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Abstract

This chapter studies the varoius efficiency arguments of the doctrine of

adverse possession, a distinctive legal method found in civil and common

law systems. We question whether there are valid arguments for the

distinction between good and bad faith possession as made in most civil law

systems. No study of adverse possession can be complete without a review of

title systems. In a world of imperfect information on the sequence of title

transfers, where competing ownership claims may arise, the finer points of

the land title systems will affect efficiency.

JEL classification: K11

Keywords: Good Faith, Bad Faith, Registration System, Recording Systems

 

                                             A. Adverse Possession

 

1. The Concept of Adverse Possession

 

Under the doctrine of adverse possession the occupier of a land who is not

the true owner acquires title to the land without consent from or

compensation to the ‘true’ owner. This legal rule, found in both civil and

common law legal systems, specifies that after a certain period of time, often

termed the limitation or statutory period, not even the true owner of the

property can bring action to eject an unauthorized possessor. Adverse

possession places a statute of limitation on the owner’s right to bring action

against a possessor.

 

Adverse possession was formalized in English common law in 1632 in

the Statute of Limitations. It fits within the framework of the general

doctrine of limitations, which fixes the time within which parties must

follow suit to bring an action. After a certain period of time a person,

whether he had acquired the possession of property rightfully or wrongfully

is to be protected from actions to recover possession of the property

(Callahan, 1961).

 

Although the doctrine of adverse possession was adopted as a rule in all

states of the US, its legal implementation and interpretation by the courts

varies (on some of these differences, see Netter, Hersch and Manson, 1986).

 

For the rules of adverse possession to apply, a few interrelated conditions

have to be met. The possessor must hold the property actually, exclusively,

continuously, openly and notoriously, adverse to the owners, for the

statutorily defined time period. The interpretation of these conditions have

been the subject of debate and the interpretation differs between states (see

Netter, Hersch and Manson, 1986). Generally it is required that the

possessor holds the possession exclusive from others for a period at least as

long as the statutory period, without being dispossessed (continuously), in an

open and visual manner that is inconsistent with the title of the owner

(adverse) and without the owner’s permission.

 

With the exception of variations in time periods and other minor

differences the doctrine of adverse possession under common law does not

differ much from that found in most civil law systems. Under the common

law system, adverse possession similarly provides an individual with a

means to acquire title through possession according to the law.

 

The major difference between the rule of adverse possession within civil

law countries and that found under common low is the significance of the

distinction between good and bad faith possessors. In Anglo-American law

there is a debate whether the intention of the possessor matters for the

applicability of the adverse possession doctrine. In the US the so-called

Maine rule holds that intent is required, as mistaken possession is not found

to be sufficiently hostile to the owner’s right. The newer Connecticut rule

emphasizes that the possessor’s state of mind is irrelevant. Under both rules

a bad faith possessor would be able to acquire ownership through adverse

possession (Mascolo, 1992). A survey by Helmholz (1983) indicates that

courts tend to rule against awarding title when encroachments were made

intentionally, whereas the opposite is true in case of good-faith errors.

Further on in this article we will consider whether the different treatment for

bona fide and mala fide possessors is economically justified (see Section 4.a,

4.b).

 

Under the Statutes of Limitation which were in force in England prior to

1833 the effect of remaining in possession for the prescribed period was to

bar only the remedy of the person dispossessed, not his rights. His title

remained intact. If he were to obtain possession of the land in a lawful

manner his title would prevail against the possessor. Under the statutes that

have been in force since 1833 the right as well as the remedy of the

dispossessed owner is extinguished. The usucapio of Roman law, as adopted

in civil law systems, represents what is often called acquisitive prescription

in the sense that adverse possession conferred a positive title upon the

occupier, who had remained in possession for a certain time. English law

never adopted this, especially not with regard to chattels, although it has

done so with profits.

 

2. Adverse Possession and Efficiency

 

Over the years various economic justifications for adverse possession statutes

have been forwarded in the literature.

 

Adverse possession involves an important reduction of evidence costs.

Evidence decays over time, which makes it difficult to try cases after some

amount of time has passed. Therefore, not to require all parties to maintain

all records necessary for litigation allows for cost saving.

 

This argument is not entirely convincing. Today, one would assume that

modern technology allows for efficient, less costly, record keeping. Another

justification would be that owners should bear a penalty for sitting on their

rights. They should be provided with incentives to make use of their property

efficiently. The objection to this argument can be that it assumes that the

original owner was not maximizing the value of the property by not using it.

