@Shiloh Lundahl
Re Wrap AITDs and alienation clauses - due on sale in California
Due-on hazards
A lender holding a trust deed that contains a due-on clause can call the loan balance due on the transfer of almost any interest in the property. The due-on clause is called an alienation clause, and the call is referred to as an acceleration of the note balance.
The due-on clause is triggered by:
any conveyance of ownership, including land sales contracts;
origination (except home equity loans) or foreclosure of junior trust deeds on the property; or
the creation of a lease for more than three years, or any lease with an option to buy. [12 Code of Federal Regulations §591.2(b)]
The carryback AITD transaction, of course, involves both a sale (the grant deed) and a further encumbrance (the trust deed).
Thus, an AITD transaction triggers the due-on clause in any underlying trust deed, allowing the lender to:
call or recast the loan unless written consent to the sale has been given; or
fail to act on the right to call after notice of the transaction, called a waiver.
Thus, when current market interest rates are high and the AITD is most beneficial to both the buyer and the seller, a senior trust deed lender is likely to call the underlying loan due on the sale. Alternatively, the lender might demand the loan be recast at current market rates, including modified payments to retain the same amortization period and fees for doing so, or the lender may do nothing at all.
Now consider an AITD buyer who (obviously) takes title subject to the underlying loan. The buyer does not assume the seller’s obligation to pay the loan at the time of sale. No lender consent to the carryback sale is sought or obtained by the seller.
Under the terms of the AITD, the seller agrees to hold the buyer harmless from all obligations which exist on the underlying loan. [See first tuesday Forms 442 and 443]
Thus, the buyer is held harmless (by the seller) against any activities of the underlying lender, unless:
the buyer interferes by triggering the due-on clause through further encumbrance, long-term lease, resale, waste, etc; or
a pass-through provision shifts the due-on-sale burden to the buyer, as with late charges, prepayment penalties or future advances.
The seller’s primary duty is to make all the payments due on the underlying loan, as long as the AITD remains of record and the buyer is not in default.
If the buyer fails to make payments on the AITD note, the seller is under no legal obligation to forward his own funds to the underlying lender, or to protect the property from a foreclosure by the first trust deed lender.
Even without the obligation to keep the first trust deed current, the AITD seller may feel compelled by the buyer’s default to advance funds to keep the underlying trust deed current, or else risk the alternative and allow his trust deed to be wiped out by the underlying lender’s foreclosure.
Should the underlying lender call the loan based on the AITD transaction, the seller may be forced to use his own funds or borrow against other assets (or collateralize the AITD) to pay off the lender. Thus, the buyer must agree in advance to cooperate with the seller should the first trust deed be called due and it becomes necessary to refinance the real estate to fund a payoff of the first trust deed.
If possible, prior arrangements should be made with senior lenders to prevent due-on enforcement during the term of the AITD, sometimes called a reverse assumption.
