UNDERSTANDING REAL ESTATE CONTINGENCIES
What is a Contingency?
In its simplest form, a contingency is generally an event that must first occur before the contract will become binding and enforceable. There are many examples of contingencies – financing, title, professional inspections, the sale of buyer’s home, etc. Until the described event occurs, the buyer can usually get out of the transaction and recover back all of the earnest money. But true to the old adage, when it comes to contingencies, “The devil’s in the details.” Understanding these details is essential if one is to write a contingency that is clear and enforceable. What follows is a discussion of contingencies found in the OREF Residential Sale Agreement and some tips on writing your own.
The Financing Contingency.
There are several important issues to remember concerning the financing contingency. First, contrary to all of the other contingencies in the OREF Residential Sale Agreement, this contingency does not automatically expire. Unless it is expressly waived, e.g. by a written addendum,1 it continues all the way up to the moment of closing. The reason the Sale Agreement form does not make the financing contingency automatically expire – say after a couple of weeks – is because the loan underwriter who gives final approval for the loan, does not usually do so until shortly before closing. Until then, even though all of the stars are aligned and the buyer has Triple-A credit, the loan is never a sure thing. A tax lien could show up right before closing; an unpaid child support judgment could surface; or a legal claim clouding title to the property could be filed. So while many sellers and buyers believe that being “pre-approved” is good enough – it isn’t. Pre-approval is frequently nothing more than a mortgage broker’s preliminary opinion of the buyer’s creditworthiness based upon a cursory review of certain financial information. This is not the same as the lender’s commitment to actually loan the funds.
Secondly, the OREF Residential Sale Agreement form does not contain a pre-printed provision describing the type of loan to be sought. For this reason, it benefits both parties if they include some descriptive language regarding the type and amount of loan to be obtained. However, buyer agents frequently insert a shorthand phrase, such as “Loan of Buyer’s choice” or similar terms. This means that if the buyer cannot obtain a loan of “their choice” – whatever that may be
–they can terminate the transaction and recover back their earnest money. Unfortunately, while such loosely drafted phrasing is good for buyers because it gives them significant “wiggle room” to change their mind, it’s not so good for sellers. For example, the buyer might be intending to apply for a type of loan that contains only a minimal chance of approval. For this reason, listing agents and their seller-clients may want to make sure they have a good idea of the buyer’s
intended loan program, such as the type of lender (e.g. conventional versus non-conventional), the buyer’s intended loan amount, and the intended loan-to-value ratio, among other things.2
The Title Contingency.
The title contingency closely resembles the other standard contingencies in the OREF Residential Sale Agreement, in that it contains language making it automatically self-expiring. Specifically, it provides that the buyer shall have five business days (if no other time is inserted) following receipt of copies of the recorded title documents to notify the seller of any objections to the preliminary report. Correspondingly, upon receipt of such notice, the seller may agree to remove them or give reasonable assurances of doing so prior to closing. If the seller fails to do so, all earnest money is to be returned to the buyer and the transaction terminated. But buyers must remember that under the OREF form silence is consent. In other words, if the buyer fails to object to some recorded exception disclosed in the preliminary title report, such as an easement or right of way, the objection is waived.3 For this reason, it is very important for the buyer’s Realtor® to make sure their client closely reviews the contents of the preliminary report and secures timely answers to any issues that could potentially pose a problem. While real estate agents are not expected to be title “experts,” in this era of increased Realtor® professionalism, it is suggested that the buyer’s agent personally review the preliminary title report. If a potential problem appears, the agent should recommend that the client contact the title officer or a real estate attorney for further clarification.4
The Professional Inspection Contingency.
Similar to the title contingency, the buyer’s silence is also consent here. Unless a different time is selected, the buyer has ten (10) business days within which to conduct one or more inspections and, if necessary, complete negotiations with the seller for any repairs, price adjustments, or other concessions. This is referred to in the Sale Agreement as the “Inspection Period.” It is important to remember that the time-frame permitted in the Inspection Period is intended to cover not only completion of the inspections themselves, but also all negotiations between seller and buyer in dealing with any adverse information disclosed in the inspection report(s). Buyer agents should never assume that there is an open-ended period of time to reach agreement with the seller. The goal is to negotiate all property condition issues and reduce them to a fully executed addendum by or before the end of the Inspection Period. If it appears that this cannot occur due to matters beyond everyone’s reasonable control, both agents should discuss with their respective clients the need to consider a written extension of time.
