Pitfalls of Buying Occupied Property

The more savvy real estate investors tend to have a hard rule against buying occupied property unless the occupant signed a written lease agreement, the seller had a detailed payment ledger, and there is a transferable security deposit. Even then, best practice would be to also personally ask the tenant whether the tenant claims any interest in the property other than a leasehold. The buyer should also possibly put the request in writing or get the tenant to sign a waiver or release of any title claims. Real estate wholesalers often think that they can get a steal of a deal by offering to evict a non-paying occupant for a beleaguered seller. However, this road often leads to problems bigger than the buyer anticipates.

The problems arise from claims that the occupant may have to the property. If you look at Schedule B to your owner’s title policy from your title insurance company of choice, then you will probably find language similar to the following: “We do not cover loss, costs, attorney’s fees and expenses resulting from . . . [t]he following matters and all terms of the documents creating or offering evidence of the matters (we must insert matters or delete this exception): . . . Rights of parties in possession.” So, your title company will not cover any claims raised by anyone who is in possession of the property at the time that you purchase the property. Bet you wish you knew that when you bought your title insurance? But alas, most people do not read their policy, would not understand it even if they did read it, and their escrow officer or title agent probably put little to no effort into explaining what the policy does and does not cover. Knowledge is power and if you know what types of title disputes you cannot insure against, then you can take steps to protect yourself from those types of disputes.

To understand what you need to do to protect yourself since your title company will not protect you, the best case to review is Madison v. Gordon, 39 S.W.3d 604, 606 (Tex. 2001): “One purchasing land may be charged with constructive notice of an occupant’s claims. This implied-notice doctrine applies if a court determines that the purchaser has a duty to ascertain the rights of a third-party possessor. See Collum v. Sanger Bros., 98 Tex. 162, 82 S.W. 459, 460 (Tex. 1904); American Surety Co., 82 S.W.2d at 183. When this duty arises, the purchaser is charged with notice of all the occupant’s claims the purchaser might have reasonably discovered on proper inquiry. Dixon v. Cargill, 104 S.W.2d 101, 102 (Tex. Civ. App.–Eastland 1937, writ ref’d); see also Flack, 226 S.W.2d at 632. The duty arises, however, only if the possession is visible, open, exclusive, and unequivocal.” Madison, 39 S.W.3d 604. The form of constructive notice described here is known as “inquiry notice,” which is notice of claims that one could discover through reasonable inquiry made to the occupant of the property.

Generally, a bona fide purchaser of real property for value (“BFP”) will acquire the property free of any unrecorded claims. Texas has codified BFP doctrine at Tex. Prop. Code § 13.001.

Madison is a fascinating case in the Texas Supreme Court where the Court of Appeals found that the occupancy of a guy who “resided on the property, had possession of the premises, and collected rents on the property before and after [the BFP’s] purchase” of the property defeated the BFP’s claim to the property due to his occupancy. Gordon v. Madison, 9 S.W.3d 476, 480 (Tex. App.—Houston [1st Dist.] 2000). The Court of Appeals found that “even minimal inquiry by [the BFP] would have made her aware of Gordon’s claim, either by Gordon himself or the tenants who were paying rent. A purchaser who fails to make reasonable inquiry is charged with notice of all claims and facts that the inquiry would have disclosed . . . . Gordon’s residence on the property, his possession of the premises, and his past and continuing collection of rents established constructive notice to [the BFP] as a matter of law. We therefore conclude that Gordon disproved [the BFP’s] affirmative defense of good faith purchaser status as a matter of law . . . .” Id. Amazingly, the Texas Supreme Court reversed the Court of Appeals because the Supreme Court found that Gordon’s possession of the property was not exclusive or unequivocal. Madison v. Gordon, 39 S.W.3d 604, 607 (Tex. 2001). In reversing the Court of Appeals and rendering judgment in favor of the BFP, the Supreme Court seemed to assign great weight to the fact that the property was a multi-unit rental property. Accordingly, Gordon’s occupancy was “compatible with [the record title holder’s] assurances of ownership” because “[a]s a rental property, one would expect occupants on the property.” Id. Seemingly, the mere fact that a property is a rental property is enough to defeat an occupant’s inquiry notice claim, even where the occupant is residing in the property and collecting rents from the other occupants. In Madison, the occupant’s possession was “‘ambiguous or equivocal possession which may [have] appeared subservient or attributable to’ [the owner of record].” Id.; Strong v. Strong, 128 Tex. 470, 479, 98 S.W.2d 346, 350 (1936).

