Property

SEVEN

Land Transactions and Title Records

WHENEVER AN OWNER CONCLUDES that someone else would make better use of some or all of the owner’s property, a transfer is likely to occur. Alienation—by gift, sale, will, or intestacy—is one of the normal incidents of ownership, and is critical to the overall functioning of a system of property rights because it allows assets to be reallocated until they end up in the hands of the person who can obtain the highest value from their use. Even some of the lesser interests such as bailments and leases are created by some kind of transfer. In this chapter, we mainly focus on sales—transfers of property for valuable consideration—but will make sideways glances at gifts and inheritance. After considering some aspects of the contractual process as it relates to property, we will consider ownership records, which generally facilitate transfers but cause certain complications in particular settings. The focus throughout will be on land, in part because the transfer process for land involves high stakes and has the most elaborate systems of transfer and record-keeping. In part, this is because land is used to ground other related transactions, especially by serving as security for mortgages. We end the chapter with a look at security interests and mortgages in particular.

Land Sale Contracts

Property and contract come together when property interests are transferred for consideration, usually for some combination of cash and debt. In the case of personal property, issues of the timing and quality of performance are handled under contract law, and the Uniform Commercial Code (UCC) in particular. Land sales differ from sales of personal property in many ways, not least in the length of time over which they stretch. Putting aside efforts related to searching for prospective buyers and sellers, which can entail entering into contracts with real estate brokers, a land sale has three phases. The process begins with the land sale contract and ends with the closing, when a deed passes from the seller to the buyer. The period in between, the executory period, can last for several months, and has a number of features unique to land transactions.

A land sale contract, to be enforceable under the Statute of Frauds, must be in writing and signed by the party against which enforcement is sought. The writing need not be terribly formal, but must identify the parties and the land, express an intent to convey it, and state the price. Because land is considered unique, land sale contracts are enforceable by the equitable remedy of specific performance. This is an order directing the party found to be in breach of the contract to carry out that party’s promises under the contract. Usually it is purchasers who seek specific performance, requiring sellers to go forward with the promised transfer of the property. Given its uniqueness, the buyer may not have any good substitute for the land subject to the contract. So an award of expectation damages will not provide the buyer complete relief. But even sellers, who are expecting only money out of the deal, can enforce a sale on a buyer with cold feet, as long as the requisites for enforcement are met. The availability of specific performance on both sides of the transaction provides more than symmetry (which may appeal to the sense of fairness at the heart of equity); it also may reflect the fact that land’s uniqueness means that being unable to rid oneself of unwanted land is difficult to measure in damages. Courts can avoid the thorny question of what damages would make a disappointed seller indifferent to retaining the land by simply enforcing the deal and having the sale go through.

Land sale contracts usually contain a number of express and implied promises. One of the most important is the seller’s promise to provide marketable title. (This is a default rule; sellers can contract around this by promising only insurable title.) “Marketable title” is a term of art around which a great deal of precedent has built up. The concept refers to certain risks that the buyer (most likely, the buyer’s attorney) discovers during the executory period before the closing. Basically a title is unmarketable if the buyer finds an undisclosed defect or cloud on the title during this period that presents a likelihood of litigation. A buyer is not required to “purchase a lawsuit.” So, for example, a disclosed easement would not be a defect. The disclosed easement is presumably already reflected in the agreed upon price. But an undisclosed easement, which would not be reflected in the price, would be a defect that presents a likelihood of litigation. Any substantial risk that the seller does not have title (which risk has not been removed during the executory period by the seller) makes title unmarketable. But a potential claim that would be barred by the statute of limitations would not render title unmarketable. Slight defects of title can be remedied (again, equitably) through a reduction in the purchase price, thus avoiding the more drastic result of undoing the entire deal. At closing, all the promises, such as the warranty of marketable title, must be fulfilled, and the land will be transferred with a deed and consideration changing hands.

The land sale contract governs the relationship between the seller and the buyer during the executory period, which runs from the signing of the contract to the closing. During this period, the state of the title is in a curious intermediate state: The seller is treated as having a personal property interest in the land and the buyer as having a real property interest. This is called equitable conversion because the seller is still the legal owner (as reflected in the land records) but is treated as the equitable owner of a personal property interest—the right to receive the proceeds of the sale. Conversely, the buyer is the equitable owner of a real property interest in the land and is the legal owner of the cash or the anticipated proceeds of the loan that will be used to purchase the land. In the executory period, both parties have an insurable interest in the property, but the default rules as to who gets insurance proceeds in the event the property is destroyed or damaged vary greatly by jurisdiction. In many jurisdictions risk of loss tracks the equitable real interest, and thus the buyer would be the recipient of any insurance proceeds. Wise parties will allocate these risks explicitly in the land sale contract, especially if they prefer a different allocation of insurance payments and proceeds than the law provides.

