Contracts for the Sale of Real Property

Terms:

Statute of Frauds:
A law, originally adopted in England in 1677, now adopted in some form by all 50 states, that states that certain contracts, including those transferring an interest in real estate, must be in writing to be enforceable.

Broker:
A person who acts as an agent to find a buyer for a product in exchange for a fee or commission.

Commission:
A percentage of the sale price that serves as the broker’s fee.

Marketable Title:
Title that is not subject to any reasonable doubt about its validity and that is not likely to be challenged in the future by a third party’s claim of ownership or by virtue of encumbrances on the property.

Encumbrance:
A burden that is attached to land, such as a mortgage or an easement that limits the owner’s rights to or ownership of the land.

Equity:
The system of justice that complements the system of “law” by modifying certain laws in certain situations to assure that justice is done to the greatest extent possible in all cases.

Equitable Conversion:
The rule that states that, in equity, property is transferred to a buyer as soon as the contract that calls for the transfer of the property to the buyer is signed.

Implied Warranty:
A promise that is inherently made from the seller of property to the buyer of property that is effective even if not spelled out in the terms of the contract.

Specific Performance:
Performance ordered by a court that a contract be carried out exactly according to its terms, instead of compensating the aggrieved party by awarding him or her monetary damages.

Real property transfers are accomplished by a two step process. The first step is the contract of sale, which is the subject of this subchapter. The second step is the closing. At the closing, the document representing the property, the “deed,” is transferred to the party receiving the property. Closings and deeds are the subject of the next subchapter.

The Contract Document- the Writing Requirement

The Statute of Frauds dictates that a contract for the transfer of an interest in real estate must be in writing and must be signed by the party against whom the contract is being enforced. Otherwise, the contract is unenforceable. Furthermore, since real estate transfers fall under the common law Statute of Frauds (as opposed to the UCC Statute of Frauds), the contract must contain all material terms of the agreement for the contract to be enforceable. The material terms in any real estate transfer contract include the identification of the transferor, the identification of the transferee, a description of the property and the terms and conditions of the transfer, including the price, if one has been agreed to.

As with many of the other contracts affected by the Statute of Frauds, part performance can make a real estate transfer contract enforceable even in the absence of a written contract. In the context of a real estate transfer contract, part performance generally means possession of the property by the transferee plus either partial payment by the transferee or improvements to the land that are made by the transferee. For example:

1) Fred and Barney conclude an oral agreement whereby Fred agrees to sell Barney Slateacre for $100,000. Barney pays $50,000 to Fred, and moves onto the land. In this case, even though the contract for the sale of Slateacre was oral, a court will uphold this contract because the part performance is sufficient to provide evidence that Fred and Barney had a contract. Therefore, the Statute of Frauds is satisfied and the court will uphold the contract.

2) Fred and Barney conclude an oral agreement whereby Fred agrees to sell Barney Slateacre for $100,000. Barney promptly moves onto the land. Later, Barney begins to construct a farmhouse on the land. Barney’s possession of the land plus the improvements made by Barney are sufficient to satisfy the Statute of Frauds.

Brokers and Commissions

Very often, real property is sold through a broker. The general procedure runs something like this. The seller will sign a contract with a broker, giving the broker the right to list and show the property to possible buyers. If the property is sold, then the broker will collect a commission, which is usually a percentage of the purchase price, from the seller. Typically, the brokers’ commission is approximately 6% of the purchase price, although the recent trend is to lower the commission because computer technology and the internet have made it significantly easier to market homes to a large number of potential buyers.

Many brokers’ agreements provide that the broker is entitled to a commission even if the buyer sells the property through an avenue other than the broker, after the broker has been hired. This, of course, protects the broker from a buyer who hires a broker to market his house and then takes advantage of the broker’s marketing of the house by selling it to the buyer without using the broker as a middleman in order to save the broker’s commission. For example:

Mike wants to sell his house. So, he calls Home Sellers, Inc. and asks them to broker the sale of his house. Home Sellers puts an advertisement in several newspapers about Mike’s house for sale and posts Mike’s house on their internet house listing. Lisa calls Mike and tells him that she saw an advertisement for his house and would like to buy it. Mike tells Lisa to come over to his house to negotiate but not to tell Home Sellers anything. Lisa comes over to Mike’s house and they negotiate a sale under which Lisa will buy Mike’s house for $250,000. Unless Home Sellers’ agreement with Mike included a clause that allowed them to receive their commission regardless of how Mike’s house was sold, Mike would be able to successfully shut out Home Sellers from their commission in spite of the fact that their services helped Mike sell his house.

