With all the talk of Santa Claus in my house, I could not resist writing about contingency “clauses” in real estate contracts. I know what you are thinking: What do contingency clauses have to do with Santa Claus? Well, nothing other than a contingency clause is the perfect gift for anyone purchasing real property.
Whether buying commercial or residential property, you should consider including contingency clauses in your agreement. A properly drafted contingency clause allows a buyer to cancel a real estate contract without any financial repercussions. Such clauses are critical if you are interested in purchasing property but are unsure about securing favorable financing or the necessary government approvals for your business.
Some of the more common contingency clauses include financing, appraisal, survey, environmental and title contingencies. Of course, there are others, but in general those are the ones I would expect to see in most contracts.
Typically, real estate contracts include some type of financing contingency. A buyer should negotiate a financing contingency clause that includes not only a specific interest rate, but also the term and type of loan. Failure to do so puts a buyer at risk that he will be forced to close on a property merely because the buyer could obtain some type of financing, regardless of whether or not the financing is favorable to the buyer.
Appraisal contingencies provide that a property’s appraised value will equal or exceed the property’s purchase price. If the appraisal is less than the purchase price, then normally there is language that allows for a reduction in the purchase price or gives the buyer the right to terminate the contract and retain its earnest money deposit. Appraisal contingencies are especially important in any deal where the buyer is not borrowing money. In an all cash transaction, the buyer cannot rely on a financing contingency to terminate the contract. An appraisal contingency provides an additional exit strategy if the buyer wishes to terminate the contract.
Real estate contracts should normally contain a contingency for the owner’s failure to provide clear title. Typically, we will see language providing the buyer’s right to review a title report to determine if there are any outstanding issues affecting the property. Should the buyer find easements, covenants or other encumbrances affecting title to the property, then the buyer may object to those title issues and terminate the contract. Some title contingency clauses provide that the owner must either cure the title defects prior to closing or allow the buyer to terminate the contract without penalty. Either way, title contingencies are necessary in any real estate contract.
Environmental and survey contingencies
These contingencies are not as prevalent in residential contracts but are very common in commercial transactions. Generally, there is a period of time (due diligence period) during which the buyer has access to the property and may conduct a survey and an environmental inspection. Should the buyer discover survey issues or environmental problems during the due diligence period, then it can terminate the contract without penalty.
One of the more common issues facing commercial real estate buyers is whether or not the zoning is appropriate for the intended use. In many instances, a buyer will locate property that seems to be perfect only to discover it is not properly zoned. One solution to this problem is to negotiate a contingency clause allowing the buyer to seek rezoning of the property and make the closing contingent upon zoning approval. These types of contingencies can tie up the property for an extended period of time and a seller should carefully review the potential effect of including such a contingency in its contract. Despite this fact, many sellers are willing to allow permitting/zoning contingencies in contacts (often for an additional extension fee) and this option should be considered before walking away from a property requiring rezoning.
Of course, there are numerous other contingency clauses you could place in your real estate contract. The key is to carefully examine your needs and negotiate those contingencies. Remember that contingencies are not favored by sellers. Your offer on that great piece of real estate may be rejected simply because there are too many contingency clauses in your offer. Properly drafted contingency clauses can enable a buyer to close on a piece of property by eliminating some of the risk associated with a property’s unknown elements.
Chad W. Lamer is an attorney and urban planner with the law firm of Spink Butler LLP in Boise. He works primarily in the areas of land use and zoning, real estate development, and construction law. He is a frequent contributor to the Idaho Land Law blog, where he touches on all topics related to the development process. Follow him on Twitter @ChadLamer.