Another important consequence of equitable conversion is what happens if either the buyer or seller dies between the contract and the closing. If the seller dies in the executory period with a will leaving personal property to relative A and real property to relative B, relative A will receive the equitable interest in the sale and eventually the proceeds at the closing. (In our example, B may receive the legal title but be obligated to turn the proceeds over to A.) For purposes such as insurance and inheritance, equitable conversion matters greatly to certain classes of third parties. Although parties are free to override some of the effects of equitable conversion by allocating insurance payments and proceeds or by writing a specific will, they are not free to alter the basic ground rules for what counts as equitable personal and real property in the executory period. The number of options are limited, and their effects are kept simple in a fashion reminiscent of the numerus clausus (see Chapter 5), with enough flexibility so as to avoid frustrating many of the ends that informed parties would want to pursue.

After the closing, the land sale contract becomes largely irrelevant; it is said to “merge” with the deed so that only those undertakings expressed in the deed bind the seller. Although there are exceptions to this doctrine of merger, sellers are mostly off the hook at this point unless the deed contains future warranties. Deeds are of three main types. A deed that does not warrant title, but passes only whatever interest the seller had, is called a quitclaim deed. If the seller warrants title, the seller can either warrant title against all defects, making it a general warranty deed. Or the seller can take responsibility only for defects arising during the seller’s period of ownership, which is called a special warranty deed.

Warranties of title typically vary in terms of when they give rise to liability and who can invoke them. Sellers giving warranty deeds may include any of six covenants in their deeds, which fall into two classes, present covenants and future covenants. Present covenants include the covenant of seisin, which provides a warranty of title in the grantor; the covenant of right to convey, which warrants the authority of the grantor to alienate; and the warranty against encumbrances, which, like the implied promise of marketable title in the executory period, warrants against undisclosed easements, clouds on the title, and so forth. If there is a violation of any of these present covenants, it occurs at the moment of the closing. By contrast, future covenants can be violated at the closing or any time thereafter. They are the covenant of warranty, which commits the seller to defend the title against lawful claims against it; the covenant of quiet enjoyment, which warrants that no one with superior title will challenge the buyer; and the covenant of further assurances, which obligates the seller to defend the buyer’s title in litigation and execute needed documents to remedy any defects in title documents. There is no violation of these covenants until a problem arises and the seller fails to perform on the covenant.

The immediate buyer may enforce any of these covenants at the time they are breached (within the statute of limitations). The present covenants may be enforced as of closing and the future covenants when and if the seller fails to act as required by the relevant covenant. In all states, the future covenants run to remote purchasers—as where A sells to B, and B sells to C, and C wishes to enforce against A. In this respect, these contractual promises take on a property-like aspect, analogous to the covenants running with the land we will consider in Chapter 8. Some states allow present covenants to run to remote grantees, but because they are violated, if at all, at the closing (here the A-to-B transfer), the statute of limitations starts running then. So if A sells to B at Time 1 with a warranty deed, and B sells to C at Time 2, C could sue A for a violation of a present covenant within the statute of limitations from Time 1 or on a future covenant if the suit is filed within the statutory period after the alleged violation.

There has been some trend toward leaving the seller on the hook after the closing. Under the common law, sellers were not permitted to make fraudulent representations, but otherwise the doctrine of caveat emptor (buyer beware) prevailed. In particular, sellers did not warrant that the land or buildings were free from defects or were fit for any particular purpose. Some states have changed the common law rule to require sellers of residential real estate to disclose material latent defects, that is, those that a reasonable inspection would not disclose. In a sense, this post-closing liability creates a more lasting in personam relationship between sellers and buyers. The tendency is to hold sellers of new homes to a higher standard than other sellers, with many courts consciously adopting a products liability theory that would allow even subsequent purchasers to sue the builder.¹ Like the implied warranty of habitability we saw in landlord-tenant law (see Chapter 6), the warranty of quality in the sale of new homes is a consumer protection measure. Probably even more so than the implied warranty of habitability (IWH), it is aimed at asymmetric information in the contracting process, because in most (but not all) jurisdictions, it can be disclaimed by the seller or waived by the purchaser. Consistent with the notice-giving rationale, such disclaimer or waiver has to be specific and explicit.

