Austin Lease-Options have always been a favorite tool of residential real estate investors. It is easy to get tenant/buyers into such an arrangement (because of the low down payment) and has traditionally been easy to get them out through the forcible detainer (eviction) process if they default. However, changes to the Texas Property Code (Sec. 5.061 et seq.) made in 2005 define lease-options for longer than 6 months as “executory contracts” which are subject to strict regulation under the Code. Numerous initial and ongoing requirements must be observed, and the burden is on the landlord/seller to meet these. Failure to do so incurs not only penalties under the Property Code but potential liability for the landlord/seller under the Deceptive Trade Practices – Consumer Protection Act. The latter can involve treble damages and an award of attorney’s fees against the landlord/seller. (See our article regarding Austin Owner Finance vs. Austin Lease to Own Homes)
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Executory Contract Defined
What exactly is an executory contract? Look at Section 5.062(a)(2) of the Property Code: “An option to purchase real property that includes or is combined or executed concurrently with a residential lease agreement, together with the lease, is considered an executory contract for conveyance of real property. There is an exception for lease-options for six months or less – otherwise, the residential sales contract promulgated by the Texas Real Estate Commission would have violated this provision if combined with a temporary lease. Note that options that are not combined with a residential lease as well as options on commercial property are not affected by Sec. 5.061.
Executory contracts include any transaction that defers some action by either party that pertains to ownership or possession of real property into the future. Think of it this way: an “executed” contract is one that is fully performed today. It is done, finished. An “executory” contract, on the other hand, leaves something dangling. Usually the dangling item is the most important item of all, namely, who owns the property and when do they get the deed?
Structure of an Executory Contract
Executory contracts can often be recognized by their similar structure. Typically, one party (the seller) holds “legal title” to the property. This usually means he retains a deed to the property in his name. The other party (the buyer) holds “equitable title,” meaning that he has only an equitable right to receive legal title at some time in the future if certain conditions are met. This arrangement gives an advantage to the seller, because enforcement of “equitable rights” by a purchaser generally involves filing suit and asking that one’s equitable rights be recognized by a court and enforced – a lengthy and expensive process at best. Buyers under financial pressure are more likely to abandon their option rights along with their down payments.
In the past, unscrupulous sellers used this situation to their advantage. They disregarded the buyer’s equitable rights, representing to Justices of the Peace that such buyers were ordinary tenants subject to ordinary leases, obtaining evictions for minor or technical defaults, and often confiscating large down payments in the process. The seller was then free to move on to his next “victim” and obtain another down payment. The legislature rightly acted to stop such abuse.
Landlords and sellers should generally avoid lease-options because of the numerous requirements and potential liability for doing them improperly. In addition to stiff penalties contained in the Property Code, certain violations are defined to be DTPA violations, which can result in treble damages plus attorney’s fees.
Such contracts are no longer advisable or even feasible for property in Texas unless the property is paid for or used exclusively for commercial purposes.