In most cases it will, however, be hard to assess the most valuable use of the

property as it might well be in the future. Then, the value maximizing use is

to wait for the optimal time to act.

 

Adverse possession reduces the risks associated with title transfer (Baird

and Jackson, 1984; Netter, Hersch and Manson, 1986; Bouckaert and De

Geest, 1998). It contains an element of transaction cost savings. Search costs

and verification costs are reduced as the potential purchaser is assured of the

validity of the title presented. A potential purchaser who knows that the

current possessor has occupied the property for the requisite statutory period

is assured that the title he acquires is good. Take the example of a young

professor who wants to build a home to start a family with his wife. He has

his mind set on a certain piece of land near the university campus. As

negotiations start it is important for him to take into account the nature of

the rights to the land held by the seller. The seller/land holder could either

be the true owner of the piece of land, in the sense that he has the best legal

title to the land or he could merely be the possessor of the land, where he is

only a person occupying the land. The higher the uncertainty of the true

ownership to the land, the lower will be the transaction price (Netter, Hersch

and Manson, 1986). In this sense adverse possession is a device that reduces

uncertainty as to the person who holds the valid title to the property

concerned. This example also illustrates the importance of a good definition

and protection of property rights. This rests on the assumption that by

eliminating old claims to property transaction costs will be cut.

 

Moreover, adverse possession can increase certainty by reducing the

effects of mistakes and errors. Miceli views the doctrine of adverse

possession as a solution to the problems associated with boundary errors in

real property. According to his theory adverse possession has a dual function

in the sense that not only does it create incentives for the possessor to avoid

boundary errors prior to investing in development (the first-best solution),

but at the same time it also maintains incentives for the owner to mitigate

errors in a timely fashion after the possessor has commenced developments

(the second best solution) as it reduces the ability of a true owner to extract

rents from a possessor who has relied on an error to improve the property

(Miceli, 1997).

 

The typical adverse possession case, according to Miceli, involves a

boundary dispute between adjacent landowners. Take our example from

above. Imagine that the professor has bought a piece of land and built a

home. Having just received tenure at the university, he wants to build a

tennis court on a portion of his land near the boundary with his neighbor.

Suppose the exact location of the boundary is uncertain. The value that the

professor attaches to the piece of land might well be higher than the

subjective valuation by the neighbor. If it were discovered that the piece of

land is owned by the professors’ neighbor there would be room for an

exchange. However, if construction of the tennis court had started, the

maximum amount the professor would be willing to pay will increase. If

constructions are halted the specific investments in the tennis court are lost.

The difference between the value he attached to the land prior to the

construction and the value afterwards would represent an ‘appropriable

quasi-rent’ (see Crawford, Klein and Alchian, 1978). To avoid wasteful

rent-seeking expenditures after the fact, it is recommended that parties

determine ownership of the disputed piece of land before any investments

are made.

 

However, it is inevitable that errors will occur. The possessor may be

convinced that the land is his. Or even worse, the possessor may encroach

intentionally. In the case of an error, the next best outcome is for the owner

to correct the error in a timely fashion. But as the valuation of the land by

the possessor will grow as he increases investment, the owner will lack an

incentive to correct the error, because by waiting he will be able to extract a

higher payment (Miceli, 1997).

 

Thus a time-limited property rule, where the owner retains a right to

eject a possessor from his land if a bargain is not reached, which resembles

the doctrine of adverse possession, offers a solution to both problems. It

provides the possessor with incentives to correct errors in a timely manner

and limits bargaining costs between both parties.

 

The possibility for the appropriation of quasi-rents by the owner is due to

the fact that the owner can eject the possessor from the land if a bargain is

not reached. An alternative would be the implementation of a liability rule in

cases of boundary encroachments. Miceli (1997) correctly notes that this

would create problems with regard to the incentives of the possessor. It

eliminates his incentives to discover errors before developing and, moreover,

it actually creates incentives for him to encroach intentionally as this will

allow him to obtain the land more cheaply than by bargaining with the

owner. In fact, the introduction of a liability rule would shift the incentive

problem from the owner to the possessor.

 

Finally, the conditions whereupon the application of adverse possession

are based seem to be designed to reduce the costs of mistakes in boundaries.

The requirements of possession during the statutory period to be actual,

open, notorious and exclusive give the true owner the opportunity to

discover boundary errors prior to investment by the encroacher (Miceli and

Sirmans, 1995b).

