Summary:

In many cases, real estate professionals are confused about the language in loan documents regarding due-on-sale or due-on-encumbrance provisions.

Article:

A Deed of Trust is a comprehensive written agreement that solidifies the parties’ mutual understanding of the loan terms and conditions.  This instrument requires that the Trustor transfer the legal title of the real property to a neutral third party, known as the trustee.  Typically, third-party trustees are entities such as title insurance companies.

The recorded deed of trust is a security instrument linked to a promissory note, which defines the loan terms and specifies the amount owed.  Statutes, such as the California Code of Civil Procedures, section 2936, determine the requirements.

A deed of trust involves three integral parties:

Borrower (Trustor)

• The borrower, the Trustor, is not just a participant in the trust deed process, but a pivotal figure.  Their role is crucial, as they are the individual or entity seeking a loan and providing security by conveying the title to their real property. Their property serves as the key security for the loan, making their role integral to the entire process.

The borrower retains equitable (the right to use and possess).

Lender (Beneficiary):

• The lender is the Beneficiary entity providing the loan.  They hold a security interest in the secured property, as evidenced by the loan documents, the note, the deed of trust, and the loan agreement. 

Trustee (Natural Third Party): 

The trustee, an impartial third party, usually a title company, holds conditional legal title as security for the loan made by a lender to a borrower. The trustee acts on behalf of the lender (beneficiaries) with three primary powers. The third-party trustee has no authority over the property other than that listed below, as long as the borrower fulfills their obligations to pay promptly, including paying off the debt at maturity. If the borrower defaults, the trustee can initiate a foreclosure and convey the title after the foreclosure period without requiring further court action. 

The trustee has only three powers.

• To foreclose, per instructions by the beneficiary, the beneficiary instructs the trustee to reconvey legal title to the borrower.

• To modify the trust deed per mutual agreement between the borrower and the beneficiary, to maintain neutrality, the trustee must remain impartial and not affiliated with the borrower (Trustor or the lender.  This impartiality is not just a requirement but also a reassurance about the fairness of the process, which enhances the reader’s trust in the system.

The structure of a third-party trustee acting as an impartial intermediary between the borrower (Trustor) and the lender (beneficiary) is subject to the laws of the state where the collateral property is located.  Applicable state laws are different.

Equitable title holder: Borrower (Trustor)

As the equitable title holder, the borrower retains certain rights to the security property.  They have the right to occupy, use, and benefit from the property, even though they do not hold legal title. This means that the equitable title holders have a beneficial interest in the property and enjoy its economic benefits.

How does this relate to a provision in the deed of trust called due on sale or due on encumbrance?

Typical language:

DUE ON SALE-CONSENT BY LENDE. At the lender’s option, the lender may declare all sums secured by this Deed of Trust immediately due and payable upon the sale or transfer, without the lender’s prior written consent, of all or any part of the Real Property or any interest in the Real Property.  A sale or transfer means the conveyance of real property, or any right, title, or interest in the real property: whether legal, beneficial or equitable: whether voluntary or involuntary: whether by outright sale, deed, installment sale contract, land contract, contract for deed, leasehold interest with a term greater than three (3) years, lease-option contract, or by sale, assignment, or transfer of any beneficial interest in or to any land trust holding the real property, or by any other method o conveyance of an interest in the real property.  Suppose anyTrustorr is a corporation, partnership, or limited liability company.  In that case, transfer also includes any restructuring of the legal entity (whether by merger, division, or otherwise) or any change in ownership of more than twenty-five percent (25%) of the voting stock, partnership interest, or limited liability company interest, as the case may be, of the Trustor.  However, the lender shall not exercise this option if such exercise is prohibited by applicable law.

Due on Further encumbrance:

The above language would be found in the first trust deed document. If a borrower is subject to having a first trust deed on their property, they retain only an equitable interest in it. The above paragraph (typical language) states whether it is legal, beneficial, or equitable.

For example, the property owner only has an equitable interest in the property; they are precluded from encumbering the property with a junior loan without the lender’s prior written consent.  This means that the borrower cannot take out a second mortgage or any other form of loan that would put a financial burden on the property without the lender’s approval, subject to applicable law.

Certain states use deeds of trust, while others use instruments called mortgages:

Trust deeds are commonly employed in specific states, including Alaska, Arizona, California, Colorado, Idaho, Illinois, Mississippi, Missouri, Montana, North Carolina, Tennessee, Texas, Virginia, and West Virginia.

Conversely, certain states require mortgage deeds, including Connecticut, Delaware, Florida, Indiana, Iowa, Kansas, Louisiana, New Jersey, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, Vermont, and Wisconsin.

Several states, including Alabama, Arizona, Arkansas, Illinois, Kentucky, Maryland, Michigan, Montana, and South Dakota, allow lenders to choose between trust deeds and mortgages.

Foreclosures in Deed of Trust States:

Since the process is a statutory procedure that allows all actions to be taken outside the court’s jurisdiction, the time to foreclosure is substantially less than a judicial foreclosure, where the lender must file a lawsuit and navigate the court system. 

The body of knowledge in the above subject varies in state procedures and interpretations.  It is essential to consult a qualified lawyer to make sure you are well-informed and prepared.

Research:

https://codes.findlaw.com/ca/civil-code/civ-sect-2936.html

https://www.investopedia.com/terms/t/trustdeed.asp

https://www.investopedia.com/deed-of-trust-definition-5221503