Wholesaling is the term for getting a property under contract and then selling that contract to a real estate investor who typically does fix-up work before re-selling the property at a profit—all within a reasonably brief timeframe. There are, of course, other wholesaling scenarios and contracts may be assigned more than once.
Both the Texas legislature and TREC have moved in recent years toward greater regulation of the business of sale and assignment of earnest money contracts.
LAW APPLICABLE TO WHOLESALING
Occupations Code Licensing Requirement (OCC Sec. 1101.002.A)
Is a real estate broker’s license required in order to engage in wholesaling? Chapter 1101 of the Occupations Code answers this question with a definite maybe depending on how one defines the brokerage of real estate. Chapter 1101 states that a real estate broker “means a person who, in exchange for a commission or other valuable consideration or with the expectation of receiving a commission or other valuable consideration, performs for another person one of the following acts . . . deals in options on real estate, including buying, selling, or offering to buy or sell options on real estate. . . .” An executed earnest money contract can be considered a kind of option to buy real estate. It definitely represents an interest in real estate. So if one is buying or selling such contracts (engaging in wholesaling) then a broker’s license may be required. More on this below.
Occupations Code Disclosure Requirement (OCC Sec. 1101.0045)
This section of the Occupations Code offers a loophole for wholesalers who are working without a broker’s license, but only so long as they make express disclosure that what they are selling is merely an equitable interest—as opposed to a legal interest. The difference can be challenging for non-lawyers to understand; however, an equitable interest means an interest that is less tangible, less certain, and more contingent than a solid and present legal interest. The statute reads:
Section 1101.0045. Equitable Interests In Real Property. (a) A person may acquire an option or an interest in a contract to purchase real property and then sell or offer to sell the option or assign or offer to assign the contract without holding a license issued under this chapter if the person: (1) does not use the option or contract to purchase to engage in real estate brokerage; and (2) discloses in writing the nature of the equitable interest to any seller or potential buyer. (b) A person selling or offering to sell an option or assigning or offering to assign an interest in a contract to purchase real property without disclosing the nature of that interest as provided by Subsection (a)(2) is engaging in real estate brokerage.
OCC Section 1101.0045 wants wholesalers to make full disclosure, which means making it clear that what is being transferred is not the property itself but only an equitable right to acquire the property subject to the terms and conditions of the contract being assigned. Accordingly, wholesalers who assign contracts are not illegally acting as real estate brokers if they fully disclose the nature of the interest they are selling. The difference between a broker’s license being required or not required comes down to disclosure.
Texas Administrative Code Disclosure Requirement (22 TAC Sec. 535.6)
TAC contains TREC rules applicable to real estate license holders. Rule 535.6 states:
TREC Rule 535.6. (a) A person may acquire an option or enter into a contract to purchase real property and then sell or offer to sell the option or assign or offer to assign the interest in the contract without having a real estate license if the person: (1) does not use the option or contract to purchase to engage in real estate brokerage; and (2) discloses the nature of their equitable interest to any potential buyer. (b) A person selling or offering to sell an option or assigning or offering to assign an interest in a contract to purchase real property without disclosing the nature of that interest to a potential buyer is engaging in real estate brokerage. (c) A license holder who is engaging in real estate brokerage by selling or buying or offering to sell or buy an option or assigning or offering to assign an interest in a contract to purchase real property must disclose to any potential seller or buyer that the principal is selling or buying an option or assigning an interest in a contract and does not have legal title to the real property. (d) A license holder acting on his or her own behalf or in a capacity described by §535.144(a) who is selling an option or assigning an interest in a contract to purchase real property must disclose to any potential buyer that the license holder is selling an option or assigning an interest in a contract and that the license holder does not have legal title to the real property.
This TREC rule echoes a theme found in the Real Estate License Act, the Property Code, and case law: full disclosure is always the safer route whether one is a license holder or not.
Property Code Disclosure Requirements (Sec. 5.0205 and Sec. 5.086)
The Property Code sets out two disclosure requirements that apply in the context of the sale and assignment of earnest money contracts:
Prop. Code Sec. 5.0205. Before entering into a contract to sell an option or assign an interest in a contract to purchase real property, a person must disclose in writing to (1) any potential buyer that the person is selling only an option or assigning an interest in a contract and the person does not have legal title to the real property; and (2) [to] the owner of the real property that the person intends to sell an option or assign an interest in a contract.
