Real Estate 101: Legal basics of the real estate contract
By CASEY A. JONES | AUGUST 29, 2015
I have been fielding a lot of questions lately from buyers, sellers, and Realtors that deal with contracting at its most fundamental level, so I thought I’d put together an article on the basics of the real estate contract.
Offer and acceptance
The essence of a real estate contract is offer and acceptance. The requirement of offer and acceptance applies to each of the major elements of the transaction, which typically include identity of the property and price.
There can be more terms, such as the personal property that accompanies the sale, who pays for the title insurance, and financing and inspection contingencies, but an offer from one party and an acceptance by another party of the major provisions is the basis of the formation of a contract.
One consideration on the issue of offer and acceptance is whether the offer or counteroffer was in fact accepted before its expiration. We have seen contracts accepted out-of-sync with the terms of the offer and acceptance process, which could empower a buyer or seller to avoid their obligations under that instrument.
If at the end of the back and forth between buyer and seller there remain differences in these material terms, there is likely no “acceptance” of the last offer (i.e., no “contract”). But if they in fact have agreed, the contract should be enforceable, subject to the “outs” noted below.
Either you are pregnant or you are not
Being in contract is kind of like being pregnant: either you are or you aren’t. There is no such thing as “kind of” being under contract. Courts should apply a fairly black-line test to this subject. Either you are or you aren’t.
Execution and delivery
“Offer” and “acceptance” typically are handled by the signature of one party physically or electronically delivered to the other party. In the “good old days” this was handled by one Realtor physically delivering a signed contract to the other Realtor. Today, delivery is more common via fax and email, both of which are acceptable methods of delivery absent specific instructions in an offer or counteroffer from one party to the other (i.e., if they specify that physical delivery to the Realtor’s office is the only acceptable method of acceptance), in which case whatever method that party specifies will stand as the only acceptable method of acceptance.
Interestingly, I litigated a case once in which only the buyer had signed the contract, and the seller sued, claiming he (the seller) had orally accepted the buyer’s written and signed offer by an oral conversation with the buyer’s Realtor. The Court agreed, and allowed the suit to proceed!
Finally, as this blog entry explains, electronic signatures are acceptable to the same extent as inked signatures under the law.
A counteroffer is a rejection and a new offer
You can’t “have your cake and eat it too.” So, a seller who is in receipt of an offer from a buyer can’t at first counteroffer, and if that fails to work, then accept the original offer. This is so because, by law, a counteroffer is a rejection of the first offer and the making of a new offer. The old offer from the buyer is rejected and “gone” as of the making of a counteroffer by the seller.
Being under contract (mostly) means you are now bound
This principle seems so obvious that it does not need stating, but when parties sign a contract, they are bound to its terms, and responsible for performance thereunder. Contrary to mistaken “water-cooler lawyering” (where laymen around a water cooler discuss supposed legal rights and remedies), there is no three-day period within which a buyer is privileged to terminate a contract.
Under a typical commercial and residential form of contract, there are a precious few escape clauses for a seller under the contract. Typically, the contract is an unconditional promise by the seller to convey title to the buyer upon the buyer’s tender of performance (usually payment of the purchase price).
The buyer on the other hand has several primary ways to avoid his obligations under a purchase contract:
- Typically, the buyer’s performance is contingent upon obtaining a satisfactory inspection of the property. If the buyer desires to terminate the contract during the inspection period, his ability to avoid his obligations under the contract is quite open-ended.
- In commercial contracts, many times buyers have similarly open-ended contingencies of acceptable zoning, economic analysis, pre-leasing, and environmental inspections. During such contingency periods, the buyer may have a significant opportunity to avoid his obligations under the purchase contract.
- In both commercial and residential contracts, financing contingencies are also common. During the period of time allowed for obtaining financing, again, a buyer may be able to terminate if contractually-adequate financing is not obtained.
