January 01, 2018

When Inquiring Minds Ought to Know . . . , Part II

Last year, in this magazine, the authors provided an introduction to the doctrine of inquiry notice. Donald J. Kochan & James Charles Smith, When Inquiring Minds Ought to Know . . . , Prob. & Prop., July/Aug. 2017, at 57. That article also focused on language in recorded instruments that triggers a duty to discover more about the state of title. Sometimes what you see in a document can create a duty to take a closer look at the property, and other times taking a look at the property can heighten the necessity to ask further questions about possible outstanding rights. Now the authors focus on the traditional rule that physical possession by persons inconsistent with recorded instruments usually triggers a duty to inquire about the possessors’ rights, the major exceptions to the duty to inquire about possession, and circumstances when visible evidence of use may trigger inquiry into the existence of an unrecorded easement or other servitude. We will cover each category in turn across this article.

Possession as Inquiry Notice (The Basics)

The most basic and prototypical inquiry notice case involves possession of the property by someone other than a record interest holder. Possession by someone other than the seller gives rise to a duty of inquiry. The rule envisions a dialogue between the buyer and the possessor. The buyer is bound by whatever rights she would have uncovered by inquiring. Only by diligent inquiry can the buyer gain the legal prize of the status of bona fide purchaser (BFP).

The many cases addressing possession as giving rise to inquiry notice fall into two groups: those in which the parties (possessor and purchaser) have interacted and those in which they have not. In the first group, legal analysis centers on the sufficiency of the interaction from the standpoint of the purchaser’s due diligence.

Martinez v. Affordable Housing Network, Inc., 123 P.3d 1201 (Colo. 2005), is a good example of the first type of inquiry-from-possession case. Marvin and JoRene Martinez, behind in payments on their two home mortgages, responded to a mailing from a mortgage rescue company named Affordable Housing Network (AHN). The company offered to help the Martinezes refinance or sell their home and purchase a new home with the remaining equity. In October 1999, the parties signed a relatively complex option agreement to govern the sales process. Under the option agreement, AHN agreed to pay the Martinezes’ mortgage deficiencies of over $9,000, and the Martinezes signed a quitclaim deed, to be placed in escrow with a title company, conveying their home to AHN. If a sale resulted, the agreement obligated AHN to pay off the two mortgages in full before release of the deed from escrow.

For six months, the Martinezes cooperated with AHN’s plans for the sale of the home, but then they became dissatisfied with AHN’s performance and the lack of communication on key issues. They decided to keep the home, refinance, and reimburse AHN for the mortgage deficiencies. In May 2000, when a real estate agent called about a potential buyer, Ms. Martinez explained their new plans and told the agent not to come. AHN insisted on showing the house, but Ms. Martinez nonetheless protested when the agent arrived. The agent “pushed her way into the home, and proceeded to show the home to Overton, a Troco, Inc. investor.” Id. at 1203. Despite being present for this altercation, “Overton testified that he had no knowledge of . . . Martinez’s statements to the agent or . . . [the] objection to their viewing of the property.” Id. at 1204. Several days later, Troco agreed to buy the home from AHN for $25,000, also taking subject to the two mortgages, with a total balance of $112,646. On May 8, 2000, AHN recorded the quitclaim deed from the Martinezes, which it had never placed in escrow. The next day the sale closed, with AHN quitclaiming the property to Troco. The Martinezes’ mortgages remained unpaid.

The Martinezes sued AHN, Troco, and others for breach of contract, fraud, rescission, unjust enrichment, and several other causes of action. The Martinezes presented substantial evidence of fraudulent inducement and other acts of fraud and thus prevailed on some of their claims against AHN and other defendants after a jury verdict. But the trial court quieted title with Troco, finding it was “a bona fide purchaser entitled to rely upon the deed recorded by AHN.” Id. at 1204–05. The appeals court affirmed.

