For most people, buying real estate is as easy as locating available property with the assistance of a realtor, negotiating a purchase contract, finding a lender, retaining a title company, and attending a closing. However, what happens if the purchaser later discovers that the property is not zoned for the anticipated use, or if the building, or proposed building, on the property violates the local zoning ordinances or building code? The answer to that question may depend on the language of the purchase agreement, the mechanism for transferring title, and the type of title insurance that was obtained at the time of the acquisition.
Real estate purchase agreements in Michigan can vary from fillable purchase and sale agreement forms to lengthy agreements for commercial transactions that can be over twenty pages long. The type and form of the agreement used will dictate certain items relevant to this article, including the document used for transferring title, warranties and representations made by the seller, and the potential protections provided by title insurance. Additionally, if the transaction is to be financed by a lender, the lender may have specific requirements for items that will be required. Obtaining counsel from an attorney—regardless of whether you are buying or selling real estate—is suggested, because the attorney can provide invaluable assistance in understanding the universe of potential issues that may arise.
What is a Warranty Deed and What is Marketable Title?
In Michigan, there are different ways to convey title to real estate, but ultimately, in a traditional arms’ length sale transaction, the document that is recorded is called a deed. The agreement between the grantor or seller and the grantee or buyer will dictate what type of deed will be used, but the three most common “standard” deeds are: (1) quit claim deeds; (2) warranty deeds; and (3) special, limited or covenant warranty deeds. Quit claim deeds are commonplace in “as-is” transactions and provide no warranties or representations about the underlying property, while warranty and limited warranty deeds provide some such warranties. Limited warranty deeds (or covenant deeds) are somewhat common in commercial transactions, as they provide an assurance that the seller has not done anything to encumber title, but provides no warranities as to whether prior owners have encumbered title. In contrast, most arms-length residential real estate transactions will involve the seller deeding the property to the buyer by way of a general warranty deed with a full warranty relating to title.
If you are giving or receiving a general warranty deed as part of your transaction, it is important to understand that, under Michigan law, “[a] warranty deed conveys the entire bundle of rights to the property from the grantor to the grantee in fee simple; it also includes the grantor’s covenant that the grantor has good, marketable title and guarantees to the grantee the right of quiet possession.” Eastbrook Homes, Inc v Dep’t of Treasury, 296 Mich App 336, 348; 820 NW2d 242 (2012). Therefore, in a sale transaction with a warranty deed, the seller must convey “marketable title” to the property, which means that it is free from encumbrances such that the buyer can have “quiet and peaceful enjoyment of the property.” In deciding whether title is marketable, the Michigan Supreme Court has said that “title may be regarded as unmarketable if a reasonably careful and prudent man, familiar with the facts, would refuse to accept the title in the ordinary course of business.” Bartos v Czerwinski, 323 Mich 87, 92; 34 NW2d 566 (1948).
When a title policy is created in advance of the sale date, it will identify known encumbrances on the property, and typically, will exclude certain items that are not readily identifiable by publicly available information. An encumbrance is defined as a “claim or liability that is attached to property or some other right and that may lessen its value, such as a lien or mortgage; any property right that is not an ownership interest.” Black’s Law Dictionary (11th ed). In Darr v First Fed Sav & L Ass’n of Detroit, 426 Mich 11, 20; 393 NW2d 152 (1986), the Michigan Supreme Court stated that an encumbrance “includes anything which constitutes a burden upon the title . . .’”, or “‘every right to, or interest in the land, to the diminution of the value of the land. . .’”
Encumbrances can have the impact of slowing down a real estate transaction, or, in some instances, the entire agreement can be terminated by one or both parties depending on the nature of the encumbrance. Sometimes, the encumbrance relates to a small issue, and can be resolved in short order and the transaction can stay on track. Building and zoning code violations, which are the subject of this article, do not typically fall in that category, however.
Nearly every property, especially if it is in an urban area, will include at least one encumbrance. Encumbrances that are commonplace in real estate transactions include mortgages, leases, liens, easements, covenants, restrictions, bylaws, encroachments, and zoning. Some encumbrances benefit the purchaser, and typically do not impact the “marketability” of the title to the property (called “permitted encumbrances”), and examples of permitted encumbrances include restrictions, subsurface leases, and easements. However, if the property is being transferred by a warranty deed, there may also be negative encumbrances that will need to be removed in the chain of title. These encumbrances would typically be identified originally as “exceptions” to title, and it would be the responsibility of the seller to cure or remove the exceptions prior to closing unless some additional agreement can be worked out between the parties.
