By way of review, a residential lease-option is simply a “regular” residential lease coupled with an option to purchase the leased property at some future time. Typically, a portion of the rental/lease payments are credited toward the Tenant/Buyer’s down payment at purchase.
A Land Contract (aka: Contract for Deed) operates in somewhat similar fashion, except that the Buyer/Tenant has an actual ownership interest in the subject property. But, unlike the usual real estate transaction, where title is conveyed to the Buyer at or near the time of purchase and the Buyer then makes loan payments to a Lender, title is not transferred to the Buyer under a Land Contract until after all the payments have been made under the contract. Hence the name: Contract for Deed.
In many (perhaps most) states, Residential Lease-Options and Land Contracts are alive and well; but not in Texas, the execution capital of the United States.
Please don’t misunderstand. We fully support capital punishment in appropriate cases. But here, in the case of State of Texas v. Residential Lease-Option, we believe the defendant was wrongfully convicted. The following is a brief summary of the case for the defense:
A few years ago, before 2005, a few Texas real estate investors were, shall we say, not displaying the best judgment and good manners, and used the Residential Lease-Options and Land Contracts in a manner that was perhaps technically legal, but shall we say, somewhat less than honorable.
In response, the Texas legislature passed the functional equivalent of a capital punishment statute for Texas Residential Lease-Options by imposing draconian requirements and restrictions on so-called “executory contracts.”
In order to accomplish its desired result, the Texas Legislature had to redefine the term “executory contract” as: “An option to purchase real property that includes or is combined or executed concurrently with a residential lease agreement, together with the lease, [of more than 180 days] is considered an executory contract for the conveyance of real property.” Texas Property Code § 5.062(a)(2). For the sake of some semblance of brevity, we’ll forgo a discussion of the poor drafting of the statute and move right along to a discussion of the substance of the statute.
Perhaps hinting that it knew it was playing “fast-and-loose” with the term “executory contract,” the Texas legislature said only that Residential Lease-Options — but not non-residential lease options or commercial lease options — will henceforth be “considered” to be “executory contracts.”
In other words, what the Texas legislature said is that: (1) residential leases ARE executory contracts, but they’re okay; (2) purchase options that do not include a residential lease ARE NOT executory contracts, and thus are okay; and that (3) purchase options which are combined with a residential lease ARE, henceforth, to be “considered” executory contracts, and thus NOT okay.
To better understand what’s going on here, we need to define the term “executory contract.” According to Black’s Law Dictionary, an “executory contract” is “[a] contract that has not as yet been fully performed or completed. . . . In the context of the Bankruptcy Code [issues regarding executory contracts historically have arisen more frequently in bankruptcy cases than in general civil litigation] an executory contract is a contract under which obligation of both [the] bankrupt and [the] other party to the contract are so far unperformed that failure of either to complete performance would constitute material breach. . . .”
The important piece of our “executory contract” puzzle is that for a contract to be “executory,” both parties must still have contractual obligations which have not yet been performed. For example, in the case of a contract for the sale of a widget, if the seller gives the widget to the buyer, but the buyer doesn’t pay, the seller sues for breach of contract. In the widget case, the contract has been fully performed by one party and breached by the other; it is no longer a contract that requires both to perform, in other words, it is no longer executory.
Now let’s define an “option.”
Black’s Law Dictionary defines an “option” as a: “Right of election to exercise a privilege. . . . An option is an agreement which gives the optionee the power to accept an offer for a limited time.”
Because an optionee has “only” a contractual right under an option contract — and does not have any obligation or duty to perform — it simply is not possible for an optionee to breach an option contract by failing to exercise the option.
Because each party to a contract must be capable of breaching the contract in order for the contract to be executory, and because it is not possible for an optionee to breach an option contract, it must logically follow that option contracts are not — indeed, by definition cannot be — executory contracts.
Except in Texas, where option contracts that are combined with residential leases are now somehow magically transformed into executory contracts, simply because the Texas legislature, by creating a legal fiction, "considers" them to be executory.
The 2005 Texas “executory” contracts law did not, however, make residential lease options illegal, but it did impose so many requirements on those real estate contracts that are considered under the law to be “executory” that no prudent or reasonably cautious investor is likely to use (or continue using) such contracts.
Thus, Texas did not “execute” the Residential Lease Option or other residential real estate contracts that it considers to be “executory.” But it did wrongfully “convict” these types of contracts based solely on the misdeeds of a very small minority of users. An analogy many Texans are likely to understand would be for the government to restrict a certain type or class of firearm so severely that the practical effect of the restrictions would be to ban the particular type or class of firearm altogether, based solely on the misuse of it by a small number of miscreants.
We submit that legally-competent adult Texans, whether they be real estate investors or home buyers, should be free to enter into the real estate contracts of their choice and that restrictions to prevent abuse or over-reaching should be narrowly tailored so as not to unreasonably dissuade honest adults from entering into legitimate real estate contracts.
The defense in the case of State of Texas v. The Residential Lease-Option rests.