Why this matters: Learn to conduct a transaction as a buyer agent when a seller breaches the purchase agreement with a buyer, discuss remedies available to the buyer and review money losses the buyer may recover on a seller’s breach.
Failure to timely act
On occasion during a period of fast rising real estate prices, a buyer agent in a sales transaction is confronted with seller conduct which interferes with closing and causes the sales transaction to fail.
The seller’s conduct is contrary to activities the seller is to timely perform for escrow to close as scheduled, which include:
- return escrow instructions;
- deliver closing documents;
- provide escrow with information on the existing lenders so payoff demands, beneficiary statements or assumption papers may be ordered on existing mortgages;
- deliver seller identification information for title insurance purposes;
- eliminate agreed-to defects and previously undisclosed property defects known to the seller and unacceptable to the buyer;
- arrange or permit inspection of the property by the buyer, appraiser, home inspector, city inspector, etc.; or
- otherwise enable escrow to close as scheduled.
A seller independently fulfills the objectives of the purchase agreement they entered into with the buyer by voluntarily and in good faith complying with instructions given to an escrow as reviewed above. Separately, a compliant buyer has either fully performed or is unable to proceed further toward closing until the seller supplies escrow with necessary information or documents. Occasionally, the seller cancels escrow and escrow cannot close.
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Seller remorse sets in before closing
Typically, a seller’s failure to timely meet their obligations to close escrow on a sales transaction arises during periods of significant price increases for the type of property the seller agreed to sell. The seller has discovered they agreed to a price below the property’s fair market value, and a far better bargain can be quickly struck with another buyer.
As a result, “seller remorse” has set in, typically manifested by the seller’s interference with efforts to trigger a default by the buyer to justify the seller terminating the transaction.
A buyer faced with the failure of escrow to close due to the seller’s interference — nonperformance or obstruction — initially turns to their agent to persuade the seller to voluntarily close escrow. Unless resolved and escrow proceeds to closing, the buyer is forced to make a pivotal decision regarding their bargained-for ownership of the property due to the seller’s breach of agreements.
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Buyer remedies
When the seller breaches the purchase agreement or escrow instructions, the buyer is forced to make decisions in response, called remedies, which include:
- abandoning the transaction by entering into a mutual cancellation of the purchase agreement and escrow instructions with the seller. Thus, the buyer agrees not to enforce their right to purchase the property or seek a money recovery from the seller, other than a release of money the buyer deposited. [See RPI Form 181];
- acquiring the property by pursuing a specific performance action — judicial enforcement — of the purchase agreement and escrow instructions;
- pursuing the recovery of money when the buyer cannot now acquire the property. Here, the seller has conveyed the property to another person who was unaware of the buyer’s purchase rights, called a bona fide purchaser (BFP); and
- pursuing the recovery of money equal to the property value lost when the buyer no longer can or wants to acquire the property and the property’s value on the date the seller canceled the transaction was measurably higher than the price the buyer agreed to pay.
A bona fide purchaser (BFP) is a buyer who acquires ownership of a parcel of real estate without knowledge of an enforceable purchase agreement held by another buyer to acquire the parcel. As a BFP, the buyer pays consideration to acquire and take title to the property without knowledge of an outstanding right held by another to buy the property. [Calif. Civil Code §3395]
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Economic motives in a rising market
Market conditions surrounding a seller’s refusal to voluntarily cooperate with a buyer and transfer property under a purchase agreement usually comprise:
- seller pricing power (due to too many prospective buyers, too little inventory and eager mortgage loan originators (MLOs));
- mortgage rates at cyclically moderate to lower levels; and
- price increases publicly recognized as an upward trend, commonly referred to as a “hot real estate market” — for sellers.
During these economic “boom” and “bubble” periods of fast upward movement in real estate pricing, sellers often agree to sell property for a price less than top dollar. The seller or the seller agent has not fully checked into the current trend in market prices experienced in sales of comparable property.