- In the Cincinnati Area Board of Realtors form of residential contract, there is an obligation upon the seller (Section 8) to provide a broad and somewhat open-ended set of documents to the buyer. There is then a period of time (blank in the form contract) for the buyer to terminate the contract based upon his review of those documents. This right to terminate is discretionary in the buyer. Further, if the seller never provides the documents, the buyer would arguably then have the right to terminate the contact all the way through the date of closing.
- The Cincinnati Area Board of Realtors Contract also contains an appraisal contingency in favor of the buyer that is above and beyond the appraisal obtained by the buyer’s bank in conjunction with his financing. (NOTE: These two last contingencies are briefly addressed in this blog entry.)
- Finally, Ohio Law (O.R.C. Section 5302.30(K)(4)) provides that, in certain residential contracts, if a seller has not provided a residential property disclosure form to the buyer, the buyer will have the right to terminate the contract all the way through the closing date.
Obligation to fulfill contingencies in good faith
Notwithstanding the seemingly open-ended nature of some contingencies, courts have found that parties have an obligation under a contract to attempt to fulfill contingencies in good faith. See Johnston v. Cochran, (10th District, 2007) 2007-Ohio-4408.
When one of the parties to a contract has direct influence over the fulfillment of a condition precedent, that party bears the burden to show that it made good faith efforts to satisfy the contractual conditions which allegedly excuse its performance. In other words, a party cannot take advantage of an unfulfilled condition precedent to excuse its performance without first proving that it exercised good faith and diligence in trying to satisfy the condition.
Therefore, refusing to properly and honestly apply for financing that results in a rejection letter from the lender may not be the basis for contract termination under the contingency that allows for the buyer to terminate if he or she cannot obtain financing. Telling your home inspector to find problems “to kill the deal” would likewise not be the proper fulfillment of an inspection contingency.
How long do I have to wait after someone’s breach?
If a buyer fails to close on the purchase and sale of real property on the date anointed by the contract, may the other party just walk away? Well, not exactly. As this blog entry explains, if the contract does not use the magic words “time is of the essence” (in this instance as to the closing date), then time is not of the essence and we don’t really mean for the dates we say in the contract to be strict deadlines. A buyer or seller would then have to wait a reasonable period (and perhaps a little longer) before they can be assured that a court would find that one party is in breach and that the other party may pursue his remedies for such breach.
Declaration of breach
If one party believes the other party is in breach of a contract, it is appropriate to send a letter formally declaring the other party in breach, and then to act in accordance therewith (i.e,, do not continue to act as if the breaching party has not breached and proceed to prepare for closing, for example).
Remedies for breach
Typically under real estate purchase contracts there are two basic remedies available to both the buyer and the seller for the other party’s breach: (i) monetary damages and (ii) an action for specific performance.
1. Monetary damages
The monetary damages available in a breach of contract setting are typically the difference between the contract price and what the house was worth at the time of the breach. That means that if the house or commercial property sold for “about” what it is worth (which it usually does), then the monetary damages one party sustains may not be all that significant. Further, regardless of the re-sale price, the proper proof of the “actual value” number is appraisal testimony presented by each party at trial.
2, Holding costs and consequential damages
Now, sellers also want to obtain damages for holding costs, and potentially the loss of their subsequent purchase. Buyers want their temporary living expenses and the cost of storing their home’s contents, as well as the interest rate they lost because of the delayed closing.
On a theoretical level, the courts are, at best, inconsistent in their awards of “holding costs” damages and will typically not award the consequential damages associated with the loss of another purchase transaction. (Roesch v. Bray, 545 N.E.2d 1301, 1304 (Ohio Ct. App. 1988) (“[C]ourts have not considered in great detail what additional losses may be compensated for in the way of damages pursuant to a breach of a real estate contract. Generally, damages on a breach-of-contract action are limited to losses that are reasonably to be expected as a probable result of the breach.”). See also Ottenstein v. Western Reserve Academy, 374 N.E.2d 427, 429 (Ohio Ct. App. 1977) (Mahoney, P.J. dissenting) (“I do not believe that those damages should include any ‘loss’ of ‘interest’ on the money as such ‘loss’ is not consequential.”).)
