When is a Contract not a Contract?
By David Weisman, Esq.
Board Certified Real Estate Lawyer
A contract for Purchase and Sale of Real Property consists of a series of promises, some by the Buyer and some by the Seller, which result in the consummation of a transaction more commonly referred to as a closing. The closing is the goal of everyone involved in a real estate transaction from the day the real estate sales person first convinces a Seller to sign a listing agreement, to the day the keys are ceremoniously handed to the buyer. The magical document which guides the performance of the parties, and leads them to the closing table, is the Contract for Purchase and Sale. In this magical document, the Buyer agrees to buy and the Seller agrees to sell. The terms sound simple enough, unless the Contract is "subject to."
The Contract contingency is a creature which makes a Contract not a contract. It is a condition precedent, which, until satisfied, prevents the Contract from solidifying into a legally binding document.
The most common of the Contract contingencies is the financing contingency whereby the Buyer is not obligated to close the transaction unless and until the Buyer qualifies for a new first mortgage. Printed forms of contracts are uniform in that they require the Buyer to diligently apply and cooperate in every way possible with a potential lender in order to obtain the financing necessary to consummate the purchase. The financing contingency is carefully prepared in the standard form of contract to allow the insertion of an amount and the maximum number of days which the Buyer must either obtain the commitment or rescind the Contract.
A Contract contingency which causes problems in a real estate transaction is one which is inserted haphazardly in a rush to obtain an agreement between an anxious seller and an emotional buyer. A Contract contingency which is not properly prepared leaves questions open as to how the parties are to proceed in the event the Contract contingencies are not satisfied. An example of such a contingency is the commonly used, "The Contract is contingent upon Buyer closing on the sale of his residence located at 123 Old House Road."
The reason this contingency is unacceptable is that it leaves the Seller unsure of whether or not a closing will take place. What happens if the Buyer's agreement to sell his existing residence falls through? Based upon the contingency as written, the Buyer is entitled to a return of his deposit and the Seller, whose house has been off the market for three months, takes nothing and is stuck with the expenses in preparing to sell his house and move.
In order for a contingency to be workable, the contingency must be limited as to time. If the Contract calls for a closing within ninety (90) days, the contingency should expire within the first thirty (30) days so that if the closing is not going to take place, the Seller has not irreversibly changed his position in reliance upon a forthcoming closing. If the contingency might fail days before a scheduled closing, the Buyer could rescind a Contract after the Seller has packed and has vacated the residence, leaving the Seller with a vacant home and no deal.
Putting in a time limit is not enough. The contingency should provide that in the event the time limit expires, the Buyer shall have the option of rescinding the Contract or waiving the contingency. Very often the Buyer will want to continue with the transaction even if the former residence has not sold, where a Buyer is fortunate enough to have other sources of funds available.
To protect a Seller, a clause could be inserted to provide that while the contingency exists, in the event the Seller receives a non-contingent offer the Seller shall have a right to accept such non-contingent offer after giving the Buyer notice of the back-up offer and giving the Buyer the option to immediately remove the contingency and close the transaction, or release the Seller so that the Seller may accept a firm offer.
In commercial transactions, more types of contingencies can be found. A Buyer might sign a contract contingent upon inspection and investigation of the property for a limited period of time. Buyers and sellers of commercial transactions tend to be more sophisticated, and the contingencies are more carefully defined. It is not uncommon to see a contingency for soil test, financing, rezoning, platting, and general inspection of improvements. Some contingencies allow a Buyer the right to rescind the Contract for a stated period of time for any reason whatsoever.
The more sophisticated commercial sellers are insisting upon a clause whereby in exchange for the inspection period, the Seller will be compensated for costs involved in preparing the Contract or for other expenses involved in connection with negotiating the sale.
Whatever the reason for the contingency and whatever the actual contingency may be, it is important to limit the duration of the contingency, to carefully define under what circumstances the Buyer may rescind the transaction, under what circumstances a Seller may terminate the contingency, and the length of time during which the contingency must be met or waived.
Careful drafting of the clause and thorough consideration of the problem at the time the Contract is signed will avoid problems for everyone as the closing approaches.