Assignments: Clever Investment Strategy or Malicious Shadow Flipping?

Happy Canada Day!

Podcast Episode 78:
“Contract Assignments.”

The practice of selling one’s interest in a real estate purchase contract—a.k.a. an assignment—has been getting a lot of bad press in BC lately. In fact, the situation there may be changing thanks to government intervention. Contract assignments are a widely used and entirely legal procedure, but the laws governing them vary by location. We’re discussing BC, and then focusing on Alberta here. As always, the principles I explain are widely applicable—as long as you consult your local regulations.

Download the audio file HERE and the text/handout HERE.
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Contract Assignments:
Clever Investment Strategy
or Malicious Shadow Flipping?

 

British Colombians are growing increasingly irate about the misuse of contract assignments, otherwise known as ‘shadow flipping.’ Take a look at the following headlines.

 

Real estate ‘contract assignments’ not illegal, but are they ethical?

Barbara Yaffe: Vancouver Sun Feb.8, 2016

Christy Clark promises an end to shadow flipping in BC real estate

“Pure, naked greed” driving real estate agents to flip a property multiple times, says Clark. New rules will require original seller to give informed consent for multiple sales, profits to go back to seller.

News 1130 Website

Real Estate Council of B.C. fast tracks new measures in light of criticisms

CBC.ca April 1st, 2016

 

 

Infographic from a damning Globe and Mail investigation.

dark-flipping-infographic

 

A lot of attention in BC has focused on realtors who purportedly are not living up to their professional obligations and responsibilities.

Complaints have been heard that enforcement against realtors by the 11 separate Multiple Listing Service boards are lax and confidential. And, further complaints surrounded the perception that the British Columbia Real Estate Association (BCREA) was paying lip service to enforcement, which the BCREA vehemently denied. In fact, they said the Christy Clark government was playing politics with their proposed legislation, not allowing the BCREA to do their job.

The BC Premier has now announced that the real estate industry in that province will no longer be self-regulated, but rather will fall under government oversight (see the Globe & Mail article). Keep reading to find out more about updates to BC law concerning the assignment of real estate contracts that occurred since the audio for this Tale was recorded!

It’s really not fair to blame realtors, as the vast majority are honorable and serve their clients well. In fact, there is some criticism of homeowners who listen to the first person who bangs on their door and offers to buy their home where the homeowner accepts without doing any kind of diligence, let alone due diligence. It’s not like the red hot Vancouver real estate market is a secret! Instead of taking a low price that only seems high relative to what the homeowner paid 25 years ago, a much better course of action would be to, at the very minimum, hire a realtor to provide an up-to-date, professional view of the market and other market possibilities.

And, you have to love those loopholes.

  1. Licensed realtors have professional responsibilities. Unlicensed entrepreneurs do not. These folks, often referred to as ‘wholesalers,’ put up flyers in neighborhoods and knock on doors offering to buy for cash with no conditions and no inspections. Typically they have buyers lined up or realtors who can find buyers.Note: if you are thinking of diving into this market, remember that lenders don’t really like assignments. They seem to think that the first price is the real price and any later assignment that increases the price is really only price inflation. Further, lenders who take this attitude will only finance on the first price. Therefore, for these big-ticket assignments you need buyers who can pay cash or it doesn’t work nearly as well.
  2. If a realtor is buying for his/her own account, then s/he has to reveal that to the seller. But, if the buyer is a corporation where the realtor owns less than 5% of the shares, then s/he doesn’t have to reveal anything.
  3. And, what about that Land Transfer Tax? I wasn’t being levied on these flips in BC, which made them even more attractive.

So, what the heck are assignments, legally speaking? Let’s get some definitions.

An assignment is an agreement that transfers your contractual rights to a third party.

“An assignment (Latin cessio) is a term used with similar meanings in the law of contracts and in the law of real estate. In both instances, it encompasses the transfer of rights held by one party—the assignor—to another party—the assignee[1]. Typically a third-party is involved in a contract with the assignor, and the contract is in effect transferred to the assignee. (From Wikipedia [edited)

“What is ASSIGNMENT?

In contracts. 1. The act by which one person transfers to another, or causes to vest in that other, the whole of the right, interest, or property which he has in any realty…”

From Law Dictionary (By Blacks Law Dictionary 2nd edition, edited)

 

Now for some facts. Following, in italics, is a section from the recently updated Professional Standards Manual of the Real Estate Council of British Columbia:

(xi) Assignments

[05/16/2016 the following section updated]

  1. a) Real Estate Contract Assignments
    A contract assignment occurs when a buyer transfers the contract to buy property to someone else before the completion date. The buyer can transfer the contract for any price, even for a higher price than they paid for the property. The buyer does not have to pay the seller any additional money if they make money from selling the contract.