 

On the other hand, there are costs to the application of the adverse

possession doctrine. With the risk of losing title, owners must monitor their

land. When they are not using the property they need to be careful not to

lose ownership to a possessor. By reducing the costs of mistakes of

encroachments, adverse possession introduces a moral hazard problem, in

the sense that there is less incentive to make sure mistakes are not made in

the first place (Netter, 1998).

 

Although there are costs associated with adverse possession (monitoring)

and although the arguments regarding the reduction of evidence costs and of

the element of punishment are not entirely convincing, sufficient economic

arguments can be forwarded to uphold the assumption that the concept of

adverse possession is called-for and economically justified within a property

order. The remainder of the article will focus on the length of the

prescription period and other possible modifications to the concept of

adverse possession, namely the distinction between good and bad faith

possessors and the optimal choice of title system.

 

3. The Optimal Statutory Period - Determination of the Limitation

Period

 

Adverse possession essentially involves the following efficiency trade-off: a

shorter statutory period reduces uncertainty as to the title in subsequent

transfers, while longer statutory period reduce the costs to property owners

to protect their land from potential adverse possessors.

 

 

Figure 1 illustrates this trade-off. At point e, where the time of occupation

(on the vertical X-axis) required to obtain title is set optimally, a balance is

found between prevention and uncertainty costs. As the limitation period is

set beyond point e, the uncertainty costs, represented by the UC curve,

increase further. The longer the statutory period is set, the lower the

monitoring costs of owners. If the limitation period is set below e,

prevention and monitoring costs, represented by the PC/MC curve, increase

while uncertainty costs go down.

 

Economic theory holds that the greater the benefit from reducing

uncertainty with regard to the ownership of a good, the shorter should be the

time period required of adverse possession.

 

A fairly recent study of prescription statutes in the different North

American states (Netter, Hersch and Manson, 1986) provides empirical

evidence on the various differences and examines the determinants of the

length of the occupation period in the statutes of limitations of states’

adverse possession at the time of statehood.

 

First, a negative relationship between property value in a state and

statute length was observed. When the property has great value, there is

simply a higher return to be obtained from ending potential disputes about

ownership that arise from mistakes. Also, the costs of mistakes are higher

when property value is high. In such circumstances it is recommendable that

adverse possession requirements (length, type of possession) are less

demanding. However, it should be acknowledged that if property values are

high, owners have more to lose from adverse possession.

 

Secondly, a positive relationship between population density and statute

length was found. As population density increases more property transfers

take place, which raises the probability that errors (in determination of

boundaries, identification of the tile holder, registration, and so on) will

occur. The length of the prescription period will affect incentives in various

ways.

 

Protection costs will be lower when protection periods are relatively long.

The shorter the prescription time period, the more theft or deceit is

encouraged (Merill, 1986). Stolen, lost and fraudulently acquired goods will

have a higher market price when potential buyers know that the possibility

of claims and other repossession actions are restricted to only a limited

period of time. Thus, the introduction of a prescription period will affect

criminality and tortuous acquisition rates. The possibility of becoming a true

owner through mere adverse possession increases the value of an adversely

possessed good. A thief who wants to resell the stolen good will be able to

charge a higher price to the buyer under a system where the latter can

become the legally unchallenged owner after the elapse of a short period of

time. As theft, fraudulent and deceptive acquisition will become more

profitable, property owners will need to invest more into protection of the

property.

 

Also, short prescription periods force owners of lost, stolen or

fraudulently divested goods to concentrate their search and repossession acts

within a short period of time, which leads to higher opportunity costs of

search (Bouckaert and De Geest, 1998). On the other hand, short

prescription periods provide the possessor with efficient incentives with

regard to investment.

 

The length of the statutory period may also be dependent on the type of

the property, and more precisely the possibility/desirability of registration.

This might provide an explanation for the long prescription periods for real

property as found in most legal systems (See Table 1 for data on the

Franco/Belgian, German, English and Quebec provisions). The possibility

to survey land registers and verify whether the seller has a valid title reduces

the uncertainty of the acquirer substantially, provided that these registers are

reliable.

 

4. Good and Bad Faith Reconsidered

 

(a) The Distinction between Good and Bad Faith Possession

One remarkable feature of adverse possession in most civil law systems is

the distinction made between good and bad faith possession. Generally,

prescription periods are longer for the bad faith possessor (mala fide

possessor) than for the bona fide possessor.

