Chapter 7

CONTRACTS

In almost every phase of real estate practice, brokers and salespersons are dealing with some form of contract, such as purchase and sale agreements, listing contracts, leases, offers and options. It is important that licensees have a basic knowledge and understanding of the fundamentals of contracts, for the protection of their clients as well as for themselves. For the most part, brokers and salespersons use standardized forms in their practice. Attorneys prepare contracts, such as deeds and mortgages, which require recording. Although it is appropriate for licensees to assist clients in executing various contracts, they must be careful never to discourage a person from seeking the advice of an attorney. Acting otherwise is a license violation. Above all, licensees have a duty to be certain that all contracts in which they are involved are fair and proper, so as to avoid unnecessary legal entanglements.

CONTRACT.

A contract is a legally enforceable agreement, either written or oral, between two competent parties to do or refrain from doing certain legal acts based upon a mutual exchange or consideration.

ESSENTIALS OF A VALID CONTRACT

MEETING OF THE MINDS

A valid contract requires a mutual assent or agreement of the parties to all the terms and conditions of the contract. A mutual mistake as to any of the vital terms will nullify the contract.

OFFER AND ACCEPTANCE

An offer is an indication of an intention to enter into a contract which, when accepted by the offeree, will create a valid contract. In the standard real estate purchase contract, the offer and acceptance are incorporated into the agreement and become binding when both parties have signed. A prospective buyer as a means of inducing the seller to lower the asking price may use a separate written offer. Acceptance of the offer by the seller completes the contract. Any alterations made by the seller will amount to a rejection of the offer. Note: All valid real estate contracts must include "offer and "acceptance".

Offer vs. Invitation to Deal.

A mere inquiry or invitation to deal is not an offer and therefore cannot be accepted so as to create a contract. Newspaper advertisements, circular letters, and merchandise displayed in stores are invitations to deal and not offers.

CONSIDERATION

Consideration is anything of value which is given or exchanged at the time of signing, or which is promised to be given or performed at a future date. Consideration can be a promise, an act or a forbearance to act, given or promised by a party to a contract. The value of the consideration is unimportant so long as it is lawful and both parties agree to it. Consideration does not have to be fair, but grossly inadequate consideration can indicate fraud.

Earnest money, (deposit) given to bind a contract to purchase real estate does not, of itself, satisfy the consideration requirement. A purchase and sale agreement without an earnest money deposit is binding so long as it contains a promise to pay an agreed price.

COMPETENCY

A person must have legal capacity in order to be bound by a contract. Everyone is capable of contracting except those under some form of disability. Minors (under the age of majority) and persons who are mentally ill or intoxicated are incompetent to enter into binding contracts. An incompetent's contract is voidable by the person under disability but valid as against the person with capacity. For example, a minor may rescind a contract to purchase real estate, but the adult seller is bound to it. If the seller defaults, the incompetent can sue for the return of the deposit and other damages, but cannot legally force the seller to convey title. Only a legally appointed guardian or conservator, acting with court approval, may execute a binding contract for the purchase or sale of an incompetent's property.

Incompetent's Ability To Own Real Estate.

Incapacity to enter into a contract does not affect the ability to own real estate. Being illiterate does not bar a person from buying or selling real estate.

Transfer of Title By a Minor or Mental Incompetent.

A deed given by an incompetent is voidable and may be disaffirmed even after recording. The conveyance is valid only if the deed is signed and delivered by a court appointed guardian or conservator.

Ratification of a Minor's Contract.

A contract made by a minor may become ratified and binding if the minor does not rescind the contract prior to becoming eighteen years of age. Ratification may be shown by express words, or it may be inferred from conduct. For example, a minor who signs a contract to sell real estate would be bound by its terms upon reaching majority unless the minor rescinded the contract prior to becoming eighteen.

LEGAL (LAWFUL) OBJECTIVE

A contract requiring the performance of an illegal act is void. For example, a buyer, wanting to use a seller's property as a place for an illegal gambling operation, as an inducement to the seller, offers the seller a percentage of the profits. Such a contract would be void and unenforceable.

