This article sets out the enforceability of one party’s right to cancel a transaction when the other party fails to perform by an appointed date.
Time is of the essence
The short, seemingly harmless time-is-of-the-essence provision stands alone amongst the boilerplate provisions of some, but not all, purchase agreement forms used to buy and sell real estate in California. By its plain words, the time-essence provision gives notice to the buyer and seller that compliance by the date scheduled for performance of an act or the occurrence of an event called for in the purchase agreement or escrow instructions is essential to the continuation of the transaction.
The time-essence clause “stacks the odds” of losing a transaction against the buyer.
Thus, the bargain built into the purchase agreement by the presence of the time-essence provision gives the buyer or seller the right to immediately cancel the transaction on the failure of the other party to act or cause an event to occur by the appointed date. By virtue of the multiple number of tasks a typical buyer undertakes to close a transaction, contrasted with the very few tasks imposed on a seller to close, the time-essence clause “stacks the odds” of losing a transaction against the buyer, even though he acted with diligence at all times.
Further, for a vast majority of listing and selling agents who work diligently to clear conditions and close a transaction, the time-essence clause places a risk of cancellation on a transaction which is not helpful as foreseeable delays in closing a transaction exist in all sales. Worse yet, the time-essence clause has, over the years, consistently demonstrated an ability to produce litigation over rights to money or ownership which have been lost or forfeited by a cancellation that is typically initiated by the seller.
Editor’s note – first tuesday’s purchase agreements do not contain a time-essence clause. Instead, the purchase agreements authorize the agents to extend performance dates by up to one month.
Purpose of the time-essence provision
The “common understanding” said to exist as the purpose for including a time-essence clause in a purchase agreement is to protect the seller from delays in the buyer’s payment of the sales price which “tie up” the seller’s real estate beyond the date or time period fixed for the transfer of ownership. [Vorwerk v. Nolte (1890) 87 C 236]
Cancellation spells the end to the expectations of everyone involved in the sale.
|Another less logical theory for enforcing appointed dates as deadlines for the occurrence of acts or events called for in agreements containing a time-essence clause, is the purported inability to estimate or compensate a seller for losses resulting from a delay in the close of escrow due to the buyer’s failure to perform. [Henck v. Lake Hemet Water Co. (1937) 9 C2d 136]|
However, delays in closing of a few days or even a few weeks or more, while inconvenient, rarely cause any compensable loss of money, value, rights or property for the party attempting to cancel. Typically, the cancellation is motivated not by time, but by greater profits elsewhere, i.e., “money is of the essence.”
Even if a money loss is incurred due to a delay in performance, the loss is usually sustained by the seller and is easily calculable. Seller losses typically consist of lost rental value (or carrying costs) for the period beyond the appointed closing date to the actual date of closing. An infrequent exception which occurs and causes the seller an incalculable (and uncollectible) loss, arises out of the seller’s reliance on the closing of a sale (not his entry into the sale) to complete some other transaction.
As for the buyer, his losses on a seller’s default usually arise out of a missed closing deadline which he needed to meet in order to receive tax benefits or a locked-in (low) interest rate loan.
Termination of rights
An effective Notice of Cancellation interferes with the completion of a transaction as initially envisioned by the buyer and seller when they entered into the purchase agreement and escrow instructions. On a proper cancellation, the party terminating the purchase agreement transaction does not need to further perform any act called for, including the close of escrow. The transaction has been terminated.
For example, the party who cancels has the unfettered right:
- in the case of a seller, to retain ownership or resell the property to other buyers at a higher price; or
- in the case of a buyer, to keep his funds or use them to purchase other property on a better bargain.
These rights to act, free of the purchase agreement and escrow obligations, are the very objectives met by cancelling rather than keeping the transaction together by determining the additional time reasonably needed by the other party to perform, and then granting an extension of time in which to perform. Should the “grace period” of additional time be granted and expire without compliance, a cancellation for failure to perform is most understandable (and enforceable) by all involved. [Fowler v. Ross (1983) 142 CA3d 472]
However, an effective cancellation by one party forfeits the rights held by the other to close the transaction and receive the benefits bargained for on entering into the purchase agreement. Further, on an effective cancellation, the agents, escrow, lender and title company all lose the time they invested to help get the transaction closed.
