Following the market crash and the Great Recession, Congress enacted the Dodd-Frank Act to effectuate a “sweeping overhaul of the United States financial regulatory system” on a scale not seen since the reforms that followed the Great Depression. Title X of the Dodd-Frank Act created the Consumer Financial Protection Bureau (CFPB) to supervise and enforce fair lending guidelines regarding real estate mortgages.
Key provisions of the Dodd-Frank Act took effect earlier this year. One consequence of the new compliance guidelines and increased scrutiny is extended closing periods for mortgages. While prior to this year most mortgages closed within 30 days, following Dodd-Frank, some loans now take 45 – 60 days to close.
Due to the longer and less predictable closing periods, buyers and sellers are encountering occupancy challenges and requesting pre or post-possession agreements until their pending transaction can close escrow. Pre-possession agreements are awkwardly named and are better understood as “pre-closing occupancy agreements.” This refers to a written agreement whereby the seller agrees to rent the property to the buyer before the transaction actually closes escrow. The term is typically brief – anywhere from one day to one month.
Pre-possession agreements present unique and interesting legal issues. They also present substantial risk to the seller. In fact, Commissioner’s Rule R4-28-1101(k) warns: “A salesperson or broker shall recommend to a client that the client seek appropriate counsel from insurance, legal, tax, and accounting professionals regarding the risks of pre-possession or post-possession of a property.”
Arizona’s statute of frauds requires that any agreement for the sale or interest in real estate must be in writing. A.R.S. §44-101(6). But one key exception to the rule concerns a lease for less than one year. So technically a verbal pre-possession agreement is legal. Under no circumstance, however, should a seller (or his agent) ever agree to a verbal pre-occupancy agreement.
Although pre-possession agreements can create certain risks for the seller, those risks may be mitigated or eliminated with a thoughtful and thorough pre-closing occupancy agreement. Below is a list of common pitfalls to pre-closing occupancy agreements:
- Risk of Loss – who has the risk of loss during the pre-closing occupancy period? According to the AAR Purchase Contract, the seller is only responsible for any warranties or damage until close of escrow or possession, whichever occurs first.
- Insurance – does the seller have valid insurance coverage during the pre-closing occupancy period?
- Repairs and Maintenance – who is responsible for repairs and maintenance?
- Occupancy Rights – who has the right to occupy the property (the seller should require the buyer to expressly identify the names of everyone who will be occupying the property and consider obtaining background check on all occupants)
- Rental Amount – what is fair rent for the term?
- Security Deposit – what is a fair security deposit? Is the security deposit limited to 1.5 times the monthly rent pursuant to the Arizona Residential Landlord Tenant Act? Probably not (see below).
- Alterations – the seller should resist any request by the buyer to make alterations prior to closing. If, however, the seller elects to allow any alterations, the seller should demand a security deposit or bond to protect the seller if the transaction doesn’t close.
- Buyer’s Contingencies – the seller should request that the buyer waive any contingencies.
- Seller’s Remedies if Buyer Breaches – the seller should expressly identify what remedies are available if the buyer breaches the contract and fails to close escrow, including liquidated damages. Also, the seller should request that the buyer agree to immediately voluntarily surrender possession and that the seller may perform a non-judicial lockout.
Notably, pursuant to A.R.S. §33-1308, the Arizona Residential Landlord Tenant Act does not apply to “occupancy under a contract of sale of a dwelling unit or the property of which it is a part, if the occupant is the purchaser or a person who succeeds to his interest.” That section, however, arguably applies only to land installment contracts (also known as “agreement for sale,” “land contract,” or “contract of sale”). But some real estate experts interpret 33-1308 to apply to pre-possession agreements as well. So to avoid confusion, the best practice is for the parties to expressly agree in the pre-closing occupancy agreement that the agreement is for a license only and the relationship is not governed by the ARLTA.
If you or someone you know has questions regarding pre-possession agreements or any other real estate matter, please call or email today.