Why this matters: Learn the contract elements comprising an enforceable agreement and how to manage the submission of an offer for the sale, lease or exchange of real estate.
The intent to contract
A contract is an agreement between persons binding them to do (or not to do) something. [Calif. Civil Code §1549]
Persons include individual people and entities qualified by the Secretary of State to contract within the state of California.
To form a contract, the elements needed in the agreement are:
- an offer;
- an acceptance;
- consideration — a bargained-for exchange;
- legally capable participants; and
- a lawful purpose. [CC §1550]
Oral agreements are valid contracts. However, participants need to formalize most agreements involving real estate interests or real estate services in a signed writing before the agreement is judicially enforceable. Brokers enter into written representation agreements when they expect to earn a fee as the buyer agent or seller agent for real estate services. [CC §§1622, 1624, 1670.50]
The elements needed to form an agreement and rules for contracting are best viewed in the setting of a typical real estate transaction.
For example, a broker acting on behalf of a buyer or seller structures a sales transaction using a variety of contracts — agreements — including:
- a representation agreement to employ the broker;
- a purchase agreement, option or exchange agreement documenting a sales transaction;
- escrow instructions to close the sales transaction;
- an interim or holdover occupancy agreement between the buyer and seller;
- a note and trust deed executed by the buyer;
- service agreements for investigations, reports, repairs and coordinators; and
- insurance policies for title, home warranty, hazards and personal liability.
The buyer, seller and broker in a transaction have varying rights and obligations under the different agreements. Additionally, duties agents owe to others not to mislead exist in all transactions.
Obligations to sign or perform one agreement, such as deeds of conveyance and escrow instructions, typically result from a prior agreement calling for the performance, such as a purchase agreement. [See RPI Form 150]
Related article:
Life cycle of a purchase contract
The life cycle of a real estate purchase agreement has four separate stages of activity:
- The formation (offer and acceptance) stage;
- The conditions (contingencies) stage;
- The performance (closing) stage; and
- The failure of performance (breach) stage.
During the formation stage, negotiations commence, and offers are made between a buyer and a seller. Eventually, one of the (counter) offers may be accepted.
The acceptance of an offer forms a binding agreement, the completion of the first stage. However, the agreement may not yet be enforceable by actual performance due to conditions contained in the agreement, called contingency provisions.
Actual performance of the agreement may not be enforced until the second stage — the conditions stage — is completed which eliminates the contingency provisions.
The conditions stage
During the conditions stage, the contingencies contained in the purchase agreement are satisfied or waived before the sales process may move toward closing. These contingencies are called conditions precedent. Contingencies must be eliminated before others can further perform or escrow can close.
Contingencies address the clearance of significant conditions negotiated by prudent buyers and sellers before they close the transaction, including:
- financial conditions (mortgage availability, price corroboration by appraisal, sale of other property, formation of an investment group, etc.);
- operating conditions (operating costs of ownership, tenant leases/income, service contracts, etc.);
- title and zoning conditions (covenants, conditions and restrictions (CC&Rs), use ordinances, etc.);
- physical conditions (home inspection, component certification, Home Energy Rating System (HERS) energy efficiency, environmental analysis, utilities, etc.); and
- location-related conditions (zoning ordinances, green belts, neighbors, natural hazards, etc.).
Additionally, the buyer or seller needs to independently complete their mutual performance obligations, called conditions concurrent, at any time prior to closing. Mutual performance obligations are tasks only one person to the agreement is to complete without concern for the other person first performing their mutual performance obligations.
For example, a seller’s obligation to deliver a deed to escrow is independent of and not conditioned on the buyer’s obligation to deposit closing funds into escrow. Neither activity is required to first be performed before the other is performed.
In contrast, a condition precedent calls for something to take place — the satisfaction or waiver of an act or event by one person — before the other person is required to take steps to close escrow.
Related article:
Brokerage Reminder: Eliminating contingencies – reasonableness required
The performance stage for closing
Activity on a binding purchase agreement has progressed to the performance stage when all the contingencies and independent activities — the conditions stage — are cleared and escrow is ready to close. To fully perform an agreement:
- all closing documents are signed and delivered to escrow; and
- funds are handed to escrow by all persons, whatever their source of funds.
Failure to close escrow, a stage beyond
When a failure to perform or a deficiency arises in one of the first three stages in the life of an agreement, the transaction has shifted into the breach stage. This stage follows any cancellation, whether the cancellation is justified or not.
