DAVID J. WILLIS ATTORNEY
Copyright © 2019. All rights reserved worldwide.
WHOLESALING IN TEXAS
Still a Wild West Business
By David J. Willis, J.D., LL.M.
Both the legislature and TREC have moved in recent years toward greater regulation of the business of wholesaling. Wholesaling, for those who do not know, is an investor practice of getting a property under contract and then selling that contract to another investor who, after closing, usually does rehab work with the intention of selling the property at a profit, all within a short-term timeframe (usually a year or less). Several statutes now work together to impose a sort of "truth in advertising" disclosure requirement upon those engaged in wholesaling.
Occupations Code §1101.002.(A) - Definitions
Do you need a real estate broker's license to engage in wholesaling? Chapter 1101 of the Occupations Code answers this question with a definite maybe. As is the case with most statutes, the first part of the law defines relevant terms, including in this case a definition of what constitutes real estate brokerage in the wholesaling context. Chapter 1101 states that a real estate broker "means a person who, in exchange for a commission or other valuable consideration or with the expectation of receiving a commission or other valuable consideration, performs for another person one of the following acts . . . deals in options on real estate, including buying, selling, or offering to buy or sell options on real estate. . . ." Since many earnest money contracts (depending on the stage they are in) can be considered a kind of option to buy real estate, if one is buying or selling such contracts (i.e., wholesaling), and if these contracts are offered and advertised as interests in real estate, then a broker's license is required.
Occupations Code §1101.0045 - Equitable Interests in Real Property
Again, the Occupations Code focuses on licensing. This section offers a loophole for wholesalers who are working without a broker's license, but only so long as they make express disclosure that what they are selling is merely an "equitable" interest, which generally means an interest that is less tangible, less certain, and more contingent than a solid and present fee simple ownership interest. The statute reads: "(a) A person may acquire an option or an interest in a contract to purchase real property and then sell or offer to sell the option or assign or offer to assign the contract without holding a license issued under this chapter if the person: (1) does not use the option or contract to purchase to engage in real estate brokerage; and (2) discloses the nature of the equitable interest to any potential buyer. (b) A person selling or offering to sell an option or assigning or offering to assign an interest in a contract to purchase real property without disclosing the nature of that interest to a potential buyer is engaging in real estate brokerage."
Section 1101.0045 wants wholesalers to make it clear to buyers of contracts that what is being offered is not the realty itself, but only contract rights to acquire the property in the future (This is what is meant by an "equitable interest."). Accordingly, wholesalers who assign contracts are not illegally acting as brokers if they fully disclose the nature of the interest they are selling.
22 Texas Administrative Code §535.6 - Equitable Interests in Real Property
The TAC contains TREC rules applicable to real estate license holders. Section 535.6 states that a "person may acquire an option or enter into a contract to purchase real property and then sell or offer to sell the option or assign or offer to assign the interest in the contract without having a real estate license if the person: does not use the option or contract to purchase to engage in real estate brokerage; and discloses the nature of their equitable interest to any potential buyer. A person selling or offering to sell an option or assigning or offering to assign an interest in a contract to purchase real property without disclosing the nature of that interest to a potential buyer is engaging in real estate brokerage. A license holder who is engaging in real estate brokerage by selling or buying or offering to sell or buy an option or assigning or offering to assign an interest in a contract to purchase real property must disclose to any potential seller or buyer that the principal is selling or buying an option or assigning an interest in a contract and does not have legal title to the real property. A license holder acting on his or her own behalf or in a capacity described by §535.144(a) who is selling an option or assigning an interest in a contract to purchase real property must disclose to any potential buyer that the license holder is selling an option or assigning an interest in a contract and that the license holder does not have legal title to the real property."
This section of the Administrative Code echoes a theme found elsewhere in the TREC rules: a license holder should disclose, disclose, disclose.
Property Code §5.086 - Equitable Interest Disclosure
Mirroring the Occupations Code and Administrative Code, section 5.086 of the Property Code provides: "Before entering into a contract, a person selling an option or assigning an interest in a contract to purchase real property must disclose to any potential buyer that the person is selling only an option or assigning an interest in a contract and that the person does not have legal title to the real property."
Unlike the Occupations Code or the TAC, the Property Code is not focused on real estate license holders or the requirement of a broker's license. The Property Code applies to everyone, licensed or not.
So even if one could argue that the Occupations Code and the Administrative Code do not apply because one is not a license holder, the Property Code makes it clear that a seller/assignor must still make the required disclosure. Looked at another way: wholesaling without the disclosure gets an investor in double-trouble, both for a violation of the Property Code and for brokering real estate without a license. Note also that the license requirement of Occupations Code sec.1101.002.(A) refers to "dealing" in contracts (selling or buying), while Property Code sec. 5.086 appears to only apply to persons selling a contract interest. So does an investor/buyer of a contract need to worry about whether or not the disclosure is present in the document assigning the contract? The prudent and safer answer is yes.