It is also important to understand what encumbrances will not be covered by title insurance. Most title insurance policies include exceptions for items such as current tenants who are in possession by way of an unrecorded lease, encroachments, or other circumstances that would only be shown on a comprehensive survey of the property, and taxes or assessments that do not appear in the public records. The reason why this is important is that if a particular encumbrance is not covered by title insurance, the purchaser may be left with no recourse if that encumbrance is discovered after the closing of the property.
Zoning, Building Code, and Other Ordinance Violations in Real Estate Transactions
Zoning and building codes and ordinances perform an important function in Michigan. For example, the zoning ordinance applicable to a particular property will identify permitted and special uses not only for the property that is being sold, but for the surrounding properties as well. The zoning ordinance typically will also provide lot size, setback, fencing, parking, landscaping, and other requirements that should be considered any time property is being acquired. Having these provisions protects a property’s value and allows owners to enjoy their properties knowing that there are penalties for people who violate them. If a zoning ordinance encumbrance is discovered before a closing, or if a particular use is critical as a buyer, it is worthwhile to obtain an opinion from an attorney about the risks involved with moving forward with the transaction. For example, if you are a buyer looking to buy a property and want to put a tiny house on it, the local zoning ordinance may have a specific requirement that the home meet square footage requirements. These ordinances should be investigated and analyzed depending on the proposed use of the property. Similarly, if the use of the property by the current owner appears to be in violation of a zoning ordinance, and you, as the buyer, intend to keep that same use, you should be aware of what can and cannot be done with a “nonconforming” property in Michigan.
Along the same lines, a building code provides guidelines so that a structure on a property not only is not a danger to the owners and occupants of that structure, but to nearby or adjoining structures. Building code issues are not as easily identified by a prospective purchaser but may be discovered by an inspection performed by a qualified inspection company.
Can an Ordinance Violation be Deemed a Breach of The Warranty of Title?
As said above, for most real estate transactions, the transaction runs smoothly, and the buyer takes possession of the property being transferred without incident. However, occasionally, title issues will arise that the parties did not anticipate. Examples of these issues include situations where: (1) a structure on the property encroaches onto another property or on an easement, or someone else’s structure encroaches on the property to be purchased; (2) the structure(s) on the property does not comply with local building or zoning codes; (3) there are pre-existing building code violations regarding the structure(s) on the property; (4) there are parties that have a recorded lien, easement, or other encumbrance that did not show on the title report; (5) the party that sold the property was not the legal title owner; (6) there are leases, contracts or options that impact the full use of the property; and (7) the proposed use of the property by the seller is not allowed under the local ordinances. If any one of these happen, and are not discovered until after the closing, the impact on the buyer can be devastating. Two Michigan appellate decisions are discussed in this article, and both show the negative impacts of a building or zoning code encumbrance on a purchaser of real estate.
In Galvan v Poon, unpublished per curiam opinion of the Michigan Court of Appeals, dated August 19, 2021, Docket No. 352559, one of those issues arose. After the close of a condominium unit, the buyers discovered a water infiltration issue. An investigation into the water infiltration issue led the buyers to reach out to the condominium association who told the buyers that a wall upstairs had been moved and the neighboring unit encroached on an upstairs bedroom. During the remediation of the issues, it was learned that there was no firewall between the two units. The buyers then reached out to the City of Ann Arbor who confirmed that a firewall was necessary and brought an action against the sellers for failing to have a firewall. The buyers then sued the sellers for this building code issue because it was an “encumbrance” and title had passed by warranty deed. Even though the sellers did not know about the lack of a firewall (the work was done before they owned the property), the Court of Appeals ruled that it was still an encumbrance, and the sellers were liable for the damage incurred by the buyers. Importantly, this decision is unpublished, appears to be an outlier in relation to rulings from other states other than Michigan and is currently being reviewed by the Michigan Supreme Court. Most other states that have ruled on the issue have, at a minimum, required the seller to have knowledge of the building code encumbrance to face liability. On July 12, 2023, the Michigan Supreme Court in Galvan v Poon, No. 163741, 2023 WL 4496998 (Mich, July 12, 2023), reversed the decision of the Court of Appeals and held that building code violations that have not yet been subject to enforcement action are hidden and not readily known or apparent through title searches or property inspections. As such, the judgment against the seller for “warranting” that the property was not subject to building code violations could not be sustained. The Supreme Court did state that its decision may be different if it was a zoning code violation (as discussed in the next paragraph), however.
