University of Missouri School of Law Scholarship Repository Faculty Publications Fall 2010 Private Transfer Fee Covenants: Cleaning Up The Mess R. Wilson Freyermuth University of Missouri School of Law, [email protected] Follow this and additional works at: http://scholarship.law.missouri.edu/facpubs Part of the Dispute Resolution and Arbitration Commons, and the Property Law and Real Estate Commons Recommended Citation R. Wilson Freyermuth, Private Transfer Fee Covenants: Cleaning Up the Mess, 45 Real Prop. Tr. & Est. L.J. 419 (2010) This Article is brought to you for free and open access by University of Missouri School of Law Scholarship Repository. It has been accepted for inclusion in Faculty Publications by an authorized administrator of University of Missouri School of Law Scholarship Repository. PRIVATE TRANSFER FEE COVENANTS: CLEANING UP THE MESS R. Wilson Freyermuth* Editors' Synopsis: The purposes for creating a "private transfer fee" covenant rangefrom supporting community services to creatingafuture revenue streamfor the developer. Traditionally,courts examined these covenants using the touch and concern standard.The Restatement (Third) of Property: Servitudes, however, rejects this standard. This Article discusses this new approach as it relates to private transferfees. The authorargues that private transferfee covenants are contrary to public policy and encourages states to enact legislationlimiting the enforcement of these covenants. I. THE ECONOMICS OF TRANSFER FEE COVENANTS (PRIVATE AND OTHERWISE) ...............................424 A. Transfer Fees Payable to a Homeowners' Association........424 B. The "Quasi-Public" or "Charitable" Transfer Fee Covenant ................... ................ 426 C. The Purely Private Transfer Fee Covenant...... ...... 428 H. PRIVATE TRANSFER FEE COVENANTS AND THE TOUCH AND CONCERN STANDARD .......................... 430 A. The Touch and Concern Standard and Its Parameters ......... 430 B. The Touch and Concern Standard as Applied to Contract and Payment Rights .................... ....... 433 1. Option Contracts ............................. 434 2. Rights of First Refusal ................... ...... 435 3. Covenants Not to Compete ...........................437 John D. Lawson Professor of Law and Curators' Teaching Professor, University of Missouri. I wish to thank the following persons for their generous endowments of the University of Missouri Law School Foundation, which provided research support for this article: Shook, Hardy & Bacon, the Lewis A. & Verne H. Snyder Faculty Research Fellowship, Robert L. Hawkins, Jr., Eugene G. Bushmann, and the late Thomas L. Patten. My thanks as well to the following persons for their comments on drafts of this article or for insights shared during earlier discussions of this topic: Justin Ailes, Danny Bogart, Bill Breetz, Carol Brown, Ann Burkhart, Rod Clement, Bob Diamond, Steve Gottheim, Barry Hawkins, Bill Henning, Carl Lisman, John Lovett, Mark Manulik, Ira Meislik, Barry Nekritz, Alice Noble-Allgire, Troy Rule, Greg Stein, Ira Waldman, Dale Whitman, and Tom Wilson. I also thank Jacque Brazas, Clark Jones, and Ross Kaplan for their research assistance. HeinOnline -- 45 Real Prop. Tr. & Est. L.J. 419 2010-2011 420 45 REAL PROPERTY, TRUST AND ESTATE LAW JOURNAL 4. Tying Arrangements.................. ....... 437 5. Agreements to Retain Development Control ................. 440 6. Agreements Imposing Fees Upon Future Resales.........443 a. "QuarterSales".... .................... 443 b. One-time Resale Fees .......................... 446 C. The Restatement of Servitudes .................... 449 M. SHOULD COURTS ENFORCE PRIVATE TRANSFER FEE COVENANTS UNDER THE THIRD RESTATEMENT?...... 451 A. Transfer Fees Payable to HOAs.............. ..... 451 B. Private Transfer Fee Covenants .................... 452 1. The Nominal Casefor the Private Transfer Fee ........... 452 2. Private Transfer Fee Covenants and Sound Land Policy ................................... 456 a. Buyers Cannot Accurately Price the Effect of a Private Transfer Fee Covenant..................... 456 b. Private Transfer Fee Covenants Substantially and Unjustifiably Impair the Alienability of Affected Land .................... ...... 461 c. Private Transfer Fee Covenants Reduce the Tax Base for the Benefit of Private Parties................... 463 IV. REINSTITUTING A PROPHYLACTIC RULE... ........... 465 V. CONCLUSION .......................................... 469 APPENDIX ................................................... 