REALITY OF CONSENT

In order to be valid and enforceable, a contract must be entered into voluntarily by parties acting without disability, and with full knowledge of all the vital facts.

LEGAL STATUS OF CONTRACTS

The ability to enforce a contract or to justify non-performance of a contract depends upon the legal status of the contract.

Contracts may be:

valid,
void,
voidable or
unenforceable.

VALID CONTRACT.

A valid contract contains all the essential elements, and is legally enforceable by either party.

VOID CONTRACT.

Void contracts have no legally binding effect and are unenforceable by either party. A contract to perform an illegal act is void. In some states certain contracts are void if entered into on a Sunday or a legal holiday. In Massachusetts, purchase and sale agreements and leases for residential property are valid whenever they are signed. It is also legal to list and show residential property on a Sunday.

VOIDABLE CONTRACT.

Voidable contracts appear to be valid and enforceable on their face, but are subject to rescission by one the parties if such party is acting under a disability. A minor's contract is voidable by the minor.

UNENFORCEABLE CONTRACT.

Unenforceable contracts may be completed by the parties, but neither may legally enforce performance. An oral contract to sell real estate, although unenforceable, would not invalidate the transfer of title from seller to buyer. Note: Contract by telephone (verbal) is "unenforceable".

VOIDABLE CONTRACTS - GROUNDS FOR RESCISSION

If one of the parties to a contract is acting under a disability because of misrepresentation, fraud, duress, undue influence or lack of competency (no reality of consent), such may refuse to perform or may rescind the contract.

MISREPRESENTATION.

A misrepresentation is a false statement or concealment of a material fact made with the intention that it be acted upon, and is relied upon by a party who is injured as a result. A misrepresentation could render a contract voidable by the injured party or give rise to a suit for damages. For example, when questioned by a prospective buyer, the seller states that the house does not have termites. After taking title, the buyer discovers that the house is termite infested. The buyer may hold the seller liable for the cost of extermination and repairs. If the defect is discovered prior to the closing the buyer may rescind the contract.

The mere expression of an opinion is not a misrepresentation. For example, a broker's statement to a prospect that "The value of this house will double in two years," is an opinion and not a misrepresentation.

Because of their opposing interests, buyers and sellers are said to be dealing at "arm's length." Each is expected to act prudently for the protection of his or her own interest, provided the means of obtaining information is equally open to both. However, if one party has knowledge of a material fact, which is not easily obtainable by the other, a failure to disclose such fact is a misrepresentation. Thus, the seller's failure to disclose the presence of termites would be a misrepresentation, even if the buyer never raised the question. On the other hand, if such a material fact is obvious or may be easily determined there is no misrepresentation. For example, if a prospective buyer observes water in the basement, it would be imprudent to rely solely upon the seller's statement that the basement is dry.

FRAUD.

Fraud is a misrepresentation intended to deceive or trick another or is made with reckless abandon, knowing that a person will act upon it to his or her detriment. A seller who gives a buyer a false structural report to cover a hidden defect is guilty of committing a fraud.

UNDUE INFLUENCE.

Undue influence is the exercise of persuasion over another so as to prevent the person from acting intelligently, understandably, and voluntarily. Coercing an owner into selling property at below market value because of fear of a racial change in the neighborhood (i.e. blockbusting) is an example of undue influence and would render the contract voidable.

DURESS.

The threat of personal injury or restraint in order to force a person into signing a contract is duress and will result in a voidable contract.

REALITY Of CONSENT.

Law considers minors and mental incompetents, to lack the ability to consent to the terms of most contracts, except contracts for necessaries of life, such as food and clothing. A person acting under a mistake as to the terms of a contract is also considered as lacking reality of consent.

STATUS OF CONTRACTS

Contracts may be entered into and performance completed all at once, or contracts may require an act to be performed at a future date.