 

 

This distinction between good and bad faith possession, as illustrated in

Table 1 with comparative data on the French/Belgian German, English and

Quebec provisions on limitation periods raises certain questions. First of all,

there is the matter of evidence. Good faith errors are difficult, often

impossible, to distinguish from intentional errors, for instance with regard to

real property issues such as boundary encroachments. Trying to proof bad

faith will impose high evidence costs, notably where the plaintiff has to

reverse the presumption of good faith against the defendant possessor. This

raises the question whether the distinction between good and bad faith

possessors, mainly grounded in notice of justice, is justified from an

economic perspective.

 

Bona fide possessors may be regarded as neutral actors within a given

property order (Bouckaert and De Geest, 1998). The notion of good faith

possession implies neutrality with respect to the incentive to affect the

property order. Good faith possessors do not disrupt or undermine the

property order intentionally the way, for instance, thieves do - they just

happen to be the possessor of property without any influence on its adverse

character.

 

This would imply that bona fida possessors should be submitted to the

normal, optimal rules of prescription, that is, short- or even zero-

prescription time periods when registration is too costly; long- or even

infinite-prescription time periods when registration is justified.

On the other hand, there seem to be solid economic arguments in favor

of extending the prescription period for mala fide possessors. As explained

above, by extending the prescription period the value of goods obtained with

wrongful intend will be lower. A thief will only not be able to obtain such a

high price for a good for which there is a prescription period of thirty years

as he would have been able to if, say, the prescription period was only three

years. Note, however that this impact of the length of the prescription period

on prices will be limited due to the difficulty to prove bad faith.

 

The advantages of a different, for example longer, prescription period for

bad faith possessors need to be balanced against the transaction and

uncertainty costs caused by long prescription periods.

 

An alternative would be to rely on criminal sanctions for thieves,

deceivers and their recipients when they are in complicity (Bouckaert and

De Geest, 1998).

 

The prospect of damages combined with criminal sanctions may deter

theft and deception in a more effective way than long prescription periods

do, without impairing investment incentives (Bouckaert and De Geest,

1998).

 

(b) Difference between the Bona Fide Acquirer in General and Bona Fide

Possessor of Stolen and Lost Goods

 

Sometimes an additional distinction is made between the good faith acquirer

of goods in general and of lost or stolen goods. Some countries make an

exception with regard to lost or stolen goods.

 

 

In the German code lost or stolen goods can be reclaimed from bona fide

possessors by the owner during a period of ten years (937 B.G.B.), while the

Code in France and Belgium explicitly provides that dispossessed owners of

lost or stolen real property (estate) can reclaim it for three years from the

date of the theft (art 2279 C.C., see Figure 2). In England and Quebec no

such distinction is made. What could be the arguments to treat the bona fide

acquirer a non domino of such goods differently from acquirers in general?

 

 

The assumption goes that there is a more than average probability that the

acquirer of stolen or lost goods is mala fide. As stolen or lost goods are

mostly sold through black markets, the buyer of such goods may well suspect

that the purchased goods were illegally obtained by the seller. However, due

to the difficulties and the costs of providing evidence of bad faith, such

buyers would in most cases escape the treatment of bad faith possessors. The

reasoning above might provide a justification for the legal distinction in

most European continental law systems which treats them as ‘semi-mala

fide’ possessors by imposing a regime which is closer to that of bad faith

possession.

 

As a result, prices for stolen or lost goods will be somewhat lower than

for normal goods because the bad faith possessor is offering a somewhat

weaker title to third parties, and the risk-averse buyer faces the possibility of

being dispossessed. The distinction would thus provide the function of

discouraging theft.

 

One should take into account the costs caused by the complexity of such

a system and compare them with the significance of the deterrent effects on

theft and fraudulent behavior. Will the increase in price outweigh the costs

associated with a complex system as found, for example, in the French code?

One alternative would be to simplify the system dramatically by treating all

bona fide third party acquirers in a homogeneous way, perhaps by applying

to all bona fide acquirers the rule of ‘possession is title’ combined with

rendering the rebuttal of the presumption of good faith less difficult

(Bouckaert and De Geest, 1998).