Another issue arises when, for whatever reason, a deal that was brokered by the broker falls through in spite of the fact that the broker did his or her job in bringing a potential buyer together with the potential seller.

The traditional rule was that the broker was entitled to his or her commission as soon as he or she presented the seller with a buyer that was ready, willing, and able to buy the property for the price set forth by the seller. This meant that if the broker brought the seller a willing buyer and the buyer and seller entered into a contract, the seller still had to pay the broker his commission, even if the buyer later breached the contract and did not buy the house. This remains the law in many states. See Greenwald v. Veurink, 37 Mich. App. 700.

In many other states, this traditional rule has been replaced by a more modern rule that says that the broker is only entitled to his or her commission if and when the buyer actually completes the transaction by paying the purchase price. In this way, the seller is protected from having to pay the broker in the event that the buyer backs out of the deal. However, in all jurisdictions, if the agreement falls through because the seller backs out of the deal, the seller is liable to the broker for the broker’s commission.

Typically, after the buyer has tendered an offer and the seller has accepted the offer, an attorney is hired to draw up a contract of sale, examine the title, draft a deed, and close the transaction. However, the involvement of an attorney is not strictly necessary in the drafting and executing of the contract of sale.

Duty to Convey Marketable Title

Unless specifically agreed to otherwise, every contract for the sale of land contains an implied promise that the seller will convey “marketable” title to the buyer. Marketable title is title that is free from contention and/or doubt to the extent that a reasonable buyer would accept it. A seller who fails to convey marketable title under a contract that, expressly or impliedly, calls for marketable title, has breached the contract. In such a case, the buyer can refuse to pay the purchase price for that land and sue the seller for whatever other damages the buyer suffered as a result of the breach.

A seller can convey marketable title in two ways. The first, and best way is to show that the seller has good title to the property by producing the property’s “chain of title.” The chain of title for a parcel of property is the series of deeds and transfer records in the history of the property from the original “root” title (how the first possessor of the property came to possess it) to the present day. This is surprisingly easy to do, since records of real property transfers are kept in each county’s county clerk’s office. “Title searches” can often be done simply by paying a visit to the county clerk’s office and looking up the chain of title that relates to a particular parcel of property. Some counties are even working to put these entire databases online, so that a title search can be done from the home or office of the buyer or the buyer’s attorney.

The second way a seller can show marketable title is by proving that he or she came to own the property by adverse possession. Of course, these two ways of showing marketable title are never both an option for the same property. Parties who come to own property via adverse possession cannot show a chain of title because there is no documentation that is filed that will indicate that ownership of property was changed by adverse possession. Proof of acquisition by adverse possession can be in the form of a court decision stating that the possessor owns the property. It is unclear whether title acquired by adverse possession that has never been adjudicated (decided) in court can constitute marketable title. See Conklin v. Davi, 76 N.J. 468 (1978).

Title is considered to be defective, and therefore unmarketable, if there is a substantial defect in the title. Essentially, a defect is substantial if it is likely to cause the buyer injury in the future. This injury could be in the form of a third party repossessing the property, or even in the form of forcing the buyer to defend against a lawsuit by such a third party. There are two possible defects that can make title unmarketable:

1) Defect in the chain of title: If the chain of title is missing a “link” in its history prior to the acquisition of the property by the seller, the title is inherently unmarketable. For example:

Seller and Buyer agree that Seller will sell Whiteacre to buyer for $100,000. The chain of title to Whiteacre reads “… 1972: Al sold Whiteacre to Bob; 1980: Bob sold Whiteacre to Christine; 1990: Dan sold Whiteacre to Seller.” Seller’s title in Whiteacre is not marketable, because there is a missing link between Christine’s ownership and Dan’s ownership. Put another way, Buyer is likely to have trouble in the future because Christine or Christine’s heirs may try to re-claim the property. Even if Buyer does manage to prevail in such an action, it is certainly likely that he will have to go through a significant amount of trouble to defend the property against such an action. Therefore, unless Seller can somehow repair the defect in his title to Whiteacre before it comes time to close, he will have no choice but to breach his contract with Buyer (unless, of course, Buyer is willing to take Seller’s title, defective though it may be).

