“Due To Unforeseen Circumstances, My Clients Are Cancelling The Contract”: revisiting some of the assumptions that have been made in the real estate market in the last 30 days

By David Hamerslough

April 3, 2020

The last 30 days have seen a shift in the real estate market that has generated a high volume of cancellations of purchase contracts and disputes over deposits. This article revisits some of the assumptions I have come across in handling these disputes.

DO NOT assume that a seller will agree to cancel a contract on the grounds stated by the buyer in the cancellation

Preparing a cancellation that states that the contract is cancelled due to unforeseen circumstances, economic and employment uncertainty, COVID-19, mutual agreement, or "other" when there has been no discussion with the seller, much less an agreement on the seller's part, is not an accurate characterization of who is cancelling and why they are cancelling. A party who repudiates (or denies the validity of) a contract by an unequivocal refusal to perform before he or she is obligated to perform commits a breach by anticipatory repudiation of the contract. The language used in any cancellation or communications (e.g., emails or texts) relating to an attempted cancellation will have an impact on the interpretation of the cancellation, the legitimacy of the attempted cancellation, and who gets the deposit.

Both the buyer and seller must agree to cancel a contract. If one party disagrees that the contract is or has been cancelled, additional negotiation and agreement on the outstanding issues are necessary. This is true even if the contract gives the party the right to cancel (e.g., after a Notice To Perform has been delivered and the other party has failed to act).

If a buyer is cancelling the contract and has no intention of purchasing the property, don't assume that a seller is going to concur that that decision constitutes a cancellation by mutual agreement. A seller may agree to accept a buyer's request to cancel with a reservation of all rights and claims or in exchange for the release and forfeiture of the deposit to the seller. The preprinted language on any cancellation form needs to be reviewed and evaluated to determine if it is consistent with any resolution of the deposit or reservation of rights and claims that are being made by the parties (e.g., the language at the bottom of the C.A.R. cancellation form), preferably by your client's qualified California real estate attorney before your client signs it.

DO NOT assume that COVID-19 automatically entitles a buyer to cancel the contract and get their deposit back

Whether COVID-19 can be used as a valid basis for cancellation will depend upon a number of factors, including but not limited to (a) the terms of the contract (e.g., were there any contingencies, and, if so, what is their status?), (b) the timing of contract formation and the foreseeability of this issue, (c) the causal connection, if any, between COVID-19 and the party's non-performance, (d) whether the contract contains any language (e.g., force majeure, impossibility, impracticability, or frustration of purpose) on the subject (absent an addendum on the subject, both PRDS and C.A.R. do not contain any such language), and (e) whether any addendum contains such language and the terms of that addendum (there are over 10 COVID-19 documents that have been created in the last 30 days - each of them is different, and many are flawed).

DO NOT assume that a seller is going to agree to sign any COVID-19 Addendum granting either extensions of time or cancellation of the contract.

Sellers' willingness to extend timeframes for contingencies and/or close of escrow (let alone cancellation) will turn on a number of factors, including the needs and wants of the seller. Most of the existing COVID-19 Addenda are not favorable to a seller.

DO NOT assume that a decline in a buyer's stock portfolio or net worth or a change in employment status automatically entitles a buyer to cancel a contract and get their deposit back

Whether any of these factors may be a legitimate basis to cancel will also depend upon a number of factors, including but not limited to the terms of the contract (e.g., whether there is a contingency in favor of the buyer on this issue and the terms of any such contingency), whether the buyer has acted in good faith, and market conditions. If a buyer is concerned about these possible issues, then a contingency should be included in the buyer's offer to address, among other issues, the price or value of the stock or the buyer's net worth at the time of the contract, the price or value drop at which point the contingency excuses further performance, when that determination is to be made and by whom, and whether the exercise of this contingency in good faith turns on an objective or subjective standard. These types of provisions should be deal with as part of the parties' contract negotiations.