Deeds in general have a notice-giving effect. Much of this effect is achieved by recording, to which we turn shortly, but the requirements for a valid deed and a conveyance have also been shaped by the problem of notice. As noted above, the Statute of Frauds requires a description of the land sufficient to identify it. Such descriptions are of two main types. In the eastern United States and in formerly independent Texas, land descriptions use the “metes and bounds” system under which parcels are identified by geographical features or landmarks (for example, stones, and less reliably, trees), lengths and directions, in a description of a trip around the boundary of the parcel (as in “start at the big stone by Lake Lemon and then proceed North 25 Degrees East for 150 rods . . .”). In the rest of the country, a rectangular survey system, which originated with the Land Ordinance of 1785, provides the parameters for identification of interests in land.² This system features six-mile square townships oriented with respect to principal base lines and principal meridians (for example, “the Northwest quarter of the Southwest quarter of Section 29, Township 3 South, Range 4 West, ____ Base and Meridian”). Each township is further divided into 36 one-mile square sections (640 acres) that can be further divided. (Corrections are needed at regular intervals to account for the roughly spherical shape of the Earth.) Two main advantages of the Public Land Survey System are the regular rectangular shape of plots and the ability to locate them from standard starting points. With GPS systems rapidly making their way into surveying, the advantage of the rectangular survey in terms of locating and describing boundaries is probably less than it used to be, but surveying still benefits from regularly shaped, especially rectangular, parcels that come neatly together across much of the country.

Surveys and land descriptions are but a part of the information of which purchasers and others need notice. The conveyancing process itself is also designed to furnish some notice. In feudal times the transfer of a freehold interest had to be accompanied by “livery of seisin,” which could take the form of a transfer of a clod of earth, a twig, or a set of keys. These days a conveyance by deed must include delivery of the deed. Delivery provides some assurance that the transfer has occurred, which is of great importance to anyone who wants to know who the current owner is. So when A grants to B, A must transfer a deed to B’s control. Borderline cases become interesting, as where A puts a deed in a place where B will find it after A’s death, as a substitute for a will devising the land to B. If the location is under B’s control, and A cannot easily get the deed back, it is probably a delivery. Conditional deliveries can receive very different treatment in different jurisdictions because two policies come into conflict. As we saw with gifts causa mortis (see Chapter 4), courts do not look with favor on parties’ attempts to evade the formal requirements for wills, which give an assurance of the testator’s intent and a lack of coercion, and so on. However, it is well known that probate is cumbersome, and the well-advised can avoid it by using trusts. So A’s delivery of a deed to a trusted person with conditional instructions for delivery (e.g., after the grantor’s death) might be regarded as a “poor man’s trust,” and if so, giving effect to the deed makes sense.

Title Records

The most elaborate notice-giving devices of modern times are the systems of title records. The most widespread title records are for property in land. Because land is fixed in location, valuable, and used for secured lending, it has lent itself to systematic record keeping, in America since Colonial times. Some types of personal property such as cars, boats, airplanes, lost artwork, and some intellectual property also have registries. But most personal property is not registered except in connection with its use as collateral for security interests (see below).

Land records in the United States are highly decentralized. Although the rectangular survey is national, and titles to much private land trace back to a grant from the federal government, title records are typically kept at the county level. Most land in the United States is covered by recording systems or recordation, in which records relating to title (deeds, mortgages, etc.) are filed in an office, and indexed by grantor and grantee. (A few jurisdictions also have tract indexes in which all the documents relating to a given parcel are referenced.) The other major type of system is registration, in which land records are typically arranged by parcel, and the land office inspects each document to be filed and guarantees the validity of titles. The Torrens system and the systems of many civil law countries exemplify registration, which has a higher start-up cost and requires better trained personnel (the more so the more definitive the title documents are meant to be).

Registration provides a more definitive answer to ownership questions than does recordation. Registration avoids more errors, and those errors that do occur are insured through registrar liability with compensation funded through registration fees. In recording systems, this insurance function is provided by private companies, which typically maintain their own version of the title records (called “title plants”). Title insurance provides a level of assurance that probably is sufficiently effective to make a shift from recordation to title registration not worthwhile once a system of recordation is established. However, countries setting up land records for the first time, as in former communist countries, tend to opt for registration, whether out of its advantages in terms of accuracy or its association with civil law, especially of the German type.