For example, there may be:
- a defect in the agreement’s formation (e.g., invalid acceptance, incapacity of a person to contract, uncertain terms, lack of essential terms, etc.);
- a failure of one person to eliminate a contingency provision allowing the other person to avoid further performance by canceling the agreement; or
- a defense to closing which arises permitting the cancellation of the transaction (e.g., misrepresentation of the property’s physical, title or operating conditions, untimely performance, etc.).
When the defect in the agreement interferes with closing:
- the broker or their agents negotiate a compromise between the persons to the agreement, called an accord and satisfaction; or
- a court order needs to resolve the dispute.
Disputes are typically resolved through negotiation handled by the brokers and agents. However, it is this stage which produces the court cases which decide and flesh out our application of real estate contract law.
Related article:
Forming a contract — the agreement
An agreement is formed as a binding contract when an offer to purchase is made and accepted. [See RPI Form 150]
The person who makes the offer is called the offeror, while the person to whom the offer is directed is called the offeree.
In real estate sales transactions, the buyer typically makes an offer to the seller and, thus, the buyer is the offeror. However, the seller is the offeror as a result of a counteroffer to a buyer in negotiations over pricing or conditions.
For example, consider a buyer who makes an offer the seller will not accept. The seller counters with an offer to sell on different terms than those offered by the buyer, commonly called a counteroffer.
Here, the buyer’s offer is terminated by the seller’s rejection on submission of the seller’s counteroffer to the buyer or the buyer agent. The seller made a different offer to the buyer and became an offeror. The buyer, as the offeree on the counteroffer, needs to decide whether to accept or reject the seller’s offer to sell.
Related video:
Read more about the counteroffer environment.
Offeror and offeree
The terms offeror and offeree are useless in practice. The cast of characters in a real estate transaction are best viewed by their most common names, such as:
- buyer and seller;
- landlord and tenant;
- owner and lender; and
- broker and client.
Once each person is identified by the title given their position in a transaction (buyer, seller, broker, etc.), then their activity is subject to the rules for their conduct as the offeror or offeree.
What is an offer?
To be valid, an offer:
- shows a serious intent to enter into a binding agreement;
- is definite and certain in detailing the essential terms, such as price, terms for payment, property identification and conditions for performance; and
- is communicated to the person who can accept the offer.
The buyer’s signing of a properly prepared purchase agreement satisfies the first two conditions of intent and terms. A letter of intent (LOI) does not meet either of these criteria.
However, consider a seller who markets their real estate as available for sale without using a seller broker as their representative. A buyer directly responding to the “For Sale By Owner” notice writes the seller a letter expressing interest in buying the property, as long as a broker is not involved. The buyer asks what price the seller expects to receive.
The seller writes back, informing the buyer they will agree to negotiate the sale without a broker as long as the buyer pays all cash for the price. They also provide the buyer with the price they expect to receive for the property.
The buyer responds by stating they agree to the seller’s terms and demands the seller convey the property as agreed.
The seller refuses to convey the property, claiming a binding contract was never entered into, that their letter to the buyer was a mere invitation for an offer — a solicitation by the seller for an offer from the buyer.
Does the seller’s letter stating the cash price they expected to receive constitute an offer to sell which the buyer may accept?
No! The letter lacked wording for a serious intent to contract. Rather, it was an invitation to the buyer to make an offer to purchase. The letter lacked words of an offer to sell, preventing a reasonable buyer from believing the letter was intended to be an offer capable of acceptance. [Richards v. Flower (1961) 193 CA2d 233]
Similarly, the following communications with respect to the purchase of real estate are not offers:
- seller representation agreements providing an asking price;
- advertisements stating a sales price;
- LOIs to determine probable terms [Rest.2d Contracts §26]; or
- preliminary negotiations or letters of proposal.
Related article:
Terms and conditions of an offer
For an offer capable of forming a binding contract on its acceptance, the stated terms of payment and conditions of the performance need to be definite and certain.
When an agreement is breached and litigation is pursued for enforcement, a court gleans from the provisions in the agreement the intent of the participants. Sufficient terms need to exist for the court to determine what performance to enforce or the amount of any money losses to award.
For example, consider a landlord and tenant who sign a lease agreement granting the tenant an option to extend the term of the lease. The amount of rent due during the extension is stated as “to be agreed on” when the option is exercised.
An option is an offer which has not yet been accepted. The offer may not be withdrawn as it is irrevocable for the period for acceptance, called exercising the option.
Here, the option granted to the tenant to renew the lease lacks an essential term. The rental rate is the price the tenant pays for the occupancy and use of the property. The price is missing, and no standard or gauge for calculating the amount to be paid was provided.