For example, when a seller cancels, the buyer loses, by forfeiture, his contract right to become the owner of the property. Conversely, if the buyer cancels, the seller loses the right to receive funds and be relieved of the obligation of ownership. Thus, a cancellation by either the buyer or the seller, if proper and enforceable, is the “final moment” in the life of a purchase agreement and escrow. Cancellation spells the end to the expectations of everyone directly or indirectly involved with the sale who would have benefitted by the closing of the transaction.
Editor’s note – For simplicity’s sake, the following discussion will refer to situations where the seller cancels. However, the discussion fully applies to situations where the buyer is the cancelling party.
For a seller to successfully cancel an escrow based on the buyer’s failure to perform an act or cause an event to occur, the purchase agreement or escrow instructions must contain:
- a clear description of the act or event required to be performed or caused to occur by the buyer;
- an appointed date or time period by which the act or event described is to occur; and
- a written provision stating in clear and unmistakable wording, understandable to the buyer, that the seller has the right to cancel the transaction as the consequence of the buyer’s failure to act or cause the event to occur by the appointed date.
If provisions in the purchase agreement or escrow instructions meet all of the above criteria, the seller will only be allowed to cancel if:
- he has performed all acts which must precede, by agreement or necessity, the buyer’s performance;
- the act or event the buyer is obligated to perform or cause to occur fails to occur by the appointed date; and
- he performs or stands ready, willing and able to perform all other acts necessary to close the transaction at the time of cancellation.
It is the notice provided by the existence of the time-essence provision which advises the buyer that his performance by the date scheduled is critical to the continuation of the purchase agreement and escrow instructions. Thus, the time-essence provision sets the buyer’s reasonable expectations of the consequences of his failure to perform, i.e., the risk that the seller may cancel the transaction and forfeit the buyer’s right to buy the property.
In order to cancel, the cancelling party cannot be in default.
However, the consequences of the buyer’s failure to perform depend upon which time-related provision is contained in the purchase agreement and escrow instructions:
- a time-essence provision with no other provision abrogating the right to cancel after the appointed date for the buyer’s performance;
- a seller-may-cancel provision describing the buyer’s performance and the appointed date by which it is to occur, authorizing the seller to cancel if the buyer does not perform, whether or not a time-essence clause exists;
- an authorization-to-extend provision granting the agents the power to extend performance dates up to 30 days (or other wording indicating an accommodation for delays), whether or not a time-essence or seller-may-cancel clause exists;
- an extension of time granted by the seller, typically in supplemental escrow instructions, with wording imposing strict adherence to the new performance deadlines and authorizing the seller to cancel on expiration of the extension should the buyer not perform;
- the nonexistence of a time-essence clause, cancellation provision or agent authorization to extend performance dates.
Elements of a default
Before either a buyer or seller can effectively cancel a transaction, they must place the other party in default. Thus, in order to cancel, the cancelling party, either the buyer or seller, cannot be in default.
For the buyer or seller to place the other in default, three transactional facts must exist:
- A date crucial to the continuation of the transaction must have passed;
- The other person in the transaction must have failed to perform his obligation to act or cause an event to occur by the scheduled date; and
- The person cancelling must have fully performed all activities required of him in order for the other person to perform, called conditions precedent, and have performed or be ready, willing and able to perform all activities he is obligated to perform by the time of cancellation, called conditions concurrent.
Events or activities called for in a purchase agreement are referred to as conditions. Not all conditions are contingencies. However, all contingencies are conditions.
