Land Contract or Residential Lease?

If you’re as old as I am, you might remember the television commercial in which twin sisters argued about the nature of Certs.  One said, “Certs is a candy mint,” iStock-947147792-300x200and her sister countered, “Certs is a breath mint.”  A booming male voice over said, “Stop. You’re both right. Certs is a candy mint and a breath mint. Certs is two, two, two mints in one.”*

In Rainbow Realty Group, Inc. v. Carter, the Indiana Supreme Court  encountered a real estate transaction in which one litigant said, “It’s a land contract,” and the other countered, “It’s a rental agreement.” Unlike the twins in the Certs commercial, only one was right.

Rainbow was a property manager for a trust that owned multiple houses for sale or rent in Marion County, Indiana. It offered four different types of transactions to its customers.  The first three were fairly standard:

  • A straightforward sale in which title to property is granted in exchange for immediate payment of the full purchase price.
  • A land contract in which the total purchase price is paid in a large down payment followed by monthly payments, with legal title transferred upon payment in full. Although the buyer in a land contract does not receive a deed until all the payments are made, the buyer receives equitable title from the beginning, affording protections for a defaulting buyer much like the protections afforded home buyers who have a mortgage. If a buyer defaults, the seller cannot simply take possession of the property, with the buyer losing all the payments already made. Instead, the seller must foreclose, sell the property, and pay to the buyer any proceeds from the sale in excess of the unpaid balance of the purchase price.
  • A straightforward rental in which a tenant leases a house from the landlord in exchange for monthly rent. In contrast to a straight sale or a land contract, Landlords of residential properties have certain obligation to tenants that cannot be waived, including the obligation to deliver the property in “clean, safe, and habitable condition.” Ind. Code § 32‑31‑8‑5.  Another distinction is that a landlord has remedies unavailable to the seller under a land contract.  If a tenant defaults, the landlord can evict the tenant, keep all the rent payments the tenant has made, and possibly collect other damages.

Rainbow also offered a more complicated transaction called a “rent-to-buy” contract that is at the center of this case. Rainbow offered rent-to-buy contracts for houses that were in such poor condition that they were uninhabitable. The house in this case was missing toilets, wiring, plumbing, and door locks. All the windows were broken, and there was nothing to keep someone from breaking in. Animals had been living in the house, and the carpets could not be salvaged.

Rainbow’s rent-to-buy contract was an unusual transaction, with terms unlike a typical purchase agreement, a typical lease, or a typical land contract. Unlike a rental agreement, its purported intent was to consummate the sale of property. Unlike a purchase agreement, title was not transferred to the buyer immediately but only after the buyer paid the purchase price in a series of monthly installment payments. In this case, the purchase price was amortized over thirty years at an annual interest rate of 16.3%, with the buyers to make 360 monthly payments of $549 each.

A rent-to-buy contract also differed from a land contract in that the purchaser had no equitable title for the first two years. If the buyer were to default before making the first twenty-four payments, the seller could evict the buyer, receive possession of the property, and retain all payments the buyer had made. It is apparent that the rent-to-buy contract was an attempt to provide the seller with a landlord’s right to eviction, at least during the first two years, while avoiding a landlord’s statutory obligations with respect to the condition of the property.

When the buyers in Rainbow failed to make all of the first twenty-four monthly payments, the seller sought to evict the buyers, to take possession of the property, to retain all payments the buyers had made, and to collect damages. The buyers counterclaimed, alleging a violation of a residential landlord’s statutory obligation to provide a dwelling unit in clean, safe, habitable condition.

Rainbow’s position was that the rent-to-buy agreement was a land contract and thus excluded from the statute governing residential leases. Ind. Code § 32‑31‑2.9-4(2). To support its position, Rainbow pointed to the form and language of the agreement itself, including acknowledgements by the buyers that they were buying the property, not renting it. However, that language was inconsistent with the substantive terms of the contract that, during the first two years, reserved to the seller the same rights of eviction and possession that a landlord would have under a rental agreement.

Thus, the Court was confronted with a mismatch between form and substance. The Court could have concluded that the contract was a land contract and (presumably) that the seller’s right to take possession from a defaulting buyer and retain the payments already made was unenforceable. Or the Court could have concluded that the grant of a right of eviction to the seller, inconsistent with a land contract, made the contract a lease despite its express language to the contrary.

The Supreme Court chose substance over form and held that the rent-to-buy agreement was a rental agreement for a dwelling unit, at least during the first two years when the seller could evict the buyer. The seller cannot have its cake and eat it, too. It must either satisfy the statutory obligations of a landlord, or it must accept foreclosure, rather than eviction, as its remedy against a defaulting buyer.

After concluding the rent-to-buy agreement was a residential lease and not a land contract, the Court went on to consider whether the seller had violated the Indiana Deceptive Consumer Sales Act, Ind. Code ch. 24‑5‑0.5.  More about that in a few days.

*You get extra credit if you remember the Saturday Night Live spoof of the Certs commercial in which Chevy Chase settled an argument between Gilda Radner and Dan Aykroyd by saying, “You’re both right.  It’s a floor wax and a dessert topping.”

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