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IDOTs Still Work for Deposit Mortgages

Recent legislation -- Senate Bill 1302 of the First Special Session of the 2012 Maryland General Assembly as modified by Senate Bill 436 and House Bill 1209 of the 2013 Session of the Maryland General Assembly -- has seriously impaired the use of indemnity mortgages and indemnity deeds of trust (either of which is called an “IDOT”) as financing devices. However, in at least some respects, the reports of the demise of the IDOT are greatly exaggerated.

Senate Bill 1302 provided that for a loan in the amount of $1 million or more (which amount has been increased to $3 million or more by the 2013 legislation), when an IDOT is used the recordation tax applies as in the case of other financing transactions. This law ended the comparative advantage of IDOTs for loans in excess of the applicable threshold amount. Other uses of IDOTs are still available, however.

The Theory of IDOTs

The theory behind IDOTs is that there is no debt incurred when the IDOT is executed, and hence there is no tax due when it is recorded. This may apply in several different ways.

In a loan context, the liability of the grantor of the IDOT is derived from a guaranty of the loan by the owner of real property, which loan is made to a different entity (the borrower). Under the theory of IDOTs, there is no indebtedness incurred by the guarantor when the loan is made and the IDOT is recorded if the guaranty agreement provides that the guarantor is not liable unless and until the borrower defaults under the loan.

IDOTs may also be used in a “true indemnity” situation in which one party agrees to be liable to another party upon the occurrence or non-occurrence of a particular event. The first party secures its obligation by giving a mortgage or deed of trust (the IDOT) on its property to secure its obligations under the indemnity agreement. Two examples of this type of IDOT are a bank-issued letter of credit for a customer, when the customer secures its reimbursement obligation with an IDOT, and a deposit mortgage, as described below.

Only IDOTs given in loan transactions were affected by Senate Bill 1302 and the 2013 legislation. In so limiting the reach of TP §12-105(f) to certain IDOTs, Senate Bill 1302 and the 2013 legislation had the effect of validating other types of IDOTs.

Deposit Mortgages

Often, a developer or builder who contracts to purchase real property will agree to give a cash deposit to the seller. The seller is interested in using the deposit immediately. If the transaction closes as provided for in the purchase and sale agreement, there is no problem because at closing the seller is entitled to the unrestricted use of the deposit. However, there is always the possibility that the conditions for closing may not occur or that the seller may default, so that the buyer cannot or chooses not to close. Then the seller will be obligated to return the deposit. How can the buyer get comfortable that it will be repaid its deposit?

The seller may agree to secure its repayment obligation with a mortgage or deed of trust on the property – a “deposit mortgage.” The deposit mortgage will be an IDOT, but this situation does not involve a loan. Instead, the IDOT secures the repayment of the deposit under circumstances that may or may not occur. Therefore, the instrument should be recordable without the payment of recordation tax. The 2012 and 2013 legislation does not reach this type of IDOT.

The discussion above relates to the possibility that the seller defaults under the purchase and sale agreement. Consideration should be given to the possibility that the buyer defaults by not closing on the transaction even though all closing conditions have occurred. In that circumstance, the seller will find that not only did it not sell its property, but that there is an IDOT of record against it. As a planning technique, it would be helpful to the seller if in the body of the IDOT the seller was granted a power of attorney from the buyer to release the IDOT if the buyer refuses to do so when it is supposed to. Then the seller, acting on behalf of the buyer, may file a release so that the IDOT will not appear as a lien when a title search is performed.

Whoever said that the age of IDOTs is over should check the famous quote of Mark Twain.

Ed Levin wrote this article, which was published in the January/February 2014 issue of BUILDING Magazine of the Maryland-National Capital Building Industry Association, Inc. (MNCBIA).

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Date

05.16.14

Type

Publications

Authors

Levin, Edward J.

Teams

Real Estate