The failure to ascertain the property’s market price before accepting a buyer’s offer sometimes results in an agreement at a sales price significantly below the market price. Then, during the escrow period, the seller discovers the property’s far greater market value and views the sale as a “bad deal.” To capture the additional money, the seller simply cancels the sale and sells the property to another buyer at a higher price.
The end game for all sellers of real estate is to net the most money possible on a sale under current market conditions. However, when a seller under contract with a buyer decides to cancel the sale so they can profit from a resale of the property at the higher market value, they merely encourage the buyer to pursue the same end game.
However, one remedy available to a buyer when the seller cancellation is not excused is the recovery of money from the seller equal to the increase in price of the property. The buyer is entitled to any increase (or decrease) in the property value above (or below) the price set in the purchase agreement.
Basically, what the seller receives in additional net proceeds on an immediate resale belongs to the buyer on the wrongfully cancelled sale. Thus, when the buyer pursues the seller to recover the increase in pricing, the seller is unable to retain the financial advantage they sought by breaching and reselling at a higher price.
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Misplaced reliance on an adverse party
Consider an owner of commercial real estate who lives out of the area. A buyer agent seeking to locate properties suitable for their buyer solicits the absentee owner of a property qualifying to meet the buyer-client’s needs. The owner agrees to sell but is unsure of the property’s value. They ask for an indication of its value from the buyer agent.
The owner is a sophisticated and intelligent individual capable of understanding the buyer and the buyer agent are their adversaries in negotiations.
After phone calls and correspondence exchanging information about the property, the buyer agent states they do not want to express an opinion of value on someone else’s property but have shown their buyer similar properties offered at $2,000,000. The owner does not indicate what they believe the value of their property might be, but acknowledges they know the market value of commercial property is on the rise.
The buyer agent prepares a purchase agreement offer for a cash price of $2,500,000. The buyer signs the offer, and the buyer agent submits it to the owner.
The owner accepts the offer, and the buyer agent promptly dictates escrow instructions. A copy of the instructions and a grant deed for the transfer are sent to the buyer and owner by escrow. The buyer signs and returns the instructions to escrow. On receiving, reviewing and approving the preliminary title report, the buyer advises escrow they will place the balance of the cash price into escrow when escrow calls for funds. The owner does not return escrow instructions or the deed for conveyance of the property.
Seller’s discovery of property value
Continuing our example, the owner then visits the community where their property is located. For the first time, the owner contacts local agents and inquires into the worth of their property. On their initial superficial inquiry, the owner finds the property is worth considerably more than the price they agreed to receive.
The owner quickly determines they have entered into an extremely bad deal concerning the price the buyer has agreed to pay. Another buyer is located, and a price of $7,500,000 is agreed to. Escrow is opened with the new buyer at different escrow and title companies and closed immediately.
Meanwhile, the original buyer is involved in a futile attempt to close their escrow with the owner. When asked to sign and return the signed instructions and the deed to escrow, the owner claims the agreement they entered into with the buyer is not a binding contract. The owner claims the buyer misrepresented the property’s value since the owner relied on the buyer agent’s evaluation to set the sales price. Thus, they have no deal.
The original buyer decides they no longer want the property (or will not pursue acquiring it since the new buyer is a BFP).
However, aware they have lost their ability to buy the property under the purchase agreement, the original buyer makes a demand on the owner for $5,000,000. The buyer claims they are entitled to the difference between the price agreed to and its worth based on the price the seller received on the resale of the property.
The owner refuses to pay the demand claiming their refusal to close escrow at the agreed price was justified since the property’s value was known to the buyer and the buyer’s agent, but not to the owner. Thus, they took advantage of the owner’s ignorance of the property’s true value, a situation called misrepresentation.
Here, the owner owes the buyer the difference between the price agreed to with the buyer and the value of the property on the date the seller breached ($5,000,000) by closing a sale with another buyer.
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Misrepresentation and deceit
Ordinarily, misrepresentation of a property’s value by a prospective buyer and their agent does not, by itself, justify an owner’s cancellation of the purchase agreement. Estimates of value made by a prospective buyer or their agent to a seller are, without more, a mere expression of their opinion of value they are willing to pay, not facts of a comparable market analysis a seller may rely on.
