BROKER RISK MANAGEMENT
WEEKLY PRACTICE TIP
Q: I am a buyer’s agent and a couple of days ago my buyer asked me to insert in a Purchase Contract offer, “Buyer reserves the right in Buyer’s sole discretion to cancel this contract at any time upon notice to Seller.” I am about to write that offer today.
That seems okay, but is there anything I should counsel my buyer about?
A: You are right to ask that question. In the 2010 California Supreme Court decision (Steiner v. Thexton), the seller Thexton agreed to sell a 10-acre parcel to buyer Steiner for $500,000. The purchase agreement provided that buyer could cancel the contract “at its absolute and sole discretion” until the close of escrow.
The California Supreme Court found in that case that a purchase contract with an ability of a party to cancel in their sole discretion was nothing more than an option.
The court pointed out that the “implied covenant of good faith and fair dealing” which applies to all contracts in California can be made inoperable with respect to a contract by an express agreement between the parties. Because the buyer could cancel for any reason, the court concluded that this implied covenant did not apply, and that this “contract” was in effect nothing more than an option.
The Supreme Court distinguished the contract in this case from the “common form of real estate contract” which:
“…binds both parties at the outset (rendering the transaction a bilateral contract) while including a contingency, such as a loan contingency, that allows one or both parties to withdraw should the contingency fail. However, withdrawal from such a contract is permitted only if the contingency fails. By contrast, the agreement here placed no such constraint on Steiner.”
In fact, the court went out of its way to state that “bilateral contracts subject to a contingency, which are widely used in real estate transactions, are not affected by our holding.”
IMPLIED COVENANT OF GOOD FAITH AND FAIR DEALING: All contracts in California are governed by this implied covenant, or promise or obligation, to deal fairly and in good faith with the other party. Failure to do so can be a breach of the contract. In the real estate business, we tend to shorthand this by saying that a seller or buyer is acting in “bad faith.” What agents usually mean is that the other party is in breach of the contract because they have not acted in good faith and/or are not dealing fairly with the complaining party.
But the court went on to point out, that this “implied covenant does not trump an agreement’s express language.”
CONTRACT LANGUAGE: Some contract forms include the above law into the contract itself. For example, all CAR Purchase Agreement forms contain the following language: “Any removal of contingencies or cancellation under this paragraph by either Seller or Buyer must be exercised in good faith and in writing.” (Similar language is included in both the PRDS and SFAR contract forms)
THE BOTTOM LINE: The lesson here is that placing language in a purchase agreement giving one party the unfettered right to cancel can turn what is otherwise a binding purchase agreement into an option, which is only enforceable if there is sufficient consideration – and that is a complicated matter indeed which it may take a court to sort out. In fact, the Supreme Court in Steiner spends more than seven pages discussing the sufficiency of consideration in this case.
PRACTICE TIPS:
BUYER’S AGENTS
- Do not recommend that your clients include language giving them the right to cancel the contract in their sole discretion, or similar language.
- If your Buyer insists on including such language, recommend in writing that they consult with their own qualified California real estate attorney about including such a clause.
LISTING AGENTS
- If you receive an offer from a buyer which includes the above language, discuss with your seller whether you want to counter that language out of the contract. In addition to the above considerations, the buyer has the right to cancel at any time giving little leverage to your seller.
- If the seller needs further guidance on this, or if the transaction will not come together without this language, recommend that Seller consult with their own qualified California attorney regarding the potential legal consequences of including this language in the contract.
WEEKLY PRACTICE TIP: DO NOT FORWARD TO CLIENTS. This Weekly Practice Tip is an attorney-client privileged communication 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.