Hi Jay,
Yes, to an extent Subject 2 transactions should be legal in every state however there have been both misunderstanding of federal code and state code written with the intent to protect but really harming sellers and buyers.
Due On Sale:
In fact, Black’s Law Dictionary defines the due-on-sale clause as a device for “preventing subsequent purchasers from assuming loans with lower than market interest rates.” This idea was also confirmed by the Court in Community Title Co v. Roosevelt Savings & Loan 670 S.W.2d 895 (Mo.App. 1984): “The due-on-sale clause was a way of eliminating these low yielding loans as soon as the property was sold, so that it could re-loan the money at current higher rates or negotiate a higher rate in the event the purchaser assumed the existing loan.”
The homeowners fought the banks in court claiming that the enforcement of the due-on-sale was “unfair trade practice” and an “unreasonable restraint on the alienation of property.” In state courts, many homeowners were winning the argument. See, e.g., Wellenkamp v. Bank of America, 21 Cal 3d 943 (1978). The banks ultimately won in a United States Supreme Court case, Fidelity Federal Savings and Loan Association v. de la Cuesta, 102 S.Ct. 3014, (1982). Congress thereafter passed the “Garn-St. Germain Federal Depositary Institutions Act” (12 U.S.C. 1701-j) which codified the enforceability of the due-on-sale clause, despite state statute or case law to the contrary.
Federal:
Some title company representatives and attorneys have refused to close “subject to” transactions, quoting 18 United States Code Section 1001, which generally states that:
“whoever, in any matter within the jurisdiction of the executive, legislative, or judicial branch of the Government of the United States, knowingly and willfully - (1) falsifies, conceals, or covers up by any trick, scheme, or device a material fact; (2) makes any materially false, fictitious, or fraudulent statement or representation; or (3) makes or uses any false writing or document knowing the same to contain any materially false, fictitious, or fraudulent statement or entry; shall be fined under this title or imprisoned not more than 5 years, or both.
Liability:
In theory, a lender could sue the borrower for fraud for deliberately making a misstatement regarding the status of his loan. Of course, this makes no sense, because a lender would do better simply calling the loan due and foreclosing the property. Furthermore, a case for fraud requires someone to lie in the first place; keeping your mouth shut is the easiest way to avoid the issue. The case for fraud would be pretty hard to make, since the standard FNMA mortgage agreement does not state that the borrower has an affirmative obligation to notify the lender if he transfers title or any other interest in the property.
What if the borrower simply keeps his mouth shut and transfers title without making any statements to the lender? This issue was addressed in a United States Supreme Court case, Field v. Mans, 1995.S.Ct.207 (1995). Defendant Mans bought a development property from Field, who carried a private mortgage on the property. Mans transferred title to an entity he and a new partner owned, then contacted Field to see if it was ok. In two written letters, Mans lied and told Field that he had not yet transferred title. Field refused permission without $10,000 compensation. Years later the real estate market tanked, Mans filed for bankruptcy and tried to absolve himself of the deficiency on the mortgage debt owed to Field. Field claimed that the “fraud” exception in the bankruptcy code would not allow the debt to be wiped out. The court agreed.
However, Justice Ginsberg, in his concurring opinion suggested that had the borrower kept his mouth shut, there would be no fraud and the debt would have been discharged. Justice Ginsberg cited the oral argument between the court and the lender’s (Field’s) attorney wherein the lender conceded that had Mans said nothing, there would be no fraud.
State Example Encouraging Prohibition:
Utah Rule R162-6.2.14 states “Real estate licensees have an affirmative duty to disclose in writing to buyer and sellers the existence or possible esistence of a “due-on-sale” clause in an underlying encumbrance on real property, and the potential consequences of selling or purchasing a property without obtaining the authorization of the holder of the underlying encumbrance” (note that the rule does not prohibit such transactions).
There is a law in MI (Sec 445.1628) that does make it a crime for a licensed agent to help someone evade a due on sale, but it only applies to the long-gone “window period” loans (originated between January 5, 1977, and ending on October 15, 1982).
These are examples as to why although potentially legal, title and escrow companies including attorney closings have avoiding these issues by refusing to do Subject 2 or Wrap closings. My investigation leads to laws regarding borrower qualifications under fair lending laws and other borrower / seller disclosures for Subject 2 type transactions including Wraps.
Although my statement was broad in scope I believe the real number of states where Title / Escrow closings cite it being illegal may in fact only be electing to limit their potential liability exposure and may not be set in actual state law or code!
GR