An installment contract (also called a land contract or articles of agreement for warranty deed or contract for deed) is an agreement between a real estate seller and buyer, under which the buyer agrees to pay to the seller the purchase price plus interest in installments over a set period of time. Upon execution of the contract the buyer immediately takes possession, but the seller retains legal title to the property until the buyer pays the full purchase price. The seller delivers the deed to the buyer once the final payment is made. Installment contracts are an alternative to traditional mortgage financing and can benefit both the seller and buyer in a real estate transaction. This article is an overview of how installment contracts are created, what interest the parties to an installment contract hold, and how such contracts can be terminated.
What Is an Installment Contract?
An installment contract is an alternative to traditional mortgage financing. Under an installment contract, the buyer gets possession of the property and makes installment payments of the purchase price over an extended period of time to the seller, who conveys legal title to property once the purchase price is fully paid. 735 ILCS 5/15-1214; See also Shay v Penrose, 25 Ill 2d 447, 185 NE2d 218 (1962).
While the installment contract is a security device, it lacks many of the formalities and buyer protections included in mortgage laws. The majority of installment contracts include a forfeiture clause, which allows a seller, upon buyer's default, to end the contract, regain possession of the property, and keep all payments made by buyer. Compared to mortgage foreclosure, the seller can recover the property more quickly because he or she is not required to sell the property, observe notice and redemption rights, or file a court case. However, for a court to enforce forfeiture of an installment contract, the right of forfeiture must be expressly provided for in the contract. Hettermann v Weingart, 120 Ill App 3d 683, 689, 458 NE2d 616, 620, 76 Ill Dec 216, 220 (2nd D 1983). Also, when drafting the contract, a seller should be sure to include a time-is-of-essence clause. To prevent waiver of the clause, the seller should not accept late payments from the buyer. Kirkpatrick v Petreikis, 44 Ill App 3d 575, 577, 358 NE2d 679, 680, 3 Ill Dec 281, 282 (3rd D 1976).
An installment contract offers a buyer less protection than a traditional mortgage. This is true mainly because of forfeiture provisions, which give the buyer no right of redemption and allow a buyer to lose all interest in the property for even the slightest breach. Because of the possibility of inequitable results, courts generally look negatively upon forfeiture clauses, Id, and they will be strictly and narrowly construed. Bocchetta v McCourt, 115 Ill App 3d 297, 300, 450 NE2d 907, 909, 71 Ill Dec 219, 221 (1st D 1983). Therefore, the "party seeking to enforce the forfeiture has the burden of proving that the right to forfeiture clearly and unequivocally exists and that no injustice will result in its exercise." Id.
Fewer formalities and greater flexibility create advantages for both the seller and buyer to an installment contract. One benefit for a seller is the tax advantage of receiving installment payments over an extended period of time. See 26 USC § 453. Additionally, under an installment contract when a buyer defaults, a seller may not always bound by mortgage foreclosure laws but instead can recover possession more quickly and at less expense. Therefore, sellers under an installment contract may be more willing to sell to buyers who do not meet the qualifications of traditional lenders. Buyers also like installment contracts because under such agreements they generally pay a lower down payment and have lower closing costs.
How do Installment Contracts Work?
The interests of a seller and a buyer under an installment contract are determined by the doctrine of equitable conversion. "[E]quitable conversion is the treating of land as personalty and personalty as land under certain circumstances." Shay, 25 Ill 2d at 449, 185 NE2d at 219. The buyer holds equitable title once the contract is executed. The seller holds the legal title in trust for the buyer and the buyer holds the purchase money in trust for the seller. Once the contract is satisfied, the seller gives the buyer a deed, which vests legal title in the buyer from the date the contract was signed.
Equitable conversion gives the contract buyer a real property interest from the date the contract is signed. "[T]he buyer under a real estate installment contract is the owner for real estate tax purposes." Farmers State Bank v Neese, 281 Ill App 3d 98, 102, 665 NE2d 534, 536, 216 Ill Dec 474, 476 (4th D 1996). Over the duration of the contract, liens may attach to the equitable title of the buyer and the buyer may assign his or her equitable interest to a lending institution as security for a loan. See First Illinois National Bank v Hans, 143 Ill App 3d 1033, 1037, 493 NE2d 1171,1173, 98 Ill Dec 150, 152 (2nd D 1986).
