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Alternative Resolution of Pennsylvania Real Estate Agreement of Sale Disputes: Part One- Residential Agreement Mediation

By: Bradley S. Dornish, Esq.

Sooner or later most real estate investors face a real estate agreement of sale dispute. It is less likely for consumers but always a possibility. There are required non-court processes in both the PA Association of Realtors’ residential agreement of sale form (ASR) and its commercial agreement of sale form (ASC). The procedures are different, in front of different types of authorities, but both types of mandatory alternative dispute resolution have a lot in common, too.

As I write this article, my last mediation representing an investor was just over a week ago and I am presently serving as an arbitrator in the resolution of a dispute under a commercial agreement. This article will examine mediation under the ASR and a second article will discuss arbitration under the ASC.

For residential agreements of sale used for single family homes and up to four unit residential apartment buildings, the process is mediation. Parties to an agreement of sale need to understand what mediation is and is not. Mediation is an opportunity for both parties to the agreement of sale to be heard by an impartial mediator, who hears both sides, typically together in the same room, then works with each, typically one at a time, to try to reach a compromise which both sides can accept, to avoid going to court against each other.

The parties required to participate in the mediation of their disputes over the agreement of sale are the seller and the buyer. Sometimes real estate agents and brokers, home inspectors or others involved in the real estate transaction may agree to participate in the mediation as parties with respect to claims against them but those parties are not bound to go through the mediation process.

The buyer and seller can each make the demand to submit their dispute to mediation and each pays an equal share of the mediator’s fees. If one party requests mediation the other is bound under the agreement of sale to participate. As a practical matter, however, if a party refuses to pay his or her share of the mediator’s fees, the mediation is reported as unsuccessful and the parties are able to proceed to court.

Each party is allowed to be represented by counsel but no party is required to have counsel to participate in the mediation.  Certain local associations of realtors, like the Realtors’ Association of Metropolitan Pittsburgh, have contracts in place to refer mediations which are presented to them to a particular mediator or service. Other associations send their mediation requests to the Pennsylvania Association of Realtors which identifies potential available mediators and provides a list of several to the parties.

One advantage of the mediation process is its relative speed. Once a request is made and a mediator is selected, it often takes only a few weeks to have the face to face, sit down mediation. This contrasts to time delays of many months or even a year to get to court. Despite the required payment of the mediators’ fees by the parties, mediation is often less expensive than filing a court action because even if the parties hire lawyers for the mediation it typically only consumes a couple of hours of attorney time, as opposed to time drafting complaints and answers, going to court for motions, asking and responding to discovery, preparing witnesses and attending trial. These types of activities typically consume ten hours or more, sometimes much more attorney time.

Of course, if either party is not prepared to compromise and reach a settlement through mediation, all the time and costs of mediation are spent already and the case still has to proceed to court. The type of court action which follows a failed mediation depends on the amount of money claimed as damages by the party bringing the action, typically the buyer. Sometimes the seller brings the action if the buyer fails to close, has not liquidated damages and the seller claims to have suffered a loss as a result of buyer’s failure to close.

For actions involving $12,000 or less, the parties can file in Magisterial District Court and get a quick hearing in front of a Magisterial District Judge. While many of these judges are lawyers, many are not and some do not have experience with real estate contracts.

For cases involving up to $50,000 in at least Philadelphia, Montgomery, Bucks and Lehigh Counties, up to $35,000 in Dauphin and Allegheny Counties (among others), and caps as low as $25,000 in some other counties, suits can be filed to be heard in front of three lawyers who practice in the county, who take turns serving as arbitrators and who may or may not have experience in real estate contract matters. When the dispute involves amounts above the arbitration limit for the particular county, such cases go directly to a judge of the county Court of Common Pleas where they are heard either with, or more often without a jury.

Like mediation, the hearings or trials in front of Magisterial District Judges or Arbitrators can be appealed to a trial de novo, or to a brand new trial in front of the Arbitrators from the Magisterial District Judge, or in front of a judge from arbitration. Each of those appeals requires more time and more preparation from attorneys, so the fast, easy result in a smaller case can turn into a long, expensive process in any event.