In a recording system, there is no certification of title by public authorities. The only function of the public records office is as a repository of records, organized by indexes. It is the responsibility of prospective buyers and lenders (and their attorneys) to examine these records and figure out for themselves whether the seller is offering a sufficiently good title. The central concepts in conducting these examinations are the title search and the chain of title. A title search involves going backward in the grantee index to find the links in the chain of title (for example, C received from B who received from A). This is less than half the story, however. The real worry is that any one of the people in the sequence might have done something untoward such as convey the same land twice. So one must go back down the grantor index to find out what these people have done. The most thorough conceivable search would involve figuring out what each person in the chain of title might have done at any time. This would be costly and largely pointless. Instead, buyers are only responsible for knowing what each link in the chain did from the time that link received a deed until the time the next person recorded. Why is that? Because in certain circumstances, persons who fail to record may lose their interest in the property to persons who acquire interests later in time.

How is it possible for C to receive good title from A when A had already conveyed the land away to B? In a world of no title records, the answer would be that C could not. The foundational principle of property transfer is nemo dat quod non habet (“one cannot give what one does not have”), and as we saw in Chapter 5, a grantor is presumed to give all that the grantor has unless specified otherwise. That is, the transferee steps into the transferor’s shoes except to the extent that a lesser interest is being carved out for transfer. If the shoes are already on some other transferee’s feet (metaphorically speaking in all cases except for shoes), then A has nothing left to transfer. The effect is like first-in-time. If A transfers to B and then to C, there was something to transfer to B the first time but not to C the second. (If A purports to transfer to B property A does not have and then later acquires it, B can sue to force a transfer to B under the equitable doctrine of estoppel by deed.)

Recording acts are superimposed on the basic nemo dat regime. Thus, if a recording act does not apply, nemo dat does. The main effect of a recording act is to cause someone—typically a later transferee—to win who would otherwise lose under nemo dat. There are three types of recording acts. The earliest type, which is still found in North Carolina, is the race statute, under which the first claimant to record wins. Thus if A sells to B, and then A sells to C, but C records before B, C has better title than B. (If B had recorded immediately, the recording act would not change the result from nemo dat, that B beats C.) What can B do? B can sue A, if A can be found and is not judgment-proof.

Courts were none too pleased when people in the situation of C, the later transferee, took the deed knowing of the earlier conveyance. For C to win under such circumstances seemed unfair, and there could be many reasons why losing the property might seem a disproportionate punishment for B’s lack of timely recording. So courts began to make exceptions, which culminated in notice statutes under which nemo dat is only overridden in favor of subsequent good faith purchasers for value (GFPVs). A purchaser for value is someone who gives consideration for the property. Thus, a person taking by gift or inheritance would not be able to take advantage of the statute. Someone is in good faith if they have no notice, actual or constructive, of a prior inconsistent interest. Thus in our example, if C pays consideration and has no notice of the prior A-to-B transaction, then C will win. If C had actual notice of the deed to B, even if it is unrecorded, C cannot benefit from the statute. More importantly, a properly recorded deed furnishes constructive notice of B’s interest, thereby preventing C from being a GFPV. (Constructive notice can be record notice as here, or inquiry notice, i.e., knowledge of a fact that would put a reasonable person upon an inquiry that would result in actual notice. For example, seeing a ditch with running water on the land would put someone on inquiry notice to find out about an easement for the ditch.) As in the case of the race statute, B can protect B’s interests by recording as quickly as possible, which will prevent C from winning under the notice statute, because the recording provides constructive notice.

Some states, especially those of the mid-Atlantic and the old Northwest, have adopted race-notice statutes, under which a GFPV must win both the race to record and be without notice of the earlier transaction. Thus in our example, if A sells to B, and then A sells to C, who has no notice, and after that B records before C, nemo dat would still apply in favor of B. Why? Because although C would win under the “notice” prong of the test, C fails to win under the “race” prong because B recorded first. Of course as always, C can sue A, if that is feasible. Again, a transferee’s best bet, besides doing a title search, is to record as soon as possible. That way, the deed will be in subsequent purchasers’ chain of title and will furnish record notice to them.

The purpose of the recording acts in limiting the rights of owners vis-à-vis GFPVs is ultimately to make property more alienable. Prospective purchasers, who will be the new true owners, will be discouraged if they cannot be assured at reasonable cost that their grantor’s title is good. In general it is advantageous to owners that prospective purchasers have such assurance.

