Common Real Estate Contract Provisions Part 2

Common Real Estate Contract Provisions, Part 2

            In our first presentation, we looked at three of the most common real estate contract provisions, their purposes and how they operate. This presentation continues with a discussion of some more provisions. A sample contract with all these provisions is linked to from the text under this presentation.[1]

Inspection Contingency

            An inspection contingency clause allows the purchaser to conduct a home inspection, usually by a professional home inspector or engineer, within a specified time after the contract is executed (for example, within seven days).

          If the inspection discloses problems with the property and the seller is not willing or able to fix the problems, the purchaser has the option of backing out of the agreement or renegotiating, usually for a lower purchase price as compensation for the problems. As a practical matter, virtually all home inspections turn up problems, and so the home inspection is often used by the purchaser as leverage for renegotiation of the purchase price.

While home inspections before going to contract are ubiquitous nowadays, sellers should try to have the inspection be done before the signing of the contract, when the seller has no obligation to the buyer. The purchaser, on the other hand, should prefer that the contract be signed before the inspection. Since the purchaser pays for the inspection, if the inspection is done before the contract is signed, the seller can always back out of the transaction after the inspection (since there is not yet a written agreement) and the purchaser will have wasted time and money on the inspection. Which party “wins” this battle of preferences depends on the parties, the circumstances and local custom.

Closing Date and Time is of the Essence

            While the signing of the contract binds the parties to carry out the transaction, the property is not actually transferred until closing. Therefore, the contract should specify the closing date or time frame. The default rule is that closing dates are not “hard” deadlines and closings are routinely postponed for one reason or another. The passing of the closing date in the agreement does allow the party wishing to close to give notice to the other party, that requires closing to occur within a reasonable time (often, 30 days). Only after the expiration of this reasonable time can the demanding party claim a breach of contract.

            On the other hand, a “time is of the essence” clause causes the closing date stated in the contract to be literal and enforceable. If the contract states that time is of the essence, then a party who is unwilling or unable to close on the stated date is considered to have breached the contract. This clause can be used when one party is subject to a hard deadline, such as when the seller needs to close by a certain date to purchase new property by a deadline shortly thereafter. This is a very serious clause and is unlikely to be easily agreed to by the other party.

Violations and Cure

            A “compliance” or “violations” clause requires that the seller comply with all zoning rules and cure any violations that prevent the purchaser from obtaining the necessary certificate of occupancy or mortgage. For example, the seller may have done some illegal construction while living in the premises. To satisfy the buyer’s title insurance or mortgage company, the seller may be required to obtain a necessary permit or take remedial action.

            A related clause may give the seller the option to withdraw from the contract if the costs of remedying violations will be excessive.

Representations on Taxes

            Contract provisions may require the seller to inform the purchaser of the real estate taxes on the property and/or common charges in the case of a condominium unit. Because real estate tax information is public record and is often available on the Internet or through easy inquiry, this clause is sometimes satisfied merely by stating that the tax information is public record.

Provisions for Overstay/Leaseback

            It is axiomatic that possession normally changes at closing. Nevertheless, there are times that the seller is not ready to vacate at the time of closing, but that the closing must go forth anyway due to mortgage timing or other reasons. The contract should provide for such a contingency by establishing the daily compensation that the seller will pay the purchaser until she vacates. This amount is set by contract and is a type of “liquidated damages” clause, which is a clause that sets the remedy in advance for a potential breach of contract.

            As in the case of any liquidated damages clause, it is only enforceable if it is a reasonable approximation of the value of the stay or the damage caused to the purchaser by the seller’s failure to vacate. For a typical residence, this may be $100 or even a few hundred dollars per day, depending on the going rental rates in the area and the circumstances of the transaction. But leaseback clauses that require payment of thousands of dollars per day or those designed to “punish” the seller rather than compensate the buyer, may not be enforced.

Personal Property

            The default rule is that real estate sales apply only to the land and buildings or fixtures to the land. If the parties wish to include personal property that is not affixed to the land, such as appliances and furniture, it should be specified in the contract that they are included in the sale. Even items that are possibly fixtures, such as water purification systems and installed air-conditioning units should be listed as included personal property to avoid confusion and controversy later.

            Real Property transactions start with certain default rules but most rules in a transaction are set forth under the contract. Therefore, the contract should be carefully negotiated and scrutinized by both parties to ensure that their expectations are consistent with the terms that will be binding on them. In these two presentations, we have presented an overview of some of the key provisions included in many real estate sales contracts.