Minnesota's Equity-Stripping Statute
By: BRIAN S. MCCOOL
Countless books, articles, and even television infomercials offer advice on investing in distressed real estate. Many claim that residential properties in foreclosure present some of the best investment opportunities among all types of distressed real estate. Owners of residential property in foreclosure often have equity in their homes, yet for one reason or another are unable to save or protect that equity. Investors attempt to capture the equity and prevent it from flowing back to the owner's lender.
In the typical transaction, an investor in a residential property purchases the owner's interest for a fraction of the value of the owner's equity in the home, pays off the owner's debt against the property, and then sells the home to a third party for a handsome gain. This transaction is often a win-win situation for all if the homeowner no longer wishes to live at the property.
This type of transaction is not mutually advantageous, however, if the homeowner wishes to remain in possession. Unscrupulous investors have developed schemes designed to prey on homeowners facing financial trouble. These schemes, commonly known as "equity stripping," aim to convince owners that their homes can be saved, while in reality the home, as well as the owner's equity, will be lost to the investor. In a new law, effective August 1, 2004, the Minnesota Legislature took significant steps to prevent vulnerable owners from becoming victims of such schemes. That legislation contains a series of complex requirements applicable to nearly all transactions involving residential properties in foreclosure.
The new statute applies to transactions that qualify as "foreclosure reconveyances" under Minn. Stat. § 325N.10, subd. 3.
A transaction must contain both of the following components to constitute a "foreclosure reconveyance":
- a transfer of title or creation of a lien by a foreclosed homeowner during a foreclosure proceeding; and
- a subsequent conveyance, or promise of a subsequent conveyance (including an interest in a contract for deed, purchase agreement, option to purchase, or lease), by the purchaser back to the foreclosed homeowner that allows the foreclosed homeowner to possess the real property following completion of the foreclosure proceeding.
Under this two-part test, an investor that purchases a home in foreclosure and does not provide the foreclosed homeowner any continuing rights in the home, whether under a lease or otherwise, will avoid the constraints imposed under Chapter 325N.
If the transaction is a "foreclosure reconveyance," Minn. Stat. § 325N.11 requires that all of the details of the transaction be contained in a written contract signed by the foreclosed homeowner and the purchaser. Minn. Stat. § 325N.12 identifies a list of terms that this written contract must contain, including a recitation of the total amount of consideration to be provided to the foreclosed homeowner and a notice to the foreclosed homeowner that it has five business days to cancel the contract. The statute also requires that a form "Notice of Cancellation" be attached to the foreclosure reconveyance contract. Chapter 325N also creates other substantive requirements that must be satisfied in any transaction that qualifies as a foreclosure reconveyance. For example, before entering into the contract, the purchaser must verify that the foreclosed homeowner has a reasonable ability to pay for the subsequent reconveyance. This will be presumed if: (1) monthly payments for housing expenses (which include principal, interest, rent, utilities, insurance, taxes, and association dues) and (2) monthly principal and interest payments on other personal debt of the homeowner, do not exceed sixty percent of the homeowner's monthly gross income. The purchaser may not rely solely upon a statement of assets, liabilities, and income furnished by the foreclosed homeowner, but instead must conduct independent due diligence.
Finally, if the property is ultimately not conveyed back to the foreclosed homeowner, Minn. Stat. § 325N.17(b)(2) requires the purchaser to pay the foreclosed homeowner, no later than 150 days following the owner's relinquishment of possession of the property, consideration in an amount that is at least eighty-two percent of the fair market value of the property (as determined by a licensed appraiser). This "consideration" includes payments made by the purchaser to satisfy debt or other legal obligations of the foreclosed homeowner. Thus, the statute essentially caps at eighteen percent the amount of equity an investor may "strip" from a residential property in a foreclosure reconveyance transaction.
The new equity-stripping statute also creates a private right of action in favor of the foreclosed homeowner for any violation of its provisions. The foreclosed homeowner may recover exemplary damages and attorneys' fees incurred in prosecuting an action in the event of a violation of the statute by a purchaser. Additionally, a foreclosure purchaser may be prosecuted criminally for certain violations.
Minnesota's new equity-stripping statute creates a regulatory framework that must not be ignored in any transaction involving residential property in foreclosure. While this statute creates additional protections for foreclosed homeowners, it also creates numerous pitfalls for investors in distressed real estate. The intricacies of the legislation, codified in Chapter 325N of the Minnesota Statutes, are beyond the scope of this article. If you are involved in a transaction involving residential property in foreclosure, you should work through the intricacies of this legislation with your attorney.