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Phillip C. Querin, Partner
Partner - Portland, Oregon Office
philquerin@dwt.com
(503) 241-2300
CONTINGENCIES – Understanding
Them, Writing Them, & Exercising Them
[May 2007]
What
is a Contingency?
In its simplest form, a contingency is generally
an event that must first occur before the contract will become fully
binding. There are many examples of contingencies – financing,
title, professional inspections, the sale of buyer’s home,
etc. Until the described event occurs, the buyer can usually get
out of the transaction and recover back all of the earnest money.
But, true to the old adage, when it comes to contingencies, “The
devil’s in the details.” Understanding these details
is essential if one is to write a contingency that is clear and
enforceable. What follows is a discussion of contingencies found
in the OREF Residential Sale Agreement and some tips on writing
your own.
The Financing Contingency
There are several important issues to remember concerning
the financing contingency. First, contrary to all of the other contingencies
in the OREF Residential Sale Agreement, this contingency does not
automatically expire. Unless it is expressly waived, e.g. by a written
addendum,1
it runs all the way up to the moment of closing. The reason the
Sale Agreement form does not make the financing contingency automatically
expire, say after a couple of weeks, is because the loan underwriter
who gives final approval for the loan does not usually do so until
shortly before closing. Until then, even though all of the stars
are aligned and the buyer has Triple-A credit, the loan is never
a sure thing. A tax lien could show up right before closing; an
unpaid child support judgment could surface; or a legal claim clouding
title to the property could be filed. So while many sellers and
buyers believe that being “pre-approved” is good enough
– it isn’t. Pre-approval is frequently nothing more
the a mortgage broker’s preliminary opinion of the buyer’s
creditworthiness based upon a cursory review of certain financial
information. This is not the same as the lender’s commitment
to actually make the loan.
Secondly, the Residential Sale Agreement form does
not contain a pre-printed provision describing the type of loan
to be sought. This means that the final terms of sale generally
must include some descriptive language regarding the purchase money
loan to be obtained by the buyer. This language is frequently inserted
at Page 1, Line 41, of the 2007 form, after the words: “Payable
as follows (Describe details of any loan(s) to be obtained):_____________.”2
However, buyer agents frequently ignore this italicized suggestion,
and simply insert a shorthand phrase, such as “Loan of Buyer’s
choice” or similar terms. This means that if the buyer cannot
obtain a loan of “their choice” – whatever that
may be - they can terminate the transaction and recover back their
earnest money. Unfortunately, while such loosely drafted phrasing
is good for buyers because it gives them significant “wiggle
room” to change their mind, it’s not so good for sellers.
For example, the buyer might be intending to apply for a non-conventional
loan; a subprime loan; one permitting no verification of income;
100% (or more) financing; or allow some other undisclosed terms
that the seller should know about before agreeing to the sale. For
this reason, listing agents and their seller-clients may want to
make sure they have a good idea of the buyer’s intended loan
program, such as the type of lender (e.g. conventional versus non-conventional),
the buyer’s intended loan amount, and the intended loan-to-value
ratio, among other things.3
The Title Contingency
The title contingency closely resembles the other
standard contingencies in the OREF Residential Sale Agreement, in
that it contains language making it automatically self-expiring.
Specifically, it provides at Section 5 that the buyer shall have
five business days (if no other time is inserted) following receipt
of copies of the recorded title documents to notify the seller of
any objections to the preliminary report. Correspondingly, upon
receipt of such notice, the seller may agree to remove them, or
give reasonable assurances of doing so prior to closing. If the
seller fails to do so, all earnest money is to be returned to the
buyer and the transaction terminated. But buyers must understand
that silence is consent. In other words, if the buyer fails
to object to some recorded exception disclosed in the preliminary
title report, such as an easement or right of way, the objection
is waived.4
For this reason, it is very important for the buyer’s Realtor®
to make sure their client closely reviews the contents of the preliminary
report and secures timely answers to any issues that could potentially
pose a problem. While real estate agents are not expected to be
title “experts,” in this era of increased Realtor®
professionalism, it is suggested that the buyer’s agent personally
review the preliminary title report. If a potential problem appears,
the agent should recommend that the client contact the title officer
or a real estate attorney for further clarification.5
The Professional Inspection Contingency
Similar to the title contingency, the buyer’s
silence is consent. Unless a different time is selected,
the buyer has ten (10) business days within which to conduct one
or more inspections and, if necessary, complete negotiations with
the seller for any repairs, price adjustments, or other concessions.
This is referred to in the Sale Agreement as the “Inspection
Period.” It is important to remember that the time-frame permitted
in the Inspection Period is intended to cover not only completion
of the inspections themselves, but also all negotiations
between seller and buyer in dealing with any adverse information
disclosed in the inspection report(s). Buyer agents should never
assume that there is an open-ended period of time to reach agreement
with the seller. The goal is to fully negotiate all property condition
issues and reduce them to a fully executed addendum by or before
the end of the Inspection Period. If it appears that this cannot
occur due to matters beyond everyone’s reasonable control,
both agents should discuss with their respective clients the need
to consider a written extension of time.