Both lower courts perceived the central issue to be whether Overton had inquiry notice stemming from Ms. Martinez’s objection to the real estate agent showing the house. The trial court reasoned that even if Overton overheard her “regret about showing the house” that day and was able to observe her hostility, “[t]he law is not intended to ask bona fide purchasers to inquire into whether or not a manifestation of some outward response is . . . buyer’s remorse [sic: the court probably meant seller’s remorse].” Id. at 1206. Moreover, in addition to refusing to find a trigger for inquiry, both courts held that inquiry, even if triggered, would have uncovered the option agreement but “would not have revealed the fraud of the underlying transaction.” Id.

In Martinez, the Colorado Supreme Court reversed for two reasons. First, it disagreed with the conclusion that Overton’s overhearing the argument between Ms. Martinez and the real estate agent would not trigger a duty to inquire. “[I]t is not too much to ask that a buyer make further inquiries when made aware that the person in physical possession of the property believes they are in fact the true owner of the property.” Id. at 1208. The court continued, “When a reasonable person is made aware that someone in physical possession of property claims ownership, the prudent course of action is to make further investigations.” Id.

Second, even if Overton did not overhear the argument, the supreme court discerned other circumstances that should “have aroused the suspicions of an ordinary purchaser.” Id. at 1207. Overton was aware of the Martinezes’ physical possession of the property and consequently had a duty to inquire as to their rights. A reasonable inquiry into the Martinezes’ rights would have revealed the written option agreement. At this point, Overton could not simply read the option agreement and stop. He needed to consider whether AHN’s conduct in selling the property complied with the option agreement. He should have concluded that it did not. “By its express terms, the option agreement would have plainly revealed that AHN had not purchased the quitclaim deed according to the option terms. . . . Given that Martinez remained liable on the mortgages and the property remained subject to the liens when Troco purchased the property, it would have been apparent that the conditions of the contract were breached by AHN.” Id. at 1208–09.

The supreme court also addressed the issue of whether the successive quitclaim deeds here raised red flags triggering an inquiry duty. Courts in the past have split on this issue, with the modern trend protecting BFPs who rely on a quitclaim deed. The Martinez court adopted a middle-ground position. After rejecting “the now disfavored notion that a quitclaim deed is enough, in itself, to put a purchaser on notice of a defect in title,” the court concluded that “although by no means dispositive, a conveyance by quitclaim is a significant factor to be considered when assessing inquiry notice.” Id.

In the second type of inquiry-notice-from-possession case, the purchaser has ignored the person or persons in possession. The purchaser may have known there was a possessor, and perhaps even that person’s identity, but decided to avoid interaction. Alternatively, sometimes the purchaser is unaware of the fact of possession by someone other than the seller. That may follow because the purchaser did not inspect the land before buying. Or it may follow because the purchaser did not inspect carefully and thoroughly. Analysis in this group of cases involves a prediction about what the purchaser may have learned, had there been a contact, questioning, or other interchange with a possessor.

In re Clare House Bungalow Homes, L.L.C., 447 B.R. 617 (Bankr. E.D. Wash. 2011), illustrates the second type of case. Clare House addressed a dispute between residents of a senior living facility and the holders of several mortgages on the facility. Clare House developed and operated a senior community, whose residents lived in bungalows. Under written and unrecorded resident agreements, residents paid a lump sum for the right to occupy the premises and use the common facilities until death. The agreements provided for termination at the resident’s death, with Clare House promising to refund a specified percentage of the lump sum to the estate of the deceased resident. The lenders made their mortgage loans after the residents took occupancy of their bungalows. The lenders obtained financial information from Clare House but did not review any resident agreements or otherwise learn of the residents’ rights.

Lacking actual notice, the lenders claimed they were BFPs who took free of the residents’ rights to occupy the bungalows for the rest of their lives (life estates) and to obtain refunds of part of their lump-sum purchase payments. The lenders lost. The court found that each “lienholder had actual notice of the occupancy of the bungalows by residents [and thus] had a duty to make reasonable and prudent inquiry as to the terms of that occupancy if the lienholder desired to obtain rights greater than the occupants.” Id. at 624. As a consequence, the lienholders took subject to the living residents’ rights to occupy their bungalows for the remainder of their lives.

The court also indicated skepticism about the lenders’ due diligence in making their loans. “The business model of Clare House was to construct and sell bungalows and, upon the death of the resident, to pay the resident some lump sum and then resell the bungalow. It is difficult to believe that lenders who received financial and other information from Clare House would not have been aware of the basic business model of the borrower.” Id.

