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Risk of Loss & Equitable Conversion: Definition & Importance

Instructor: Shawn Grimsley
If there is significant damage to a property after a sales contract is signed but before closing, who bears responsibility for the damage? In this lesson, we will learn about equitable conversion and risk of loss in real estate transactions.

Equitable Conversion

Natasha is happy because she just received a call from her real estate agent. The offer she made on a house has been accepted. She'll be a new homeowner in about thirty days when the sales transaction closes. Although she doesn't realize it, Natasha became the equitable owner of the property when the seller signed the contract accepting her offer. This is due to the doctrine of equitable conversion.

Equitable conversion holds that a vendee, or buyer, of real estate takes equitable title to the land upon the execution of an enforceable contract for its sale. If you have equitable title, the law recognizes that you have a beneficial interest in the real estate even though you don't currently hold legal title to it. The vendor, or seller, of the property maintains legal title only as security to make sure that he's paid pursuant to the sales contract. In other words, the seller can withhold granting a deed and conveying legal title until the buyer pays for the property.

Death Doesn't Kill the Deal

Equitable conversion can be a blessing or a curse for the buyer depending upon the circumstances. Let's say that Natasha wakes up the following morning to a phone call from her agent informing her that the buyer died during the night. While tragic, the sale will go forward because of equitable conversion. The seller's probate estate will be required to deed legal title to Natasha and the heirs will receive the purchase price according to the seller's will or the law of intestate succession (which would apply if there was no will). Likewise, if Natasha was to die before closing, her probate estate would have to pay for the property and the property would be distributed to her heirs.

Risk of Loss

Now let's say that Natasha wakes up to the phone ringing and her real estate agent informs her that not only did the seller die the night before but he died in a fire that burned the house to the ground. What will be the result?

It depends. Courts are split on the issue of who bears the risk of loss, which is the risk that the real estate will be damaged or destroyed between the time of execution of the purchase agreement and conveyance of legal title. The majority of states hold that the buyer bears the risk of loss because the doctrine of equitable conversion has given the buyer equitable title. A minority of states hold that the seller bears the risk of loss until legal title passes to the buyer. A third group of states hold that the risk of loss is borne by the buyer only if the buyer is in possession of the real estate or has received legal title.

What if the seller had insurance on the property? Who would get the insurance payout? Once again, the states are split. The majority of courts hold that the buyer is entitled to the proceeds if the buyer bears the risk of loss. In such a case, the seller is viewed as holding the insurance proceeds in a constructive trust for the benefit of the buyer. A minority of states hold that the seller gets the insurance proceeds because it was the seller's contract of insurance, but there are exceptions. The buyer will get the proceeds if the seller was required by the sales contract to insure the property for the benefit of the buyer or if the contract required the buyer to pay the insurance premiums.

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