This article explains when a buyer or seller is entitled to exercise their right to cancel a purchase agreement and escrow instructions, such as on a breach or failure of an event to occur or condition to be approved.
The recession wave of buyer cancellations
Over the past decade, home sellers — and their agents — have had the luxury of home sales being a virtual guarantee. If you list it, they will come. Easy.
That is, until 2022 when the bubble of buyer irrational enthusiasm — or fear — popped, and home sales volume and prices began what will be a prolonged crash.
In a falling price environment, the certainty of a quick and easy sale for real estate listings is a thing of the past. As buyers already in escrow see equivalent homes listed below their contract price, they are more likely to find reasons to back out. Likewise, willing buyers may succumb to job losses during the pending recession, losing access to funding.
What are the situations when a breach or failure of conditions in provisions of a purchase agreement entitles a buyer or seller to exercise their right to cancel?
Further, how can you distinguish a unilateral cancellation to terminate further performance under a purchase agreement from a bilateral rescission of a purchase contract — which restores the buyer and seller to their respective positions before entering into their purchase agreement?
Exercising the right to terminate the deal
Consider a seller who agrees to carry back a note secured by a trust deed junior to an existing mortgage the buyer will assume. The purchase agreement entered into with the buyer contains a further-approval contingency provision which grants the right to cancel the transaction to:
- the seller when the buyer’s creditworthiness is unacceptable to the seller [See RPI Form 150 §8.5]; and
- both the buyer and the seller when either one disapproves of the existing trust deed lender’s terms for an assumption of the mortgage by the buyer when the terms offered exceed the mortgage parameters agreed to in the purchase agreement. [See RPI Form 150 §8.6 and 10.3]
On the seller’s receipt of the buyer’s credit application form, the seller’s agent orders and receives a report on the buyer’s creditworthiness from a credit reporting agency. [See RPI Form 302]
Editor’s note – One such source of a comprehensive credit report is Tenant Screening Center. More information is available from their website.
The seller, on review of the credit report information with their agent, is concerned about the buyer’s payment history. The seller’s agent acts on these concerns by asking the buyer for financial statements including:
- a balance sheet listing assets and liabilities [See RPI Form 209-3] and
- an end-of-year financial statement on the buyer’s income and expenses for the past two calendar years.
The buyer promptly supplies the requested financial data. The seller notes the buyer is cash poor with insufficient cash on hand to make the down payment called for in the purchase agreement.
Meanwhile, the seller’s agent learns the buyer is going to use a line of credit at a bank to finance the down payment. This debt-leveraging information when known to the carryback seller might affect their decision to exercise their right to cancel the transaction under the credit approval contingency. Thus, the seller’s agent relays the information to the seller.
The seller now has all the relevant credit information readily available or known to the seller’s agent. The seller determines they have justification for exercising their option to cancel the purchase agreement and escrow instructions. However, the seller has not yet decided what to do about allowing the transaction to continue.
Related article:
Review data and respond timely
The seller’s agent is mindful of the upcoming expiration date of the seller’s right to cancel and of their duty to protect the interests of the seller. Seeing their client’s inaction, the agent advises the seller that when they do nothing to cancel before the expiration of their right, they will lose their ability to be excused from completing the transaction as agreed.
Thus, a choice is made through inaction.
The seller understands they need to serve the buyer with a notice of cancellation before the expiration date stated in the contingency provision. Otherwise, the period for cancellation will expire and they will need to proceed to close escrow. [See RPI Form 183]
By the expiration date of the seller’s right to cancel, the seller decides to do nothing. The seller is willing to undertake the additional risks, including the possible need to foreclose presented by the buyer’s insufficient creditworthiness to become owner of the property subject to the seller’s carryback mortgage.
Meanwhile, the existing mortgage lender processes the buyer’s application to assume the mortgage and forwards assumption documents to escrow for the buyer to sign and return. The terms for an assumption demanded by the lender include:
- a modification of the interest rate to current rates;
- a new payment schedule for amortization; and
- a fee extracted for allowing the assumption.
However, these terms exceed and are more financially burdensome than the mortgage assumption parameters agreed to in the purchase agreement.
Related article:
Carryback seller’s refusal to subordinate
The buyer promptly signs the mortgage documents and returns them to escrow, along with the assumption fee demanded by the mortgage holder. Thus, the buyer, by conduct inconsistent with their right to cancel granted by the mortgage assumption contingency provision, waives their right to cancel the transaction.
The buyer now no longer has the authority to terminate the purchase agreement based on excessive financial demands by the mortgage holder to allow an assumption than agreed to in the purchase agreement. [See RPI Form 150 §10.3]
Meanwhile, the carryback seller determines the terms for assumption and modification of the existing mortgage are financially unacceptable and that they exceed the parameters of the mortgage assumption terms agreed to in the purchase agreement. The seller instructs their agent to prepare a notice of cancellation to terminate the transaction and escrow. The notice is immediately signed by the seller and delivered to the buyer and escrow, called a unilateral cancellation. [See RPI Form 183]
Here, the seller has a valid reason for refusing to subordinate. The risk of loss presented by the mortgage modification accompanying the assumption agreement is greater than the risks presented by the terms agreed to in the purchase agreement.