The recording acts also make a major exception to promote the alienability of property by someone who has won under the act. Consider the situation under a notice statute, in which A sells to B, and then B sells to C, who was without notice, and then D purchases from C knowing of the A -to- B transaction. Should D beat B? Taken literally, because D had notice of the A -to- B transaction, D is not a GFPV and so would not prevail under the act against B. But D’s grantor, C, who did not have notice, would beat B. The idea of the so-called shelter rule is that D should be able to shelter under C’s rights: Once C wins under the recording act, C can then transfer these rights to anyone without the transferee losing the protection of the act. So D wins against B by virtue of C’s rights. The shelter rule protects D by letting D step into C’s shoes. Otherwise C would have a hard time finding a buyer. (There is one exception to the shelter rule: If C transfers to A, the original grantor, then A cannot take advantage of the shelter rule, because a C -to- A transfer carries with it a danger of collusion. And discouraging someone like C from selling to someone like A does not diminish C’s potential market much).

In thinking about the chain of title, it is worthwhile to take the perspective of one searching the title records. Although it is true that adverse possession and some liens may not appear on the land records, the chain of title is meant to limit the search that grantees are responsible for. Consistent with this purpose, a deed needs to be not only recorded but also linked up with the rest of the chain of title. Consider the situation in which A sells to B who does not record, B then sells to C who records, and then A sells to D. What happens under any of the types of statutes (assuming there is no tract index)? If D uses the grantee index to work backwards, D will find A, but working forward in the grantor index, D has no way to find C, because the intermediate link through B is absent. As far as the records are concerned, B is a “stranger to the title.” Again, D is not required to search the entire land records, which would be prohibitively expensive. Instead C is not counted as having recorded until Cs deed is linked up to A’s through a recorded chain. Otherwise C s deed is termed a wild deed, and does not count as recorded vis-à-vis D. (Relativity applies, though, meaning that C s deed is recorded for purposes of anyone claiming under C such as C s successors in interest.) Again, the goal of the recordation system is to furnish cost-effective notice, even though, as we will see, problems do remain.

For personal property the exception to nemo dat in favor of GFPVs generally comes in through the Uniform Commercial Code (UCC) as enacted in all the states except Louisiana (which is a civil law jurisdiction). For example, if an owner entrusts a chattel to someone who deals in goods of that kind—for example, leaving a watch at a watch shop in a bailment for repair—a person purchasing the watch from the shop in the ordinary course of business will obtain good title even as against the original bailor-owner.³ This is probably a situation where the owner clearly can do more to avoid the problem than the subsequent good faith purchaser—the owner picked the bailee. But in many scenarios, deciding between innocent owners and GFPVs is very difficult in terms of comparative fault. By and large, U.S. law (of the various states) favors original owners more than does civil law or even English law, which tend to be relatively more solicitous of good faith purchasers. In U.S. jurisdictions, someone, even a GFPV, purchasing from a thief will lose to the original owner, unless enough time has passed, and the other requirements for adverse possession have been met.

Otherwise the UCC provides for limited circumstances in which a good faith purchaser for value can acquire title when the transferor has what is called “voidable title.” ⁴ Suppose S sells a watch to P, who in turn sells to G. If P obtained the watch from S by fraud or using a check that bounces, P has a title that is voidable, because S can bring an action to have the transaction undone. (By contrast, “void” title is invalid for all purposes, without any need for one side to act to set it aside.) Under these circumstances, if P sells to G before S finds out about the defect in the S-to-P transaction, and G purchases from P in good faith (without notice of the problem) and for consideration, G obtains good title even against S.⁵ Of course, S can go after P, if possible. G must qualify as a GFPV in order to win; otherwise S beats G. Thus, if G had notice of the bad check, or if G did not pay consideration, G would not keep the watch. Sometimes a very low price in the subsequent (here, P -to- G) transaction can be evidence of bad faith on G’s part. In these voidable title situations of fraud and the like, it is harder to say in general who is more at fault: G and S are both innocent parties, but P (who is truly at fault) is typically not available, so one of them must bear the loss. Conceivably the loss could be split between the two, but this option is almost never used. Rather than try to allocate the loss based on fault or even a fifty-fifty split, the property-like all-or-nothing approach is used instead. Here clarity and predictability are usually at a premium.

