This article discusses conditions which must be eliminated before a purchase agreement becomes enforceable.
Occur, approve, waive or exercise
As a result of negotiations over the content of a purchase agreement, buyers and sellers frequently include provisions in the agreement which place conditions on their duty to close escrow, called contingencies. Contingency provisions placed in a purchase agreement grant the authority, which may only be used for good cause, to terminate the buyer’s duty to pay the purchase price or the seller’s duty to deliver title.
Contingencies describe an event or condition which the buyer or seller feels must occur or be approved before the purchase agreement transaction can proceed to closing. These contingencies need to be eliminated before a binding purchase agreement becomes fully enforceable, obligating the buyer and seller to close the transaction.
Contingency provisions contained in purchase agreements are eliminated by either:
- satisfaction of the contingency provision by the occurrence of an event or by someone’s approval of the conditions contained in information, data, documents or a report; or
- waiver or expiration of the contingency provision.
On the occurrence or approval as described in a contingency provision, the condition is said to be satisfied, such as the buyer’s receipt of a loan commitment or approval of disclosures.
If a condition is not satisfied, the person authorized in writing or benefitting from the contingency can either:
- cancel the transaction by serving the other person with a Notice of Cancellation [See Form 183 accompanying this article]; or
- waive the contingency and proceed with the transaction by notifying the other person the contingency has been waived or by allowing the time period for cancellation to expire. [See Form 182 accompanying this article]
If the event or approval called for in the contingency provision does not come about, the person with the right to cancel may waive the contingency provision or allow it to expire and proceed to closing. If the contingency provision is not waived or allowed to expire on failure of the event or approval to occur, the purchase agreement transaction can be terminated by the person with the right to cancel.
The person with the right to cancel may only exercise the right if they have a reasonable basis for the cancellation. If a reasonable basis exists, they can avoid enforcement of the purchase agreement by the other person. To exercise the right to cancel, a notice of cancellation must be delivered to the other person during the period for timely exercise of the right to cancel, and in the manner set out in the cancellation provision. [See first tuesday Form 150 §10.5]
Colorful jargon in the real estate industry has tagged contingency provisions with such titles as “weasel clauses,” “escape clauses” or “back-door provisions.” These titles suggest a misunderstanding of the ability to use contingency provisions to cancel and avoid buying or selling the property should the person wishing to cancel merely have a change of heart about proceeding with the transaction.
He who benefits may waive bye-bye
Consider a buyer who agrees to purchase property for a price acceptable to the seller. The terms for payment call for the buyer to fund part of the price by obtaining a purchase-assist loan at a particular interest rate with a specific monthly amortization schedule, until paid, e.g., a loan amount of no less than $200,000 at a fixed rate no greater than 6.5% amortized by monthly payments over a 30-year period.
Included in the purchase agreement is a provision stating the close of escrow is “contingent on” the buyer obtaining the purchase-assist loan, an event-occurrence contingency provision. [See first tuesday Form 150 §10.3]
The buyer discovers that mortgage lenders are raising rates, encouraged by a national monetary policy aimed at dampening an asset inflation bubble reflected in fast rising property values. As a result, one loan commitment received by the buyer comes in at a higher fixed rate of interest and a lesser loan amount than sought. Another is for the amount sought, but with a variable rate of interest. Neither commitment falls within the parameters of the terms set for the purchase-assist loan in the purchase agreement. [See first tuesday Form 150 §6]
The seller is advised the loan commitments do not satisfy the terms called for in the purchase agreement. At the same time, the buyer either hands the seller a notice of waiver of the contingency or lets the right to cancel expire, as called for in the loan contingency provision.
When the seller receives confirmation the loan commitments do not satisfy the contingency provision, the seller cancels the transaction. The seller claims the failure of the loan commitments to meet the conditions set for the loan gives him the power to terminate any further performance of the purchase agreement or escrow.