Later, the tenant exercises (accepts) the option (irrevocable offer to extend the lease). The landlord refuses to comply, claiming the option is unenforceable as the rent terms are too vague.
Is the option to renew too vague to be enforced?
Yes! The purported renewal option was merely an “agreement to agree.” It expressed an intent to charge a different rate of rent during the extension of the lease but did not state the amount or provide a formula for setting the rent. Thus, the option is unenforceable. [Ablett v. Clauson (1954) 43 C2d 280]
Related article:
Form-of-the-Week: The option to buy and its variations — Forms 161, 161-1 and 161-2
Essential elements of an offer
To be definite and certain in its terms and conditions for enforcement, an offer contains provisions covering the essential elements of the transaction, including:
- the identity of the participants;
- a description of the real estate;
- the price and form of payment; and
- the time for performance — closing. [King Stanley (1948) 32 C2d 584; CC §1550]
The offer need not be prepared by use of a published standardized form to be enforceable. In fact, an offer may even be made on the back of a business card.
Finally, an offer submitted, called communicated, to the person intended to accept the offer may only be accepted by that person as the offeree.
In real estate transactions, the buyer typically makes the initial offer to buy on terms stated in the provisions of a purchase agreement form signed by the buyer. The offer to buy intends for the owner of the property to accept the offer, a person known but not usually identified by name in the offer. Thus, the offer may only be accepted by the owner.
Related video:
Read more about the option to buy.
Regular offers
For an offer to exist, real estate brokers and their agents use regularly published, checklist-type forms to prepare and transmit offers between buyers and sellers.
A Real Estate Purchase Agreement form is used in the purchase and sale of fee simple and existing leasehold estates, such as ground leases, long-term leases or master leases. The real estate interest purchased is the acquisition of one of several types of rights to possession. [See RPI Form 150]
California real estate licensees have access to an extensive variety of boilerplate agreements for practically any contractually negotiated real estate situation. Competitive publishers market real estate forms for use by brokers and their agents in lieu of forms independently drafted by brokers or their attorneys.
The use of a published form to prepare an offer to buy or sell real estate is justified for three reasons. Published forms in regular long-standing use:
- Satisfy the writing requirements mandated by the California’s Statute of Frauds. [CC §1624]
- Have evolved with clarity of meaning and uniformity than results from individually drafted agreements (which are usually drafted using provisions from published forms).
- Are encouraged by Errors and Omission (E&O) carriers.
However, published forms are not a cure-all. Regular forms used to prepare agreements merely decrease the potential for error or omission. When using published forms, brokers and their agents are limited in analysis to the task of filling in blanks and checking the boxes to indicate the provisions included in the agreement.
Related video:
Read more about purchase agreement types and variations.
Purchase agreements at work
Regular purchase agreements set forth the essential terms and conditions of an offer to make it enforceable, complete and clear in meaning.
Specifically, purchase agreements contain clauses for:
- the identities of the participants;
- the location of the real estate sold, leased or encumbered;
- the price and financing;
- the time for acceptance and elimination of contingencies;
- the time for opening and closing escrow;
- title conditions and vesting;
- the physical condition of the property;
- the property’s natural hazards and environmental conditions;
- tax planning; and
- agency relationships and the buyer broker fee.
A variety of purchase agreements exist with terms and contingencies considered for different types of properties and transactions. Thus, a purchase agreement is a grand checklist of provisions considered for inclusion in the final agreement by:
- filling in the blanks and checking boxes; or
- leaving them blank and not a part of the agreement.
Related video:
Read more about the purchase agreement contents.
Rationalizing the breach of an agency duty
The seller agent has a duty to present every purchase offer they receive to their seller, regardless of its content or method of presentation, written or oral. [CC §2079]
Although the failure of a seller agent to present an offer to purchase may go unnoticed by an unskilled buyer agent or buyer, it does not mean a failure to present offers happens infrequently. Numerous reasons exist to explain a seller agent’s improper failure to transmit an offer to their seller, but an explanation does not make the conduct appropriate.
Seller agents occasionally “cherry pick” offers for presentation which yield the highest fees, a serious misdeed which places the agent’s interests ahead of the client’s.
Other examples of bad seller agent behavior include:
- pre-screening offers and submitting only those the agent believes the seller is most likely to or should not accept (in essence, making unauthorized discretionary decisions on the client’s behalf);
- discarding an offer based on a belief the offer is not likely to gain a third party’s approval needed for the transaction to close — a contingency;
- dismissal without presentation of an offer submitted on a form unfamiliar to the agent (a conflict of interest arising from an agent’s bias toward or against a publisher); or
- refusal to submit offers presented on non-trade union forms in the erroneous belief their E&O insurance policy will not cover claims arising from a dispute.
