Lesson. When determining whether a real estate agreement is a lease or a land sale contract, follow the money.
Legal issue. Whether an agreement was a lease (subject to an eviction remedy) or a land sale contract.
Vital facts. Elra, as the owner, and Vic’s, as either the purchaser or the tenant, executed a “Lease Agreement” for a building and 3+ acres of real estate. Vic’s agreed to pay $1,265.30/month for twenty years with an option to purchase the property for $1.00 at the end. The opinion details the terms and conditions of the agreement. The language of the contract controlled the outcome – not testimony or any other documents. Of paramount importance were “the economics of the transaction.”
Procedural history. About a year after the signing of the agreement, Elra filed an eviction action against Vic’s based, not on a payment default, but on other breaches related to the maintenance and condition of the property. The trial court ruled in Elra’s favor and ordered Vic’s to vacate the property. Vic’s appealed.
Key rules. In Indiana, “the transaction's purported form and assigned label do not control its legal status.” Therefore, “to determine whether the agreement is a lease or a land sale contract, [Indiana courts] look beneath the surface of the agreement and … consider the substance of the agreement to determine the intent of the parties.”
“'In effect,' a land sale contract is 'a sale with a security interest in the form of legal title reserved by the vendor' and that the 'retention of the title by the vendor [owner] is the same as reserving a lien or mortgage.' In other words, in a land sale contract, the vendor retains legal title to the real estate until the vendee pays the total contract price. And … a land sale contract is ‘in the nature of a secured transaction.’”
The Court also looked to the UCC for help in making its decision as “essentially the same rules which distinguish a lease from a sale under the UCC apply….”
Holding. The Indiana Court of Appeals reversed the trial court and concluded that the agreement was a land contract, which could not give rise to an eviction.
Policy/rationale. The Vic’s opinion is excellent in terms of how the Court relies upon and analyzes the financial aspects of the deal. Vic’s is a valuable resource for parties or counsel on the origination side of such deals and on the back-end enforcement of them. Although the facts are dense, there is a road map within the case about how to create a land contract or how to create a lease with an option to buy so as to avoid land contract status—depending upon your objectives. This case, together with the Indiana Supreme Court’s decision in Rainbow Realty (link to my 8/22/20 post here), have really helped define this area of Indiana law over the last couple years.
The Court’s comments below capture the essence of its overall rationale, which zeroed in on the “economics” of the deal:
In addition, in order to exercise its $1.00 “option to purchase,” Vic's must first have paid a sum equal to 240 monthly payments of $1,265.30, or a total of $303,671.63, which is $103,671.63 more than the purchase price. Elra has failed to account for this additional payment. A simple calculation confirms that this amount represents interest on the $200,000 purchase price.
Amortization is the payment of a debt with interest over time. The agreement provides for the amortization of $200,000 in principal payable in 240 monthly payments of exactly $1,265.30. Solving for the interest rate yields a rate of 4.5%. This amortization is the Rosetta Stone that unpacks and reveals the nature of the agreement. All four of these factors—the principal amount, the number of monthly payments, the amount of each monthly payment, and the interest rate—are integral to the amortization schedule, and each factor depends upon the others.
Interest represents the time value of money. While contract purchasers pay interest on the unpaid principal balance of a land sale contract, lessees do not pay interest on future rent payments. Here, the four factors comprising the amortization show that the monthly payments were not “rent payments” but contract payments of principal and interest on a fully amortized land sale contract.
The Court concluded that, although the contract “contains terms that are consistent with a lease, it is clear from the economics of the transaction that from the outset the parties intended for Vic's to acquire the option property. Accordingly, we can say with confidence that the agreement … is a land sale contract.”
Note: I regret that the opinion in Vic’s did not address the remedy available to Vic’s: foreclosure vs. forfeiture. The Court was on a roll, and the remedy aspect of land contract cases can be just as complicated as determining whether the agreement is or is not a land contract to begin with. Alas, that issue was not ripe for a ruling, and the early termination of the contract weighed heavily in favor of forfeiture anyway.
- REAL ESTATE FINANCING TIDBITS: Consistency In Both the Form and Substance Of An Indiana Land Contract Is Essential To Post-Breach Enforcement
- Indiana Land Contracts and Forfeiture
Part of my practice involves handling real estate and loan-related disputes. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at firstname.lastname@example.org. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.