask for the right to inspect all structural components and mechanical systems in addition to termite and radon inspections. Insist on as short a period as possible (usually 15 to 20 days are sufficient) because, again, the property is off the market during this uncertain period. Also, insist on setting limits on the amount the owners must spend to correct problems, if defects are discovered. (Be assured the inspector will find several deficiencies if the house is more than three hours old.) Whether the maximum set by the agreement to be spent by the owners is $500 or $5,000, instruct the owners that they should consider the purchase price diminished by that amount and be prepared to pay it; keep the amount as low as possible, and let the buyer decide whether he/she is prepared to abandon the deal if the costs to repair deficiencies exceeds the owners’ maximum. If there are a number of legitimate defects, the owners can always negotiate with the buyer to increase their contribution if it appears the buyer is about to walk away. Keep in mind if the buyer opts out, the next buyer will also want an inspection and will probably discover the same defects; it is nearly always better to negotiate with a buyer under an agreement and salvage the deal if a reasonable amount for the repairs can be agreed upon (the old bird-in-hand metaphor!).
3.5. Down Money. A rule-of-thumb is that the down payment should be 10% of the purchase price; this will afford reasonable protection to the owners if the buyer defaults. The money must be escrowed with either a broker or attorney. If the buyer is unable to put 10% down and seems to be a good credit risk (i.e., owns real estate with good equity) you might consider something less than 10% with the difference made up with a judgment note. Remember though, all cash is better. One of the things most buyers will insist upon is that the down money will be retained by the owners/sellers as liquidated damages in lieu of any other remedy if the buyer defaults; this requires a modification of most printed agreements (see paragraph 26[B] of the attached agreement) and is a change that is generally acceptable to sellers.
3.6. Realtors’ Form. Attached is a form (attached as Exhibit 3.6), which is used widely in the Philadelphia area, adopted by the Pennsylvania Association of Realtors. It is anything but brief (especially if you attach riders), but it is complete and does anticipate most circumstances. It can also be completed by most ordinary mortals, if patience is invoked, and it is completed methodically. It apportions real estate taxes, rents, etc. and fairly divides transfer taxes equally (usually 2% in Pennsylvania, with exceptions, notably Philadelphia) between seller and buyer. One of the easily overlooked pitfalls (for the buyer)in the form is the mortgage contingency; if the buyer is unable to obtain financing, it is the seller who has the option to terminate the agreement, not the buyer. Many people (read, lawyers) who fail to read it carefully assume otherwise. Prepare to yield on that if you represent the seller.
3.7. Capital Gains Exclusion. There is a federal income tax exemption (§121, IRC) of $250,000 for each party, or $500,000 for a couple, on the capital gain on the sale of a personal residence. This can be of enormous significance to the parties; and the full $500,000 exclusion is available to a divorcing couple even though the property is conveyed to one of the parties under a divorce settlement. Note that in order to qualify for the exclusion the parties must have used the property as their principal residence for a total of two years in the five years prior to the sale. Also the exclusion is not available if one of the spouses has previously claimed the exclusion on another property within two years.
3.8. Settlement. Mindful of fees, some clients will try to close on a transaction without counsel. It can be done, but having an attorney throughout can relieve the owner/seller of many aggravations. Prior to settlement scrutinize carefully the title report so that all objections are resolved by settlement. Have the owner/seller put all tax and sewer receipts together, and go through the agreement of sale to prepare a check list of items needed to complete settlement.
4. Seller Financing. There may be circumstances when a property has been on the market for an extended period where a buyer cannot obtain financing because of insufficient down money or a bad credit rating. While it is usually not the optimal kind of sale, seller-financing can work if all efforts to sell conventionally fail; the owner/seller should receive a better than market rate of interest because of the inherent risk. The other advantage is time; since there is no commercial lender involved, the transaction can proceed quickly without the expenses (points, etc.) of a commercial loan. The parties enter into an installment sale agreement in which the amount financed will be amortized and repaid as though it were bank financing. These are of necessity complex agreements. Some suggestions in your negotiations:
4.1. Maximize Down Money. Obtain as much down payment as possible.
4.2. Default; Liquidated Damages. Provide that in the event of default all payments made to the time of default, including down payment, should be deemed to be rent and retained by the seller as liquidated damages. Note that confession of judgment is not available in consumer transactions.
