OFFICIAL OPINION No. 29

OFFICIAL OPINION No. 29 Interest-Residential Mortgages-Vacation Lot Sales-Act No. 6 of 1974. 1. The sale and financing of land does not come within the requirement of "residen- tial mortgage" in Act No. 6 of 1974 that it be property "on which two or fewer residential units are to be constructed," unless the construction of a residence is included or required in the agreement of sale or is provided for in a separate agreement approximately contemporaneous with the agreement of sale. 2. A "residential mortgage" exists even though the transaction may involve a vaca- tion home or second residence. 3. Article III of Act No. 6 of 1974 (involving financing of residential mortgages) may apply to sales of lots where it is determined that a residence is to be con- structed if title is transferred to the buyer and a security document given to the seller or other lender to finance the sale. 4. Articles II and III of Act No. 6 of 197 4 do not clearly apply to sales of lots where it is determined that a residence is to be constructed where the lot is sold on an installment sale. Legislation is recommended to rectify this situation. 5. Article III of Act No: 6 of 1964 is not merely an exception to Article II. It also covers transactions such as purchase-money mortgages which do not come under Article II. 6. Where a financial institution is intimately involved in the sale of vacation lots, there may be a loan or use of money, and the Department of Banking is urged to keep a close watch on such transactions and determine whether legislation, regulation or litigation is warranted. 1 It should be emJ?hasized that the rationale of this Opinion applies only wh~re the local authonty is required to let bids and becomes a party t<:> the constru~on contract or otherwise authorizes the public work throug~ a direct undertaking with the contractor or subcontractor. Where the Authonty preforms merely a financin~ function (like the Pennsylvania Industrial Dev~lopment ;Auth?~ty, see Official Opinion No. 252 of July 25, 1962), the conclusions of this Op1ruon are not applicable. 100 OPINIONS OF THE ATTORNEY GENERAL Honorable Carl Dellmuth Secretary of Banking Harrisburg, Pennsylvania Dear Secretary Dellmuth: Harrisburg, Pennsylvania June 7, 1974 You have requested our opinion regarding the application of Act No. 6 of 19741 to sales of land in the so-called vacation home market. Typically, in this type of transaction, a developer sub- divides lots, installs certain amenities and recreational facilities, and sells lots to the public. Three main methods of selling and financing these lots have been brought to our attention by the Pennsylvania Vacation Land Developers Association. These are: (1) a cash sale where the buyer provides his own financing; (2) a sale under an installment sales contract where title to the land is held by the developer until final payment; and (3) a sale where title is immediately transferred to the buyer in return for a note in which the buyer promises to pay the balance of the purchase price in installments. In cases (2) and (3), the developer will normally discount the note or installment sales contract with a bank or other financing in- stitution. The purpose of Act No. 6 is to reform the general usury law and deal with problems regarding residential mortgages and liens on residential properties. It contains six articles but the only ones we are concerned with here (aside from Article I which contains definitions) are Articles II and III, the former of which is concern- ed with interest rates generally, and the latter of which concerns interest on "residential mortga~es," as defined in the Act. The basic question to be answered is whether Article III applies to these sales of lots. The key to this ci,uestion is whether the transaction involves a "residential mortgage. 'If it does, the maximum interest rate is a flexible one which will normally exceed 6%,2 provided the 1 41 P.S. §101-605, al proved on January 30, 1974. Act No. 6 generally retains 6% as the maximum lega rate of interest for loans or use of money in an amount less than $50 000 (Section 201, 41 P.S. §201) but provides for flexible rates of interest for "residential mortgages" based on Long Term United States Government Bond Yields. Section 30l(b), 41 P.S. §30l(b). Section 604, 41 P.S. ~604 , excludes all other acts providing special interest rates from the effect of Act No. 6, and the only Act it specifically repeals is the Act of May 28, 1858, P.L. 622, as amended, 41 P.S. §§3-4. 2 The legal rate of interest for June, 1974 under Article III is 9\.\i%. 4 Pennsylvania Bulletin 949. Section 301(f)(ii), 41 P.S. §301(f)(ii) excepts obligations of $50,000 or less from the maximum interest rates provided by both Articles II and Ill, which are "evidenced by a security document and secured by a lien upon real property, other than a residential mortgage .... " OPINIONS OF THE ATTORNEY GENERAL 101 other provisions of Article III are met. See Sections 301(b), (d), 41 P.S. §§ 30l(b), (d). "Residential mort~age" is defined as "an obligation to pay a sum of mone)7 in an original bona fide principal amount of fifty thou- sand dollars ($50,000) or less, evidenced by a security document and secured by a lien upon real property located within this Com- monwealth containing two or fewer residential units or on which two or fewer residential units are to be constructed and shall include such an obligation on a residential