The potential costs and time consumed by litigation create an incentive for all parties to participate in mediation. Any party who does not understand the potential costs, and those who do not care about the costs and just want to exact punishment on their opponents, do not heed the economic incentive to mediate.

In my experience there are some parties who are by nature more or less likely to successfully mediate. First time homebuyers who confuse seller disclosure claims with a warranty or guarantee, are often made to understand the difference by a mediator. Lawyers and engineers as parties, who often approach mediation as only the first phase in a process, are less likely to reach a settlement by sitting with a mediator.

Consider the parties as well.  Claims against real estate sellers which also involve claims against brokers, agents, inspectors or others may not be able to be mediated effectively if those parties decline to participate.

For parties ready and willing to resolve their disputes quickly and efficiently, mediation remains an extremely effective tool and should not be overlooked.  If you have a dispute over a residential agreement of sale for which the Pennsylvania Association of Realtors ASR form was used, consider the factors above and determine whether you want to pursue mediation.  If you receive notice that mediation has been requested by the other party to such an agreement, be prepared to respond.  In either instance, you should consult with an attorney familiar with the mediation process before you go it alone.

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania.  He can be reached at bdornish@dornish.net.

June 2017

Crowdlending Mortgages for Pennsylvania Real Estate Investment

By Bradley S. Dornish, Esquire

Solicitation of mortgage backed loans for rest estate investment has long been regulated and greatly limited by both Federal and Pennsylvania Securities laws.

Federally, under the Securities Act of 1933, the offer and sale of securities is required to be registered. Under the Securities Exchange Act of 1934, once a registered offering is made, the offeror is subject to ongoing reporting obligations over the life of the investments.  Many exceptions to the requirements of these laws are limited to investors known as “accredited investors,” those with high net worth and investing experience.

Pennsylvania real estate investors seeking private money backed by mortgages to buy and/or renovate Pennsylvania investment properties with funds from Pennsylvania residents, may be able to avoid the imposition of Federal Securities Laws, but Pennsylvania has its own Securities Law, the Pennsylvania Securities Act of 1972.  Under that Act, the offering of securities in Pennsylvania is regulated, subject to very limited exemptions.  Offers to no more than 50 persons over the course of a year which result in sales to no more than 25 investors who meet the Pennsylvania standards for “accredited investors” avoid registration under the Pennsylvania Securities Act, but still must be documented as “limited offerings” with thick, detailed Private Placement Memoranda requiring detailed legal disclosures and accountant prepared financial forecasts.   These costs can be substantial.  The last private placement I was involved in ran over $10,000.00 in legal fees and more than that in accounting fees, taking a year to prepare before the first solicitation could be made.

For these reasons, we have long directed our clients away from raising capital by selling shares or interests in proposed real estate mortgages, unless they are ready to spend tens of thousands of dollars on securities compliance in an effort to raise millions of dollars of real estate financing.  Most investors with purchase and development plans which meet these threshold requirements also have the cash or equity and good credit to finance through bank loans at lower cost and with shorter turnaround times.

Since the emergence of the internet as a primary means of communication and connection between those with needs and those with skills or money, the ways of doing business have changed substantially.

First, crowdsourcing became a means by which those with problems were able to find those with skills and desire to solve those problems without hiring the problem solvers and creating an in-house research and development team.  Much innovation by small business relies, at least in part, on crowdsourcing and major companies have also turned to the crowd to augment their own research and development.

Crowdfunding has taken longer to develop in the United States due to the complex Federal and State Securities Laws described above.   The first crowdfunding activities here were on a non-equity donation basis, where someone with a business dream asked for, and sometimes received, small donations from the crowd, with no expectation of return of capital, interest or equity in the business.  Certainly, this avoided securities problems but meant that there was no investment benefit to those in the crowd who parted with their money.

The Jumpstart Our Business Startups Act, known as the JOBS Act, was enacted in April of 2012 and established a regulatory structure for startups and small businesses, including real estate investors, to raise capital through securities offering using crowdfunding on the internet.

