Planning for and Completing a Montana Land Sale

by James B. Lippert
copyright 1999

 

Introduction

Real estate transactions have become increasingly complex over the past twenty years and because of that increased complexity the time and money required to complete those transactions has also increased. Of course, each transaction contains its own nuances and indeed reflects the personalities of the parties. Some land sales still take place with a handshake over the fence, while others become a struggle from the sale price negotiations to the final closing. My hope is that by informing both buyer and seller about the process, the land sale becomes more of a handshake and less of a struggle.

For the seller, this means preparation and planning. Many farms and ranches operate, in part, with unwritten agreements between neighbors. These agreements typically involve access but may include property boundaries, ditches, roads and fences. This accommodation of ones neighbors is a reflection of past customs where neighbors helped neighbors so that both could go about their business without undue hardship.

Although neighbors may operate for generations in this fashion, they may balk at putting such agreements in writing or making them permanent. This reluctance arises especially when the prospect of new and unknown parties, a buyer, enters the picture. However, a buyer paying today's prices for land does not want to depend on a neighbor's good will to reach property or irrigate land. Without planning, the landowner finds himself caught between a neighbor's distrust for new ownership and the new owners need for written and sometimes ironclad agreements.

For the buyer, there must be an awareness that some of these understandings exist and may continue to exist even after the sale. They should also be aware of the impression, whether real or imagined, that new buyers, especially from out-of-state, simply want to buy their piece of the Big Sky and close the gate behind them, creating an island unto themselves. This impression creates an attitude of distrust and reluctance among adjoining neighbors to continue with past customs and understandings.

For this reason, the property owner who is considering selling property should consult with an attorney and convert as many of these understandings to recordable documents before a buyer enters the picture. Failure to complete this advance work may mean the seller is "held hostage" by a neighbor, demanding far more for a written agreement than it is worth.

That is not to say that oral agreements and understandings between neighbors are the only areas that may create added time and expense in completing a transaction. In the typical ranch sale, there are water rights, leases, and perhaps mineral rights to be transferred. There may also be easements, rights-of-way, and ditch and access agreements that must be assigned. Finally, there are corporate resolutions, mortgages, and perhaps trusts that need to be addressed. All these matters should be checked and if possible be resolved or at least explored before the buy- sell agreement is signed. Many will require negotiations with or at least approval by the buyer and seller, which, depending on the parties' attitude, may ultimately delay the closing date.

This article is intended to inform both the potential buyer and seller of some of the steps necessary to complete a typical land transaction. It is not intended to encompass all real estate transactions and does not constitute a comprehensive list of matters that may arise during the process of preparing for a closing. I hope, though, by providing some insight into the land sale process and the steps necessary to complete a sale, realistic expectations of both buyer and seller can be made and met. So for both, this article also includes a small note of caution. Depending on the legal condition of the property and the willingness of the parties to work cooperatively, getting from the buy-sell agreement to closing could involve many underlying transactions and unexpected delays.

The Buy-Sell Agreement

This contract is the "road map" for the actions of both parties until the deal closes. Both buyer and seller will or should have an attorney representing them in putting together the buy-sell if the transaction is of some magnitude. Because of its importance to the events that follow, great care should be taken in the preparation of the buy-sell agreement.

Both parties should have their obligations and duties spelled out in the agreement. The buyer should state exactly what is to be bought and the seller should list exactly what is being sold. It is imperative that both parties must understand exactly what the agreement contains and what each party must do to satisfy the other in preparation for closing the sale.

In general, the buy-sell sets out the purchase price, a description of the property to be bought, an earnest money requirement, a closing date, provision for title insurance, cost obligations, and any other terms or conditions required by the buyer or seller. Depending on the concerns of the two parties, the buy-sell may also address access, mineral rights, water rights, taxes, crops, fixtures, deed requirements and state, federal and private easements or leases. The buy-sell should also set out the conditions under which either party may stop the sale before completion.

Once the buy-sell is signed, the real work of getting the deal to closing begins. Although both sides are be represented by lawyers in a large land transaction, usually, the relationship between the two lawyers is more congenial and cooperative than in a litigation setting. In a real estate transaction, both sides are working toward the same goal, to get the deal done.

