When buying or selling real estate, we look to the contract of sale to specify all the terms, understandings, and agreements between the buyer and the seller.
One critical category of terms that the parties should pay very close attention to is whether there are any contingencies. A contingency is a clause that allows one party to terminate the contract (and walk away) without penalty. For instance, in the case of a down payment, the down payment paid by a buyer at the outset would be returned if a certain condition does or does not occur. These conditions are typically part of the initial negotiations and offer. Some contingencies are standard and show up in most contracts, while others are less common and show up on a case-by-case basis based on how parties negotiate the transaction.
The core meaning of a contingency is: what must or must not happen for one to be legally obligated to proceed under a contract. Contracts can have more than one contingency specified. Keep in mind, as discussed below, that various contingencies have different time periods attached to them as to when they need to be fulfilled.
Here are some contingencies that we have seen appear in contracts:
Financing or Mortgage Commitment
Unless an “all cash” purchase is contemplated, a buyer may need to secure financing, whether in the form of a mortgage (a loan secured by the property) or some other form of financing. The amount of the financing needed is specified in the contract, and a buyer may seek financing only up to that certain amount. For example, a typical residential purchase allows a buyer to seek financing up to 80% of the purchase price. If a buyer seeks up to this amount and gets denied, then the buyer can terminate the contract without penalty. However, if a buyer seeks more than the specified amount and get denied, the buyer has not fulfilled the condition and may have trouble terminating the contract without penalty.
The parties agree that buyer will have a certain period of time to apply for and secure financing. For residential purchases, this time period is usually 45 days, but this can vary on a case-by-case basis. During this time period, the buyer is charged with applying to one or more financial institutions and working diligently in order to secure a firm commitment. (A commitment is a promise by a financial institution to fund this particular transaction.)
Oftentimes a commitment will have additional conditions to satisfy, such as a satisfactory appraisal. The buyer and his attorney must work together with a mortgage banker to ensure that all conditions are met, and that the buyer receives a firm and unconditional commitment within this time period. Sometimes more time is needed to get all of this done, at which point the buyer’s attorney would request an extension from seller’s attorney. During this time, it is critical for all parties to work together, communicate regularly, and act diligently in ensuring that the end goal of the issuance of a commitment is forthcoming.
As part of the mortgage process, a financial institution would typically require that the property being purchased receive a satisfactory appraisal. The appraisal itself is another contingency, even though it goes hand in hand with the financing contingency. The appraisal typically involves a licensed independent appraiser conducting a review of the property and recent comparable sales to determine the fair market value of the property. If an appraisal comes in lower than the selling price, that may trigger a renegotiation of the purchase price, a termination of the contract, or the buyer putting up additional funding. The attorney is heavily involved in this process by ensuring that any agreement is properly memorialized.
“All Cash” Purchase
You should know that an “all cash” purchase does not necessarily mean that there is no financing involved. It only means that by signing the contract of sale, the buyer is taking the risk of procuring financing and will not be able to terminate the contract if the buyer’s financial institution denies a loan. Typically, buyers will sign such a clause if the buyer is very sure that financing will not be an issue, or a backup plan exists as to how to secure the funds. In reality, “all cash” offers are oftentimes more attractive to sellers because there is a lower risk of transaction termination, which is why buyers tend to sign on to such a commitment and make their offer more attractive.
Some transactions allow a buyer a certain period of time to conduct various due diligences, inspections, and investigations of the property. This is more common in a commercial real estate transaction, where the buyer wants to conduct engineering, environmental, and other structural investigations of the property. Buyers may also investigate zoning, defects in the property, or other issues. These clauses are typically heavily negotiated and discussed.
After such negotiations, the buyer usually seeks the right to walk away from the contract for any reason and without penalty, while the seller attempts to limit the scope, nature, and duration of a buyer’s ability and opportunity to investigate. Each party needs to work closely with his/her transactional attorney to ensure that all of the issues and concerns are properly addressed. If the property contains tenants, for instance, the buyer will typically want to review the leases, the rent roll, and any potential landlord-tenant issues (i.e. nonpayment or eviction proceeds). Attorneys would also carefully review and negotiate various representations and warranties that are relevant for the transaction in order to ensure that both parties adequately address all issues.
Seller’s Work Contingency
In some instances, the consummation of a transaction would include a condition that seller make certain improvements, renovations, or do some work to the property. This type of contingency may be tricky since determining whether work done is satisfactory may be subjective and the parties can disagree. Typically there is a “walk through” conducted right before closing, where the buyer walks through the entire property to ensure that any repairs were done and that the property is in the condition that is required by the contract of sale. Any issues that arise in the course of the walk through should be immediately communicated to the realtor and to the attorney before closing.
Other Sales or Purchases as Contingencies
In some cases, a party’s ability to buy or sell a property may depend on other transactions. For example, a buyer may need to sell a current home in order to be able to purchase a new home. Alternatively, a seller may need to purchase another home in order to be able to sell and move out of the current home. These arrangements should be discussed and carefully evaluated on a case-by-case basis with the parties working together in good faith to accommodate all parties’ concerns and issues.
In short, all contingencies that are important and relevant to a party are negotiable and should be carefully reviewed and discussed with your attorney. Never sign any contract without consulting with an attorney who understands your situation, goals, and needs.
Using a knowledgeable and experienced real estate attorney is a wise investment to help you through this process and protect your interests.
Call the attorneys at Beress & Zalkind PLLC at 71 8513 3588 or email at firstname.lastname@example.org to set up an appointment to assist with your real estate transaction