At that time, Title II of the JOBS Act directed the Federal Securities Commission to amend its Rule 506 of Regulation D to permit general solicitation or general advertising in offerings under Rule 506 but still required that all purchasers of the securities had to be accredited investors.

Title III of the JOBS Act added a new Section 4(a)6 {15 U.S.C. 77d(a)(6)} to the Securities Act and that exemption created the greatest opportunity for crowdfunding business investment including mortgage loans on investment real estate.

The Section 4(a)6 crowdfunding exemption has specific requirements and limitations, which include:

  • The amount of capital raised must not exceed one million dollars in a twelve (12) month period.
  • Individual investments in all crowdfunding issuers in a twelve (12) month period are limited to:
  1. the greater of $2,000 or five (5%) percent of annual income or net worth, if the annual income or net worth of the investor is less than $100,000; and,
  2. ten (10%) percent of annual incomed or net worth (not to exceed an amount sold of $100,000), if annual income or net worth of the investor is $100,000 or more.
  • Transactions must be conducted through an intermediary that either is registered as a broker dealer or is registered as a new type of entity called a “funding portal.”

Section 4A of the Securities Act was also part of Title III of the JOBS Act.  That section, 77 U.S.C 77a, requires the issuers of crowdfunding securities and the intermediary broker-dealers or the funding portals who connect those securities to the investors, must provide certain specific information about the investment, the issuer and the intermediary, to the investors, take offer actions and provide notices and information regarding the transactions to the Securities Commission.

Or

Section 4A of the Securities Act was also part of Title III of the JOBS Act.  That section, 77 U.S.C 77a, requires that the issuers of crowdfunding securities and the intermediary broker-dealers or the funding portals who connect those securities to the investors, must provide to the investors certain specific information about the investment, the issuer and the intermediary and must take offer actions and provide notices and information regarding the transactions to the Securities Commission.

After the JOBS Act was enacted in 2012, the Securities and Exchange Commission (SEC) began to develop regulations to implement the new law.   Some provisions on crowdfunding were ambiguous in the law as written and required clarification through regulation before they could be implemented.

In October of 2013, the SEC published proposed new rules for crowdfunding, which generated almost 500 detailed comments from industry groups, state securities regulators, investor organizations, Members of Congress and others.  After consideration of all of those comments, final rules for “Regulation Crowdfunding” were published by the SEC in 2015, and became effective May 16, 2016.   With these rules in place, borrower/issuers, Crowdfunding Portals and lender/investors can now feel comfortable moving forward with compliant crowdlending transactions.

The first clarification offered in Rule 100(a)(1) of Regulation Crowdfunding is a clear limit of one million dollars in the aggregate amount a borrower/issuer can borrow from all crowdlending investor/lenders in a twelve (12) month period.  This limit is on the total amount loaned and does not allow for deduction of the amount of fees and costs the borrower/issuer pays to the funding portal to process and place the loan transaction.  The rule also makes clear that there is a control group test for the aggregation.  This means that you, as a borrower/issuer, cannot increase the amount of money you can borrow by forming one or more additional entities.

Under Regulation Crowdfunding Rule 100(c), an investor/lender is limited to investing the greater of $2,000 or five (5%) percent of the lesser of the investor’s annual income or net worth if either net worth or annual income is less than $100,000. An investor whose net worth and annual income both exceed $100,000 is limited to investing ten (10%) percent of the lesser of annual income or net worth, in any event not to exceed $100,000 across all crowdfunding investments, even if the crowdfunding investor/lender is an “accredited investor”.

The SEC provided the following chart to help explain the rules.

Investor

Annual                        Investor                                                                                               Investment

Income Net Worth Calculation Limit

$     30,000      $   105,000      Greater of $2,000 or 5% of $30,000 ($1,500)                        $    2,000

$   150,000      $     80,000      Greater of $2,000 or 5% of $80,000 ($4,000)                        $    4,000

$   150,000      $   100,000      10% of $100,000                                                        $  10,000

$   200,000      $   900,000      10% of $200,000                                                        $  20,000

$1,200 000      $2,000,000      10% of $1,200,000 (Capped at $100,000)                 $100,000

Next under Rules 100(a)(3) and 300(c), borrower/issuer is limited to using a single portal and its associated platform for each proposed loan.  This is to help assure transparency for the transaction, making it easier to confirm the maximum aggregate borrowing of the borrower/issuer and the maximum permitted investment of each lender/investor.