Whether transactors qualify as GFPVs is largely governed by statutes such as the recording acts or the UCC. Occasionally, equitable principles fill in interstices left by these fairly comprehensive systems. Courts sometimes hold the original owner responsible for negligence for succumbing to a fraud, as where a fraudster tricks the owner into signing documents that turn out to be a deed.⁶ Some courts will allow a subsequent GFPV to prove that the original owner was negligent so as to estop the owner from denying the GFPV’s title. If the owner’s negligence led to justified reliance on the part of the GFPV, they hold that it would be unfair for the original owner to prevail against the GFPV. In economic terms, the original owner in such situations was the cheapest cost avoider—as determined on a relatively individualized basis. The application of estoppel here operates as a more fine-grained balancing of relative fault between the original owner and the GFPV and allows the GFPV to win even though the deed was a void one. This ex post approach is reminiscent of the equitable exceptions that courts first made to the original race-type recording acts. What the division of labor should be between hard-and-fast rules with ex ante clarity and ex post standards couched in terms of individualized justice runs throughout property law and beyond.

Not everything relevant to title is reflected in the land records. Some types of liens, such as “mechanic’s liens” for tradespeople who have worked on a building, and tax liens, might qualify the title without having to be recorded. And problems such as the incapacity of the grantor might invalidate the title, without any sign on the face of the records.

Adverse possession, which we encountered in Chapter 2, can also affect title without appearing in the record chain of title. If A acquires title by adverse possession against O and does not record, and then O sells the land to P who records, who owns the land? Even if P does a thorough search of the land records, A’s interest will not appear. Although it might seem that the policy of the recording acts should require that P win in such a case, nevertheless courts hold that A wins by adverse possession. P is required to protect P’s interest against adverse possession by inspecting the land itself, in a form of inquiry notice. If someone with no apparent connection to the prospective grantor is occupying the land, the would-be purchaser must inquire further to find out whether the occupier has a claim based on adverse possession. If the statute of limitations has run, there can be no valid sale by the record owner. If the statute has not yet run, the record owner must remove the adverse possessor to provide marketable title: Remember that no one is expected to purchase a lawsuit. (Similar considerations of inquiry notice apply to easements by prescription, which we will take up in Chapter 8.)

Adverse possession also occurs in boundary disputes, which can cause special headaches for purchasers. Suppose A fences in a strip of B’s land and meets all the requirements for adverse possession (open and notorious, adverse, etc.) for the requisite period. Years go by, and the fence disintegrates. B then sells the land to C. As in our previous example, C is expected to inspect the land, but the fence is not there, so C has no way of knowing about the loss of the land to A. Nevertheless, adverse possession is robust enough that A still wins in such a situation, even though the idea of inquiry notice here is far-fetched.⁷ The law shows great solicitude that title by adverse possession is as valid as any other title, and successful adverse possessors like other owners are not required to mark their boundaries. One possible solution would be to require adverse possessors to record their interests. But notice that the only adverse possessors likely to do so would be those in bad faith (and those who have recently discovered the adverse possession). Depending on the purpose of adverse possession, this could be quite perverse.

Another method of preventing ancient history from being relevant in title disputes and searches is to cause them to be beyond the chain of title. Marketable title acts make unenforceable those interests that have not been recorded (or re-recorded) within a given time period working back from the present, typically the last forty years. This has the effect of eliminating constructive notice of any inconsistent unrecorded claims more than forty years old, so the old claims are eliminated by a transfer to a GFPV. And as noted earlier, title insurance is used to cover certain risks of defects in the title. These usually do not include adverse possession, which despite the fence example above, is usually best discovered by the purchaser inspecting the land.

Whether the problems of notice and the state of title are solved with bright line rules or vague standards or some combination of the two, it is important to remember that they raise the issue of relativity of title we saw in Chapter 2. Property rights are distinctively in rem, but questions of ownership are often presented in litigation between two identified parties. Such litigation can have what amounts to an in rem effect, however. If a GFPV or an adverse possessor (AP) “beats” the record owner, the GFPV or AP has title good against the world. But note that this does not mean that the original owner has nothing: The owner’s title still trumps everyone else’s. By the same token, relativity of title tells us that in the situation in which owner A is defrauded of real or personal property by B, who “sells” to C, and estoppel or the UCC tells us that C beats A, A still has better title than B, which leaves A with a claim for damages against B. Even when quiet title actions are brought to remove known clouds on title or resolve known problems (e.g., adverse possession), these actions, although in theory in rem, tend to involve identified competing claimants. Only in registration systems does a registrar give conclusive title against all claims both known and unknown. For this reason the registrar can be thought of as standing in for the (in rem) public and correspondingly, registration countries (notably but not exclusively those following the German system) tend to have a strict numerus clausus (Chapter 5). Registrars can pronounce on title more easily if they need not incur the information costs of figuring out how idiosyncratic interests fit into the array of interests relating to the land in question.⁸

