Arizona is reported to have one of the highest foreclosure rates in the nation. As a result, many REALTORS® are involved in the sale of properties that are owned by lenders. The vast majority of foreclosures in Arizona occur through a trustee’s sale. If the lender is the highest bidder at the trustee’s sale, the lender takes the title and becomes the owner of the property. When listed for sale, these properties are referred to as “foreclosures,” “bank owned,” “lender owned,” or “REO” (real estate owned) properties. For more information on the foreclosure process, go to www.aaronline.com/documents/AzPropForeclosure.aspx.
When the lender enters into a contract to sell the REO properties, the lender is generally treated like any other seller from a legal perspective. However, transactions involving the sale of lender-owned properties involve numerous unique considerations.
Liability and Insurance Issues with REO Listings
Because of the potential liability, every broker should have errors and omissions (“E&O”) insurance and consider general liability insurance. E&O insurance generally covers the amount a broker is legally required to pay as damages for a loss that results from performing specific real estate duties, which are specified in the policy. Most E&O policies have deductibles and limits of coverage for each wrongful act and for each policy year. E&O policies also have exclusions.
Some REO listing agreements require the listing broker to perform duties, such as inspections, maintenance, and repair of the premises. These activities may be considered property management by the insurance company. Therefore, confirm that the E&O policy will cover any claims that arise from these activities. Some listing agreements also require the broker to indemnify the lender, which may not be covered under the E&O policy. Therefore, read the terms of the listing agreement, understand the duties the lender expects to be performed on the listed property and discuss these issues with your broker and insurance representative.
REO Properties Are Often Sold “As Is”
If the lender directs that the property is sold “as is,” we use to use the AAR “As Is” Addendum. That addendum does not exist anymore. The Residential Purchase contract states that the buyer and seller agree the premises is being sold in its present physical condition as of the date of contract acceptance. This does not mean that the buyer can not ask for repairs, of course, they are able to, however, the seller is not obligated to make those repairs.
Many lenders require additional addenda to be included in any contract for an REO property. These addenda may contain many provisions that change the standard terms of the AAR Residential Resale Purchase Contract. For example, the addenda may contain terms that:
- alter the inspection period in the AAR Contract
- alter the seller warranties in the AAR Contract
- alter the financing provisions in the AAR Contract
- impose monetary penalties for the buyer’s failure to close escrow on the agreed upon date
- contain mold and other environmental disclaimers
- limit the seller’s liability
Again, it is imperative that the buyer and brokers involved in the transaction thoroughly review and understand all the provisions in the REO addenda before agreeing to the terms.
REO Disclosure Obligations
A seller, including a lender-seller, has a legal obligation to disclose all known defects to a buyer. Of course, it is unlikely that a lender-seller is aware of all of the property’s defects. Therefore, most lender-sellers will not provide an AAR Seller’s Property Disclosure Statement (SPDS).
If the lender indicates that an SPDS will not be provided, a buyer’s broker should nonetheless advise the buyer to request the SPDS in the offer. The seller can respond with a counter-offer that an SPDS will not be provided. However, before the buyer agrees to waive the SPDS, the buyer’s broker should provide the buyer with a blank copy of the SPDS form, which will enable the buyer to make an informed decision regarding whether to waive the SPDS. In these circumstances, a buyer’s broker would be wise to obtain the buyer’s written acknowledgment of receipt of the blank form. The buyer can and should utilize a blank SPDS as a checklist in conducting the desired inspections and investigations. The SPDS can prompt questions that will assist the buyer in evaluating the property.
Federal lead-based paint law (42 USCS §4852d) and the subsequent rules and regulations require that before a buyer is obligated under any contract to purchase a home constructed prior to 1978, the seller must make certain lead-based paint disclosures to the buyer. “Foreclosure transactions” are exempt from the lead-based paint disclosure requirements. The law defines “foreclosure” as: “any of the various methods, statutory or otherwise, known in different jurisdictions, of enforcing payment of a debt, by the taking and selling of real property.” See, 24 CFR §35.86; 61 FR 9064 at Section IV(A).
A seller, including a lender-seller, has a legal obligation to disclose all known?
In other words, a trustee at a foreclosure sale who is enforcing the terms of a deed of trust is not considered a seller and is therefore not required to make the lead-based paint disclosures. However, when the lender becomes the owner at the trustee’s sale, the lender is required to comply with the lead-based paint disclosure law when they sell the REO. Thus, the lead-based paint disclosure exemption applies to the trustee’s sale, but not to the sale of the REO acquired through foreclosure.
A seller of five or fewer parcels of land in an unincorporated area of a county, other than subdivided land, is required to furnish a written affidavit of disclosure to the buyer at least seven days before the transfer of the property. A.R.S. §33-422. The only exemptions to this requirement are a trustee of a deed of trust who is selling a property by a trustee’s sale, or any officer who is selling a property by execution sale to enforce a judgment or to foreclose a mortgage.
Therefore, again, when selling an REO after foreclosure in an unincorporated area of the county that is not in a subdivision, the lender-seller must provide the buyer with an Affidavit of Disclosure. The Affidavit must be recorded at the close of escrow.
Subdivision Public Report Requirements
The Department of Real Estate has taken the position that when a lender forecloses on the sixth property (or forecloses on six or more properties) in a subdivision, the lender is a subdivider and must obtain a Public Report before offering the properties for sale. The Department adopted Substantive Policy Statement No. 2008.02 (SPS) in an effort to create expediency in these cases. This SPS is available Here. Brokers working with REOs should consider alerting the lender of this requirement in writing.
Septic and Other On-site Wastewater Disposal System Requirements
Any on-site wastewater treatment facility (conventional septic tank or an alternative system) must be inspected within six months prior to a transfer in ownership. Within 15 days after the date of an ownership change, the buyer is responsible for submitting the Notice of Transfer form to the applicable governmental agency. The only exemption in the Rule is that the inspection is not required if the facility was not put into service before the property transfer. A.A.C. R18-9-A316(E).
The Arizona Department of Environmental Quality (ADEQ) has indicated that when a lender forecloses a property with an on-site wastewater system, ADEQ does not consider this act a “property transfer” between a “buyer” and a “seller” and the inspection is not required. However, when the lender sells the REO property, the parties must comply with the Rule. Therefore, when the REO is listed for sale after the foreclosure, the lender is required to obtain a septic inspection and the buyer is required to file a Notice of Transfer form at the close of escrow.
Additional REO Information
The AAR Legal Affairs podcasts have additional information on the issues related to REO transactions at www.aaronline.com/PodCast/Default.aspx. AAR also offers several webinars addressing this issue at www.aaronline.com/Webinars/Recorded.aspx. Other REO and foreclosure-related information is available at www.aaronline.com/law-ethics/risk-management/foreclosures-reos-liens.aspx.