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This open letter was written to the editor of the Georgia Real Estate Investors Association newsletter, The Offer.  It was not published.  


Avoiding Bad Advice

An Open Letter to the Editor By David J. Reed, Esq.

I read the article Avoiding the Due on Sale Clause in the June issue of The Offer with great interest.  I wanted to know if Congress had changed Garn-St. Germain while I wasn’t looking.  I assumed I would be disappointed.  I was prepared for advice about trusts. I expected to disagree with that advice.  I was not prepared for advice that flies in the face of basic principles of contract and collection law. 

Due-on-sale clauses provide that a note may be called due if the borrower transfers and interest in the property.  Federal law and regulation, 12 USC 1701j-3 and 12 CFR 591, provides that lenders may not enforce due-on sale clauses in certain specific circumstances.  The purpose of the Federal law is to prohibit enforcement of due-on-sale clauses by lenders in circumstances that were deemed unfair by the government.  One of those instances of deemed unfairness is in the context of a homeowner placing their home in a trust for estate planning purposes. 

Mr. Gatten, the author of Avoiding the Due on Sale Clause, writes about “effecting such a take-over” and about getting “100% of the use, occupancy, possession” of the property.  He is clearly recommending that an investor-buyer have a seller place a property in trust, assign beneficial interest to the seller, and, this is key, move out.  If the seller does not move out the investor-buyer cannot sell or lease the property.  But therein lies a primary problem with the recommended strategy. 

Federal law provides “… a lender may not exercise its option pursuant to a due-on-sale clause upon- … a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property.” (emphasis supplied) 12 USC 1701j-3(d)(8).  The law says that you can transfer your property to a trust and not trigger a due-on-sale clause as long as you are a beneficiary of the trust and remain an occupant.  Clearly Mr. Gatten envisions a transfer of the “rights of occupancy”.  The law was written primarily to assist people making transfers for estate planning purposes, not to assist investors.  The law cannot be used in the manner recommended by Mr. Gatten. 

Federal regulation amplifies the law and provides as follows, “A lender shall not (except with regard to a reverse mortgage) exercise its option pursuant to a due-on-sale clause upon: … A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property …”  12 CFR 591.5(b)(1)(vi).  Again the requirement of remaining an occupant appears.  The regulation goes on to require that the person placing the property into a trust provide the lender with reasonable means, acceptable to the lender, to assure to lender of timely notice of any transfer of any beneficial interest in the trust.  So the would-be seller in one of Mr. Gatten’s suggested transactions would have to remain an occupant in the property, and would have to give his lender a mechanism for notice of a transfer of a beneficial interest in the trust and then pursuant to that mechanism would, of course, have to actually give the lender notice of any such transfer of a beneficial interest in the trust. 

Federal law and regulations pretty well blow Mr. Gatten’s recommended strategy out of the water.  As an investor-buyer you simply cannot avoid the implications of a due-on-sale clause by placing title to the property into a trust but that might not be as big a problem as it might otherwise seem on the surface. 

Federal law limiting enforcement of due-on-sale clauses should be understood in historical context.  The law was written at a time of extremely high interest rates in the very early 1980s.  Lenders were looking for ways to call low interest rate loans due to clear their portfolios of under performing obligations and re-lend the money at higher rates.  Abuses were seen and laws and regulations were written to limit certain conduct.  Since 1981, when Garn-St. Germain was passed, interest rates have generally fallen.  We currently experience historically moderate to low interest rates.  Lenders are far less likely in today’s climate to call due performing obligations with rates in the 7s, 8s, and 9s, only to lend the money out at prevailing rates in the 5 to 6 percent range.  Fear of the due-on-sale clause enforcement may be overblown.  Use of trusts may be appropriate in some circumstances but may unnecessarily complicate title to property and do not provide the benefits mentioned in Mr. Gatten’s article. 

After over representing trusts ability to avoid due-on-sale clauses, Mr. Gatten then takes a dangerous detour into fantasy land.  He suggests that by the use of a specific "trademarked" trust, which presumably you must purchase from him or some company with which he is affiliated, an investor “is protected from liens, suits, judgments, divorce actions or claims, bankruptcies or anything else you can think of-on both sides-including state and/or IRS tax liens.”  That is simply not true and/or is grossly misleading.  There is no trust, regardless of the words in it, that protects all rights in property in this manner.  If you owe the IRS money they can lien your property or seize your beneficial interest in a trust.  The mere fact that the recording of a tax lien against an individual will not immediately tie up a beneficial interest in a trust is little comfort to the obligor on a substantial tax lien.  If the beneficial interest in the trust is owned by a corporation they can seize your shares in the corporation and liquidate the property through the corporation’s beneficial interest.  The same goes for bankruptcy trustees and judgment creditors.  Not only is Mr. Gatten wrong in suggesting that asset protection can be accomplished in this manner but also his advice may be dangerous in that it may encourage investors to employ a structure or device that may be unnecessary and expensive.  His advice may encourage investors to take unwise risks based on incorrect assumptions. 

About the Author

David J. Reed is in the private practice of law with the firm of Law Offices of David J. Reed.  For inquiries see davidjreed.com. 

Send mail to davidjreed@davidjreed.com with questions or comments about this web site.
Last modified: December 05, 2006