WHO CARES ABOUT THE STATUTE OF FRAUDS?

                                          SOMETIMES, NOT CARING CAN BE COSTLY

            A concept that investors rarely discuss is the Statute of Frauds.  What is the Statute of Frauds, and how could it affect my deal?  The Statute of Frauds is legislation, and it comes from early English law.  The statute was created in the seventeenth century, when real estate transactions were relatively infrequent and many people could not read or write.  The purpose of the statute was “the Prevention of Frauds and Prejudices,” and this meant that people should be required to have written proof of their intentions in real estate deals so that frauds on the unwary could be avoided.

            In Washington, the Statute of Frauds applies to brokerage agreements and agreements for the transfer of interests in land.  Such agreements must be signed, in writing and sufficient for the intentions of the parties to be understood.  If a transaction does not meet this requirement it is void. 

            What can this mean for investors?  We know that a purchase and sale agreement is the usual starting point in an investment deal.  In a purchase and sale agreement there needs to be an agreed statement of what the parties are contracting to purchase and sell, namely the specific real estate involved.

            What happens if the parties sign a purchase and sale agreement, and the prospective buyer pays a substantial earnest money deposit, but the parties never really agree at the outset on how much property the seller is selling and the buyer is buying?  The result may surprise you.  This happened in a recent case from Eastern Washington.

            A seller hired a broker to list a large undeveloped parcel near Quincy for sale, but the seller wanted to retain a 3.93 acre portion of the property for his own use.  The listing agreement described the property as “included in Farm Unit 182”, and consisting of 30.12 acres.  The total parcel was 43 acres.  A developer made an offer to purchase the 30.12 acres and included a provision allowing him to purchase the 3.93 acre portion of the remaining area later if the seller decided to develop that property.  That offer was not accepted, but after a period of time another offer by the same purchaser was accepted, again reciting the area to be purchased as 30.12 acres, but omitting any mention of the 3.93 acres and including a $50,000 earnest money on a purchase price of $1.65 million.  The purchase and sale agreement was written with this second description of the sale.

            Some conditions needed to be satisfied before closing could occur, and after about a year closing was scheduled.  The purchaser went to the closing appointment and then refused to close because, among other things, he claimed that the 3.93 acres that had been omitted from the description of the sale should have been included.  Both sides filed lawsuits against each other.  The seller sought to have the sale completed and the purchaser sought rescission of the contract and refund of the earnest money.

            The court decided that the contract did not satisfy the Statute of Frauds because of the ambiguity surrounding whether the missing 3.93 acres was or was not in the deal.  One would think that if the court decided that the agreement was void for failure to meet the Statute of Frauds, then the purchaser should receive back the earnest money, right?  Wrong.  The court said that it was the purchaser’s burden in order to receive back his $50,000 earnest money to prove that the seller was not “ready, willing and able” to proceed to closing of the agreement.  The court further said in order to do that the buyer had to prove that the agreement legally included the 3.93 acres.  The court recognized that the sides held opposing views of what the agreement actually included.  Given that all parties recognized it was impossible for the party with the burden to meet it under the circumstances, practically the case means that the buyer is out his $50,000 earnest money.

            The lesson of this case is that “buyer beware” of a real estate contract that does not adequately describe the real estate that is to be purchased and sold.  This information is provided for education only and may not be construed as legal advice.

Who Cares About the Statute of Frauds?

            A concept that investors rarely discuss is the Statute of Frauds.  What is the Statute of Frauds, and how could it affect my deal?  The Statute of Frauds is legislation, and it comes from early English law.  The statute was created in the seventeenth century, when real estate transactions were relatively infrequent and many people could not read or write.  The purpose of the statute was “the Prevention of Frauds and Prejudices,” and this meant that people should be required to have written proof of their intentions in real estate deals so that frauds on the unwary could be avoided.

            In Washington, the Statute of Frauds applies to brokerage agreements and agreements for the transfer of interests in land.  Such agreements must be signed, in writing and sufficient for the intentions of the parties to be understood.  If a transaction does not meet this requirement it is void. 

            What can this mean for investors?  We know that a purchase and sale agreement is the usual starting point in an investment deal.  In a purchase and sale agreement there needs to be an agreed statement of what the parties are contracting to purchase and sell, namely the specific real estate involved.

            What happens if the parties sign a purchase and sale agreement, and the prospective buyer pays a substantial earnest money deposit, but the parties never really agree at the outset on how much property the seller is selling and the buyer is buying?  The result may surprise you.  This happened in a recent case from Eastern Washington.

            A seller hired a broker to list a large undeveloped parcel near Quincy for sale, but the seller wanted to retain a 3.93 acre portion of the property for his own use.  The listing agreement described the property as “included in Farm Unit 182”, and consisting of 30.12 acres.  The total parcel was 43 acres.  A developer made an offer to purchase the 30.12 acres and included a provision allowing him to purchase the 3.93 acre portion of the remaining area later if the seller decided to develop that property.  That offer was not accepted, but after a period of time another offer by the same purchaser was accepted, again reciting the area to be purchased as 30.12 acres, but omitting any mention of the 3.93 acres and including a $50,000 earnest money on a purchase price of $1.65 million.  The purchase and sale agreement was written with this second description of the sale.