condominium unit." Section 101, 41 P.S. § 101. (Emphasis supplied). The fundamental question which must be answered in deter- mining whether the vacation land sale transaction comes within this definition is whether it involves real property "on which two or fewer residential units are to be constructed," because, at the time the property is transferred, it is a vacant lot. While it is normally anticipated that a residential structure or some type of building will be constructed, it is often uncertain as to when this will be done, or whether it will be done, since the buyer may elect not to construct any building on the lot. In addition, a question is raised as to whether a vacation home is in fact a "residential unit." In our opinion, the determining factor is the interest of the lender or seller in the ultimate construction of a "residential unit." This factor is critical not only in the vacation sale transaction, but in any sale of land. Unless the lender is in some way involved in financing the construction of a residential unit, it would be im- possible for the lender to ascertain whether a particular vacant lot would meet the criteria of a residential mortgage. A borrower might certify that a residential unit is or is not to be constructed, but the lender could not hold the borrower to such a certification or the borrower might, in good faith, change his mind. We do not believe that Act No. 6 can operate on such uncertainties. We are therefore of the opinion that the residential mortgage provisions were not intended to cover simple land sales, unless the construc- tion of the residence is included either in the agreement of sale or in a separate agreement approximately contemporaneous with the agreement of sale. We note that the definition of "actual settlement costs" in Section 101, 41 P.S. § 101 allows a service charge, which, "in the case of a construction loan" may be as high as 2% of the original principal amount of the loan. It is therefore clear that a "residential mortgage" exists where a lender finances both the sale of the lot and construction of the residence. Where only the finan- cing of the sale of the lot is involved, a "residential mortgage" would nevertheless exist if the agreement requires that a residence be constructed within a certain period of time or states that the 102 OPINIONS OF THE ATTORNEY GENERAL seller or some other contractor will construct a residence. If, on the other hand, these conditions do not exist, or if the agreement or deed specifically states that no residence is to be constructed,3 then the requirements of a residential mortgage are not met. Furthermore, in our opinion, the fact that the buyer might be using the property as his second reside!1ce .or vacation. reside_nce makes no difference. In terms of regulat10n, it would be impossible to make legal distinctions on this variable. Different persons might purchase the same lot. For one, a rustic, it would be his only residence; for another, it might start out as a second residence and become a primary residence. The application of Article III cannot be practically determined by these factors, nor need it be. The definition speaks in terms of whether a "residential unit" is to be constructed, not whether it is the only residence of the individual. Accordingly, so long as the contemplated structure is a residential- type structure, the requirements of this section are met. Based on the foregoing observations, which can only be general in nature, we recommend the promulgation of regulations by your Department specifying how a determination may be made whether a "residential unit" is "to be constructed" on land. We next analyze the three main methods of selling and finan- cing, bearing in mind that before Article III can apply to any of them, they must meet the initial hurdle of constituting land on which a residential unit is to be constructed. (1) A cash sale where the buyer provides his own financing. Where a buyer pays cash, Act No. 6, of course, has no applica- tion. Where however, a buyer or seller arranges financing from other than the seller, the transaction would be subject to Article III under the circumstances discussed in (3) infra. If it did not meet the requirements of a "residential mort~age," it would be exempt form both Articles II and III under Section 301(f)(ii), 41 P.S. §§301(f)(ii). (2) A sale under installment sales contract where title to the land is held by the developer until final payment. Upon ou~ review of this type of transaction, we reluctantly con- clude that it does not appear to be covered under either Articles II4 3 We are adv.ised that so!Yle vacation land sale developments are for camp sites only and proh1b1t construct10n. Such developments wo.u ld.not be subject to Article III of Act No. 6. nor would they be subject to the 1Im1tat10ns of Article II under Sec- tion 30l(f)(ii). 