In other words, two types of conditions exist, and are distinguished by the legal consequences which result when the condition is not satisfied by the occurrence of the event called for:
Events which are contingencies either occur (the buyer obtains a loan commitment) or are approved (the buyer approves the property’s title conditions, leases, income and expenses). If the event neither occurs nor is approved, the event (condition) can be waived, allowing the transaction to continue to closing (as would happen if a survey revealed less acreage than originally disclosed, but the buyer decides to purchase the property anyway). If the event called for is not forthcoming, such as the submission of a disclosure to the buyer, the transaction can be cancelled by the buyer. Thus, should an event fail to occur, the person with the right to cancel may waive the right, allowing the transaction to continue, or cancel the transaction outright.
Usually, a contingency calls for the buyer to approve property conditions, make financial arrangements, obtain further approval for a tax situation or require confirmation of a situation, and to either waive the right to cancel or cancel the transaction if these events do not happen.
Further-approval and event-occurrence contingencies giving the buyer the right to cancel usually arise due to the buyer’s need to obtain financing or conduct a due diligence investigation to confirm his expectations about the conditions affecting the property (physical, title, income/expense and location). The events called for in a contingency provision which allow the buyer to cancel typically include approval of tax ramifications, sufficiency of the property’s value (buyer’s appraisal), financial suitability of a carryback, sale or purchase of other property, zoning, feasibility reports, building or land-use permits, operating income and expense confirmation, lease estoppel certificates, preliminary title reports and home inspection reports.
Was the cancellation timely?
|The setting of a time for an act or event to occur does not, by itself, allow a purchase agreement transaction to be terminated by one party when the appointed date has passed and the other person has not yet performed.||
Manifest your intent: Is the date for performance a “target date” or a “deadline”?
To permit a cancellation immediately following the expiration of the appointed time for performance, the purchase agreement or escrow instructions must clearly state it is the intention of both parties that the failure by one or the other party to perform by the appointed day will subject his contract rights to forfeiture. Thus, clear cut wording throughout the purchase and escrow documents must consistently manifest an intent to make time for performance crucial to the continued existence of the transaction before the appointed dates have significance for a cancellation.
For example, on occasion, the only wording regarding any right to cancel a transaction appears in the escrow instructions. Escrows are nearly always instructed to close at any time after the date scheduled for closing if escrow is in a position to close, provided it has not yet received instructions to return documents and funds.
Thus, neither the purchase agreement nor the escrow instructions contain a clause stating “time is of the essence in this agreement.” Further, no clear, unequivocal or unmistakable wording shows an intent on the part of the buyer and seller to make time of the essence, such as wording giving the seller or buyer the “right to cancel” on the failure of the other party to perform the described event by a scheduled date.
Under these examples, which lack time-essence provisions, the time appointed for the delivery of such items as loan commitments, termite reports, funds for closing or clearance of encumbrances from title is only a sort of “target date,” preliminary to exercising the right to cancel.
To exercise the right to cancel when time is not established as crucial, the defaulting party must be notified that the “new deadline” will be strictly adhered to, and be given a realistic time period in which to perform before cancelling. Continued nonperformance past the new deadline date will be treated as a default and escrow can be immediately cancelled.
For example, a purchase agreement calls for a buyer to close escrow within 45 days after acceptance. No time-essence clause, cancellation provision (other than the implied right to cancel exercisable on failure to perform) or agent authorization to extend performance dates exists.
The seller orally agrees to extend the date of performance (closing) an additional 30 days. Two days after the extended (deadline) date, the seller cancels the transaction.
Is the seller’s cancellation of the transaction effective?
Yes! The 30-day extension was a reasonable amount of time for the buyer to perform before the seller exercised his right to cancel. A further extension of time is not needed for the cancellation to be reasonable and effective. [Fowler v. Ross (1983) 142 CA3d 472]
Now, consider an example of strict compliance with performance dates as “deadlines,” after which the purchase agreement and escrow can be terminated for failure of the described act or event to occur. The purchase agreement contains a simple time-essence clause. Authority is not granted to the agents to extend performance dates should the appointed date for performance prove to be an inadequate amount of time for either the buyer or seller to complete all of their closing activities.