However, the power to cancel a transaction due to the failure of a contingent event can only be exercised by the person who benefits from the inclusion of the contingency provision in the purchase agreement.
Here, the seller has agreed to a cash transaction. On closing, the seller will receive net proceeds consisting of cash; nothing else. Thus, while the loan will help the buyer fund the sales price, the existence or nonexistence of the purchase-assist loan has no effect on the seller’s ability to perform or the seller’s net proceeds. The loan contingency does not benefit the seller.
If financing is not available and the buyer could not otherwise fund the close of escrow, the buyer would be in breach of the purchase agreement, unless he had the right to cancel the transaction and be excused from closing. Thus, the event-occurrence contingency provision calling for the recording of a purchase-assist loan was solely for the benefit of the buyer.
Accordingly, only the buyer held the right to cancel the transaction or waive the contingency. The buyer did neither. He did not exercise his right to cancel by stating he disapproved of the loan commitment or by delivering a notice of cancellation (as required by the contingency provision). The seller’s attempt to usurp the benefits of the provision by canceling had no legal effect on the continued enforceability of the purchase agreement. [Wesley N. Taylor, Co. v. Russell (1961) 194 CA2d 816]
Mutually beneficial further-approval contingencies
Now consider a buyer who agrees to purchase and develop real estate.
The seller agrees to carry back a purchase-money note secured by a trust deed which is subordinate to a construction loan the buyer is to originate to fund his development of the property. It is agreed the loan is to be approved and insured by the Federal Housing Authority (FHA). Neither the seller nor the buyer are given the written right to cancel if the approval is not forthcoming, although closing is contingent on recording the loan.
The FHA fails to approve the development project for mortgage insurance. As an alternative, the buyer obtains financing for the project elsewhere and notifies the seller he waives the FHA-approval contingency. [See Form 182]
On receipt of the buyer’s notice of waiver of the FHA further-approval contingency, the seller hands escrow a notice of cancellation and refuses to close escrow. The seller claims the failure to obtain FHA approval excuses the seller’s performance as he did not waive his right to an FHA approval.
Can the seller enforce his cancellation of the purchase agreement and escrow instructions when the buyer’s application for FHA approval was rejected?
Yes! Here, the FHA approval benefits both the carryback seller and the buyer. Thus, one or the other can cancel the transaction on the failure of the FHA approving the project since the contingency provision did not note who had the right to waive the provision or cancel on failure of the event to occur. Thus, each party who benefits from the inclusion of a contingency provision has the power to exercise the right of cancellation.
The buyer benefits under the contingency since FHA insurance will induce a lender to make a construction loan so he can fund the project.
However, the seller also benefits. An FHA-approved and insured project is additional security (protection) and provides a reduced risk of loss for his subordinated carryback trust deed note.
Thus, the contingency was included for the mutual benefit of both the buyer and seller, and cannot be waived — except by mutual consent — and either the buyer or seller may cancel on failure of the buyer to obtain FHA approval. [Spangler v. Castello (1956) 147 CA2d 49]
Waiver implied by conduct
When a buyer’s conduct leads a seller to believe a contingency benefitting the buyer has been waived and the seller then relies on the buyer’s indications by taking steps to complete his performance under the purchase agreement, the contingency is deemed to have been waived.
For example, a buyer enters into a purchase agreement with a builder to buy a lot on which the builder will 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 his current residence for sale and locate a buyer until just before the completion of construction, as he has no other place to live.
The buyer instructs the builder to begin construction based on plans and specifications approved by the buyer for the new home. During construction, the buyer continually reviews the progress of the construction with the builder. Also, the buyer orders changes in the plans and specifications during construction, with which the builder complies. The buyer never tells the builder to stop construction, nor does he advise the builder his current residence has not yet been sold.
On completion of construction, the builder makes a demand on the buyer to fund and close escrow.
The buyer then cancels the purchase agreement and refuses to perform. The buyer claims the contingency provision calling for the sale of other property has not been satisfied, which triggers his right to cancel since the sale of the current residence has not occurred.