Over the duration of the contract, liens may also be imposed upon the seller's interest in the property. For the buyer's protection, the installment contract should require the seller to convey marketable title at the completion of the contract. To ensure completion of the contract upon the death of the seller, the deed should be held in escrow for the duration of the contract. Unless there is a fixed time for delivery of a deed in the contract, the seller does not have to provide merchantable title to a buyer until the last payment is made. Tolbird v Howard, 101 Ill App 2d 236, 248, 242 NE2d 468, 474 (4th D 1968), rev'd on other grounds 43 Ill 2d 357, 253 NE2d 444 (1969).
Illinois law recognizes the doctrine of equitable conversion, except where the contract stipulates that no interest shall pass until the contract is satisfied. Ruva v Mente, 143 Ill 2d 257, 265, 157 Ill Dec 424, 428, 572 NE2d 888, 892 (1991). However, Indiana still holds that the buyer has equitable title upon execution of the contract, even if there is such a provision in the contract. See Kolley v Harris, 553 NE2d 164 (Ind Ct App 1990).
The buyer takes legal title free of any liens and encumbrances that attached to the seller's interest after the contract was executed, if the contract was recorded or the creditor had actual notice. Under Illinois law "[p]ossession of property is equivalent to the recording of a deed both as to subsequent purchasers and as to judgment creditors who claim interest in land of which another has possession when the judgment was secured." Beals v Cryer, 99 Ill App 3d 842, 844, 426 NE2d 253, 255, 55 Ill Dec 278, 280 (5th D 1981) (citations omitted). But possession must be open, visible, exclusive, and unambiguous in order for such possession to operate as notice of an unrecorded deed. Id. Therefore, recording the contract is the best way to ensure third parties are on notice of the buyer's interest in the property.
Seller Remedies against a Defaulting Buyer
An installment contract may be terminated in a variety of ways. Upon a buyer's default, a seller has available both statutory and common law remedies. Despite the similarities, courts generally do not view installment contracts as functionally equivalent to mortgages, and therefore installment contracts are usually not subject to mortgage laws. Therefore, it is generally easier for a seller to terminate an installment contract and recover possession of the property. When a buyer defaults upon an installment contract, a seller may elect to enforce the contract or to declare the contract at an end.
The seller can seek to enforce a contract in an action for specific performance or an action to recover the unpaid purchase price. However, such actions may not be helpful unless the defaulting buyers have the money necessary to complete the contract. The seller may also seek rescission of the installment contract, where the seller returns the payments made by buyer in exchange for the property and the fair rental value while the buyer was in possession. Rescission attempts to return the parties to the positions they were in prior to execution of the contract.
More common remedies allow the seller to terminate the installment contract upon the buyer's default. The seller must give the buyer a notice of intent to terminate the contract and request that buyer return possession of the premises. Once the buyer returns possession, the seller may need to file a quiet title action to remove the buyer's interest as a cloud on the title of the legal owner. See Dodge v Nieman, 150 Ill App 3d 857, 860, 502 NE2d 393, 395, 104 Ill Dec 130, 132 (1st D 1986); Shelt v Baker, 137 NE 74 (Ind Ct App 1922); and Kallenbach v Lake Publications, Inc, 30 Wis 2d 647, 651, 142 NW2d 212, 215 (1966). However, a seller can bring an action to quiet title only if the seller has possession of the property. Dodge v Nieman, 150 Ill App 3d at 860, 502 NE2d at 395, 104 Ill Dec at 132. If possession is not voluntarily relinquished, the seller may also file an action for ejectment or, in Illinois, an action for forcible entry and detainer. See 735 ILCS 5/9-101 and 5/6-101.
A seller may also declare forfeiture based on the terms of the installment contract. Historically, a forfeiture clause would allow installment sellers to forfeit the contract without notice, regain possession, and keep all money previously paid by the installment buyer. Even if the buyer had substantial equity in the property, it could be lost for even the smallest breach of the installment contract. Recognizing the unfairness of forfeiture clauses, judges and legislators have enacted certain protections for installment buyers. The following are statutory and common law protections for installment buyers established in Illinois, Indiana, and Wisconsin.
