The Basics of Real Estate Contracts
For fights between buyers and sellers in real property transactions, it is always important to begin with the basic question – what does the contract say? The contract’s meaning is determined by its terms, whether they are scattered across multiple documents or parts of a single document. Legal arguments about what the contract means must be based on language, not the other party’s or witness’s opinions about what should be fair.
The most important piece of evidence in a contract dispute should be the contract itself. The buyer’s defaults that commonly give rise to litigation often appear in the contract or in documents incorporated into it. But the extent of remedies available to the seller is normally limited to what the contract provides. There are exceptions, including when a party intentionally causes harm to another or when actual fraud takes place. But business people should assume that sophisticated remedies are only available if the other party’s actions are spelled out in a contract.
A buyer’s common contract defaults include not meeting deadlines to close or sign documents, and failing to make payments when due. It is only in very rare circumstances that this can be construed as intentional misconduct by the buyer.
A purchase agreement also typically contains an "execution version" that is signed by both parties. If this version contains a payment schedule, however , it probably incorporates a statement of each party’s obligations from other documents. The seller may have clear rights in the event of buyer default but one will have to find them in other documents or the body of the purchase contract itself. And it’s not enough for the seller’s lawyer or witness to "remember" what the contract meant.
One provision sometimes included in real estate contracts is a right to cancel if 100% of the buyer’s lenders do not approve the transaction. In these situations, the seller may have clear rights, but there are also penny-ante remedies in the event of buyer default. A buyer may have the right to receive his $1,000 deposit back on the day of closing or even after closing if the deal cannot go forward with the buyer’s funding.
A seller’s damages for buyer’s breach will usually be limited to the down payment or deposit under the contract. It will be necessary, then, to show that the seller has lost the amount of money paid by the buyer. Damages for a lost bargain depends on showing that the seller can offer an unfound buyer for the same amount of money that would have been paid under the terms of the contract.
Some contracts contain a liquidated damages provision limiting the seller’s recovery for the buyer’s breach. If this is the case, the plaintiff will usually not be able to obtain more than the deposit or another sum provided by the contract. Courts usually enforce liquidated damages provisions and determine whether they apply by looking at the contract language. These provisions, like any contract term, may be outside the understanding of ordinary business people but will usually be enforced when it is an important part of the bargain between the parties.
Common Scenarios Leading to Buyer Default
The reasons behind buyer default on real estate transactions can be as diverse as the purchasers themselves. Yet, a number of common themes are often observed among buyers who fall short of their contractual obligations. Typically, the default occurs as a result of financial difficulties created from medical expenses, job loss, divorce, or other sudden loss of income. These financial problems may lead purchasers to become unable to afford their mortgage or home loan payments, or simply exhaust their ability to cover the transaction’s down payment or closing costs.
In some cases, a purchaser may fail to acquire the necessary financing for their home purchase and be forced to withdraw from the agreement. Government action may thwart the transaction, as well. For example, if an engineering study reveals that a parcel has been harmed by environmental contamination or if it is discovered that a local plan prohibits the construction of additional homes, the buyer may be forced to withdraw from the agreement.
Sometimes, personal circumstances come into play. A buyer may be forced to relocate due to a job transfer, to care for elderly parents, or for another reason. When such a relocation occurs that is unrelated to the purchase, actual damages may be difficult to prove if the case goes to litigation. A buyer who simply changes his or her mind before closing, however, is almost always in breach of contract.
Legal Ramifications of Buyer Default
For the seller, the default of a buyer on a real estate contract has a direct impact on his or her rights to compel performance under the contract, to pursue monetary damages for the default or to prevent the sale of the property to a third party.
The Agreed Statement of Fact that a seller can obtain from the buyer to stipulate facts and limit issues to be decided by the Court regarding a breach of contract, if it is determined that the buyer is in breach, give a seller the ability to seek recovery on the costs of repairs for damage to the the home, other losses that the buyer defaults caused including loss of employment and medical problems that may have been avoided but for the breach.
Sellers can use judgments/interim orders against any deposits made by the buyer, other charges owing by the buyer and still more damages against the buyer for any and all breaches of the Agreement to Buy and Sell Real Estate. A breach of a Agreement to Buy and Sell Real Estate is costly: property such as mortgages, land transfer and property tax savings are difficult to remedy in many areas of the housing market.
The buyer may find itself the subject of a warning letter to him or her from the lender, private mortgage lender or credit rating agency which will specify that the buyer has experienced breach of contract. Such actions will often result in a lower credit rating for the buyer, making it more difficult for the buyer to enter secured agreements with lenders, banks and private agencies.
Remedies and Options for the Seller
Buyers occasionally default on their contracts, and when they do, sellers have options, including retaining the earnest money deposit, terminating the contract, or suing for specific performance. These remedies are not exclusive, in other words, the seller could pursue all of these options at once.
Retaining the Earnest Money Deposit. If the buyer defaults, the seller first might have a claim to keep the earnest money deposit. Because the earnest money is typically a substantial amount of money, the parties might use it as an alternative to a liquidated damages provision that would limit the seller’s claim in the event the buyer defaults. A seller also might be entitled to retain the earnest money deposit as damages if the parties’ contract expressly so provides, or if the damages exceeds the amount of the deposit. However, if the matter ends up in litigation, the seller will still have to prove damages.
