• Jason R. Davis

Is Wholesaling Legal?

A debate that rages in many states is finding its own legs in Arkansas and poses the question as to whether real estate wholesaling is legal. This debate stands on a couple of grounds:

  • First, whether contract between a wholesaler and a homeowner is valid if the wholesaler has no intent of closing on the sale without a buyer to whom (or which) to assign the contract; and

  • Second, whether real estate investors are in violation of real estate license law by “brokering” without a license.

My goal here is to briefly examine the concept of wholesaling and address our two questions above.

Due to the complexity of the practice and the law on the matter, this post, while longer than it probably needs to be, cannot adequately address in full these two questions. My hope is that this post will help you to be aware of the law on the matter so that you may determine if you need to dive deeper into your practices with an attorney. This is not legal advice, but a discussion on the state of the law. If you wish to determine how the law applies to your practice, please contact us at 501-500-3320.

Put simply: wholesaling is obtaining the right to a property at one price and then selling it at a higher price.

Ok, that is put very simply. But that is wholesaling in a nutshell. It is not a typical flip because you’re not putting any money into the property to increase the value. You are simply finding a good deal, obtaining the right to the property, and then selling it to another person.

So what is the issue? This issue is entirely in how you do it. Often times, wholesaling is accomplished through an assignment of a purchase/sell agreement.

Example: Billy is a real estate investor who “buys houses” in distressed neighborhoods. Jennifer lives in one of those distressed neighborhoods and is looking to move. She doesn’t have the money to put into her house to get it in good listing condition and because of what she owes on the house, she cannot afford to hire a real estate agent for the price the house will sell at.
While watching Goalcast on Facebook one night she sees an advertisement with Billy detailing that he buys houses in distressed neighborhoods. Jennifer picks up the phone and calls Billy who tells her that he will give her $80,000 for her house. They agree and Jennifer and Billy sign a purchase/sell agreement—a contract. Billy knows that if he puts $30,000 into the house, he can resell it for $120,000-$130,000.
But Billy doesn’t want to do that. Instead Billy goes to another investor, Glenda, who does more flips and tells Glenda that he has a house in a neighborhood that she has her eye on and he’ll sell it for $85,000.
They agree and Billy then assigns the contract to Glenda.

Billy obtained the right to the property—in his contract with Jennifer—and then sold that right to Glenda for a higher price. Billy netted $5,000 with no out of pocket money without tying up credit and capital. Sounds like a good investment strategy.

Let's first examine the contracts in our example.

Contracts require six things: (1) an offer (I’ll sell you my house for $80,000), (2) an acceptance, (I will buy your house for $80,000) (3) legal subject matter (in this case a real estate contract), (4) capacity to contract (legal age, legal right to sell, etc), (5) consideration (very simply an exchange of or promise to exchange something of value), and (6) mutuality of obligation.

While each of these can be a factor in a wholesale transaction, in our example with Billy/Jennifer/Glenda, we have (1)-(5). Where wholesalers get in trouble is with mutuality of obligation.

Mutuality of obligation is also called, and perhaps more easily understood as, a meeting of the minds. For there to be an enforceable contract, there must be a meeting of the minds as to the subject matter and purpose of the contract. Here is where Billy can get in trouble. Jennifer thinks that Billy is buying her house, but Billy has no intention to buy Jennifer’s house, he only wants the contract so that he can sell his rights under the contract for a profit. In this case, Billy does not have a valid contract with Jennifer and therefore does not have rights to sell to Glenda.[1]

How does a Billy get around this? One way is by double-closing; the other way, is to simply inform Jennifer that his goal is to sell or assign the contract. Assignment of contracts is generally legal unless the original contract states that the contract cannot be assigned. Yet the question that arises out of this scenario, is whether Billy, who is not a licensed real estate broker, is brokering a real estate deal without a license—especially if Billy’s stated and contractual purpose is to find a buyer and not to buy the property himself.

Let’s look at that question in more depth. Is Billy brokering a real estate deal if the announced intent (or even unannounced intent) is to find a buyer for the house and NOT to close on the house himself.

Arkansas law says that anyone “who directly or indirectly from another with the intention, or on the promise of receiving any valuable consideration, offers, attempts, or agrees to perform any single act [of a principal broker], whether as part of a transaction or as an entire transaction, shall be deemed a broker or salesperson” under Arkansas license law.[2] Further, “no person shall practice or represent himself or herself as a real estate broker or salesperson without first applying for and receiving a license to practice under [Arkansas License Law].”[3]

What does it mean to perform an act of a principal broker? A principal broker is an individual expecting to act or acting for another for a fee, commission, or other consideration who does any of the following:[4]

  1. Sells, exchanges, purchases, rents, or leases real estate;

  2. Offers to sell, exchange, purchase, rent, or lease real estate;

  3. Negotiates, offers, attempts, or agrees to negotiate the sale, exchange purchase, rent, or lease of real estate;

  4. Lists, offers, attempts, or agrees to list real estate for sale, lease, or exchange;

  5. Auctions, offers, attempts to agrees to auction real estate, or participates in a real estate auction;

  6. Buys, sells, or assigns or offers to buy, sell, or assign or otherwise deals in options on real estate or improvements to real estate;