2) Encumbrances: Certain private encumbrances on the land can also make the seller’s title unmarketable. For example, if third parties hold mortgages, liens or easements on the property, or if the property is subject to certain covenants, this may or may not make the seller’s title unmarketable. These encumbrances and the rules that govern them are the subject of later chapters in this course. We will therefore suspend our discussion about their effects on marketable title until we cover the encumbrances themselves. Note that restrictive zoning laws are not considered to be encumbrances and such zoning laws will never, by themselves, make a seller’s title unmarketable. However, if the property is being used in a manner that violates the zoning law, that can potentially make the seller’s title unmarketable. See Lohmeyer v. Bower, 170 Kan. 442 (1951).

Duty of Disclosure and Implied Warranties

As we have discussed during our Contracts and Torts classes, the traditional common law approach was to hold the seller in breach of contract only for his or her false representations to the buyer. In other words, a seller could neglect to mention a substantial defect in the real property being sold, and this would not lead to any liability whatsoever on the part of the seller. For example:

Seller is selling his house. Buyer sees the “for sale” sign up in the front yard and comes into Seller’s house and asks for a tour. Seller shows Buyer around the house, but “forgets” to mention that the kitchen ceiling leaks every time it rains. Buyer contracts to buy the house from Seller. Under the traditional common law rule, Buyer will not be able to get out of the contract when he finds out about the leaking roof, because seller did not make any affirmative misrepresentations in the course of the sale of the house.

Today, many states have consumer protection laws that require sellers of real property to fill out disclosure forms. These forms often ask very specific questions about the condition of the house. If, in the form, the seller lies, there will almost certainly be adequate grounds for the buyer to avoid the contract.

Even if a state does not have a form requirement, the modern trend is to require the seller to disclose any defective condition in the house that would not be apparent to the buyer in the course of his or her cursory inspection of the house (a “latent” defect). If the seller fails to disclose a latent defect and the defect is material, such a nondisclosure will be grounds for avoidance of the contract.

Equitable Conversion and Risk of Loss

In between the time that a contract for the sale of real estate is signed and the time that the deed is actually delivered to the buyer, the property is in a state of limbo. On the one hand, the buyer has the contractual right to receive the property. On the other hand, the seller still has possession and the current enjoyment of the property. In fact, the ownership of the property during this period is said to be split between the equitable ownership and the legal ownership.

As soon as the contract is signed, the buyer is said to own the house in “equity” since he or she has the right to receive possession of the house and it is only a matter of time before he or she does receive that possession. In other words, the “equitable title” changes hands as soon as the contract is signed. This rule is called the doctrine of “equitable conversion.” The “legal” title to the property on the other hand, does not pass to the buyer until possession of the property is actually deeded over to the buyer. For example:

Jan is selling Bradyacre to Marsha. They sign the contract for the sale on July 1, with the closing set for August 1. During the month of July, Marsha is the equitable owner of Bradyacre, while Jan is the legal owner of Bradyacre.

The importance of equitable ownership by the buyer manifests itself in many areas. If the buyer were to die in the interim, for example, his or her estate would be considered to be the owner of the real property, even though the buyer only owned a contractual right to the property. For example:

Jan is selling Bradyacre to Marsha. They sign the contract for the sale on July 1, with the closing set for August 1. On July 15, Marsha dies. In her will, Marsha left all of her real property to Cindy and all of her personal property to Peter. Because Marsha was the equitable owner of the property on July 15, Cindy would get Bradyacre.

