The many colors of contingency elimination

In purchase agreement negotiations, buyers and sellers frequently place conditions on their rights and obligations to further perform and close escrow, called contingencies. Contingency provisions in a purchase agreement allow:

  • the buyer to terminate their obligation to pay the purchase price; or
  • the seller to terminate their obligation to deliver title and possession.

Contingencies describe an event, activity or further approval which needs to occur before the transaction may proceed to closing. These contingencies need to be eliminated before an otherwise binding purchase agreement becomes fully enforceable, obligating the buyer and seller to close the transaction as agreed.

Contingency provisions contained in purchase agreements are eliminated by:

  • satisfaction;
  • waiver; or
  • expiration.

On the occurrence of a specified event or approval of information obtained as described in a contingency provision, the contingency is said to be satisfied.

When a contingency is not satisfied, the transaction participant benefitting from the provision may:

  • cancel the transaction by serving the other participant with a timely Notice of Cancellation [See RPI Form 183];
  • waive the contingency and proceed with the transaction by notifying the other participant the contingency has been waived [See RPI Form 182]; or
  • allow the expiration of the time period for cancellation to run.

The participant with the right to cancel may only exercise that right when they have a reasonable basis for the cancellation — otherwise, the other participant may enforce the terms of the purchase agreement. This basis may not merely be a personal change of plans or eleventh hour cold feet.

The right waiver

A buyer’s conduct will occasionally lead a seller to erroneously believe a contingency benefitting the buyer has been waived and will not be invoked to cancel the transaction. When the seller relies on the buyer’s indications and takes steps to complete their performance under the purchase agreement, the contingency is deemed to have been waived by the buyer. Here, the buyer cannot later cancel the transaction based on that contingency.

For example, consider a buyer who enters into a purchase agreement with a builder to purchase a lot on which the builder plans to construct a single family residence (SFR) for the buyer. The purchase agreement contains a provision conditioning the close of escrow on the sale of the buyer’s current residence, an event-occurrence contingency provision.

However, the buyer does not want to market their current residence for sale and locate a new buyer until just before the completion of construction, as they have no other place to live.

During construction, the buyer continually reviews the progress of the construction with the builder. However,  the buyer does not advise the builder their current residence has not yet been sold.

On completion of construction, the buyer cancels the purchase agreement with the builder and refuses to perform, citing the contingency provision as a reasonable basis for cancellation. However, by weighing in on the construction and failing to notify the builder they did not sell their current residence as agreed, the buyer effectively waived the “sale-of-other property” contingency.

Thus, the buyer’s failure to close the transaction was a breach of the purchase agreement, removing their power to exercise the right of cancellation. [Noel v. Dumont Builders, Inc. (1960) 178 CA2d 691]

Two roads to satisfaction

Contingency provisions identifying events, activities or conditions allowing for termination of an agreement are separated into two categories:

  • those satisfied by an occurrence, described as the existence, completion or outcome of an activity or event to eliminate the contingency, the previously illustrated event-occurrence contingency provisions; and
  • those satisfied by approval, describing the receipt and review of information obtained from data, documents, reports and inspections subject to approval to eliminate the contingency, called further-approval or personal-satisfaction contingency provisions.

Event-occurrence contingency provisions address the occurrence of activities and events, such as:

  • the sale or acquisition of other property by the buyer or the seller;
  • the cancellation of a prior sale by the seller;
  • the recording (or approving) of a lot split or subdivision map;
  • rezoning;
  • the issuance of a use permit or a variance;
  • the approval of building permits;
  • the issuance of subdivision reports;
  • the documentation from off-record spouses;
  • the availability of utilities;
  • the availability of hazard/fire insurance;
  • the elimination of title conditions, or the release of encumbrances, such as liens or leases;
  • building permit compliance;
  • providing warranties on appliances;
  • a mortgage commitment;
  • the recording of a mortgage; and
  • the deposit of equity financing funds for the down payment by a syndicator.

Further-approval contingency provisions address the right of the buyer or seller to cancel the transaction on their disapproval or the disapproval by a third-party due to unacceptable property conditions and material facts related to:

  • disclosures and inspection reports concerning the physical integrity and natural and environmental hazards of the property;
  • due diligence investigative reports;
  • title reports;
  • leases and estoppel certificates;
  • rent control restrictions;
  • service contracts;
  • operating income and expense statements;
  • the financial suitability of a carryback note;
  • credit reports;
  • appraisals;
  • income tax aspects;
  • survey of boundaries;
  • utilities, well water and sewage conditions;
  • use feasibility reports;
  • engineering reports on land use;
  • existing plans and specifications for building;
  • ingress and egress;
  • mortgage commitments; and
  • the availability of equity financing.

A buyer or seller with the right to cancel based on a further-approval contingency has an obligation to fairly evaluate the information obtained to be approved or disapproved prior to their cancelling the transaction, behavior broadly called acting in good faith.

A buyer or seller who attempts to terminate a purchase agreement under a right-to-cancel contingency without first acting to satisfy the contingency is taking an unfair advantage of the provision. Even when a purchase agreement includes a boilerplate contingency, the mere existence of the contingency alone does not allow a transaction to be terminated “at will” — the  participant cancelling needs reasonable cause for the cancellation to be enforceable.

Similarly, a personal-satisfaction contingency allows a buyer or seller to avoid performance of the purchase agreement when they are not personally satisfied with the information, event or occurrence referenced in the contingency provision. [See RPI Form 150 §11.10 b]

Personal-satisfaction contingencies are identical to further-approval contingencies, except the buyer or seller is the one who approves or disapproves the subject matter of the contingency — not a third party, such as a home inspector. However, they are judged by the same reasonableness standard when it comes to cancellation.

Approval by waiver

When a buyer eliminates a contingency provision — whether by approval or cancellation — they are required to give the seller appropriate notice. [See RPI Form 150]

Here, the contingency provision may require the buyer’s agent to prepare a notice of waiver to eliminate the contingency. The buyer signs it and delivers it to the seller, escrow or the seller’s agent as called for in the contingency provision. [See RPI Form 182]

Some purchase agreements have disruptive contingency or cancellation provisions which require the buyer to also notify the seller of the buyer’s intention not to cancel ­— in effect, no different from a waiver. Here, the buyer’s agent uses the same notice of waiver form to avoid giving the seller grounds to cancel.

This article was originally posted January 2016, and has been updated.