A buyer and their agent are known adversaries of any seller. Further, they owe no specific fiduciary duties to the seller.
More importantly, the owner in our example was not persuaded by the buyer or the buyer agent to forego an independent investigation into their property’s value. Also, the owner by their own conduct was able to undertake a reasonable investigation into the property’s value. However, the owner delayed their investigation until after entering into a purchase agreement which set the price to be paid.
A representation of value a buyer or their agent makes to an owner is deceitful when the representation is coupled with some other misfeasance, bad behavior or false representation. Further, the owner was neither ignorant, nor unable to protect and care for themselves against the buyer or agent they claim took unconscionable advantage of their ignorance of the property’s current value.
Thus, an owner’s reliance on evaluations of their property based on expressions of value by a buyer and buyer agent to set a price they are willing to pay does not justify the owner’s cancellation of the transaction.
To prevent this lack of knowledge about their property, an owner needs to take the opportunity “up front” before agreeing to sell, rather than later by retaining a broker (and paying a fee for advice) to determine the value of the property before agreeing to accept a price. [Kahn v. Lischner (1954) 128 CA2d 480]
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Recover money, not the property
A buyer who seeks to recover money from a breaching seller, in lieu of ownership of the property, does so based on three categories of money losses:
- general damages, being money directly expended in the transaction or the monetary value lost in the transaction;
- special damages, also called consequential damages, being money collaterally lost in the future due to the seller’s breach; and
- prejudgment interest on all monies recovered. [CC §3306]
General damages are money losses incurred by the buyer due to their cash expenditures and value of a lost right to acquire property — price increase in property over the purchase price. These money losses directly relate to a buyer’s right to acquire a property they no longer will acquire, including:
- money advanced by the buyer toward the price of the property, such as deposits held by a broker or escrow, or previously released to the seller;
- expenses incurred examining title conditions, inspecting the property, verifying operating income and expenses, and obtaining financing, escrow services, engineering and improvement plans, etc., all called transactional expenses;
- move-in expenses incurred to prepare the property in anticipation of possession; and
- the price-to-value difference between the price set in the breached purchase agreement and the value of the property on the date of the seller’s breach.
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Extending performance dates to attain purchase agreement objectives
Price-to-value difference on date of breach
Consider a buyer of real estate who enters into a purchase agreement to acquire one of two adjacent lots held by the owner. The purchase agreement contains a provision granting the buyer a right of first refusal to acquire the adjacent lot, also called a preemptive right to buy.
The right of first refusal provision sets the price of the adjacent lot at $900,000 but does not state an expiration date for the right to buy it. Thus, the buyer believes they have the right to buy the adjacent lot whenever the owner decides to sell it. A more formal documentation of the right of first refusal is not entered into, and no memorandum of the right is recorded. The transaction closes.
Many years later, the owner conveys the adjacent lot to another person for $2,000,000. The person who acquires the adjacent lot has no knowledge of the outstanding right of first refusal which was triggered by their purchase.
Thus, the buyer holding the right of first refusal is unable to exercise their preemptive right — triggered by the owner’s decision to sell — and acquire ownership of the adjacent lot from the other person. The person who acquired the adjacent lot is a BFP, barring any recovery of the lot by the buyer.
The buyer claims the owner has breached the right of first refusal provision in their purchase agreement. Thus, the buyer makes a demand for the dollar value of the lost right to acquire the property at the agreed price since they no longer can acquire the adjacent lot.
The buyer’s demand on the owner is for $1,100,000. This loss of money is the difference between the price set in the right of first refusal provision and the value of the property on the date of the breach. The demand also includes interest at 10% (the legal rate) on the amount from the date of the breach until the demand is paid.
The owner refuses to pay the demand. The owner claims the right of first refusal they granted expired prior to the owner’s sale of the lot based on the expiration of a reasonable period of time following the grant since the first refusal right documentation did not contain an expiration date.
