The standard California residential real estate purchase contract, which is produced by the California Association of Realtors® (CAR), contains a default seventeen-day inspection and contingency period. This provision is not mandatory. The buyer and seller can agree to change the length of this period, or not to have it all. The provision is a default in the sense that it stands unless the parties affirmatively decide to change it.

The period is often referred to, sometimes with a degree of cynicism, as a “free look” period. The buyer’s “acceptance of the condition of, and any other matter affecting the property” is a contingency of the purchase agreement (§ 9.A.) and he is given this period of time to satisfy himself as to the condition of the property and matters affecting it. By the end of the time period, he is to remove the contingency or cancel the agreement. (§ 14.B.(3) ) If he cancels the agreement, “… Buyer and Seller agree to sign mutual instructions to cancel the sale and escrow and release deposits to the party entitled to the funds …” (§14.E.).

A recent decision from California’s Court of Appeal for the Third Appellate District (Steiner v. Thexton) suggests that having such a free-look period in a purchase contract may have serious implications that no one seems to have previously thought of.

In September of 2003 Martin Steiner, buyer, and Paul Thexton, seller, executed a document entitled “REAL ESTATE PURCHASE CONTRACT” which had been drafted by Steiner, a real estate developer. Steiner wished to purchase a 10-acre portion of Thexton’s property for development. Thexton had previously been offered substantially more than Steiner was willing to pay. However, that prospective buyer wanted Thexton to process the lot split that would be necessary. This was something Thexton was unwilling to do.

In the deal between Thexton and Steiner, Steiner was to process the engineering and paperwork to accomplish the lot split. The contract stipulated “Buyer will move expeditiously with the parcel split.” If this were not completed within three years the contract would cancel. The contract also said, “Buyer, at his sole option and expense, will conduct all necessary investigations, engineering, architectural and economic feasibility studies as outlined.” While all such work was to be paid for by the buyer, the contract stipulated that, should the contract terminate, the seller would receive all reports and information that had been obtained. Finally, the contract stipulated, “It is expressly understood that the Buyer may, at its absolute and sole discretion during the period, elect not to continue in this transaction and this purchase contract will become null and void.”

The buyer put $1,000 into escrow, to be applied to the purchase price.

By August of the following year an application had been made to the county for a tentative parcel map. By that time, according to their estimates, the buyer had spent approximately $60,000. But then, in October of 2004, Thexton ordered the escrow to be cancelled, saying he no longer wanted to sell.

Not surprisingly, the buyer sued for specific performance. The trial court refused to grant performance. It reasoned that, “The contract is unenforceable against Defendant Paul Thexton the seller because it is, in effect, an option that is not supported by consideration.” It held that the contract had to be construed as an option because the owner was bound to sell at a certain price, yet the “buyer” was not obligated to buy. He could walk away from the deal at any time. “The unilateral nature of this agreement is the classic feature of an option … .”

Moreover, the court held that Thexton, the owner, had received no consideration for this option. The $1,000 was not his to keep. It was to be applied to the purchase price; but, if there were no purchase, it was to be returned to the would-be buyer. And, as the court pointed out, an option without consideration is not enforceable. Hence, the seller could back out.

The court of appeal upheld the trial court’s ruling.

Now, the contract at issue in this case was not a CAR contract, but a number of attorneys and observers have expressed the opinion that its similarities to the “free look” period in the CAR contract are strong enough that the ruling in this case could be applied to the standard residential contracts. This would be a devastating result. The free look period, which had seemed to be a good thing for a buyer, would also be a free-to-cancel period for the seller. That might not mean much in today’s market, but in other times it could be disastrous for buyers. No one would be comfortable with it.

CAR has to hope that the California Supreme Court will accept this case for review, and that, if it does, the Supreme Court will either overturn the appellate ruling or, at a minimum, that it will provide a way of distinguishing this case from the standard residential contract. Otherwise, we can expect to see some changes in the CAR purchase contract.