Buyers Who Backed Out Tripled Down On A Bad Bet

By Richard B. Gullen

I recently won an arbitration on behalf of a seller who was forced to sue the buyers for backing out of a contract after waiving all contingencies and then refusing to forfeit their deposit, as required under the liquidated damages clause.

Prior to listing the property for sale, the seller had completely rebuilt a high-end luxury home after the original home burned to the ground. Originally on a septic system, during the rebuild the seller invested extra funds to connect to a sewer located about a mile down a private road. To do this, he obtained easements from multiple neighbors over whose land the new sewer line would pass. Unbeknownst to the seller, the neighbors had deeds of trust on their properties securing prior loans from lenders. As a result, the sewer easements were junior to those earlier recorded deeds of trust, which therefore had senior priority.

The buyers reviewed a preliminary title report before making their offer. The report correctly disclosed the neighbors' deeds of trust as exceptions to the easements, but not to the seller's property, because the neighbors' deeds of trust were not recorded against the seller's property. The neighbors' deeds of trust were exceptions to the easements because, if the neighbors defaulted on their loans and the lenders foreclosed, the easements would be wiped out.

The buyers made an offer with no title contingency, but only a loan contingency. The buyers' lender, which reviewed the same preliminary title report, gave multiple assurances during escrow that the loan would be approved. In reliance upon these green lights, the buyers removed their loan contingency. Subsequently, the lender changed its mind, declaring that due to the exceptions to the sewer easements and the risk that the easements could be wiped out by a foreclosure if the neighbors defaulted on their loans, it could not approve the buyers' loan. The buyers then cancelled the sale. During the two-month delay until the property could be resold, the seller suffered tens of thousands of dollars in extra carrying costs, including construction loan payments at a high interest rate.

Attempting to avoid losing their deposit, the buyers claimed the seller breached the standard form contract provision requiring the seller to deliver title to the property free and clear of all "liens," but subject to "other exceptions," arguing that the term "property" included easements, and the neighbors' deeds of trust were liens on the easements.

The parties mediated and, per the mediator's suggestion, the seller offered to split the deposit; however, the buyers refused. Shortly before the arbitration hearing, and despite being forced to incur many thousands of dollars for investigation and preparation, the seller again offered to split the deposit, but the buyers again refused.

The issues at arbitration were whether the term "property" included easements such that the seller was obligated, as a matter of contract, to guarantee the existence and transfer of the easements, and whether the neighbors' deeds of trust constituted "liens" the seller was required to remove, or rather "other exceptions" subject to which the buyer had agreed to take title.

The arbitrator found that, although the easements attached to the property as a matter of law, they did not fall within the definition of "property" the seller had promised to transfer under the contract. The arbitrator further found that even if the term "property" included easements, the neighbors' deeds of trust were not liens on the easements, but rather senior encumbrances on the same property, that therefore constituted "other exceptions." The arbitrator also rejected the buyers' argument that the lender's refusal to approve their loan established that the seller was not delivering marketable title.

Because the parties had initialed the liquidated damages clause, the arbitrator awarded the full amount of the buyers' deposit to the seller, plus all of the seller's litigation costs, i.e. attorneys' fees, expert witness fees, and arbitration fees - costs that approximated the amount of the deposit. The buyers also incurred their own attorneys' fees and litigation costs. Consequently, the outcome for the buyers was a self-inflicted triple financial whammy.

The bottom line is that the buyers ignored the express terms of the contract and rolled the dice based on the assumption that their inability to obtain a loan excused their performance under the contract. The lesson here for buyers is that once contingencies are removed, unless there is an express exception otherwise stated in the contract, buyers are committed to buying the property, even if a loan subsequently falls through. Thereafter, buyers backing out of a contract with a liquidated damages clause should be prepared to walk away from the deposit. Resisting and forcing the seller to litigate will only result in tripling down on a bad bet.

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