May the buyer recover money equal to the price-to-value difference of a sale several years later of the lot covered by the right of first refusal?
Yes! The right of first refusal which the owner granted did not state a date for its expiration. Thus, the date of expiration becomes the date of the death of the owner who granted the right.
More importantly, the right to buy granted to the buyer had not been previously triggered by the owner’s actions to sell. Thus, the buyer never was in a position to exercise the right until the owner triggered the right to buy by their decision to sell the property.
It is the owner’s decision to sell which provides the buyer, when notified of the seller’s decision (which did not occur in our example, and thus the breach), with their opportunity to exercise the right — to form a binding bilateral agreement with the seller. Only then may the buyer make the decision and communicate their intent to buy the property at the price on the terms called for in the preemptive right to buy agreement.
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Read more about the right of first refusal.
The notice of intent to sell
The period following the notice of the owner’s intent to sell controls the buyer’s actions. Until the buyer receives the owner’s notice of intent to sell, the buyer does nothing but wait to see whether the owner ever decides to sell. It is the owner’s delivery of the notice to sell which starts the running of the period for the buyer’s exercise of their right to buy.
When this period for exercise is not stated in the right of first refusal provision, it is limited to a reasonable period of time for exercise of the right. [See RPI Form 162-2]
Thus, the period after the notice is what expires, not the grant of the preemptive right to buy, unless the right of first refusal provision specifically limits the term of the grant.
Accordingly, the buyer’s money recovery of the price-to-value loss is the difference between the:
- value of the property on the date of the breach, here set by the price the owner received for the property on the resale, the event which triggered the right to buy; less
- price agreed to in the right of first refusal provision as the amount the buyer was to pay for the property on exercise of the right to buy. [Mercer v. Lemmens (1964) 230 CA2d 167]
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Form-of-the-Week: Right of First Refusal Addenda — Forms 162, 162-1 and 162-2
The buyer prepares to take possession
Consider a buyer who enters into a purchase agreement with a builder to construct a new home. The buyer purchases appliances and upgraded fixtures, which the builder installs.
Later, the builder substantially alters the construction plans for the exterior without the buyer’s approval. The buyer demands the builder complete construction under the plans and specifications as agreed. The builder refuses. Prospective buyers for the property will pay a significantly higher price.
The buyer decides they no longer want the new home due to their conflict with the builder. They unilaterally cancel the purchase agreement as the builder breached the agreement, and they no longer want to acquire the property. The buyer decides to recover money, not the property, from the builder.
Here, the amount of money losses the buyer is owed by the builder include:
- funds advanced toward the purchase price, including good-faith deposits and monies released to the seller;
- the price-to-value difference between the price the buyer agreed to pay in the purchase agreement and the resale value of the property at the time of the builder’s breach;
- expenses incurred to prepare the property for possession, i.e., the expenditures made by the buyer for the additional appliances and upgraded fixtures — limited to the amount they exceed the price-to-value recovery; and
- interest from the date of the breach on all amounts of money recovered.
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Fees for withdrawal or termination of a representation agreement
Recovering expenditures to occupy
A buyer can recover expenditures to prepare a property for their taking possession when incurred prior to a seller breach. However, a purchase agreement provision needs to specify what improvements the buyer intends to make at the buyer’s expense.
The buyer’s recovery of costs advanced by a buyer for upgrades and additions gives the buyer the benefit of the bargain contemplated by both the buyer and seller when they entered into the purchase agreement.
However, the buyer is not entitled to a double recovery for the upgrades they paid for when the property’s price-to-value increase at time of breach exceeds the cost of the upgrades. Any upgrades are deemed to have contributed to the increase in value.
Expenditures to purchase furnishings incurred by a buyer before acquiring ownership to a home are excluded from recovery. Recovery of personal property expenditures is typically not agreed to or contemplated by a seller when entering into a purchase agreement.
Here, money spent on furnishings is not related to the acquisition of real estate. Accordingly, a prudent buyer agrees to buy furnishings contingent on closing the purchase of the property and delivery of the furnishings to the property.