  7. Collects, offers, attempts, or agrees to collect rent from the use of real estate;

  8. Advertises or holds himself or herself out as being engaged in the business of buying, selling, exchanging, renting, or leasing real estate;

  9. Assists or directs in the procuring of prospects calculated to result in the sale, exchange, lease, or rent of real estate;

  10. Assists or directs in the negotiation of any transaction calculated or intended to result in the sale, exchange, lease, or rent of real estate;

  11. Engages in the business of charging an advance fee in connection with any contract whereby he or she undertakes to promote the sale or lease of real estate either through its listing in a publication issued for such a purpose or for referral of information concerning the real estate to brokers, or both; or

  12. Performs any of the acts described above as an employee for or on behalf of the owner of, or any person who has an interest in, real estate.

One look at this list and you would come to think that any real estate investor would need a broker’s license. But there are exceptions such as the individual or company owner of a freehold or leasehold interest in real estate acting within that interest; or an individual or company attempting to acquire for his, her, or its own use a freehold or leasehold interest in real estate and acting within that interest.[5]

To play the legal game and try to get around this is where many will run into issues. The argument would go that Billy is an individual attempting to acquire for his own use (the original contract between Billy and Jennifer) and then an individual owner of a freehold interest attempting to sell that interest (the second contract between Billy and Glenda).

The problem here is that Billy does not have a freehold interest in the estate until he closes on the property. A freehold interest requires that you own the property and that the duration of that ownership is indefinite. This means that Billy’s contract with Glenda is not selling a freehold interest in an estate but the legal interest in a contract. Billy cannot then use this exemption to move around the Arkansas license law.

So what happens if you get caught? Arkansas law provides that even one act by a person required to be licensed under Arkansas License Law and not so licensed shall constitute a violation of [Arkansas License Law]. [6] Such an act violates criminal law [7] and is a Class D felony. [8]

A defendant convicted of a Class D felony may be punished by up to six (6) years in prison [9] and fined up to $10,000.00 [10] per violation.

Wholesaling is a common way for new real estate investors to get into the business because it is considered low cost and low risk. But as laid out above, to do it right still requires risk and cost; to do it wrong, requires even more.

Under contract law, so long as disclosures abound as to the true intent and purpose of the wholesaler, you can wholesale real estate with little risk and no cost. You never have to close on the property, so you don’t need the closing costs or the down payment (the person to whom you assign the contract pays all of that) and you have low risk because if you do not have a buyer, you can get out of the contract (if it is written properly). The issue, however, is that that arrangement appears to violate Arkansas Real Estate License Law (see above).

To comply with Arkansas License Law and contract law, practice what is commonly called a double-close. A double-close is where you close on the first contract (Billy and Jennifer) and then close on the second contract (Billy and Glenda), in this case. At the closing of the first contract you hold the freehold interest (again, assuming everything was correctly contracted and performed), which you can then sell as the individual owner of a freehold estate. The closings occur back-to-back so you do not hold the property for long and put no-money into it for rehabilitation. A later post will discuss how to draft those contracts to ensure your risk and exposure are minimized.

In Closing: Don’t hesitate to call.

I often tell my prospective clients, and you will see me repeat it time and again, that involving a lawyer on the front end is cheaper than involving them on the back end. If you get hauled in front of a court or in front of the real estate commission, the cost of bringing a lawyer is much more expensive than if you had a lawyer set up the project from the beginning. Hiring a lawyer cannot guarantee that you do not get sued, charged, or penalized, but it does allow you to prepare for the possible case from the beginning.

If you have any questions or concerns about your real estate investing practice, feel free

to reach out to our offices at (501) 500-3320.

Full disclosure:Jason Davis holds an Arkansas Real Estate License, which hangs at RE501-LFRO in Little Rock, Arkansas; however, he does not actively engage in the marketing or selling of real estate at this time. This post is designed to be a survey of the law but is not and should not be taken as legal advice. If you are engaged in the practice of wholesaling or any other real estate investing, you are encouraged to contact an attorney to determine if you have exposure or liability. You can call our offices at (501) 500-3320 if you have any questions or email Jason at jason@davisfirmpllc.com.

Disclaimer:It should also be noted, that Arkansas law has not truly dissected the practice of wholesaling and determined the true nature of contract and license law implications. What precedes is my interpretation of the law and not a guarantee of any outcome by a court or contract.

[1] The recourses permitted to the parties here is another subject matter and another blog post.

[2] Ark. Code Ann. § 17-42-301(b)

[3] Ark. Code Ann. § 17-42-301(a)

[4] Ark. Code Ann. § 17-42-103(10)

[5] Ark. Code Ann. § 17-42-104(1). There are other exceptions, but they do not apply in this case.

[6] Ark. Code Ann. § 17-42-301(c)

[7] Ark. Code Ann. § 17-42-105(a)

[8] Ark. Code Ann. § 17-42-105(d)

[9] Ark. Code Ann. § 5-4-401(a)(6)

[10] Ark. Code Ann. § 5-4-201(a)(2)

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