The builder claims the buyer’s conduct constituted a waiver of the contingency, which now requires the buyer to perform.
Here, the buyer, by his conduct in changing the construction specifications and remaining silent concerning the lack of activity on the sale of his current residence during his inspections into the progress of construction, reasonably induced the builder into believing the “sale-of-other property” contingency had been considered by the buyer to be waived. Thus, the buyer’s failure to close the transaction was a breach of the purchase agreement since the power to exercise the right of cancellation authorized by the sale-of-other property contingency provision no longer existed after the waiver. [Noel v. Dumont Builders, Inc. (1960) 178 CA2d 691]
Satisfaction by occurrence or approval
Events or conditions identified in contingency provisions, which if not forthcoming allow the transaction to be terminated, fall into two categories:
- those which are satisfied by occurrence, consisting of event-occurrence contingency provisions which are dependent on the existence, completion or outcome of an activity or event for their elimination; and
- those satisfied by approval, consisting of further-approval and personal-satisfaction contingency provisions calling for the receipt and review of information, data, documents and reports as the conditions to be approved, waived or disapproved by others or by the person authorized to terminate the transaction.
Event-occurrence contingency provisions address the occurrence of activities and events, such as:
- the sale or acquisition of other property or the cancellation of a prior sale;
- the recording (or approving) of a lot split or subdivision map;
- 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 loan commitment;
- the recording of a loan; and
- the deposit of equity financing funds for the down payment.
Further-approval contingency provisions address the right of a party to the purchase agreement or a third party to cancel the transaction should they disapprove or find the following unacceptable:
- disclosures and inspection reports concerning the physical integrity and natural and environmental hazards of the property sold;
- 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;
- tax aspects;
- utilities, well water and sewage conditions;
- use feasibility reports;
- engineering reports on land use;
- existing plans and specifications for building;
- ingress and egress;
- loan commitments; and
- the availability of equity financing.
The buyer or seller with the right to cancel based on a further-approval contingency has a duty to fairly evaluate the condition to be approved or disapproved prior to canceling the transaction, called acting in good faith.
The buyer or seller who tries to terminate a purchase agreement under a right-to-cancel contingency without first acting to satisfy the contingency would be exercising an unfair advantage since to do so would allow them to terminate the transaction “at will,” simply because a contingency existed in their agreement.
A personal-satisfaction contingency allows the buyer or seller to avoid performance of the purchase agreement if they are not personally satisfied with an aspect of the transaction referenced in the contingency provision.
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.
Since the personal-satisfaction contingencies are essentially the same as the further-approval contingencies, they are judged by the same reasonableness standard when used to cancel a transaction.
Thus, a buyer or seller must have a reasonable basis for disapproving a personal-satisfaction contingency before a cancellation of the agreement is permitted.
Approval by waiver
The objective of a buyer’s agent when he includes a contingency provision in a purchase agreement for the benefit of his buyer is to provide the buyer with the ability to cancel the transaction should the event fail to occur or the condition be disapproved.
If the contingency is to be eliminated by approval (waiver) or expiration of the right to cancel, or exercised by cancellation of the purchase agreement prior to the date scheduled for the close of escrow, the buyer is to act by giving the appropriate notice to the seller as called for in the purchase agreement.
If the condition reviewed is acceptable or the event occurs, the buyer’s agent may be required by the wording of the provision to prepare a notice of waiver to eliminate the contingency. It is then signed by the buyer and handed to the seller, escrow or the seller’s agent, as called for in the contingency provision. [See Form 182]
The buyer may also waive the right to cancel and, while neither approving nor disapproving the situation, eliminate the contingency provision as called for in the purchase agreement. Here, the buyer’s agent uses the same notice of waiver form used for an unequivocal approval, if the buyer is required by the purchase agree-
ment to notify the seller of the buyer’s intention not to cancel, but to continue with the further performance and closing of the transaction. [See Form 182]