The buyer’s temporary housing and storage may be recoverable, but would the court offset the mortgage payments that would be insured if the sale had gone forward? Similar to the refusal to award consequential damages to a seller, the higher interest rate paid by a buyer may be difficult to obtain. (Quinn v. Bupp, 955 A.2d 1014, 1021 (Pa. 2008) (citing Rusiski v. Pribonic, 511 Pa. 383, 515 A.2d 507, 512 (Pa. 1986) (declining to award damages to a buyer in a land sales transaction calculated upon an increased mortgage interest rate).)
3. Practical problems in damage recovery
Beyond the theoretical problems in damage recovery, we have the practical. The cost and difficulty in obtaining monetary damages beyond the valuation question will be challenging when compared to the attorney’s fees that will be incurred in the pursuit of the same. In the commercial setting, breach damages can be significant. In the residential setting, it is rarely worth it to pursue a damages claim.
4. Specific performance
The other remedy for breach of a real estate contract, available to both buyers and sellers, is an action for specific performance. In a specific performance action, we ask the judge to order the breaching party to perform his obligations under the contract. For the breaching seller, it is to give a deed and do other things required at the closing. For the buyer, it is to pay the purchase price and perform his other contractual obligations. Because every parcel of real property is considered unique and irreplaceable under the law, this remedy is — as a matter of law — available under each real estate contract.
However, consider the practical difficulties of a specific performance action:
- For sellers, they need to take their property off the market for the duration of litigation — which can last three years or more in the case of an appeal — in order to force this specific buyer to close on this specific property. Further, once the seller achieves this victory in court, how does he force the buyer to get a bank loan and acquire the funds to buy the property if he otherwise does not have the cash?
- For buyers, they should be able, through a specific performance action (read here about lis pendens actions), to tie up the title to the seller’s property, but they too will need to be prepared to pursue the matter through its conclusion in the trial court (18 to 36 months) and potentially through the appellate process as well (another 18 to 24 months). Further, despite some case law that supports a claim for an award of attorney’s fees at the conclusion of such action, typically the cost of pursuing the claim will fall to the plaintiff.
In short, it is the rare buyer or seller plaintiff who has the wherewithal and fortitude to see a specific performance action through to its conclusion.
Obligation to mitigate damages
Whenever a party breaches a contract, the non-breaching party has a duty to mitigate damages. (30 Oh Jur Damages § 102 (2015) (citing Chicago Title Ins. Corp. v. Magnuson, 487 F.3d 985 (6th Cir. 2007)). See also Reitz v. Giltz & Assocs., 2006 Ohio App. LEXIS 4120, at *19 (Ohio Ct. App., Aug. 11, 2006) (“The duty to mitigate damages, otherwise known as the doctrine of avoidable consequences, requires a plaintiff to avoid those damages resulting from a breach of contract that may be avoided “with reasonable effort and without undue risk or expense.”).) Let’s give an example unrelated to property sales:
A seller brings a truckload of peaches to a buyer in Cincinnati. When he goes to deliver them, the buyer refuses the product. The seller cannot simply allow the peaches to spoil on the truck and escalate his damages, he must go to a produce house and sell them for whatever he reasonably can get, holding the buyer responsible for the difference in price between that which was originally promised versus that which was obtained at the produce house sale. This is called “mitigation of damages.”
Similarly, when a buyer breaches a real estate contract, a seller is obligated to place the property back on the market and obtain the highest possible price and best possible terms to reduce the damages for which the buyer is responsible.
While the idea of a real estate contract might sound intimidating, the law provides guidance as to how the parties should approach these contracts and is fairly lenient as to their execution aside from a few strict requirements (such as offer and acceptance). However, parties should be aware of the consequences should something go wrong in the process due to the potential difficulties of obtaining relief and shift in responsibilities in the event of a breach by the other party.
We recommend for your reading these additional resources:
How to break a real estate contract by Massachusetts Realtor Bill Gassett >>
How to determine what is a breach of contract by New Hampshire law firm of Fojo, Dell’Orfano >>