Real estate contracts are assignable under the law unless the contract expressly forbids it. Section 36 of the Law and Equity Act provides that the seller’s consent to the assignment is not required, provided that notice in writing of the assignment is given to the seller.

  1. b) New Provincial Requirements for Licensees Relating to Real Estate Contract Assignments
    On May 16, 2016, new requirements relating to the assignment of real estate contracts came into force in BC. The amendments to the Real Estate Services Regulation (the “Regulation”) apply in all transactions where a licensee is acting for the seller and/or the prospective buyer of real estate (except where the contract is for the sale of a development unit by a developer, as those terms are defined in section 1 of the
    Real Estate Development Marketing Act). 

    All licensees providing trading services should carefully review the amendments to the Regulation. 

    The amendments provide that a licensee preparing a proposed contract for the purchase and sale of real estate (an “offer”) must include the following terms (the “Standard Assignment Terms”) unless otherwise instructed in writing by the person to whom they are providing trading services:

  1. this contract must not be assigned without the written consent of the seller; and

  2. the seller is entitled to any profit resulting from an assignment of the contract by the buyer or any subsequent assignee.

For those interested in doing contract assignments in BC, I highly recommend going to the original documents to read more!

Now, let’s move over to Alberta.

 

Alberta Land Titles Act
Assignments of Contracts of Sale
Assignment of contract

 

154(1)                        Any contract in writing for the sale and purchase of any land, mortgage or encumbrance is assignable notwithstanding anything to the contrary contained in it, and any assignment of any such contract operates according to its terms to transfer to the assignee mentioned in it all the right, title and interest of the assignor both at law and in equity, subject to the conditions and stipulations contained in the assignment.

 

154(2)                        Nothing in this section affects any rights at law or in equity of the original vendor or owner of the land, mortgage or encumbrance, until notice in writing of the assignment has been either sent to the original vendor or owner by registered mail or served on the original vendor or owner in the way process is usually served…

 

Let’s repeat again the nugget and difference between Alberta and BC.

“Any contract in writing for the sale and purchase of any land, mortgage or encumbrance is assignable notwithstanding anything to the contrary contained in it…”

What this means is that, in Alberta, you don’t have to say a contract is assignable because it is by law. And, no one can contract out of this right as they can in BC. This is similar to Residential Tenancy Act (RTA) legislation that says your security deposit can’t be more than one month’s rent or that you have to give a certain amount of notice. It doesn’t matter that your tenant might have agreed to a two-month security deposit or less than the usual notice; those agreements are unenforceable because the RTA says so.

 

Assignment Basics

Again, here is my definition: An Assignment is an agreement that transfers your contractual rights to a third party.

A Contract of Assignment, usually just called an ‘assignment,’ is useful in any real estate market. You can make big money in BC and less in most other places. Here’s how they work. You write a real estate purchase contract offering to purchase a piece of property and the seller accepts your offer. This gives you control of that piece of property. You can then sell your interest in the property by way of an assignment before or after you go unconditional on the purchase contract. The assignment contract itself is usually just a page or two but it’s important. It sets out the parties, timing, assignment monies, and other details in writing.

CAUTION: Assignments are a sophisticated investor strategy. Don’t dive into these without some initial real estate experience.

 

Why Use An Assignment?

There are three basic scenarios, two of which are relevant for this Tale.

Scenario I

Let’s call this scenario the ‘Big Gap’ scenario, you just want to tie up a property because you believe the after repaired value (ARV) worth more than you agreed to pay. Typically, this is an ‘ugly property’ where the cost of repairs adds at least double the repair cost to the ARV. If you could find a buyer that wants the property and agrees it is worth more money, then you can `assign’ them the contract.

How much you can `assign’ for, or in other words, sell the contract for, is a function of hidden value in the property, market psychology, and simply how much your ultimate buyer (assignee) is willing to pay. Once you have established that number, your ideal scenario is that you prepare your Assignment, both of you sign it, you staple it to a real estate purchase contract, and your assignee gives you the Assignment price along with any deposit you have already paid. Your part of the original real estate purchase contract is now finished. You walk away and your Assignee closes the deal.