Regulation Crowdfunding Rule 100(b) excludes from using crowdfunding foreign issuers and investment companies, as well as Exchange Act reporting companies (companies issuing securities listed on securities exchanges like the New York Stock Exchange).  The Rule also prevents those borrower/issuers who are delinquent in providing their annual Regulation Crowdfunding reports to the SEC under Rules 202 and 203(b), from issuing additional offering of securities under this Section.  So, a borrower who wants to continue borrowing up to a million dollars each year under Regulation Crowdfunding has to keep up on all annual required reports or will be shut off from further use of the borrowing process.

The information required to be disclosed when money is sought through Crowdfunding is clear:  Rule 201(a) and (c) requires a borrower/issuer to disclose information about each person having a twenty (20%) percent or greater interest in the borrower/issuer and information about the business experience over the past three (3) years of its officers, directors or others with similar roles.

Rule 201(d) requires disclosure of the business and business plan of the borrower/issuer, but is flexible to allow the scope of those disclosures to match the amount of money sought.

Rule 201(i) requires a description of the use of proceeds sufficient to permit prospective lender/investors to evaluate the investment.  The level of detail is determined based upon particular facts and circumstances, and the rules contemplate that even a range of possible uses of proceeds without a single definitive plan can be the basis for a request for funding under this Regulation.

There are additional disclosure requirements on the identity and compensation of the intermediary or crowdfunding portal, risk factors of the investment, other debt of the borrower/issuer, as well as its other exempt offerings and related party transactions.  Rule 201(y) added a catchall provision for the borrower/issuer to disclose any material information to not make the rest of the information disclosed not misleading in light of the circumstances under which they were made.

Disclosures of the financials of the borrower/issuer are also scaled to the amount of the loan being requested.  For amounts up to $100,000, disclosure of total income, taxable income and total tax on tax returns and financial statements certified by the principal executive officer covering the past two fiscal years are sufficient for offerings more than $100,000 up to $500,000.  Rule 201(t)(2) adds a requirement for accountant reviewed financial statements and for offerings more than $500,000, a one-time use of reviewed financial statements, followed by a general requirement for audited financial statements.

All statements issued are to be prepared in accordance with Generally Accepted Accounting Principles (GAAP).

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania.  He can be reached at bdornish@dornish.net.

February 2017


Investors – HR-5201 is Our Chance to Bring Back the Seller Financing Business

By Bradley S. Dornish

Recently, I attended the National REIA Mid-Year Leadership Conference in Atlanta. While there, I had the opportunity to network with Charles Tassell, National REIA’s Chief Operating Officer and Director of Government Affairs, and with Jeff Watson, who leads the Distressed Property Coalition and is Nations REIA’s representative to the Seller Finance Coalition. (For those who don’t remember, ACRE is the Southwestern Pennsylvania Chapter of National REIA and we contribute over $5,000.00 per year from your ACRE dues to National REIA to support its operations).

The most exciting news to come out of this year’s Mid-Year Conference is that HR-5301 had gotten broad bi-partisan support from liberal and conservative members of Congress, and is not opposed by the National Association of Realtors. This means HR-5301 has a great chance of passing, even in an election year.

So, why should you as a real estate investor care about this? Because not too long ago, buying and renovating single family homes and selling them to consumers with seller financing was an important part of many investors’ businesses, as well as a great way to improve the housing stock in U.S. cities, provide more jobs in the rehab construction industry and provide clean, safe, affordable homes to consumers who wanted to own, not rent.

When the SAFE Act, Dodd-Frank Act became law, investors were limited first, to no more than five, and then to no more than three, seller financed loans to consumers per year. Even more restrictive, the Dodd-Frank regulations imposed the same burdens on investors to verify consumer credit and income from third party sources and properly calculate each consumer’s ability to repay which it imposed on big banks like Bank of America, Wells-Fargo and Chase. And if that weren’t enough, seller financed loans from mom and pop real estate investors were subject to the same voluminous and strict scrutiny of the Consumer Finance Protection Bureau in Washington, D.C.