            Some conditions needed to be satisfied before closing could occur, and after about a year closing was scheduled.  The purchaser went to the closing appointment and then refused to close because, among other things, he claimed that the 3.93 acres that had been omitted from the description of the sale should have been included.  Both sides filed lawsuits against each other.  The seller sought to have the sale completed and the purchaser sought rescission of the contract and refund of the earnest money.

            The court decided that the contract did not satisfy the Statute of Frauds because of the ambiguity surrounding whether the missing 3.93 acres was or was not in the deal.  One would think that if the court decided that the agreement was void for failure to meet the Statute of Frauds, then the purchaser should receive back the earnest money, right?  Wrong.  The court said that it was the purchaser’s burden in order to receive back his $50,000 earnest money to prove that the seller was not “ready, willing and able” to proceed to closing of the agreement.  The court further said in order to do that the buyer had to prove that the agreement legally included the 3.93 acres.  The court recognized that the sides held opposing views of what the agreement actually included.  Given that all parties recognized it was impossible for the party with the burden to meet it under the circumstances, practically the case means that the buyer is out his $50,000 earnest money.

            The lesson of this case is that “buyer beware” of a real estate contract that does not adequately describe the real estate that is to be purchased and sold.  This information is provided for education only and may not be construed as legal advice.

THE PROPOSED STATE CAPITAL GAINS TAX: OLD WINE IN NEW WINESKINS?

            It seems that our elected representatives never tire of seeking new or retrying old ways of separating the citizens from their money.  This legislative session, a bill was introduced to establish a state capital gains tax.  This bill, HB 2563, would impose a five percent tax on all gains from sales of property that are reported on federal tax forms 1040 or 1041.  There is an exemption in the proposed tax for profit from the sale of a primary residence, and the first $5,000 of gain for a single taxpayer or $10,000 in gain for joint filers, is exempt from taxation. 

            Clearly capital gains are a form of property, and for investors they are a primary reason for entering into the investment.  Some real estate investments are “buy and hold” investments but ultimately investors expect that they will reap a profit from selling at a price that exceeds their purchase price plus holding costs.

            We have recently lived through a bruising campaign to establish a state income tax by initiative.  That effort failed at the ballot box, and so there was no occasion for the courts to examine whether that proposed income tax would survive the Fourteenth Amendment to the Washington Constitution.  That amendment states: “All taxes shall be uniform upon the same class of property within the territorial limits of the authority levying the tax and shall be levied and collected for public purposes only.  The word 'property' as used herein shall mean and include everything, whether tangible or intangible, subject to ownership. All real estate shall constitute one class.” 

            It is reasonable to ask whether based on the Supreme Court’s precedents, a tax such as that which would be imposed by HB 2563 would meet the constitutional test of uniformity.  The Supreme Court considered two different income tax measures in 1933 and 1936 and held that both of them were unconstitutional in light of the Fourteenth Amendment.  In Jensen v. Henneford, the 1936 case, the court considered a tax that was graduated, and applied to all net income including gains from dealings in properties, but which allowed credits against such net income that differed between single and married taxpayers.

            The court determined that income was property for purposes of the Fourteenth Amendment, because it was capable of being owned.  Having made that determination, over the objection that income was income and property was something else, the court moved on to the uniformity question.  The court easily concluded that the graduated tax, with a base rate of three percent for incomes less than $4,000 and a surtax of an additional one percent for incomes over $4,000, violated the uniformity requirement.  The court decided that income was property and the Fourteenth Amendment required all property of the same class to be taxed uniformly and therefore a tax difference of one percent based on the level of income a person received was not a uniform tax.

            The proposed tax in HB 2563 does not contain a graduated rate based on the amount of capital gains received in one year.  However the bill does exempt gains from the sale of a primary residence and it exempts the first $5,000 of gains for a single filer and $10,000 of gains for joint filers in a single year.  The court in Jensen v. Henneford also considered the effect of exemptions on the constitutionality of the tax in 1936.  Based on that review, the court decided that exemptions of the first $1,000 for a single filer and $2,500 for joint filers also caused the tax to fail the uniformity requirement.  This same structure exists in HB 2563.  There was no exemption similar to the gains from sale of a primary residence exemption in the 1936 law but it seems clear that this exemption in HB 2563 also results in similar property, namely gains, being taxed differently based on the source of the gains, which would appear to violate the uniformity requirement.

            During the recent campaign to adopt the “rich person’s income tax” by initiative, there was speculation that enough time had passed since 1936 and the composition of the Supreme Court had changed sufficiently that such an income tax would be upheld by that court.  We have no recent case law from our court to guide us but we know that the courts are supposed to adhere to their own precedents until a reasonable basis for showing that they were erroneously decided, appears.  Nothing has changed in the wording of the Fourteenth Amendment and it does not appear that HB 2563 would impose a tax that meets the uniformity requirement.

            The preceding is for education only and should not be considered as legal advice.