Transfer Fee Covenants in New York?

The ostensible justification for imposing these fees is that if the developer knows it will be receiving transfer fees in the future, it can reduce the current sale price accordingly, allowing the buyer to defer some of the costs associated with developing the property until the time of sale, when the obligation to pay the transfer fee will reduce the amount the buyer can recover from a subsequent buyer. The developer, in turn, would be able to sell the income stream from transfer fees to a third party, thus recovering development costs up front rather than waiting for sales to generate actual transfer fees.

Problems

Monitoring by the Beneficiary

Whether this model proves economically attractive to many developers remains to be seen. The first problem is that the beneficiary of the transfer fee covenant ' whether the original developer or a transferee ' will have to monitor the property in order to collect the fees. Suppose, for instance, that the initial purchaser becomes obligated to pay $5,000 to the developer upon sale of the property Once that purchaser transfers title to a subsequent purchaser, the initial purchaser has little incentive to pay the fee; foreclosure on the property is of little moment to a party who has already received payment for that property. The subsequent purchaser bears the principal foreclosure risk, and therefore has an incentive to assume the obligation to pay in return for a reduction in the purchase price. But once the purchaser does that, the purchaser has no incentive to report the sale to the developer or the developer's assignee. As a result, the developer will have to check recorded deeds on a regular basis to ascertain whether fees have become due.

Enforeceability

The larger problem may be the enforceability of the restrictions. To date, at least eight states have enacted statutes explicitly prohibiting private transfer fee covenants. See Freyermuth, supra. California, by contrast, has explicitly authorized these covenants, subject to a number of disclosure requirements. The New York legislature has not addressed the issue, but in New York, a variety of common law doctrines make enforcement problematic.

First, New York courts have historically been hostile to the enforcement of affirmative covenants, holding that those covenants do not “touch or concern” the land. The Court of Appeals relaxed that rule in Neponsit Property Owners' Association, Inc. v. Emigrant Industrial Savings Bank, 278 NY 248. In Neponsit, the developer inserted covenants in the deeds to all parcels in a residential tract, obligating the purchasers, their heirs and assigns, to pay an annual fee not to exceed $4.00 per year for each 20 x 100 foot lot. Of critical importance, however, the developer also provided that the fee would be “devoted to the maintenance of the roads, paths, parks, beach, sewers and such other public purposes as shall from time to time be determined” by the developer or its assigns (which might include a homeowners association). The Court of Appeals emphasized that the individual homeowners were granted easements over roads and common areas, and that those easements needed maintenance. In the court's view, the developer did nothing more than exact a covenant “that the burden of paying the cost should be inseparably attached to the land which enjoys the benefit.” The court did not, however, authorize imposition of a covenant unrelated to a continuing maintenance obligation.

Moreover, in Eagle Enterprises v. Gross, 39 NY2d 505, the Court of Appeals held that a covenant to pay money for the seasonal supply of water did not “touch or concern” the land, and was therefore unenforceable. The court emphasized that “[t]he landowners in Neponsit received an easement in common to utilize public areas”; by contrast, in Eagle Enterprises, the promise to pay for water resembled a “personal, contractual promise” that the court was unwilling to enforce against successors in interest. Applying that standard, it is difficult to see how the court would hold that a private transfer fee ' unconnected with any correlative obligation to provide services to the burdened land ' would “touch or concern” the land.

Other Doctrinal Obstacles

At least two other doctrinal obstacles might prevent enforcement of transfer fees in New York. First, the Neponsit court also acknowledged the common-law rule that requires privity of estate between the initial beneficiary of the covenant and the party seeking enforcement of that covenant. In Neponsit itself, the burdened landowners argued that the property owners' association could not enforce the covenant because it had not succeeded to ownership of any of the land originally owned by the developer. The court rejected that argument because the association was, in effect, the alter ego of the homeowners ' who had succeeded to land previously owned by the developer. By contrast, with the transfer fees, any assignees of the original developer would not qualify as the alter ego of the burdened homeowners, and might be met by the argument that privity of estate barred any action to enforce.

Second, in Eagle Enterprises, the court cited the rule barring enforcement of affirmative covenants as an “undue restriction on alienation or an onerous burden in perpetuity.” Whether this argument would apply to a 99-year restriction is an open question, but it does furnish another basis for attack on transfer fee covenants.

Conclusion

In New York, then, a developer takes a significant risk in imposing a transfer fee covenant on subsequent purchasers: the risk that courts will find the covenant unenforceable. And if, as proponents of transfer fees argue, the developer will have to accept a lower price to compensate for the covenant, the developer would be better off foregoing that risk.

It should not be surprising that in a weak real estate market, developers would seek new sources of revenue. One recent source has generated controversy across the country ' requiring buyers to agree, for themselves and their assigns, to pay a fee upon each resale of the property. These transfer fee covenants raise a number of practical problems, not the least of which is the underlying legal question: Are they enforceable?

