Q: I represent a Buyer who is worried about going forward with the transaction; she had removed all of her contingencies before the recent wildfires in California and wants to know what will happen if the Property is totally or partially destroyed prior to the Close of Escrow. We looked at the CAR Purchase Agreement that she signed and there is no provision for that. What does happen if a house burns down? Does my Buyer still have to close escrow?
A: This question is part of the broader topic of who bears the “Risk of Loss” to the Property during the escrow if, through no fault of the Buyer, the Property is destroyed, in whole or in part.
I. Risk of Loss in Standard Residential Purchase Agreement Forms:
A. CAR: The CAR Purchase Agreement does not specifically address Risk of Loss but the Seller is obligated to maintain the property in substantially the same condition through to the Close of Escrow as when the Parties signed the Agreement. Because the CAR form is silent on this issue, California statutory law controls (see Section II below).
B. PRDS: Of the three most frequently-used residential purchase contract forms, PRDS has the broadest Risk of Los Provision. Paragraph 29L gives the Buyer the right to cancel and recover all of Buyer’s deposited funds if there has been substantial damage to the Property. However, if a Buyer elects to close escrow instead of cancelling, then the Buyer is to receive an assignment from the Seller of any insurance proceeds covering the damage.
C. SFAR: Paragraph 25 of the SFAR Purchase Agreement specifies that if the Property has been “materially destroyed” prior to Close of Escrow, Buyer can cancel and recover deposits actually made. This paragraph also cites California Civil Code §1662 (see Section II below).
II. Civil Code Section 1662: In California, if real property is totally or partially destroyed, this statute (also known as the Uniform Vendor and Purchaser Risk Act) provides:
“(a) If, when neither the legal title nor the possession of the subject matter of the contract has been transferred, all or a material part thereof is destroyed without fault of the purchaser or is taken by eminent domain, the vendor cannot enforce the contract, and the purchaser is entitled to recover any portion of the price that he has paid;
(b) If, when either the legal title or the possession of the subject matter of the contract has been transferred, all or any part thereof is destroyed without fault of the vendor or is taken by eminent domain, the purchaser is not thereby relieved from a duty to pay the price, nor is he entitled to recover any portion thereof that he has paid.” [Emphasis added.]
Unless the contract provides otherwise, if escrow has not closed and Buyer has not taken possession of the Property, if the Property is totally destroyed or materially damaged without the fault of the
Buyer, then the Buyer may cancel and recover all deposits.
III. Partial Destruction: If the Property is partially destroyed, the law does not establish any clear criteria to determine at what point the Property is destroyed in “material part.” When there is partial destruction of the Property, there are usually disagreements between the Parties as to whether either the Buyer or the Seller has the right to cancel, and/or if the Seller has the option to repair and compel the Buyer to complete the purchase. The resolution of these disputes is best handled by the qualified California real estate attorneys who have been retained by each of the Parties.
The issues that the qualified California real estate attorneys for the Seller and Buyer will need to work out if the Parties do not mutually agree to cancel include, but are not limited, to:
A. Does the Close of Escrow date need to be extended;
B. Who is to perform any agreed upon work and when (before or after escrow);
C. Who receives insurance proceeds, if any; and
D. If there are credits or price reductions in lieu of repairs, will the Lender agree to that change?
If the Parties and their real estate attorneys cannot agree on any or all of the above, then mediation may be necessary and, if that fails, then arbitration or possibly a judicial action, will ensue if one of the Parties seeks Specific Performance to compel the Close of Escrow.
IV. Buyer Taking Possession: After Close of Escrow, the risk of loss transfers to the Buyer even if the Seller is retaining possession; the Buyer would not have a right to cancel if the Property is damaged. However, if the loss is caused by the Seller, then the Seller may have potential liability for the damages.
If the Buyer takes possession prior to Close of Escrow, then the risk of loss transfers to the Buyer and the destruction of the Property does not give the Buyer a right to cancel. Even the Buyer storing items in the garage may be sufficient to transfer the risk of loss to the Buyer.
Use of either the CAR Buyer Early Occupancy Addendum (“BEO”) or the CAR Pre-Occupancy Storage Addendum (“POSA”) are fraught with legal and insurance issues which is why neither of these forms should be signed by either the Buyer or the Seller until after the Parties have reviewed the situation with their own qualified California real estate attorney and insurance broker.
PRACTICE TIPS
- If a Buyer or Seller has concerns about what happens if the Property is totally or partially destroyed, refer them to the Risk of Loss contract paragraph, if any, in the form that they signed; if the client needs additional information or if there has been damage to the Property prior to the Close of Escrow, then the clients must consult with their own qualified California real estate attorney.
If a Buyer is going to occupy the Property or store their personal property prior to Close of Escrow, both Parties should be told to consult with their own qualified California real estate attorney and their insurance broker prior to signing either the BEO or the POSA forms.
DO NOT FORWARD TO SELLERS OR BUYERS. 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.
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