Consistent with the time-essence clause in the purchase agreement, escrow instructions provide for termination of the escrow after the date initially targeted for closing by stating escrow may close at any time after expiration of the escrow period, unless escrow has received instructions calling for the return of documents and funds.
One day after the date scheduled for closing, the buyer cancels escrow. Twelve days later, the seller is able to close. The seller challenges the cancellation as premature, claiming the buyer is required to grant him the additional time needed to close escrow before his right to enforce the buyer’s promise to purchase the property is forfeited.
Is the seller entitled to the additional time he needs to close escrow?
No! The seller was on notice by the existence of the time-essence clause in the purchase agreement and the buyer’s (and seller’s) right stated in the escrow instructions to terminate the transaction on failure of escrow to close on the date scheduled. No provision in any document expressed an intent to the contrary.
Thus, the buyer’s cancellation, one day after the appointed closing date, was in accordance with the intent stated in the purchase agreement and escrow instructions, i.e., that time was essential and that the money and instruments were to be returned should the closing not occur on or before the date set for closing. Therefore, the buyer was not required to grant any additional time to the seller to close the transaction. [Ward v. Downey (1950) 95 CA2d 680]
Notice of intent to cancel
In an effort to put the buyer or seller on notice of the extended time period in which they can perform before the right to cancel is exercised, some purchase agreement provide for an unalterable two-day notice before the right to cancel can be exercised by cancellation. Thus, the party who fails to perform knows he will have the opportunity to perform on two days’ notice should he, for whatever reason, fail to meet the appointed deadline. This notice before cancellation is a slightly better approach than the raw unnoticed (and possibly unenforceable) cancellation on the appointed date when time for performance has been established as essential.
However, two days may not be reasonably sufficient for the parties and the agents (using diligence from the outset) to complete arrangements for loan commitments, inspections and reports, clearances, approvals, funding or closing. Thus, it is the inclusion of an authorization-to-extend provision in the purchase agreement or escrow instructions granting agents the right to extend performance dates which best serves everyone’s original bargain to close a transaction, unless the buyer and seller include wording for strict compliance with performance deadlines and instant cancellation on the slightest delay in performance. [Stratton v. Tejani (1982) 139 CA3d 204]
Time is not of the essence when agents have the right to extend performance dates.
|Now, consider a sale under a purchase agreement (or escrow instructions) which contains a provision authorizing the agents to extend the time for performance of any act for a “period not to exceed one month.” The purchase agreement also includes a boilerplate provision that “time is of the essence of this contract.” Escrow is for a 60-day period, the end of which is the appointed date for closing the transaction.|
On the date scheduled for closing, escrow is not in a position to close due to the buyer’s inability to record his loan. The seller immediately cancels escrow in an attempt to terminate the transaction, claiming time was of the essence by agreement.
Can the seller cancel without giving an extension of time when both a time-essence and an authority-to-extend provision exist?
No! The bargain struck by the provisions controlling performance dates did not contemplate time for the performance of acts or events by their appointed dates to be so essential that the transaction could be cancelled on the mere passing of the appointed date. The use of a purchase agreement (or escrow instructions) containing wording that “time is of the essence” does not allow for the forfeiture of contract rights on a failure to perform within the agreed-to time period when other provisions exist expressing an intent contrary to the time-essence provision. When logically possible, courts ignore boilerplate time-essence clauses and enforce the original bargain if no financial harm results from the delay.
Here, the purchase agreement (or escrow instructions) gave the agents the unconditional right to extend performance dates. Thus, the date set for closing escrow was hardly crucial to the continued viability of the transaction. Accordingly, the seller had to extend to the buyer a reasonable amount of time to close escrow, i.e., the additional days needed for the agent to record the buyer’s loan, before the buyer’s failure to perform justified exercising any cancellation rights. [Stratton, supra]
Editor’s note – The fact the agents did not exercise the authority granted to them to extend the time for performance is of no concern. It is the mere existence of the agents’ unrestricted right to extend performance dates by up to 30 days that requires the person cancelling to allow a reasonable, additional time period in which to perform before cancellation can occur.