DO NOT assume that because liquidated damages is initialed that a seller's sole and exclusive remedy is the amount of the deposit actually paid (up to 3% in residential 1-4)

Any party can breach a contract as long as they are prepared to accept the consequences of doing so. Where initialed and to the extent the deposit is actually paid, liquidated damages is the sole and exclusive remedy under the PRDS contract. Under those same circumstances, it is not the sole and exclusive remedy under the C.A.R. contract. Under the C.A.R. contract, a seller can sue for specific performance. The recovery in such an action may be greater than 3% of the purchase price. This can occur in a sharply declining real estate market. It also may arise where the offer that is accepted is significantly higher than any other competing offers. While there are a number of issues involved in a seller successfully suing for specific performance, the remedy exists and can present more downside to a buyer. Irrespective of what remedy the seller pursues, the preprinted language on any cancellation form needs to be reviewed and evaluated to determine if it is consistent with any resolution of the deposit or reservation of rights and claims that are being made by the parties (e.g., the language at the bottom of the C.A.R. cancellation form).

GIVEN THE CURRENT MARKET CONDITIONS, sellers may want to carefully consider whether or not the liquidated damages will provide adequate compensation in the event of a buyer's breach. The pros and cons of that election may be of greater concern during uncertain times.

DO NOT assume that a deposit dispute or a dispute over the right to cancel justifies using either of those disputes as a basis to prevent the seller from re-marketing the property and the obligation for the seller to mitigate their damages

The concept of recording a lis pendens requires that there is an actual legal dispute concerning title to or possession of the property that has been filed with the Superior Court. A dispute over a deposit is a dispute about money and (absent some unique set of circumstances) does not justify refusing to cancel and/or refusing to release the deposit pending a resale of the property. Using a dispute over the deposit as leverage to retain all or a portion of the deposit may be an additional breach of the implied covenant of good faith and fair dealing (which is an independent tort), as well as other tortious conduct that may expose the buyer to even greater liability, including attorneys' fees and costs.

DO NOT assume that there is NO basis to justifiably cancel or rescind the contract.

Even if you suspect that your client may not be legally justified in cancelling or rescinding the transaction, do not give any opinions on the topic but strongly encourage your client to consult with a qualified California real estate attorney, who may be able to see an alternative approach. Alternatively, just because you think there may be a basis to do so, if that perception turns out to be incorrect, there may be another justifiable basis on which to cancel or rescind that a qualified California real estate attorney could identify.

DO NOT assume that contracts between buyers and developers are balanced

Contracts with developers remain as onerous and one-sided as ever, including concepts such as force majeure in favor of the developer, not allowing any interest rate caps to protect a buyer, forfeiture of the benefits of an initialed liquidated damages clause unless the buyer relinquishes all rights to the property at the time of cancellation, etc. (see my prior article on this subject for other one-sided terms and conditions).

While the foregoing assumptions are ones that I have encountered frequently in the last 30 days, I have no doubt that they will continue to be relevant in the near future. While we are all concerned about our health and well-being, as well as our ability to earn a living, under COVID-19 circumstances, care should be taken in evaluating the impact of local Shelter-in-Place Orders on whether and to what degree real estate transactions can take place. These issues will evolve and will continue to be the subject of industry addenda and advisories.

DO NOT assume that any COVID-19 forms prepared by anyone will appropriately address all potential scenarios - the wants and needs of each transaction and each client can vary dramatically, and thus the appropriateness of any addendum or advisory needs to be evaluated within the context of that particular transaction, and your clients should be urged to consult with a qualified California real estate attorney.

Many of the contracts I have dealt with in the last 30 days were written with no contingencies, even in some cases where there were no competing offers. Whether the current market conditions justify non-contingent offers remains to be seen. Under any circumstances, discussing the pros and cons of contingencies with the buyer and seller is still appropriate.

If market conditions no longer justify non-contingent offers, consider including realistic timeframes given COVID-19. For example, a five-day appraisal contingency is probably not realistic given current market conditions and the availability of appraisers. Writing an offer that includes contingencies that can be realistically performed within the agreed-upon timeframe is a better practice than writing an offer with unrealistic timeframes but including a COVID-19 extension agreement as part of the offer.

Negotiating contracts that can realistically be performed by both parties may help in eliminating future disputes over the basis for any cancellation and addressing the issues that are identified in this article.