Seller's Remedies When Buyer Defaults

Written by Posted On Sunday, 15 August 2004 17:00

Q.I thought I had sold my house last month. There was a signed contract with the buyer, and settlement was to take place toward the end of this month. The buyers removed all contingencies and arranged for a title attorney to handle the closing. However, I have just been advised that the buyers are being transferred out of the area and they cannot purchase my house. What rights do I have?

A:Hopefully, the contract which you entered into with your buyers will give you guidance. Most standard form contracts contain provisions relating to defaults – both by the buyer as well as the seller.

First, we have to define “default”. When a real estate contract is entered into, it often contains certain contingencies – such as obtaining a satisfactory home inspection, or getting a firm loan commitment, or even selling the purchaser’s home. These contingencies should include time limitations, whereby if the contingency is not removed within a certain time frame, the contract will either become null and void or will become a valid and binding contract. The specific contingency will usually spell out the consequences of not meeting the time deadlines.

Where there is a contingency in a sales contract, a buyer will not be in default should the contingency not pan out. For example, the buyer signs a contract to purchase your house, and the contract is contingent on the buyer obtaining financing. So long as the buyer promptly makes application for a mortgage loan, if the buyer is unable to obtain the necessary financing within the time spelled out in the contract – and advises the seller in writing of this fact – the contract will usually become null and void. Under these circumstances, the earnest money deposit will be returned to the buyer and there is no default.

Thus, whether you are a buyer or a seller, you want to make sure that any contingencies which are contained in the sales contract are well-drafted. You also want to keep a calendar so that any time limits are not missed.

Once all contingencies have been removed, both the seller and the buyer have the legal obligation to go to settlement. Usually, the sales contract will contain a specific date when settlement must take place. The seller may want to add language in the contract that all time limits contained in the contract are “time of the essence”. This generally means that if the deadline passes, there will be a default.

The legal dictionary defines “default” as “an omission or failure to perform a legal duty”. But no definition can do justice to the facts of each case. There can be no universal definition; each case must be determined on its own facts – and on the language of the sales contract.

Buyer Default

If the buyer defaults, generally the seller has three alternative remedies:

  • Keep the earnest money deposit. A potential buyer who signs a real estate contract generally gives the title attorney or the real estate agent between 5 and 10 percent of the purchase price. This is referred to as the “earnest money deposit”. It is a show of good faith on the part of the buyer that they are serious in wanting to purchase the property in question. A seller would like 100 percent of the purchase price as this deposit, while a buyer would only like to sign a promissory note and shake hands with the seller.

    However, the general practice is that the buyer will put up some agreed upon percentage of the sales price as this deposit.

    In the event of a default, the seller has the right to keep this deposit, and put the house back on the market and resell it. However, the person holding this deposit is called the “escrow agent”. This agent does not have the unilateral right to release the deposit – to either buyer or seller – unless there is a written statement from both buyer and seller authorizing the release or – if the matter has to go to Court -- a court settlement agreement or a Court order.

  • Sue for specific performance: There is a legal right for the seller to file suit against the buyer, asking the Judge to order that the buyer actually go to closing. This is known as an action for specific performance. Legal actions take time and are expensive. But if the buyer is financially able – and for example if the property values has declined – this is a possible alternative for the seller to consinder.

  • Bring a lawsuit for damages: Let us assume that the sales contract called for a $500,000 purchase price. After the buyer defaulted, the seller was only able to sell the property for $400,000. The seller has the right to file a lawsuit against the buyer for this $100,000 loss. Damages would also include any carrying costs which the seller had to absorb until the property was in fact sold to someone else.

    Once again, litigation is time consuming -- and unpredictable.

    These are the basic remedies which a seller has on the default by the buyer. Smart buyers will generally want to limit their exposure by spelling out in the sales contract that the seller can only keep the deposit, and not be able to assert any of the other two options.

    Smart sellers, on the other hand, will want to keep all options open, and try to get as high an earnest money deposit as possible.

    Seller Defaults

    Should the seller default, the buyer should have the absolute right to sue for specific performance and damages. Generally, when sellers default, it is because they think they can get a higher price for the property. It would be manifestly unfair to the buyer to allow that to take place, and accordingly the law gives the buyer the right to file a suit for specific performance. And in most jurisdictions, such a suit (often accompanied by documents recorded against the property in the land records) puts a cloud on the seller’s title. This is known in the law as “lis pendens”. It puts the world on notice that there is a lawsuit involving the property. No third party buyer would dare to even consider buying the property while that lawsuit is pending in the courts.

    Default – whether by buyer or seller – should not be taken lightly. Nor should it be asserted without giving the defaulting party an opportunity to cure the default. Regardless of the merits, litigation is both time consuming and expensive.

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    Benny L Kass

    Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of KASS LEGAL GROUP, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts.

    Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.

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