The current economic and real estate crisis has affected all sectors of America’s economy, and while short sales can provide agents with the opportunity to assist sellers through a troubled time in the seller’s lives, short sales present a myriad of challenges and liability traps to the unwary real estate agent. This article will address issues and challenges that the agent may face from entering into the listing agreement with the seller through the closing of the sale.
Is the agent a “Debt Management Service Provider”?
In 2009, the Oregon legislature passed House Bill 2191, which expanded the state’s licensing, regulation and enforcement of “debt management service providers.” The effects of this law on real estate agents was previously discussed in Principal Broker, but the summary is that a real estate agent that negotiates a short sale on behalf of a seller for the agent’s standard commission is exempt from obtaining a license as a ‘debt management service provider.’ However, if the agent charges a higher commission rate or additional fees as part of the short sale negotiation, the agent is now a ‘debt management service provider’ and must obtain a license as such from the Oregon Department of Consumer and Business Services.
The listing agreement
ORS 696.805(3) provides that, among other duties, the seller’s agent has a duty “to advise the seller to seek expert advice on matters related to the transaction that are beyond the agent’s expertise.” Matters related to a short sale may include negotiating release of personal liability of the seller to lenders, potential tax consequences and eviction of tenants. For example, the discharge of debt by a lender is generally considered by the IRS to be income to the borrower. However, the Mortgage Forgiveness Debt Relief Act of 2007 generally allows borrowers to exclude income from the discharge of debt on their personal residence. The agent should not be advising the seller as to whether or not the seller will meet the qualifications of the Mortgage Forgiveness Debt Relief Act of 2007. Therefore, in order to become fully informed about the consequences of a short sale, the seller may need legal and tax advice, and unless the agent is also an attorney and a certified public accountant, advising the seller on these issues would be beyond the agent’s expertise. Therefore, once the agent becomes aware that the listing may be a short sale, the agent should advise the seller to seek professional legal and tax advice regarding the consequences of a short sale. The agent may choose to include this language in the listing agreement in order to ensure that the client is fully advised from the beginning of the relationship.
The Earnest Money and Sale Agreement
Once signed, the Earnest Money and Sale Agreement is a binding contract between the seller and buyer for the sale of the property on the terms and conditions of the Earnest Money and Sale Agreement. A short sale transaction requires one or more creditors of the seller to agree to release their security interests against the property for less than the full payoff owed to them. This means that those secured creditors must agree to the short sale terms, otherwise the seller will be unable to sell the property. Therefore, when drafting the Earnest Money and Sale Agreement, the listing agent should include that the sale is conditioned upon third party (secured creditors) approval of the short sale terms AND seller’s approval of the third party terms as seller’s conditions of the sale. The last condition is critical to protect the seller’s right to terminate the sale without penalty if a secured party has unreasonable terms of approval, such as requiring the seller to sign a promissory note for any deficiency.
Negotiating the short sale
Oregon law has long provided that a lender that forecloses a trust deed non-judicially (i.e., by advertisement and sale on the courthouse steps) is not entitled to any deficiency and recovery of the real property is the only remedy. A recent law change (HB 3004 and HB 3656) has now extended that protection to multiple trust deeds, IF the trust deeds were originated by the same lender and on the same day. This law extends the ‘anti-deficiency’ protection to the 80/20 loans that, in reality, were one single loan that was broken in to two loans either to provide better rates for the primary loan or to avoid mortgage insurance. When the seller has only one trust deed encumbering the property or has the situation where the senior and junior trust deeds were recorded on the same day with the same beneficiary, the listing agent can use these laws to negotiate with the lenders to approve the short sale terms and to release the seller from any further liability. Otherwise, if the lender(s) are unwilling to agree in writing to release the seller from liability, the seller may be in a better position financially to just let the property go to foreclosure.
Complications will arise when there is a junior trust deed and the junior trust deed does not meet the qualifications of HB 3004 and HB 3656 (i.e., the second loan was originated on a date after the first loan or was from a different lender). In those situations, foreclosure is not an inviting alternative, because the lender on the junior trust deed can still sue the borrower on the promissory note. If the junior lender will not agree to release the seller’s liability, the seller needs to consider whether the short sale will reduce the liability owed to the lender to a manageable amount or whether bankruptcy may be a better alternative to discharge the debt.
It is important for the agent to remember that a short sale is really nothing more than a loan modification, and the agent should do his or her best to ensure that all secured parties agree in writing to release the seller from liability. The fact that the seller may be released from liability under a foreclosure does not mean that the liability is automatically released in a short sale. If the lender or lenders will not agree in writing to release the seller from liability, then the seller should be aware that the lender may attempt to seek recovery of any deficiency.
Short sales are complex transactions coupled with reduced commissions. Agents should tread lightly when entering into listing agreements that may result in short sales and should make sure that the agent is either fully informed or has the resources available to inform the agent and the seller on all of the consequences of the short sale. Additionally, if the agent has any concerns about representing the sellers, then the agent may consider withdrawing from the listing agreement. The agent should consider if the commission that will be paid from the sale is worth the possible lawsuit or loss of license that could follow.
This article has only touched on a few of the possible issues that may arise when trying to sell a house by short sale. The agent should be diligent and thorough throughout the entire process in order to make sure that the seller’s best interests are served.