This article discusses rent skimming remedies for sellers and lenders affected by a buyer’s rent skimming activities.

Five or more is a crime!

Rent skimming is the use of rents received by a buyer from a parcel of residential rental property during the buyer’s first year of ownership, without the buyer first applying the rent (or an equivalent amount) to the payments due on all notes secured by the property. [Calif. Civil Code §890(a)]

A parcel is real estate with a single legal description: containing one-or-more residential units within the boundaries of the parcel.

A buyer who rent skims from five-or-more parcels exposes himself to the penalties for multiple acts of rent skimming.

The multiple act of rent skimming occurs when a buyer skims rents during the first year of ownership from five-or-more parcels of residential rental property which he acquired during a two-year period and are security for loans. [CC §890(b)]

Skimming the rents

A buyer seeks to purchase residential rental property. The buyer has insufficient cash savings for a down payment on investment property. The buyer locates residential property valued at $150,000, encumbered with a $130,000 first trust deed.

The seller is motivated to accept a “no-down” offer since he will:

• sell the property at his asking price;

• earn interest income on a carryback arrangement; and

• defer profit tax reporting on the sale until the principal is paid.

The buyer offers to enter into a land sales contract, all-inclusive trust deed (AITD) or a lease-option sale with the seller, called wrap-around financing.

The buyer will not make a down payment on the property. However, a deferred down payment will be paid through additional periodic payments over a three-year period.

The seller will defer payoff of his equity in the property via the carryback arrangement, and continue to make payments to the underlying lender himself. The payments to the lender will be funded by the buyer’s installment payments due on the carryback.

The purchase agreement calls for the seller to convey (or reconvey) the real estate to the buyer on completion of all payments on the purchase price.

For the seller, this financing arrangement seems to match his goals. The seller can convert his real estate equity into interest income and principal payments with:

• what he perceives as a high degree of safety;

• a higher interest rate than offered on insured savings accounts; and

• apparent out-of-pocket relief from loan payments and property management.

The seller accepts the buyer’s offer, and the buyer takes possession of the property.

The buyer then rents the property to a tenant. However, within one year of purchasing the property, the buyer fails to make payments to the seller.

The seller defaults on the payments to the first trust deed holder since the seller is unable to fund the loan payments without payments from the buyer.

Due to the seller’s default in payments, the senior trust deed holder forecloses on the property and acquires it at the foreclosure sale, wiping out the seller’s, buyer’s and tenant’s positions.

The lender, having acquired title, serves the tenant with a 30-day Notice to Quit Due to Foreclosure, and the tenant vacates the property. [See first tuesday Form 573]

The tenant sues the buyer seeking to recover his security deposit and moving expenses.

Also, the seller sues the buyer for money damages caused by the buyer’s rent skimming activities. The seller seeks to recover the amount of his equity still owed to him on the purchase price.

Can the tenant and the carryback seller collect their money losses caused by the buyer’s rent skimming?

Yes! Both the tenant and the carryback seller have separate claims against the buyer. Each individually can collect their money losses caused by the buyer’s rent skimming activities.

Now consider an individual who occupies an abandoned residential property, which is encumbered by a trust deed lien, by taking possession and renting it to a tenant.

The individual, sometimes called an adverse possessor, collects rent during the first year after occupying the property. No part of the rent is applied toward payments on the trust deed note.

The lender holding the trust deed claims the adverse possessor engaged in rent skimming since no part of the rents collected was applied toward the payments due on the trust deed note.

The adverse possessor claims he did not engage in rent skimming since he rented the abandoned property as his initial step toward acquiring title to the property.

However, the adverse possessor has engaged in rent skimming. He occupied the property, rented it to a tenant and failed to use the rent received to pay the mortgage. [People v. Lapcheske (1999) 73 CA4th 571]

The tenant recovers

A tenant in residential property may recover actual out-of-pocket money losses from a buyer who engages in rent skimming causing:

• the property to be sold at a foreclosure sale; and

• the tenant to be forced to move.

The tenant’s recovery includes any security deposit lost, moving expenses, and attorney fees and court costs.

Also, the tenant may collect punitive damages from the buyer at three times the amount of the tenant’s out-of-pocket losses when:

• payments on the trust deed were delinquent at least two months at the time the tenant rented the property; or

• the buyer participated in multiple acts of rent skimming. [CC 891(d)]

The tenant’s recovery for rent-skimming is in addition to his remedies for the buyer’s breach of the rental agreement. For example, under a landlord’s breach of a lease, the tenant can collect lost rental value for the remaining lease period should the rent he pays on a comparable replacement residence be higher.

The seller recovers

The carryback seller is entitled to his actual money losses caused by the buyer’s rent skimming. The seller’s recovery includes the amount owed under a carryback note, land sales contract or lease-option – despite anti-deficiency, nonrecourse law.

Also, the carryback seller is entitled to collect other money losses caused by the buyer’s activities, such as waste. [CC §891(a),(g)]

The carryback seller is further entitled to punitive damages of no less than three times the seller’s out-of-pocket losses – if the buyer participated in multiple acts of rent skimming. [CC891(a)]

Deed-in-lieu protection

A carryback seller who reacquires the property by a deed-in-lieu of foreclosure from a buyer who engaged in rent skimming is entitled to a court order clearing title of any judgment liens brought about by the rent skimmer.