The seller’s notice of cancellation terminates the purchase agreement and escrow. Cancellation avoids any further performance of the purchase agreement or escrow instructions by the seller and buyer since all obligations to close escrow have been excused.
As authorized to cancel unilaterally
Unilateral cancellation of a real estate purchase agreement and escrow instructions may be initiated by a seller or buyer due to:
- a material breach of the agreement by the other participant; or
- the failure of an event to occur or a condition to be approved as called for in a contingency provision in the agreements.
Unilateral cancellation eliminates whatever remains to be performed under the purchase agreement, called a termination of the contract. Thus, a cancellation abolishes any future enforcement of the agreement by either participant from the moment of cancellation.
Here, the purchase agreement is cancelled by a unilateral act since the cancellation is achieved by one participant acting alone.
Further, the cancellation of a purchase agreement does not alter the consequences of any liability for activities and events which precede the cancellation.
Conversely, a rescission of either an unexecuted purchase agreement (i.e., escrow has not yet closed) or of a completed real estate transaction (i.e., escrow has closed) is a bilateral agreement. As a bilateral rescission, both the buyer and seller act in concert to retroactively annul the purchase agreement as ineffective from the moment it was entered into.
Alternatively, a cancellation brings a purchase agreement and escrow instructions to a standstill. Only future obligations under the agreement are eliminated.
In contrast, a rescission returns the buyer and seller to the respective positions they held prior to entering into the purchase agreement. When a contract is rescinded, it is as though the participants had never agreed to the transaction. The retroactive return to their former, pre-contract positions is called restoration.
When both the buyer and seller enter into a rescission agreement, the buyer and seller are restored to their pre-purchase agreement positions. Thus, a rescission eliminates all claims they may have had against each other for conduct which occurred after entering into the purchase agreement and prior to its rescission.
A rescission is a mutual agreement, entered into voluntarily, which eliminates the purchase agreement, by a buyer and seller executing a release and waiver agreement. [See RPI Form 181]
This episode digests agency disputes which arise between the agent and their client after a purchase agreement has been entered into, and principal disputes between the buyer and seller.
Escrow instructions cancelled separately
Consider a buyer in escrow on a purchase agreement with a contingency provision for the origination of mortgage financing necessary to fund the purchase price. The provision contains no parameters for acceptable terms of the new funding.
When the mortgage lender forwards the note and trust deed documents for the buyer to sign and return before funding, the buyer rejects the mortgage terms. The interest rate and payment schedule set by the lender in the closing documents are greater than orally represented by the mortgage loan originator (MLO) and do not support the price the buyer agreed to pay.
The buyer instructs escrow to prepare instructions to cancel escrow and the purchase agreement and return all funds and documents – instruments – to the participant who deposited them with escrow. The seller refuses to cancel the purchase agreement or reduce the sales price, but agrees to cancel only the escrow instructions. The seller claims the buyer seeks to cancel the purchase agreement to avoid paying the agreed price since comparable properties are now selling for a lower price.
Here, the cancellation of a purchase agreement is distinguished from both a unilateral or mutual cancellation of the escrow instructions. The cancellation of only the escrow instructions does not cancel the purchase agreement which continues in effect.
Often, due to a dispute or failure of a contingency, escrow will not close. Here, escrow issues instructions calling for the return of funds and documents to the participants who deposited them in escrow, part of the provisions canceling escrow instructions.
These escrow cancellation instructions, signed by both the buyer and seller, need not but may provide for cancellation of the purchase agreement. When the purchase agreement is not referenced as cancelled, the cancellation instructions handed to escrow do not interfere with any rights the participants may have to enforce the purchase agreement. Thus, the purchase agreement remains intact to be enforced to buy, sell or recover money losses since it has not been cancelled or rescinded, just escrow. [Calif. Civil Code §1057.3(e)]
Negotiations by the transaction agent to resolve the misunderstandings or differences and close escrow might not be successful. When the purchase dispute is unresolvable, the agents need to consider advising the buyer and seller to terminate not only escrow, but the purchase agreement as well. On cancelling both documents, the property is released and placed back on the market by the seller — and the buyer is free of obligations to the seller.
When the buyer and seller terminate the transaction, it is in everyone’s best interest for the buyer and seller to also release each other, the brokers and escrow from any claims they may have against one another. They do so by entering into a cancellation, release and waiver agreement to put the transaction to rest forever. [See RPI Form 181]
Cancellation for a valid reason
A seller or buyer occasionally refuse or are unable to hand escrow the instruments (funds and documents) needed to close the transaction in compliance with escrow instructions. Unless their nonperformance is excused, they have breached the purchase agreement.
Nonperformance is excused and the refusal to act is not a breach of the purchase agreement, when:
- a contingency provision exists authorizing the buyer or seller benefitting from the contingency to terminate the purchase agreement on the failure of an event to occur or on disapproval of data, information, documents or reports;
- the event fails to occur or the condition reviewed is disapproved; and
- the person authorized or benefiting from the contingency provision acts to terminate the agreement by delivering a notice of cancellation prior to the expiration of their right to cancel. [See RPI Form 183]
When a valid reason exists which triggers the buyer’s or seller’s right to exercise their right to cancel and they choose not to timely serve a notice of cancellation on the other participant, their right to be excused from further enforcement of the transaction expires.