Both Martinez and Clare House apply the duty-to-inquire rule to the plainest and most obvious type of possession—persons other than a record holder were present and living in houses on the property. But possession of property, as law students quickly learn, is a hard-to-define, slippery concept. This is also true in our context of inquiry notice, as exemplified by Chornuk v. Nelson, 857 N.W.2d 587 (N.D. 2014). In Chornuk, before purchasing 44 acres of land, the buyers noticed neighbors mowing the grass and watering trees on a small part (1.6 acres) of the property. The buyers did not ask questions, and it turned out that the neighbors were claiming under a prior unrecorded deed. The buyers’ BFP claim failed. The court charged the buyers with inquiry notice, even though they did not know at the time who had planted the grass and trees. Even in cases in which evidence of human presence or use might be interpreted as transitory, due diligence means it is best to ask questions before paying the purchase price or funding a mortgage loan. Because of the limits to BFP status, learning information later is often too late.

Exceptions to Duty to Inquire of Possessors

Possession Is Consistent With Record Title

Courts have fashioned several exceptions to the general rule that a possessor puts the buyer on inquiry notice. One prime exception is when possession is consistent with record title. The buyer is entitled to assume that the possessor’s claim matches the possessor’s interest of record. In City of Rio Rancho v. Amrep Southwest Inc., 260 P.3d 414 (N.M. 2011), a case the authors discussed more fully in the July/August issue, the city claimed that its “open possession” of a tract imparted notice of its claim that the tract was to remain as undeveloped “open space.” The court held a purchaser of the tract qualified as a BFP, finding no duty to inquire because the city’s possession was consistent with the terms of a recorded drainage easement granted to the city.

Problems concerning the duty to inquire of possessors often arise when a person contracts to buy rental property from the landlord. If the tenant’s lease is recorded, the tenant’s possession is consistent with record title, and the buyer need not ask the tenant what rights she is claiming. The buyer can assume the recorded lease discloses the nature and full extent of the tenant’s rights. Conversely, if the tenant’s lease is not recorded, possession and record title are not consistent. The buyer is on inquiry notice that the tenant possessor has an unrecorded interest. The buyer can choose to trust the landlord/seller to accurately describe the tenant’s rights, but the buyer does this at her peril. The buyer is not a BFP if the seller told her the tenant has a month-to-month lease, but the tenant really has a term for years. See Janss v. Pearman, 863 S.W.2d 643 (Mo. Ct. App. 1993) (buyer takes subject to tenant’s right of first refusal under unrecorded lease).

The rule excusing inquiry when possession is consistent with record title plays an important role when record title is held by cotenants. Sometimes both (or all) cotenants will be in possession, in which event possession and record title match completely. But sometimes fewer than all the cotenants are in possession. Courts have deemed this situation to be consistent with record title. There is no duty to inquire, even if only one cotenant is in possession, because it is permissible and not unusual for cotenants to agree that all will not occupy. Thus, a buyer may presume that the possession of a single cotenant is consistent with, rather than adverse to, record title. See 5 Tiffany Real Prop. § 1289 (3d ed. 2016). A different rule may apply, however, when the cotenants are former spouses. See In re Weisman, 5 F.3d 417 (9th Cir. 1993) (finding a duty of inquiry when ex-wife held one-half interest of record in home presently possessed by ex-husband and his new wife; divorce property settlements do not usually continue shared ownership of the marital home).

Possessor’s Rights Are Not Real Property

In Clare House, the residents got only part of the relief they wanted. The court protected the right of existing residents to remain in their bungalows and prohibited the mortgage lenders from evicting them or charging rent. But it did not protect the residents’ rights to partial refunds of their purchase price. Under the resident agreements, when a resident died, the resident’s estate was to receive a percentage of the lump-sum payment (typically 80%) based on a number of variables.