That is not to say that there won't be conflicts and problems that arise along the way. Problems arise primarily because as the process progresses, the buyer and seller both become better informed about the property, any title defects, access or other issues that were not readily apparent from the outset. These types of problems that arise must be resolved to the satisfaction of both parties or the deal may blowup.

Title Insurance

One of the first steps taken after the buy-sell is signed is to acquire a preliminary title commitment on the property. The preliminary commitment may be the first indication to both parties that the transaction will be quick and simple or long and protracted. The preliminary commitment will reveal mortgages, easements, ditch easements, rights-of-way, tax liens, mechanic's liens or any other item that may appear on the public record relating to the property.

The preliminary commitment does not identify all the problems that may surface, however. Matters not of public record that can cause headaches for both buyer and seller include state and federal leases or permits, water rights, and as I have mentioned informal agreements or understandings. The standard title policy will not insure against matters that are not of public record, and in the absence of such insurance, the buyer will typically demand some sort of written guarantee and indemnification against such matters from the seller.

Partial or Full Release of Mortgage

It is a rare farmer or rancher that does not have a mortgage on at least part of the farm/ranch property. Mortgages will appear as exceptions in the preliminary title commitment and must be cleared before the final title policy is issued. Depending on the mortgage amount and remaining security, the lender may be willing to release the mortgage it holds before closing. If the lender is unwilling to release the mortgage before closing, it will be necessary to pay off the mortgage with the sale proceeds. Generally, the lender is willing to forward a mortgage release to the closing agent provided there are assurances that the release will not be filed until payment of the debt is paid.

Mineral Rights

This is a topic that should be covered by the buy-sell agreement. Mineral rights can be severed from the surface rights and so may or may not transfer with the surface rights. Depending on the location, mineral rights may be valuable or very limited in value. Most purchasers will want to enjoy the surface with as little interference as possible from outside influences, and will want minerals included in the sale. The greater the percentage of minerals the surface owner controls, the more the surface owner can prevent the exploitation of the minerals under his land.

If the minerals will be transferred, the buyer should order a mineral title opinion which identifies the owners and percentage of ownership of mineral rights under the property. Alternatively, the buyer may want a special title insurance rider which insures title to the minerals.

In some cases, the minerals may have been retained by a prior seller or reserved by the United States when the land was granted to a patent holder under a federal homestead act. In either of those cases, the minerals will not be available for sale from the seller and it is unreasonable to expect that the seller can deliver anything more than what he owns. In other words, from the buyer's perspective, if the minerals are held by a third party the decision must be made whether to abandon the present deal, or complete the deal and attempt to acquire the minerals from third parties after the sale is completed.

Water Rights

In most parts of the West, if water rights are attached to land, its value is greatly enhanced. Many farm/ranch operations could not exist without the availability of large and dependable volumes of water for various agricultural uses. Depending on anticipated future uses of the land, water rights may be more or less valuable to the future owner. Water rights may also be severed from the land, like minerals and bought or sold separate from the land.

Montana is in the middle of a statewide water rights adjudication. All claims are being reviewed, revised and authenticated by a special Montana court. Because the water rights adjudication is itself a long and protracted process, few water right claims in Montana have been decreed and verified by the water court under the current procedure. The uncertain status of Montana's water rights should be an area of concern to the potential buyer if the anticipated use of the land involves the beneficial use of surface water.

A review of the water right claims by an attorney or water right specialist will assure the buyer that the claims have been timely made and to the extent necessary, defended before the water court. The presence of objectors (other water rights holders) or remarks (irregularities noted by the State) may require further investigation. The presence of either does not mean the claims are invalid, it may simply mean that some other person or a governmental entity does not agree with the claim as filed. However, it may also mean that the claim is invalid or that the priority date, amount of water claimed or acreage claimed will be reduced from that stated on the claim. If the use of water is critical to the purchaser's plans, water rights may require considerable time and expense to reconcile.

There is some discussion that title insurance companies will provide insurance to water rights. So far as I am aware, water is the only property right that will not be insured by a title insurance company. However, as of the date of this writing, I do not know of any water rights riders available in Montana.

