Inspections: Let the Seller Beware

By David Weisman, Esq.
Board Certified Real Estate Lawyer
November 2009

Buyers have the right to be sure they're getting their money's worth, but protect your sellers from extraordinary repair costs - and yourself from reduced commissions-by imposing limits on what inspection clauses can call for.

Almost universally, contracts for the purchase and sale of real estate grant the buyer a right to make a physical inspection of the property which is the subject of the contract. They place upon the seller the burden of repairing any defects which may be discovered as a result of the inspections.

The inspection paragraphs, intended for the protection of the buyer, have become a loaded gun to be used at the closing table to negotiate a lower price for the property under contract. In many cases, the seller executes the contract without being aware of the nature and extent of the inspections which the buyer is entitled to make.

The purpose of this article is not to explore the technical, legal ramifications or the fine print of the inspection clauses; rather, it is the author's intention to point out a few pitfalls and practical suggestions to avoid the arguments at the closing table which turn an otherwise happy occasion into a nightmare.

Inspection clauses might be as simple as provisions for roof and termite inspections to be performed by individuals licensed in those fields; or they might be as complex as provisions for inspections of the mechanical, structural, and plumbing components and the seawall, swimming pool, machinery, and appliances, with no standard other than "good working order". The phrase "good working order" is often misinterpreted and misunderstood to mean that a seller must make the house new, even though the seller has been living in it for 25 years and the price of the property reflects the fact that the home is not new.

The problem often arises as a result of a comprehensive inspection performed by a company whose only business is performing such inspections. The comprehensive inspection may indicate leaking faucets, non-functioning light switches, and an oven clock which runs three minutes slow every leap year. A buyer, and the buyer's representatives, must understand that a home which has been lived in for a number of years will have certain inherent defects — directly related to the age of the property — which the seller should not be obligated to repair.

Conversely, the buyer, having viewed the property once, twice or maybe three times with the selling agent, cannot possibly analyze the physical condition of the property by walking through and looking at the interior of the house. The buyer should be entitled to inspect the condition of the roof and to determine that the house has no termites, as these are major repair items which can cause a substantial financial burden on the buyer in addition to the purchase price and typical closing costs. Added to the simple fairness, most banks and mortgage companies must know that the security for their loan will not crumble to the ground a week after closing.

In some cases, the seller knows that the roof is leaking. The seller hears the termites chewing on the attic rafters in the middle of the night. That seller might be willing to make those repairs and may figure the cost of them into the purchase price. Under the recent landmark decision Johnson v. Davis, the seller is under an affirmative duty to disclose hidden defects of which the seller has knowledge. Enough has been written about that case so that the details of the decision need not be set forth here, but the overall effect is that the doctrine of caveat emptor (let the buyer beware) no longer applies to the sale of real property. This is not an unfair proposition when one considers that the seller who has been living in the house is in the best position to know of its physical defects. Given that knowledge, and assuming proper disclosure in accordance with the holdings of Johnson v. Davis, the seller should then be free to negotiate a purchase price without fear of further bargaining at the closing table.

The most common way to reduce the amount of bargaining which takes place is a limitation on the dollar amount which the seller will be required to spend to correct the defects discovered by the inspections. The limitation is generally stated as a percentage of the purchase price, allocated in some contracts to each item subject to inspection and set forth in a blanket amount in other contracts. For example, one contract might obligate the seller to repair the roof up to 3% of the purchase price, set forth a repair limitation of 2% for the termite repair, and set forth an additional 1.5% for the appliances and other personal property. This would expose the seller to a potential liability of 6.5% of the purchase price, or a whopping $6,500 in a $100,000 transaction.

The inspection paragraphs, intended for the protection of the buyer, have become a loaded gun to be used at the closing table to negotiate a lower price for the property under contract.

Another method of allocating the limitation is to set a maximum limitation on the cost of all repairs. A 4% limitation on roof, termite, appliance, and all other repairs reduces the seller's repair obligation in the $100,000 transaction to $4,000.

The inspections themselves can often result in problems. The buyer, or typically the selling agent, will arrange to have XYZ Roofing Company inspect the roof. XYZ, hungry for a repair order, offers to install a new Tiffany roof for $15,000. The Tiffany roof will have the finest tile and seven layers of roofing materials to create the finest roofing system known to mankind. That will be wonderful for the buyer, but will cost the seller a fortune. The seller, conversely, will hire the ABC Roofing Company to provide an estimate for the installation of a thrift shop roof, which will be water tight at least through the closing and will feature the latest in economy shingles and one layer of the finest off-price roofing material available.

Obviously, there is room for moderation and negotiation between the Tiffany and the thrift shop roofs. A more complicated contract will set forth provisions for a third inspection, to be performed at the direction of the first two inspections, and after much discussion, grumbling, and argument, the buyer will receive a credit at closing for an amount somewhere between the two original inspection reports. The buyer then can choose whether he wants to live under a Tiffany or thrift shop roof and can add or subtract from the credit as he sees fit.

The alternative to this is a clause which says that the buyer is buying and the seller is selling the property in "as is" condition. This means that the buyer and seller have agreed that no repairs will be made by the seller, and presumably the price of the property will reflect the condition as observed by the buyer.

An "as is" contract probably does not relieve the seller of the obligation to disclose known defects. Accordingly, if the roof is leaking and the termites chewing, and the seller is aware of it, the seller must speak up. Unfortunately for the buyer, an "as is" contract might save some money at the closing, but the buyer will not know which costs must be paid.

A simple middle ground can be reached. The buyer can agree to acquire the house "as is:' but should retain the right to make whatever inspections the buyer chooses to make immediately after the contract is signed. Title inspections are made within five days of the execution of the contract. The buyer could be given the right to rescind the contract if the inspections are not satisfactory or have the option to move forward and accept the property "as is".

What happens if the estimated cost of repairs exceeds the limitation in the contract? In most cases, the contract provides that if the cost of repairs exceeds the stated limitation, either party shall have the right to pay such excess, and if neither party chooses to pay the excess over the limitation, the contract shall be cancelled, the deposits refunded, and the deal is over. This clause gives the party with the most economic motivation the right to close the transaction at a slightly greater cost.

The role of the real estate broker at the closing table has become one of peace-maker. The loaded gun in the buyer's hand must be put back in its holster. The seller must be made to realize that his castle creaks. How do the agents make peace? By convincing all parties to concentrate on the major items and to avoid the discussions which make tempers flare, cooperation turn to antagonism, and deals fall apart. Cooperate, compromise. . . and close.