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Defining Default

Written by on Sunday, 14 November 2004 6:00 pm

Question: I have signed a contract to sell my house, but it appears that the buyer is having a case of "buyer's remorse." I believe she wants to back out from under the contract. My real estate broker has asked me to determine if she is in default on the terms of the contract. How do I do this and what exactly constitutes a "default?"

Answer: I am surprised that your real estate broker was unable to provide you with a basic understanding of the concept of "default."

The dictionary defines "default" as "an omission or failure to perform a legal duty."

You and your buyer have signed a purchase and sales contract. The first question is whether this is a valid, legally binding document. In order to have a valid contract, four things are required:

  1. An Offer: In the Washington metropolitan area, it is customary for a potential buyer to make an offer to the seller. The seller can either accept, reject or counter that offer. If the seller opts for either of the latter approaches, the original offer presented by the buyer is no longer in effect.

  2. Acceptance: Sometimes, buyers and sellers go back and forth, making offers and counteroffers. Finally, if an offer (or a counteroffer) is acceptable, and everyone signs off, there is a contract. This means that both parties have reached agreement on all of the various terms and conditions which are included in a real estate sales contract.

  3. Consideration: Generally, when a buyer makes an offer which is ultimately accepted, he will give his attorney or his real estate broker a check for a percentage of the purchase price (usually 5 or 10 percent). This is known as the "earnest money deposit." In order to have a valid, binding contract, there must be some consideration -- and it usually requires money. However, consideration need not always be financial; if the purchaser has refrained from buying some other property (or if the seller has taken the house off the market because of the contract) this can also be considered "consideration." To be on the safe side, it is always best to have some money attached to the sales contract.

  4. Written Document: To have a legal contract for the purchase and sale of real estate, there must be a written document, signed by both buyer and seller. Oral promises will generally not be upheld in a Court of law. In modern times, faxes and emails have become standard practice, but even if you have reached agreement by email, make sure that you still have a paper trail, signed by all parties to the transaction.

Once you have determined that there is a valid contract, the next step is to see if there are any contingencies which would give your buyer the right to cancel the contract and not be in default. There are many different types of contingencies -- ranging from home inspection, financing, review of condominium or homeowner association documents, or even sale of the purchaser's home. Read the contingencies carefully, and if you have any questions as to their applicability, talk with your own attorney as to the impact and effect of any such contingency.

Let us now assume that there is a valid, legal contract, and your buyer has removed all contingencies. Your buyer has obtained a satisfactory home inspection, and has obtained a firm commitment for a mortgage loan. But at the last minute, your buyer wants out of the deal. Unfortunately, this is not an uncommon situation nowadays.

You must look at your real estate contract. It should spell out your rights when your buyer has failed to perform a legal duty -- in other words is in "default" on the terms of the contract.

Generally speaking, when a buyer is in default, a seller has three alternative remedies:

  1. Keep the earnest money deposit: A buyer wants to put down as little as possible as the earnest money deposit, but a seller wants as much as possible. As indicated earlier, the normal range of this deposit is between 5-10 percent of the purchase price. If the seller believes that the house can sell quickly to a third party, he may opt to keep the deposit and put the house back on the market. However, it should be noted that in most cases, if there is a real estate broker (or brokers) involved in the transaction, they generally will be entitled to half of the deposit as their commission. The real estate contract should contain all of these terms and conditions, so there is no mistake -- and no legal fights -- should the buyer be in default.

    It should also be noted that the buyer might not be willing to release the deposit. This deposit is held in escrow -- usually by the title attorney or the real estate broker. The escrow agent must not -- and cannot -- release the funds to anyone unless there is a release document, signed by buyer and seller, spelling out the terms of the distribution.

    The buyer may dispute that she is in default. In this case, the seller may have to take the buyer to court. We follow what is known as the "American Rule" regarding legal fees. Unless there is language in a statute or a contract which will give the prevailing party in litigation attorneys fees, each side will have to pay its own lawyer. Thus, it is important that every real estate contract contain language such as this:

    In the event litigation is required involving the terms and conditions of this contract, the prevailing party shall be entitled to reasonable attorneys fees and costs as determined by the Court.

  2. Sue for specific performance: A seller has the right to sue the buyer in Court, asking that the Court require that the buyer comply with the terms of the sales contract. Obviously, if the buyer has no money, such a remedy would be useless. But many buyers are financially able to go to closing on the house under contract, and our legal system has created a mechanism whereby those buyers can be forced to honor the terms of the contract they signed.

    A 1980 District of Columbia Court of Appeals case involved singer Roberta Flack. In that case, the court stated:

    Specific performance of a contract is ordered when the legal remedy, usually money damages, is deemed to be either inadequate or impracticable. When land is the subject matter of the agreement, the legal remedy is assumed to be inadequate, since each parcel of land is unique; thus, equitable jurisdiction in this case is firmly established.

    Obviously, litigation is timely, expensive -- and uncertain. But if the earnest money is small -- or if the property has gone down in value below the contract price -- specific performance is an option for consideration by the seller.

  3. Lawsuit for damages: A seller has a third option, namely to sue the buyer for damages. Let us assume that the contract sales price was $300,000. After the buyer defaulted, the seller was only able to sell the property for $250,000. And in addition, the seller had to carry the house for a long period of time, thus paying additional real estate taxes, insurance and home mortgage payments.

    The seller has the right to sue the buyer for these damages. However, Courts are often stingy when it comes to determining damages, and this should be a remedy of last resort.

When your buyer is in default -- or at least you think she is -- you should give careful consideration as to all of your options. It is easy to say "let's sue," but a lawsuit is not always the answer. Talk to the buyer first, and see if there is a compromise position. Perhaps the buyer can be convinced to go to closing if you reduce the price by a couple of thousand dollars. Clearly, that is faster -- and much less expensive -- than litigation.

And it should also be noted that many purchasers, when they sign a real estate contract, limit their exposure to the loss of their earnest money deposit. They specifically prohibit the seller from suing either for damages or specific performance.

A real estate contract is a very important legal document. The form contract which your real estate agent gives you is only a form -- it is not carved in stone. In my opinion, every sales contract must be read carefully by both buyer and seller, line by line, and paragraph by paragraph. If you do not like -- or understand -- a particular provision in that form, question it.

Whether you are a buyer or a seller, you do not have to sign the form in its "as is" condition. You have every right to make all of the changes which you desire. It's up to the other party to decide whether to accept or not.

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  About the author, Benny L. Kass

Individual news stories are based upon the opinions of the writer and does not reflect the opinion of Realty Times.