Here are real estate contract escape (contingency) clauses buyers and sellers need to know. For sellers who must close on their home in order to buy a new one, it is imperative to understand how these clauses work before signing a sales contract. The ability to negotiate these is dependent on, among other things, local market conditions, the parties’ motivation & the skill of the negotiator. Note: This post is based on typical New York contracts, which should mimic those in other states. Always consult your local professional. The four listed are common contingencies, but there are others in your contract, including for fire damage or destruction before closing. The fifth is a self-created escape clause we call the “Houdini”.
1. Mortgage Commitment. Often referred to by attorneys (myself included) as a mortgage contingency clause. This term is misleading. The clause allows a buyer to cancel the contract, and get the deposit returned, if the buyer does not receive a mortgage commitment—NOT a mortgage. Here’s the difference. A commitment is a letter from a lender that says it will lend you x amount of dollars on certain terms to buy the property PROVIDED…. The words that follow are the conditions that must be met before the bank actually has to pony up the loan money. The buyer’s receipt of the commitment letter satisfies the contingency and the escape door is closed. But what if a condition can’t be met, eg. continued employment or payment of a large credit card or judgment debt? In such case, the buyer won’t get the loan but may not escape under the contingency.
TIPS: A smart experienced lawyer can draft a better clause than what’s in most preprinted contracts. If you’re the seller, you can limit the time to wait for the buyer to get the commitment. If you’re the buyer, you can set a cap on the mortgage rate you have to accept (if rates are rising), acceptable loan types (fixed only), or, the best situation, that the contingency is tied to actually getting the loan, if the conditions are beyond your power to meet (loss of job, transfer, military service, illness). Some conditions, like satisfactory appraisal & clear title, are normally standard & need not be negotiated in order to allow the buyer to escape. With pre-construction contracts, this clause should be fine-tuned because there are loan & lock extensions, rate changes & higher likelihood of changed circumstances and costs associated with builder delay. Caveat: As with most escape clauses, you must give a timely and proper notice of cancellation or the clause is usually forfeited.
2. Property Condition Reports. These include termite, radon & engineering/home inspections. This clause allows the buyer, and also the seller, to cancel a sales contract, depending on the quality of the discovered conditions, which is usually tied to a remediation cost. If the parties set a ceiling & the cost is below it, the seller agrees to remediate or offset the cost against the price and the buyer has to accept it. If the cost is above the ceiling, the parties have choices to escape. For example, if an underground oil tank is leaking and the remediation cost is $50,000, the seller can choose to remediate, offset or cancel the contract. The buyer may also choose to cancel, regardless if the seller agrees to remediate or offset.
TIPS: An alternative is to perform the inspections before contract signing & offer. The downside is cost. Another alternative is for the seller to offer the buyer a home warranty in lieu of an inspection. Home warranties are fine but buyers should be aware of some risks, especially for new construction, and should not forego the inspection. The main risk of a home warranty in lieu of an inspection is that it must be enforced after closing. Any defects discovered after closing have time restrictions & notice requirements under the policy. Also, you are now dealing with an insurance company and not the selller. You are also living in the home with the defect. Doing the inspection before closing means you need not close and move in (& incur mortgage payments) until the defect is corrected. Radon Tip: When testing for radon, parties may insist on several tests, due to the fleeting nature of this odorless gas. Location of the sensors is also a factor since higher levels are detected in basements. Remediation can be expensive so choose an acceptable level in the contract, as there may not be a standard in your locality. With termite inspections, make sure to include carpenter ants.
3. Clear Title. Again, most attorneys use the word “unmarketable” to describe the title that is grounds for contract cancellation. The test is simple: If a reputable title company will not issue an insurance policy, the buyer can escape the contract.