 

Scenario II

Let’s call this scenario ‘Rising Market.’ Classic examples of the rising market are what we have seen in British Columbia, particularly Vancouver, and in Toronto over the past few years rising to a crescendo in 2016, at least according to the breathless media. When prices rise dramatically, there is money to be made. Sometimes listings drop as sellers wait to see how the market will proceed. The idea is to get control of a property in a hot market. Try for a longer closing to give a little more time for the market to rise further and give you time to find a buyer. Then, sell your interest by way of assignment before closing on the property. You (the ‘assignor’) get your deposit back and whatever your ‘assignee’ (new buyer) will pay you for taking over your position in the original contract. Of course, if the market drops you may not be able to assign. Obviously, BC and Ontario are in a rising market. Alberta is not, however, during these times of low oil prices and a depressed economy.

 

Scenario III

This scenario involves members who are looking to do Joint Ventures (“JV”). They are the `Finders’ of property who have real estate expertise but may have run out of money. They have a JV relationship with the `Investor’ or `money person’ and have agreed that the Joint Venture wants to buy property. The Finder goes out and ties up a property with an offer to purchase. Then, if the Finder and Investor agree that it is an appropriate property, the Finder assigns all or part of his/her interest to the Investor. The Investor then applies for financing, either on his/her own or in conjunction with the Finder. This scenario is more of the technical explanation of how to transfer a portion of your interest to your money partner or investor.

 

Points To Remember:

  1. Contracts where you might want to assign used to be written showing the buyer as “John Jones or Assignee.” or perhaps “John Jones or Nominee.” With the rise in mortgage fraud, lenders and title insurance companies don’t particularly like assigned contracts. For another reason, as the BCREA says to their members, “licensees should not use clauses such as ‘and/or nominee’ or ‘and/or assignee’ in the description of the buyers. Arguments could be made that contracts containing such phrases in the description of the buyer are unenforceable due to uncertainty in the identity of the buyer.” You are better off showing just your name as the buyer. Then, in the terms section of your contract, (currently section 7.6 in the AREA contract), you add some extra words. Those words are, “buyer reserves the right to unilaterally amend buyer’s name.”I also like additional ‘disclosure words’ that are very helpful. You can add these disclosure words (amend to fit your deal) to 7.6 or put them in a separate schedule/addendum, “Buyer discloses to seller buyer may move into the property, rent out to tenants or sell at a profit to a third party before or after closing. Seller will, in all respects, cooperate with buyer to facilitate sale to a third party buyer.”

    Why do these words make a difference? Firstly, with this term(s) in the contract, if you want to assign the contract or JV you have the stated right to do it on your own. You don’t have to go asking the seller pretty please or bring up s.154 of the Alberta Land Titles Act. Secondly, it appears that while lenders don’t like assignments, they are very familiar with amendments to contracts and, if the buyer’s name changes by way of amendment, they are okay with that. Thirdly, disclosure protects you and requires the seller to cooperate in your sale to a third party.

 

  1. When you write a purchase contract in this manner you have flexibility. You may choose to close for yourself and add the property to your rental portfolio. Or, any contract with the assignment clause also indicates and gives you the right to change the buyer’s name to facilitate a cash assignment or the sale to a third party.

 

  1. Lenders finance on the lower of the price in the purchase contract or the appraised value. In a Scenario II situation (Rising Market), if you have a purchase contract with a seller for $300,000 and you assign the contract to the ultimate purchaser for $10,000 then the ultimate purchaser is paying $310,000. Based on the rule above, the lender will only finance on the basis of $300,000. Lenders also don’t like it if the seller to the ultimate buyer is not the name of the owner on title. How can you organize it so your ultimate buyer will get financing based on all the dollars he has paid and have a contract the lender will live with? Remember full disclosure at all times to your lender/broker.

 

  1. You may have to go back to your seller and explain the situation to them. What you need is a new purchase contract written between the current owner and the ultimate buyer for the ultimate buyer’s price. This is where the words in clause 7.6 come in. They say to the seller that you might buy the property and move in yourself, you might rent it out, or you might sell the property to somebody else. The schedule says that whatever you do, the seller will cooperate with you to facilitate a sale to your ultimate buyer. Replacing one contract with another can be a little tricky so get help from your lawyer on the type of wording for the 7.6 clause or perhaps a schedule to use to replace one contract with another.

 

 

Let’s talk about some of the issues surrounding Assignments

An assignment is a sale of a contractual right, not a real estate transaction

Pay Me The $$!

