Landrecs.com – Land Title Consulting & Education

For more than two years, I have been blogging about private transfer fee covenants and the group that is promoting them, Freehold Licensing.  Freehold has actually attempted to patent their business strategy of creating private transfer fee covenants (a separate act that I find offensive).  The group now has a new name and a new strategy, all evolving while several states and trade organizations are trying to put a stop to private transfer fee covenants.

To summarize, a private transfer fee covenant is a covenant that purports to run with the land and bind subsequent owners of property to pay a 1% fee to the original covenantor.  Freehold, of course, gets to share in the fee for their assistance in setting up the covenant.  To briefly recap my previous blogs, In Patently Stupid, I explained the covenant and my opinion of their attempt to patent the practice as a "business strategy."  In Freehold Licensing Defends Covenants, I addressed comments posted by a representative of Freehold and the Texas legislation aimed at banning private transfer fee covenants.  And in a third blog, To Touch and Concern, I hypothesized that such covenants are unenforceable under common law. 

After I suggested in my blog that states should pass legislation, as they had in Texas, to ban private transfer fee covenants, four states did just that - Florida, Missouri, Kansas and Oregon. I followed up with a blog about Ohio's pending legislation, Banning Transfer Fee Covenants in Ohio. 

After the blog about Ohio's legislation, I started to get calls from people across the country with an interest in these covenants.  I was contacted by an attorney in South Carolina who was referred to me by a national underwriter that issued a bulletin stating that they would no longer insure property subject to a private transfer fee covenant.  He was representing an organization of homeowners' associations concerned about transfer fee covenants commonly used to fund their members' associations.  I responded with a blog about the importance of legitimate uses of transfer fee covenants to fund homeowners associations and not-for-profit groups that actually provide a benefit to the property and their communities,  Underwriters Refuse to Insure Transfer Fee Covenants. 

I was later contacted by the American Land Title Association (ALTA) which is working with the National Association of Realtors (NAR) on model legislation to assist states with banning the Freehold-type covenants.  (See The American Land Title Association Opposes Private Transfer Fee Covenants). 

Just last week, I was interviewed by a journalist with the Washington Post who is working on an article for consumers about private transfer fee covenants.

With all the activity centered around prohibiting private transfer fee covenants, I thought I'd see what Freehold was up to these days.  I was surprised to find out that they are still quite active and even more aggressive in their marketing of private transfer fee covenants.

Freehold Licensing issued a press release a couple of weeks ago to announce the move of its corporate offices from Austin, Texas to Midtown Manhattan.

Bringing the Freehold team to the heart of the financial markets is important for the Company's continued growth.  The move will provide close proximity to major investment banks, will allow the Company to attract top talent, and further illustrates Freehold's focus on strengthening its growing portfolio of financial instruments.

It has also apparently changed its name to Freehold Capital Partners.  Maybe because of the extensive bad press associated with "Freehold Licensing."  If you Google Freehold Licensing, the search results include such listings as "Closing the Door on Freehold Licensing" and "Is this a scam..."  In fact, when you enter the search term "Freehold Licensing" in Google, they suggest the search term "Freehold Licensing Scam." 

But, the name isn't all that has changed.  What Freehold used to refer to as "Transfer Fee Instruments" on its old Web site is now called "Reconveyance Fee Instruments" on its new Web site.  Again, could this possibly be because of the negative press associated with the former?

If this isn't enough to make you cringe, Freehold is now touting the benefits of pooling and securitizing the covenants into securities that can be sold to provide a lump sum payment to the covenantor, usually a developer, of the present value of the covenants.  We are now familiar with Mortgage Backed Securities (MBS) that contributed to the financial crisis.  It was once thought that there was no risk associated with MBS.  Freehold makes the bold statement that "Reconveyance Fee Instruments represent a fully-collateralized financial instrument with no meaningful risk of default... Investors acquiring shares of the pool would own a long-term income-producing asset secured by a real property interest, and which carried no meaningful risk of default."  

Of course, it states in the small print that "this is not an offer to sell, buy, market, offer, broker or securitize Reconveyance Fee Instruments.  There is no assurance that any particular Instrument will be suitable for sale or securitization or that public market for Reconveyance Fee Instruments will develop, mature or persist."  Even so, I think the Securities and Exchange Commission should keep a close eye on Freehold's marketing material. 

And what of their claim that there is "no meaningful risk of default" on such instruments?  Could that be true?  I don't think so.  In fact, in my opinion there is a very real and substantial risk of default.  A handful of states have already banned private transfer fee covenants.  Though they only apply to attempts to create such covenants after the passage of the legislation, there seems to be a general sense that private transfer fee covenants violate public policy and there is a concern that they may be held unenforceable under common law.  Should that happen, investors would likely stand to lose their entire investment.

Freehold realizes the controversy surrounding private transfer fee covenants and has provided a page in its brochure dedicated to "Reconveyance Fees Rights & The Law: A Primer for Lawyers."

• Filing the Freehold Reconveyance Fee Instrument in the public records obligates future sellers to pay a 1% fee at the time of sale.  The process is analogous to deed restrictions and common subdivision restrictions, though the Freehold instrument has been crafted with particularity to Reconveyance Fees.