Content of Required Disclosure
Our suggestion would be to include the following wording at or near the top of the instrument that assigns the earnest money contract:
EQUITABLE INTEREST DISCLOSURE PURSUANT TO TEXAS PROPERTY CODE SEC. 5.086: THIS INSTRUMENT REPRESENTS ONLY AN OPTION OR ASSIGNMENT OF AN INTEREST IN REAL PROPERTY. IT IS NOT A TRANSFER OF TITLE. ASSIGNOR DOES NOT HAVE LEGAL TITLE TO THE PROPERTY. CONSULT AN ATTORNEY PRIOR TO EXECUTION IF YOU DO NOT UNDERSTAND THIS DISCLOSURE.
A buyer of an earnest money contract should want the assignment instrument to be recorded in the real property records. Why? As insurance that the contract will not later be sold by an unscrupulous seller to someone else. So the equitable interest disclosure would probably best be inserted just beneath the notice of confidentiality rights that is required by Texas county clerks to be present on filed documents:
NOTICE OF CONFIDENTIALITY RIGHTS: IF YOU ARE A NATURAL PERSON, YOU MAY REMOVE OR STRIKE ANY OR ALL OF THE FOLLOWING INFORMATION FROM ANY INSTRUMENT THAT TRANSFERS AN INTEREST IN REAL PROPERTY BEFORE IT IS FILED FOR RECORD IN THE PUBLIC RECORDS: YOUR SOCIAL SECURITY NUMBER OR YOUR DRIVER'S LICENSE NUMBER.
Assignability of the Contract
It should go without saying that the contract in question should expressly state that it is assignable. This is a suggested way to list the buyer in paragraph 1 of the TREC contract: "Action LLC and/or its assigns without Seller consent." Of course, a careful lawyer would prefer a more comprehensive clause such as "It is expressly agreed that this contract may be assigned at any time by Buyer before closing without prior notice to or consent by Seller. The effect of any such assignment will be to immediately, entirely, and unconditionally relieve any person signing as Buyer of any further obligations under the Contract. Seller unconditionally agrees to accept the assignee as Buyer and timely close without objection according to the terms of this Contract." But the available line is just too short for this (unless a special provisions addendum is being used).
The Assignment Instrument
Transfer of an earnest money contract should be accomplished by means of a "Sale and Assignment of Earnest Money Contract" which shares many of the same features as the note transfer instrument described in our web article Buying and Selling Real Estate Notes. The principal difference is that earnest money contracts, unlike notes, are not negotiable instruments subject to the Uniform Commercial Code.
Characteristics shared by these two types of assignments are: (1) the necessity for thorough due diligence by the prospective assignee, which in the case of an assignment of earnest money contract requires not only an examination of the contract terms but also the underlying realty; (2) the general preference on the part of the assignor to make the transfer "as is," to the greatest extent possible; (3) the issue of representations and warranties and, if they are included, the extent to which they may be limited; (4) the period during representations and warranties will survive, if at all; and (5) the requirement that the assignor disclose any material issues, facts, or conditions (pending or threatened) that could reasonably influence the decision of the assignee to buy or not buy the interest being assigned.
Express Consent from the Owner of the Property
It is important - vital, in fact - for the assignee/buyer of an earnest money contract to be sure that the owner of the property consents to the assignment and will honor his or her status as the new buyer. This can be overlooked, and the buyer of the earnest money contract may wind up facing a hostile seller who refuses to accept the assignee as the legitimate buyer and refuses to close. Sellers in typical fix-and-flip contracts are not sophisticated in the real estate business and cannot automatically be counted on to go along with the sale of the contract on "their home" without their consent, even if the contract expressly states that it is assignable by the buyer. After all, the assignee of a fix-and-flip contract does not want to be put in the position of being forced to sue the seller for specific performance - an expensive event that could easily destroy the profitability of purchasing the contract in the first place. Accordingly, the sale and assignment document should include consent wording along the following lines: "I/We, the undersigned, am/are listed as the seller in the Contract which is the subject of this Sale and Assignment. I/We give my/our unconditional consent to the sale and assignment of the Contract to the above-named Assignee, and agree to in all respects henceforth recognize Assignee as the rightful buyer under the Contract to purchase the Property. My/Our consent is effective on the Effective Date of the Sale and Assignment."
The addition of Property Code sec. 5.086 requiring an equitable interest disclosure is the beginning of a regulatory scheme for wholesaling. Abuses and mishaps in this area will make the news from time to time, so it is likely that future Texas legislatures will build on 5.086 and expand it, just as occurred in the case of executory contracts. The pressure for regulation may also increase as cases inevitably appear seeking to bring wholesaling within the reach of the Deceptive Trade Practices Act.
Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is retained and expressly retained in writing to do so.
Copyright © 2019 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.