Default needed to justify cancellation
Before a buyer or seller may consider cancelling a transaction, the other party must have defaulted on an obligation imposed on him to perform some act.
For example, a seller cancels a 30-day escrow the day after escrow was scheduled to close. The purchase agreement gives the agents authorization to extend performance dates, including the date for closing, up to 30 days.
Thirty-three days later, the buyer obtains final loan approval and has all the funds needed to close escrow, a total of 63 days from acceptance.
May the seller cancel without first giving an extension by claiming the buyer has not performed by the date scheduled for the close of escrow?
No! The buyer is not yet in default. Sixty-three days is a reasonable time for the buyer to obtain the purchase-assist mortgage funds agreed to in the purchase agreement. Most importantly for the buyer and agents, time for closing was not made crucial to the continuation of the agreement. Thus, a reasonable period of time must pass before the buyer is in default. Only then may the seller exercise his right to cancel. [Henry v. Sharma (1984) 154 CA3d 665]
Now, consider an agent who prepares a purchase agreement and inadvertently fails to set a fixed time period for the opening of escrow. However, the purchase agreement states the appointed date for closing is 60 days from the date the purchase agreement was entered into by the buyer and seller.
The buyer fails to sign and return escrow instructions to open escrow.
The seller cancels the transaction 12 days after the date escrow was scheduled to close.
Was the buyer in default at the time of cancellation?
Yes! The buyer was in default for his failure to sign and return escrow instructions. The buyer had an obligation to open escrow within an unstated period of time. Since the time for opening escrow was not agreed to, a reasonable period of time for opening escrow is allowed.
A reasonable period for opening escrow is from a date sufficiently in advance of the date set for the closing to give escrow enough time to perform its tasks by the date scheduled for closing. The cancellation 12 days after the closing date was effective to terminate the transaction since a reasonable period for the buyer to open escrow ended well before the scheduled closing date (and the cancellation). Therefore, having failed to open escrow before the closing date, the buyer was in default. Thus, the buyer lost his right to buy the property since he did not cure the default by fully performing before the seller’s cancellation. [Consolidated World Investments, Inc. v. Lido Preferred Ltd. (1992) 9 CA4th 380]
However, a one-day delay in the buyer’s signing and delivering instructions to open escrow does not allow a remorseful seller to cancel the transaction and avoid closing escrow. Reasonably, a one-day delay in opening escrow is not a default at all, even when time is declared to be of the essence in the purchase agreement. [Doryon v. Salaut (1977) 75 CA3d 706]
To cancel you must first perform
Consider a seller who wants to cancel a transaction since the buyer is in default under the purchase agreement or escrow instructions. Before the seller may cancel, the seller must:
- perform any act or cause any event to occur, such as delivery of disclosures, pest control reports, etc. that require the buyer’s approval, and which, by agreement or necessity, is his obligation and must occur before the buyer becomes obligated to perform or can perform, called a condition precedent;
- fully perform all obligations imposed on him, such as handing escrow a grant deed and all other items required to close, which are to occur at the same time as the buyer’s performance, without concern for whether the buyer has performed, called conditions concurrent; and
- perform or demonstrate he can perform all other acts or events, such as meeting any requirements of the buyer’s lender for repairs or clearances, which are his obligations for closing the transaction, whether or not the buyer ever performs, called conditions subsequent.
Thus, while the buyer may have failed to perform by the time agreed, the seller may not cancel until he has performed or stands ready, willing and able to perform under the above three conditions (precedent, concurrent and subsequent) which exist in most purchase agreements and escrow instructions.
Failure to fund not a default
On the date set for the closing of escrow, buyers often have not deposited their down payment funds into escrow as called for in the purchase agreement and escrow instructions. When the deposit of closing funds does not occur as scheduled, the buyer clearly has not yet performed his obligation to close escrow. However, the failure to fund does not necessarily mean the buyer is in default.