Over the past few years this led me to advise my client investors to not finance to consumers – PERIOID. You could still buy, renovate and rent properties, and even give tenants the option to buy (with financing they could get from a bank or mortgage lender). But a seller financed mortgage or installment land contract was just too risky for most sellers under these laws. Because of this advice, some gurus even said I was unfriendly to investors, which is ironic since real estate investors are the bulk of my clientele.

In the wake of these onerous laws and regulations, National REIA became the largest member of the Seller Finance Coalition and helped to craft and supported what has now become HR-5301, The Seller Finance Enhancement Act. HR-5301 was introduced in the House in May and is now in review by the House Committee on Financial Services, a standing committee on which Pennsylvania representatives Keith Rothfus and Michael Fitzpatrick sit as members.

What does HR-5301 actually say or do for us if it passes and becomes law? You can read the whole text at Congress.gov, searching under bills, or see the link on our ACRE website. No need to fear, it is not a whole book like Dodd-Frank or Obama Care. It is only four short pages.

The short summary is that it EXEMPTS sellers of real estate who provide seller financing on up to 24 properties, in a 12 month period, to consumer borrowers by mortgage loans or equivalent (i.e. installment land contracts) from the Loan Originator Licensing and Registration requirements of the SAFE Act (12 U.S.C. §5103), and from the debt to income ratio restrictions of the Dodd-Frank Act (15 U.S.C. §1693c (b)(2)(A).

Twenty four seller financed loans per year, including first mortgages, second mortgages and installment land contracts is enough for almost any small real estate investor to get back to improving our cities’ housing stock, providing clean, safe housing for consumers to own, and making some long term interest on these transactions to help secure and stabilize our own financial futures.

Call or email Keith Rothfus today to express your support for HR-5301. (412) 837-1361; rothfus.house.gov.

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania. He can be reached at bdornish@dornish.net.

July 2016

Tax Proration and Payment Tips When Buying and Selling Real Property

By Bradley S. Dornish, Esquire

Last month, I was contacted by a seller who sold his home last August. He had been trying for months to figure out why he paid 2015/2016 school taxes through his tax escrow, paid more 2015/2016 school taxes at closing, and never got his money back. He thought when he came to me that the settlement company (not my settlement company) had cheated him on his tax proration, the division of the tax bill between buyer and seller.

I reviewed his Settlement Sheet from closing, fortunately an old form HUD-1, since the new TRID forms, the closing disclosures, are in separate parts for buyers and sellers, making the review harder, but not impossible. I saw that the settlement company for an August closing had properly asked for the school tax bills from the municipal tax collection agency, which happened to be Jordan Tax Service, and that Jordan in mid- July had reported the new tax bill amount, which it had just received, that the tax was unpaid, and that this remained true until shortly before closing.

The settlement company charged the seller for the full school tax bill on the second page of the HUD, and then had the buyer reimburse the seller for the portion of the tax which applied from the date of closing to June 30th of 2016, being all but about six weeks of the tax, in the section marked items paid by seller in advance. The settlement company sent its check for the full 2015/2016 school taxes, almost $3,500.00, which was received by Jordan Tax Service and deposited to the benefit of the school district, with the reference for the buyer of the property.

However, the seller’s lender had an escrow for taxes, and several days before closing, the escrow agent had sent an electronic funds transfer of the same amount, almost $3,500.00, from the seller’s money held in escrow. Thus, the school taxes had been paid twice for the property for the 2015/2016 school tax year. The school district saw on its records in September, that taxes had been paid twice, and also saw that the new buyer was the record owner of the property. The district issued its check for the overpayment to the buyer, with a letter explaining that the taxes had been overpaid, and the buyer happily cashed the check, and likely spent the money on items for his new home.

It took great cooperation from Jordan Tax and the school district to figure out what happened, and when the buyer understood that the refund he received belonged to the seller, he wrote another check to the school district, which finally issued a refund check to the seller late last month, over six months after closing.