4.3. Balloon Payment. Although the loan may be amortized over a protracted period of perhaps 20 years, you should try for a balloon payment of the remaining principal balance after a couple of years. As the buyer builds equity and the property appreciates in value (assuming it will), at some point commercial financing should be available.
4.4. Expenses to Buyer. All expenses related to preparation and filing of documents should be borne by the buyer just as they would be if there were a commercial lender.
4.5. Prorations. All of the prorations and adjustments of taxes, rents, etc. should be as they would be in a standard agreement of sale.
4.6. Memorandum of Record. Generally, the parties will execute a memorandum of the agreement to be entered of record to protect the buyer’s interest in the property in the event of a judgment or other kind of a lien against the owners/sellers.
4.7. Transfer and Mortgage as Alternative. An alternative that a buyer’s lawyer may insist upon is a transfer of the real estate with a mortgage back to the owner/seller. The obvious problem with this is the difficulty (and expense) of a sheriff’s sale to reclaim the property in the event of a default. Also, there are expenses of transfer (principally the transfer taxes) which are deferred until all payments have been made (and never paid if the buyer defaults) in an installment sale.
4.8. Installment Sale Land Contract Law. Note that there is an Installment Land Contract Law (Act of 1965, P.L. 115, 68 PS§902), which governs every “executory contract for the purchase and sale of a dwelling situate in any city of the first class or county of the second class.” Philadelphia is the only city of the first class and Allegheny County is the only county of the second class. The Act imposes very strict conditions upon these transactions; and while most parts of the state are excluded from its coverage, anyone preparing an installment sale agreement should familiarize himself/herself with its provisions. If you are in compliance with its provisions, it will enhance your position if the agreement is ever contested, even though the property is outside of Philadelphia or Allegheny County and technically the Act does not apply.
5. Mortgage Default; Foreclosure. A common by-product of separation/divorce is a default on the mortgage against the family residence. Because the mortgage foreclosure process is cumbersome and uncertain most lending institutions will make every effort to resolve a default amicably. Assuming that this has occurred and foreclosure becomes inevitable, what are the consequences?
5.1. Timing. Assuming your client has no valid defense, from the filing of the complaint in mortgage foreclosure until the sale the period will be 2½ to three months. If your client has a material defense, this period could stretch on for many additional months, depending on the nature of the defenses and the backlog in your county.
5.2. Right to Cure. Before there can be a residential mortgage foreclosure, there must be what has come to be known as an “Act 6 Notice”. At least 30 days before commencing foreclosure, the lender must give the defendants a detailed notice specifying the nature of the default, their legal rights in the process, and advising them of their right to cure all defaults by paying all amounts due, including payment of all reasonable costs and fees incurred by the foreclosing lender in the proceeding. If the defendants make these payments any time prior to one hour before the scheduled sale, the loan must be fully reinstated and the defendants can begin making monthly payments again as though the default had not occurred. See Act of 1970, P.L. 13, No. 6; 41 PS §403 and §404, as amended.
5.3. Deficiency Judgment. If the foreclosing lender purchases the property at the judicial sale but fails to receive all principal, interest, and other charges due under the note and mortgage, the bank has the right to proceed against the defendants individually under Act of 1998, P.L. 1082; 42 Pa CSA §8103. The lender must proceed within six months of the sale, or the right to proceed for the difference will be forever lost. Note that any attempt by a lender to have a borrower waive its rights under this Act will be void.
5.4. Bankruptcy. If the defendants commence a proceeding in bankruptcy prior to the sale, all proceedings will stop at least temporarily. Though there are times when it may be appropriate. Bankruptcy is hardly a panacea for the defendants; if the note and mortgage are in proper order, and the lender is properly secured, at best the bankruptcy will buy only a few months’ time before the lender will be able to resume the foreclosure proceeding. Additionally, bankruptcy can be very expensive and disruptive; and there is always the intangible stigma that accompanies bankruptcy and can impair a person’s credit rating for many years.
6. Collection of Deficient Support Payments. Under the Act of 1990, P.L. 1240; 23 PS §4355 a child support order which has been duly certified to the Court of Common Pleas against one spouse will become a judgment lien against property the spouses own in the county of the certification. Once that occurs, any such property cannot be transferred free of liens without satisfaction of the judgment. At settlement the amount of the deficiency will be deducted from the proceeds due to the delinquent spouse.
H. Kenneth Butera
Butera, Beausang, Cohen & Brennan
Attorneys at Law
630 Freedom Business Center, #212
King of Prussia, PA 19406