• In order to constitute an UNREASONABLE RESTRAINT ON ALIENATION, the restraint must (a) be unreasonable and (b) actually restrain alienation.  The mere obligation to pay money will generally not suffice to unreasonably restrain alienation because the sales price will adjust to account for the restraint.  This is particularly true when the restraint is limited to a de minimus fee (e.g. 1%).

• The Freehold Reconveyance Fee Instrument does not violate the RULE AGAINST PERPETUITIES because the term is limited of 99 years and because the rights VEST immediately upon recording.

• If a state passes laws to ban Reconveyance Fees, not only must they ban them for charitable purposes (or run afoul of the constitution) but they must "GRANDFATHER" existing Reconveyance Fee Instruments or it would be an impermissible "TAKING." 

Freehold also provides several "representative cases" and claims that "the Freehold system is based upon sound legal principals."  Poppy-cock!  Freehold cites cases and picks precise quotes that appear to support its position.  However, the cases are not "representative" of the Freehold system.  All of the cases clearly involve covenants that "touch and concern" the land in some way.  Some involve restrictive covenants prohibiting certain types of buildings (e.g. multi-family), fences or tree lines. Others deal with affirmative covenants requiring the payments of fees for recreational purposes (e.g. to support a recreational facility), upkeep of dams, roads and other improvements, or homeowner's association dues.  All of these clearly touch and concern the land and benefit the property owners in some fashion.

By contrast, the Freehold covenant does not provide any benefit to the property owners or their community.  It is, as Freehold says, "a mere obligation to pay money."  The only party that benefits from the fee is the original covenantor/developer, who is likely to be out of the picture before the payments are due.  The funds collected do not go toward supporting common areas, recreational facilities, or homeowner's associations; it merely creates "a long-term income stream" for the covenantor or investors.

The Supreme Court of Florida explained this distinction in Palm Beach County v. Cove Club Invs., 734 So. 2d 379 (Fla. 1999).

A covenant running with the land differs from a merely personal covenant in that the former concerns the property conveyed and the occupation and enjoyment thereof, whereas the latter covenant is collateral or is not immediately concerned with the property granted. If the performance of the covenant must touch and involve the land or some right or easement annexed and appurtenant thereto, and tends necessarily to enhance the value of the property or renders it more convenient and beneficial to the owner, it is a covenant running with the land.

. . .

A personal covenant creates a personal obligation or right enforceable at law only between the original covenanting parties whereas a real covenant creates a servitude upon the reality for the benefit of another parcel of land. A real covenant binds the heirs and assigns of the original covenantor, while a personal covenant does not.

See also, Regency Homes Ass'n v. Egermayer, 243 Neb. 286, 295 (Neb. 1993).

Generally, in the United States the three essential requirements for a covenant of any type to run with land are (1) the grantor and the grantee intend that the covenant run with the land, as determined from the instruments of record; (2) the covenant must "touch and concern" the land with which it runs; and (3) the party claiming the benefit of the covenant and the party who bears the burden of the covenant must be in privity of estate.

. . .

If the covenant at issue is personal, it is not binding on [subsequent owners]; if the covenant is real, it runs with the land, and the [subsequent owners] are bound by the terms of the Declaration.

And, to put it even more simply, see Beeter v. Sawyer Disposal LLC, 2009 ND 153, P9 (N.D. 2009).

If a covenant or deed restriction benefits the grantor personally, and serves no real benefit to the land, then the covenant is personal in nature and does not 'run with the land' upon a subsequent sale of the property.

Of course, none of these case, including those cited by Freehold, are exactly on-point.  I have not been able to find a published case that has addressed the type of covenant being promoted by Freehold.  That will not likely happen for some time.  It will take a property encumbered by a Freehold covenant transferred to a subsequent purchaser who desires to challenge it in court.  These covenants are still fairly new and there haven't likely been many re-sold yet.

It will be interesting to see what legislation develops and the effect that has on transfer fee covenants.  With the new efforts of ALTA and NAR to raise awareness among state legislators, it is likely that the bans will spread to more states soon.  Of course, most of the laws on this issue, including those proposed by ALTA and NAR, contain exceptions for non-profit organizations.  Freehold contends that this "runs afoul of the constitution."  We could see some litigation in the near future, but I suspect that such laws would be upheld. 

Whether Freehold calls them "transfer fee instruments" or "reconveyance fee instruments," they just don't pass the smell-test.  Clearly, many organizations and state legislatures do not favor them.  One state senator called them "sophisticated pyramid schemes which steal equity from the owner."  Public sentiment is against Freehold on this one.

Imagine what would happen if everyone were to sell their property with such a covenant?  If this type of covenant were allowed, theoretically, any seller who is not satisfied with the sales price he is able to get could just include a covenant in the deed to the buyer that required him to be paid 1% every time the property sells for the next 99 years.  And, what would happen when the property had been sold two or three times with each subsequent owner reserving such payment rights by covenant?  That would create a terrible mess and would, of course, be absurd.  But, what would prevent it from happening (other than common sense)?  

But, I digress.  Freehold has continued to get my dander up... first by coming up with this ridiculous concept, then by attempting to patent it, and now... trying to securitize the covenants in to an investment.  Where will it all end?

Robert A. Franco
SOURCE OF TITLE