Contracts for the Sale of Real Estate

Contracts for the Sale of Real Estate

Every autumn, first-year law students are taught that land is “unique.”[1] Our legal system treats land distinctly from other types of property and contracts for the sale of land differently from other types of contracts.

A real estate sale has two phases:

1.    The “contract” phase in which the parties agree upon the terms under which the sale will occur; and

2.    The “closing” at which time the land is transferred to the purchaser.

This presentation will focus on the first phase and examine the requirements inherent in contracts for the sale of real estate, discuss the most fundamental responsibilities of the seller in a real estate transaction and discuss remedies for breach of a land sale contract.

            To be enforceable, a land sale contract must satisfy the Statute of Frauds, which generally requires that these contracts be in writing and signed by the parties. Note that this writing is apart from the instrument under which the actual transfer takes place, which is known as the “deed.”

The real estate sales contract should incorporate all terms which the parties wish to agree to, [2]  but must, at a minimum:

·         List the names of the parties involved in the sale;

·         Identify the parcel of land with reasonable certainty;

·         Provide the conditions of the transfer; and

·         State the price of the sale[3]

Land can be transferred or sold without a written contract, but the effect of the Statute of Frauds is that an oral agreement to sell real estate will not be effective to force the parties to go through with the contemplated sale. There is however, an exception where the parties have substantially “performed” the transfer. If a buyer provides payment (even a partial payment) to the seller after an oral contract AND takes control of the land or makes substantial improvements to the land, then the contract will be enforceable despite the lack of a written agreement.[4]

For example, assume that Steve agrees to sell Jason his 3,000-square foot 4-bedroom home for $400,000. Jason provides Steven with $40,000 in cash as a down payment Steven gives him the keys to the home. Jason then renovates the home and installs LED lighting and installs an energy efficient central air conditioning unit. Even though there is no formal writing to document the sale of the home, a court will likely uphold the sale. The payment, possession and improvements make it self-evident that there was an agreement between the parties. Since the Statute of Frauds is there to ensure that fraudulent contracts are not enforced, this alternative evidence of the existence of an agreement will satisfy the policy reason behind it.

Duties of the Seller

The parties can agree to substantially any terms they like in an agreement. However, two fundamental responsibilities are implied by the very nature of the land sale agreement:

-          The duty to convey marketable title

-          The duty to transfer and vacate the property within a reasonable time after the contract.

Marketable Title      

Every land sale contract contains an implied promise that at closing, the seller will convey marketable title to a buyer. Marketable title is free from doubt or impairments and thus allows the buyer freedom to use the land. [5] The conveyance marketable title allows the buyer to rest assured that she will not be subject to claims of other people or lienholders after purchasing the property.

            Title can be unmarketable for any number of possible reasons. One such example occurs when there is a defect in the “chain of title.” For example, if the seller or a previous possessor of the property who had it before the seller did not have documentation (in the form of a deed or court judgment) that established his ownership, it is unclear that the current seller is the true owner of the property. As such, the title is not marketable. Another example would be where the seller has mortgaged or otherwise encumbered the property. It is assumed that the seller will satisfy all outstanding liens at the time of the closing. A third example could occur when the seller has engaged in illegal construction on the premises or made improvements that are barred by local zoning ordinances. Failing to remedy these by obtaining valid certificates of occupancy before closing constitutes a violation of the duty to convey marketable title.

            Today, most purchasers do title searches and investigations to ensure title is marketable and/or may purchase title insurance that indemnifies her if some defect in the title is later revealed. Title insurance companies will conduct thorough due diligences to ensure that there are no title defects before issuing policies. Therefore, purchasers who intend to purchase title insurance often leave the title investigation to the insurance company. While title insurance is not required by law, most banks will require title insurance as a condition of granting a purchase money mortgage.

            To remedy unmarketable title, a seller may be provided a reasonable amount of time to cure the defects. If the seller fails to remedy the issues, the buyer can rescind the contract or obtain specific performance with abatement. This means that the buyer can still purchase the land, but will be entitled to a reduction in the purchase price to account for the unmarketable title.

Time of Performance

            While the default rule is that closing must be made within a reasonable time, most land sale contracts identify closing dates.

            The closing dates, however, are generally not “hard” deadlines. Failure to close by the closing date is not always considered a breach. Instead, once the stated closing date passes, a party may send to its counterpart notice the closing must take place within a reasonable time, which is often construed as being 30 days. However, even this may be extended, especially when the extension is due two factors outside the party’s control.

            Parties may insist on “hard” closing dates by inserting the language “time is of the essence” to the closing date clauses of the agreements. [6] A party that is not ready, willing and able to close on the date listed in a “time is of the essence” cause will be considered to have breached the agreement. [7] 

Equitable Conversion

            Under the doctrine of equitable conversion, once a contract is signed, the purchaser becomes the “equitable” owner of the property even though the seller remains the “legal” owner until closing.[8]

One manifestation of equitable conversion applies to allocate the “risk of loss” before closing. If the property is damaged or destroyed prior to transfer of legal title through the fault of neither party, the buyer bears the risk of loss. So, if the property does get damaged through no fault of any party between the contract and closing, the seller is still required to purchase the property under the contract terms. The purchaser is, however, entitled to the proceeds of any homeowners’ insurance payouts covering these losses.[9]

Also due to equitable conversion, if the buyer dies before the closing date, his heirs are still entitled to close on the property. Conversely, if the seller dies before closing, the seller’s heirs are required to close and transfer the property to the buyer.[10]

Remedies

When a seller breaches a land sale contract, the purchaser is entitled to specific performance, which means that a court will force the seller to go through the sale.[11] This is because each parcel of land is considered unique, and monetary damages are therefore not considered adequate to truly give the purchaser the benefit of his bargain.[12] The buyer can also recover monetary damages for other breaches such as remaining in the property longer than is allowed under the agreement or failing to fix defects in title or failing to live up to other responsibilities under the contract.

In lieu of specific performance, and agrees purchaser may choose rescission instead. Rescission unwinds the real estate transaction and restores both the seller and buyer to their pre-deal positions.[13] Rescission could also include a restitution of benefits that each party conferred upon one another.

            If the purchaser breaches, the seller is entitled to monetary damages to compensate for her loss. Because these are very hard to pinpoint, real estate contracts often stipulate that if the purchaser breaches, the seller may keep the down payment (also sometimes referred to as “earnest money”) as compensation for losing the sale. While the National Association of Realtors indicates that earnest money is typically 1 to 2% of the purchase price, it can be substantially higher (as much as 10%) in some markets. The amount of earnest money is, of course, negotiable between the parties.

Due to the uniqueness of real estate, land sale agreements, the variety of unique rules and procedures. Other presentations cover other common issues that arise in real estate sales, but as we’ve discussed, there are many fundamental rules that apply to all real estate sales contracts.