Rewriting the Laws on “Subject to…”

Real Estate Cases to Watch, Miller Starr Regalia, Walnut Creek, San Jose, San Francisco,
Marc A. Eisenhart
Marc A. Eisenhart

Court of Appeal Re-Writes the Laws on Property Purcahsed “Subject To…”

By Marc Eisenhart

When an investor buys property subject to a mortgage or an easement, is she waiving any right to challenge that mortgage if it is based on fraud, mistake or other invalidity? Is the investor just acknowledging the existence of the encumbrance on title? Or is she vouching for the validity of that encumbrance? Most investors would say the former, but at least one court recently concluded the latter.

Why do you think people are concerned about the court’s decision in this case?

Real estate and commercial transaction attorneys, real estate brokers and agents, loan brokers, REIT’s, and a wide swath of commercial transaction professionals all rely upon established terms of art in their transactions. Some of the most common terms of art involved in the sale of property address liens, encumbrances—such as leases—and other title exceptions, such as easements, CC & R’s, other recorded covenants that attach to real property and servitudes. For example, instead of property being sold “free and clear” of any liens or encumbrances, property will typically be sold “subject to” identified liens or encumbrances such that, after the close of escrow, they “remain on title.” Free and clear, subject to, remain on title… these are all well-established terms of art which merely provide notice to the purchaser of the state of the title of the property, and whether or not such title will be transferred “free and clear” or “subject to” the title exceptions.

Before the Loubar v. U.S. Bank (“Loubar”) decision by California’s Sixth District Court of Appeal, there was no uncertainty on what these terms of art meant or how they have been applied for over a century in California. Unfortunately, Loubar now throws that certainty into doubt. Loubar holds that when real property is sold “subject to” specified title exceptions, then as a matter of law, such title exceptions may never be challenged in the future. Not only does Loubar reject the industry’s established use of the term “subject to” (which is merely to provide notice that the property will not be sold “free and clear”), but it will cause real estate attorneys and real property practitioners to scramble. Every time property is sold “subject to” an exception, it will be malpractice for the buyer’s agent/attorneys not to thoroughly investigate any basis for any claim to challenge the validity or enforceability of the title exception, lest such challenge be forever waived.

Loubar also opens the litigation floodgates in partition actions. The facts in Loubar surround the sale of real property as part of a partition action. Attorneys will now be compelled to join, as indispensable parties, all lessees, leasehold lienors, and potentially all parties holding any easement or servitude interest in the property in order to avoid the waiver of any future claims against these lesser interest holders by the purchaser of the partitioned property. In other words, not only did Loubar hold that a “subject to” disclosure constitutes waiver of any future claims against the lesser interests, but so, too, did the failure to join those lesser interest holders in the partition action constitute a bar to future claims.

Although Loubar was not published, this only means that attorneys may not cite to the case in California State courts. The unpublished status will not prevent Loubar from being cited in federal court. Moreover, attorneys and other real property practitioners will not ignore Loubar’s unprecedented holding simply because it is unpublished. In the absence of any contrary case law, attorneys will most definitely pay heed to the opinion lest they risk being held liable for malpractice for ignoring it. Likewise, treatises such as Miller & Starr regularly cite to unpublished opinions where there is no published guidance on the subject.

This opinion could severely impair the traditional methods by which escrows and real estate transactions are handled in California.

Where do you think the court of appeal got it wrong?

The Loubar court misconstrued the Partition Act statutes by failing to acknowledge that the terms “subject to” and “remain on title” are terms of art embedded in the Partition Act statutes themselves, with the very same meanings attributed to them as established by industry standard. Specifically, the Law Revision Commission Comments to CCP section 873.610 provide, in pertinent part: “Section 873.610 is new; it makes clear the court’s authority to control the manner, terms, and conditions of sale. These include, but are not limited to, the following: […] Prior estate, charge, or lien to which the property will be subject” (emphasis added). Further, the Loubar court ignored CCP section 873.820 which expressly contemplates that property may be sold without disposition or satisfaction of any liens: “The proceeds of sale for any property sold shall be applied in the following order: […] (c) Payment of any liens on the property in their order of priority except liens which under the terms of sale are to remain on the property.” (emphasis added.)

In the end, Loubar failed to appreciate that the effect of these procedural statutes providing for the sale of one estate in land “subject to” a different estate or lien, which estate or lien shall “remain on title,” is not to quiet title to such non-partitioned estate or lien. To the contrary, invoking these procedures actually removes the lesser estate or lien from the partition dispute.

The court also reversed nearly a century of law establishing that a co-owner of property may not challenge another co-owner’s lease of the his/her interest in the property. In Swartzbaugh v. Sampson (1936) 11 Cal.App.2d 451, that court held that a co-tenant could not challenge another co-tenant’s lease of the property. Swartzbaugh has been cited for this proposition in many cases and treatises, including Verdier v. Verdier (1957) 152 Cal.App.2d 348, 352; In re Knox’ Estate (1942) 52 Cal.App.2d 338, 351; Tompkins v. Superior Court of City and County of San Francisco (1963) 59 Cal.2d 65, 69; 16 Cal.Jur.3d Cotenancy and Joint Ownership §44; Miller & Starr CA Real Est. 3D, 5 Cal. Real Est. §12:3. In Loubar, and contrary to the cases and treatises on this point, the court held that the non-leasing co-owner did have standing to cancel his co-owner’s lease, and that the failure to do so during the fee estate partition action precluded the subsequent purchaser of the partitioned property from bringing an action to cancel that former co-owner’s lease.

Is there any chance that the law will get clarified?

One can hope. If our Supreme Court grants Review of Loubar, then certainly we should expect to benefit from clarification of these and related issues. Interestingly, the Partition Act was the subject of across-the-board amendments in 1976, and virtually none of those amendments have been judicially construed. It may now be time for our Supreme Court to step in.

Is there anything people involved in property transactions can do to protect themselves?

Until Loubar gets reversed or clarified, real property attorneys and practitioners will need to radically change their thinking and procedures when approaching most real property transactions and litigation. For example, any attorney involved in a partition action will now be required, or at a minimum in an abundance of caution, to join as parties all persons with any interest whatsoever in the property. What’s more, the partition action attorney will necessarily be required to investigate all potential claims, offsets and other disputes as to every lesser interest in the property, and to join such claims, in order to avoid forever waiving the claims in the future.

Real Property brokers, loan brokers, REIT’s, family real estate partnerships, and all commercial property professionals will have to do exactly the same when transferring property “subject to” disclosed title exceptions. The due diligence process will now necessarily include investigating all potential claims, offsets and disputes regarding any title exceptions, lest they be forever waived after the “subject to” transaction closes.

Also, under Loubar, if a co-owner of property wishes to bring a claim against his/her co-owner’s lease, the limitations period could begin to run as early as the time the lease was first executed, as opposed to when the non-leasing co-owner first acquires an interest in the lease.

As Loubar is still relatively new, the full ramifications are yet to be inventoried, so every attorney and real estate practitioner should read the opinion for themselves in order to be familiar with every aspect that may impact established industry standards.

Marc A. Eisenhart is a property attorney at Gates Eisenhart Dawson in San Jose, Calif. He can be reached at mae /at/ gedlaw.com.

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