Failure to deposit funds before escrow is in a position to close is NOT a default.
The question which arises for a seller who is attempting to cancel when time has been established as essential and the buyer has not delivered his closing funds, is whether the buyer is in default or is not yet obligated to deposit funds.
Escrow, as a matter of custom, will not call for closing funds from the lender or the buyer until escrow is in a position to close. As an entirely practical matter, closing funds should not be sitting in an escrow that is not ready to close or may never close.
Specifically, before escrow calls for funds, the seller must have already fully performed by providing documents (deeds, releases, reconveyances, clearances, etc.) so the conveyance of title can be insured and property clearances, prorates and adjustments can be delivered and accounted for as called for in the escrow instructions. If the seller has not complied by the date scheduled for closing, then escrow does not make a demand on the buyer (or lender) for funds. The deposit of closing funds would be premature since escrow cannot yet close.
Further, when the closing is contingent on the buyer recording a purchase-assist loan, escrow, as a matter of commercial necessity, does not call for the buyer’s funds until the lender is ready to fund.
Thus, the buyer has no obligation to deposit any money into escrow and is not in default, until escrow requests the buyer’s funds and the buyer then fails to deliver the funds. Until the buyer is in default due to a failure to timely respond to escrow’s request for funds, any attempt by the seller to cancel is premature and ineffective.
Escrow instructions usually state the buyer is to deposit funds for use by escrow provided the seller has performed. Thus, the obligation of the buyer to deposit closing funds is subject to the seller performing, called a condition precedent to the buyer’s performance. Therefore, the buyer’s “failure” to deposit funds before escrow is in a position to close is excused until the seller performs.
Consider a seller who is unable to convey title to a buyer and deliver a title insurance policy by the closing date as called for in the purchase agreement and escrow instructions. The title company cannot issue a policy as ordered due to encumbrances affecting title, such as abstracts, trust deeds, leases, tax liens, assessments, etc., which have not been released, and the amounts needed for discharge and payoff have not yet been determined.
Here, the time for closing has arrived and the seller cannot deliver a marketable title as agreed. Thus, until the seller obtains title insurance for his deed, the buyer is not in default for not having deposited his funds.
Cancellation right waived by conduct
Even when the date scheduled for the buyer or seller to perform is crucial, thus allowing one party to immediately cancel on the other’s default, inconsistent conduct by the party entitled to cancel can constitute a waiver of his right to cancel. Once the right to immediately cancel has been waived, the party who failed to perform by the agreed-to deadline is no longer in default. Until a default again exists, the right to cancel cannot be exercised.
For example, the date set for escrow to close arrives. The seller has not yet handed escrow (or the buyer) property clearances which are required before escrow may close.
A few days after escrow is scheduled to close, the seller deposits the clearances with escrow and the buyer deposits his closing funds.
Two days later, the seller cancels escrow, claiming the buyer was in default since he failed to deposit his funds by the appointed date.
Here, the cancellation is ineffective and the buyer is entitled to close escrow. The seller waived his right to cancel, time having been of the essence, by conducting himself without concern for the passing of the appointed date for closing. The seller failed to meet the deadline. [Katemis v. Westerlind (1953) 120 CA2d 537]
However, a waiver does not occur simply because a person’s right to cancel the transaction is not immediately exercised on the failure of the other party to perform. Affirmative conduct must occur by the party entitled to cancel, not just mere inaction, before the right to cancel under a time-essence situation is waived.
After a waiver, time must be reinstated as crucial to the continuance of the transaction, or a reasonable, additional period of time must have passed after waiver of the right to cancel, before the transaction can be cancelled. Time is best reinstated as being essential by notifying the party who needs to perform that he must perform by the end of an additional period of time sufficient in length to provide him with a realistic opportunity to perform.
If performance is not forthcoming during the additional time period, the transaction may be promptly cancelled since strict compliance with the extension is now enforceable.