Seller Financing Pitfall

We can all learn a lesson from the sad case of the Seller Butts and the Buyer Browns, two couples in Crenshaw County, Alabama. They landed in court, and then on appeal. After that, the Butts went home very unhappy. You don’t want that to happen to you.

The Butts bought some land and financed it. Then they bought a mobile home and also financed it. They made payments for a couple of years and decided to sell the land and mobile home for $85,000. They arrived at the number by adding up the payoffs on the two mortgages and adding some extra as compensation for improvements they’d made.

The Browns agreed to buy the land and mobile home for $85,000, but were turned down for 3rd party financing. The Butts said they would hold the financing. The Butts hired an attorney to draw up documents.

lease purchase agreementThe documents consisted of a 30-year lease with a purchase option.  Rent was $728/month. The Butts said the number was calculated by taking the total of the two mortgage payments, plus a little extra for taxes and insurance.  The Browns could buy the property at any time during the lease term for $85,000. All lease payments would be applied as a credit against the purchase price.

Almost ten years later, the Browns elected to buy the property. After subtracting all their lease payments, a balance of $9,288 remained on the $85,000 purchase price. They paid that amount to the Butts, and asked for a deed and title insurance.

That’s when the Butts realized they’d made a terrible mistake in the lease purchase agreement.  At that time, $51,757 remained unpaid on the original two mortgages!

Neither the Butts, nor their attorney, thought about the fact that a large portion of each mortgage payment was interest.  Although the Browns might make a $728 lease/purchase payment in a particular month, maybe only $15 of that reduced the mortgage loan balance. As a result, only $15 should have reduced the option purchase price.

The attorney testified he thought this was a short term arrangement, so he didn’t think about the interest component. But, it WAS a 30-year lease!  In reality, if the Browns paid all their lease payments on time, they would have paid the final $728 after only nine years and nine months.

The Butts, faced with receiving only $9,288 and having to pay off a $51,757 mortgage in order to deliver good title, promptly asked the courts to “reform” the agreement for them. Reformation is a legal term for a court ordered do-over. “We know we signed this document,” they said, in essence, “But it’s not what the parties intended. Your Honor, please re-write the document to what we all intended, and that’s the way things will be.”

The trial judge was sympathetic to the Seller Butts. Using various perfectly good legal theories, he found in favor of the them. The Buyer Browns would have to pay more money if they wanted to get clear title.

The Alabama Court of Civil Appeals was not as sympathetic. They found that the trial court’s legal theories did not apply to the facts of this particular case, because of a variety of perfectly good technicalities.

Bottom line (unless  it is appealed further):  The Seller Butts made a very foolish mistake because they did not think about the interest component of the monthly mortgage payments. The Buyer Browns are entitled to pay only $9,288 and the Butts will have to deliver good legal title. In order to do so, they will have to come up with the money to pay off $51,757 in mortgages that encumbered the property.

Can the Butts recover from their attorney for malpractice? Maybe, maybe not.

  1. ALWAYS ask your attorney for proof of malpractice insurance before hiring. The ones with insurance will not be offended. The ones with no insurance will either be offended, or will give you an explanation regarding why they don’t have insurance.  At that point, make an informed decision about whether this is important to you or not.
  2. Attorneys were not put on this earth to save you from foolish business decisions.  If you ask an attorney to prepare a document like the one described above, it is not the attorney’s job to figure out if that is a good deal or not UNLESS YOU ASK THE ATTORNEY FOR THAT BUSINESS ADVICE!  Most people don’t ask. If you do ask, make sure your question is in writing, in case  you later need to prove you were relying on the attorney’s business advice. Remember, also, that malpractice insurance is for bad legal advice. Not bad business advice.

The decision is Butts v. Brown, February 12, 2016, Alabama Court of Civil Appeals.

Even if you are selling property that does not have a mortgage on it, this case is still relevant to you. Many people call to ask me about seller financing terms. Most of them suggest applying lease payments to the purchase price. The Butts/Brown case is an extreme example, but you should always think about the time value of money in such negotiations.