'Capital Recovery Fees'

Freehold Capital Partners claims to have helped developers impose “Capital Recovery Fees” on an estimated $600 billion worth of real estate throughout the United States. See www.freeholdcapitalpartners.com/forms/freehold_brochure.pdf. The basic model is to include a recorded restrictive covenant that obligated the purchaser to pay a transfer fee ' generally in the neighborhood of 1% of the sale price ' to the developer. The covenant imposes the same restriction on subsequent purchasers, so that the developer collects the fee each time the property is sold. Moreover, the declaration of covenants gives the developer a lien on the land to secure payment of any unpaid transfer fees. See generally, R. Wilson Freyermuth, Putting the Brakes on Private Transfer Fee Covenants, Probate & Property, July/August 2010.

The ostensible justification for imposing these fees is that if the developer knows it will be receiving transfer fees in the future, it can reduce the current sale price accordingly, allowing the buyer to defer some of the costs associated with developing the property until the time of sale, when the obligation to pay the transfer fee will reduce the amount the buyer can recover from a subsequent buyer. The developer, in turn, would be able to sell the income stream from transfer fees to a third party, thus recovering development costs up front rather than waiting for sales to generate actual transfer fees.

Problems

Monitoring by the Beneficiary

Whether this model proves economically attractive to many developers remains to be seen. The first problem is that the beneficiary of the transfer fee covenant ' whether the original developer or a transferee ' will have to monitor the property in order to collect the fees. Suppose, for instance, that the initial purchaser becomes obligated to pay $5,000 to the developer upon sale of the property Once that purchaser transfers title to a subsequent purchaser, the initial purchaser has little incentive to pay the fee; foreclosure on the property is of little moment to a party who has already received payment for that property. The subsequent purchaser bears the principal foreclosure risk, and therefore has an incentive to assume the obligation to pay in return for a reduction in the purchase price. But once the purchaser does that, the purchaser has no incentive to report the sale to the developer or the developer's assignee. As a result, the developer will have to check recorded deeds on a regular basis to ascertain whether fees have become due.

Enforeceability

The larger problem may be the enforceability of the restrictions. To date, at least eight states have enacted statutes explicitly prohibiting private transfer fee covenants. See Freyermuth, supra. California, by contrast, has explicitly authorized these covenants, subject to a number of disclosure requirements. The New York legislature has not addressed the issue, but in New York, a variety of common law doctrines make enforcement problematic.

First, New York courts have historically been hostile to the enforcement of affirmative covenants, holding that those covenants do not “touch or concern” the land. The Court of Appeals relaxed that rule in Neponsit Property Owners' Association, Inc. v. Emigrant Industrial Savings Bank , 278 NY 248. In Neponsit, the developer inserted covenants in the deeds to all parcels in a residential tract, obligating the purchasers, their heirs and assigns, to pay an annual fee not to exceed $4.00 per year for each 20 x 100 foot lot. Of critical importance, however, the developer also provided that the fee would be “devoted to the maintenance of the roads, paths, parks, beach, sewers and such other public purposes as shall from time to time be determined” by the developer or its assigns (which might include a homeowners association). The Court of Appeals emphasized that the individual homeowners were granted easements over roads and common areas, and that those easements needed maintenance. In the court's view, the developer did nothing more than exact a covenant “that the burden of paying the cost should be inseparably attached to the land which enjoys the benefit.” The court did not, however, authorize imposition of a covenant unrelated to a continuing maintenance obligation.

Moreover, in Eagle Enterprises v. Gross , 39 NY2d 505, the Court of Appeals held that a covenant to pay money for the seasonal supply of water did not “touch or concern” the land, and was therefore unenforceable. The court emphasized that “[t]he landowners in Neponsit received an easement in common to utilize public areas”; by contrast, in Eagle Enterprises, the promise to pay for water resembled a “personal, contractual promise” that the court was unwilling to enforce against successors in interest. Applying that standard, it is difficult to see how the court would hold that a private transfer fee ' unconnected with any correlative obligation to provide services to the burdened land ' would “touch or concern” the land.

Other Doctrinal Obstacles

At least two other doctrinal obstacles might prevent enforcement of transfer fees in New York. First, the Neponsit court also acknowledged the common-law rule that requires privity of estate between the initial beneficiary of the covenant and the party seeking enforcement of that covenant. In Neponsit itself, the burdened landowners argued that the property owners' association could not enforce the covenant because it had not succeeded to ownership of any of the land originally owned by the developer. The court rejected that argument because the association was, in effect, the alter ego of the homeowners ' who had succeeded to land previously owned by the developer. By contrast, with the transfer fees, any assignees of the original developer would not qualify as the alter ego of the burdened homeowners, and might be met by the argument that privity of estate barred any action to enforce.

Second, in Eagle Enterprises, the court cited the rule barring enforcement of affirmative covenants as an “undue restriction on alienation or an onerous burden in perpetuity.” Whether this argument would apply to a 99-year restriction is an open question, but it does furnish another basis for attack on transfer fee covenants.

Conclusion

In New York, then, a developer takes a significant risk in imposing a transfer fee covenant on subsequent purchasers: the risk that courts will find the covenant unenforceable. And if, as proponents of transfer fees argue, the developer will have to accept a lower price to compensate for the covenant, the developer would be better off foregoing that risk.