The court held that residents’ refund rights were contract rights enforceable against Clare House (the bankrupt) but not against the mortgage lenders. The right to occupy the bungalows—a right to possession—was a right to real property and therefore superior to the lenders’ real property rights. But the obligation to refund part of the purchase price arose only at termination of the resident agreements. The court called this “an obligation to pay money” that was not “an interest in real property.” In re Clare House Bungalow Homes, L.L.C., No. 09-04651-PCW11, 2010 WL 5155949, at *4 (Bankr. E.D. Wash. Dec. 14, 2010).

On its face, the classification and outcome in Clare House seem consistent with the basic principles of recording statutes and inquiry notice doctrine. The law determines priority among competing claims to real property and says nothing about other legal claims, including contract rights and personal property. But is this outcome fair and equitable? If the issue is framed in terms of the lenders’ due diligence—what they should have learned by prudent investigation and by questioning residents—their reimbursement rights should have been as easy to discover as their rights to continued occupancy (life estates in the bungalows). If the lenders obtained and read the resident agreement, express provisions covered both topics. And if the lenders rang the doorbell of the bungalows and asked the residents what rights they were claiming, it is likely the residents would have disclosed both claims.

Obviously, the resident agreements did not give the residents an express lien on the residential units to secure repayment. The court in effect treated Clare House’s obligations as unsecured debts. Nominally they were, but a court could have implied an equitable lien, similar to the usual vendee’s lien. Alternatively, Clare House’s promise to reimburse could be construed as a covenant running with the land, binding the new owner who had inquiry notice of the promise.

Grantor’s Retained Possession After Conveyance

When an owner conveys an estate in real property, the grantee normally acquires the right of possession and in fact takes possession promptly. Sometimes, however, a grantor remains in possession after the conveyance. When the grantee’s deed is recorded, the grantor’s retained possession is inconsistent with record title. If the grantee attempts to sell the property, a prudent purchaser should notice that the grantor (the prior owner) is in possession and should make inquiry. Many states have adopted this line of reasoning, charging the purchaser who does not inquire with any unrecorded rights to the property held by the grantor. See Chandler v. Georgia Chem. Works, 185 S.E. 787 (Ga. 1936) (buyer from grantee takes subject to grantor’s claim that deed, absolute on its face, was made in trust for grantor’s benefit); M.C. Dransfield, Grantor’s Continued Possession of Land After Execution of Deed as Notice of His Claim Adverse to Title Conveyed, 105 A.L.R. 845 (1936). For example, the grantor may claim under a life estate or a “lease back” from the grantee.

But authority is split on the question whether the purchaser has a duty to ask the grantor why she is in possession. Some states excuse inquiry when the possessor is the grantor in the last deed in the chain of title, and the new transfer takes place a reasonably short period after the possessor’s conveyance. E.g., Chen v. Bell-Smith, 768 F. Supp. 2d 121 (D.D.C. 2011) (lender does not have inquiry notice of rights claimed by homeowners remaining in possession after fraudulent mortgage foreclosure rescue scheme). The rationale is that, although the norm is for a grantee to take possession on delivery of the deed, it is not unusual for the parties to agree that the grantor can stay in possession for a limited time period. Under this view, a grantor’s retained possession is consistent with record title for a reasonable period, but not indefinitely.

Unrecorded Servitudes

Sometimes, certain physical characteristics of a parcel of property other than human presence may indicate possessory claims or other ownership interests in the property. For example, you may not see a person other than the seller living on the premises, but you may spot evidence suggesting that someone else temporarily absent may live there. You might observe mail addressed to someone at the property’s address on the kitchen counter during an inspection. This might be enough to cause a prudent person to ask, “Why is this strange person getting mail at the property?”

Similarly, physical evidence might cause one to question whether someone has an easement on the property. If one sees a road across Lot X that leads to Lot Y’s garage, one might question whether the owner of Lot Y has a right to use that road. The purchaser observing such physical facts would have a duty to inquire further and be charged with the knowledge obtained on diligent investigation. Two very recent cases decided in 2017 consider when a purchaser has inquiry notice of an unrecorded easement.

In Gunter v. Peeples, No. 2015-CA-000527-MR, 2017 WL 544643 (Ky. Ct. App. Feb. 10, 2017), the Peepleses acquired property in 2007 under a deed stating they would have a right-of-way easement across the property of their neighbors. After buying, they regularly used an existing road across that neighboring property. In 2009, the Gunters purchased the neighbors’ property under a deed that made no mention of the Peepleses’ easement.