Two buyers of property who closed (through my settlement company) early last July recently called and e-mailed us that they had received notices that their 2015/2016 school taxes were not paid, but they saw the proration on their settlement sheets, so something must not have been paid by the settlement company from closing. I pulled electronic copies of their HUD-1s, and saw exactly what had happened.

The school tax bills for the districts in which they bought property had not yet been determined by the districts or sent out in early July. There were no tax escrows, as one of the buyers paid cash, and the other bought with a loan which did not require a real estate tax escrow. We properly estimated the seller’s portion of unpaid school tax based on the prior year’s taxes for that property, charged each of the sellers and credited each of the buyers for a few days of school tax for the period from July 1 to the date of closing. We also had each buyer sign a form provided by the title company for which we are agents, which indicated that the tax bills hadn’t come out, the seller had been charged a prorated share of school tax for the new tax period based on the last year’s bill, and that the proration amount collected from the seller was final even if the tax bill went up.

Since two people in similar situations must not have understood the form they signed about taxes at closing, I rewrote the form to make it clearer.

I can explain in more depth in this article: When the tax bill isn’t out for school taxes in July or even into August, or for municipal and/or county real estate taxes in January or even February, the settlement company can only use its best approximation of the tax bill for the new tax year in prorating taxes, which is the bill for the prior year. If the new tax bill is not yet out, we can’t pay the bill, so we charge the seller his or her portion based on the prior year, and credit that amount to the buyer. That means the buyer will owe the whole tax bill for the new tax year when the bill comes out, and should be looking for a bill to pay if the money is not in escrow. Most municipal and county tax bills come out and are due sometime in the first quarter, as are Pittsburgh, Philadelphia and Scranton school tax bills.

If you have no escrow, and you don’t get a bill after you buy the property, ask for it quickly. Nobody else is going to pay your real estate taxes. If the bill goes to someone else after the deed is recorded in your name, and you miss paying the tax on time, most taxing bodies can and will waive penalties and interest, and collect the tax at face value only. Ask them to do that if you are late.

If you have an escrow set up when you buy a property, and the tax bills have not been finalized and sent out by the time you close, know that the escrow has been set up based on an estimated tax bill. When the escrow company gets the actual tax bill, if it went up from the prior year, they will pay the bill and it will result in a shortage in your escrow account. Usually, banks only analyze the escrow account once each year, so by the time the bank figures out you are short, you will owe the difference for both the present year and the next year. That means if your escrow account is short $120.00 for this year, your escrow payment will go up for a year by $20.00 each month, $10.00 for the current year shortage, and $10.00 to be sure the same problem isn’t happening with your escrow for the next year.

When you sell a property and you have an escrow account for taxes, make sure you know what tax bills are due around the time you are closing, and make sure the escrow agent for your lender is not in the process of paying the same taxes the settlement company is collecting from you at closing. You should get a copy of your payoff letter to see if the escrow balance is being subtracted from the payoff, or being reimbursed to you by the lender after closing. Typically, if it being reimbursed, you should get your reimbursement check within 30 to 45 days after closing.

When you sell a property on which you don’t have an escrow account for taxes, don’t pay tax bills after the date you have a signed agreement of sale by mail. Of course you should pay those bills as they are due, at discount if you can, but PAY THEM IN PERSON at the tax collector’s office, and get a paid receipt which you can provide to the settlement company before closing. This avoids the settlement company collecting for a tax you know you paid, but the tax collector has not processed before closing.

The author, Bradley S. Dornish is a licensed attorney, title insurance agent and real estate instructor in Pennsylvania. He can be reached at bdornish@dornish.net.

April 2016

In Act 167 PROA Sees Another Victory for Landlords Dealing with Abandoned Tenant Property

By Bradley S. Dornish, Esq.

Since the passage of Act 129 in the summer of 2012, landlords in Pennsylvania have had far more direction from PA law on how to handle personal property left behind by tenants who have vacated their rental units than was ever previously available. Our state organization, the Pennsylvania Residential Owners’ Association, (PROA) worked for many years to get that key piece of legislation drafted, through the legislative process, and to see Act 129 become law. Click here to read more »