In this regard, the status of a contract may be either :

executory or
executed.

EXECUTORY CONTRACTS.

An executory contract is one that has not yet been completely performed, such as a contract for the sale of real estate prior to the closing.

EXECUTED CONTRACTS.

An executed contract is one that has already been performed. The delivery and acceptance of a deed becomes an executed contract, since performance is completed and fulfilled at that moment.

TYPES OF CONTRACTS

Although most contracts require an act to be performed by both parties, there are contracts, which require performance by only one. Contracts may be either: (1) bilateral or (2) unilateral.

BILATERAL CONTRACT.

A bilateral contract is one in which both parties are equally bound, such as a real estate purchase and sale agreement. Both are bound by their mutually exchanged promises to perform in accordance with the agreement. A lease is a bilateral contract.

UNILATERAL CONTRACT.

A unilateral contract is one in which only one party must perform to be binding. Listing agreements, exclusive listings, and options are examples of unilateral contracts. A listing agreement is a unilateral contract since the broker is not obligated to find a buyer, but the seller is liable for the commission if the broker performs.

IMPLIED CONTRACTS

In an implied contract, the actions of the parties, not a specific agreement, make one or more liable. For example, in a listing contract, it is implied by law that the broker is to be paid a reasonable commission even though a commission may not be specifically mentioned in the hiring. By contrast, an expressed contract is one in which all of the terms are set forth in the agreement so as to exclude the possibility of anything being implied.

DEFENSES FOR NON-PERFORMANCE OF A CONTRACT

The ability to legally enforce a contract depends upon whether the contract meets all of the legal requirements. The following legal defenses, in addition to the ones mentioned previously, may be raised by a defaulting party who is being sued for non-performance of a contract:

DESTRUCTION OF THE PROPERTY.

Generally, a substantial destruction of the improvements without the fault of either party results in a voidable contract. In Massachusetts, destruction of the property does not result in a voidable contract, but the seller is held liable to the buyer for the loss. Thus, if a sales contract is signed and the house burns down prior to the closing, the buyer is bound to accept a deed, but the purchase price would be reduced by the amount of the loss. For this reason, the purchase agreement should contain a clause requiring the seller to keep the buildings insured in an agreed amount. In the event of a loss, the insurance proceeds are paid to the buyer.

DEATH.

Unless the contract depends upon one's own personal services, death or disability does not excuse performance. A purchase and sale agreement signed by an owner who dies before title passes is enforceable. The representative of the seller's estate is required to complete the contract by executing and delivering a deed. However, if a seller signs a deed but dies before delivery, the deed is void. An executor's or administrator's deed would be required to complete the sale, provided the owner had signed a valid purchase and sale agreement prior to his or her death.

STATUTE OF FRAUDS.

By law (Statute for Prevention of Frauds), an oral contract to sell real estate is unenforceable. The contract may be valid (i.e. one containing all the essential elements), but not legally enforceable. However, if an oral contract is fully performed, neither party may assert the Statute of Frauds as a basis for rescission. An exception is allowed in cases where the other unjustly enriches one party as a result of full or partial performance. For example, a seller orally agrees to sell property to a buyer who makes a large down payment and is allowed to take possession before delivery of the deed. The buyer' occupies the premises for several months during which time the buyer makes substantial improvements with the owner's consent. The seller cannot assert the Statute of Frauds as a defense for refusing to deliver a deed and for not accepting the balance of the purchase price. Note: The Statute of Frauds indicates that contracts must be in writing to be enforceable.

STATUTE OF LIMITATIONS - LACHES.

The statute of limitation determines the legal time limit for bringing a court action for breach of contract. The delay or negligence in asserting one's rights within the statutory period is a defense for non-performance of a contract known as laches.

REMEDIES FOR BREACH OF CONTRACT (DEFAULT)

A default occurs when either one of the parties to a contract fails to perform as per the terms of the contract. When a default or breach occurs, the non-defaulting party has certain rights or remedies.