This is a simplified example, but if you were selling a car, would you give it to the buyer and let him drive away before you got your money?

In a recent transaction, a buyer (Assignor) assigned his interest in a purchase contract for $8,000. In other words, this is Scenario I where the Assignor is selling his interest in the real estate purchase contract. My firm, RMLO Law LLP, acted for the ultimate buyer (Assignee). After closing, the Assignor called me and asked when I was going to send him his Assignment monies of $8,000. I had to tell him that I didn’t have his $8,000 and it wasn’t my job to collect it for him.

If you are a Scenario I Assignor, your job is tying up the property, finding your Assignee, negotiating the Assignment, and collecting your assignment funds. Don’t release the assignment document to the ultimate buyer until you have all assignment monies and return of deposit in your hands. Then your part of the assignment is finished.

 

Timing

Watch your timing. In a busy market, everyone in the real estate chain is busy. Realtors, lenders, surveyors, house inspectors, and lawyers all take longer to do their job than it takes in a quiet market.

No matter which assignment scenario, the assignment process usually shortens the amount of time available to close the transaction. Make sure everyone in your chain knows there is an assignment involved.

 

Liability

What happens if the ultimate buyer (Assignee) does not close on the property? Who does the seller look to when his sale collapses?

Whether you are Scenario I ‘Big Gap’ (selling) or Scenario II ‘Rising Market’ or Scenario III (JV’ing), the seller will look to the Assignor. Why? Because the seller signed the original contract with the Assignor (first buyer). The seller has no contract with the Assignee (the ultimate buyer). When sellers learn of an Assignment, they usually cooperate in dealing with the Assignee (better cooperation with the 7.6 disclosure clause, but that doesn’t mean there is a contract between the seller and the assignee).

Therefore, before you remove conditions on a contract, either hoping to assign the contract or even with an Assignee already lined up, you better be ready to close on the deal yourself.

 

Due Diligence

Doing diligence is ultra-important. You must do enough diligence so that you are confident of your buying decision. Only then have you done your due diligence. Getting to the due diligence stage is important for all buyers. In the most recent batch of assignments coming through my law office, we have seen the following:

  1. a) Assignors who did due diligence before assigning
  2. b) Assignors who did some diligence before assigning
  3. c) Assignors who did no diligence before assigning

As Assignors in whatever scenario, especially Scenario I & II, you must be incredibly careful to make sure your Assignee knows what you have done about due diligence. It’s fine, but not recommended, not to do any diligence or even some diligence, but your Assignee must understand. Assignees are often less experienced buyers and they usually, without even saying it, are relying on you to tell them this is a ‘good’ property. As always, early written disclosure is best and provides you some measure of protection from an Assignee who later says you misrepresented the property.

 

What Specific Things Can You Do?

  1. a) Finalize your Assignment before the deal goes unconditional. If you are using a realtor, make sure they know. If it’s a private sale, make sure the seller knows.
  1. b) Amend the contract, in writing, to show that there is a new buyer. You can use various forms; an Amendment, an Addendum, or a Schedule, they all will accomplish the same thing. What words do you use? In three recent assignment situations, I have seen the following words used in the amendment:
  1. i)  “this contract is amended to delete John Jones as buyer and replace with William Smith”
  2. ii) “the buyer John Jones has been replaced by the buyer William Smith”
    iii)  “John Jones as buyer hereby gives notice that he has assigned his interest in the contract to William Smith”
  1. c) Call your lawyer early on and discuss your plans in detail.

 

Lessons Learned:

  1. Assignments can take a good chunk of the time available for closing. They often turn ‘normal’ deals into ‘rush’ deals.
  2. In Alberta, you can assign your contract without the seller’s consent. You must give the seller notice that you have assigned the contract. The seller’s lawyer will now typically deal with your ultimate buyer’s lawyer to close the deal. As an Assignor, you continue to remain liable even after you have assigned.
  3. Make sure your Assignee acknowledges ‘in writing’ what you have told them about the diligence you have done.
  4. Give your lawyer, lender, and realtor lots of detail as early as you can.
  5. The Assignment concept is deceptively simple. There are lots of other issues. Always get legal advice before you start using Assignments, including the form of Assignment you will use.

 

Contact Barry McGuire now. Alberta real estate needs an Alberta lawyer.

“3D Realty Handshake” image courtesy of Scott Maxwell. Used under Creative Commons Attribution-Sharealike 2.0.