An offer not presented
Consider a seller who enters into a representation agreement with a broker to market a property for sale. The seller broker and their agents are employed to locate qualified buyers who will make offers for the seller to consider.
While marketing the property, the seller broker receives an offer to purchase the property from a buyer at a price lower than the asking price sought by the seller. Concurrently, the seller broker receives another offer to purchase the property. This second offer is for a price greater than the asking price.
The seller broker has previously dealt with this second buyer and knows the buyer is less financially qualified — and less likely to close escrow — than the buyer who submitted the first offer. The broker, sensing the second buyer will have difficulty securing purchase-assist financing to eliminate a contingency provision in the purchase offer and thus less likely to acquire the property, does not submit the second offer to the seller.
The agent presents the first buyer’s lower priced offer to the seller. The seller believes the offer is their only available sales opportunity and accepts the offer. The seller closes escrow on the first offer.
Later, the seller discovers the existence of the second offer and its greater amount of net sales proceeds they lost. The seller seeks to recoup their money losses from the broker for the difference between the amount of net sales proceeds received and the amount the second offer would have provided.
The seller broker claims they believed the second offer was not credible and discarded it as a service to the seller since they had a bona fide offer to purchase.
Is the seller broker liable for the seller’s losses?
Yes! The seller broker breached their fiduciary duty to care for and protect the seller’s best interests.
Regardless of the intentions of the seller broker, their failure to present the second offer to the seller is tantamount to an outright denial the offer existed. This failure raises the seller broker’s silence about the offer to the level of deceit by omission.
Not only did the seller broker breach their fiduciary duty owed as an agent to their seller, but they also acted fraudulently by the non-disclosure. The broker’s deceptive silence entitles the seller to collect their losses from the broker, plus an additional punitive money recovery. [Simone v. McKee (1956) 142 CA2d 307]
Related video:
Read more about an agent’s fiduciary duty.
Duty to present all types of offers
The agency relationship imposes fiduciary duties on an agent mandating the disclosure of any fact which potentially affects their client’s interests in a transaction, known as a material fact.
An offer to purchase is critical to a seller’s decision-making process regardless of its content, terms or form of presentation — oral offers included. The offer is a factor in the seller’s evaluation of the desirability of their property and negotiation over price and terms of sale. [CC §2079(a)]
Failure to present an offer denies the seller the opportunity to weigh all offers their broker receives and to better understand buyer demand. Failure to present any offer, oral or written in any form, is essentially an affirmative representation to the seller-client that the offer does not exist. [Miller & Starr §3:27]
This duty is not just a benefit due the seller, but helpful information for the buyer. A buyer has an implicit right to have their offer looked at by a seller when an agent participates in the transaction. Further, presenting all offers serves a critical public purpose: enhanced perception of fairness and transparency in the real estate marketplace, fortified by the conduct of the agents as they are the gatekeepers to real estate ownership for both the buyer and the seller.
Handling a purchase offer
When the seller is not going to accept a buyer’s offer, the seller agent needs for the seller sign either a counteroffer or rejection for delivery to the buyer.
A rejection of an offer occurs by:
- returning a signed, written rejection stating no counteroffer will be forthcoming [See RPI Form 184]; or
- preparing and submitting a counteroffer, using either a counteroffer form or a freshly prepared purchase agreement form stating different terms. [See RPI Form 180 and 150]
Related article:
Form-of-the-Week: Counteroffer and Rejection of Offer — Forms 180 and 184
No duty to respond
It is important to remember neither the seller nor their agent has any legal duty to respond to an offer. Failure to respond to an offer does not mean an offer was not presented but does raise the issue. Also, when a seller instructs their agent (preferably evidenced in writing) not to present offers which fail to meet agreed-upon criteria, the seller agent is excused from submitting those offers to the seller. [Stevens v. Hutton (1945) 71 CA2d 676; CC §2079]
However, when a dispute over the seller agent’s handling of an offer arises, the burden of proof that an offer was presented falls on the seller agent. Here, the seller agent needs to produce documentary evidence they fulfilled their fiduciary duty and presented every offer received to their client.
To meet this burden, the seller agent submitting an offer the seller rejects needs to instruct the seller to sign the rejection provision on the purchase agreement form. With a signed rejection or counteroffer delivered to the buyer agent or buyer, the agent provides evidence the offer was submitted. [See RPI Form 150]
Related article:
Counteroffers — practice dictated by buyer representation agreements