The alternative to a deed-in-lieu is to foreclose on the carryback trust deed and eliminate the junior liens by a trustee’s sale.

The seller reacquiring clouded title under a deed-in-lieu must give the lienholders at least 30 days advance written notice of the seller’s intention to remove the liens by court order. [CC §891(b)]

The lender’s recovery

A lender whose loan is secured by property acquired by a buyer involved in multiple acts of rent skimming may recover its actual money losses from the buyer, limited, however, to the rent collected on the property – whether or not the buyer assumed the loan. [CC §891(c)]

Rent recovery is separate from any recovery on the note through foreclosure. If the lender underbids at the trustee’s sale by the amount of rent collected, anti-deficiency law will not prevent the lender from recovering the rents – up to the amount of the loss on the underbid.

Rent skimming prosecution

Not only will a buyer engaged in multiple acts of rent skimming be liable for money losses he inflicted on the tenant, seller and lender, but the buyer will be subject to criminal prosecution.

Prosecution for the multiple acts of rent skimming must be filed within three years after the last parcel involved in each rent skimming charge was acquired by the buyer. [CC §892(c)]

For example, a landlord skims the rents off more than five parcels, all of which were acquired within a two-year period.

The state files criminal charges on:

• an initial act of rent skimming (rent skimming on five parcels acquired in a two-year period); and

• additional acts of rent skimming for each parcel not included in the five parcels establishing the initial act.

The state files the charges within three years of the landlord’s acquisition of the fifth parcel included in the charge for the initial act (five parcels). However, while the parcels under the additional charges were acquired during the same two-year period covered by the initial charge, the parcels were not acquired within the three-year statute of limitation for rent skimming.

The landlord claims the criminal charges cannot be brought for the additional acts since the landlord acquired those parcels more than three years before the state brought the action.

The state claims the prosecution of each additional violation is proper since all the charges were brought within three years after the last acquisition of a parcel subject to rent skimming, and the additional acquisitions occurred within the two-year period ending on acquisition of the last parcel.

However, the state’s action for each additional rent skimming act after the first violation (comprised of five separate acts of rent skimming) is time-barred. The acquisition of each additional parcel which is the subject of each additional charge did not occur within three years prior to filing the action. [People v. Bell (1996) 45 CA4th 1030]

A buyer found guilty of five acts of rent skimming is subject to imprisonment for one year, a fine of no more than $10,000, or both imprisonment and a fine.

For each additional act of rent skimming in excess of the five properties, the buyer is subject to an additional one-year imprisonment, or $10,000 fine, or both the imprisonment and fine. [CC §892(a)]

If the buyer was previously convicted of multiple acts of rent skimming, further rent skimming will subject the buyer to one-year imprisonment, a fine of no more than $10,000, or both imprisonment and a fine for each additional act of rent skimming. [CC §892(b)]

Buyer’s defenses

The buyer may avoid rent skimming charges, both criminal and civil, if the rents were used to pay medical expenses, or licensed contractors or material suppliers to correct violations relating to habitability of the property if:

• the payments are made within 30 days of receiving the rental revenue; and

• no other source of funds existed from which to make the payments. [CC §893]

Thus, to avoid rent skimming charges, buyers who become delinquent must mail in the monthly rent received from tenants to the lender. Typically, the lender sends it back, refusing the rents since the amount is insufficient to fully reinstate the loan.

The federal scheme

Many buyers seek out desperate sellers who are in default on loans insured by the Federal Housing Administration (FHA) or Veterans Administration (VA). The buyer acquires the property with little or no money down, then converts the property to a rental unit.

For example, an investor purchases homes in default, encumbered by FHA and VA loans. The investor rents the properties but makes no attempt to pay on the underlying loans after receiving rents from the properties.

The investor is prosecuted for equity skimming by the federal government.

The investor claims the government cannot prosecute him unless it can show the investor had an intent to defraud the government.

However, the investor need not even be aware the properties are FHA- or VA-insured in order to be convicted for rent skimming when the investor:

• rents the property;

• collects rents; and

• fails to make payments on the loans. [United States v. Laykin (9th Cir. 1989) 886 F2d 1534]

An investor will be guilty of rent skimming under federal law if the investor:

• purchases one-to-four unit residential properties subject to FHA/VA loans which are in default at the time of purchase, or defaults on the loan within one year after purchase;

• intentionally fails to make payments on the loans as they become due; and

• uses the rental income for his own purposes. [12 United States Code §1709-2]

The investor may be guilty of rent skimming regardless of whether the investor is personally obligated on the FHA/VA loan.

However, the federal rent skimming statute does not apply to the investor of only one property subject to a FHA/VA loan. The investor must be guilty of two or more acts of rent skimming on properties subject to FHA/VA loans.

An investor found guilty of rent skimming will be subject to a fine no greater than $250,000, imprisonment for no more than five years, or both a fine and imprisonment. [12 USC §1709-2]

In response to previous rent-skimming conduct by investors, the Department of Housing and Urban Development (HUD) now attempts to prohibit the assumption of post-1989 loans, even by qualified investors.

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