Preforeclosure Problems for the Licensee Acting as a Principal

Arizona has moved through the short sale era. The Arizona real estate investors are once again finding distressed properties, many facing foreclosure, that present attractive investment potential. These opportunities present great potential to those individuals with the skill and knowledge to locate such distressed and foreclosure properties, as well as an understanding of what it takes to close these nontraditional transactions. However, as many real estate investors who are also real estate licensees know, the pre-foreclosure transaction can present unique risks.

In today’s pre-foreclosure transaction, the licensee, acting as an investor, approaches the homeowner either prior to or during the pendency of the trustee sale and negotiates a purchase of the property that allows the homeowner to avoid foreclosure, and allows the licensee to make a profit for the effort involved.

Regrettably, a pre-foreclosure transaction has many characteristics that differ from a traditional real estate transaction. First, the transaction does not fit nicely into the AAR documents so commonly used today. Moreover, the timing of the transaction and the goals of the homeowner are often radically different from a traditional home sale transaction. Finally, the very nature of the pre-foreclosure transaction will often result in both the homeowner being unrepresented by either an attorney or a real estate broker, and dealing with a real estate licensee who is acting as a principal. These are all ingredients for a disaster.

Avoiding Inadvertent Agency

A common problem with a real estate licensee engaging in pre-foreclosure purchases made on behalf of the real estate licensee is the inadvertent creation of an agency relationship with seller of the real property who is facing foreclosure. Arizona law is very permissive in the creation of an agency relationship. An agency relationship can be formed merely by the words or conduct of the parties. A written contract is not required to establish an agency relationship. The mere fact that a real estate licensee is purchasing property on their own behalf, or on behalf of an entity in which they have an interest, does not necessarily mean that the licensee is not also representing the seller. Any real estate licensee may be rendered a dual agent if the licensee conducts himself or herself in such a way, either intentionally or unintentionally, as to be deemed an agent of the buyer.

This problem is compounded in the pre-foreclosure transaction because the only real estate licensee in the transaction is usually the one acting as the principal. Because the Department of Real Estate may suspend or revoke the real estate license of one who represents more than one party in a transaction “without the knowledge or consent of all parties,” caution must be taken. For the licensee’s protection, all conduct during a pre-foreclosure purchase transaction must be conducted with the express purpose of avoiding the inadvertent agency relationship. A well-written agency disclosure form, such as the form available through the Arizona Association of REALTORS, should be used. However, the mere existence of a disclosure form is not conclusive proof that an agency relationship does not exist.

Agency Arising From Written Solicitations

The agency issue is further complicated by the common business practice in the pre-foreclosure industry for individuals engaged in pre-foreclosure home purchases is to send out written solicitations to homeowners facing foreclosure. These solicitations will often contain offers by the licensee to help the homeowner and will request that the home owner contact the soliciting individual or company. Often, the real estate licensee will list the same information used to obtain a listing in this promotional material creating the mistaken belief in the recipient that they will have the same relationship with the licensee as the licensee’s other clients. This is a problem.

While these solicitations are a source of potential liability and can prove to be the document that actually creates the agency relationship, when properly drafted, they can also be used to provide the initial level of protection a licensee needs against an inadvertent agency relationship. Care should be taken to avoid language that appears that the licensee is seeking to represent the homeowner. Indeed, an express disclosure that the licensee is acting as a principal or investor is recommended.

Close Through Escrow

It is advised that the licensee close all pre-foreclosure transactions through escrow. There are several protections afforded the licensee when the transaction is closed through escrow. First, the licensee is able to obtain buyer’s title insurance. Pre-foreclosure deals often occur fast and furiously. Many times, the homeowner facing foreclosure does not being to seek assistance until days before the trustee sale. It is not uncommon for the homeowner to call prospective investors on the weekend before the sale. The homeowner will then be tempted to sell the home several times on one day to every prospective purchaser who comes to the door with a hand full of cash and blank quit claim deed. The Monday morning rush to the county recorder’s office then dictates who is the real owner of the property. Obtaining title insurance prevents the licensee as buyer from being burned by the homeowner who may have been selling his home to every prospective purchaser who has come to the door with a hand full of cash and blank quit claim deed.

Perhaps an even greater protection by closing through escrow is the benefit and security that can be obtained when a planned set of escrow instructions are used in the transaction. Often, the pre-foreclosure transaction occurs so rapidly that there is not time to obtain a proper purchase contract. A properly drafted set of escrow instructions should address the following issues:

Any necessary adjustments to the sales price based upon the amount necessary to cure the default.
Disclosure of licensee status.
Disclosure of financial interests in the transaction.
Disclosure of agency status.
Any indemnity and exculpatory language desired by the buyer.
Terms of any new rental agreement or purchase options that survive the closing.
Integration clause addressing any outstanding side agreements.
Disclosure of transaction terms and express acknowledgement the transaction is not a loan transaction.

Careful thought and drafting must go into the documents used in a pre-foreclosure transaction. A real estate licensee acting as a principal in such a transaction must be constantly aware of the issues involved and the potential sources of liability so that they may be avoided. Is it strongly recommended that licensees engaged in the pre-foreclosure industry consult a broker or attorney experienced in such matters so the licensee’s actions can be a source of protection, and not future liability.