Contract for Deed – Is the Buyer Owed Money Upon Their Default? – Part 3 of 5

In part two of my article series on the contract for deed, I promised to discuss the most popular remedies a seller can select when a buyer defaults under a contract for deed, including the risk the seller may owe money to the buyer when the buyer defaults.

The most popular options when a buyer defaults under a contract for deed are (1) to rescind the contract and evict the occupying party or (2) to rescind the contract and repossess the property (if it is vacant).  However, when the contract is rescinded, the law requires that the parties be restored to their original status.[1]  In the context of a contract for deed, restoring the parties to their original status means following a restitution formula.  In accordance with the formula, the seller must account to the buyer: (1) all payments made, (2) the value of improvements made, and (3) damages incurred.[2]  Let me give an example:

Suppose Buyer Bob buys a property from Seller Sally using a contract for deed.  The market rent for the property is $500 per month.  Bob and Sally agree that Bob will make a $10,000 down payment and make payments of $1,000 per month for five years.  At the end of the five years Bob will receive the deed, free and clear.  However, two years into the agreement, and after Bob has spent $5,000 renovating the property, he defaults.  In response, Sally decides to rescind the contract and evict him.  Sally is legally entitled to do this, but now the parties need to be restored according to the legal formula – which means she must give an account to Bob.

In this scenario, the parties need to be put back in their original condition.  Thus, Bob would be due his $10,000 down-payment, plus $24,000 for the 24 months of payments he made plus $5,000 in renovations he made to the property.  This totals $39,000.  Sally, would have earned market rent at $500 per month for 24 months, so she is due $12,000.  Thus, Seller Sally owes Buyer Bob the difference, $27,000, even though Bob was the defaulting party.  Most people would not expect this outcome. 

While this outcome can be avoided by foreclosing on a contract for deed, the desire to bypass foreclosure is one of the primary reasons sellers use a contract for deed over a traditional financing arrangement (security deed and note).  Thus, this outcome is one of several reasons most attorneys recommend other legal structures in place of a contract for deed.  In the next two articles, I will discuss several other risks of using a contract for deed both from the seller’s and buyer’s perspective. 

Disclaimer: The information contained in this article is for informational purposes only and is not legal advice or a substitute for legal counsel. It does not constitute advertising or solicitation. The information in this article may not reflect the most current legal developments; accordingly, this article is not guaranteed to be perfect, and should not be considered an indication of future results.