Prop. Code Sec. 5.086. Before entering into a contract, a person selling an option or assigning an interest in a contract to purchase real property must disclose to any potential buyer that the person is selling only an option or assigning an interest in a contract and that the person does not have legal title to the real property.
These sections of the Property Code apply to everyone whether licensed or not. Every seller-assignor (wholesaler) must comply.
Reading the above statutes together, it should be clear that wholesaling without providing the required equitable interest disclosure (to the property owner and the buyer-assignee of the contract) can get an investor in double trouble, both for violating the Property Code and potentially for brokering real estate without a license.
Equitable Interest Disclosure
The following proposed wording at or near the top of the contract assignment would likely satisfy equitable interest disclosure requirements:
EQUITABLE INTEREST DISCLOSURE PURSUANT TO TEXAS PROPERTY CODE SECTIONS 5.0205 and 5.086: THIS INSTRUMENT REPRESENTS ONLY AN OPTION TO PURCHASE REAL PROPERTY OR AN ASSIGNMENT OF AN INTEREST IN REAL PROPERTY. IT IS NOT A SALE OF THE PROPERTY OR A TRANSFER OF TITLE TO THE PROPERTY. ASSIGNOR DOES NOT HAVE LEGAL TITLE TO THE PROPERTY. ASSIGNOR IS NOT A REAL ESTATE BROKER AND HAS NOT GIVEN ASSIGNEE REAL ESTATE ADVICE. CONSULT AN ATTORNEY PRIOR TO EXECUTING THIS DOCUMENT IF YOU DO NOT UNDERSTAND IT.
The disclosure is probably best inserted beneath the customary notice of confidentiality rights that is required by Texas county clerks for recordable instruments.
Note that a buyer-assignee of an earnest money contract should probably want the assignment instrument to be recorded. Why? To insure that the contract will not later be sold by an unscrupulous seller-assignor to someone else.
SALE AND ASSIGNMENT OF AN
EARNEST MONEY CONTRACT
Assignability of the Contract
An earnest money contract that is destined to be wholesaled should expressly state that it is assignable. A common way to list the buyer in paragraph 1 of the TREC contract is (for example) “ABC LLC and/or its assigns.” Time and space permitting, however, careful lawyers would prefer a more comprehensive provision such as:
It is expressly agreed that this contract may be assigned at any time by Buyer before closing without prior notice to or consent by Seller. Seller unconditionally agrees: (1) that the effect of any such assignment will be to immediately relieve the person presently named as Buyer of any further obligations under the contract; (2) to accept the assignee as Buyer; and (3) to timely and without object cooperate in the execution and delivery of closing documents, including a warranty deed, according to the terms of this contract.
Since the available line on the TREC 1-4 form is just too short for this longer and more thorough clause, an investor involved in the business of wholesaling should consider including a custom attorney-drafted special provisions addendum. I have beat the drum in other articles regarding the usefulness of a special provisions addendum in non-standard transactions. This is a case in point.
The Assignment Instrument
The assignment instrument is often entitled “Sale and Assignment of Earnest Money Contract” or “Assignment of Contract” or something similar. We will refer to it simply as the assignment.
It goes without saying that the assignment should adequately describe both (1) the main features of the contract and (2) the underlying real property. In order to make the assignment a complete package, it is good practice to attach a copy of the contract as an exhibit. If there is a lengthy metes and bounds property description (rather than the usual lot and block) then this should be attached as well.
Assignment of a contract is comparable to assigning a promissory note since many of the same principles apply. The main difference is that earnest money contracts, unlike notes, are not negotiable instruments subject to the Uniform Commercial Code. Even so, these two types of assignments share a number of characteristics:
(1) the necessity for thorough due diligence by the prospective buyer-assignee, which requires not only an examination of the terms of the contract itself but also the underlying realty;
(2) the general preference on the part of the assignor to make the transfer “as is” and without recourse, to the extent possible;
(3) the inclusion and limitation of representations and warranties by the seller-assignor;
(4) the period during representations and warranties will survive, if at all; and
(5) the requirement that the seller-assignor disclose any material issues, facts, or conditions that could reasonably influence the buyer-assignee’s decision to buy or not buy the contract. Failure by the seller-assignor to disclose known defects in either the contract or the underlying realty could (if justifiably relied upon by the buyer-assignee) constitute fraud.