Several years later the Gunters blocked the road with a gate, and the Peepleses sued to establish an easement. The Gunters claimed they took free of the easement as BFPs, but the Peepleses claimed the Gunters had actual, constructive, and inquiry notice of the easement. The parties contested whether the easement was properly recorded under Kentucky law so as to impart constructive notice. Rather than ruling on the issue of recordation, the court resolved the dispute based on inquiry notice.

Before their purchase, the Gunters “viewed a sale map which showed that an ‘unnamed road’ traversed” the property to be purchased. Id. at *1. The trial court held that the Gunters had inquiry notice of the Peepleses’ right of way. The court of appeals affirmed. According to both courts, the Gunters’ review of the sales map triggered inquiry notice.

The court of appeals observed that the Gunters never walked the property before they purchased and were never curious enough after seeing the sales map to “investigate the site of the ‘unnamed road’ listed on” it. Id. at *3. Thus, as with any inquiry notice case, the court asked what the Gunters would have discovered had they acted prudently to follow up. Seeing the road would have triggered the duty to conduct further inquiry about the ownership rights associated with the road. By acting with ordinary diligence, they would have learned of the easement’s existence. They thus took subject to the burden of the easement.

Would the Gunters have prevailed had they not seen the sales map showing the “unnamed road” on the property they were buying? It is hard to say. Gunter illustrates how facts work in combination when a court sets the boundaries on due diligence and reasonable investigation. Here the buyers’ review of documents before purchasing heightened their duty to look for the road shown on the map. Without the map, it would have been easier to forgive the Gunters’ failure to ascertain the Peepleses’ claim to an easement.

A Washington case, also from 2017, wrestled with the same issue of inquiry notice of an access easement, but with a different conclusion, highlighting the fact-specific nature of these cases. Gervais v. Miederhoff, No. 47852-8-II, 2017 WL 588440 (Wash. Ct. App. Feb. 14, 2017). In 1992, Gervais subdivided a 15-acre tract of land into four lots. Although all the lots fronted the public road, because of the steep slope of the property he installed only two private roads for the four lots. Lots 1 and 2 shared a road connecting to the public road near the boundary between lots 2 and 3. Lots 3 and 4 shared a road that crossed lot 3 for approximately 200 feet before entering lot 4.

The recorded subdivision plat (left) showed an express 20-foot easement for the private road benefitting lots 1 and 2 but failed to show a similar easement for the road across lot 3. The plat did contain the words “Access to Lot 4” and “Access to Lot 3” pointing close to the corner between the two lots at the public road. In 2004, Rosenlund bought lot 3 and granted Gervais an easement across lot 3 for ingress and egress to lot 4, but the easement was not recorded until 2010. In 2009, Rosenlund sold lot 3 to Miederhoff.

Gervais brought an action asking the court to recognize an access easement across lot 3 for lot 4. Miederhoff did not have actual notice of Gervais’s easement, and he did not have constructive notice because of the delay in recording. So, the case turned on whether Miederhoff had inquiry notice when he bought lot 3.

Before the purchase in 2009, Rosenlund gave a disclosure form to Miederhoff stating (1) there was a road for “access to the property” and (2) “there were [not] any easements on the property or joint maintenance agreements.” Id. at *1. Miederhoff also reviewed the subdivision plat. The court concluded that neither document triggered a duty to inquire. The disclosure form language of “access to the property” unambiguously pointed to lot 3, so “a prudent person would not have been prompted to inquire as to whether this actually referred to an easement for access to lot 4 across lot 3.” Id. at *5 (emphasis in original). Nor did the plat trigger create a duty for Miederhoff to inquire, especially because it expressly included easements for lots 1 and 2, while including none for lot 4.

Thus, the only issue remaining was what Miederhoff should have discerned from his inspection of the land. Gervais claimed that the presence of a road to lot 4 across lot 3 imparted inquiry notice, but the court of appeals held that “the mere presence of a road would not necessarily have conferred inquiry notice of a full access easement over lot 3 serving lot 4.” Id. at *4. The court distinguished it from a case presenting evidence of “frequent use and clear purpose, such as a garage on the grantee’s property that faced the grantor’s property,” facts which could trigger the duty to inquire. Id.