Mortgages

Another device closely related to land transfer and records, and in which equity has played a major role, is the mortgage, as well as security interests more generally. Mortgages on real estate are familiar examples of security interests. A security interest is a conditional property right in an asset that secures the payment of a debt. The mortgage is evidenced by a document separate from the promissory note or the debt contract. The security interest gives its holder the right to seize the asset in the event of nonpayment of the debt, as well as the right to be paid ahead of other junior creditors, which is very relevant in bankruptcy. The filing of a bankruptcy stays proceedings to seize an asset but maintains the security interest holder’s seniority. Whether inside or outside bankruptcy, priority means that secured creditors are to be paid before general creditors, who are to be paid before equity holders (shareholders in a corporation, the landowner in the case of a real estate mortgage). Various secured creditors are paid in the order of their priority, which is usually first-in-time according to when their interest was perfected. Mostly perfection is effected by recording or filing, but some security interests can receive their priority through possession or other special rules. (Note that all these devices for perfection, whether it be recording, filing, or taking possession, have a notice effect.) A house worth $200,000 might be subject to a first mortgage of $100,000 and a second mortgage of $50,000. The homeowner then has equity of $50,000. (As we will see, this term derives from the “equity of redemption,” which is the right of the owner to save the property by paying off the debt.) Suppose the value of the house declines to $130,000, and the owner defaults. The holder of the first mortgage is paid in full ($100,000), the holder of the second mortgage gets $30,000, and there is no equity. If the loan is a recourse loan, the second mortgage holder might be able to get a deficiency judgment against the borrower for $20,000. If the loan is nonrecourse, the borrower is not personally liable.

Why would a lender and borrower agree on a security interest? The borrower can get a lower interest rate if the debt is secured, because the lender runs less risk of not getting its money back. Of course the interest rate on other debt incurred by the borrower should adjust upward, because the borrower will have fewer assets available to satisfy other debts. Sophisticated lenders dealing with borrowers will ask to inspect the borrower’s books and put covenants against pledging borrower assets into their loan agreements. But in the case of tort creditors and other small creditors, no upward adjustment in rates may happen. Some have theorized that secured debt is thus problematic, because it harms tort creditors and other nonadjusting creditors, but there is scant empirical evidence that this is a major problem.⁹ (To some extent, the problem is handled by mandatory insurance requirements in certain industries, such as taxi cabs.) Others argue that secured debt allows for specialization in monitoring the activities of the borrower, who as an equity holder prefers risk more than is optimal overall. (As residual claimants, equity holders get all the upside after fixed claims are paid but suffer no losses beyond their investment.) Where security interests fit into the overall picture of financing both descriptively and normatively is still an active area of inquiry.

We saw in Chapter 4 how security interests in personal property are governed by the UCC and leave a large scope to self-help by the holder of the security interest in the event of nonpayment. Mortgagees (the holders of real estate security interests) are not allowed to use self-help against defaulting mortgagors (borrowers giving mortgages). Instead they must go through an elaborate process of foreclosing on the mortgage. Traditionally, in a strict foreclosure the lender-mortgagee would go into equity court to set a time limit on the mortgagor’s exercise of the equity of redemption, thereafter “foreclosing” that possibility forever and leaving the property with the mortgagee. In almost all states the strict foreclosure has been replaced with judicial foreclosure, in which the mortgagee files an action seeking a foreclosure sale. These days the procedures for judicial foreclosures and foreclosure sales are governed by statute. At any time during the process, the debtor has the right to pay the debt and keep the property. States vary also in whether the lender-mortgagee can seek a deficiency judgment where the proceeds from the foreclosure sale are insufficient to cover an outstanding recourse debt. The foreclosure sale is not necessarily the end of the story. In roughly half the states, the borrower-mortgagor has a time period (up to two years) to exercise a statutory right of redemption by paying the price paid by the purchaser at the foreclosure sale. Over time, there has been some oscillation in terms of how much extra leniency to provide for defaulting borrower-mortgagors. Some see a tendency for legislatures to favor bright line rules, which are then muddied up by courts, whereas others have argued that the system is relatively stable except in periods of widespread financial distress during which both courts and legislatures try to rescue borrowers who are in trouble.