41 P.S. §30l(f)(ii). cl Our inquiry into the.applicability of Ar~icle.II is necessary because of our conclu- sion, mfr,c; .. that this type of trans~ct10n 1s not ."secured by a lien upon real property. Accordingly, the exernpt10n from Article II otherwise provided by Section 30l(f)(n), cl l P.S. §30l(f)(n), is not applicable. OPINIONS OF THE ATTORNEY GENERAL 103 or III of Act No. 6. Article II governs the interest rate on "the loan or use of money." Under cases construing the prior usury law, Act of May 28, 1858, P.L. 622 (found, before repeal, at 41 P.S. §3), our courts construed similar language not to include installment sales of merchandise on credit. See Equitable Credit and Discount Co. v. Geier, 342 Pa. 445, 455 (1941); Equipment Finance, Inc. v. Grannas, 207 Pa. Superior Ct. 363 (1966); Lansdowne Finance Co. v. Prusky, 120 Pa. Superior Ct. 555 (1936); Personal Discount Co. v. Lincoln Tire Co., 67 D. & C. 35 (1949); Melnicoff v. Huber Investment Co., 12 D. & C. 405, 407-408 (1929). These cases have never been overruled in Pennsylvania. The theory of these cases is found in Geier, supra: "[i]t being uni- formly held that sellers are free to contract with buyers as to the terms and conditions of sales, the financing of sales of merchandise by the extension of credit has never been considered subject to the prohibition of usury or to regulations applicable to banking and loan transactions." 342 Pa. at 455. The parties may thus" ... agree on one price if cash is to be paid and upon as large an addition to cash price as may suit themselves if credit be given, and it is wholly im- material whether the enhanced price is ascertained by the simple addition of a lumping sum to the credit price or by a percentage thereof." Melnicoff v. Huber Investment Co., supra at 408. While these cases involve merchandise, the rationale would apply equally to the sale of real property, and interestingly enough, the seminal case espousing this doctrine did involve the sale of real property. Hogg v. Ruffner, 66 U.S. 115 (1861). We do note, with considerable interest, that the effect of these cases has been considerably limited by legislation. The doctrine no longer applies to installment sales of certain goods and services used primarily for personal family or household purposes,5 install- ment sales of goods or rendition of services for home im- provements,6 and installment sales of motor vehicles.7 An extreme- ly interesting question may be raised as to whether the General Assembly, through the passage of these acts, has in effect changed the Common Law of the Commonwealth so as to abolish the doc- trine excluding installment sales from usury. See Landis, Statutes and the Sources of Law, Harvard Legal Essays 213 (1934). In addition, courts in other states have abrogated the doctrine in 5 See Goods and Services Installment Sales Act of October 28, 1966, P.L. 55, 69 P.S. §1101 et seq. 6 See Home Improvement Finance Act of August 14, 1963, P.L. 1082, as amended, 73 P.S. §500-101 et seq. 7 See Motor Vehicle Sales Finance Act of June 28. 1947, P.L. 1110, as amended, 69 P.S. §601 et seq. 104 OPINIONS OF THE ATTORNEY GENERAL recent years8 and it is possible that our Supreme Court might also do so. While these interesting speculations may be raised, we believe that in our role as the legal advisor to State government,9 we are bound by the final decisions of Pennsylvania courts. We therefore conclude that there is not a loan or use of money in such transactions and Article II does not apply. We next turn to whether the transaction is nevertheless covered under Article III of Act No. 5 as a residential mortgage. 10 We face this question because in our opinion, Article III is not simply an ex- ception to Article II, but is rather an independent section govern- ing "residential mortgages" whether or not the transaction involves the loan or use of money. Our reason for this conclusion is the legislative intent found in Section 301(a), 41 P.S. §301(a) to establish a flexible maximum rate for "residential mortgages." While the heading of Article III is entitled "Exceptions to Maximum Lawful Interest Rate," it is not controlling. Section 1924 of the Statutory Construction Act, 1 Pa.S. §1924. Nor is the language in Section 201(a), 41 P.S. §201(a), controlling. That section simply means that Article III is an exception to certain Article II transactions, not that it applies only in transactions which would come under Article II. Otherwise, purchase money mortgages of residential units, which are clearly within the definition of "residential mortgage" and within the legislative intention, but do not involve the loan or use of money under Article II, would not be covered by Article III. In our opinion, therefore, to read Article III as simply an exception to Arti- cle II would frustrate the legislative intent. Turning to the question, however, it is our opinion that the defini- tion of residential mortgage does not clearly cover this transaction. In addition to the question discussed above regarding the construc- tion of a residential unit, we are of the opinion that the requirement that the obligation be secured by a lien upon real property is not met where the seller simply retains title. While it might be argued that the retention of title 1s the ultimate lien on real property, the statute 8 The seminal case is State v. J.C. Penny Co .. 48 Wis. 2d 125, 179 N.W. 2d 641(1970). This case was followed in Rollinger v. J.C. Penny Co., 192 N.W. 2d 699 (S.D. 1971) and State ex rel. Turner u. Younker Brothers, Inc., 210 N.W. 2d 550 (Iowa 1973). Other states have declined to follow Wisconsin. See Johnson v. Sears Roebu.ck & Co., 14 Ill. AJ2p. 3d 838, 303 N .E. 2d 627 (1973); Standard Oil Co. v. Williams, 288 N.E. 2d 170 (lnd. 1972); Sligerv. R.H. Macy& Co., 59 N.J. 465, 283A.2d 904(1971). The most recent cases are collected in qecil_v .. Allied Stores Corp .. 513 P. 2d 7_04, 707-709 (Mont. 1973) and m Annot., Va!td1ty and Construct10n of Revolving Charge Acco~pt Contract or Plan," 41A.~.R . 