470 Assume that ten years ago, Homeland Development Company (Home- land) acquired a parcel of land that it subdivided into the proposed devel- opment of Sea View, an upscale, covenant-restricted residential community. In the recorded declaration for Sea View, Homeland imposed a "recon- veyance fee" covenant, which was binding for a period of ninety-nine years, upon each lot. This covenant required the payment to Homeland of a fee upon each resale of each lot following Homeland's original transfer in an amount equal to 1%of the price in the relevant resale. The covenant further provided that if a transfer occurred and the buyer/seller did not pay the fee, a lien would arise in favor of Homeland to secure the transfer fee. Now assume that Bob and Nancy Smith, who purchased a home in Sea View from Homeland nine years ago, recently sold the home to Paul and Joanne Grant for $500,000. Several related questions now arise: Is Home- land entitled to collect a $5,000 transfer fee from the Smiths? Will a valid lien against the home arise if the Smiths do not pay the transfer fee? And will the obligation to pay this fee upon a future resale bind the Grants-will HeinOnline -- 45 Real Prop. Tr. & Est. L.J. 420 2010-2011 FALL 2010 Private Transfer Fee Covenants 421 this transfer fee covenant "run with the land" to bind successor owners of lots within Sea View? Under the traditional formulation for the enforcement of covenants run- ning with the land, the burden of a covenant did not run to bind a successor to the covenantor unless both the benefit and the burden of the covenant in question "touched and concerned" the land.' The transfer fee covenant de- scribed above is an affirmative covenant to pay money, and while the en- forcement of such covenants has a somewhat checkered history, both the benefit and the burden of an affirmative covenant to pay money can touch and concern land. 2 The classic example in modern common interest devel- opment is the lot assessment covenant, which imposes an assessment on each lot (typically payable to a homeowners' association) to fund communi- ty services and the maintenance of community facilities. Because these services and amenities benefit community residents directly (for example, by providing access to pools and parks) or indirectly (for example, by pre- serving property values through maintenance of desired amenities), both the burden and benefit of the typical lot assessment covenant touch and concern land.3 But in the hypothetical Sea View development, the transfer fee is paya- ble to Homeland, the developer, and not to the owners' association; in other words, the transfer fee is a private transfer fee. When Homeland attempts to enforce this fee upon a future transfer, Homeland likely will have sold all lots within Sea View and will no longer have any interest-other than repu- tation-in the community. In this context, the benefit of the private transfer fee covenant is personal to Homeland. In the language of the common law, the covenant is a benefit "in gross." Under the traditional common law of real covenants, in cases in which the benefit of a covenant was in gross, the burden of that covenant did not run to bind successors to the original cove- nantor.4 I See the original RESTATEMENT OF PROP. § 537 (1944); WILLIAM B. STOEBUCK&DALE A. WHITMAN, THE LAW OF PROPERTY § 8.15 (3d ed. 2000); see also RICHARD R. POWELL & PATRICK J. ROHAN, POWELL ON REAL PROPERTY 675 (1968); 2 AMERICAN LAW OF PROPERTY § 9.13 (1952). 2 STOEBUCK & WHITMAN, supra note 1, § 8.15; JOHN E. CRIBBET & CORWIN W. JOHNSON, PRINCIPLES OF THE LAW OF PROPERTY 383-87 (3d ed. 1989); 20 AM. JUR. 2D Covenants § 29 (2005). See, e.g., Neponsit Prop. Owners' Ass'n, Inc. v. Emigrant Indus. Say. Bank, 15 N.E.2d 793, 797 (N.Y. 1938). 4 See, e.g., Garland v. Rosenshein, 649 N.E.2d 756 (Mass. 1995); Bremmeyer Excavating, Inc. v. McKenna, 721 P.2d 567 (Wash. Ct. App. 1986); Caullett v. Stanley HeinOnline -- 45 Real Prop. Tr. & Est. L.J. 421 2010-2011 422 45 REAL PROPERTY, TRUST AND ESTATE LAW JOURNAL The publication of the Restatement (Third) of Property: Servitudes (Third Restatement) in 2000 has called into question the status of the touch and concern standard. The ThirdRestatement purports to abandon the touch and concern standard, and substitutes a standard under which a covenant is a servitude (enforceable against successors) unless the covenant is arbitrary, spiteful, capricious, or creates an unreasonable restraint on alienation or trade.5 In cases in which a covenant imposes only an indirect restraint on alienation-as would be the case with a private transfer fee covenant-the Third Restatement provides that the covenant does not create an unreasona- ble restraint on alienation unless it "lacks a rational justification."6 Relying in part upon this change in the Third Restatement, a developer like Homeland will argue that a private transfer fee covenant does not create an unreasonable restraint on alienation of the affected land. Instead, Home- land will