Because of the inherent uncertainty attached to most claims and the lack of available title insurance, water right claims will not be included in the Warranty Deed transferring the land. About the best a purchaser can expect from the seller is a special warranty deed. This type of deed transfers the water right claims with assurances the claims have not been conveyed by seller and seller has done nothing to cloud the title to the claims.

State and Federal Leases

The assignment of state and federal leases to a new buyer can be a relatively painless process. However, neither state nor federal agencies assign leases to new landowners without some internal review. Generally, though, if the new buyer can show him/herself to be a responsible landowner and caretaker of the land, the agencies will agree to the assignment.

Neither Montana nor federal agencies approve assignments of leases to new buyers until the deed is recorded in the new buyer's name. A deed will not be recorded, generally, until the property is paid for. If the sale is contingent on the assignment of the leases, then either seller allows the deed to be recorded before he is paid or the buyer pays for the property before the leases are transferred. Usually, however, neither party is willing to, nor should, assume the risk. A practical solution in that event is the creation of an escrow whereby a third party ensures that neither buyer nor seller are burned by a sale gone bad.

Private Easements

Many farmers and ranchers have operated for years with informal agreements or understandings with their neighbors regarding access to land. These types of agreements are not on the public record and would not appear in a title report. While these relationships may have worked well in the past, they are based on personal relationships between the parties. In some instances, the minute a new personality enters the picture, those understandings become strained and may even dissolve.

More importantly, a title company will not insure access to the sale property unless the access if of record. For the buyer paying top dollar for land or a vacation or retirement ranch, the prospect of uninsured access is unacceptable and greatly devalues the land. It is therefore, imperative that a person considering selling a farm or ranch formalize and record access agreements before a buy sell agreement is even contemplated.

There are cases where adjoining landowners became opposing parties in a lawsuit over access when access was not of record and a potential sale became common knowledge. In some instances the price for settling or litigating such a dispute is many times what the access is actually worth. This situation can create long delays and added costs for the seller and consternation for the buyer. It is very important that any informal agreements regarding access be formalized and recorded before a buyer enters the picture. The delay involved in resolving this type of problem can risk the sale at worst and at best delay it and add to transaction expenses.

Rights of Way or Easements from State Governments

Recently a land sale requiring a right-of-way across state (Montana) land created considerable problems. In this transaction, the sale included deeded land accessible only through State trust land. This created a problem because the buyer contemplated placing a conservation easement on the deeded land after the sale. A conservation easement is either a sale or donation of the development rights to property from which the seller or donor gains tax benefits. Those benefits are maximized when the development rights to be sold or donated are also maximized.

In this transaction, the State was willing to grant a right-of-way deed for historic farm and ranch uses and limited additional development. Due to the potential for future impacts to the trust lands, the State was unwilling to grant a right-of-way for unlimited development. The development limitations did not allow maximization of the tax benefits the buyer wanted. Without delving further into the intricacies of this transaction, this sale was at risk because neither the buyer nor the seller understood in advance the effect that a state access easement could have on a transaction.

So for potential buyers especially, this is a note of caution. The terms of a State of Montana right-of-way deed can affect the use to which private deeded land can be put if State land provides access to deeded land. This could result in tax implications if the State right-of- way limits the development rights on private land. Prospective buyers should consult with their tax advisors and attorney if this situation arises and understand that they may not receive the full tax benefit they anticipate from a conservation easement.

Environmental Survey

Although a landowner has a duty to disclose known and obvious environmental hazards before the sale, today's environmental laws almost demand that the buyer conduct an independent investigation. Montana and many parts of the West have been explored for and produced various metals and hydrocarbons which left in their wake potential hazardous waste sites. Additionally, many farms and ranches used underground storage tanks and their own waste disposal sites. These sites can create unwanted liability to the buyer for cleanup costs.

Both Montana and federal environmental laws recognize very few defenses for liability for cleanup of such environmental liabilities. A thorough Phase I environmental review may be a key component of the "innocent purchaser" defense which may absolve the new owner of environmental liability.