A violation of a local zoning ordinance was at issue in the case of St Clair Inn, LLC v Transcapital Bank, unpublished per curiam opinion of the Michigan Court of Appeals, dated March 24, 2015, Docket No. 319481. In the St. Clair Inn case, a real estate transaction occurred whereby a party acquired six lots subject to a planned unit development or PUD. The transaction was consummated by way of a covenant deed. After the closing, it was discovered that the seller actually owned seven lots, and the zoning ordinance required all seven lots to be kept together as part of the PUD. In that case, the Court of Appeals held that, although restrictions in place by zoning ordinances are not typically “encumbrances,” a violation of a zoning ordinance is such an encumbrance. Importantly, however, the Court of Appeals also held that there was no zoning violation at the time of the closing, but it was only the severance of the seventh lot from the remaining six at closing that caused the encumbrance. Therefore, although the plaintiff had obtained relief for a violation of the covenant deed, and to reform the agreement to include the seventh lot, the Court of Appeals reversed, saying that the trial court could not grant that relief to the buyer. The Court of Appeals went further and stated that the PUD regulations were matters of public record, and therefore, the buyer was put on constructive notice that taking title to less than all seven parcels would create unmarketable title post-closing. In that case, if the buyer had obtained a zoning endorsement to title (as outlined below), it may have had a claim against the title company. However, because the only affirmative warranties related to zoning were as of the date of the closing, there was no claim to be asserted against the seller when the violation only occurred as a result of the closing itself.
What Can Be Done to Protect Yourself as a Buyer in a Michigan Real Estate Transaction?
There are certain steps that a buyer can take to insulate itself from damages caused by building or zoning code issues, as well as many other encumbrances. Five of those steps are outlined below:
#1) Make a list of all items that you feel are important in your new property, including what the planned use will be and if structures on the property will be added or altered. After this is done, review the zoning ordinance and the zoning map for the property to confirm that the proposed use and structures will be compliant. An attorney can assist with providing you an opinion about whether your proposed use or structure is allowable under the local ordinance.
#2) Reach out to the local municipality and see if any permitted construction work has been done on the property in the past. This may provide information that can be provided to an inspector, but also where you, as the buyer, can discover what construction has been performed on the property and when.
#3) Obtain title insurance, which should cover against losses caused by encumbrances recorded with the Register of Deeds. Although some items can be discovered by reviewing records online or in person, title companies have employees who are trained in performing these searches. Also, ask for copies of recorded encumbrances so they can be reviewed.
#4) Obtain a survey and ask that all encumbrances be shown on that survey. Many times, people take title with easements disclosed in a title search with no idea where on the property the easement(s) is located or what the easement covers. This may be required by the lender as well.
#5) Obtain an inspection of the property, which may identify problem areas in the property, or areas that were built in violation of the local building code. Typically, code compliancy inspections are in addition to ordinary real estate inspections.
#6) Review the language of the purchase agreement and deed to determine if any disclaimers were made with respect to zoning or ordinance violations.
As additional protection against encumbrances, a buyer can also require that certain title insurance endorsements be provided as part of the title insurance policy. The American Land Title Association (ALTA) has nearly 100 separate endorsements that can be obtained (for a cost) that provide additional insurance coverage in the case of an unexpected encumbrance. Some of the potentially pertinent endorsements include: (1) Encroachment/Easement; (2) Zoning; and (3) Covenants, Conditions and Restrictions. The more endorsements that are obtained, the more expensive the title insurance policy will be. However, obtaining relief from a title company may be significantly easier than against the seller, who may no longer have assets or the means to satisfy any judgment.
Building codes, master plans, and zoning ordinances can be very extensive and confusing, and in some instances, just figuring out which codes or ordinances apply to a particular property can be difficult. Parties who intend to purchase properties, especially if the current use seems questionable, or the proposed use of that property is different than the current use, should spend time reviewing these ordinances and codes before moving forward with the transaction. This review should be done with both an attorney and a title company if possible. Obtaining title insurance will provide some additional assurances but having title insurance and recovering a claim against a title company are two very different things. Additionally, if a claim must be made against a seller, there is no guaranty that the seller will have assets to satisfy a judgment for damages incurred. Although there is no bulletproof method to protect against every single building code or zoning ordinance violation, if the steps identified herein are taken, the risk of a catastrophic incident arising as a result of an encumbrance on the property should be significantly lowered.
Adam Toosley is a member at Hirzel Law, PLC and focuses his practice on real estate litigation, zoning and land use, construction, and financial services litigation. Over the course of his career, he has represented property owners, landlords, condominium associations, lenders and all parties in the construction chain, handling all aspects of real estate-related disputes, including construction defect cases, payment and landlord-tenant disputes as well as real estate foreclosures, mechanic’s lien cases and fraud and business tort claims in state and federal court as well as in mediations and arbitrations throughout the United States. He is licensed in both Michigan and Illinois. He can be reached at (248) 986-2290 or at email@example.com.