Special damages, a natural loss result
A buyer whose seller breaches their purchase agreement is also entitled to recover related expenses incurred by the buyer after the breach. These post-breach expenditures only qualify for recovery when they are the natural result of the seller’s breach, called special damages.
For the buyer to recover post-breach expenditures, the seller on entry into the agreement needs an awareness the buyer will incur expenses as an unavoidable natural result of the seller’s breach of the purchase agreement.
For example, consider a buyer who enters into a purchase agreement to acquire an unimproved parcel from a builder. The builder agrees to complete construction of improvements on the parcel and convey the property to the buyer on or before an agreed date.
Before entering into the agreements to sell and construct improvements on the property, the builder is advised that failure to complete construction and convey the property to the buyer by the date scheduled will result in adverse tax consequences for the buyer. Thus, the time for performance by completion of construction and close of escrow is known by the builder before entering into the agreements as a prerequisite for the buyer avoiding profit taxes on a prior sale of other property.
Unless the time constraint is met, the buyer’s prior sale will not qualify for an Internal Revenue Code (IRC) §1031 exemption. Without the exemption, the buyer is required to report profits and incur state and federal tax liability on the profits from the sale.
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Read more about §1031 reinvestments.
Recoverable special losses, the fallout
The builder fails to complete construction and convey the property prior to the date set for closing. Here, due to the builder’s breach, the buyer is unable to avoid incurring and paying income taxes on the profit taken on their prior sale of real estate used in their trade or business. The buyer is also forced to rent another property (and incur moving expenses) until the construction the builder promised is completed.
Here, the special damages recoverable by the buyer as a money award include:
- the full amount of the profit tax the buyer paid;
- the rent paid for the temporary facilities until the improvements were completed (plus the cost of additional moving expenses); and
- interest at 10% from the date the amounts of rent and profit tax were paid by the buyer. [Walker v. Signal Companies, Inc. (1978) 84 CA3d 982]
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Interest due accruing from date of loss
Now consider a buyer who is awarded money losses due to a breach of their purchase agreement by the seller for failure to convey the property to the buyer. The buyer is also awarded interest at the (legal) rate of 10%, accruing from the date the seller breached the purchase agreement, on amounts awarded for:
- the price-to-value differential lost on the resale value of the property at the time of the breach;
- money paid toward the purchase price, whether held by the seller, broker or escrow, until the date released to the buyer;
- funds expended on title examination and other transaction expenses incurred preparing to take title;
- expenses incurred preparing the property to take possession; and
- interest accruing from the date of disbursements on further losses logically the result of the breach. [Al-Husry v. Nilsen Farms Mini-Market, Inc. (1994) 25 CA4th 641]
Now consider a buyer who enters into a purchase agreement on a one-to-four unit residential property with a seller. The buyer opens escrow and deposits funds called for in the purchase agreement.
Meanwhile, the seller receives a better offer from another buyer. The seller conveys the property to the second buyer.
The first buyer, whose purchase agreement has now been breached by the seller’s conveyance to the second buyer, is entitled to recover the:
- amount of the increase in value of the property on the date of the breach exceeding their purchase price;
- interest on the price-to-value difference at the legal rate (10%) from the date of the breach until paid; and
- refund of their deposits held either in escrow or by the seller; plus
- interest on the deposits from the date of the breach to the date the deposits are returned to the buyer. [Rasmussen v. Moe (1956) 138 CA2d 499]
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Losses you cannot recover
A buyer’s expenses and losses unrelated to the real estate itself and not intended to be incurred by the buyer under the terms of the purchase agreement are not the responsibility of the breaching seller.
Losses and expenses deemed too remote and speculative for a seller to foresee as obligations on a breach are not recoverable from the seller.
For example, a buyer enters into a purchase agreement to acquire an unimproved parcel of commercial property. The seller knows the buyer plans to develop the property. Before escrow closes, the seller determines a higher price can be had for the property from another buyer and cancels escrow.