Related article:
Conduct less than disapproval
Consider a buyer who enters into a purchase agreement to acquire an income-producing property before a recovery from a recession has taken hold. A provision calls for the buyer to review and approve the operating income and expenses experienced by the property. The buyer is handed a property operating cost spreadsheet for review and approval, called an income and expense statement or an Annual Property Operating Data sheet (APOD). [See RPI Form 352]
The receipt of the data commences a period of review for the buyer to determine whether to exercise their right of approval.
The data tends to confirm the general information received by the buyer before making the offer. However, the breadth and depth in the detail of the information seems inadequate for a long-term investment, the price of which is based on the buyer’s capitalization (cap) rate.
The buyer’s agent asks the seller to supply additional data and information, including access by the buyer for a review of all supporting documents regarding the property’s operating history, including leases, unit occupancy rates, expense records, list of contracted service providers — the works.
The seller claims the buyer’s request for more data and documents constitutes disapproval of the information and a cancellation of the agreement since the information already handed over sufficiently discloses the property’s operating history.
The seller claims the deal is dead – cancelled – and they are no longer required to perform. The seller has back-up offers at a higher price which the seller has accepted based on cancellation of this sale.
Has the buyer, by seeking additional information, disapproved of the condition of the income and expenses, and thus exercised their right to terminate the agreement?
No! The buyer’s request for additional data on the property’s operations is an expression of concern, not disapproval as clarification was sought. Implicit in a request for more information is the notion a decision of any type has not yet been made. Further, the seller has not fulfilled their obligation to deliver sufficient information to allow the buyer to complete their review and make an informed decision about the full nature and thus the acceptability of the property’s operations.
Termination of the agreement
Before an agreement is terminated by a buyer exercising a contingency provision, the buyer’s conduct needs to rise to the level of an unequivocal disapproval of the conditions presented by the data, information, documents and reports supplied by the seller.
For a termination of the purchase agreement to occur, the buyer needs to either:
- deliver a notice of cancellation, as called for to exercise the right granted to terminate the agreement; or
- otherwise communicate an unequivocal rejection of the disclosed condition to the seller.
The seller who fails to comply with a good faith request for more information to assist the buyer in the decision-making process of approval or disapproval of the condition under review has breached their obligation under the contingency provision to hand over data, information, documents, and reports.
Thus, the seller has defaulted on their obligations. This default is a breach which excuses the buyer’s further performance until the seller complies with the requests. Further, the seller’s breach of the provision allows the buyer to either cancel the agreement or pursue enforcement by a suit for specific performance.
Post-cancellation waiver attempt
Consider a prospective buyer of commercial property who includes a further-approval contingency provision in their purchase agreement offer calling for their approval of a survey to be furnished by the seller or cancellation by written notice. The seller accepts the offer, and a survey is conducted.
The surveyor’s observations are delivered to the buyer as agreed in the contingency provision. On the buyer’s review of the survey and accompanying report, the buyer discovers the location of structures does not conform to building permit requirements.
Thus, the buyer has a reasonable basis for exercising their right to cancel the transaction under the contingency provision.
However, the buyer’s agent does not prepare a notice of cancellation form for the buyer to sign and deliver to the seller as called for in the purchase agreement to terminate the transaction. Instead, the buyer advises the seller of their disapproval of the survey in letter form — but does not state they are cancelling the transaction due to their disapproval.
The seller does not respond to the buyer’s disapproval letter. At the same time, the market for income producing real estate is showing signs of a price recovery from recession levels.
The seller makes no effort to work out the discrepancies found in the survey so the buyer can approve the survey and waive the further-approval contingency.
Unequivocal disapproval terminates escrow
Prior to the date originally scheduled for escrow to close, the buyer’s agent prepares a notice of waiver of the further-approval contingency which the buyer signs. On the seller’s receipt of the notice of waiver, the seller has escrow prepare unilateral cancellation instructions which the seller signs and hands to escrow. The buyer then demands a conveyance of the property as agreed in the purchase agreement, which the seller rejects.
The seller claims the letter disapproving the survey terminated the transaction and excused the seller (and relatedly the buyer) from further performing on the purchase agreement or escrow.
The buyer believes their communication did not cancel the transaction, but merely disapproved of the survey without explicitly exercising the contingency provision which they now waived to allow the transaction to close.
Here, the buyer unequivocally disapproved the conditions disclosed by the survey. As a result, their rejection of the survey by the disapproval was itself an exercise of the buyer’s right under the contingency provision to terminate the purchase agreement and escrow. Thus, the disapproval is as effective as though they had signed a notice of cancellation and delivered it to the seller.
Here, the buyer is left without an enforceable contract, much less a right to cancel which they may later attempt to waive. [Beverly Way Associates v. Barham (1990) 226 CA3d 49]
