The hot topic today in Ohio real estate law is the problem for sellers and Realtors of buyers backing out of residential purchase contracts and thus, after tying up a property for 15 to 30 days, putting the property back on the market for sale. This creates the problem of a “stale” listing and the further problem of other Realtors and buyers asking “what was wrong with that property that Buyer #1 backed out?”
How can your seller avoid this problem?
Defining the problem
First, let’s define the problem. In today’s hot real estate market, residential properties come on the market and days or even hours later they are under contract and unavailable. Buyers, fearful of missing out on a deal, have met this challenge by quickly placing a property under contract, figuring they could make their “real decision” during the inspection or financing contingency periods.
Thus, after 10 to 20 days, they perform their home inspection and decide — perhaps for no valid reason — to terminate the contract, leaving the seller holding the bag after having wasted that two to four weeks of prime marketing season.
So, I have had prominent Realtors ask me: What can sellers do to prevent this? Here’s some perspectives:
Contracts mean something
As a starting proposition, even though the CABR Contract has some holes (read here) and contingencies (inspection, financing, etc.) can provide an “out,” contracts actually mean something. In other words, contracts are written to be enforced (i.e., use as a basis for a law suit), not to be put on a shelf.
If a buyer has not threaded the needle in terms of properly terminating a contract pursuant to a contingency, then the buyer is obligated to perform. If he fails to, he can be sued for either specific performance (i.e., make him buy) or money damages for their breach.
Earnest money does not define or limit damages available
Here are two blog entries I have written on earnest money under Ohio real estate law:
The pertinent language I want to highlight is:
- “a common misunderstanding of parties to a purchase contract is that the escrow money is some sort of measure of or limitation on damages for the buyer’s breach, or, conversely, that the return of the earnest money “cures” the seller’s breach and is the limitation on his damages as well. However, unless the real estate purchase contract specifically calls out either of those limitations, neither of those propositions is true.”
- “This article seeks to bust a common myth about an escrow deposit: That a seller must return the earnest money of a buyer he claims is in breach before selling the home to a second buyer.”
Thus, forfeiture of the buyer’s earnest money in the event of a clear default is not the default remedy — although many times the parties settle for that. The Buyer has open-ended exposure for the seller’s damages arising from a breach.
Residential property litigation is rarely cost-effective
For a host of reasons (see this blog entry), litigation is typically not cost-effective, meaning that frequently the cost of litigation will exceed the recovery. This is so because (a) litigation is so incredibly expensive, (b) the damages recovery available to a seller are both difficult to determine and many times lower than a seller might anticipate, and (c) the outcome of litigation is incredibly unpredictable. I tell clients that many times they would be better taking their money to the casino and betting it than investing in litigation.
However, using the cudgel of threatened or actual litigation can either help (a) force a buyer to close or (b) leverage a favorable settlement for the seller in the event of breach.
In a typical arm’s length purchase contract in the greater Cincinnati marketplace, the buyer has an inspection and a financing contingency, and places a low ($1,000 or less) in escrow with the buyer’s broker at the time of contract signing that is refundable if the contingencies are not fulfilled.
But in today’s “Seller’s market,” there’s nothing to say that a seller cannot demand a better position in the purchase contract to address the “backing out” problem.
- Get more earnest money.
- Limit the contingency period so the time “off market” is reduced. (When I am a seller, this is paramount to me. Don’t waste my time if you are not serious.)
- More due diligence on the buyers to “know” they are serious (are they prequalified?, are the planning to buy and flip?, do they have a house they themselves need to sell first before buying?, what is their background?).
- Did the buyer actually look at the property before making an offer? This is a sure sign of a buyer who intends to “make his decision” at a later date.
- Deal only with serious agents and serious brokerages on the other side. In my experience, buyers are going to find a broker who meets their profile. Flaky agent, flaky company = flaky buyer.
- Make earnest money non-refundable and even payable directly to the seller, not in escrow.
- Have the home pre-inspected, and have the buyer use that inspection report, thus no contingency needed.
- Sue to obtain actual damages or to intimidate a buyer into closing.
We have a problem of balancing the legitimate interests between (a) the seller not wanting unserious buyers tying up their property on the one hand, and (b) buyers legitimately needing to “kick the tires” before closing on the other hand. This balance in a traditional purchase contract is heavily tilted to buyers to give them an open-ended opportunity to walk away during the contingency periods. It doesn’t have to be that way. Sellers can “tighten things up” in a purchase contract to tilt that equation more in their own direction.