Good News: That Tenant You May Not Have Known You Had Is Not A Cloud On Title

by:  Peter J. Gallagher (@pjsgallagher) (LinkedIn)

AuctionIf you have ever been to a sheriff's sale in New Jersey then you are familiar with the litany of announcements that precede each sale — "This sale is made subject to easements of record," "The property is being sold on an 'as is' basis," etc. Sellers make these announcements because, under New Jersey law, they are required to disclose "any substantial defect in or cloud upon the title of the real estate sold, which would render such title unmarketable." If a seller intentionally or negligently fails to disclose any substantial defects or clouds on title, then a court may vacate the winning bid and return the winning bidder's deposit. For example, if a seller fails to reveal the amount of unpaid taxes on a property before a sheriff's sale, the sale can be vacated if the winning bidder discovers the amount and is unwilling to pay it.

Usually included in these announcements is something making clear that the property is being sold subject to the rights of tenants and occupants, if any. But what happens when, after the sale, the winning bidder visits the property and discovers a tenant, or at least someone claiming to be a tenant, occupying the property? Does that entitle the winning bidder to vacate the sale and get its deposit back?

This is exactly what happened in PHH Mortgage Corporation v. Alleyne. In that case, the winning bidder at a sheriff's sale moved to set aside its successful bid and compel a refund of the amount it tendered to the sheriff at the sale (winning bidders are generally required to put 20% of the bid price down at the sale and pay the balance within 30 days). The winning bidder argued that, after the sheriff's sale, it sent a representative to the property and he discovered an individual who "refused to give his name but asserted rights to possession of the property as a tenant." The winning bidder argued that (1) this tenancy was a cloud on title, therefore it should have been disclosed at the sale, and (2) the seller has an independent duty to inspect for tenants on the property before the sale. The trial court rejected these arguments and the Appellate Division affirmed.

The Appellate Division held that a cloud on title "arises when an individual purchases land and his or her fee interest or ownership is either limited, questioned, or subject to an interest that will otherwise invalidate or limit his or her ownership interest in the property." As examples, the Appellate Division offered situations involving future interests, adverse possessors, covenants, easements, and any other "scenario[] where another party may divest the owner of his title." A tenant, however, cannot challenge a property owner's title. Therefore, even if the tenant in PHH Mortgage was a legitimate tenant, his presence was not a cloud on title or a defect affecting marketability that would allow the winning bidder to vacate the sheriff's sale.

The Appellate Division observed that sheriff's sales were once "subject to the doctrine of caveat emptor, and a successful bidder was bound by his purchase irrespective of the condition of the title of the premises purchased." This changed when New Jersey enacted a statute that "remediat[ed] the rule of caveat emptor in three circumscribed areas," including where there is a cloud on title or a defect affecting marketability. But, it noted that, "[o]utside of the[se] three delineated exceptions, a buyer at a sheriff's sale is subject to caveat emptor." Therefore, contrary to what the winning bidder argued in PHH Mortgage, the bidder, not the seller, bears the risk that a tenant may be on the property being sold.

Finally, the Appellate Division noted that a sheriff's sale can only be vacated when the alleged cloud on title was the result of "either an intentional failure or a negligent failure to make [a] disclosure." In PHH, there was no evidence that the individual who claimed to be a tenant actually was a tenant, much less that the seller knew of the alleged tenant, and much less that the seller acted intentionally or negligently in failing to disclose the alleged tenant's existence. As a result, even if the presence of a tenant were considered a cloud on title, the Appellate Division would not have vacated the sheriff's sale in that case.

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