 

                                    B. Personal and Real Property: Title Systems

 

We have seen above that uncertainty plays an important role as one of the

dominant cost factors in title transfer. This is certainly the case with real

property where boundary and survey errors are common and often very

costly. In a world of perfect information about all previous transfers of

property the law should simply enforce the rights of the current possessor. If,

however, there is uncertainty whether a fraudulent transfer occurred, the

law faces a trade-off between protecting the rights of the current possessor or

those of the last possessor prior to divestment. A comparison between a

system where title is established by mere possession (possession is title), to a

filing system built upon public records of property exchanges that can be

used to trace the history of a title, leads us to conclude that the latter is more

costly to administer but reduces the likelihood of non-consensual transfer

while the former facilitates transactions but not without raising the

possibility of fraud and theft (Baird and Jackson, 1984).

 

The choice between a property-based system and a filing system will

depend on the magnitude of the different cost categories (Miceli, 1997),

which in turn will be determined by the characteristics of the property. In

the literature the following determinants for the choice between a filing

system or a property-based system have been advanced: the durability of the

good in question, homogeneity, frequency of transfer, the value of the good

(Bouckaert and De Geest, 1998) and the desirability of shared ownership

(Miceli, 1997). If a good is durable, it will be relatively more worthwile (that

is, cheap) to register. Non-homogeneous goods will be easier to register. If

goods are frequently transferred, registration becomes very costly. If the

value of the good tends to be high the costs of registration will be relatively

low, so that it is efficient to reduce the costs of uncertainty of title by

registration. When a certain good regularly requires shared ownership it will

be costly to rely solely on possession as evidence of ownership. As Miceli

notes (1997), land is considered as the standard type of property for which a

filing system is preferred. Land is not transferred often, it can easily be

distinguished and, moreover, shared ownership is often required to cultivate

or use the land.

 

Within a property order that incorporates a regime of adverse possession,

what is then the optimal type of filing system? We can distinguish two types

of title systems: the registration and the recording system.

 

5. Registration System

 

Under a registration system the owner registers his or her land with the

government. When a legitimate claimant arrives at a later date, the current

owner retains title while the claimant must seek compensation from a public

fund, financed by registration fees. The current owner retains the land in

event of a claim and the claimant receives monetary compensation. The

government provides insurance for wrongfully displaced owners, subsidized

by the registration fees.

 

6. Recording System

 

Under a recording system the written record provides only evidence of title,

it does not guarantee title. Errors in records or in the interpretation by the

searcher remain possible.

 

As a result private title insurance has developed under the recording

system to protect holders against financial losses (for a survey of the

possibilities of title insurance under both title systems, see Miceli and

Sirmans, 1995a)

 

7. Normative Goals under Economic Analysis

 

Miceli and Sirmans argue that an efficient title system should create proper

incentives for landowners to invest in capital improvements prior to the

appearance of adverse claims and provide compensation for wrongfully

injured parties. A title system that satisfies the demand of the former motive

has the following characteristics:

 

a) It promotes ex-post efficiency as it allocates land to the highest valuing

user. We may assume there is a positive relationship between increase of

subjective valuation of the land, above market value and land tenure.

Therefore, a system that awards the land to the current holder and

compensates legitimate claims by the original owner at market value will

maximize the value of the land with regard to the enhancements that have

been made previously by the owner.

 

b) It provides incentives for efficient investment in land ex-ante by the

landowner.

 

8. Evaluation of Both Systems

 

Under the registration system the current holder who has successfully

registered the property will be able to retain the property rights to the land

that he has occupied during the statutory period. The true owner, on the

other hand, may seek compensation through an insurance system provided

by the registration fees. It can easily be observed that a registration system of

such nature promotes ex-post efficiency, as it allows the most valueing

owner, most likely to be the occupying party, to benefit from his benefits/his

reliance interest. Regarding incentives for capital improvements to the land

Miceli and Turnbull conclude (1997) that the registration system is also

efficient ex-ante as it induces owners to maximize the return from land.

A recording system, on the other hand, seems more likely to meet the

requirements of ex-ante efficiency, as the possibility of future expropriation

will provide landowners with an incentive to investigate title prior to

investment decisions.

 

In their model Miceli and Turnbull postulate that under the registration

system current owners retain title and have no incentive to insure against

potential claimants, which precludes private insurance provision. While the

registration system creates publicly mandated insurance, that of levying

transfer fees or property taxes, under the recording system owners have an

incentive to insure themselves against risks. Owners, faced with the risk of

expropriation, will desire protection of their reliance interests through

insurance. Under the assumption that the profit incentives of private

insurance firms enforces efficiency in the title examination process to an

extent beyond the reach of a governmentally administered registration

indemnity fund, where this profit incentive is lacking, they conclude that the

recording system may have an advantage over the registration system.







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