The Well Inspection Contingency. This is another pre-printed contingency in the standard OREF Residential Sale Agreement form. It is different from the property condition contingency. First, it provides that the cost of the state-required well water testing will be borne by the seller. The buyer may, at the buyer’s expense, have any additional tests performed. If any tests indicate a substantial deficiency in well water quality or quantity, the buyer may withdraw from the transaction and recover back all deposits – so long as it is done within the time-frame agreed upon in the Sale Agreement. Absent the selection of some other timeframe, the buyer will have seven business days to give such notice to the seller. However, the seller may prevent termination if he/she gives written notification within 24 hours of receipt of the buyer’s notice that the seller will correct the deficiencies shown in the well report(s). This opportunity for the seller to “cure” any disclosed deficiencies is materially different than the property inspection contingency in which buyers may terminate simply by giving notice that they reject the professional inspection report.
Drafting Your Own Contingency.
When drafting a special contingency it is important to avoid ambiguity. If reasonable minds can differ upon the meaning of a contingency provision, it is “ambiguous.” So when drafting language unique to a specific transaction, it is important to make sure that all parties and their Realtors® agree upon its meaning. The following issues should be addressed: (a) The specific event that is the subject of the contingency; (b) How long the party for whose benefit the contingency is written has to exercise the contingency;5 (c) What event is necessary for the contingency to be satisfied or to fail; (d) The form and timing of the notice necessary for a party to get out of the transaction should the contingency trigger a right of termination; (e) The form of the notice (e.g. written) and to whom it must be given (e.g. the party or their agent, or either one); and (f) What happens if timely notice is not given (e.g. is silence equal to consent for the transaction to continue?) For example, in the professional inspection contingency, upon the failure to give timely notice of objection a buyer shall be deemed to have accepted the condition of the property.6
OREF has two separate contingency forms available for buyers to use. It is generally better to use one of these forms than to attempt to draft your own. However, each form is different, and should be closely reviewed before selection.
Conclusion. Since most contingencies usually permit the buyer to terminate the transaction without liability, such termination can occasionally be met with resistance from the seller. Even though the OREF Residential Sale Agreement provides that upon timely exercise, all deposits will be refunded, if the money is in escrow, the seller can effectively “veto” the return of funds by simply refusing to sign the mutual termination agreement. Escrow will not act without joint instructions, which means that the seller’s refusal to cooperate can hamper the timely return of funds – even though the buyer may believe they properly exercised their right of termination under the contingency. 7 In order to avoid misunderstandings, Realtors® should make sure that all contingencies are fully explained to their clients, and if called upon to write a special contingency, make sure everyone is in agreement upon when it must be exercised, and how that exercise is to occur.
© 2010 QUERIN LAW, LLC
1Some listing agents unilaterally prepare an addendum releasing “all contingencies” which includes the loan contingency. Buyer agents should be careful about routinely allowing their clients to sign such an addendum, since it means that if the loan falls through at the last minute due to reasons outside of the buyer’s control, the buyer could lose their earnest money. Realtors® representing buyers should thoroughly discuss this risk with their clients before allowing them to release the financing contingency. Remember, the OREF Residential Sale Agreement form itself does not require that the financing contingency be released at any time before closing. So a buyer’s willingness to do so should be based upon an evaluation of the risk of the loan falling through.
2Some savvy buyers and/or buyer brokers may insert an interest rate cap into their loan contingency.
3However, the Sale Agreement also provides that the buyer’s failure to object will not relieve a seller from the duty to convey marketable title at the time of closing.
4While Realtors® may undertake some of the responsibility for collecting information from the title officer, they should be careful to document all such communications and remind their clients to personally verify the information and secure competent legal counsel.
5If the deadline is to be measured in business days, it must be specified. Failure to so specify will be construed to mean calendar days. If the period is measured in a specific number of days, be sure that you and the other side agree upon the beginning and end dates.
6Although more commonly found in commercial transactions or those contemplating the future development of the property, sometimes the failure to give notice that the contingent event has not occurred (e.g. getting preliminary plat approval for a 34 lot subdivision), means that the transaction is automatically terminated. In other words, silence is not consent.
7This may not necessarily be so if the earnest money deposit is retained in the buyer broker’s trust account. See Oregon Administrative Rule 863-015-0186.