Buyer's Remedies When Seller Defaults:

Rescind the contract. Recover the earnest money deposit.
Sue for specific performance. Specific performance is a court order compelling the seller to complete a contract and deliver a deed.
Sue for damages.

Seller's Remedies When Buyer Defaults:

Rescind the contract and return the deposit.
Sue for specific performance. This is not a satisfactory remedy if the buyer doesn't have the cash or financing.
Declare forfeiture. Retain the deposit as liquidated damages.
Sue for damages.

ESSENTIALS TERMS FOR A REAL ESTATE PURCHASE AND SALE AGREEMENT

A contract to sell real estate, more commonly known as a "purchase and sale agreement" or an "offer to purchase," is a formal, written agreement which sets forth the essential terms and conditions of the sale . In addition to satisfying the statute of frauds, to be legally enforceable, the contract must contain the following essential terms:

Date signed. A closing date is not an essential term, since a court could imply that the parties intended a reasonable time for performance.
Description of the Buyer and Seller.
Description of the Real Estate.
Consideration. Consideration is the agreed purchase price, not the deposit.

The form and length of the contract is unimportant as long as it is in writing, is signed by the party to be charged (i.e. the person being sued), and the contract contains the essential terms. Any form of writing, such as a binder or memorandum, will be sufficient to satisfy the statute of frauds. For example, a check for a deposit made out to a buyer was held to be a valid contract because of the buyer's endorsement which read, "Deposit on house and land on the corner of School Street and Salem Street, South Groveland, Mass., price $90,000. Signed Henry H. Mustonem."

STANDARD PRINTED CLAUSES IN PURCHASE AND SALE AGREEMENTS.

Most real estate brokers use standard forms published by professional organizations or sold in legal stationary stores. In addition to meeting the requirements of the Statute of Frauds, for the protection of all parties the form should contain the following standard clauses:

List of items to be included with or excluded from the sale.
Earnest money deposit, and terms and form of payment.
Escrow agreement for holding earnest money until closing.
Assurance of clear title, and seller's right to perfect title.
Provision for the event of loss or destruction of the property.
Provision for proration and adjustment of taxes, rents, water, etc.
Form of title and deed to be delivered.
Mortgage conditions or contingencies.
Date of possession and closing date, time and location.
Broker's commission agreement.
Default provisions. Liquidated damages clause.
Seller's requirement to deliver a 6-D certificate and a copy of the association insurance policy for condominium sales
Seller's requirement to deliver a smoke detector approval by the fire department.
Buyer's right of inspection for structural defects, termites and hazardous material.

NUMBERS OF COPIES.

At least four copies of the agreement should be executed and signed by all parties. Massachusetts requires brokers to give copies of the purchase agreement to each person who has signed.

CHANGES IN THE TERMS.

Changes or additions to the contract must appear on all copies and must be dated and initialed by all parties. If major changes are to be made, it is usually best to destroy the original contract and execute a new one.

EARNEST Money Deposit.

It is customary in most real estate transactions for the buyer to give a deposit with the agreement as a show of good faith. Although the deposit is not essential to the validity of the contract, it serves to assure the seller that the buyer will not default. Since it is virtually impossible to enforce a real estate contract against an unwilling buyer, forfeiture of the deposit is usually provided as liquidated damages in case of default.

ESCROW ACCOUNT.

Brokers are required to maintain a separate bank account for the deposit of moneys held in escrow. It may be an interest bearing account, but the interest must be accounted for at the closing. The purchase agreement usually stipulates the interest to be divided equally between the buyer and seller unless there is a default, in which case the interest will be paid to the party entitled to the deposit.

OTHER FORMS OF CONTRACTS

OFFER TO BUY.

As previously discussed, two of the essentials of a valid contract are an offer and an acceptance (i.e. meeting of the minds). This is accomplished when both parties agree to the terms and sign a written contract.