Perhaps the most important ramification of the equitable conversion doctrine, however, is its effect on who bears the risk of loss of, or damage to the property that occurs through the fault of neither party. Under the traditional doctrine of equitable conversion, because equitable title to the property passes at the time of the signing of the sales contract, the risk of loss also passes from the seller to the buyer at the time of the signing of the sales contract. This remains the law in most states. For example:

Jan is selling Bradyacre to Marsha. They sign the contract for the sale on July 1, with the closing set for August 1. The contract price and the approximate market value of Bradyacre is about $500,000. On July 15, an accidental fire that started as a forest fire burns the house on Bradyacre to the ground. The market value of Bradyacre is decreased to $200,000 because of the fire. Under the majority rule, Marsha bore the risk of loss during the time period between the signing of the contract and the closing. Therefore, Marsha will still have to pay the $500,000 contract price at the time of the closing, even though the value of the house has decreased to $200,000.

Many courts feel that this is an unfair rule because the seller, as the party in possession of the property until the closing, is in the best position to prevent damage to the property. Therefore, some courts, and even some states, have enacted laws that provide that the risk of loss does not pass from the seller to the buyer until the closing. Instead, the risk of loss always stays with the party in possession of the property. Under this rule, if there is a disaster that substantially reduces the market value of the property in between the signing of the contract and the closing, the buyer may deduct the amount of that decrease in value from the purchase price.

Of course, if one party is responsible for the decrease in value either through his or her negligence or intentional act, that party bears the risk of loss or damage. For example:

Jan is selling Bradyacre to Marsha. They sign the contract for the sale on July 1, with the closing set for August 1. The contract price and the approximate market value of Bradyacre is about $500,000. On July 15, the power on Bradyacre gets blacked out. Jan lights a candle so that she can read. Later, she goes to sleep without having blown out the candle. Eventually, a blanket catches fire and the fire spreads to the walls. Thankfully, Jan escapes unharmed, but the whole house is burned down. Even under the majority rule, since it was Jan’s fault that the house burned down, Marsha can deduct from the purchase price the amount that the value of the house decreased.

Remedies for Breach

As is discussed in the contracts course in more detail, a buyer who is the victim of a breach of contract by the seller for the sale of real estate has three options:

First, the buyer can rescind the contract and not pay the purchase price. In addition, the buyer may be entitled to damages that were caused by the breach and expenses incurred by the buyer during the contract negotiations. For example:

Seller agrees to sell a house that is worth $300,000 to Buyer for $250,000. Seller and Buyer eventually sign the contract, but Seller later backs out. One of the available options that Buyer has is to rescind the contract and collect the $50,000 from Seller which represents the gain that Buyer would have realized had the sale gone through.

The second option that the buyer has is to demand specific performance of the contract. Although courts do not generally force parties to actually perform their end of a contract (monetary damages is the preferred remedy for a breach of contract), land is an exception. Since each particular parcel of land is considered unique from every other parcel of land, the common law considers monetary damages inadequate to compensate an aggrieved buyer. Therefore, if a seller breaches a land sale contract, the court can force the seller to turn over the land to the buyer for the purchase price. For example:

Seller agrees to sell a house that is worth $300,000 to Buyer for $250,000. Seller and Buyer eventually sign the contract, but Seller later backs out. One of the available options that Buyer has is to have the court force Seller to go through with the sale.

A third option can arise for the buyer in a case where the seller still wants to sell the property, but breached the contract in some other way (eg. by making a misrepresentation in the contract or by failing to deliver the house by the agreed upon date etc.). In such a case, the buyer may rescind the contract or allow the sale to go through. If the buyer allows the sale to go through, he or she can deduct any damages that he or she suffered because of the breach from the purchase price. For example:

Seller agrees to sell a house to Buyer for $250,000. Under the terms of the agreement, Seller must move out by August 1. However, Seller stays in the house until August 15. Because of this, Buyer had to put himself and his family in a motel for the 2 weeks and that cost him $1,000. Assuming that the $1,000 is a reasonable figure, a court will allow Buyer to go through with the purchase of the house and to deduct the $1,000 from the purchase price.

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