Representations and Warranties by Assignor
An assignment may include extensive representations and warranties (reps and warranties), limited reps and warranties, or no reps and warranties at all—in which case the assignment is made entirely “as is” and without recourse against the assignor. It should be obvious that these issues need to be made clear in the instrument, but one often sees assignments that ignore reps and warranties altogether in the interest of “keeping it short.” Internet junk forms are particularly deficient in this respect.
A poorly-written assignment that does not address the full range of reps and warranties (and how they may be limited or excluded) is an engraved invitation to a lawsuit. If this subject is not thoroughly addressed, either or both parties may assume that reps and warranties exist when they do not, or they may later assert that reps and warranties were somehow implied in the course of dealing between the parties. Either outcome can lead to litigation involving a lot of finger-pointing and he-said-she-said allegations. Dodging reps and warranties in the interest of document brevity is amateurish and dangerous. Critical legal issues do not go away merely because they are ignored.
Covenants and Agreements
When it comes to duties and obligations of seller-assignor and buyer-assignee, clarity and express written provisions are important. Nothing oral should be relied upon. Nothing should be assumed or implied. For example, a well-drafted assignment would include agreement by the assignor to promptly deliver the original contract and any related documentation to the assignor. The assignee should agree to be bound by the earnest money contract and perform accordingly as the new buyer thereunder. Both parties should agree to take such other and further action, including the execution and delivery of additional documents, as may be reasonable or necessary to effectuate the assignment.
Recourse in Event the Contract or Closing Fails
As is the case with promissory notes, contracts can be assigned with or without recourse against the assignor. Recourse comes in three varieties: none, full, or limited. No recourse means what it says—if the contract does not close, then the assignee is stuck with a failed contract and is solely responsible for pursuing remedies against the selling property owner. Full recourse means that the buyer-assignee gets to give the contract back to the seller-assignor if the transaction fails to close through no fault of the buyer-assignee. Limited recourse can mean different things, but it falls somewhere between no recourse and full recourse. In any of these cases, the assignment should provide that the availability of recourse—whether none, full, or limited—is circumscribed within a specific time period.
It is often the case that earnest money contracts are assigned without recourse, meaning “as is.” If sale of a contract is to be entirely “as is,” an effective clause for this purpose is essential. Drafting of an “as is” clause should be carefully done, since the seller-assignor will want not only to disclaim assurances regarding the transferred earnest money contract but also any reps or warranties concerning the condition and value of the underlying real property.
Oral statements should of course be disclaimed.
Express Consent from the Owner of the Property
It is important—vital, in fact—for the buyer-assignee of an earnest money contract to be sure that the property owner consents to the assignment and will honor the buyer-assignee’s status as the new buyer under the contract. Otherwise, the assignee may face a hostile seller at closing who refuses to accept the assignee of the contract as the legitimate buyer of the property.
The cooperation of the property seller should not be simply assumed. After all, the buyer-assignee of the contract does not want to be put in the position of being forced to sue the property owner for specific performance—an expensive event that could easily destroy the profitability of the transaction. Accordingly, the assignment should include owner-consent wording along the following lines:
I/We, the undersigned, am/are listed as Seller in the Contract which is the subject of this Sale and Assignment. I/We give my/our unconditional consent to the sale and assignment of the Contract to the above-named Assignee, and I/we agree to in all respects recognize and cooperate with Assignee as the rightful Buyer under the Contract to purchase the Property.
The equitable interest disclosure requirement of the Property Code could be the beginning of a regulatory scheme for the wholesaling of earnest money contracts. Abuses and mishaps in this area will make news from time to time, so future Texas legislatures may build on existing disclosure requirements and expand beyond them, just as occurred in the case of executory contracts in 2005. The pressure for regulation may also increase as cases appear that seek to bring wholesaling within the reach of the Deceptive Trade Practices Act.
Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is retained and expressly retained in writing to do so.
Copyright © 2023 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.