A judicial foreclosure sale is administered by a court, but some states allow parties to include a provision for a private foreclosure sale in the mortgage. As with judicial foreclosure sales, there is a concern that the price the property fetches in such sales will be on the low side (often the lender-mortgagee is the only bidder), and in a private foreclosure sale courts must also scrutinize the procedure adopted by the mortgagee administering the sale.¹⁰ Often it makes sense for a defaulting borrower-mortgagor if possible to sell the property him or herself and use the proceeds to pay the lender.

The equity of redemption and the more recent statutory right of redemption act like call options held by the mortgagor, that is, the right but not the obligation to purchase the property for the outstanding debt (in the case of the equity of redemption) or the foreclosure sale price (in the statutory right of redemption). Because the borrower-mortgagor retains this stick in the bundle of rights, one can expect the price a bidder would pay to be correspondingly depressed. Although this is clearly a benefit to a defaulting borrower ex post, whether this helps borrowers (or which ones at the expense of which others) ex ante depends on the adjustment in interest rates and any cross-subsidies involved. In a nonrecourse debt, the borrower-mortgagor has the opposite type of option. Because the borrower is not on the hook beyond the value of the security, the borrower in effect has a put option whose exercise price is the outstanding amount of the debt. Thus in our example above, if the property is worth only $125,000, the nonrecourse borrower has the right to force a sale (like the exercise of a put option) to the lender for the value of the loan, here $150,000.

Lenders have used other mortgage-like devices, sometimes to get around the procedural requirements of a foreclosure. A deed of trust is structured like a transfer of ownership of the land to the lender-mortgagee who holds the land in trust for the mortgagor until the debt is paid. As option theory would indicate, this is an equivalent structure to the regular mortgage lien in which the mortgagor is considered the owner. From a legal point of view, the equivalence has led courts to treat deeds of trust the same as mortgages, including providing for procedural safeguards and the right of survivorship (see the discussion of severance in Chapter 5). Another method, which was originally designed to give the lender maximum protection, is the installment sales contract, in which the lender retains ownership until all the payments (over time) are made. In the old days, the lender could retain the land even if the buyer defaulted after paying almost all the purchase price. Equity courts, not surprisingly, intervened to allow late payment or restitution of amounts paid when a forfeiture appeared unfairly excessive or unfair. (Courts often point to the maxim that “equity abhors a forfeiture.”) The same equitable tradition is at work here as with the penalty doctrine in contract law, according to which liquidated damages clauses providing for damages greatly in excess of actual damages will not be enforced unless they are a reasonable ex ante forecast of damages. Given the general policy of freedom of contract, a flat ban on penalties has long been treated as a puzzle in need of explanation. Although it is true that high liquidated damages in the general contractual context can be used to deter entry into an industry (reducing competition and increasing market power), it is doubtful that installment sales contracts may be used for such purposes. Perhaps, as with the related (and again equitable) unconscionability doctrine, courts use the antiforfeiture reasoning in cases in which some other type of hard-to-prove over-reaching or opportunistic behavior has infected the deal. By their nature, these considerations are difficult to tease out of appellate opinions. These days, installment sales contracts and other similar devices are often treated as mortgages, with the full redemption rights that mortgagors enjoy.

The tendency to treat other mortgage-like devices as mortgage liens, with all that that entails, can be regarded as yet another instance of the numerus clausus at work. Rather than let parties create new and possibly idiosyncratic variants on security interests, the law mandates a standard package of rights, duties, and procedures for this special property interest. In a particularly dramatic recent example, the Federal Communications Commission (FCC) tried to achieve the effect of a security interest by cancelling a broadband personal communications service (PCS) license for failure to pay after a spectrum auction. The U.S. Supreme Court held that under the Bankruptcy Code, the FCC could not do this without actually taking a security interest, which it had failed to do.¹¹

Finally, it is worth recalling that mortgages on land go a long way toward explaining the continued importance of land to property law. Although it is true that personal property and intellectual property are increasingly important, and land is less central to advanced economies than in the formative years of the estate system, land is a convenient security for loans, often for loans that have little to do with real estate. Think of a chip manufacturer giving a mortgage in its land and factory, or a publishing house mortgaging its headquarters. Because land is valuable, long-lasting, and stationary, it is easy to document and to lend against—two considerations that are tightly connected. Indeed in emerging economies there is a school of thought that giving informal occupiers formal title to land, which they can then use as collateral on impersonal markets, is the way to unlock the economic potential of land and the enterprises that land-based financing could foster.¹²

SEVEN

Land Transactions and Title Records

Land Sale Contracts

Title Records

Mortgages

Further Reading