The Well Inspection Contingency
This is the remaining printed contingency in the standard
OREF Residential Sale Agreement form. It is different from the property
condition contingency. First, it provides that the cost of the state-required
well water testing will be borne by the seller. The buyer may, at
the buyer’s expense, have any additional tests performed.
If any tests indicate a substantial deficiency in well water quality
or quantity, the buyer may withdraw from the transaction and recover
back all deposits – so long as it is done within the time-frame
agreed upon in Section 12 of the Sale Agreement. Absent the selection
of some other time-frame, the buyer will have seven business days
to give such notice to the seller. However, the seller may prevent
termination if he/she gives written notification within 24 hours
of receipt of the buyer’s notice, that the seller will correct
the deficiencies shown in the well report(s). This opportunity for
the seller to “cure” any disclosed deficiencies is materially
different than the property inspection contingency, in which buyers
may terminate simply by giving notice that they reject the professional
inspection report.
Drafting Your Own Contingency
When drafting a special contingency it is important
to avoid ambiguity. If reasonable minds can differ upon the meaning
of a contingency provision, it is “ambiguous.” So when
drafting language unique to a specific transaction, it is important
to make sure that all parties and their Realtors® agree upon
its meaning. The following issues should be addressed: (a) The operative
event that is the subject of the contingency; (b) How long the party
for whose benefit the contingency is written has to exercise the
contingency;6
(c) What “exercise” means (e.g. the transaction shall
be terminated and all deposits refunded); (d) The form of the notice
(e.g. in writing); (e) To whom notice must be given (e.g. the party
or their agent, or either one); and (f) What happens if timely notice
is not given (e.g. the contingent event is deemed to be waived –
in other words, as in the professional inspection contingency, the
buyer shall be deemed to have accepted the condition of the property,
i.e. silence is consent).7
OREF has two separate contingency forms available
for when the buyer wants to make their purchase subject to the sale
of their existing residence. It is generally better to use one of
these forms than to attempt to draft your own. However, each form
is different, and should be closely reviewed before selection.
Conclusion. Since most
contingencies usually permit the buyer to terminate the transaction
without liability, such termination can occasionally be met with
resistance from the seller. Even though the OREF Residential Sale
Agreement provides that upon timely exercise, all deposits will
be refunded, if the money is in escrow, the seller can effectively
“veto” the return of funds by simply refusing to sign
the mutual termination agreement. Escrow will not act without joint
instructions, which means that the seller’s refusal to cooperate
can hamper the timely return of funds - even though the buyer may
believe they timely exercised their right of termination under the
contingency.8
In order to avoid misunderstandings, Realtors® should make sure
that all contingencies are fully explained to their clients, and
if called upon to write a special contingency, make sure everyone
is in agreement upon when it must be exercised, and how that exercise
is to occur.
FOOTNOTES
1 Some
listing agents unilaterally prepare an addendum releasing “all
contingencies,” which includes the loan contingency. Buyer
agents should be careful about routinely allowing their clients
to sign such an addendum, since it means that if the loan falls
through at the last minute due to reasons outside of the buyer’s
control, the buyer could lose their earnest money. Realtors®
representing buyers should thoroughly discuss this risk with their
clients before allowing them to release the financing contingency.
Remember, the OREF Residential Sale Agreement form itself does
not require that the financing contingency be released at any
time before closing. So a buyer’s willingness to do so should
be based upon an evaluation of the risk of the loan falling through.
2
It is important to note, however, that regarding the financing contingency,
Section 3 of the OREF Sale Agreement does impose several important
printed provisions.
3
Some savvy buyers and/or buyer brokers, may insert an interest rate
cap in their loan contingency.
4
However, this Section also provides that the buyer’s failure
to object will not relieve a seller from the duty to convey marketable
title at the time of closing.
5
While Realtors® may undertake some of the responsibility of
collecting information from the title officer, they should be careful
in documenting all such information, the source of the information,
and in reminding their clients to personally verify it and/or secure
competent legal counsel.
6
If the deadline is to be measured in business days, it must be specified.
Failure to so specify will be construed to mean calendar days. If
the period is measured in a specific number of days, be sure that
you and the other side agree upon the beginning and end dates.
7
Although more commonly found in commercial transactions or those
contemplating the future development of the property, sometimes
the failure to give notice that the operative event has not occurred
(e.g. getting preliminary plat approval for a 34 lot subdivision),
means that the transaction is terminated. In other words, silence
is not consent.
8
This may not necessarily be so if the earnest money deposit is retained
in the buyer broker’s trust account. See Oregon Administrative
Rule 863-015-0186.
© Copyright
2007. Phillip C. Querin, Davis Wright Tremaine. No part may be reproduced
without the author’s express written consent.
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