Here, the buyer may recover any increase in the value of the land over the agreed-to purchase price on the date of breach as may be reflected by the seller’s resale of the property.
However, the buyer is not entitled to recover profits they might earn had they acquired the land and developed it. Lost profits for the anticipated use of a property the buyer does not acquire are unrelated to the sale. Worse, future operating profits are way too speculative for a buyer to recover. [Stewart Development Co. v. Superior Court for County of Orange (1980) 108 CA3d 266]
Also, lost income from rents a buyer might receive had the seller not breached and the buyer acquired a property subject to a long-term lease are not recoverable. Here, the recovery of lost future rental income is barred in a failed acquisition on a different legal theory from consequential losses. Rents are what give a property its present value as an investment at the time of purchase, a capitalization issue incorporating rents in the value.
Rent produced by income property is a factor, together with vacancies and operating expenses, used to establish the property’s present value — the price to be paid for the property and its flow of rents. To allow a buyer to receive a money award for both the increase in the resale value and future rents from a breaching seller is a double recovery. The buyer by the seller’s breach cannot achieve a better financial position than had the seller performed by conveying the property.
Commercial reality of escrow’s call for funds
Consider a buyer and seller who enter into a purchase agreement which sets the date for close of escrow. Neither the purchase agreement nor escrow instructions set a time period for the seller to deliver documents necessary for escrow to close. The transaction is contingent on the buyer obtaining purchase-assist mortgage funding at closing.
The buyer obtains a commitment letter from an MLO for a purchase-assist mortgage. The MLO issuing the commitment informs escrow they will prepare mortgage documents and fund escrow within five days after the MLO receives an estimated closing statement from escrow.
On the day scheduled for closing, the seller has not yet submitted a current rent roll statement requested by escrow. Thus, escrow is not in a position to prepare an estimated closing statement or call for closing funds from the MLO or the buyer.
Later that day, the seller submits a current rent roll statement to escrow, completing their performance of all conditions imposed on the seller by the date set for closing. Knowing the buyer has not deposited purchase funds into escrow by the date scheduled for closing, the seller hands escrow a written notice of cancellation.
The buyer makes a demand on the seller to convey title as soon as the MLO is able to fund the mortgage. The buyer claims their failure to fund escrow by the closing date is excused due to the seller’s untimely delivery of the rent roll statement to escrow.
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Nonperformance excused by tardy delivery
The escrow process depends on the orderly receipt of documents to close an escrowed transaction, a procedure a buyer and seller are required to honor. As a matter of commercial reality, escrow calls for closing funds from either the buyer or the lender only when escrow is able to close. In turn, neither the buyer nor the lender deposit or wire funds until they receive a call from escrow for funds.
Since escrow is not ready to call for funds due to the seller’s untimely delivery to escrow of necessary documents only the seller possessed, the buyer’s delivery of funds by the date scheduled for closing is excused. [Ninety Nine Investments, Ltd. v. Overseas Courier Service (Singapore) Private, Ltd. (2003) 113 CA4th 1118]
The seller’s obligation to deliver documents and the buyer’s obligation to fund escrow are considered mutually exclusive conditions concurrent. As such, the buyer and the seller each independently and separately perform by the date scheduled for closing. However, management of a closing by escrow requires their receipt of all documents needed to close before they call for funds.
When all the buyer’s and seller’s documents are delivered and held by escrow, and escrow calls for funding, lenders generally need five to seven days to prepare, forward and receive signed mortgage documents before they will fund.
Purchase agreements do not call for the buyer or seller to deliver documents to escrow prior to the date set for closing. However, an implied covenant of good faith and fair dealing exists in all real estate agreements.
The implied covenant imposes a duty on the seller to timely perform by taking action to avoid frustrating the buyer’s right to receive the benefits of the agreement. For example, the seller must perform early enough to allow time for the buyer and their lender to fund escrow when the seller intends to treat the date scheduled for closing as an absolute deadline.
Related video:
Read more about escrow disputes.