Equitable Title. Counter-intuitively, the State of Texas gives buyers under an executory contract for purchase of real property an ownership interest in the property called “equitable title.” See Johnson v. Wood, 138 Tex. 106, 157 S.W.2d 146 (1941). So, in Texas, if you sign a contract as a buyer, or even just an option agreement, or a lease-option, then you arguably have “equitable title,” which you can convert to official, legal title by suing on the contract within the limitations period (generally four years from contract execution date). See New York & T. Land Co. v. Hyland, 8 Tex. Civ. App. 601, 604 (Tex. Civ. App. Austin 1894). So, non-real estate attorneys might assume that anyone without a deed to property cannot be the owner of that property.  Life would be easier if that were true.

In conclusion, the primary concerns for the buyer of occupied property are whether the occupant has an option to purchase the property; an executory contract to purchase the property, i.e., a contract to buy the property that remains open because the deadlines have not passed yet or payments remain to be made, or for whatever reason, the right to purchase the property may possibly still exist; or any other unrecorded claim of ownership to or interest in the subject property. The savy buyer needs to worry about every potential claim of an occupant, regardless of whether the claim is valid or not. Even an occupant who has clearly defaulted on an executory contract can claim equitable title through “substantial performance” (See 18-270 Dorsaneo, Texas Litigation Guide § 270.22 (2017); O.W. Grun Roofing & Constr. Co. v. Cope, 529 S.W.2d 258, 261–262 (Tex. Civ. App.—San Antonio 1975, no writ) or through application of the contract-for-deed regulations (see Subchapter D, Chapter 5 of the Texas Property Code).

The reason that the buyer needs to worry about invalid claims as well as valid claims is that the presence of any claim, whether valid or not, can deprive the Justice of the Peace Courts of jurisdiction over an eviction suit. See Espinoza v. Lopez, 468 S.W.3d 692, 696-97 (Tex. App.—Houston [14th Dist.] 2015, no pet.). An eviction, from start to finish, in a Texas Justice of the Peace Court (“JP Court”) can end in under sixty days, easily. The owner of property seeking to evict an occupant in JP Court generally does not even need the help of an attorney. If, however, a title dispute exists, even a title dispute where the occupant has little chance of success on the merits, then the JP Court lacks jurisdiction and will dismiss the eviction suit.

At this point, the owner of the property will need to turn to higher courts to have the occupant evicted. In those higher courts, either a county court at law or a district court, the case will probably have a Level Two Discovery Control Plan (See Tex. R. Civ. P. 190.3), which means that there will be a nine (9) month long discovery period followed by a trial that may be reset multiple times. The owner will be lucky to have the occupant evicted within a year. In the meantime, the judgment-proof, deadbeat occupant will simply occupy the property for free unless the record owner can get the occupant evicted before trial through an injunction. Pre-trial injunctions, however, are very hard to get and are not granted easily. Most importantly, the time and effort, from an attorney’s fees standpoint, between getting an occupant evicted in a district court versus a JP Court is vast. Many attorneys will handle JP Court evictions for a relatively small flat fee or the record owner can handle the JP Court eviction themselves. In a district court, however, the owner definitely needs an attorney to ensure compliance with the Texas Rules of Evidence and Procedure and the attorney will probably demand a substantial retainer with an hourly billing arrangement because quoting a flat fee for a district court lawsuit is extremely difficult due to the extreme open-endedness of district court litigation where the parties can bring all manner of counter and cross-claims and argue over nearly every bit of minutia. Also, predicting the amount of pre-trial hearings, depositions, discovery, legal research, briefing, factual research, mediation, and other time-consuming matters in district court is nigh impossible in most instances.

The prudent buyer will take every possible step to avoid getting into a situation where an occupant in the property to be purchased may have any sort of claim against the property. This means making adequate inquiry and obtaining adequate assurances from the seller that the seller has good and marketable title that is superior to and consistent with any of the occupant’s claims.


Copyright 2017, Ian Ghrist, All Rights Reserved.

Disclaimer: This blog is for informational purposes only. Do not rely on any part of this blog as legal advice. Instead, seek out the advice of a licensed attorney. Also, this information may be out-of-date.