BROKER RISK MANAGEMENT
WEEKLY PRACTICE TIP
Bad Faith – What is it?
Q: I hear a lot about a buyer or seller acting in bad faith. What does that mean?
A: In the real estate brokerage industry, we often hear the term “Bad Faith.” What is really being said, in a shorthand way, is that the buyer or seller is breaching the “implied covenant of good faith and fair dealing.”
This implied covenant, or promise, has been created by the courts and applies to all contracts — including contracts for the purchase of real property, listing agreements and buyer-broker agreements. That duty has been defined in court opinions as:
“There is implied in every contract a covenant by each party not to do anything which will deprive the other parties thereto of the benefits of the contract. This covenant not only imposes upon each contracting party the duty to refrain from doing anything which would render performance of the contract impossible by any act of his own, but also the duty to do everything that the contract presupposes that he will do to accomplish its purpose.”
Simply stated, each party must act in good faith to complete the contract, and not do anything that will impede the other party from completing the contract.
Whether a buyer or seller has acted in bad faith is easy to allege, but harder to prove, because it is fact-based. That is, it will be decided by the facts of each case. But, some commonly-observed conduct clearly would draw an allegation of bad faith, such as:
1. Seller refusing to allow an inspection or appraisal, if allowed by the contract.
2. A seller or buyer just “changed their mind” and decides not to go forward with the contract – even one day after the contract was ratified.
3. Buyer applies, and gets turned down, for a 90% LTV loan when the contract specified an 80% LTV loan; and then refuses to remove the loan contingency.
4. Evading the spirit of the bargain; lack of diligence and slacking off; interference with or failure to cooperate in the other party’s performance.
All standard purchase contract forms specifically require a buyer to apply “in good faith” for the loan specified in the contract. In addition, the CAR purchase agreement forms require the sellers and buyers to exercise good faith in the removal of contingencies or in cancelling the contract.
For example, if buyers just “change their minds” and decide not to buy shortly after the contract is ratified, and if that change of mind is communicated to seller, then seller may just allege bad faith and refuse to return the deposit – even if buyers later attempt to cancel the contract for TDS or inspection contingency reasons.
While purchase agreement forms do not require that buyers GIVE a reason why they are cancelling THEY SHOULD HAVE A REASON.
If a seller asks why the buyers are cancelling and the buyers don’t give a reason, that may well lead the seller to claim that the buyers are acting in bad faith.
If a party breaches the implied covenant of good faith and fair dealing (i.e., acts in “bad faith”), this constitutes breach of the contract and entitles the other party to damages and/or specific performance, where a court compels completion of the sale by the parties.
So, if your buyers are having second thoughts about proceeding with the purchase, suggest that they look to the TDS or a contingency for a valid reason to cancel, and to contact a qualified California real estate attorney for advice if they have questions.
PRACTICE TIPS:
1. Remind your clients that they have a good faith obligation to comply with the contract terms. That doesn’t mean that they can’t negotiate. Nor does it mean that they can’t cancel the contract if they have a legitimate right to do so. But, they do have a duty to do everything that the contract requires to accomplish its purpose.
2. If a seller or buyer start acting in a manner “which will deprive the other party of the benefits of the contract,” then they have crossed the line and may get into trouble with that other party. If they persist, advise your clients that they should talk to an attorney about what could constitute bad faith under the circumstances – and what the consequences of those acts might be.
3. Do not advise your buyers to just enter into a contract for the purchase of property because they can just back out if they change their minds. That is not only bad advice, it could lead to legal liability for the buyer – and for you.
This Weekly Practice Tip is for the exclusive use of clients of Broker Risk Management and their agents. It may not be reproduced or distributed without the express written consent of Broker Risk Management. The advice and recommendations contained herein are not necessarily indicative of standards of care in the industry, but rather are intended to suggest good risk management practices.