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The Doctrine of

Equitable Conversion:

The Buyer Takes the Hit!

NOTE:  This article is intended to be a brief summary of law only, parts of which may or MAY NOT be applicable to your situation and/or your local jurisdiction(s).  Any information you glean from this article DOES NOT constitute legal advice and should be supplemented with the advice of an attorney licensed to practice law in your locality.

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Because of the peculiarities of real property at common law, the legal ownership of a given parcel of land or a given house or any other piece of real estate does not pass from Seller to Buyer when a real estate sales contract is signed. Assuming a viable contract was signed between Buyer and Seller, and that the contract comports with the relevant state’s Statute of Frauds, legal ownership does not even technically pass at the moment Buyer pays Seller! In order for ownership to “officially and legally pass to Buyer, Seller must convey the real property to Seller by way of a viable deed. Both payment and conveyance typically take place some time after the contract is signed, usually at the Closing, so this question often arises: Which party  the Seller or Buyer  takes the hit (i.e., is liable for the loss) if property is damaged after the contract was signed but before Closing

Damage or Destruction to the Property After the Contract is Signed but Prior to Closing

As you can imagine, the answer to this question can have important consequences for the signatories to a real estate contract. For example, what happens if a Buyer contracts to purchase Seller’s house, but the house burns down a week later, a full three weeks before the Closing? Traditionally, according to what became known as the Doctrine of Equitable Conversion, the answer was: The Buyer takes the hit. The theory behind the Doctrine of Equitable Conversion is that although Buyer does not obtain legal title to the property upon executing the contract, he/she does obtain title in equity. In other words, traditionally in U.S. real estate transactions, Buyer would be liable for any losses resulting from damage to the subject property prior to Closing because he/she is deemed to be the “true” or equitable owner of the property, whereas the Seller’s interest is limited to a contractual right to the sale proceeds. Under this rigid rule designed to protect the Seller’s interests, the Buyer would still be required to pay the full purchase price to the Seller, even if the subject property was destroyed by fire before Buyer received the deed!

In order to trump or mitigate the harsh Doctrine of Equitable Conversion, parties to a real estate contract are always free to add their own rules regarding liability for losses occurring during the pre-Closing period. Thus, prior to signing, a Buyer may insist that a clause be added to the contract making the Seller liable for any damage to the property (not caused by Buyer) that occurs prior to Closing. Furthermore, regardless of what rule is in effect regarding pre-Closing liability, Buyer, like Seller, typically has an insurable interest in the property after signing the contract, and thus can purchase insurance that covers pre-Closing damage to the property.

Death of the Seller or Buyer After the Contract is Signed but Prior to Closing

Note that the Doctrine of Equitable Conversion also affects the status of a given property’s ownership when either party to the real estate contract dies or is otherwise incapacitated prior to the Closing. Thus, for example, in the event of the Seller’s pre-Closing death, and absent an agreement to the contrary, legal title to the property will pass to the Seller’s heirs, not the Buyer, but the Buyer retains equitable title, and thus Seller’s heirs must still convey the property to Buyer at the Closing. The heirs would thus take legal title to the real estate sale proceeds according to the Seller’s will or the applicable state’s intestacy laws.

See Also:

The Statute of Frauds

Common Law Vs.
Civil Law

Real Estate Sales
Transaction Overview

Preliminary Matters

v

The Role
of the Attorney

v

Hiring a Real Estate

Agent/Broker

Real Estate Seller’s Agent

Real Estate Buyer’s Agent

Real Estate Broker

v

Negotiating the
Real Estate Contract

‘For Sale By Owner’

Deciding Key Terms

v

Pre-Closing Matters
Inspections

Mortgage Issues

v

The Closing

The Deed

Affidavit of Title
ALTA Statement

 

 

 

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* Licensed to practice law in New York and Illinois.

© Roger Galer, 2004

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