3d 682 (1970 and supplements). See also, Annot., Advance m Price for Credit Sale as Compared with Cash Sale as Usury," 14 A.L.R. 3d 1065 (1965). !.l Sections 512, 902 of the Administrative Code of 1929, 71 P.S. §§192, 292. 10 The discussion of this question assumes that the initial hurdle discussed above - that the transaction involves land upon which a residential unit is to be con- structed - has first been overcome. OPINIONS OF THE ATTORNEY GENERAL 105 is ambiguous on this score, 11 and we do not believe that it covers such installment sales of real estate where title does not pass. We are further supported in this conclusion by the title of Act No. 6 which nowhere gives notice that it would cover an installment sale of real estate where title is retained. 12 In view of the abuses that the General Assembly has noted in this type of transaction, 13 we recom- mend that the General Assembly amend Act No. 6 to clarify this situation since persons purchasing under installment contracts are often the persons who most need protection against an excessive rate of interest. (3) A sale where title is immediately transferred to the buyer in return for a note whereby the buyer promises to pay the balance of the purchase price in installments. In our opinion, this type of transaction would be covered by Arti- cle III of Act No. 6 if the sale involves real property on which a residential unit is "to be constructed," as we defined that term above. Where a seller conveys title to such property to a buyer a.nd takes back either a note or other form of indebtedness covered un- der the definition of "security document," in our opinion, a "residential mortgage" is created if the other requirements of the definition are met. This type of transaction meets the other re- quirements of Article III missing in (2) above. (4) Involvement of Financial Institutions. In all of the above discussions, we have assumed a simple trans- action between a seller and a buyer. It is true in the large majority of cases, the seller will then discount the agreement or note with a bank or other financial institution. Nevertheless, based on the cases we have discussed, the mere sale of such agreements or notes does not convert the transaction to a "loan or use of money." However, there may be instances where the financial institution is intimately involved in the entire transaction, as, for example, where a bank or other financial institution agrees with a developer to buy all the develop_er's sales agreements or loans; where the 11 The ambiguity in the statute is further enhanced by the requirement in the definition of "residential mortgage" that the obligation be evidenced by a "securi- ty document." "Security document" is defined in Section 101 to mean a "mortgage, deed of trust, real estate sales contract or other document creating upon recordation a lien upon real estate." (Emphasis added). Normally, a real es- tate sales contract does not, upon recordation, create a lien upon real estate. Rather, it evidences an equitable interest in favor of the buyer rather than a lien for the purchase price in favor of the seller. While we recognize this further am- biguity, it does not change our position because there may be instances where real estate sales contracts would or could contain provisions favorable to a seller which possibly could create a lien. We recommend this to the General Assembly for further clarification. 12 See Pa. Const., Art. III, § 3. 13 See Installment Land Contract Law of June 8, 1965, P.L. 115, 68 P.S. § 901 et seq., which, however, applies only to Philadelphia and Allegheny Counties, Sec- tion 3(a), 68 P.S. § 903(a). 106 OPINIONS OF THE ATTORNEY GENERAL developer guarantees the loan; where the developer uses the forms of the bank or where the credit of the buyer must be approved by the bank before the developer will sell the property to him on an in- stallment basis. It may be argued that this type of involvement does convert the transaction into a loan or use of money. There is no prior Pennsylvania appellate case law on this ques- tion. The lower court cases reach different decisions without ex- plaining satisfactorily the basis of those differences. Compare Medical Dental Business Service of New Jersey, Inc. v. Morrison, 51 D. & C. 552 (1944) and Professional Service Credit Association, Inc. v. O'Hara, 40 D. & C. 291 (1940) with General Motors Accep- tance Corp. v. Freeman, 63 D. & C. 163 (1946). An attempt to ex- plain these decisions is found in Weaver, Grose, Langhart & May, Inc. 'V. Myers, 17 D. & C. 2d 405 (1958). The Court there stressed the facts of each case as being important determinants and dis- tinguished cases involving subsequent sales of paper from those in- volving the original creation of obligations. Accordingly, since the law is not clear, we believe that your Department should keep close surveillance on the involvement of financing institutions in these types of transactions so that ap- propriate action, by way of legislation, regulations or litigation by this office may be instituted where indicated. We trust the above discussion has been helpful in setting forth some of the parameters of the transactions which come under Act No. 6. We have no doubt but that there will be additional problems which will arise under the Act, and we stand ready to be of such further assistance as we may be called upon to render. Sincerely, Gerald Gornish Deputy Attorney General Israel Packel Attorney General