An offer to buy may be made in the form of a sales contract. It must be in writing and contain the essential terms and be signed by the offeror. It is usually accompanied by a deposit and should contain a fixed time limit (i.e. two or three days) for acceptance. The offer is not capable of being accepted unless communicated or delivered to the offeree.

An offer becomes a binding contract when acceptance has been communicated to the offeror. At any time prior to acceptance, the offer may be withdrawn by the offeror. The contract is completed when the offeror receives a copy of the offer bearing the seller's signature. Acceptance of a mailed offer becomes a binding contract when deposited in the mail.

Counteroffer.

Any changes to the buyer's offer made by the seller is a counteroffer and results in a rejection of the original offer. This precludes the seller from later accepting the original offer as presented if the buyer should reject the seller's counteroffer.

Termination Of Offer.

An offer may be terminated before acceptance in any one of the following ways:

Withdrawal or revocation by the offeror prior to its acceptance.
Rejection of the offer or by a counteroffer.
Death of the offeror or offeree.
Lapse of time.
Destruction or disposal of the improvements.

Note: Death of the seller terminates a listing contract.

BINDER.

A binder is an agreement to accompany an earnest money deposit for the purchase of real estate as evidence of good faith on the part of the buyer. It may be in the form of a memorandum, deposit receipt or endorsement on a check. Usually, the binder requires a full purchase agreement to be signed within a certain time period. A binder is a valid and enforceable contract, which cannot be withdrawn after signing.

OPTION.

An option is a right or privilege given for consideration, to demand within a specified time period, the carrying out of a transaction upon stipulated terms. Options are often used in land sales where a developer wants to bind the seller (optionor) to a contract but needs time to check out subdivision requirements. For giving the option, the seller receives a substantial deposit, which is forfeited if the optionee (buyer) does not exercise the option within the time stipulated. An option is a unilateral contract since only one party (optionor is required to perform. Note: An "option" is a unilateral contract, which becomes bilateral when exercised. A valid option needs to be signed only by the optionor.

INSTALLMENT CONTRACT, LAND SALES CONTRACT, CONTRACT FOR A DEED, CONDITIONAL SALE CONTRACT.

These are all financing agreements in a sale of real estate whereby the seller retains the legal title as security for the buyer's promise to pay at a future date. The purchase price may be paid in installments of principal and interest over the period of the contract, with the balance due at maturity. The contract is usually recorded to protect the buyer's interest. Note: Under an "installment contract", title passes to buyer when the obligation is paid in full. Until delivery of the deed, the buyer has equitable title.

MISCELLANEOUS TERMINOLOGY

ASSIGNMENT OF A CONTRACT.

Generally, contracts that do not require an act of a personal nature may be assigned. The assignee becomes primarily liable and the assignor retains secondary liability for the assignee's default. The assignor may be released from liability agreement of all parties to the contract.

RESCISSION.

Rescission is a legal remedy to cancel or annul a contract.

WAIVER.

A waiver is the surrender of a right without affecting the entire contract. For example, an offeror may waive the time limit and allow the offer to be accepted after it has expired.

PAROLE EVIDENCE RULE.

When the parties to an agreement put the terms into a written and signed contract, the Parole Evidence Rule bars the admission of evidence into court of any prior oral or written agreements that contradict the terms of the final written contract. Thus, if a seller orally agrees to include a refrigerator with the sale of the house, but fails to mention it in the written sales contract, the buyer cannot enforce the oral agreement.

"TIME IS OF THE ESSENCE."

The use of these words in a contract indicates that punctual performance is an essential requirement of the contract. For example, a seller sues a buyer for breach of contract because the buyer was unable to close until one day after the agreed date. Without the words "time is of the essence" in the contract, a court might not consider buyer's conduct a default, especially if the seller suffered no harm as a result.

NOVATION.

Novation is the substitution of one party in a contract for another. The departing party is released from the obligation to complete the contract . For example, in a mortgage takeover, a lender may release the original borrower and substitute the new owner as the party primarily liable for the debt.