Illinois
Illinois Mortgage Foreclosure Law requires foreclosure proceedings to terminate any residential real estate installment contract that was entered into on or after July 1, 1987, and extended over five years or more, when more than 20 percent of the purchase price has been paid by buyer. 735 ILCS 5/15-1106. Foreclosure grants the installment buyer the right of reinstatement (735 ILCS 5/15-1602) and the right of redemption (735 ILCS 5/15-1603). Despite the additional time and expense, foreclosure proceedings cut off all interests of third parties that attached to the property through the buyer.
Installment sellers may still elect to forfeit those installment contracts that fall outside the Illinois Mortgage Foreclosure Law. In order to declare a forfeiture the following conditions must exist: (1) "a valid contract containing a forfeiture clause," and (2) a buyer in actual default. Kirkpatrick, 44 Ill App 3d at 577, 358 at 680, 3 Ill Dec at 282. To exercise the forfeiture option, the seller must make a clear declaration of forfeiture to the buyer. Otherwise the duty to perform under the contract will not be extinguished. Bocchetta, 115 Ill App 3d at 299, 450 NE2d at 909, 71 Ill Dec at 221. Generally, the contract's forfeiture clause will provide the procedure the seller must follow to effectively forfeit the contract. These procedures must be strictly followed in order for a court to uphold forfeiture of the contract. Id. at 300-01, 450 NE2d at 910, 71 Ill Dec at 222.
To pursue a forfeiture, the seller should serve a Notice of Default and Intent to Declare Forfeiture upon the buyer and any lien holders with a lien recorded against the buyer's interest in the property. When the notice period has expired, the seller should deliver a Declaration of Forfeiture to the buyer and any lien holders with a lien recorded against the buyer's interest in the property. A seller should not accept a quitclaim deed from the buyer before the interest of any third parties has been extinguished.
Sellers in Illinois may also bring a forcible entry and detainer action to enforce a forfeiture clause. By statute, courts are given the discretion to stay enforcement of such an action for no more than 60 days from the date of judgment, during which time the buyer may redeem the property. 735 ILCS 5/9-110. When at least 25 percent of the original purchase price is paid, the courts are required to stay enforcement of the judgment for 180 days. Id.
Indiana
There are no statutory limits on the seller's right to forfeiture, but Indiana courts will enforce forfeiture only "under circumstances in which it is found to be consonant with notions of fairness and justice under the law." Skendzel v Marshall, 261 Ind 226, 241, 301 NE2d 641, 650 (1973). There are two situations in which a forfeiture is appropriate in Indiana: (1) where there is an abandoning, absconding vendee; and (2) "where the vendee has paid a minimal amount on the contract at the time of default and seeks to retain possession while the seller is paying taxes, insurance, and other upkeep in order to preserve the premises." Id. at 240-01, 301 NE2d at 650.
Unlike Illinois, Indiana does not define how to determine if there is a "minimal amount" paid on a contract, which would preclude the seller from exercising the right of forfeiture. "Whether a particular sum paid toward a particular contract price is minimal depends upon the totality of the circumstances surrounding the contract and its performance." Johnson v Rutoskey, 472 NE2d 620, 626 (Ind Ct App 1984). While Indiana case law provides some guidelines, there is no set percentage of the contract price to be paid that precludes forfeiture. Where forfeiture is inappropriate the seller may foreclose pursuant to Trial Rule 69 (C), In State Trial P Rule 69(c) and the mortgage foreclosure statute, IC 32-8-16-1 (2000).
Wisconsin
Under Wisconsin law, the majority of sellers elect to pursue the remedy of strict foreclosure. Like forfeiture, the remedy of strict foreclosure allows the seller to regain possession without providing the redemption rights to the defaulting purchaser. City of Milwaukee v Greenberg, 163 Wis 2d 28, 471 NW2d, 33. The remedy of strict foreclosure requires the buyer to pay the full amount of the unpaid contract price within the time set by the court. If the buyer fails to do so, the buyer's rights are terminated and the seller regains equitable title in the property. The court has complete discretion to determine the time in which the buyer may pay off the full purchase price. Westfair Corp v Kuelz, 90 Wis 2d 631, 636, 280 NW2d 364, 367 (Wis Ct App 1989).
Conclusion
At common law, installment contracts provided an alternative to third-party lending, which freed sellers from the complexities of traditional mortgage foreclosure. However, as courts and legislators have limited sellers' rights to forfeiture, the line between installment contracts and mortgages is being erased, and this simple alternative to traditional mortgage financing may no longer be so simple.
