I have written a few blog posts about the Freehold Licensing transfer fee covenant.  Since the last one was posted, I have received two emails from readers which included attached underwriting bulletins with the same directive - do not insure transactions that include the Freehold covenant.  There seems to be consensus among both title industry insiders and legislatures that these types of private transfer fee covenants are bad news.  However, we must not confuse these rather unique covenants with traditional transfer fee covenants that are beneficial to the property owner, such as those used to fund community associations.

Both underwriting bulletins are similar, here is one of them:

We have received a number of questions concerning transactions in which the Freehold Licensing transfer fee covenant has been placed on the property, or it is anticipated that it will be put on the property at the closing.  This covenant purports to run with the land and requires subsequent sellers to pay a "transfer fee" of a specified percentage (usually one percent (1%)) of the consideration to a named trustee representing the original covenantor and the Freehold organization.

Several states have already passed statutes that deem such covenants void or requiring specific disclosure of its existence.  There are questions about the validity and enforceability of these covenants such as restraint on alienation, a personal right that does not touch and concern the land, covenant against public policy for free transferability of property or an illegal private transfer tax.  There is exposure to future claims for [the underwriter] if payments are not properly made by the trustee to the appropriate parties.

Accordingly, if a transaction involves property for which a Freehold Licensing covenant is previously recorded or to be recorded as part of the insured transaction, then it will be necessary to either require that the covenant be released prior to insuring, or decline to insure the transaction altogether.

These bulletins appear to be targeted specifically at the private transfer fee covenants being marketed by Freehold Licensing.  Let us not forget that not all transfer fee covenants present such problems.  In a previous blog, To Touch And Concern, I hypothesized that the Freehold covenant is not truly a covenant that runs with the land.  I believe that it is merely a private covenant to pay a sum of money and thus should not be enforceable against subsequent purchasers.  However, transfer fee covenants which are commonly used to fund homeowners' associations do not suffer from this problem.

As one court noted, homeowners' associations are created "as the medium through which enjoyment of [home owners'] common right might be preserved equally for all." The very nature of a homeowners' association is to protect home values for all in the community and, thus, there is a correlation between the fee and the land. 

This concept seems to be widely recognized by the states which are passing legislation to ban private transfer fee covenants. Texas, Florida, Missouri, Hawaii, Kansas, Oregon and Ohio have all passed or introduced legislation to ban them.  Of these states, all except for Missouri have exceptions for homeowners' associations (as well as a few other exceptions). I'm not sure why Missouri did not include such an exception, but I would guess that it was an oversight that may need to be addressed.

The number of states which are banning the Freehold-type covenants, the underwriters' refusal to insure them, and the negative press they have generated shows that there is a public policy which disfavors such encumbrances.  If you come across one of these in your search, be sure to make a clear notation for your client.  Before insuring a transaction in which such a covenant is included, a call to your underwriter may be in order.

The important thing is that you recognize the difference between the type of covenant referred to in the underwriting bulletins and legitimate transfer fee covenants used by homeowners' associations and other organizations which clearly touch and concern the land.

The legislative actions addressing these covenants are certainly good for homeowners and the title industry.  Unfortunatley, they are prospective in nature and will not affect the covenants already of record.  It would be nice to see a challenge brought against one of these covenants to see if a court would enforce them.  My guess is that it would be enforceable against the first purchaser, but most likely struck down as a private covenant that does not run with the land to bind subsequent owners.

Robert A. Franco
SOURCE OF TITLE