Although a seller may indemnify the purchaser against any environmental hazards that may exist on the land, Montana and federal laws do not recognize such contracts as a defense to liability. Thus, although the purchaser may be indemnified by the seller, the purchaser may ultimately front the cleanup operation and have to sue the seller for recovery of the expenses. If this situation arises and the seller is unable to reimburse the costs of cleanup, the buyer is left with the cleanup burden. However, if a Phase I environmental survey has been completed and no waste sites are revealed, the purchaser may successfully assert the "innocent purchaser" defense and perhaps avoid liability and cleanup costs.

Land Surveys

Depending on the amount of property to be purchased, the prospective buyer may want a current survey of the land. This decision may rest on how recently the property was surveyed and whether or not the parcel is all or only a part of the farm/ranch. If the parcel is only part of the farm/ranch then the buyer can legitimately expect the seller to pay the survey costs for delineating the subdivided land. However, if the buyer is purchasing a parcel that was previously surveyed, either the buyer or seller may pay for those survey costs. In either event, survey costs can be significant and should be addressed in the buy-sell agreement.

Fences

Fences should not create a problem if the buyer is purchasing a parcel that is already fenced. However, if the buyer is buying only a part of the existing farm/ranch, then both buyer and seller should know that the cost of erecting a boundary fence, by Montana law, is a shared expense. Thereafter, the parties also share the obligation to maintain the fence.

Although a fence may be a barrier between two parcels of land, it may not be a legal boundary. Under Montana law, a fence does not create a legal boundary between parcels of property unless the land owners agree it creates a boundary. If there is no such agreement, yet both parties recognize the fence as a boundary, it is in fact the legal boundary line until the true boundary line is surveyed in. In that case, once the true boundary is determined, the property owners must recognize the true line as the boundary and not the fence.

Corporate Resolutions

It is a fact of modern farming and ranching these days that most farms and ranches are incorporated or have acquired some state recognized business status. Although a buyer negotiates with the principal shareholder of a farm corporation, it is imperative that before the consummation of the sale the selling corporation, LLC, or partnership officially ratifies the terms of the sale. Proof of ratification will in fact be a requirement for issuance of the title policy if either the buyer or seller is anyone other than an individual. In most cases, this meeting is a mere formality, but disgruntled minority shareholders may at some point object and disrupt the sale absent formal action.

Escrow

Escrow is a commonly used device which allows complex and simple land sales to be completed without a great deal of risk to either buyer or seller. The escrow agent is a third party that holds purchase funds and deeds until the contingencies of the sale are satisfied. In this way neither party is injured by a sale gone bad.

The instructions to the escrow agent may be a standard set of instructions, or they may be negotiated by the parties and drafted to custom fit the transaction. The instructions are a three party contract between the buyer, the seller and the escrow agent which provides the procedure the escrow agent must follow to ensure that both parties receive the benefit of the sale.

In the simple case, the seller places a signed warranty deed into escrow to be held by the agent until the buyer pays the purchase price. The escrow agent holds the warranty deed until both deed and money are in the agent's hands. Assuming the funds are secured, the escrow agent will then disburse the funds according to the escrow instructions and record the deeds necessary to complete the transaction.

In a more realistic example, the buyer places a signed warranty deed into escrow and instruments such as partial or full releases of mortgage, water rights and lease transfers, mineral rights or easements or other rights to be conveyed. The buyer places the purchase money and a signed quit claim deed into escrow. As noted above, state and federal agencies will not issue leases in the name of the buyer until they have a recorded deed. In this instance, the escrow agent will order the deed recorded and copies sent to the appropriate agencies. Once the leases are returned in the name of the buyer, the agent will record documents and disburse funds as required by the escrow instructions.

In the rare instance that the land sale cannot be completed the escrow agent will follow the escrow instructions, generally returning deeds, leases and other rights to the seller and money to the buyer. When large amounts of money and acreage are at stake, an escrow agent can provide a large measure of certainty to the transaction and remove the risk of a sale gone bad for both parties.

Conclusion

There is no doubt that land sale transactions have become more complex, requiring more effort for both parties to complete. Some complexity is due to the litigious times we live in, part is due to the fact that many sales are to strangers as opposed to neighbors, and part due to the money at risk. Whatever the reason, the process does not have to include unexpected delays and elevated costs. With some planning by the seller and some education of the buyer, both parties can work toward their common goal, to sell/buy a piece of land.

 

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