Release Agreement. If a seller wants to get paid out of the earnest money deposit, the seller will have to sign a release agreement, which is likely to be signed only if the prospective buyer admits fault. A release agreement is a contract between the buyer and seller that provides for the buyer’s default and sale of the property to a new buyer.
Suing For Specific Performance. In addition to retaining the earnest money deposit, a seller also may have the option of suing the buyer for specific performance. The buyer will not be able to walk away if a court orders specific performance. In the court’s view, you are not ready to give up on the sale until the buyer has been given every possible chance to perform. In other words, the court preserves the earnest money deposit until those odds are very slim, then it will restore the deposit to the buyer.
Terminating a Contract. Before a seller may exercise this right, however, notice and opportunity to remedy the default must be given to the defaulting party unless, of course, there is a material breach. Some examples of a material breach may include one party’s intent to abandon the contract, refusing to pay rent when due, or failing to make repairs when and as required by the lease.
Risk Reduction & Cure of Defaults
One way to mitigate the risk of a buyer default – or even to resolve the default amicably – is to include a SETTLEMENT CONFERENCE clause in the real estate contract. This clause provides that, upon a breach, excluding a failure to make a mortgage application in good faith, the parties must meet in the city where the real estate is located to discuss how best to resolve the dispute. Further, if that fails to resolve the matter, they agree to submit the dispute to mediation or to arbitration under the Federal Arbitration Act.
However, there are many other means to resolve disputes between a buyer and seller. The first and best course is always to try to come to an agreement on the new terms of the deal directly with the party that has defaulted. For example, don’t store a buyer’s furniture if the buyer wants it back and will complete the closing in a reasonable period of time. That can be hard if the seller doesn’t have an alternate place to store it, but the buyer may be more inclined to agree to a consensual storage arrangement than if you simply throw her stuff on the sidewalk.
Of course, the buyer would like to negotiate a discount on the closing price to make up for the time delay and expense involved for the buyer to obtain a renegotiated mortgage . But it may be well worth the additional time and effort to obtain that mortgage. In the long run, the discount on the closing price might just be the amount that the buyer saves on the fees associated with obtaining and maintaining a mortgage for the duration of the mortgage, particularly if they are at a higher-than-market rate and there is no commercial-style prepayment provision.
Sometimes it is just not possible to come to an amicable agreement that is acceptable to both parties that a new closing date and terms be substituted for the original date and terms. That is particularly the case if the contract required that all conditions be cleared by the buyer prior to a specified closing date. In that event, the seller has every right to utilize its deemed-satisfaction remedy and move forward with the sale. However, at least one court has found an exception to the deemed satisfaction remedy where the buyer was "diligently pursuing" lenders’ loan approvals prior to the date that the seller refused to extend the closing date. See Lehman v MacGregor, 33 Mass App Ct 899 (1992). In that case, the court considered the failing economy, declining interest rates, and unearned seller’s commission in determining whether, under all of the circumstances, to grant specific performance rather than damages.
The Importance of the Experts
In addition to assessing the buyer’s capacity to close or the facts which may entitle the seller to a cancellation of the contract, it is also important to consider the procedural requirements which must be met in order to obtain agreed or judicial remedies from a buyer in case that buyer’s default on the contract. Most real estate contracts will have provisions specifying the number of days in which a buyer must cure items of default such as the payment of a deposit or the cure of a title defect. Failure to comply with these protocol can jeopardize a buyer’s claims to recoup its deposit or close on the property.
Finally, it is important to remember that the remedies available to a party for the other party’s default will invariably depend on the underlying contract and the facts and circumstances surrounding the breach. Only an experienced real estate lawyer can provide you with the legal counsel necessary to protect your interests in a contractual dispute and obtain or defend against claims for damages.
Buyer’s Responsibilities and Warnings
Buyers should educate themselves on the obligations of a contract and take precautionary measures. As you all know, it is one of the most common states to buy a home and end up losing your earnest money deposit because you made an unintentional mistake. And that is a horrible way to be introduced into the legal system for not only the buyer but the agent as well. It is important to do a few things to ensure that the purchaser will not lose their deposit. First off, it is important to be financially ready for the purchase. The buyer should be pre-qualified or better yet, pre-approved. This way you will know what price range you are dealing with and let’s face it, that phone call to the lender needing more money is not fun if it can be avoided. Secondly, read the contract, know the closing date, know when you can terminate and why, and know who is responsible for what. Make sure that you understand the entire real estate contract from A – Z. Take the time to read it with your agent(s) before you actually write a contract on a property. Thirdly , make sure to meet any and all deadlines that are in the contract. Almost every contract has a 5-day due diligence clause and this is where you can terminate the contract during this period, for any reason. It is crucial to remember that even if you have done your due diligence on the property and discovered problems that you were not aware of, you cannot terminate the contract for other reasons after the due diligence period has passed. One final point, make sure to take a look at all of the special provisions, as well as the seller’s property disclosure to see if there are any additional deadlines that are within those clauses. Many buyers don’t realize that if they are doing a new construction, for example, before the property is built, the contract may state that you must pick out your colors within 30 days (or whatever it may be) after the home is started. Again, read the contract and understand the deadlines and obligations within it.