Caveat: There is more to title than just getting a policy. Title policies routinely contain exceptions to coverage set forth in Schedule B. These exceptions can include easements, fences, improvement or alterations extending over boundaries. If these exceptions are important to you as a buyer, you will want a contingency to cover you. An escape clause for title exceptions is sticky. Here is one area where an attorney earns their fee.
TIPS: Ask to see the current property survey and existing title insurance policy. The survey will reveal boundaries and structures. The title policy will reveal the Schedule B exceptions that are likely to be passed on to you as owner. Once, an owner in the Hamptons (Long Island, NY) asked for my opinion on his neighbors’ lawsuit against him over an easement. I checked his title policy and, unfortunately for the owner, the easement was listed as an exception. Had it not been, the title company would have defended the suit and the owner would have saved hefty legal fees. Fortunately, the easement was not written into the neighbors’ deed & the case was subject to dismissal.
4. Approvals. These include building department approvals for improvements, alterations and structures, many times added without proper approvals. For new & pre-construction, a Certificate of Occupancy (C of O) is a normal contingency. In New York, co-ops cannot be transferred without prior approval of the Board of Directors. There are exceptions between family members & Sponsor apartments. Therefore, every co-op contract has this escape clause. It is not found in condominium contracts.
Co-op TIPS: Some co-op Boards only meet once a month to interview prospective buyers. Find out when interviews occur and make sure the paperwork (Board package) is submitted to the managing agent on time. Set your other time frames to prevent buyers from missing the interviews. It is also essential to know the Board’s financial requirements for buyers (many limit the % a buyer can borrow). Here is where an experienced real estate agent is ESSENTIAL. If a contract is signed and the buyer is rejected, BOTH parties have lost months & money. Experienced agents know the buildings, the Boards & the procedures to insure a smooth and fast transfer. Beware of conditions Boards may impose, which may be onerous, such as maintenance deposits or guarantees. If the conditions are not met, the buyer escapes the contract. A seller may eliminate that risk, and close the escape hatch, by having a clause that requires a buyer to meet all Board conditions.
5. The Houdini: Making Time of the Essence. This is the hardest of escapes because you create it. It works for sellers or buyers. I should only be attempted with the help of a seasoned real estate attorney. You also need nerves of steel. Just like Harry. It is used when the closing has been unreasonably delayed far past the date set in the contract. Here’s how it’s done by a seller: Have your attorney send a certified letter to the buyer or attorney as per the contract. Advise them of the facts of the unreasonable delay and declare “time of the essence” to close in 30-60 days or forfeit the deposit. 30 days is the typical legal minimum but 60 is safer. If the buyer does not close send a second letter declaring the deposit forfeited.
Caveat: Since the delay must be legally unreasonable, your attorney should make this call. Also, you must show for the closing and be able to close. If you’re unable to close, the escape will fail. Since a lawsuit will likely be filed, the Houdini is a drastic step in an emergency. What is often does is force the other side to close & not risk losing the deposit & possibly the lawsuit to get it back. TIPS: Almost never sign a contract where time is of the essence to close. To avoid having to resort to the Houdini as a seller, set an outside adjournment date beyond which there are no further adjustments and/or where the buyer pays a per diem to you for your waiting (to cover your mortgage interst or other carrying costs, for example).
Remember contracts to sell real estate MUST be in writing to be enforceable. Therefore, do not rely on any promise that is not written into the contract or rider. Read the entire contract & ask a lawyer to explain any parts you don’t understand before you sign a contract. We realize that many states do not use attorneys to close real estate transactions but it might be worth consulting one for an opinion on the contract.
Real estate transactions are heavily regulated by each state. Here in minnesota we don’t even use attorney’s and our boiler plate contracts cover so much that a purchase agreement is 28 to 35 pages long. It is interesting to see how it is done in other states.
Do your contingency clauses match those in NY? Are you able to modify them to accomodate a client’s particular need? Do any cause concern for real estate agents? In NY the coop Board contingency is often a source of frustration because a Board is not required to give a reason for a rejection–yet.