The physical condition of the road and Gervais’s actual use of the road both counted in favor of Miederhoff. The court noted that “[t]he developed portion of the road across lot 3 consists of gravel, which is rapidly replaced by undergrowth and brush,” and the “unkempt brush” and fallen “tree branches” on the road blocked vehicular traffic and made it look more like an “an abandoned logging road” than a presently operative easement. Id. at *5.

And Gervais, not then living on lot 4, used the road only occasionally, to enter lot 4 for maintenance work. The occasional use of an easement does not trigger inquiry notice unless the buyer actually observes its use.

The supposed “clues” claimed by Gervais were neither independently nor cumulatively “enough to prompt a prudent buyer to inquire as to the existence of an unrecorded access easement for lot 4.” Id. Therefore, the court of appeals held that “Miederhoff was a bona fide purchaser who took lot 3 free of the unrecorded easement.” Id.

Implied Easements

Unrecorded easements are not the only category of servitudes that raise potential inquiry triggers. Most servitudes are created by express language, but our system of land law permits the creation of several types of servitudes by implication. Typically, such servitudes are created by the process of subdivision, that is, when the grantor sells a part of his land but retains neighboring land that is either burdened or benefited by the implied servitude. Although the implied servitude may serve the worthwhile purpose of effectuating the intent of the parties to the sale, these implied rights are hard to detect when third parties subsequently come on the scene.

One example is the reciprocal negative easement, also known in some jurisdictions as the implied equitable servitude. Sanborn v. McLean, 206 N.W. 496 (Mich. 1925), is a classic case holding that the buyer of a subdivision lot had inquiry notice of the developer’s common plan to restrict the neighborhood to residential use only. In Sanborn, the developer sold 21 lots, expressly restricting them to residential use only. The next lot, ultimately acquired by the McLeans, lacked the restriction. Eventually, 59 of the 98 lots in the subdivision had express deed restrictions. The McLeans began to build a gasoline station on their lot. The court enjoined them, subjecting the McLeans’ property to a reciprocal negative easement and rejecting their claim of lack of notice. They were “put to inquiry” on “the notice [they] had from a view of the premises on the street, clearly indicating the residences were built and the lots occupied in strict accordance with a general plan.” Id. at 498. By inquiring they “would have found of record the reason for such general conformation” lying in the obligations running with the land that prevented departures by any residents within it. Id.

In each of these kinds of cases, the courts are required to consider whether the character of the property’s use, condition, or placement within the surrounding community of properties is consistent with the possible existence of an unrecorded servitude. The American Law of Property categorizes these cases under the title “possession without human occupancy” and considers for possible inquiry triggers things like the presence of improvements, cultivation of land, cutting timber, and the like. 4 American Law of Property §§ 17.12–17.15. Persons and conditions that are potentially inconsistent with record title—and thereby possibly representative of competing claims—should be investigated by a purchaser, lest she risk losing priority to one whose interests should have been discovered and for which the purchaser will be charged with notice.

Conclusion

Inquiry notice is a factor that every prudent purchaser must comprehend. And purchasers can manage and reduce risk by obtaining an expert legal opinion on the subject. An expert legal opinion adds value for any purchase by identifying the triggers, developing the questions that must be asked, avoiding pitfalls, and otherwise organizing the due-diligence steps necessary for a purchaser to achieve BFP status.

Becoming expert in these matters opens up many new opportunities for engagement with the property sought by the client. Of course, you will obtain and carefully review all the relevant documents, including the contract of purchase and title documents. But isn’t there more to do? It’s time for a field trip. You should make the case for joining the group traveling to inspect the property. You’re knowledgeable about the doctrine of inquiry notice as it applies to persons in possession of the property. You know many of the things that can go legally wrong from failing to spot visual hints of possible third-party interests in the real property. It may serve your client well if your capable eyes study the property and develop a strategy for following up on any leads. This should help to protect your client’s expectations of good and marketable title.